Rev. Rul. 55-373

Advice has been requested with respect to the tax consequences for Federal income tax purposes of a partial liquidation of a corporation under the following circumstances.

A corporation was organized as an appliance distributor, principally under a franchise from a certain manufacturing corporation. The president of the distributor corporation and his family owned 60 percent and 40 percent, respectively, of such corporation's stock. The president died, and under the terms of his will, his widow and children are to receive, directly or in trust, substantially all of his estate.

After the death of the president the distributor corporation was served notice by the manufacturing corporation that under its policy the franchise for distributing its products would be canceled due to such death. This franchise had been the reason for the organization of the distributor corporation and the sales of the franchised products had constituted approximately 85 percent of its business. After the loss of its key franchise the corporation continued to operate a distributorship for other products for a trial period but its business was unprofitable. Accordingly, it was determined that the corporation would cease all of its prior operations and become a holding corporation for its real estate. All of its inventory, other than real estate, was disposed of in a series of bulk sales. The manufacturing corporation purchased all the inventories that were related to its line of products and the remainder of the inventories were sold in bulk to other purchasers. As a result of the foregoing measures the corporation was in an extremely liquid position.

After the appliance distributorship had been abandoned and the corporation became only a holding corporation for real estate, its capital and surplus were far in excess of the needs of the corporation. Accordingly, the stock held by the estate of the late president was purchased by the corporation at a price determined from the net worth of the corporation. The total redemption price was in excess of the net proceeds derived by the corporation from the bulk sales of its inventories.

Section 115 of the Internal Revenue Code of 1939 provides in part:

(a) DEFINITION OF DIVIDEND.-The term `dividend' when used in this chapter * * * means any distribution made by a corporation to its shareholders, whether in money or in other property, (1) out of its earnings or profits accumulated after February 28, 1913, * * *.

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(c) DISTRIBUTIONS IN LIQUIDATION.-Amounts distributed in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock, and amounts distributed in partial liquidation of a corporation shall be treated as in part or full payment in exchange for the stock. The gain or loss to the distributee resulting from such exchange shall be determined under section 111, * * *.

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(g) REDEMPTION OF STOCK.-

(1) IN GENERAL.-If a corporation cancels or redeems its stock * * * at such time and in such manner as to make the distribution and cancellation or redemption in whole or in part essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation of the stock, to the extent that it represents a distribution of earnings or profits accumulated after February 28, 1913, shall be treated as a taxable dividend.

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(i) DEFINITION OF PARTIAL LIQUIDATION.-As used in this section the term `amount distributed in partial liquidation' means a distribution by a corporation in complete cancellation or redemption of a part of its stock, * * *.'

It is held that to the extent the distribution by the corporation in complete cancellation and redemption of a portion of its capital stock does not exceed that net proceeds by the corporation from the bulk sales of its inventories, such distribution constitutes a distribution in partial liquidation within the meaning of section 115(c) and section 115(i) of the Revenue Code of 1939. To the extent that the amount distributed exceeds the net proceeds, such excess is taxable as a dividend under the provisions of section 115(a) and section 115(g) of the 1939 Code and section 115(g)-1 of Regulations 118. Since the individuals who at the time of the redemption owned 40 percent of the stock of the corporation are also the beneficiaries of the decedent's estate, this case is not controlled by the sentence in section 39.115(g)-1(a)(2) of Regulations 118 relating to the redemption of all of a particular shareholder's stock so that he ceases to be interested in the affairs of the corporation. See Commissioner v. John T. Roberts, et al. , 203 Fed.(2d) 304