IRS Ruling Interprets Reorganization Definition

The IRS ruled that if, pursuant to an integrated plan, a newly formed wholly owned subsidiary of an acquiring corporation merges into a target, followed by the target's merger into the acquiring corporation, the transaction would be a single statutory merger of the target into the acquiring corporation that qualifies as a Sec. 368(a)(1)(A) reorganization, rather than an as acquisition through a Sec. 338 qualified stock purchase (QSP) followed by a liquidation under Sec. 332.

Rev. Rul. 2001-46

In Rev. Rul. 2001-46, the Service explains its position on two apparently conflicting prior revenue rulings: Rev. Rul. 67-274 is amplified and followed, and Rev. Rul. 90-95 (including a similar example in the regulations) is distinguished.

Rev. Rul. 2001-46 describes two situations:

Situation 1. Corporation X owns all the stock of Corporation Y, a newly formed wholly owned subsidiary. Pursuant to an integrated plan, X acquires all of the stock of Corporation T, an unrelated corporation, in a statutory merger of Y into T (the acquisition merger), with T surviving. In the acquisition merger, the T shareholders exchange their T stock for 70% X voting stock and 30% cash. Following the acquisition merger and as part of the plan, T merges into X in a statutory merger (the upstream merger). It is assumed that the step-transaction doctrine would apply to treat the acquisition merger and the upstream merger as a single integrated acquisition by X of all T's assets.

Situation 2. The facts are the same as in Situation 1, except that in the acquisition merger, the T shareholders receive solely X voting stock in exchange for their T stock, so that the acquisition merger, if viewed independently of the upstream merger, would qualify as a reorganization under Sec. 368(a)(1)(A) by reason of Sec. 368(a)(2)(E).

Prior Rulings

In Rev. Rul. 90-95, the merger of a newly formed wholly owned domestic subsidiary into a target with the target shareholders receiving solely cash in exchange for their stock, immediately followed by the merger of the target into the domestic parent of the merged subsidiary, was treated as a QSP of the target followed by a Sec. 332 liquidation of the target. The acquisition of the target's stock was accorded independent significance from the target's subsequent liquidation and, therefore, was treated as a QSP, regardless of whether a Sec. 338 election was made. Regs. Sec. 1.338-3(d) incorporates the approach of Rev. Rul. 90-95.

In Rev. Rul. 67-274, Corporation Y acquired all of Corporation X's stock in exchange for some of Y's voting stock and, thereafter, X completely liquidated into Y. Because the two steps were parts of a reorganization plan, they could not be considered independently of each other. Thus, the steps did not qualify as a Sec. 368(a)(1)(B) reorganization followed by a Sec. 332 liquidation, but instead qualified as an acquisition of X's assets in a reorganization under Sec. 368(a)(1)(C).

Analysis

Situation 1. Because of the amount of cash paid to T's shareholders, the acquisition merger does not qualify as a reorganization under Sec. 368(a)(1) (A) and (a)(2)(E).

In determining which of the two rulings to follow, the Service stated that unless the policies underlying Sec. 338 dictate otherwise, the integrated asset acquisition in Situation 1 is properly treated as a statutory merger of T into X that qualifies as a Sec. 368(a)(1)(A) reorganization. It said that the rejection of step integration in Rev. Rul. 90-95 and Regs. Sec. 1.338-3(d) is based on congressional intent that Sec. 338 "replace(s) any nonstatutory treatment of a stock purchase as an asset purchase under the Kimball-Diamond doctrine." Thus, Rev. Rul. 90-95 and Regs. Sec. 1.338-3(d) treat the acquisition of the target's stock as a QSP followed by a separate carryover-basis transaction, to preclude any nonstatutory treatment of the steps as an integrated asset purchase.

The IRS ruled that the policy underlying Sec. 338 is not violated by treating Situation 1 as a single statutory merger of T into X; such treatment results in a transaction that qualifies as a Sec. 368(a)(1)(A) reorganization, in which X acquires T's assets with a carryover basis under Sec. 362 that does not result in a cost basis for those assets under Sec. 1012. Thus, Situation 1 is not a stock acquisition that is a QSP followed by a Sec. 332 liquidation, but instead is an acquisition of T's assets through a single statutory merger of T into X that qualifies as a Sec. 368(a)(1)(A) reorganization. Accordingly, a Sec. 338 election may not be made.

Situation 2. Situation 2 differs from Situation 1 only in that the acquisition merger, if viewed independently of the upstream merger, would qualify as a Sec. 368(a)(1)(A) reorganization by reason of Sec. 368(a)(2)(E). This difference does not change the result from that in Situation 1. The transaction is treated as a single statutory merger of T into X that qualifies as a Sec. 368(a)(1)(A) reorganization, without regard to Sec. 368(a)(2)(E).

Application

The Service also ruled that it would not use Rev. Rul. 2001-46 to challenge a taxpayer's position on the treatment of a multistep transaction, one step of which, viewed independently, is a QSP if:

1. A timely (including extensions) and valid election (without regard to whether there was a QSP under the principles of the revenue ruling) under Sec. 338(h)(10) or (g) is (or was) filed for the acquisition of the target's stock; and

2. Either:

(a) the target's acquisition date is on or before Sept. 24, 2001; or

(b) the acquisition of the target's stock meeting the Sec. 1504(a)(2) requirements by the purchasing corporation is pursuant to a written agreement binding on Sept. 24, 2001 and until the acquisition date; and

3. Such taxpayer does not take a position for U.S. tax purposes inconsistent with the acquisition's treatment as a QSP for which it made the election.

Proposed Regulations

The Service and Treasury are considering whether to issue regulations that would reflect the general principles of Rev. Rul. 2001-46, but allow taxpayers to make a valid Sec. 338(h)(10) election for a step of a multi-step transaction that, viewed independently, is a QSP if pursuant to a written agreement that requires (or permits) the purchasing corporation to cause a Sec. 338(h)(10) election in respect of such step to be made.

From Bill Zimbalist, J.D., LL.M., CPA, Washington, DC