Rev. Rul. 74-54

Advice has been requested concerning the tax treatment of an indebtedness owed by a parent corporation to a subsidiary corporation under the circumstances described below.

P corporation owned all of the stock of S corporation for a number of years. P and S were both engaged in the manufacturing business. In 1969, P borrowed 2,000x dollars from S to repay a bank loan made by P. A note for this amount was given to S by P. The note provided for repayment in five equal annual installments, with interest, beginning one year from the date of the note. In 1972, after three annual installment payments on the note by P, S adopted a plan of complete liquidation and distributed all of its assets to P, including the note, which was reflected as a receivable on the books of S, in complete cancellation and redemption of all of the S stock. There was no specific forgiveness of the indebtedness represented by the note prior to the liquidation, and the note was cancelled in connection with the liquidation.

The liquidation of S met the requirements of section 332(b) of the Internal Revenue Code of 1954. Section 332(a) provides that no gain or loss shall be recognized on the receipt by a corporation of property distributed in complete liquidation of another corporation as defined in section 332(b).

Section 61(a)(12) of the Code provides that gross income means all income from whatever source derived, including income from discharge of indebtedness. Section 1.61-12(a) of the Income Tax Regulations provides, in part, that the discharge of indebtedness, in whole or in part, may result in the realization of income.

Section 1.301-1(m) of the regulations provides that the cancellation of indebtedness of a shareholder by a corporation shall be treated as a distribution of property.

In Helen Gilmore, 40 B.T.A. 945 (1939), acq. 1940-1 C.B. 2, the issue was whether a principal shareholder of a corporation realized ordinary income from the discharge of indebtedness upon receipt and cancellation of his indebtedness to such corporation pursuant to a distribution in complete liquidation of the corporation. It was found as a fact that no forgiveness of indebtedness occurred, that all the corporation's assets were distributed, and that the indebtedness was treated as an asset by the distributing corporation at the time of the liquidation. The Commissioner contended that there was a constructive forgiveness of the indebtedness because the debt was never paid and was wiped out by the liquidation. The United States Board of Tax Appeals recognized that the effect of the liquidation was similar to a forgiveness of the indebtedness in that the taxpayer was saved the inconvenience of actually paying the amount of the indebtedness and receiving it back in distribution. The Board concluded, however, that since the indebtedness was treated by the corporation as an asset, and since all of its assets were distributed in complete liquidation, there was no forgiveness of the indebtedness, and that the proper treatment of the indebtedness for tax purposes was that it was property distributed in the liquidation which was to be taken into account by the shareholder in determining the amount realized from the liquidation.

It is held that, in the instant case, the note is property for purposes of section 332(a) of the Code and, therefor, no gain or loss is recognized to P on the receipt of its note distributed in complete liquidation of S. Accordingly, P does not realize income under section 61(a)(12) or section 1.301-1(m) of the regulations by reason of the cancellation of the note in connection with the liquidation.