Rev. Rul. 76-454

Advice has been requested concerning the Federal income tax treatment of the transaction described below.

For many years A, an individual, owned all of the stock of X, a domestic corporation. A organized Y, a domestic corporation, paying 50x dollars in cash for all of its common stock, and subsequently as part of the plan of incorporation, caused X to purchase from Y all of Y's 4 percent noncumulative, nonvoting preferred stock for 255x dollars. Upon liquidation, the net assets of Y are distributable 50 percent to the holders of its common stock and 50 percent to the holders of its preferred stock. Because the right to share in the net assets upon liquidation for each class of stock is substantially disproportionate to the amounts paid for each class of stock, the 255x dollars paid by X for the preferred stock exceeds its fair market value.

Section 351(a) of the Internal Revenue Code of 1954 provides that no gain or loss will be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation and immediately after the exchange such person or persons are in control (as defined in section 368(c)) of the corporation. Section 368(c) defines control to mean the ownership of stock possessing at least 80 percent of the total combined voting power of all classes of stock entitled to vote and at least 80 percent of the total number of shares of all other classes of stock of the corporation.

Section 1.351-1(a)(1) of the Income Tax Regulations states, in part, that it is necessary that transfers to a corporation be simultaneous in order for section 351(a) of the Code to apply where the rights of the parties have been previously defined.

Section 1.351-1(b)(1) of the regulations provides, in part, as follows:

Where property is transferred to a corporation by two or more persons in exchange for stock or securities * * * it is not required that the stock and securities received by each be substantially in proportion to his interest in the property immediately prior to the transfer. However, where the stock and securities received are received in disproportion to such interest, the entire transaction will be given tax effect in accordance with its true nature, and in appropriate cases the transaction may be treated as if the stock and securities had first been received in proportion and then some of such stock and securities had been used to make gifts * * *, to pay compensation * * *, or to satisfy obligations of the transferor of any kind.

In the instant case, after the transfers of cash to Y by A and X, A and X owned stock possessing 80 percent or more of the total combined voting power of Y voting stock and 80 percent or more of all other classes of Y stock. Thus, the control requirement of section 351 of the Code is satisfied.

Furthermore, since A received more stock in Y than A would have received if Y had issued its stock in proportion to the cash transferred by A and X, section 1.351-1(b)(1) of the regulations is applicable.

Accordingly, it is appropriate to treat the transactions in the instant case as transfers by X and A, respectively, of 255x dollars and 50x dollars and the receipt from Y by X and A of stock worth, respectively, 255x dollars and 50x dollars followed by a distribution by X of a sufficient amount of the stock it constructively received to reflect the true values of the stocks in the hands of X and A after the transactions. That is, X is treated as having received all of the Y preferred stock and enough of the Y common stock so that the total value of the stock it received equalled the 255x dollar contribution it made to Y. X is then considered to have distributed the Y common stock it constructively received to A to reflect the fact that after the transaction X owned only Y preferred stock and A owned all of Y's common stock. This distribution is subject to the provisions of section 301 of the Code.