Rev. Rul. 70-522

Advice has been requested whether the transactions described below constitute tax-free exchanges under section 351(a) of the Internal Revenue Code of 1954. Advice is also requested whether an advance ruling is required under section 367 of the Code.

W, a domestic corporation, produces and sells a product in the United States which it would like to market aboard. X, a foreign corporation owned by nonresident aliens produces and sells a similar type product in its country which it would like to market in the United States. In order to achieve their goals, W and X entered into a joint venture agreement for the organization of domestic corporation Y and foreign corporation Z.

W plans to organize Y and transfer assets worth 5x dollars to Y in exchange solely for all of the Y stock. X, in turn, plans to organize Z and transfer assets worth 5x dollars to Z in exchange solely for all of the Z stock. Thereafter, pursuant to the joint venture agreement, W will exchange 49 percent of its Y stock with X for 49 percent of X's Z stock.

Section 351(a) of the Code provides, in relevant part, that no gain or loss will be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation if immediately after the exchange such person or persons are in control of the corporation.

Section 368(c) of the Code provides that the term "control" means the ownership of stock possessing 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 each other class of stock of the corporation.

Section 367 of the Code provides, in part, as follows:

In determining the extent to which gain shall be recognized in the case of any of the exchanges described in section 332, 351, 354, 355, 356, or 361 a foreign corporation shall not be considered as a corporation unless, before such exchange it has been established to the satisfaction of the Secretary or his delegate that such exchange is not in pursuance of a plan having as one of its principal purposes the avoidance of Federal income taxes.

The joint venture agreement obligates W and X to exchange 49 percent of their respective stock of Y and Z. Therefore, the receipt of 49 percent of all of the Y stock by W will be disregarded for purposes of section 368(c) of the Code since W's holding of such shares will be transitory and without real substance. Likewise, the receipt by X of 49 percent of all of the Z stock will be disregarded.

Accordingly, since W is not a transferor of property as to Z and does not have "control" of Y after transferring property to that corporation and since X is not a transferor of property as to Y and does not have "control" of Z after transferring property to that corporation, there is no tax-free exchange under section 351 of the Code upon the organization of either Y or Z.

Under these circumstances, there will be no transfer of property, within the meaning of section 351 of the Code, by a United States person to a foreign corporation. Thus, an advance ruling under section 367 of the Code is not necessary.

Gain or loss will be recognized to W on the exchange of its property for Y stock measured by the excess of the fair market value of the Y stock received by W over the adjusted basis of the property exchanged therefor. In addition, gain or loss will be recognized to W on the exchange of the Y stock for Z stock measured by the difference, if any, between the fair market value of the Z stock received and the basis of the Y stock exchanged therefor. The basis of the remaining Y stock in the hands of W will be the fair market value of such stock as of the date received by W in exchange for the property transferred to Y. The basis of the Z stock in the hands of W will be the fair market value of the Y stock exchanged therefor.