rr-98-10.pdf

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Part I
Section 368.--Definitions Relating to Corporate Reorganizations
26 CFR 1.368-2: Definition of terms.
(Also § 354; § 1.354-1.)
Rev. Rul. 98-10
ISSUE
Where a stock for stock acquisition otherwise qualifying
under § 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 § 354(a)(1) and, thus, do not represent an
equity interest. Disregarding the exchange of debentures, the
transaction meets the requirements of § 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
§ 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 § 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,
§§ 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 § 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
§ 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 § 354. See
§ 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 § 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 § 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 § 354 applies to the exchange of warrants
provided that the warrants constitute securities. See § 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
§ 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 § 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).