rr-01-46.pdf

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# Part I

Section 368(a)(1)(A). - - Definitions relating to corporate reorganizations
26 CFR 1.368-1: Purpose and scope of exception of reorganization exchanges.

Rev. Rul. 2001-46

## ISSUE

Under the facts described below, what is the proper tax treatment if, pursuant to
an integrated plan, a newly formed wholly owned subsidiary of an acquiring corporation
merges into a target corporation, followed by the merger of the target corporation into
the acquiring corporation?

# FACTS

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 consideration, 70 percent of which is X voting stock and 30
percent of which is cash. Following the Acquisition Merger and as part of the plan, T
merges into X in a statutory merger (the Upstream Merger ). Assume that, absent
some prohibition against the application of the step transaction doctrine, the step
transaction doctrine would apply to treat the Acquisition Merger and the Upstream

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Merger as a single integrated acquisition by X of all the assets of T. Also assume that
the single integrated transaction would satisfy the nonstatutory requirements of a
reorganization under 368(a) of the Internal Revenue Code.

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 368(a)(1)(A) by reason of
368(a)(2)(E).

LAW

Section 338(a) provides that if a corporation makes a qualified stock purchase
and makes an election under that section, then the target corporation (i) shall be treated
as having sold all of its assets at the close of the acquisition date at fair market value
and (ii) shall be treated as a new corporation which purchased all of its assets as of the
beginning of the day after the acquisition date. Section 338(d)(3) defines a qualified
stock purchase as any transaction or series of transactions in which stock (meeting the
requirements of 1504(a)(2)) of one corporation is acquired by another corporation by
purchase during a 12-month acquisition period. Section 338(h)(3) defines a purchase
generally as any acquisition of stock, but excludes acquisitions of stock in exchanges to
which 351, 354, 355 or 356 applies.

Rev. Rul. 90-95, 1990-2 C.B. 67 (Situation 2), holds that the merger of a newly
formed wholly owned domestic subsidiary into a target corporation with the target
corporation shareholders receiving solely cash in exchange for their stock, immediately

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followed by the merger of the target corporation into the domestic parent of the merged
subsidiary, will be treated as a qualified stock purchase of the target corporation
followed by a 332 liquidation of the target corporation. As a result, the parent s basis
in the target corporation s assets will be the same as the basis of the assets in the
target corporation s hands. The ruling explains that even though the step-transaction
doctrine is properly applied to disregard the existence of the [merged subsidiary], so
that the first step is treated as a stock purchase, the acquisition of the target
corporation s stock is accorded independent significance from the subsequent
liquidation of the target corporation and, therefore, is treated as a qualified stock
purchase regardless of whether a 338 election is made.

Section 1.338-3(d) of the Income Tax Regulations incorporates the approach of
Rev. Rul. 90-95 into the regulations by requiring the purchasing corporation (or a
member of its affiliated group) to treat certain asset transfers following a qualified stock
purchase (where no 338 election is made) independently of the qualified stock
purchase. In the example in 1.338-3(d)(5), the purchase for cash of 85 percent of the
stock of a target corporation, followed by the merger of the target corporation into a
wholly owned subsidiary of the purchasing corporation, is treated (other than by certain
minority shareholders) as a qualified stock purchase of the stock of the target
corporation followed by a 368 reorganization of the target corporation into the
subsidiary. As a result, the subsidiary s basis in the target corporation s assets is the
same as the basis of the assets in the target corporation s hands.

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Section 368(a)(1)(A) defines the term reorganization as a statutory merger or
consolidation. Section 368(a)(2)(E) provides that a transaction otherwise qualifying
under 368(a)(1)(A) shall not be disqualified by reason of the fact that stock of a
corporation (controlling corporation), which before the merger was in control of the
merged corporation, is used in the transaction if (i) after the transaction, the corporation
surviving the merger holds substantially all of its properties and the properties of the
merged corporation, and (ii) in the transaction, former shareholders of the surviving
corporation exchange, for an amount of voting stock of the controlling corporation, an
amount of stock in the surviving corporation which constitutes control of such
corporation.

In Rev. Rul. 67-274, 1967-2 C.B. 141, Corporation Y acquires all of the stock of
Corporation X in exchange for some of the voting stock of Y and, thereafter, X
☒

completely liquidates into Y. The ruling holds that because the two steps are parts of a
plan of reorganization, they cannot be considered independently of each other. Thus,
the steps do not qualify as a reorganization under 368(a)(1)(B) followed by a
liquidation under 332, but instead qualify as an acquisition of X s assets in a
reorganization under 368(a)(1)(C).

ANALYSIS

## Situation (1)

Because of the amount of cash consideration paid to the T shareholders, the
Acquisition Merger could not qualify as a reorganization under 368(a)(1)(A) and

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368(a)(2)(E). If the Acquisition Merger and the Upstream Merger in Situation (1) were
treated as separate from each other, as were the steps in Situation (2) of Rev. Rul. 90-
95, the Acquisition Merger would be treated as a stock acquisition that is a qualified
stock purchase, because the stock is not acquired in a 354 or 356 exchange. The
Upstream Merger would qualify as a liquidation under 332.

However, if the approach reflected in Rev. Rul. 67-274 were applied to Situation
(1), the transaction would be treated as an integrated acquisition of T s assets by X in a
single statutory merger (without a preliminary stock acquisition). Accordingly, unless
the policies underlying 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
reorganization under 368(a)(1)(A). See King Enterprises, Inc. v. United States, 418
F.2d 511 (Ct. Cl. 1969) (in a case that predated 338, the court applied the step
transaction doctrine to treat the acquisition of the stock of a target corporation followed
by the merger of the target corporation into the acquiring corporation as a
reorganization under 368(a)(1)(A)); J.E. Seagram Corp. v. Commissioner, 104 T.C. 75
(1995) (same). Therefore, it is necessary to determine whether the approach reflected
in Rev. Rul. 90-95 applies where the step transaction doctrine would otherwise apply to
treat the transaction as an asset acquisition that qualifies as a reorganization under
368(a).

Rev. Rul. 90-95 and 1.338-3(d) reject the approach reflected in Rev. Rul. 67-
274 where the application of that approach would treat the purchase of a target
corporation s stock without a 338 election followed by the liquidation or merger of the

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target corporation as the purchase of the target corporation s assets resulting in a cost
basis in the assets under 1012. The rejection of step integration in Rev. Rul. 90-95
and 1.338-3(d) is based on Congressional intent that 338 replace any nonstatutory
treatment of a stock purchase as an asset purchase under the Kimbell-Diamond
doctrine. H.R. Rep. No. 760, 97th Cong., 2d Sess. 536 (1982), 1982-2 C.B. 600, 632.
(In Kimbell-Diamond Milling Co. v. Commissioner, 14 T.C. 74, aff d per curiam, 187
F.2d 718 (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 a purchase of the target
corporation s assets with the purchaser receiving a cost basis in the assets.) Rev. Rul.
90-95 and 1.338-3(d) treat the acquisition of the stock of the target corporation as a
qualified stock purchase followed by a separate carryover basis transaction in order to
preclude any nonstatutory treatment of the steps as an integrated asset purchase.

The policy underlying 338 is not violated by treating Situation (1) as a single
statutory merger of T into X because such treatment results in a transaction that
qualifies as a reorganization under 368(a)(1)(A) in which X acquires the assets of T
with a carryover basis under 362, and does not result in a cost basis for those assets
under 1012. Thus, in Situation (1), the step transaction doctrine applies to treat the
Acquisition Merger and the Upstream Merger not as a stock acquisition that is a
qualified stock purchase followed by a 332 liquidation, but instead as an acquisition of
T s assets through a single statutory merger of T into X that qualifies as a

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reorganization under 368(a)(1)(A). Accordingly, a 338 election may not be made in
such a situation.

### 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 reorganization under
368(a)(1)(A) by reason of 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 reorganization under 368(a)(1)(A) without regard to
368(a)(2)(E).

# HOLDING

Under the facts presented, if, pursuant to an integrated plan, a newly formed
wholly owned subsidiary of an acquiring corporation merges into a target corporation,
followed by the merger of the target corporation into the acquiring corporation, the
transaction is treated as a single statutory merger of the target corporation into the
acquiring corporation that qualifies as a reorganization under 368(a)(1)(A).
APPLICATION

Pursuant to 7805(b)(8), the Service will not apply the principles of this revenue
ruling to challenge a taxpayer's position with respect to the treatment of a multi-step
transaction, one step of which, viewed independently, is a qualified stock purchase if:

(1) a timely (including extensions) and valid (without regard to whether there was
a qualified stock purchase under the principles of this revenue ruling) election under

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338(h)(10) or 338(g) (Election) is or was filed with respect to the acquisition of the
stock of the target corporation; and

(2) either

(a) the acquisition date for the target corporation is on or before
September 24, 2001; or

(b) the acquisition of stock of the target corporation meeting the
requirements of 1504(a)(2) by the purchasing corporation is pursuant to a written
agreement that (subject to customary conditions) is binding on September 24, 2001,
and at all times thereafter until the acquisition date; and

(3) such taxpayer does not take a position for U.S. tax purposes that is
inconsistent with the treatment of the acquisition as a qualified stock purchase with
respect to which the Election was made.

Further, the Service and the Treasury are considering whether to issue
regulations that would reflect the general principles of this revenue ruling, but would
allow taxpayers to make a valid election under 338(h)(10) with respect to a step of a
multi-step transaction that, viewed independently, is a qualified stock purchase if such
step is pursuant to a written agreement that requires, or permits the purchasing
corporation to cause, a 338(h)(10) election in respect of such step to be made. The
Service and the Treasury request comments regarding the adoption of such an
approach.

# EFFECT ON OTHER DOCUMENTS

Rev. Rul. 67-274 is amplified and Rev. Rul. 90-95 is distinguished.

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# DRAFTING INFORMATION

The principal authors of this revenue ruling are Reginald Mombrun and Joseph
M. Calianno of the Office of the Associate Chief Counsel (Corporate). For further
information regarding this revenue ruling, contact Mr. Mombrun on (202) 622-7750 (not
a toll-free call) or Mr. Calianno on (202) 622-7930 (not a toll-free call).