Rev. Rul. 56-513

Advice has been requested as to the effect, for Federal income tax purposes, of a redemption by a corporation of stock in partial liquidation under the circumstances described below.

Prior to 1944, a certain corporation was engaged in two separate businesses, i.e. , one dealing in bread, cake, and bakery goods and the other dealing in crackers, cookies, and biscuit goods. Both bought, sold and manufactured their respective products.

In the early part of 1944, the assets of the bread division were transferred to a new corporation in exchange for all of the latter's capital stock. In the latter part of the same year, the old corporation constructed a new cracker and biscuit manufacturing plant. After the business operations were moved to the new plant, the old corporation began to sustain operating losses. Such losses continued and, as a result, the new plant was sold in 1953 to an unrelated corporation for 1,200 x dollars.

On the date of the sale of the plant, the old corporation ceased manufacturing and selling cracker and biscuit products. Thereafter, the remaining assets of such business not purchased by the unrelated corporation were sold to other parties. The assets of the bread business previously transferred to the new corporation were then transferred back to the old corporation and the stock of the new corporation retired and cancelled.

At the annual meeting of the stockholders of the old corporation hled in September 1954, the stockholders discussed the feasibility of distributing the funds received from the sale and liquidation of the assets of the biscuit business. A resolution was proposed and adopted by the directors and stockholders within the taxable year, providing for the reduction of the number of shares of authorized common stock and a reduction of the authorized capital. The stated capital of the corporation was reduced by redeeming on a pro rata basis 80 percent of the shares of common stock held by each stockholder. The shares so redeemed resulted in a total distribution of 300 x dollars in cash to the stockholders. Such shares were cancelled.

At the date of the transaction, the corporation had an excess of current assets over current liabilities of 600 x dollars. It had been determined by the directors of the corporation that a net working capital of 200 x dollars would be sufficient to successfully operate the business henceforth.

Section 346 of the Internal Revenue Code of 1954, defining a partial liquidation, provides in part:

(a) IN GENERAL.-For purposes of this subchapter, a distribution shall be treated as in partial liquidation of a corporation if-

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(2) the distribution is not essentially equivalent to a dividend, is in redemption of a part of the stock of the corporation pursuant to a plan, and occurs within the taxable year in which the plan is adopted or within the succeeding taxable year, including (but not limited to) a distribution which meets the requirements of subsection (b).

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(b) TERMINATION OF A BUSINESS.-A distribution shall be treated as a distribution described in subsection (a)(2) if the requirements of paragraphs (1) and (2) of this subsection are met.

(1) The distribution is attributable to the corporation's ceasing to conduct, or consists of the assets of, a trade or business which has been actively conducted throughout the 5-year period immediately before the distribution, which trade or business was not acquired by the corporation within such period in a transaction in which gain or loss was recognized in whole or in part.

(2) Immediately after the distribution the liquidating corporation is actively engaged in the conduct of a trade or business, which trade or business was actively conducted throughout the 5-year period ending on the date of the distribution and was not acquired by the corporation within such period in a transaction in which gain or loss was recognized in whole or in part.

Upon the facts presented, it is evident that the redemption was attributable to a bona fide contraction of the corporation's business operation and a consequent reduction in capital used. See Joseph Imler v. Commissioner , 11 T.C. 836.

Accordingly, it is held that the distribution by the corporation of 300 x dollars in redemption of a portion of its outstanding common stock on a pro rata basis constituted a distribution in partial liquidation under provisions of section 346(a) and is treated as a full payment in exchange for the stock under section 331 of the Code. The gain or loss realized by the stockholders upon the partial liquidation constituted capital gain or loss under the provisions of subchapter P of the Code. In determining the amount of the gain or loss, regardless of the actual number of shares surrendered for redemption by the stockholders, the total number of shares deemed to have been surrendered is that number which bears the same ratio to the total number of shares outstanding as the cash distributed bears to the total fair market value of the net assets of the corporation immediately prior to the distribution.