Citations: Rev. Rul. 74-269; 1974-1 C.B. 87
Rev. Rul. 74-269
Advice has been requested whether the situation described below constitutes a recapitalization and, therefore, a reorganization under section 368(a)(1)(E) of the Internal Revenue Code of 1954.
A, the founder of X corporation, owns 50 of X's outstanding 100 shares of common stock. B and C, A's sons, each owns 25 shares. In anticipation of A's retirement and pursuant to a plan of recapitalization, X proposes to exchange shares of newly issued $100 par value six percent cumulative non-voting preferred stock for all of A's common stock. B and C will not participate in the exchange. The terms of the preferred stock provides that on liquidation, the preferred shareholder will receive the par value of his shares plus accrued dividends. The book value per share of X common stock was calculated to be $10x, or a total book value of $500x for the 50 shares held by A.
Pursuant to the plan, A will exchange all of his X common stock with a book value of $500x for five shares of new X preferred stock with a par value of $500x.
Section 368(a)(1) of the Code provides in subparagraph (E) that a recapitalization constitutes a "reorganization." Section 354(a)(1) provides, in 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 such corporation. Section 358 provides, in effect, that in an exchange to which section 354 applies, the basis of the stock permitted to be received pursuant to the 354 exchange will be the same as that of the stock exchanged therefor. Section 356(f) provides that for transactions described in section 354, but which result in a gift or have the effect of the payment of compensation, the appropriate sections of the Code will apply.
In the exchange of stock described above, the parties contend that the fair market value of the preferred stock is equal to the fair market value of the common stock exchanged therefor. As support for this contention, the parties use the book value of the common stock and par value of the preferred stock.
The fair market value of stock is a factual determination and is not necessarily the book value or par value of the stock. However, to the extent that the fair market value of the preferred stock received in the instant case is found, in fact, to be equal to the fair market value of the common stock exchanged therefor, the transaction will constitute an exchange pursuant to a reorganization within the meaning of section 368(a)(1)(E) of the Code.
Accordingly, the exchange of stock described above will constitute a reorganization within the meaning of section 368(a)(1)(E) of the Code and no gain or loss will be recognized to A under section 354 on the exchange of those shares of his common stock which are equal in value to the value of the shares of the preferred stock which are received in exchange therefor. Under section 358 the basis of the preferred stock received by A in the exchange will be the same as the basis of those shares of the common stock which are considered exchanged under section 354. However, if A receives shares of preferred stock having a fair market value in excess of the fair market value of the common stock surrendered, or surrenders shares of common stock having a fair market value in excess of the fair market value of the preferred stock received, the amount representing such excess will be treated as having been used to make gifts, pay compensation, satisfy obligations of any kind, or for whatever purpose the facts indicate. The reorganization will not diminish the accumulated earnings and profits of X corporation available for the subsequent distribution of dividends within the meaning of section 316.
Rev. Rul. 54-13, 1954-1 C.B. 109, is hereby superseded, since the position set forth therein is restated under the current law in this Revenue Ruling.