Rev. Rul. 78-287

Advice has been requested whether the downstream merger of a first-tier subsidiary into its wholly owned subsidiary qualifies as a reorganization within the meaning of section 368(a)(1)(F) of the Internal Revenue Code of 1954.

Corporation X, a widely held corporation engaged in the loan business, owned all of the stock of corporation Y which, in turn, owned all of the stock of corporation Z. Both Y and Z were stock life insurance companies and had conducted identical life insurance operations for a number of years. X, Y, and Z filed their returns on the basis of the calendar year.

Pursuant to a plan of reorganization and for valid business reasons, Y merged into Z pursuant to the applicable state law. Thereafter, Z continued to conduct its life insurance operations, as well as those formerly operated by Y.

Section 368(a)(1)(F) of the Code defines a "reorganization" as "a mere change in identity, form, or place of organization, however effected."

Section 1.368-1(b) of the Income Tax Regulations provides, in part, that a continuity of interest on the part of those persons who, directly or indirectly, were the owners of the enterprise prior to a reorganization is a prerequisite to a reorganization under the Code. The interest continued must be definite and material and must represent a substantial part of the value of the property transferred. See Helvering v. Minnesota Tea Co., 296 U.S. 378 (1935), XV-1 C.B. 189 (1936).

In Rev. Rul. 75-561, 1975-2 C.B. 129, the Internal Revenue Service announced that it would follow certain court decisions holding that the combination of two or more commonly owned operating corporations, or the merger of a wholly owned subsidiary into its parent qualifying as a liquidation under section 332 of the Code (to which section 334(b)(2) does not apply) and as a reorganization under section 368(a)(1)(F), would qualify as a reorganization within the meaning of section 368(a)(1)(F), provided certain requirements were satisfied. These requirements are:

(1) There must be a complete identity of shareholders and their proprietary interests in the transferor and acquiring corporations. In the case of a wholly owned subsidiary into parent merger, this requirement will be deemed satisfied when the shareholders and their proprietary interests in the parent do not change as a result of the merger;

(2) The transferor and acquiring corporations must be engaged in the same business activities or integrated activities before the combination; and,

(3) The business enterprise of the transferor and the acquiring corporations must continue unchanged after the combination.

In Performance Systems, Inc. v. United States, 382 F. Supp. 525 (M.D. Tenn. 1973), aff'd per curiam. 501 F.2d 1338 (6th Cir. 1974), a case followed by the Service in Rev. Rul. 75-561, the United States District Court discussed the question of whether a downstream merger of one corporation into another qualifies as a reorganization pursuant to section 368(a)(1)(F) of the Code, saying at page 534:

If instead of liquidating the subsidiary, a parent merged into the subsidiary in a merger qualifying as an 'F' reorganization, there would be no doubt that the carryback provision of section 381(b) would be applicable. What difference should there be if a parent merges into subsidiary or subsidiary is merged into parent? The resulting business enterprise, proprietary interests, and identity of shareholders is the same. Therefore, there is merely a change in form, but not in substance, and the tax consequence should be the same regardless of the direction of the transaction.

In the instant case, the merger of Y into Z resulted in the continuation by Z of the insurance business of each corporation without disturbing the complete identity of shareholders and their proprietary interests as required by Rev. Rul. 75-561.

Accordingly, the downstream merger of Y into Z qualified as a reorganization pursuant to section 368(a)(1)(F) of the Code.

Rev. Rul. 75-561 is amplified.