Citations: Rev. Rul. 90-95; 1990-2 C.B. 67
Rev. Rul. 90-95
(1) If a corporation organizes a subsidiary solely for the purpose of acquiring the stock of a target corporation in a reverse subsidiary cash merger, is the corporation treated on the occurrence of a merger as having acquired the stock of the target in a qualified stock purchase under section 338 of the Internal Revenue Code?
(2) If the corporation makes a qualified stock purchase of the target stock and immediately liquidates the target as part of a plan to acquire the assets of the target, is the corporation treated as having made an asset acquisition pursuant to the Kimbell-Diamond doctrine or a section 338 qualified stock purchase followed by a liquidation of the target?
Situation 1. P, a domestic corporation, formed a wholly owned domestic subsidiary corporation, S, for the sole purpose of acquiring all of the stock of an unrelated domestic target corporation, T, by means of a reverse subsidiary cash merger. Prior to the merger, S conducted no activities other than those required for the merger.
Pursuant to plan of merger, S merged into T with T surviving. The shareholders of T exchanged all of their T stock for cash from S. Part of the cash used to carry out the acquisition was received by S from P; the remaining cash was borrowed by S. Following the merger, P owned all of the outstanding T stock.
Situation 2. The facts are the same as in Situation 1, except that P planned to acquire T's assets through a prompt liquidation of T. State law prohibited P from owning the stock of T. Pursuant to the plan, T merged into P immediately following the merger of S into T. The merger of T into P satisfied the requirements for a tax-free liquidation under section 332 of the Code. The liquidation was not motivated by the evasion of avoidance of federal income tax.
LAW AND ANALYSIS
In Kimbell-Diamond Milling Co. v. Commissioner, 14 T.C. 74 (1950), aff'd per curiam, 187 F.2d 718 (5th Cir. 1951), cert. denied, 342 U.S. 827 (1951), the court held that the purchase of the stock of a target corporation for the purpose of obtaining its assets through a prompt liquidation should be treated by the purchaser as one transaction, namely, a purchase of the target's assets with the purchaser receiving a cost basis in the assets. Old section 334(b)(2) of the Code was added in 1954 to codify the principles of Kimbell- Diamond. See S. Rep. No. 1622, 83d Cong. 2d Sess. 257 (1954).
In 1982, Congress repealed old section 334(b)(2) of the Code and enacted section 338. Section 338 was "intended to replace any nonstatutory treatment of a stock purchase as an asset purchase under the Kimbell-Diamond doctrine." H.R. Conf. Rep. No. 760, 97th Cong, 2d Sess. 536 (1982), 1982-2 C.B. 600, 632. Under section 338, in the case of any qualified stock purchase, rules are provided governing whether the transaction gives rise to purchase of target stock treatment or purchase of target asset treatment. Under these rules, stock purchase or asset purchase treatment generally results whether or not the target is liquidated, merged into another corporation, or otherwise disposed on by the purchasing corporation. See Section 1.338-4T(d) Question and Answer 1, temporary Income Tax Regulations.
A qualified stock purchase is generally the purchase by a corporation of at least 80 percent of a target's stock, by vote and value, within a 12-month period. Section 338(d)(3). The requirements for a qualified stock purchase may be satisfied through a combination of purchases of target stock by purchasing corporation and redemptions by the target. Section 1.338-4T(c)(4) of the temporary regulations.
Stock purchase or asset purchase treatment generally turns on whether the purchasing corporation makes or is deemed to make a section 338 election. If the election is made or deemed made, asset purchase treatment results and section 338 of the Code generally treats all of the assets of the target as having been sold by the target at fair market value on the date of the qualified stock purchase and then repurchased by the target on the following day. The basis of the target's asset is adjusted to reflect the stock purchase price and other relevant items. If an election is not made or deemed made, the stock purchase treatment generally results. In such a case, the basis of the target's assets is not adjusted to reflect the stock purchase price and other relevant items.
Question and Answer 3 of section 1.338-4T(d) of the temporary regulations provides that the parent of the subsidiary corporation in a reverse subsidiary cash merger is considered to have made a qualified stock purchase of the target if the subsidiary's existence is properly disregarded under the step-transaction doctrine and the requirements of a qualified stock purchase are satisfied. A subsidiary used to acquire target stock in a reverse subsidiary cash merger is ordinarily disregarded for federal income tax purposes if it was formed solely for the purpose of acquiring the stock and did not conduct any activities other than those required for the merger. See Rev. Rul. 79-273, 1979-2 C.B. 125; Rev. Rul. 73-427, 1973-2 C.B. 301.
Section 269 of the Code generally provides that the Secretary may disallow certain tax benefits when evasion or avoidance of federal income tax is the principal purpose for the acquisition of a corporation or its assets. The section 269 disallowance may apply to a qualified stock purchase followed by a liquidation of the target pursuant to a plan of liquidation adopted not more than two years after the purchase of the principal purpose of the liquidation was the evasion or avoidance of federal income tax by securing tax benefits that the purchasing corporation would not otherwise enjoy. Section 269(b).
In Situations 1 and 2, the step-transaction doctrine is properly applied to disregard the existence of S for federal income tax purposes. S had no significance apart from P's acquisition of hte T stock. S was formed for the sole purpose of enabling P to acquire the T stock, and S did not conduct any activities that were not related to that acquisition. Accordingly, the transaction is treated as a qualified stock purchase of T stock by P.
In Situation 2, the step-transaction doctrine does not apply to treat the stock acquisition and liquidation as an asset purchase. Section 338 of the Code replaced the Kimbell-Diamond doctrine and governs whether a corporation's acquisition of stock is treated as an asset purchase. Under section 338, asset purchase treatment turns on whether a section 338 election is made (or is deemed made) following a qualified stock purchase of target stock and not on whether the target's stock is acquired to obtain the assets through a prompt liquidation of the target. The acquiring corporation may receive stock purchase treatment or asset purchase treatment whether or not the target is subsequently liquidated. A qualified stock purchase of target stock is accorded independent significance from a subsequent liquidation of the target regardless of whether a section 338 election is made or deemed made. This treatment results even if the liquidation occurs to comply with state law. Accordingly, in Situation 2, the acquisition is treated as a qualified stock purchase by P and T stock followed by a tax-free liquidation of T into P.
(1) In Situations 1 and 2, P is treated as having acquired stock of T in a qualified stock purchase under section 338 of the Code.
(2) In Situation 2, P is treated as having acquired stock of T in a qualified stock purchase under section 338, followed by a liquidation of T into P, rather than having made an acquisition of assets pursuant to the Kimbell-Diamond doctrine.
The principal author of this revenue ruling is Robert M. Casey of the Office of Assistant Chief Counsel (Corporate). For further information regarding this revenue ruling contact Mr. Casey on (202) 566-3551 (not a toll-free call).