Rev. Rul. 73-237

Advice has been requested whether the transaction described below satisfies the active trade or business requirements of section 355(b) of the Internal Revenue Code of 1954.

Since 1960, X corporation has been engaged in business as a general contractor in the construction industry. During this same period Y corporation, a wholly-owned subsidiary of X corporation, has been actively engaged in the manufacture and sale of electrical equipment.

The activities of X corporation, performed by several salaried employees, consist of submitting bids on prospective jobs; negotiating and entering into contracts with principals and with subcontractors, acting as independent contractors; purchasing or leasing equipment or supplies, depending on the particular job; and supervising work of subcontractors to determine if it conforms to contract specifications. X has the primary responsibility for the completion of each job.

For valid business reasons, X corporation proposes to distribute the stock of Y corporation to those shareholders who are primarily interested in the manufacture and sale of electrical equipment in exchange for all their stock in X corporation. The shareholders of X corporation who are interested in the construction business will become the owners of all the outstanding X corporation stock after the exchange.

Section 355 of the Code provides rules for the distribution, without recognition of gain or loss to the shareholders, of stock of a corporation controlled by the distributing corporation. For such treatment section 355(b)(1)(A) of the Code requires that both the distributing corporation and the controlled corporation must be engaged immediately after the distribution in the active conduct of a trade or business. Section 355(b)(2)(B) of the Code provides that a corporation will be treated as engaged in the active conduct of a trade or business if and only if such trade or business has been actively conducted throughout the five-year period ending on the date of distribution. Section 1.355-1(c) of the Income Tax Regulations, in defining "active business," provides, in part, that a trade or business consists of a specific existing group of activities being carried on for the purpose of earning income or profit from only such group of activities, and the activities included in such group must include every operation which forms a part of, or a step in, the process of earning income or profit. Such group of activities ordinarily must include the collection of income and the payment of expenses.

Section 355 of the Code, by requiring that a trade or business be actively conducted, connotes substantial management and operational activities directly carried on by the corporation itself and not the activities of others outside the corporation, including independent contractors. However, the fact that a portion of a corporation's business activities is performed by independent contractors will not preclude the corporation from being engaged in the active conduct of a trade or business if the corporation itself directly performs active and substantial management and operational functions.

In the instant case, X's general contracting activities include its direct performance of active and substantial management and operational functions, apart from those activities performed by the subcontractors acting as independent contractors. Accordingly, X is engaged in the active conduct of a trade or business within the meaning of section 355(b) of the Code. Provided all the other requirements of section 355 of the Code are met, the distribution by X of the stock of Y, as described above, will qualify as a distribution under section 355(a)(1) of the Code.

See Rev. Rul. 73-234, page 180, this Bulletin, which holds that a corporation's direct performance of substantial management and operational farm activities, apart from those activities performed by tenant farmers acting as independent contractors, satisfies the active conduct of a trade or business requirements in section 355 of the Code.

Compare Rev. Rul. 73-236, page 183, this Bulletin, which holds that a trust conducting its real estate leasing business activities through independent contractors in compliance with the real estate investment trust provisions of section 856 of the Code does not and cannot satisfy the active conduct of a trade or business requirements in section 355 of the Code.