Rev. Rul. 72-320

Advice has been requested whether a corporation's momentary ownership of stock in another corporation, in connection with a reorganization described in section 368(a)(1)(D) of the Internal Revenue Code of 1954, terminated its election as a small business corporation.

X corporation, a small business corporation within the meaning of section 1371(a) of the Code, elected not to be subject to the taxes imposed by Chapter 1 of the Code as provided for in section 1372(a) of the Code. X corporation is a manufacturer of heavy construction equipment. It has been engaged in this business in California since 1965. In 1970 X corporation opened a division in New York. Four brothers, A, B, C, and D, own all the stock of X corporation in equal amounts. A and B operate the California division. C and D operate the New York division. In recent years the conduct of the business has been hindered by basic differences between the brothers. A and B are interested in expanding and diversifying the business. C and D want to receive a guaranteed income in the form of large cash dividends.

Since the brothers' objectives were in conflict, a plan of reorganization was adopted pursuant to which X created Y corporation and transferred the assets, subject to all the liabilities, of the New York division to Y in exchange for all of Y's stock; and immediately thereafter C and D exchanged all their stock in X for all of Y's stock in a transaction qualifying under section 355 of the Code. The transfer of assets by X to Y qualified as a reorganization under section 368(a)(1)(D) of the Code.

Section 1371(a) of the Code provides, in part, that a small business corporation means a domestic corporation which is not a member of an affiliated group as defined in section 1504 of the Code.

Section 1504(a) of the Code defines the term "affiliated group" as one or more chains of includible corporations connected through stock ownership with a common parent corporation which is an includible corporation, if (1) stock possessing at least 80 percent of the voting power of all classes of stock and at least 80 percent of each class of nonvoting stock of each of the includible corporations (except the common parent corporation) is owned directly by one or more of the includible corporations, and (2) the common parent corporation owns directly stock possessing at least 80 percent of the voting power of all classes of stock and at least 80 percent of each class of nonvoting stock of at least one of the other includible corporations.

Section 368(a)(1)(D) of the Code provides that the term "reorganization" means a transfer by a corporation of all or part of its assets to another corporation if immediately after the transfer the transferor or one or more of its shareholders, or any combination thereof, is in control of the corporation to which the assets are transferred; but only if, in pursuance of the plan, stock or securities of the corporation to which the assets are transferred are distributed in a transaction which qualifies under section 354, 355, or 356 of the Code.

It is held in the instant case that since X never contemplated more than momentary control of Y, the affiliation will not be considered as terminating the small business corporation election of X under Subchapter S of the Code.