Rev. Rul. 82-130

ISSUE

Is the business purpose requirement of Section 1.355-2(c) of the Income Tax Regulations met by a distribution of stock of a controlled corporation, under the circumstances described?

FACTS

P is a closely held corporation that develops and markets computer software. P has for more than 5 years owned all of the stock of S, a corporation that owns and operates several residential rental properties. The software business is in a period of rapid technological growth, which is expected to lead to a large increase in P's market share. This business is in need of substantial amounts of additional working capital to continue to adequately finance this growth. P has approached its traditional sources of debt financing, but they have declined to loan P the necessary funds. P has approached several securities underwriters to explore equity financing through a public offering of P stock. The underwriters have declined to make P public because of the very high amount of long-term debt existing on P's consolidated balance sheet attributable to the operations of S, and because it would be difficult to attract strong investment interest in P's business when a significant portion of the value of the P stock includes the real estate business of S. The underwriters do not believe that the offering will succeed unless S is completely separated from P. The underwriters have also stated that even if a holding company structure was created in which P and S would both be subsidiaries of a new parent company, a public offering of the stock of the new parent company would be subject to the same problems as the present stock of P. The underwriters have recommended that all of the stock of S be distributed to the shareholders of P. This would permit P to prepare a balance sheet showing a relatively small amount of long-term debt. The underwriters will then market an amount of additional P stock equal in value to 25 percent of all of the P stock outstanding immediately before the public offering. The shareholders of P will not sell any of their P stock in conjunction with the public offering.

In accord with the underwriters' recommendation that P divest itself of its S stock, P intends to distribute the stock of S pro rata to the P shareholders. Except for the question here at issue of business purpose, this distribution will meet all the requirements of section 355 of the Code and the regulations thereunder.

LAW AND ANALYSIS

Section 355 of the Code provides that under certain circumstances a corporation may distribute stock or securities in a corporation it controls to its shareholders or its security holders in a transaction that is nontaxable to such shareholders or security holders. Section 1.355-2(c) of the regulations states that a distribution by a corporation of stock or securities of a controlled corporation to its shareholders with respect to its own stock will not qualify under Section 355 of the Code when carried out for purposes not germane to the business of the corporation. This provision is intended to limit the application of section 355 to those readjustments of corporate structure that are required by business exigencies.

The distribution by P of the S stock is for the purposes germane to the business of P within the meaning of section 1.355-2(c) of the regulations, since it is reasonable to expect that the distribution will enable P to secure needed additional capital.

HOLDING

The distribution of the S stock is supported by a valid business purpose within the meaning of section 1.355-2(c) of the regulations. Since all other requirements of section 355 of the Code and regulations thereunder have been met, the distribution qualifies under section 355.