Rev. Rul. 54-139

Advice is requested with respect to the tax consequences for Federal income tax purposes of a proposed `spin-off' reorganization hereinafter described.

M Corporation has outstanding 2,500 shares of common stock, all of which is owned by one stockholder. It is engaged in two diverse fields of endeavor, each of which is operated as a branch of the corporation. One branch manufactures specially designed electronic products for the United States Government; the other branch manufactures and sells air conditioners. The air conditioner branch has a separate sales force and separate production workers. M Corporation feels that the two branches should be separated in order to insulate each from the liabilities of the other. The electronics branch is volatile in nature and depends upon Government contracts, economic conditions, and changes in world affairs. The air conditioner branch is subject to litigation involving claims of patent infringement.

M Corporation proposes to organize a new corporation and transfer to it the assets of one of the branches in exchange for all the capital stock (consisting solely of common stock) of the new corporation. Such stock will then be distributed to the sole stockholder of M Corporation without the surrender by him of any of his stock in the latter corporation. The sole stockholder has no present intention of selling or otherwise disposing of any of the stock of either corporation or of liquidating either corporation.

Both corporations will continue to operate as separate entities, and in general they will have separate personnel and facilities. However, M Corporation will continue to manufacture a small proportion of the parts used by the new corporation, and in the event of common use of facilities and employees the costs and salaries will be allocated between the two corporations on an equitable basis. Any sales by M Corporation to the new corporation will be effected at fair market prices.

Section 112 of the Internal Revenue Code provides in part as follows:

(g) DEFINITION OF REORGANIZATION.-As used in this section * * *

(1) The term `reorganization' means * * * (D) a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor or its shareholders or both are in control of the corporation to which the assets are transferred * * *

Section 39.112(g)-1 of Regulations 118 provides in part that the purpose of the reorganization provisions of the Internal Revenue Code is to except from the general rule with respect to the recognition of gain or loss certain specifically described exchanges incident to readjustment of corporate structures as are required by business exigencies and which effect only a readjustment of continuing interests in property under modified corporate forms. Requisite to a reorganization under the Code are a continuity of the business enterprise under the modified corporate form, and a continuity of interest therein on the part of those persons who were the owners of the enterprise prior to the reorganization.

It is held that the transfer by M Corporation of the assets of one of its branches, subject to liabilities pertaining to that branch, to the new corporation in exchange solely for all of the stock of the latter will constitute a reorganization under section 112(g)(1)(D) of the Internal Revenue Code. No gain or loss will be recognized to either corporation as a result of the reorganization; and no gain or loss will be recognized as a result of the receipt by the sole shareholder of the stock of the new corporation. The basis of the assets acquired by the new corporation will be the same as the cost or other basis in the hands of M Corporation; and the cost or other basis to the sole shareholder of the stock of M Corporation will be allocated between the stock of M Corporation and the stock of the new corporation acquired as a result of the transaction. A proportionate part of the accumulated earnings and profits of M Corporation will be allocable to the new corporation. See Revenue Ruling 270, C.B. 1953-2, 35.