IRS Revenue Ruling
2001-26

Code Sec. 368

<<FULL TEXT>>

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

Two-step stock acquisitions. The ruling holds that certain two-step
stock acquisitions comprised of a tender offer and a merger qualify as
reorganizations under sections 368(a)(1)(A) and 368(a)(2)(E).


REV. RUL. 2001-26

ISSUE

On the facts described below, is the control-for-voting-stock
requirement of section 368(a)(2)(E) of the Internal Revenue Code
satisfied, so that a series of integrated steps constitutes a tax-free
reorganization under sections 368(a)(1)(A) and 368(a)(2)(E) and section
354 or section 356 applies to each exchanging shareholder?


FACTS

SITUATION 1. Corporation P and Corporation T are widely held,
manufacturing corporations organized under the laws of state A. T has only
voting common stock outstanding, none of which is owned by P. P seeks to
acquire all of the outstanding stock of T. For valid business reasons, the
acquisition will be effected by a tender offer for at least 51 percent of
the stock of T, to be acquired solely for P voting stock, followed by a
merger of a subsidiary of P into T. P initiates a tender offer for T stock
conditioned on the tender of at least 51 percent of the T shares. Pursuant
to the tender offer, P acquires 51 percent of the T stock from T's
shareholders for P voting stock. P forms S and S merges into T under the
merger laws of state A. In the statutory merger, P's S stock is converted
into T stock and each of the T shareholders holding the remaining 49
percent of the outstanding T stock exchanges its shares of T stock for a
combination of consideration, two-thirds of which is P voting stock and
one-third of which is cash. Assume that under general principles of tax
law, including the step transaction doctrine, the tender offer and the
statutory merger are treated as an integrated acquisition by P of all of
the T stock. Also assume that all nonstatutory requirements for a
reorganization under sections 368(a)(1)(A) and 368(a)(2)(E) and all
statutory requirements of section 368(a)(2)(E), other than the requirement
under section 368(a)(2)(E)(ii) that P acquire control of T in exchange for
its voting stock in the transaction, are satisfied.

SITUATION 2. The facts are the same as in Situation 1, except that S
initiates the tender offer for T stock and, in the tender offer, acquires
51 percent of the T stock for P stock provided by P.


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
merged 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 (the "control-for-voting-stock
requirement"). For this purpose, control is defined in section 368(c).

In King Enterprises, Inc. v. United States, 418 F.2d 511 (Ct. Cl.
1969), as part of an integrated plan, a corporation acquired all of the
stock of a target corporation from the target corporation's shareholders
for consideration, in excess of 50 percent of which was acquiring
corporation stock, and subsequently merged the target corporation into the
acquiring corporation. The court held that, because the merger was the
intended result of the stock acquisition, the acquiring corporation's
acquisition of the target corporation qualified as a reorganization under
section 368(a)(1)(A).

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 the reorganization.

Section 356(a)(1) provides that, if section 354 would apply to the
exchange except for the receipt of money or property other than stock or
securities in a corporate party to the reorganization, the recipient shall
recognize gain, but in an amount not in excess of the sum of the money and
the fair market value of the other property.

Section 1.368-1(c) of the Income Tax Regulations provides that a plan
of reorganization must contemplate the bona fide execution of one of the
transactions specifically described as a reorganization in section 368(a)
and the bona fide consummation of each of the requisite acts under which
nonrecognition of gain is claimed. Section 1.368-2(g) provides that the
term plan of reorganization is not to be construed as broadening the
definition of reorganization as set forth in section 368(a), but is to be
taken as limiting the nonrecognition of gain or loss to such exchanges or
distributions as are directly a part of the transaction specifically
described as a reorganization in section 368(a).

As assumed in the facts, under general principles of tax law, including
the step transaction doctrine, the tender offer and the statutory merger
in both Situations 1 and 2 are treated as an integrated acquisition by P
of all of the T stock. The principles of King Enterprises support the
conclusion that, because the tender offer is integrated with the statutory
merger in both Situations 1 and 2, the tender offer exchange is treated as
part of the statutory merger (hereinafter the "Transaction") for purposes
of the reorganization provisions. Cf. J. E. Seagram Corp. v. Commissioner,
104 T.C. 75 (1995) (treating a tender offer that was an integrated step in
a plan that included a forward triangular merger as part of the merger
transaction). Consequently, the integrated steps, which result in P
acquiring all of the stock of T, must be examined together to determine
whether the requirements of section 368(a)(2)(E) are satisfied. Cf.
section 1.368-2(j)(3)(i); section 1.368-2(j)(6), Ex. 3 (suggesting that,
absent a special exception, steps that are prior to the merger, but are
part of the transaction intended to qualify as a reorganization under
sections 368(a)(1)(A) and 368(a)(2)(E), should be considered for purposes
of determining whether the control-for-voting-stock requirement is
satisfied).

In both situations, in the Transaction, the shareholders of T exchange,
for P voting stock, an amount of T stock constituting in excess of 80
percent of the voting stock of T. Therefore, the control-for-voting-stock
requirement is satisfied. Accordingly, in both Situations 1 and 2, the
Transaction qualifies as a reorganization under sections 368(a)(1)(A) and
368(a)(2)(E).

Under sections 1.368-1(c) and 1.368-2(g), all of the T shareholders
that exchange their T stock for P stock in the Transaction will be treated
as exchanging their T stock for P stock in pursuance of a plan of
reorganization. Therefore, T shareholders that exchange their T stock only
for P stock in the Transaction will recognize no gain or loss under
section 354. T shareholders that exchange their T stock for P stock and
cash in the Transaction will recognize gain to the extent provided in
section 356. In both Situations 1 and 2, none of P, S, or T will recognize
any gain or loss in the Transaction, and P's basis in the T stock will be
determined under section 1.358-6(c)(2) by treating P as acquiring all of
the T stock in the Transaction and not acquiring any of the T stock before
the Transaction.


HOLDING

On the facts set forth in Situations 1 and 2, the
control-for-voting-stock requirement is satisfied in the Transaction, the
Transaction constitutes a tax-free reorganization under sections
368(a)(1)(A) and 368(a)(2)(E), and section 354 or section 356 applies to
each exchanging shareholder.


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).

<<END RULING>>

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