Rev. Rul. 79-104

ISSUE

On the sale of the stock of a Domestic International Sales Corporation (DISC), as part of a liquidation sale under section 337 of the Internal Revenue Code of 1954, to what extent, if any, is the seller of the DISC stock required to recognize deferred accumulated DISC income?

FACTS

P-1, a domestic corporation, organized a wholly-owned subsidiary, S, on January 1, 1973. Shortly thereafter S qualified as a DISC, as defined in section 992 of the Code. P-1 and S used a calendar year and the accrual method of accounting for reporting federal income taxes. On January 10, 1975, while S had deferred (untaxed) accumulated DISC income of 300x dollars, P-1 sold to P-2, an unrelated corporation, for cash, all of its assets, including all of the S stock pursuant to a plan of sale and complete liquidation under section 337. P-1 had 250x dollars of unrecognized gain from the sale of the S stock.

The stock of S has been retained by P-2 and S continues to operate under the DISC provisions of the Code.

LAW AND ANALYSIS

Section 995(c) of the Code, as originally enacted, provided that if a shareholder disposed of stock in a DISC, any gain recognized on such disposition would be included in gross income as a dividend to the extent of accumulated DISC income of such DISC attributable to the shareholder's stock interest. The section also provided that if the disposition transaction terminated the separate corporate existence of the DISC, any gain realized on the disposition of such stock will be recognized to the extent of accumulated DISC income attributable to the disposing shareholder's stock.

Section 995(c)(1)(C) of the Code, which was added by the Tax Reform Act of 1976 [Pub. L. 94-455], section 1101(d)(1), 1976-3 (Vol. 1) C.B. 1, 134, provides additionally that if a shareholder sells stock in a DISC in a liquidation qualifying for nonrecognition of gain under section 337, then the excess of fair market value over adjusted basis of such stock will be included in gross income of the shareholder as a dividend to the extent provided in section 995(c)(2). Section 995(c)(2) provides that the amount described in section 995(c)(1)(C) shall be included in gross income as a dividend to the extent of the accumulated DISC income of the DISC which is attributable to the stock disposed of and which was accumulated in taxable years of such corporation during the period or periods the stock disposed of was held by the shareholder which disposed of such stock.

The Senate Finance Committee (S. Rep. No. 94-938, 94th Cong., 2d Sess. 299 (1976), 1976-3 (Vol. 3) C.B. 57, 337) in explaining the law change stated:

The committee amendment also includes two provisions to resolve technical problems in existing law. The first relates to recapture of accumulated DISC income upon disposition of stock of a DISC. Under present law if stock in a DISC is distributed, sold, or exchanged in certain tax-free transactions (sec. 311, 336, or 337) there is no recapture because neither of the conditions for recapture are satisfied: No gain is recognized and the corporate existence of the DISC is not terminated. The committee's amendment specifically requires recapture under these circumstances.

As originally enacted, section 995(c)(1)(C) of the Code was to apply to transactions occurring after December 31, 1975, in taxable years ending after such date. However, the Revenue Act of 1978, section 701(u)(12)(A) extended the effective date of section 995(c)(1)(C) to transactions occurring after December 31, 1976, in taxable years ending after such date.

HOLDINGS

P-1 is not required to include in its gross income for 1975, as ordinary income, any of the 250x dollars of gain from the sale of S stock.

If an identical transaction occurs after December 31, 1976, a seller of DISC stock would be required to include in its gross income as a dividend the excess of the fair market value over the adjusted basis of the DISC stock, in the hands of the seller, to the extent of the accumulated DISC income of such DISC attributable to the seller, as provided in section 995(c)(2) of the Code.