Rev. Rul. 69-461

Advice has been requested whether the transaction described below satisfies the active trade or business requirements of section 355(b)(2)(D) of the Internal Revenue Code of 1954.

X corporation has operated a business since 1960 and has owned all the stock of Y corporation which has conducted an active trade or business since its incorporation in 1961. In 1963 Y purchased for cash 100 percent of the outstanding stock of Z corporation, which conducts an active trade or business. In 1966 Y distributed all of the stock of Z to its shareholder, X. In 1969 X distributed the Z stock to its shareholders in a distribution that was intended to qualify under section 355 of the Code.

Section 355 of the Code provides rules for the distribution, without recognition of gain or loss to the shareholders, of stock of a corporation controlled by the distributing corporation. For such treatment section 355(b) of the Code requires that both the distributing corporation and the controlled corporation must be engaged in the active conduct of a trade or business.

Section 355(b)(2)(D) of the Code provides that a corporation will be treated as engaged in the active conduct of a trade or business if and only if control of the corporation which (at the time of acquisition of control) was conducting such trade or business, was not acquired directly by another corporation within the five-year period described in subparagraph (B), or was so acquired by another corporation within such period, but such control was so acquired only by reason of transactions in which gain or loss was not recognized in whole or in part, or only by reason of such transactions combined with acquisitions before the beginning of such period.

In order to prevent a distributing corporation from accumulating excess funds to purchase the stock of an active business and immediately distributing the stock of such corporation to its shareholders, section 355(b)(2)(D)(ii) of the Code provides that the distributing corporation cannot have acquired the stock of the controlled corporation during the five-year period. However, where control was acquired by the distributing corporation in a transaction in which gain or loss was not recognized, the distributing corporation is permitted to include in its holding period the time that the controlled corporation was held by another party. Conversely, where control is acquired in a transaction in which gain or loss is recognized, the distributing corporation cannot distribute to its shareholders the stock of the controlled corporation within the five-year period and qualify the transaction under section 355 of the Code.

Distributions of stock from one corporation to another corporation, where the distributee is in control of the distributor is not the type of transaction to which section 355(b)(2)(D) of the Code was intended to apply. Section 355(b)(2)(D) of the Code was intended to prevent the acquisition of stock of a corporation conducting an active trade or business in a taxable transaction from a party not within the direct or indirect control of the distributing corporation.

Where the distributing corporation acquires the stock of the controlled corporation as the result of a distribution from a subsidiary that merely has the effect of converting indirect control into direct control, the abuse that section 355(b)(2)(D) of the Code was designed to prevent is not present. This section of the Code applies to a transaction in which stock is acquired from a corporation outside a direct chain of ownership.

Under the views expressed above, the distribution of Z stock by Y to X is a transaction that should be disregarded for purposes of determining whether X acquired the stock of Z within the five-year period in a taxable transaction.

Accordingly, since the Z stock was acquired by Y at least five years prior to the time that X distributed such stock to its shareholders the requirement of section 355(b)(2)(D) of the Code is satisfied and provided all the other requirements of section 355 of the Code are met, the distribution by X in 1969 qualifies as a distribution under section 355(a)(1) of the Code.