Rev. Rul. 68-285

Advice has been requested whether there can be a reorganization under section 368(a)(1)(B) of the Internal Revenue Code of 1954 if the corporation to be acquired established an escrow account from its own funds to pay dissenting shareholders who elect to accept cash for their stock in the acquired corporation according to the provisions of a state banking law, rather than exchange their stock for stock in the acquiring corporation.

Corporation X and corporation Y are banking corporations. X wanted to acquire all of the outstanding stock of Y in exchange for voting stock of X . In order to be assured 100 percent control of Y, X elected, pursuant to a plan, to acquire the Y stock in accordance with the state's banking law.

The state banking law allows dissenting shareholders of the acquired corporation to register their dissent and elect to be paid cash for their shares in the acquired corporation. Under the provisions of the state banking law, any shareholder of the acquired corporation who elects not to participate in the exchange must completely terminate his stock ownership in the acquired corporation. Shareholders of Y owning 25 percent of the outstanding stock of Y elected not to participate in the exchange and they all perfected their election to dissent under the state banking law.

Y established an escrow account and transferred from its funds to this account sufficient cash to pay all of the Y shareholders who desired to perfect their rights under the state banking law. All payments were made from the escrow account and no cash payments were made by X either to Y , the dissenting shareholders to Y , or to the escrow account. The balance remaining in the escrow account after the dissenting shareholders were paid was returned to Y . These payments were made both before and after the exchange of X stock for Y stock.

Section 368(a)(1)(B) of the Code defines as a reorganization the acquisition by one corporation, in exchange solely for all or a part of its voting stock (or in exchange solely for all or part of the voting stock of a corporation that is in control of the acquiring corporation), of stock of another corporation if, immediately after the acquisition, the acquiring corporation has control of such other corporation (whether or not the acquiring corporation had control immediately before the acquisition).

Establishment by Y of an escrow account to pay dissenting shareholders under the circumstances described above will not preclude a reorganization under section 368(a)(1)(B) of the Code. This is true even though Y had not redeemed all the dissenting shareholders' stock prior to the effective date of the exchange. Under the state banking law, each dissenting shareholder of Y ceased to have any shareholder rights except the right to demand payment for the fair market value of his shares. Therefore, immediately after the exchange, X owned all the outstanding Y stock.

Revenue Ruling 55-440, C.B. 1955-2, 226, involved the question of whether preferred shares that had been called for redemption but not yet surrendered at the time of the exchange should be counted as `stock' under section 368(c) of the Code for the purpose of determining whether the 80 percent control requirement of section 368(a)(1)(B) of the Code had been satisfied. Revenue Ruling 55-440 held that the rights of the owners of the preferred stock as stockholders had terminated upon the call of the preferred shares and they thereafter possessed only the right to demand the call price upon the presentation of such shares for redemption. Based on this determination, Revenue Ruling 55-440 concluded that the transaction is a reorganization within the meaning of section 368(a)(1)(B) of the Code, regardless of the number of shares of preferred stock of the acquired company that at the time of the consummation of the stock for stock exchange, had not been presented for redemption.

Similarly, the acquisition of the outstanding stock of Y in exchange for voting stock of X is a reorganization under section 368(a)(1)(B) of the Code even though, in accordance with state banking law, an escrow account was established in order to pay dissenting shareholders for their stock and even though the stock of some dissenting shareholders was not redeemed until after the consummation of the exchange. Thus, no gain or loss will be recognized to the shareholders of Y who exchanged their stock in Y solely for X voting stock, under section 354(a) of the Code.

However, it should be noted that section 368(a)(1)(B) of the Code does not treat as a reorganization any transaction in which the acquiring corporation pays the dissenting shareholders or reimburses the acquired corporation for its payment to the dissenting shareholders.