Rev. Rul. 61-156

Advice has been requested whether the transaction described below should be treated, for Federal income tax purposes, as a sale of corporate assets to a newly organized corporation followed by the liquidation of the `selling' corporation under sections 337 and 331 of the Internal Revenue Code of 1954, or whether the transaction should be treated as a reorganization within the meaning of section 368 of the Code.

Within a 12-month period following the adoption of a plan of complete liquidation, a corporation sold substantially all of its assets to a new corporation formed by the management of the selling corporation. The `purchasing' corporation paid 18,000 x dollars for the assets as follows:

(a) 2,025 x dollars in shares of its stock equal to 45 percent of all the shares to be issued,

(b) 4,975 x dollars in long-term notes, and

(c) 11,000 x dollars in cash obtained through a first mortgage borrowing on the assets acquired.

Immediately thereafter, the new corporation sold shares of its stock, equal to 55 percent of all the shares to be issued, to the public through underwriters.

The `selling' corporation was then completely liquidated, paying off its funded and unfunded liabilities and distributing the balance of its assets, including the 45 percent stock interest in the purchasing corporation, the long-term notes, and cash to its shareholders. As a result of the transaction, the business enterprise continued without interruption in the corporate form with a substantial continuing stock interest on the part of those persons who were shareholders in the selling corporation.

Section 1.331-1(c) of the Income Tax Regulations provides as follows:

A liquidation which is followed by a transfer to another corporation of all or part of the assets of the liquidating corporation or which is preceded by such a transfer may, however, have the effect of the distribution of a dividend or of a transaction in which no loss is recognized and gain is recognized only to the extent of `other property.' See sections 301 and 356.

In this case, if the issuance of stock to the new investors is disregarded, there is clearly a mere recapitalization and reincorporation coupled with a withdrawal of funds. The withdrawal would be treated either under section 356(a) of the Code as `money or other property' received in connection with a reorganization exchange of stock for stock, or under section 301 of the Code as an unrelated distribution to the shareholders.

The issuance of stock to new investors can be disregarded as being a separate transaction, since even without it the dominant purpose-to withdraw corporate earnings while continuing the equity interest in substantial part in a business enterprise conducted in corporate form-was fully achieved. The issuance of stock of new investors was not needed to implement the dominant purpose and, therefore, the rest of the transaction was not fruitless without it and so dependent on it.

The transaction was shaped so as to make it essentially `a device whereby it has been attempted to withdraw corporate earnings at capital gains rates by distributing all the assets of a corporation in complete liquidation and promptly reincorporating' them. See Conference Report No. 2543, 83d Cong., to accompany H.R. 8300 (Internal Revenue Code of 1954), page 41.

It was not intended by Congress that such a device should obtain the benefits of section 337 and avoid dividend taxation. In substance there was no reality to the `sale' of corporate assets or to the `liquidation' of the selling corporation, since each was only a formal step in a reorganization of the existing corporation. The entire transaction was consummated pursuant to a plan of reorganization which readjusted interests in property continuing in a modified corporate form. Sections 1.368-1(b) and 1.368-2(g) of the regulations.

The newly formed `purchasing' corporation was utilized to effect, in substance, a recapitalization and a change in identity, form, or place of organization of the `selling' corporation and, at the same time, to withdraw accumulated earnings from the corporate enterprise for the benefit of the shareholders, while they nevertheless continued a substantial equity interest in the enterprise.

The fact that the shareholders of the `selling' corporation own only 45 percent of the stock of the `purchasing' corporation because of the public stock offering does not dispose of the reorganization question. A surrender of voting control, or ownership of less than 50 percent of the stock of a newly-formed corporation, does not in itself mark a discontinuity of interest. In John A. Nelson Co. v. Helvering , 296 U.S. 374, Ct.D. 1062, C.B. XV-1, 274 (1936), the Supreme Court of the United States held that there was a `reorganization' even though the shareholders of the acquired corporation received less than half of the stock of the acquiring corporation and received only nonvoting preferred stock therein. It is necessary only that the shareholders continue to have a definite and substantial equity interest in the assets of the acquiring corporation.

In view of the foregoing, it is held that the transaction here described constitutes a reorganization within the meaning of sections 368(a)(1)(E) and (F) of the Code. No gain or loss is recognized to the `selling' corporation on the exchange of property, as provided by section 361 of the Code. The basis of the assets in the hands of the `purchasing' corporation will be the same as in the hands of the `selling' corporation, as provided in section 362(b) of the Code. No gain or loss is recognized under section 354 of the Code on the exchange of the stock of the `selling' corporation for stock of the `purchasing' corporation pursuant to the plan of reorganization.

With regard to the stockholders' withdrawal of money and other property from the corporate solution, it is necessary to determine whether such withdrawal is to be treated as `boot' received as part of the consideration for their stock in the `selling' corporation in accordance with section 356(a) of the Code or as a separate dividend distribution taxable in accordance with the provisions of section 3-01 of the Code. See sections 1.301-1(1) and 1.331-1(c) of the regulations and J. Robert Bazley v. Commissioner , 331 U.S. 737, Ct.D. 1687, C.B. 1947-2, 79, rehearing denied and amended, 332 U.S. 752 (1947).

Under section 356(a)(1) of the Code, gain would be recognized to the shareholders of the `selling' corporation upon the surrender of their shares of stock in exchange for stock of the `purchasing' corporation, its long-term notes, cash, and other assets, but in an amount not in excess of the sum of cash and the fair market value of the long-term notes and other assets received. Under section 356(a)(2) of the Code, such gain would be taxable as a dividend to each shareholder to the extent of his ratable share of the undistributed earnings and profits of the corporation accumulated after February 28, 1913; the remainder, if any, would be treated as gain from the exchange of property. Under section 301 the distribution would be taxable as a dividend to the same extent as a dividend formally declared in the same amount.

In this case, viewing the issuance of stock of the `purchasing' corporation to new investors as a transaction separate from the reorganization, it is concluded that the distribution to stockholders of the `selling' corporation of the cash, long-term notes, and other assets should be treated as a distribution under section 301 of the Code.

In view of the conclusions reached herein, reconsideration has been given to Revenue Ruling 56-541, C.B. 1956-2, 189, which holds under similar circumstances that a nontaxable corporate sale of assets was effected under section 337 of the Code and that distributions to the shareholders were to be treated as in full payment in exchange for their stock under a plan of complete liquidation of the old corporation. The conclusions reached in the instant case are equally applicable to the question involved in Revenue Ruling 56-541. Accordingly, Revenue Ruling 56-541, C.B. 1956-2, 189, is revoked.

Under authority of section 7805(b) of the Code, this Revenue Ruling will not be applied retroactively in any case in which transactions were consummated prior to August 21, 1961, in reliance on the Service's position as published in Revenue Ruling 56-541 and a retroactive application would be to the taxpayer's detriment.