Rev. Rul. 72-530

Advice has been requested regarding the application of the "business purpose requirement" prescribed by section 1.355-2(c) of the Income Tax Regulations to a distribution of stock of a controlled corporation that otherwise qualifies under section 355 of the Internal Revenue Code of 1954.

X corporation and Y corporation had been engaged in the active conduct of a warehousing business and a transportation business, respectively, for the last five years. X had owned all the outstanding capital stock of Y since Y was organized. The value of X's net assets was evenly divided between the Y stock and the warehousing business. Z was an unrelated corporation engaged in the warehousing business. Z's business was equal in value to X's warehousing business. X would be substantially strengthened in its competitive position with other warehousing businesses by the acquisition of the assets of Z. It was not practical to transfer the X and Z warehousing businesses to a new corporation because the new corporation would have to apply for a new state warehousing license and comply with conditions applicable to new but not existing warehousing businesses. This would have constituted a severe encumbrance to the new corporation. X, Z and the Z shareholders entered into negotiations with respect to the merger of Z into X with the Z shareholders receiving solely X stock. The terms of the merger agreement were acceptable in all respects to the parties involved except that the shareholders of Z were unwilling to accept an amount of stock in X representing only a one-third equity interest. Negotiations were stalemated solely because of this objection by the Z shareholders.

In order to permit the Z shareholders to have a one-half equity interest in X after the merger, X distributed all the outstanding Y stock pro rata to the X shareholders. Z then merged into X and the shareholders of Z received a one-half equity interest in X as a result of the merger.

Section 1.355-2(c) of the regulations states that a distribution by a corporation of stock or securities of a controlled corporation to its shareholders with respect to its own stock will not qualify under section 355 of the Code where carried out for purposes not germane to the business of the corporations. This provision is intended to limit the application of section 355 of the Code to a readjustment of corporate structures as is required by business exigencies.

The improvement of X's position with its competitors in the warehouse business is germane to its corporate business and the acquisition of Z will accomplish this purpose. Although a new corporation might have been organized to acquire the warehousing business of X and Z, the new corporation could not have engaged in the warehousing business without subjection to the severe state licensing requirements. Therefore, in order to acquire Z and strengthen its competitive position in the warehousing business, it was necessary for X to dispose of its transportation assets in order to give the Z shareholders a one-half equity interest in the warehousing business. A distribution by X to its shareholders of the Y stock was the only practical means for Z to merge into X and for the Z shareholders to be able to acquire a one-half equity interest in X.

Accordingly, the distribution to the X shareholders of the Y stock met the "business purpose requirement" of section 1.355-2(c) of the regulations and since all the other requirements under section 355 of the Code and the regulations thereunder have been met, the distribution qualifies under section 355 of the Code.