Rev. Rul. 74-503
Advice has been requested as to the basis of the stock acquired in the transaction described below.
X corporation transferred shares of its treasury stock (with a fair market value of $3,000x and purchased by X several years previously from its shareholders for $2,000x) to Y in exchange for newly issued shares of Y stock (with a fair market value of $3,000x) which constituted 80 percent of the only outstanding class of stock of Y. The transfer of X stock was not for the purpose of enabling Y to acquire property by the use of such stock. No gain or loss was recognized to X under section 351(a) (and section 1032(a)) of the Internal Revenue Code of 1954. No gain or loss was recognized to Y under section 1032(a).
Section 358(a) of the Code provides, in part, rules for determining the basis of property received by a transferor in a transaction to which section 351 applies. However, section 358(e) provides that section 358(a) does not apply to property acquired by a corporation by the exchange of its stock as consideration in whole or in part for the transfer of property to it. Therefore, section 358(a) is not applicable in determining the basis of the Y stock received by X in the transaction.
Section 1.1032-1(d) of the Income Tax Regulations provides:
(d) For basis of property acquired by a corporation in connection with a transaction to which section 351 applies or in connection with a reorganization, see section 362. For basis of property acquired by a corporation in a transaction to which section 1032 applies but which does not qualify under any other non-recognition provision, see section 1012.
Section 362(a) of the Code provides, in part, that the basis to a corporation of property acquired in a section 351 transaction will be the same as it would be in the hands of the transferor, increased in the amount of gain recognized to the transferor on such transfer.
Pursuant to section 1.1032-1(d) of the regulations, the basis of the stock of X received by Y and the basis of the stock of Y received by X will be determined under section 362(a) of the Code since the transaction also qualifies, for purposes of determining basis, under section 351.
Therefore, the basis of the X treasury stock received by Y will be the same as it was in the hands of X immediately prior to the exchange. In addition, the basis of the newly issued stock of Y received by X will be the same as it was in the hands of Y immediately prior to the exchange.
The basis of previously unissued stock in the hands of the corporation issuing it in a transaction to which section 362 of the Code applies is zero. However, in order to ascertain the basis of the stock received by Y, a determination must be made as to the basis of the X treasury stock.
In Firestone Tire & Rubber Company, 2 T.C. 827 (1943), acq., 1945 C.B. 3, withdrawing nonacq., 1944 C.B. 38, the taxpayer-corporation purchased shares of its common stock for cash in the open market and held them as treasury shares. At a later date, it exchanged these shares in a nontaxable reorganization described under the predecessor of section 368(a)(1)(B) of the 1954 Code for all the stock of S corporation. Section 113(a)(7) of the Revenue Act of 1936 (the predecessor of section 362(b) of the 1954 Code) provided that the basis of shares acquired in a reorganization exchange by the transferee for the issuance of its own shares was the same as the transferor's basis of the shares received. The taxpayer-corporation contended that the exchange of its treasury stock for all the stock of S corporation was not an issuance since it had purchased the treasury stock in the open market for cash.
The Tax Court of the United States in Firestone relied on two interrelated propositions for its decision. The first was the pre-1954 Code rule that a corporation dealing in its shares as it might in the shares of another corporation must recognize gain or loss on the disposition of its treasury stock. The second, as a necessary corollary to the first, was that a corporation has a basis in its treasury stock equal to the amount paid therefor.
The validity of these propositions was abolished for post-1954 Code years by the enactment of section 1032(a) of the Code, effective with respect to taxable years beginning after December 31, 1953, and ending after August 16, 1954. Section 1032(a) expressly provides nonrecognition treatment for a corporation upon the disposition of its treasury stock. It was intended to remove the uncertainties under prior law relating to whether a corporation was "dealing" in its own shares, and to eliminate any distinction between treasury stock and previously unissued stock. See H. Rep. No. 1337, 83rd Cong. 2d Sess. 268; S. Rep. No. 1622, 83rd Cong. 2d Sess., 426. Among the reasons for this provision were the tax avoidance possibilities of the prior law, under which a corporation expecting a gain upon disposition of treasury shares might avoid such gain by cancelling its treasury shares and issuing "new" stock, whereas a corporation might produce a fictitious loss by purchasing its own shares and reselling them at a lower price.
The enactment of section 317(b) of the Code, which makes it clear that a "redemption" of stock can occur whether such stock is cancelled or held as treasury stock, is further evidence of Congress' intention to eliminate the formalistic distinctions that had existed under pre-1954 Code law with respect to treasury stock. See S. Rep. No. 1622, at page 252.
Therefore, the Firestone decision is not applicable under the 1954 Code. Thus, under the 1954 Code, a corporation's treasury stock is no different than its previously unissued stock, the purchase of such treasury stock being merely a part of the capital transaction which began when such stock was first issued.
Accordingly, the basis of the X treasury stock received by Y is zero and the basis of the newly issued Y stock received by X is zero.
Rev. Rul. 62-217, 1962-2 C.B. 59 (which refers to the "cost basis" of treasury stock), Rev. Rul. 70-117, 1970-1 C.B. 30 (which holds that premiums paid by a corporation on life insurance policies used to fund the cost of a stock purchase agreement do not represent ordinary and necessary business expenses of the taxpayer but are in the nature of amounts paid for the acquisition of a corporation asset (treasury stock)), and Rev. Rul. 70-305, 1970-1 C.B. 169 (which holds, in part, that the sale of stock of a parent corporation held by a subsidiary corporation, which was acquired by the subsidiary in a transaction described in section 304(a)(2), can result in a loss), are hereby modified to remove any implication that for tax purposes a corporation's treasury stock held by it has a cost basis rather than a zero basis.