Rev. Rul. 55-103
Distinguished by Rev. Rul. 78-251
Advice has been requested with respect to the tax consequences of a proposed transaction under the circumstances set forth below.
The X Corporation is engaged in the manufacture of paper products. It also owns 80 percent of the stock of Y, a foreign corporation, which operates a lumber business. The Y Corporation's stock has greatly appreciated in value and constitutes a large proportion of the total asset value of X Corporation. The X Corporation has common stock of 120 x dollars and an earned surplus of 100 x dollars. For the past several years, the X Corporation has suffered severe operating losses and its stockholders have received no dividends. For that reason the stockholders of X have voted to liquidate and start dissolution proceedings on a specified date, unless negotiations to sell their stock have been completed on or before such date.
The Z Corporation is interested in buying all of the outstanding common stock of X Corporation and has made an offer to purchase such stock which has not yet been acted upon by X or its stockholders. However, the Z Corporation's offer does not contemplate payment for the value of the Y Corporation's stock as an asset of X Corporation.
Since the Z Corporation has no interest in Y stock held by X Corporation, the latter corporation proposes to distribute this stock to its shareholders, prior to the completion of the sale negotiations.
Section 355(a) of the Internal Revenue Code of 1954 states that, if all the requirements of that section are satisfied, the distribution by a corporation of the stock of a controlled corporation to its shareholders will not result in the recognition of any gain or loss to a shareholder or securities in one or more of such corporations However, one of the requirements of section 355(a)(1) is that:
(B) The transaction was not used principally as a device for the distribution of the earnings and profits of the distributing corporation or the controlled corporation or both (but the mere fact that subsequent to the distribution stock securities in one or more of such corporations are sold or exchanged by all or some of the distributees (other than pursuant to an arrangement negotiated or agreed upon prior to such distribution) shall not be construed to mean that the transaction was used principally as such a device), * * *.
In the instant case, subsequent to the proposed distribution of Y stock by X, the stock of X Corporation may be sold by the present stockholders pursuant to an arrangement negotiated immediately prior to the distribution. The sale of stock of the distributing corporation immediately subsequent to a distribution of stock of a controlled corporation, when negotiations for such a sale are already in process, is generally considered sufficient evidence that the distribution of stock was used principally as a device for the distribution of earnings and profits of the distributing corporation. The purpose of the requirement that the transaction not be used principally as a device for the distribution of earnings and profits is to limit the application of section 355 of such Code to those cases in which the distribution of stock of the controlled corporation effects only a readjustment of continuing interests in property under modified corporate forms.
In the instant case, the purpose in distributing the Y stock is to facilitate the sale of stock of X Corporation. No continuing interest in X on the part of any of the present stockholders is contemplated. The distribution of the Y stock is merely a device to give to the X stockholders certain assets for which the prospective purchaser of their stock is unwilling to pay. Therefore, it is an arrangement for distributing the earnings and profits of X Corporation and section 355 of the Code is not applicable to such a transaction.
Accordingly, it is held that the amount and taxability of the distribution of the stock of Y Corporation to the stockholders of X Corporation will be determined in accordance with the provisions of section 301(c)(1) of the Internal Revenue Code of 1954. The portion of the distribution constituting a dividend will be determined under the provisions of section 316 of such Code