Rev. Rul. 65-110

Advice has been requested concerning the effect, for Federal income tax purposes, of the distribution of portfolio securities as a dividend by a wholly-owned subsidiary to its parent during a consolidated return period, under the circumstances described below.

A parent corporation and its wholly-owned subsidiary filed consolidated returns for the past several years. In 1963, the subsidiary made a distribution with respect to its stock to its parent of portfolio securities. The adjusted basis of the securities in the hands of the subsidiary and the fair market value of the securities as of the date of distribution varied. The adjusted basis of some of the securities to the subsidiary was lower than the fair market value and the adjusted basis of other securities was higher than the fair market value. As of January 1, 1963, the subsidiary had zero earnings and profits. However, for the taxable year 1963, the corporation had earnings and profits in excess of the basis of the securities distributed.

Section 1.1502-31(b)(1) of the Income Tax Regulations, pertaining to consolidated returns, provides, in part, that the taxable income of each corporation shall be computed in accordance with the provisions covering the determination of taxable income of separate corporations except that unrealized profits and losses in transactions between members of the affiliated group and dividend distributions from one member of the group to another member of the group (referred to in the regulations under section 1502 of the Internal Revenue Code of 1954 as intercompany transactions) are to be eliminated.

Section 1.1502-38(b) of the regulations provides that the basis for property shall not be affected by reason of a transfer during a consolidated return period, other than upon liquidation (whether by sale, gift, dividend or otherwise) from a member of the affiliated group to another member of such group.

Section 301(b) of the Code provides rules for determining the amount of a distribution received by a shareholder from a corporation. Section 301(b)(1)(B) of the Code provides, as far as here pertinent, that, in the case of a corporate distributee, the amount of the distribution shall be the lesser of the fair market value of the other property received or the adjusted basis (in the hands of the distributing corporation immediately before the distribution) of the other property received.

Section 301(d) of the Code provides rules for determining the basis of property received as a corporate distribution. Section 301(d)(2) of the Code provides that, in the case of a corporate distributee, the basis of the property received shall be the lesser of the fair market value of such property or the adjusted basis of such property in the hands of the distributing corporation immediately before the distribution.

Dividend distributions otherwise subject to section 301(b)(1)(B) of the Code which qualify as intercompany transactions when a consolidated return is filed are governed by the provisions of sections 1.1502-31(b)(1) and 1.1502-38(b) of the regulations.

Based on the facts of this case, it is held that: (1) the dividend distribution from the subsidiary to the parent is an intercompany transaction and the amount of the distribution to the parent is the adjusted basis of the securities transferred; (2) the basis of the securities received by the parent is the smae in the hands of the parent as it was in the hands of the subsidiary as provided by section 1.1502-38(b) of the regulations and not the lesser of the fair market value or basis as provided by section 301(d)(2) of the Code; and (3) the amount of the adjustment to the earnings and profits of the transferor and the transferee is the adjusted basis of the securities transferred as provided by section 312 of the Code.