IRS Revenue Ruling
1998-10

 
Code Secs. 368, 354

<<FULL TEXT>>

26 CFR 1.368-2: Definition of terms.
(Also section 354; section 1.354-1.)

REV. RUL. 98-10

ISSUE

Where a stock for stock acquisition otherwise qualifying under section
368(a)(1)(B) of the Internal Revenue Code is accompanied by an exchange of
securities, how should the transaction be treated?


FACTS

The facts are substantially similar to the facts in Rev. Rul. 69-142,
1969-1 C.B. 107.

Corporation X acquires all of the outstanding capital stock of
Corporation Y in exchange for voting stock of X. Corporation Y is a
solvent corporation. Prior to the exchange, Y has an issue of six percent
fifteen-year debentures outstanding. Pursuant to the plan of
reorganization, X acquires all the outstanding debentures of Y in exchange
for an equal principal amount of new six percent fifteen-year debentures
of X. Some of the debentures of Y are held by its shareholders, but a
substantial proportion of the Y debentures are held by persons who own no
stock.

X is in control of Y immediately after the acquisition of the Y stock.
The X and Y debentures constitute "securities" within the meaning of
section 354(a)(1) and, thus, do not represent an equity interest.
Disregarding the exchange of debentures, the transaction meets the
requirements of section 368(a)(1)(B).


LAW AND ANALYSIS

Section 368(a)(1)(B) provides that a 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.

Section 1.368-2(c) of the Income Tax Regulations provides:

In order to qualify as a "reorganization" under section 368(a)(1)(B),
the acquisition by the acquiring corporation of stock of another
corporation must be in exchange solely for all or a part of the voting
stock of the acquiring corporation . . ., and the acquiring corporation
must be in control of the other corporation immediately after the
transaction. If, for example, Corporation X in one transaction exchanges
nonvoting preferred stock or bonds in addition to all or a part of its
voting stock in the acquisition of stock of Corporation Y, the transaction
is not a reorganization under section 368(a)(1)(B).

Section 354(a)(1) provides 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 another corporation a party to a reorganization.

In the circumstances set forth above, the Y shareholders receive
exclusively voting stock of X as consideration for the exchange of their Y
stock. The fact that a substantial proportion of the Y debentures is held
by bondholders who own no stock in Y has the effect of ensuring that the
value of the debentures issued by X in exchange for the debentures of Y
realistically reflects the value of the Y debentures alone and does not
constitute indirect nonqualifying consideration for the Y stock. Because
the Y shareholders, in their capacity as shareholders, receive only X
voting stock, the transaction constitutes a reorganization within the
meaning of section 368(a)(1)(B).

Although the acquisition by X of the debentures of Y in exchange for
debentures of X occurs as part of the overall transaction, it is not a
part of the stock-for-stock exchange which qualifies as a reorganization.
It is, however, an exchange of securities in parties to a reorganization
which occurs in pursuance of the plan of reorganization, and, therefore,
meets all the conditions of section 354(a)(1). Accordingly, any gain or
loss realized by the debenture holders of Y as a result of their exchange
of their Y debentures for an equal principal amount of debentures of X
will not be recognized. Section 354(a)(1). If, under different facts, the
principal amount of the debentures of X was greater than the principal
amount of the debentures of Y, sections 354(a)(2) and 356(d) would apply
to require the debenture holders of Y to recognize some or all of any gain
realized.


HOLDING

The exchange of Y stock for X stock is a reorganization described in
section 368(a)(1)(B); and any gain or loss realized by the shareholders of
Y as a result of the exchange will not be recognized. Section 354(a)(1).

The separate exchange of Y debentures for X debentures is an exchange
in pursuance of the plan of reorganization described in section
368(a)(1)(B). Thus, any gain or loss realized by the debenture holders of
Y as a result of their exchange of their Y debentures for an equal
principal amount of debentures of X will not be recognized. Section
354(a)(1).

In certain cases, rights to acquire stock of a party to a
reorganization are "securities" for purposes of section 354. See section
1.354-1(e) (as amended by T.D. 8752, 1998-9 I.R.B. 4, effective for
exchanges occurring on or after March 9, 1998). An exchange of such
rights, although separate from a section 368 exchange, may also be in
pursuance of the plan of reorganization. In such cases, any gain or loss
realized by the holder of such rights as a result of the exchange will not
be recognized. Section 354(a)(1).


EFFECT ON OTHER REVENUE RULINGS

Rev. Rul. 69-142, which dealt with substantially identical facts, is
modified and superseded.

Rev. Rul. 70-41, 1970-1 C.B. 77, deals with a stock-for-stock exchange
accompanied by an exchange of Acquired debentures for Acquiring stock. It
is modified such that section 354 applies to the exchange of debentures
for stock.

Rev. Rul. 78-408, 1978-2 C.B. 203, deals with a stock-for-stock
exchange accompanied by a warrant-for-warrant exchange. It is modified
such that section 354 applies to the exchange of warrants provided that
the warrants constitute securities. See section 1.354-1(e).

Rev. Ruls. 68-637, 1968-2 C.B. 158, and 70-269, 1970-1 C.B. 82,
similarly deal with reorganization exchanges accompanied by exchanges of
warrants or options. Each is amplified such that section 354 applies to
the exchange of warrants or options, provided that, as in Rev. Rul. 78-408
above, the warrants or options constitute securities.


PROSPECTIVE APPLICATION

Section 7805(b) provides that the Secretary may prescribe the extent,
if any, to which any ruling relating to the internal revenue laws shall be
applied without retroactive effect.

Pursuant to the authority contained in section 7805(b), this revenue
ruling will be applied only to corporate reorganizations in which the
exchange of securities occurs on or after March 9, 1998, the date this
revenue ruling is published in the Internal Revenue Bulletin. Transactions
in which the exchange of securities occurs prior to this date will
continue to be governed by the rules as they existed prior to publication
of this revenue ruling.


DRAFTING INFORMATION

The principal author of this revenue ruling is Michael J. Danbury of
the Office of Assistant Chief Counsel (Corporate). For further information
regarding this revenue ruling, contact Mr. Danbury on (202) 622-7750 (not
a toll-free call).

<<END RULING>>

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