Rev. Rul. 73-257

Advice has been requested regarding the qualification of a transaction as a reorganization under sections 368(a)(1)(A) and (a)(2)(D) of the Internal Revenue Code of 1954.

Corporation Y, a wholly owned subsidiary of corporation X, desired to acquire all of the assets of corporation Z, an unrelated corporation. This acquisition was effectuated by the merging of Z into Y in exchange for stock of X, pursuant to the laws of the state of A, in which all three corporations were incorporated. No stock of Y was used in the transaction. In the merger Y received substantially all of the assets of Z and assumed most of the liabilities of Z, while X, for a bona fide business purpose, assumed the remaining liabilities of Z. All of Z's outstanding liabilities at the time of the merger had been incurred in the ordinary course of its business. If Z had been merged into X, the merger would have qualified under the provisions of section 368(a)(1)(A) of the Code as a statutory merger.

Section 368(a)(2)(D) of the Code provides that the acquisition by one corporation in exchange for stock of a corporation ("controlling corporation") which is in control of the acquiring corporation, of substantially all of the properties of another corporation which in the transaction is merged into the acquiring corporation will not be disqualified under section 368(a)(1)(A) of the Code if such transaction would have qualified under section 368(a)(1)(A) of the Code had the merger been into the controlling corporation and no stock of the acquiring corporation is used in the transaction.

The transaction described above meets the requirements of section 368(a)(2)(D) of the Code, but a question arises regarding the assumption of some of Z's liabilities by X.

By way of analogy section 368(a)(1)(C) of the Code permits only the "acquiring corporation" to assume the liabilities of the acquired corporation. See Rev. Rul. 70-107, 1970-1 C.B. 78. In contrast, neither section 368(a)(1)(A) nor section 368(a)(2)(D) of the Code contains a limitation on which a corporation (the acquiring corporation or its parent) may assume such liabilities in a statutory merger. There is no provision in either section 368(a)(1)(A) or section 368(a)(2)(D) of the Code that would prohibit both the acquiring corporation and its parent from assuming the liabilities of the acquired corporation (although section 368(a)(2)(D) of the Code does prohibit the issuance of stock of both the parent and the subsidiary).

Accordingly, liabilities of Z may be assumed by both X and Y without disqualifying the reorganization under section 368(a)(2)(D) of the Code and thus the merger of Z into Y meets the requirements of sections 368(a)(1)(A) and (a)(2)(D) of the Code.

Since the transaction meets the definition of a reorganization under sections 368(a)(1)(A) and (a)(2)(D) of the Code, the question arises as to whether the assumption of the liabilities by X should be treated as if money or other property were received by Z from X, resulting in the recognition of gain to Z under section 361(b) of the Code, or whether section 357(a) of the Code is applicable preventing the recognition of gain by Z.

Section 361(a) of the Code provides that no gain or loss will be recognized if a corporation a party to a reorganization exchanges property, in pursuance of the plan of reorganization, solely for stock or securities in another corporation a party to the reorganization. However, section 361(b) of the Code provides, in part, that if subsection (a) would apply to an exchange but for the fact that the property received in exchange consists not only of stock or securities permitted by subsection (a) to be received without the recognition of gain but also of other property or money, then, if the corporation receiving such other property or money does not distribute it in pursuance of the plan of reorganization, the gain, if any, to the corporation shall be recognized in an amount not in excess of the sum of such money and the fair market value of such other property so received, which is not so distributed.

Section 357(a) of the Code provides, in part, that, except as provided in subsections (b) and (c), which are not applicable in the instant case, if a taxpayer receives property which would be permitted to be received under section 361 of the Code without the recognition of gain if it were the sole consideration, and, as part of the consideration, another party to the exchange assumes a liability of the taxpayer, or acquires from the taxpayer property subject to a liability, then such assumption or acquisition shall not be treated as money or other property, and shall not prevent the exchange from being within the provisions of section 361 of the Code.

Since the term "a party to a reorganization" applies to X under section 368(a)(2)(D) of the Code, by virtue of section 368(b) of the Code, X must also be considered a "party to the exchange" as such term is used in section 357(a) of the Code. Thus, since subsections (b) and (c) of section 357 of the Code are not applicable to the transaction, section 357(a) of the Code applies. Accordingly, the assumption by X of liabilities of Z will not be treated as the receipt of money or other property by Z by virtue of section 357(a) of the Code. Thus, the exchange by Z of substantially all of its assets in return for X stock is within the provisions of section 361(a) of the Code and no gain or loss will be recognized to Z on the exchange.