Rev. Rul. 57-465: Foreign downstream merger constitutes a D reorganization

In Rev. Rul. 57-465, the IRS holds that a downstream merger pursuant to foreign law qualifies as Type D reorganization.
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Citations: Rev. Rul. 57-465; 1957-2 C.B. 250

Rev. Rul. 57-465The Internal Revenue Service has been requested to state its position with respect to the tax effect of a proposed exchange of stocks pursuant to a merger of two foreign corporations under the circumstances as described below.

X corporation, a domestic corporation, owns all of the outstanding stock of Y corporation. Y corporation, which is a holding company, owns all of the outstanding stock of Z corporation, an operating company. Both Y and Z are foreign corporations organized under the laws of the same country. The investment in the stock of Z corporation comprises over one-half of the assets of Y corporation. The assets of Z corporation consists principally of accounts receivable, inventories, and fixed assets.

For valid corporate business purposes, it is desired that the separate existence of Y corporation as an intermediate holding company be terminated and that the properties of the two foreign corporations be combined. It is proposed, therefore, that Y corporation be merged into Z corporation. Z corporation is to be the surviving corporation in the merger in order to avoid the necessity of transferring patents, trade names, trade marks, labor agreements, and government land concessions owned by Z corporation and to avoid other difficulties that would be encountered if, instead, Z corporation were to be merged into Y corporation.

Under the plan of merger, Y corporation will be absorbed by Z corporation, and Z corporation will continue to be governed by its present charter, as amended. The outstanding shares of Y corporation will be cancelled, and the outstanding shares of Z corporation will be replaced with new common shares, which will be issued to X corporation.

X corporation has established to the satisfaction of the Commissioner of Internal Revenue that the proposed transaction is not in pursuance of a plan having as one of its principal purposes the avoidance of Federal income taxes within the meaning of section 367 of the Internal Revenue Code of 1954.

Section 368 of the Internal Revenue Code of 1954, relating to definitions of corporate reorganizations, provides, in part:

(a) REORGANIZATION.-

(1) IN GENERAL.-* * * the term `reorganization' means-

(A) a statutory merger * * *

*

(D) a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor, or one or more of its shareholders (including persons who were shareholders immediately before the transfer), or any combination thereof, is in control of the corporation to which the assets are transferred; but only if, in pursuance of the plan, stock or securities of the corporation to which the assets are transferred are distributed in a transaction which qualifies under section 354, * * *

Section 354, relating to exchanges of stock and securities in certain reorganizations, provides, in part:

(a) GENERAL RULE.-

(1) IN GENERAL.-No gain or loss shall 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 such corporation or in another corporation a party to the reorganization.

*

(b) EXCEPTION.-

(1) IN GENERAL.-Subsection (a) shall not apply to an exchange in pursuance of a plan of reorganization within the meaning of section 368(a)(1)(D), unless-

(A) the corporation to which the assets are transferred acquires substantially all of the assets of the transferor of such assets; and

(B) the stock, securities, and other properties received by such transferor, as well as the other properties of such transferor, are distributed in pursuance of the plan of reorganization.

The specific questions presented are whether the proposed `downstairs' merger of the intermediate foreign holding company into its subsidiary will qualify as a reorganization within the purview of section 368 and whether the resultant exchange of stocks by the domestic parent will be nontaxable under the provisions of section 354(a)(1).

The proposed merger of the two foreign corporations cannot qualify as a reorganization under section 368(a)(1)(A) of the Code, in view of section 1.368-2(b) of the Income Tax Regulations, which states that the words `statutory merger' refers to a merger effected in pursuance of the laws of the United States or a State or Territory or the District of Columbia. However, since the assets of Y corporation will be transferred to Z corporation under the plan of merger and X corporation, the sole stockholder of Y corporation, will own all of the stock of Z corporation immediately after the transfer, the transaction can qualify as a reorganization under section 368(a)(1)(D), provided the distribution of the stock of Z corporation to X corporation qualifies under section 354(a)(1). See H. B. Leary, Sr. v. Helvering , 93 Fed.(2d) 826; J. F. Schoellkopf, Jr. v. Helvering , 100 Fed.(2d) 415; George O. Kolb v. Commissioner , 100 Fed.(2d) 920.

Pursuant to section 354(b), quoted above, the nonrecognition provisions of section 354(a)(1) will not apply to exchanges in pursuance of a plan of reorganization within the meaning of section 368(a)-(1)(D) unless the corporation to which the assets are transferred acquires substantially all of the assets of the transferor and the stock received by the transferor, as well as its other properties, are distributed in pursuance of the plan of reorganization. In the instant case, the principal asset of Y corporation (its stock of Z corporation), while it will be transferred to Z corporation, will be transferred only for cancellation and will not be received or held by Z corporation as an asset. Instead, the new shares of Z corporation, representing the same rights and powers as those in the old shares owned by Y corporation, will be owned by the stockholder of Y corporation after the merger. Therefore, the question is presented whether, in the instant case, Z corporation is not acquiring `substantially all' of the assets of Y corporation, with the result that section 354(b) will prevent the application of section 354(a)(1).

The report of the Senate Finance Committee on the Internal Revenue Code of 1954, Report No. 1622, 83rd Cong., makes it clear that section 354(b) was included in the law in order to prevent section 354(a)(1) from applying to exchanges relating to divisive reorganizations (`split-ups' and `split-offs') and to require that such exchanges be considered under the provisions of section 355. The instant case does not involve a divisive reorganization and, therefore, the exchange cannot qualify under section 355. Accordingly, since (a) the assets of Y corporation are to be transferred to only one transferee under the plan of merger, (b) Y corporation will retain no assets and will go out of existence, and (c) the stock of Z corporation held by X corporation after the merger will not represent any greater property rights than the stock of Y corporation held prior to the merger, Z corporation will acquire substantially all of the assets of Y corporation within the meaning of section 354(b), and the conditions of section 354(b) will be satisfied.

Therefore, it is held that the proposed merger of Y corporation into Z corporation will constitute a reorganization within the meaning of section 368(a)(1)(D) of the Code. Under the provisions of section 354(a)(1), no gain or loss will be recognized to X corporation as a result of the exchange of the stock of Y corporation for the stock of Z corporation. As provided by section 358(a)(1), the basis of the stock of Z corporation received in the merger will be the same as the basis of the stock of Y corporation exchanged therefor.

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