Rev. Rul. 70-140: § 351 transfer fails business purpose test

In Rev. Rul. 70-140, the IRS holds that a transfer by an individual of the assets of a sole proprietorship to his controlled corporation, pursuant to an integrated plan, followed by the acquisition of that corporation's stock by an unrelated corporation does not qualify under § 351.
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Citations: Rev. Rul. 70-140; 1970-1 C.B. 73

Rev. Rul. 70-140Advice has been requested whether the provisions of section 351 of the Internal Revenue Code of 1954 apply to the transfer of property under the circumstances described below.

All the outstanding stock of X corporation was owned by A, an individual. A also operated a similar business in the form of a sole proprietorship on the accrual basis of reporting income. Pursuant to an agreement between A and Y, an unrelated corporation, A transferred all the assets of the sole proprietorship to X in exchange for additional shares of X stock. A then transferred all his X stock to Y solely in exchange for voting common stock of Y, which was widely held.

Section 351(a) of the Code provides, in part, that no gain or loss will be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation if immediately after the exchange such persons are in control of the corporation.

Section 368(c) of the Code provides that the term "control" means the ownership of stock possessing at least 80 percent of the total combined voting power of all classes of stock entitled to vote and at least 80 percent of the total number of shares of each other class of stock of the corporation.

Section 368(a)(1)(B) of the Code provides, in part, that the term 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.

The two steps of the transaction described above were part of a prearranged integrated plan and may not be considered independently of each other for Federal income tax purposes. The receipt by A of the additional stock of X in exchange for the sole proprietorship assets is transitory and without substance for tax purposes since it is apparent that the assets of the sole proprietorship were transferred to X for the purpose of enabling Y to acquire such assets without the recognition of gain to A.

Section 351 of the Code is not applicable to the transfer of the sole proprietorship assets to Y inasmuch as A was not in control of Y immediately after the transfer. The sole proprietorship cannot be a party to a reorganization within the meaning of section 368(b) of the Code. Thus, the transfer of the sole proprietorship assets to X is treated as a sale by A of the assets to Y followed by a transfer of these assets by Y to the capital of X.

Accordingly, that portion of the stock of Y received by A equal to the fair market value of the sole proprietorship assets is treated as an amount received from the sale of those assets. Gain or loss is recognized to A as provided in sections 1001 and 1002 of the Code. The exchange by A of all the outstanding stock of X, solely for voting common stock of Y, other than the Y stock received in payment for the sole proprietorship assets, is a reorganization within the meaning of section 368(a)(1)(B) of the Code.

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