Rev. Rul. 79-70

ISSUE

Is the control requirement of section 351(a) of the Internal Revenue Code of 1954, which provides for nonrecognition of gain or loss on transfers of property to a controlled corporation, satisfied where part of the stock of the controlled corporation received by a transferor in exchange for property is sold to another person who transferred property to the corporation in exchange for securities?

FACTS

Corporation X transferred property to a newly organized corporation, Newco, in exchange for all of Newco's stock (a single class of voting common stock). Pursuant to a prearranged binding agreement between X and corporation Y, X sold 40 percent of its Newco stock for its fair market value to Y, and Y purchased securities for cash from Newco. Newco would not have been formed if Y had not agreed to purchase securities for cash from Newco and part of the Newco stock from X.

LAW AND ANALYSIS

The specific sections of the Code that are applicable are section 351(a), which provides that no gain or loss will be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation and immediately after the exchange such person or persons are in control of the corporation, and section 368(c) which defines control for purposes of section 351(a), to mean the ownership of stock possessing at least 80 percent of the total combined voting power of all classes of stock entitled to vote.

Since the sale of Newco stock by X to Y was an integral part of the incorporation and pursuant to a binding agreement entered into prior to the exchange, the control requirement of section 351(a) of the Code is determined after the sale. See Hazeltine Corp. v. Commissioner, 89 F.2d 513 (3rd Cir. 1937), Intermountain Lumber Co. v. Commissioner, 65 T.C. 1025 (1975), and Rev. Rul. 70-522, 1970-2 C.B. 81, all of which hold that the control requirement of section 351(a) is not satisfied where, pursuant to a binding agreement entered into prior to the transfer of property to the corporation, a transferor loses control of a corporation by a sale of stock received in the transfer to a third party, who does not transfer property to the corporation in the transaction. After the sale was completed in the instant case, 60 percent of the Newco stock was owned by X and 40 percent of the stock was owned by Y. However, since Y was not a "transferor" of property to Newco with respect to Newco stock, Y's ownreship of the Newco stock purchased from X cannot be counted in determining whether the control requirement of section 351(a) was met. The fact that Y transferred cash to Newco in exchange for securities as part of the transaction does not make Y a transferor for purposes of the control requirement of section 351(a). See Rev. Rul. 73-472, 1973-2 C.B. 114, and Rev. Rul. 73-473, 1973-2 C.B. 115, which hold that a person who receives only securities from a corporation in exchange for property, and who is not a shareholder prior to the exchange, is not a "transferor" for purposes of satisfying the section 351 control requirement.

HOLDING

Since X only owned 60 percent of the Newco stock "immediately after the exchange" within the meaning of section 351(a) of the Code, the 80 percent control requirement of section 351(a) was not satisfied. Gain or loss to X will be determined and recognized under section 1001.