IRS Revenue Ruling
2001-25

Code Sec. 368

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26 CFR 1.368-1: Purpose and scope of exception of reorganization
exchanges.

Reverse triangular merger. A reverse triangular merger qualifies as a
tax-free reorganization under sections 368(a)(1)(A) and 368(a)(2)(E) of
the Code, notwithstanding that immediately after the merger, and as part
of a plan that includes the merger, the surviving corporation sells a
portion of its assets to an unrelated party for cash that it retains.


REV. RUL. 2001-25

ISSUE

On the facts below, does a merger fail to qualify as a tax-free
reorganization under sections 368(a)(1)(A) and 368(a)(2)(E) of the
Internal Revenue Code if, immediately after the merger and as part of a
plan that includes the merger, the surviving corporation sells a portion
of its assets to an unrelated party?


FACTS

P is a manufacturing corporation organized under the laws of state A. T
is also a manufacturing corporation organized under the laws of state A. P
organizes corporation S as a wholly owned state A subsidiary of P, and S
merges with and into T in a statutory merger under the laws of state A. In
the merger, the shareholders of T holding 90 percent of the T stock
exchange their T stock for voting stock of P. The remaining shareholders
of T receive $y cash for their T stock. Immediately after the merger and
as part of a plan that includes the merger, T sells 50 percent of its
operating assets for $z cash to X, an unrelated corporation. After the
sale of the assets to X, T retains the sales proceeds. Without regard to
the requirement that T hold substantially all of the assets of T and S,
the merger satisfies all the other requirements applicable to
reorganizations under sections 368(a)(1)(A) and 368(a)(2)(E).


LAW AND ANALYSIS

Section 368(a)(1)(A) states that the term "reorganization" means a
statutory merger or consolidation. Section 368(a)(2)(E) provides that a
transaction otherwise qualifying under section 368(a)(1)(A) will not be
disqualified by reason of the fact that stock of a corporation (the
"controlling corporation") that before the merger was in control of the
acquiring corporation is used in the transaction, if (1) after the
transaction, the corporation surviving the merger holds substantially all
of its properties and of the properties of the merged corporation (other
than stock of the controlling corporation distributed in the transaction),
and (2) in the transaction, former shareholders of the surviving
corporation exchanged, for an amount of voting stock of the controlling
corporation, an amount of stock in the surviving corporation that
constitutes control of such corporation.

Section 1.368-2(j)(3)(iii) of the Income Tax Regulations provides that,
for purposes of section 368(a)(2)(E), "[t]he term 'substantially all' has
the same meaning as in section 368(a)(1)(C)."

Rev. Rul. 88-48, 1988-1 C.B. 117, holds that the requirement of section
368(a)(1)(C) that the acquiring corporation acquire "substantially all" of
the properties of a target corporation is satisfied when immediately prior
to the target corporation's transfer of assets to the acquiring
corporation, the target corporation sells 50 percent of its historic
assets to unrelated parties for cash and immediately transfers that cash,
along with its other properties, to the acquiring corporation.

Section 368(a)(2)(E) uses the term "holds" rather than the term
"acquisition" as do sections 368(a)(1)(C) and 368(a)(2)(D) because it
would be inapposite to require the surviving corporation to "acquire" its
own properties. The "holds" requirement of section 368(a)(2)(E) does not
impose requirements on the surviving corporation before and after the
merger that would not have applied had such corporation transferred its
properties to another corporation in a reorganization under section
368(a)(1)(C) or a reorganization under sections 368(a)(1)(A) and
368(a)(2)(D).

In this case, T's post-merger sale of 50 percent of its operating
assets for cash to X prevents T from holding substantially all of its
historic business assets immediately after the merger. As in Rev. Rul.
88-48, however, the sales proceeds continue to be held by T. Therefore,
the post-acquisition sale of 50 percent of T's operating assets where T
holds the proceeds of such sale along with its other operating assets does
not cause the merger to violate the requirement of section 368(a)(2)(E)
that the surviving corporation hold substantially all of its properties
after the transaction.

Accordingly, the merger qualifies as a reorganization under sections
368(a)(1)(A) and 368(a)(2)(E), notwithstanding the sale by T of a portion
of its assets to X immediately after the merger and as part of a plan that
includes the merger.


HOLDING

On the facts above, a merger qualifies as a tax-free reorganization
under sections 368(a)(1)(A) and 368(a)(2)(E), notwithstanding the fact
that the surviving corporation sells a portion of its assets to an
unrelated party immediately after the merger and as part of a plan that
includes the merger.


DRAFTING INFORMATION

The principal authors of this revenue ruling are Marnie Rapaport and
Joseph M. Calianno of the Office of Associate Chief Counsel (Corporate).
For further information regarding this revenue ruling, contact Ms.
Rapaport at (202) 622-7550 (not a toll-free call) or Mr. Calianno at (202)
622-7930 (not a toll-free call).

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