NEW ACTIVE TRADE OR BUSINESS TEST'S EFFECT ON CORPORATE STOCK DISTRIBUTIONS IS DESCRIBED.

Rev. Rul. 89-37

PURPOSE

This revenue ruling obsoletes Rev. Rul. 74-5, 1974-1 C.B. 82, in light of the amendment of section 355(b)(2)(D) of the Internal Revenue Code by section 10223(b) of the Revenue Act of 1987, Pub. L. No. 100-203, 101 Stat. 1330 (1987) ("Act") and section 2004(k)(1) of the Technical and Miscellaneous Revenue Act of 1988, Pub. L. No. 100- 647, 102 Stat. 3342 (1988)("TMRA").

LAW AND ANALYSIS

Rev. Rul. 74-5 involved a distribution of the stock of a controlled corporation, Y, by a distributing corporation, X, to X's parent corporation, P, 2 years after P acquired the stock of X for cash in a transaction in which gain or loss was recognized ("first distribution"). At the time of the first distribution, X had owned the stock of Y for more than 5 years. P subsequently distributed the stock of Y to its shareholders at a time when it had not owned the stock of Y directly or indirectly through X for a 5-year period prior to the distribution ("second distribution"). Rev. Rul. 74-5 considered whether the requirements of section 355(b)(2)(D) of the Code were met with regard to each of the distributions, since P acquired control of X directly and Y indirectly in a transaction in which gain or loss was recognized within the 5-year period to each of the distributions.

Section 355(b)(2)(D) of the Code, prior to its amendment by the Act and TMRA, provided that control of a corporation that, 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 5-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. Rev. Rul. 74-5 reasoned that the purpose of section 355(b)(2)(D) was to prevent a distributing corporation from accumulating excess funds to purchase the stock of a corporation having an active business and then immediately distributing such stock to its shareholders. Rev. Rul. 74-5 concluded that the first distribution was not the type of transaction to which section 355(b)(2)(D) of the Code was directed because P was merely the shareholder receiving the distribution and not the distributing corporation or the controlled corporation and, therefore, the ruling held that section 355(b)(2)(D) was inapplicable to the first distribution. Rev. Rul. 74-5 further held that the second distribution did not meet the requirements of section 355(b)(2)(D) because the distributing corporation, P, indirectly acquired control of the controlled corporation, Y, through another corporation, X, in a transaction in which gain or loss was recognized within the 5-year period prior to the distribution.

Section 10223(b) of the Act and section 2004(k)(l) of TMRA amended section 355(b)(2)(D) of the Code to provide that a corporation is engaged in the active conduct of a trade or business only if control of a corporation which (at the time of acquisition of control) was conducting such trade or business (i) was not acquired by any distributee corporation directly (or through one or more corporations, whether through the distributing corporation or otherwise) within the 5-year period ending on the date of the distribution, and was not acquired by the distributing corporation directly (or through one or more corporations) within such period, or (ii) was so acquired by any such corporation within such period, but, in each case in which such control was so acquired, it was so acquired only by reason of transactions in which gain or loss was not recognized in whole or in part, or only by reason of such transactions combined with acquisitions before the beginning of such period.

Under section 355(b)(2)(D) of the Code, as amended by section 10223(b) of the Act and section 2004(k)(l) of TMRA, the first distribution described in Rev. Rul. 74-5 is now a transaction described in section 355(b)(2)(D). Therefore, because Y was acquired by a distributee corporation within the meaning of section 355(b)(2)(D) in a transaction in which gain or loss was recognized within the 5-year period prior to the distribution, the first distribution fails to meet the active trade or business requirement of section 355(b)(2)(D).

The holding as to the second distribution in Rev. Rul. 74-5 has not been affected by the Act or by TMRA.

EFFECT ON OTHER REVENUE RULINGS

Rev. Rul. 74-5 is obsoleted.

PROSPECTIVE APPLICATION

This revenue ruling is effective for distributions of stock which are subject to the amendments made by section 10223(b) of the Act and section 2004(k)(1) of TMRA. Under section 10223(d)(2)(A) of the Act and section 2004(k) of TMRA, the transition rules provide that the amendments do not apply to any distribution after December 15, 1987, and before January 1, 1993, if (l) 80 percent or more of the stock of the distributing corporation was acquired by the distributee before December 15, 1987, or (2) 80 percent or more of the stock of the distributing corporation was acquired by the distributee before January 1, 1989, pursuant to a binding written contract or tender offer in effect on December 15, 1987. For purposes of these transition rules, stock described in section 1504(a)(4) of the Code is not taken into account.

DRAFTING INFORMATION

The principal author of this revenue ruling is Jean Marie Whelan of the Corporation Tax Division. For further information regarding this revenue ruling contact Peter J. Bautz on (202) 566-3341 (not a toll-free call).