SECTION 306 STOCK ISSUED BY A WIDELY HELD CORPORATION WILL NO LONGER BE CONSIDERED AUTOMATICALLY EXEMPT FROM SECTION 306'S GENERAL RULE.

Rev. Rul. 89-63

The Internal Revenue Service has reconsidered Rev. Rul. 56-116, 1956-1 C.B. 164, Rev. Rul. 57-103, 1957-1 C.B. 113, and Rev. Rul. 57- 212, 1957-1 C.B. 114. In each of these rulings, certain preferred stock that qualified as section 306 stock within the meaning of section 306(c)(1)(B) of the Internal Revenue Code was held to fall within the exception provided by section 306(b)(4), which renders the provisions of section 306(a) inapplicable. Those revenue rulings are hereby revoked.

LAW AND ANALYSIS

Section 306(a) of the Code concerns the treatment of the amount realized on the disposition or redemption of section 306 stock (as defined in section 306(c)). Section 306(b)(4) provides in part that section 306(a) shall not apply if it is established to the satisfaction of the Secretary that the distribution and the disposition or redemption of the section 306 stock was not in pursuance of a plan having as one of its principal purposes the avoidance of federal income tax.

In Rev. Rul. 56-116, two widely held corporations, X and Y, were merged in a reorganization qualifying under section 368(a)(1)(A) of the Code. In the merger, both preferred and common stock of X were issued in exchange for the common stock of Y. There was a business reason for issuing both preferred and common stock of X in exchange for the Y common stock. The management of X had no intention of redeeming any of the preferred stock issued in connection with the merger, except as required under the provisions of purchase fund and sinking fund agreements.

The ruling holds that the X preferred stock issued in connection with the merger is section 306 stock, but it concludes without full explanation that section 306(a)(1) of the Code does not apply to the proceeds of the disposition of such stock, unless the disposition is in anticipation of redemption.

In Rev. Rul. 57-103, 1957-1 C.B. 113, a publicly held corporation acquired all the assets of a closely held corporation with only common stock outstanding in return for voting preferred stock and common stock, constituting 5 percent of the acquiring corporation's outstanding stock, in a reorganization described in section 368(a)(1)(C) of the Code.

Although the preferred stock issued in the reorganization constituted section 306 stock, as defined in section 306(c)(1)(B) of the Code, that ruling holds, citing Rev. Rul. 56-116, that the issuance of such stock was not in pursuance of a plan having as one of its principal purposes the avoidance of federal income tax within the meaning of section 306(b)(4).

In Rev. Rul. 57-212, 1957-1 C.B. 114, publicly held corporation B was merged into publicly held corporation C in a reorganization described in section 368(a)(1)(A) of the Code. Each share of B common stock (the only class of B stock outstanding) was converted into one share of first preferred stock, one-half share of second preferred stock, and three shares of common stock of C. All three classes of C stock were widely held and traded on the New York Stock Exchange. Pursuant to the provisions of a sinking fund, so long as any of the shares of first preferred stock were outstanding, C was required to redeem 3 percent of the outstanding first preferred shares annually.

Rev. Rul. 57-212 reasons that Rev. Rul. 56-116 stands for the proposition that section 306(b)(4) of the Code provides relief from section 306(a)(1) on the disposition of section 306 stock issued by a widely held corporation unless the disposition was in anticipation of redemption. The ruling then considers whether the sinking fund provisions precluded relief under section 306(b)(4) from the operation of section 306(a)(2). It holds that the distribution of the first preferred stock and the subsequent redemption of portions thereof under the sinking fund provisions were not in pursuance of a plan having as one of its principal purposes the avoidance of federal income tax within the meaning of section 306(b)(4). The ruling also states in summary that the provisions of section 306(a)(1) are not applicable to the proceeds of a sale of such shares (whether or not in anticipation of a redemption through the operation of the sinking fund), and the provisions of section 306(a)(2) are not applicable to amounts distributed by C in redemption of such first preferred shares to meet the requirements of its sinking fund provisions.

Upon reconsideration, the Service has concluded that the fact that the section 306 stock is issued by a corporation whose stock is widely held is not sufficient grounds for the application of section 306(b)(4) of the Code. Thus, in such circumstances, relief from the provisions of section 306(a) should not be automatic. Although Rev. Rul. 56-116 does not support its application of section 306(b)(4) by specifically relying on the fact that the section 306 stock was issued by a widely held corporation, Rev. Rul. 56-116 was cited in both Rev. Ruls. 57-103 and 57-212 for that proposition. Both Rev. Ruls. 57-103 and 57-212 use that proposition to support their holdings. Because these rulings conflict with the conclusion that the widely held nature of the issuing corporation's stock is not sufficient grounds for the application of section 306(b)(4), they are revoked.

EFFECT ON OTHER RULINGS

Rev. Ruls. 56-116, 57-103, and 57-212 are revoked.

PROSPECTIVE APPLICATION

Pursuant to the authority contained in section 7805(b) of the Code, the conclusion of this revenue ruling will not be applied adversely to taxpayers who treat transactions in accordance with the position set forth in Rev. Ruls. 56-116, 57-103, 57-212 in the case of stock either issued before May 1, 1989, date of publication of this revenue ruling in the Internal Revenue Bulletin, or issued after that date pursuant to the terms of a plan of reorganization which was adopted before that date and the terms of which remained in effect at all times until that date.

DRAFTING INFORMATION

The principal author of this revenue ruling is David Madden of the Office of Assistant Chief Counsel (Corporate). For further information regarding this revenue ruling, contact David Madden on (202) 566-3205 (not a toll-free call).