Rev. Rul. 69-142

Advice has been requested whether the transaction described below satisfies the "solely for voting stock" requirement of section 368(a)(1)(B) of the Internal Revenue Code of 1954 and whether any resulting gain or loss will be recognized upon the exchange of debentures.

Corporation X acquired all of the outstanding capital stock of corporation Y in exchange for voting stock of X. Corporation Y is a solvent corporation. Prior to the exchange, Y had an issue of six percent ten-year debentures outstanding. Pursuant to the plan of reorganization X acquired all of the outstanding debentures of Y in exchange for an equal amount of new six percent ten-year debentures of X. Some of the debentures of Y were held by its shareholders, but a substantial proportion of the Y debentures was held by persons who owned no stock.

X was in control of Y immediately after the acquisition of the Y stock. The X and Y debentures constitute "securities" within the meaning of section 354(a)(1) of the Code and thus do not represent an equity interest.

Section 368(a)(1)(B) of the Code provides in part that a reorganization includes the acquisition by one corporation, in exchange solely for all or a part of its voting stock, of stock of another corporation if, immediately after the acquisition, the acquiring corporation has control of such other corporation.

Section 1.368-2(c) of the Income Tax Regulations provides in pertinent part:

"In order to qualify as a 'reorganization' under section 368(a)(1)(B), the acquisition by the acquiring corporation of stock of another corporation must be in exchange solely for all or a part of the voting stock of the acquiring corporation, and the acquiring corporation must be in control of the other corporation immediately after the transaction. If, for example, Corporation X, in one transaction exchanges nonvoting preferred stock or bonds in addition to all or a part of its voting stock in the acquisition of stock of Corporation Y, the transaction is not a reorganization under section 368(a)(1)(B)." (Emphasis added.)

Section 354(a)(1) of the Code provides in pertinent part that no gain or loss will be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in another corporation a party to a reorganization.

In the circumstances set forth above, the Y shareholders received exclusively voting stock of X as consideration for the exchange of their Y stock. The fact that a substantial proportion of the Y debentures was held by bondholders who owned no stock in Y had the effect of insuring that the value of the debentures issued by X in exchange for the debentures of Y realistically reflected the value of the Y debentures alone and did not constitute indirect nonqualifying consideration for the Y stock.

Although the acquisition by X of the debentures of Y occurred as part of the overall transaction, it is held that the acquisition of the debentures of Y for the debentures of X did not constitute additional consideration for the stock of Y and therefore was not a part of the reorganization exchange for purposes of sections 368(a)(1)(B) and 354(a)(1) of the Code. See Beal's Estate v. Commissioner, 82 F. 2d 268 (1936), affirming 31 B.T.A. 966 (1934). See also Rev. Rul. 69-91, page 106 this Bulletin.

Accordingly, only voting stock was utilized as consideration "in the acquisition of stock" within the meaning of section 1.368-2(c) of the regulations and the "solely for * * * voting stock" requirement contained in section 368(a)(1)(B) of the Code is satisfied. The above-described transaction therefore constitutes a reorganization within the meaning of section 368(a)(1)(B) of the Code. Any gain or loss realized by the shareholders of Y as a result of the exchange of their Y stock for the stock of X will not be recognized inasmuch as section 354(a)(1) of the Code is applicable.

However, it is further held that, inasmuch as the acquisition by X of the debentures of Y was not a part of the reorganization exchange, section 354(a)(1) of the Code is not applicable to that acquisition. The acquisition by X of the outstanding debentures of Y is governed by section 1001 of the Code and consequently any gain or loss realized by the bondholders of Y will be recognized and determined under that section of the Code.