Rev. Rul. 56-450

Advice has been requested as to the Federal income tax consequences of a proposed distribution by Y corporation of stock in a controlled corporation.

Y corporation is engaged in the business of commercial printing and has been so engaged for the past five years. Its outstanding stock consists of shares of common stock of which 15 percent is owned by three related individuals. The balance of the stock is owned by unrelated shareholders.

Y owns more than 80 percent of the common stock of Z corporation which is engaged in the business of typesetting and electrotyping and has been so engaged for the past five years. This stock of Z has been owned by Y for more than five years.

One of the three related individuals owning stock of Y is president of Z . He manages the activities of the latter corporation and, in addition, is salesman for Y , but he does not participate in the managenment of Y .

A plan has been formulated which will accomplish the separation of the stock ownership of Y and Z into unrelated groups, to the end that the three related individuals owning 15 percent of the stock of Y will own over 80 percent of the shares of Z . Pursuant to the plan, Y proposes to distribute all the stock of Z held by it in exchange for all shares of its stock held by the three related individuals. Each of the three individuals will receive the same proportion of the shares of Z held by Y as the number of shares of Y held by each bears to the total number of shares of Y held by them together.

The business purpose of the exchange is to divorce Z from ownership and control by Y . The bulk of the trade service of Z is to printers who are competitors of Y . Printers are reluctant to place orders with a firm owned by a direct competitor, because they do not wish to become dependent on the services of a company controlled by their competitor. Moreover, the president of Z , as the owner of a substantial direct interest in Z , will be motivated to devote more time toward increasing the earnings of Z .

Both Y and Z will continue to engage in the conduct of their respective businesses after the exchange and no sales of stock are contemplated.

As to the effect on the shareholder of a corporation which distributes, with respect to its stock (with or without a surrender by the shareholder of stock in the distributing corporation), solely stock of a corporation which it controls immediately before the distribution, section 355 of the Internal Revenue Code of 1954 provides, in part, as follows:

(a) EFFECT ON DISTRIBUTEES.-

(1) GENERAL RULE.-If-

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(D) as part of the distribution, the distributing corporation distributes-

(i) all of the stock and securities in the controlled corporation held by it immediately before the distribution, * * *

* then no gain or loss shall be recognized to (and no amount shall be includible in the income of) such shareholder or security holder on the receipt of such stock or securities.

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(b) REQUIREMENTS AS TO ACTIVE BUSINESS.-

(1) IN GENERAL.-Subsection (a) shall apply only if either-

(A) the distributing corporation, and the controlled corporation * * * is engaged immediately after the distribution in the active conduct of a trade or business, * * *

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(2) DEFINITION.-For purposes of paragraph (1), a corporation shall be treated as engaged in the active conduct of a trade or business if and only if-

(A) it is engaged in the active counduct of a trade or business, or substantially all of its assets consist of stock and securities of a corporation controlled by it (immediately after the distribution) which is so engaged,

(B) such trade or business has been actively conducted throughout the 5-year period ending on the date of the distribution,

(C) such trade or business was not acquired within the period described in subparagraph (B) in a transaction in which gain or loss was recognized in whole or in part, and

(D) control of a corporation which (at the time of acquisition of control) was conducting such trade or business-

(i) was not acquired directly (or through one or more corporations) by another corporation within the period described in subparagraph (B), * * *

`Control' is defined under section 368(c) of the Code as consisting of at least 80 percent of the total combined voting power of all classes of stock entitled to vote and at least 80 percent of the total number of shares of all other classes of stock of the corporation.

In the instant case, Y and Z will each be engaged immediately after the distribution in the active conduct of a trade or business which had been actively conducted by it throughout the five-year period ending on the date of the distribution. Y has been in control of Z throughout the five-year period. There is a valid business purpose for the distribution.

Accordingly, under section 355 of the Code, no gain or loss will be recognized to, and no amount will be includible in the income of, the stockholders of Y as a result of the receipt by them of stock in Z in exchange for their stock in Y . Under section 358 of the Code, the basis in the hands of each former stockholder of Y receiving stock in Z will be the same as the basis of the stock exchanged. As provided in section 312(i) of the Code, proper allocation will be made with respect to the earnings and profits of Y Z .

No opinion is stated whether the proposed transaction may result in gifts or in the payment of compensation to any stockholders of Y in the event that, on the date the exchange is effected, there is a disparity in the value of the stock surrendered and the stock received in exchange.