Rev. Rul. 57-212

Advice has been requested as to the status, under section 306 of the Internal Revenue Code of 1954, of amounts paid by a corporation to its shareholders under its sinking fund provisions in redemption of preferred shares previously issued pursuant to a nontaxable reorganization.

Pursuant to a merger agreement, corporation B was merged into corporation C under the nontaxable provisions of sections 368(a)(1)(A), 361(a) and 354(a) of the Code. Both corporations were large publicly owned corporations. Under the terms of the merger agreement, each share of corporation B common stock (the only class of stock outstanding) was converted into one share of first preferred stock, one-half share of second preferred stock, and three shares of common stock of corporation C .

Under its amended certificate of incorporation, as set out in the merger agreement, corporation C is required, so long as any of the shares of first preferred stock are outstanding, to set apart in each year on specified dates cash in amounts equal to three percent of the greatest aggregate par value of shares of first preferred stock outstanding at any time after the effective date of the merger. In lieu of cash, corporation C may set aside at the par value thereof shares of first preferred stock acquired by it, other than through the operation of the sinking fund. Any cash set aside is to be applied to the purchase of shares of preferred stock at a price not exceeding their par value or in redemption of such shares at par value.

Each of the three classes of outstanding shares of corporation C is widely held and is listed and traded extensively on the New York Stock Exchange. Since the first preferred stock has been selling on the New York Stock Exchange at a price in excess of its par value, cash set aside in the sinking fund has not been applied to the purchase of any such shares in the open market, but has been applied to the redemption, by lot, of sufficient first preferred shares to satisfy the sinking fund requirements.

In Revenue Ruling 56-116, C.B. 1956-1, 164, it was held that preferred stock issued (together with common stock) by the surviving corporation in exchange for common stock of the merging corporation in connection with a nontaxable statutory merger was section 306 stock as defined in section 306(c)(1)(B) of the Code. However, in view of the exception provided by section 306(b)(4), since the stocks of the two corporations were widely held by the public, it was held that section 306(a)(1) shall not be applicable to the proceeds of the disposition of the preferred stock issued in the merger, unless such disposition is in anticipation of a redemption after the issuance of the stock. Therefore, the issue presented in the instant case is whether the exception provided by section 306(b)(4), which otherwise would appear to be applicable under the above-cited Revenue Ruling, is rendered inapplicable by the operation of the sinking fund provisions.

In view of the facts presented, the Internal Revenue Service holds that the distribution of the first preferred stock at the time of the merger and the subsequent redemption of portions thereof under the sinking fund provisions are not in pursuance of a plan having as one of its principal purposes the avoidance of Federal income tax within the meaning of section 306(b)(4). Therefore, the provisions of section 306(a)(1) will not be applicable to the proceeds of a sale of such shares (whether or not in anticipation of a redemption through the operation of the sinking fund), and the provisions of section 306(a)(2) will not be applicable to amounts distributed by corporation C in redemption of such first preferred shares to meet the requirements of its sinking fund provisions.