Rev. Rul. 63-234

Advice has been requested whether the successive exchanges of corporate stock described below constitute, separately or in concert, a reorganization as defined in section 368(a)(1)(B) of the Internal Revenue Code of 1954.

In 1960, the M corporation directly and through its subsidiaries operated a chain of retail stores. It owned 60 shares (60 percent) of the 100 outstanding shares of N corporation's voting common stock. A group of taxpayers, hereinafter referred to as the X group, owned 18 shares (18 percent) of N's voting stock, and the remaining 22 shares (22 percent) were held by other shareholders.

Among the assets of the N corporation was 50 percent of the voting stock of the O corporation. The remaining 50 percent of O's voting stock was owned by members of the X group.

For the purpose of affecting certain economies in operation and to make the filing of a consolidated income tax return possible, the above-mentioned parties adopted a plan of reorganization pursuant to which the following action was taken:

(1) The charter of the N corporation was amended to enlarge its board of directors from ten to 12 members and to provide that the two new members of the board would be elected by the owners of a newly authorized class of preferred stock.

(2) Newly created preferred stock of the N corporation was issued to the members of the X group in exchange for all their holdings of the O corporation's voting stock.

The N corporation thus acquired 100 percent of the outstanding stock of the O corporation and the holdings of the X group in the N corporation were increased to include all of that corporation's preferred stock.

(3) Immediately thereafter, the X group transferred all of its stock of the N corporation (18 percent of the common stock and 100 percent of the preferred stock) to the M corporation in exchange for the latter's voting common stock. As a result, the M corporation became the owner of 78 percent of N's common stock and 100 percent of the preferred shares.

The voting power of the N corporation preferred stock confers upon the holders of such stock the right to significant participation in the management of the affairs of the corporation. This preferred stock is therefore `voting stock' within the meaning of the reorganization provision. See I.T. 3896, C.B. 1948-1, 72. Under the principles set forth in I.T. 3896, the voting rights of the M corporation respecting the affairs of the N corporation, when properly weighted, totaled 81.67 percent of the `voting power' of all classes of `voting stock' of the N corporation. Thus, the M corporation acquired `control of the N corporation within the meaning of section 368(c) of the Code.

Section 368(a)(1)(B) of the Code provides that, for purposes of parts I, II, and III of subchapter C of chapter 1 of subtitle A of the Code, the term `reorganization' means-

the acquisition by one corporation, in exchange solely for all or a part of its voting stock, of stock of another corporation if, immediately after the acquisition, the acquiring corporation has control of such other corporation (whether or not such acquiring corporation had control immediately before the acquisition);

Among the requisites to a reorganization under the Code is that of continuity of interest on the part of those persons who, directly or indirectly, were the owners of the enterprise prior to the reorganization. See section 1.368-1(b) of the Income Tax Regulations.

Taking into account all the facts and circumstances, it is concluded that the two exchanges of corporate stock in the instant case were but successive steps in the execution of the single plan adopted earlier by the parties. See Whitney Corporation v. Commissioner , 105 Fed.(2d) 438 (1939), and United Light and Power Co. v. Commissioner , 105 Fed.(2d) 866 (1939), certiorari denied, 308 U.S. 574 (1939). When the component steps in the plans are combined it becomes apparent that the X group exchanged its stock in the O corporation for stock of the M corporation, which did not thereafter directly own either stock of O corporation or its assets. The receipt of N corporation preferred shares by the X group may be disregarded for purposes of the reorganization provisions of the Code since the X group's holding of such shares was `transitory and without real substance.' Helvering v. Raymond I. Bashford , 302 U.S. 454 (1938), Ct. D. 1299, C.B. 1938-1, 286, at 288; see also the United Power and Light Co. case, supra .

Under the principles established by the Supreme Court of the United States in Herman C. Groman v. Commissioner , 302 U.S. 82 (1937), Ct. D. 1285, C.B. 1937-2, 286, and the Bashford case, the stock of M corporation does not provide the X group with the requisite continuity of interest in the O corporation stock transferred to the N corporation because the group had only an indirect interest in the O stock following the transaction. The rule of the Groman and Bashford cases is still applicable to reorganizations sought to be brought within the provisions of section 368(a)(1)(B). See S. Report No. 1622, Eighty-third Congress, Second Session, 51 and 273.

Accordingly, it is held that the transfer by the X group of its shares in the O corporation to the N corporation in exchange for the latter's newly issued preferred stock and the subsequent transfer of the newly acquired preferred shares of N to the M corporation in exchange for voting stock in M does not qualify, either in whole or in part, as a reorganization within the meaning of section 368(a)(1)(B) of the Code.

However, it is held that the exchange of N corporation stock owned by the X group before any of the exchanges described above for voting common stock of M corporation constitutes a reorganization within the meaning of section 368(a)(1)(B) of the Code, and that M and N corporations are each a party to such reorganization within the meaning of section 368(b)(2) of the Code.