Rev. Rul. 74-5

Advice has been requested whether the transactions described below satisfy the active trade or business requirements of section 355(b) of the Internal Revenue Code of 1954.

All the outstanding stock of P corporation is owned by individual shareholders. In 1969 P acquired for cash all the outstanding stock of X corporation from T corporation, an unrelated party, in a transaction in which gain or loss was recognized to T. The assets of X include all the outstanding stock of Y corporation. X has owned all the Y stock since 1965. In 1971 X distributed all the Y stock to P. In 1972 P distributed all its Y stock to the P shareholders. P, X, and Y have each conducted an active trade or business since 1960.

Section 355 of the code provides for the distribution without recognition of gain or loss to the shareholders of the stock of a corporation controlled by the distributing corporation. For such treatment, section 355(b)(1)(A) requires that both the distributing corporation and the controlled corporation be engaged immediately after the distribution in the active conduct of a trade or business. Section 355(b)(2)(A), in defining an active trade or business, requires that the distributing corporation and the controlled corporation each be engaged in the active conduct of a trade or business, or hold as substantially all of its assets, stock and securities of a corporation controlled by it (immediately after the distribution) which is so engaged. Section 355(b)(2)(B) provides that such trade or business must have been actively conducted throughout the five-year period ending on the date of the distribution. Section 355(b)(2)(C) provides that the trade or business must not have been acquired within the period described in section 355(b)(2)(B) in a transaction in which gain or loss was recognized in whole or in part.

Section 355(b)(2)(D) of the code provides further that control of a corporation, which at the time of acquisition of control was conducting an active trade or business, must not have been acquired directly (or through one or more corporations) by "another corporation" within the five-year period described in section 355(b)(2)(B), or if so acquired by "another corporation" within such period, such control must not have been acquired by reason of transactions in which gain or loss was recognized in whole or in part, or acquired by reason of such transactions combined with acquisitions before the beginning of such period.

The purpose of section 355(b)(2)(D) of the code is to prevent a distributing corporation from accumulating excess funds to purchase the stock of a corporation having an active business and immediately distributing such stock to its shareholders. See H.R. Rep. No. 2543, 83rd Cong., 2d Sess. 37 (1954). Thus where control is acquired by the distributing corporation in a transaction in which gain or loss is recognized, the distributing corporation cannot distribute the stock of the controlled corporation within the five-year period and qualify under section 355.

The requirements of sections 355(b)(2)(A), (B), and (C) of the code are met with regard to both the distribution by X of the Y stock to P and the distribution by P of the Y stock to the P shareholders. The question presented is whether the requirements of section 355(b)(2)(D) have been met with regard to each of the distributions since P acquired control of X directly and Y indirectly within the five-year period prior to the distributions in a transaction in which gain or loss was recognized.

The distribution by X of the Y stock to P satisfies the requirements of section 355(b)(2)(D) of the code even though P ("another corporation") acquired control of X directly and Y indirectly within the five-year period prior to distribution in a transaction in which gain or loss was recognized. The purchase of the X stock by P within the five-year period is not the type of transaction to which section 355(b)(2)(d) is directed since P is merely the shareholder receiving the distributions and not the distributing or controlled corporation. In the distribution of the Y stock to P it is impossible for P to pass accumulated excess funds through another corporation to P shareholders. Thus in this transaction the abuse that section 355(b)(2)(D) was designed to prevent is not present and the section has no application to the acquisition of control of X, and indirectly of Y, by P.

However, the distribution by P of the Y stock to the P shareholders does not satisfy the requirements of section 355(b)(2)(D) of the code since the business of the controlled corporation, Y, was indirectly acquired by the distributing corporation, P, through another corporation, X, during the five-year period ending on the date of the distribution in a transaction in which gain or loss was recognized.