Rev. Rul. 80-101

ISSUE

Do the nonrecognition of gain or loss provisions of section 311(a)(2) of the Internal Revenue Code apply to the receipt by a corporation (X) of its stock from another corporation (Y) upon the liquidation of Y? FACTS

X corporation, an operating company, held 70 percent of the outstanding stock of Y corporation. A, an individual, held the other 30 percent of the outstanding Y stock. Y, a corporation engaged in holding certain investments, owned 25 percent of the outstanding X stock. The value of the X stock owned by Y constituted half of the net value of all of Y's assets. For various reasons, both X and A felt it would be desirable for Y to dispose of, or otherwise cease to hold, the X stock. After a series of negotiations, X and A agreed to liquidate Y and have Y distribute its assets, including the X stock, to X and A.

In accord with the plan of liquidation, Y paid all its liabilities and then distributed 70 percent of each remaining asset to X and 30 percent of each remaining asset to A. One-half of the value of the distribution to both X and A consisted of X stock. At the time of exchange, the fair market value of the Y stock held by X was 16x dollars and X's adjusted basis in the Y stock was 10x dollars. Therefore, X realized a gain of 6x dollars on the transaction.

LAW AND ANALYSIS

Pursuant to section 336 of the Code, gain or loss realized by Y on the distribution of its property to X and A in complete liquidation is not recognized. The property received by A in the liquidating distribution from Y is treated as in full payment in exchange for A's Y stock pursuant to section 331(a), and the gain or loss realized is recognized pursuant to section 1001(c).

Upon the liquidation of Y, X in its capacity as a shareholder of Y received X stock and other assets from Y in exchange for the Y stock X owned. Under section 331(a) of the Code, the distribution is treated as received by X in full payment in exchange for the Y stock, and, under section 1001, the gain realized by X is recognized unless, as provided in section 1001(c), another provision of Subtitle A of the Code requires otherwise. There is no provision of the Code that provides nonrecognition for the gain realized by X on the liquidating distribution in its capacity as a shareholder.

However, the exchange by X of its Y stock for X stock owned by Y upon liquidation of Y meets the definition of a "redemption" as defined in section 317(b) of the Code (the acquisition by a corporation (X) of its stock from a shareholder (Y) in exchange for property (Y stock) as defined in section 317(a)). Section 311(a)(2) provides the general rule that gain or loss is not recognized to a corporation on a distribution of property with respect to its stock. Section 1.311-1(a) of the Income Tax Regulations states that the term "distributions with respect to its stock" includes distributions made in redemption of stock (other than distributions in complete or partial liquidation). Thus, since that portion of the transaction that resulted in X receiving its own stock from Y is a redemption, the general nonrecognition rule of section 311(a)(2) is applicable to that part of the Y stock that X transferred (distributed) to Y in exchange (redemption) for the X stock received from Y.

Moreover, since Y completely terminated its interest in X within the meaning of section 302(b)(3), and since the other requirements of section 311(d)(2)(A) are met, the provisions of section 311(d)(1) do not apply. Nor are any of the other exceptions to section 311(a) applicable.

Rev. Rul. 79-314, 1979-2 C.B. 132, holds in a similar situation that the nonrecognition provision of section 311(a) prevails over the recognition provisions of section 1001 of the Code where one corporation (X) acquires (redeems) part of its stock from a second corporation (Y) in exchange for Y stocked owned by X. Although the transaction in Rev. Rul. 79-314 did not involve the liquidation of Y, the holding therein that the nonrecognition provision of section 311(a) prevails over the general recognition provision of section 1001 is applicable to the transaction in the present case.

HOLDING

No gain is recognized to X under section 311(a)(2) on that part of the Y stock (one half) that was exchanged for X stock of equal value. However, gain is recognized to X under section 1001 on that part of the Y stock (one half) that was exchanged for property other than X stock. Thus, of the total 6x dollars gain realized by X 3x dollars is not recognized under section 311(a) and 3x dollars is recognized under section 1001.