Rev. Rul. 73-427

Advice has been requested concerning the Federal income tax treatment of the transaction described below.

Corporation P wanted to acquire all of the outstanding stock of corporation Y for cash and thereby become the sole shareholder of Y. Pursuant to the plan of acquisition, P was only able to purchase 97.9 percent of the outstanding stock of Y for cash. In order to complete the acquisition, P, as part of the same plan, acquired the remaining 2.1 percent of the outstanding stock of Y in the following manner. P transferred to S, a wholly owned subsidiary formed solely to effectuate the acquisition, 5x dollars (solely to satisfy capital requirements of state law) and 10x shares of P stock in exchange for 10x shares of S stock. Pursuant to the applicable state laws, S was merged with and into Y, with Y acquiring all the assets of S (the 5x dollars and the 10x shares of P stock). Y distributed the 10x shares of P stock received in the merger to the minority shareholders of Y in exchange for their stock, and by operation of state law the S stock held by P was automatically converted into Y stock. Y, as part of the plan, returned the 5x dollars to P.

The result of the entire plan described above was that P acquired all of the stock of Y partly in exchange for cash and partly in exchange for P voting stock, with Y becoming a wholly owned subsidiary of P. This result is not negated because part of the acquisition was cast in the form of a redemption by Y of its stock from the minority shareholders of Y in exchange for the P stock received by Y in the merger of S into Y. Therefore, the transaction will be treated for Federal income tax purposes as though P transferred its stock directly to the minority shareholders of Y in exchange for their Y stock. Furthermore, the transitory existence of S, and therefore the transactions described above involving S, will be disregarded.

Accordingly, it is held as follows:

1. No gain or loss will be recognized to P upon the receipt of the Y stock from the minority shareholders of Y in exchange for P stock under section 1032(a) of the Internal Revenue Code of 1954.

2. No gain or loss is realized by S or Y as a result of the transactions described above.

3. Gain or loss is realized and recognized to the minority shareholders of Y upon the receipt by them from P of P stock in exchange for their Y stock under sections 1001 and 1002 of the Code. Gain or loss is also realized and recognized by those former shareholders of Y who received cash from P in exchange for their Y stock under sections 1001 and 1002.

4. The 5x dollars transferred by P to S to satisfy capital requirements and which was returned to P by Y is disregarded and results in no tax consequences.

The same results would obtain if:

1. P actually received Y stock in exchange for the S stock rather than, as in the instant case, the S stock held by P being converted into Y stock by operation of law;

2. no Stock of P was transferred to S and the Y stock held by the minority shareholders of Y was converted into P stock by operation of law; or

3. the 5x dollars transferred to S to satisfy capital requirements was not returned to P by Y. In such case the 5x dollars is a contribution by P to the capital of Y.

In Rev. Rul. 67-448, 1967-2 C.B. 144, pursuant to a plan of reorganization, a parent corporation, P, issued some of its voting stock to its new subsidiary S which, pursuant to the plan, merged into unrelated corporation Y, with some of the Y shareholders exchanging their Y stock, in an amount constituting control of Y, for the P stock received by Y in the merger of S into Y. Rev. Rul. 67-448 states that the net effect of this series of steps for Federal income tax purposes is a direct acquisition by P of the stock of Y from the Y shareholders in exchange solely for P voting stock, with the transitory existence of S being disregarded, and holds that the transaction is a reorganization within the meaning of section 368(a)(1)(B) of the Code. In the instant case, the net effect of the transaction (that is, a direct acquisition by P of all of the Y stock from the Y shareholders partly in exchange for cash and partly in exchange for P stock) does not qualify as a reorganization described in section 368(a)(1)(B) since such acquisition was not made by P solely for P voting stock as required by section 368(a)(1)(B). Furthermore, the merger of S into Y does not qualify as a reorganization under section 368(a)(1)(A) by reason of section 368(a)(2)(E) since 97.9 percent of the total consideration received by the shareholders of Y consisted of cash, and only 2.1 percent of the total consideration received by the Y shareholders consisted of stock of the acquiring corporation. Consequently, the continuity-of-interest requirement was not satisfied. See section 1.368-1(b) of the Income Tax Regulations.

Rev. Rul. 67-448 distinguished.