Rev. Rul. 70-269

Advice has been requested whether the assumption of outstanding employee stock options under the circumstances described below violates the "solely for voting stock" requirement of section 368(a)(1)(B) of the Internal Revenue Code of 1954.

Pursuant to a plan of reorganization, X corporation acquired all the outstanding stock of Y corporation from the Y shareholders in exchange for voting stock of X, the ratio of exchange being two shares of X stock for each share of the stock of Y based upon their fair market values at the time of the exchange. Y had outstanding qualified stock options (as defined in section 422(b) of the Code) to purchase Y stock. X substituted its own options for Y's outstanding qualified stock options when it acquired the Y stock in the exchange.

Some of the option holders of Y also owned stock of Y so that they received both X voting stock and X options in the transaction. The X options contained the same terms as the Y options except for relating to X stock with the number of shares being twice the number of shares of Y stock. The substitution of options was not a modification of the Y options, as defined in section 425(h)(3) of the Code, so that it was not considered the granting of new options under section 425(h)(1) of the Code.

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 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).

In the instant case, although the substitution of options occurred as part of the overall transaction, the Y shareholders received exclusively X voting stock as consideration for the stock of Y. Shareholders owning stock of Y and who did not hold any Y options before the transaction did not receive options of X as a result of the transaction. Since the options contained the same terms as would have applied to the purchase of Y stock under the Y options, no additional benefits inured to the shareholders on the substitution of the options.

Accordingly, in the instant case, 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.