Rev. Rul. 82-219

ISSUE

Whether a corporation is considered to be engaged in the active conduct of a trade or business within the meaning of section 355(b) of the Internal Revenue Code and section 1.355-1(c) of the Income Tax Regulations, under the following circumstances.

FACTS X is a corporation which for more than 5 years has been engaged in the active conduct of a trade or business within the meaning of section 355(b) of the Code and section 1.355-1(c) of the regulations. X has for more than 5 years owned all of the stock of corporation Y.

Y's assets consist of a plant and equipment related to its business of manufacturing unique pollution control equipment for a single automobile manufacturer, unrelated corporation Z.

Y, which began selling its equipment to Z in 1974, conducts no other business activity. All operational and managerial activities in connection with Y's manufacturing business are performed by employees of Y.

In January 1980, Z unexpectedly went bankrupt, and unilaterally cancelled further orders from Y. Insofar as Y's pollution control equipment had been specifically designed for use in Z's automobiles, no customers for such equipment were found to replace Z until January, 1981, although Y's engineers redesigned Y's product to make it compatible with automobiles of various manufacturers, and Y's employees actively searched for new customers during this period. During the year that no pollution control equipment was sold, Y shut its plant down and, in so doing, substantially reduced its employees, though it continued to employ a sufficient number of individuals to maintain its plant in anticipation of eventual future sales. No income was generated by Y during this year, although expenses were incurred by Y.

In January, 1982, for valid business reasons, X distributed all of the stock of Y pro rata to its shareholders. Except for the question here at issue with respect to active trade or business, the distribution met all of the requirements of section 355 of the Code and the regulations thereunder.

LAW AND ANALYSIS

Section 355(a) of the Code provides that under certain circumstances a corporation may distribute stock or securities in a corporation it controls to its shareholders or security holders in a transaction that is nontaxable to such shareholders or security holders.

Section 355(b) of the Code requires, in part, that both the distributing and controlled corporations be engaged, immediately after the distribution, in the active conduct of a trade or business that has been actively conducted throughout the 5-year period ending on the date of the distribution.

Section 1.355-1(c) of the Income Tax Regulations, in defining "active business," provides, in part, that a trade or business consists of a specific existing group of activities being carried on for the purpose of earning income or profit. Such group of activities ordinarily must include the collection of income and the payment of expenses.

In the present situation, Y has incurred expenses and engaged in substantial managerial and operational activities representative of the active conduct of a trade or business for each of the 5 years preceding the date of the distribution of the Y stock, but it has collected income for only 4 of the preceding 5 years, since no manufacturing receipts were received by it in 1980. The use of the word "ordinarily" in section 1.355-1(c) of the regulations indicates that there are exceptional situations where, based upon all the facts and circumstances, there is no concurrent receipt of income and payment of expenses which, nevertheless, will constitute an active trade or business within the meaning of section 355(b) of the Code. Y's failure to receive manufacturing receipts during 1980 was unforeseen and caused by events outside of its control. Y took all reasonable steps to secure manufacturing receipts by redesigning its limited use product and actively seeking new customers for such product, and shortly thereafter began to again receive manufacturing receipts from its business. These extraordinary facts, when coupled with Y's activities before January, 1980, and after January, 1981, indicate that Y was engaged in the active conduct of a trade or business within the meaning of section 355(b) for the 5-year period preceding the date of the distribution of its stock by X.

HOLDING

Based on all the facts and circumstances, Y was engaged in the active conduct of a trade or business within the meaning of section 355(b) of the Code for the 5-year period preceding the distribution of its stock, notwithstanding the fact that during one of the past 5 years Y did not collect income.