rr-01-25.pdf

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# Part I

Section 368. -- Definitions Relating to Corporate Reorganizations

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

Rev. Rul. 2001-25

## ISSUE

On the facts below, does a merger fail to qualify as a tax-free reorganization
under §§ 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 §§ 368(a)(1)(A) and 368(a)(2)(E).

LAW AND ANALYSIS

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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 § 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 § 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 § 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 §§ 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

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§ 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 § 368(a)(1)(C) or a
reorganization under §§ 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 § 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 §§ 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.

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# HOLDING

On the facts above, a merger qualifies as a tax-free reorganization under
§§ 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 on (202) 622-7550 (not a toll-free
call) or Mr. Calianno on (202) 622-7930 (not a toll-free call).