Internal Revenue Service
Revenue Ruling
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smRev. Rul. 54-65
1954-1 C.B. 101
Sec. 368
Sec. 1036
IRS Headnote
Special stock of one series exchanged for special stock of another series issued by the same corporation operating as a regulated investment company, where each series is wholly dependent for its earnings and liquidating value upon entirely different underlying assets, gives rise to a taxable gain or deductible loss on the exchange. The fact that a plan of reorganization provides that such conversion may be made within 90 days after the effective date of a corporate recapitalization will not make the exchange nontaxable under the provisions of section 112(b)(3) of the Internal Revenue Code.
Full Text
Rev. Rul. 54-65
Advice is requested relative to the effect, for Federal income tax purposes, of an exchange by a holder of special stock of one series in a regulated investment company for special stock in another series issued by the same company under circumstances set forth below.
The certificate of incorporation of the M Company, organized and registered as a regulated investment company as defined in section 361 of the Internal Revenue Code, authorizes the issuance of 1 x shares of common stock and 100 x shares of special stock, the latter to be issued in one or more series pursuant to action by the Board of Directors. The Board of Directors subsequently authorized the issuance of the special stock in several series. Each share of each class of stock has equal voting rights with all other shares of all other classes. Each series is named for the type of investments purchased with the funds obtained from the sale of the special stock of that series. The underlying assets of each series, representing the investment of the proceeds from the sale of shares and the undistributed earnings and profits therefrom are segregated upon the books of account. The holders of shares of any designated series have no interest in the assets or income of any other series. Each series is charged with its equitable proportions of the expenses and liabilities of the corporation. Shares of any series are redeemable at their current net asset value and are also convertible into shares of any other series at their relative net asset values.
Pursuant to a plan of reorganization the management of the M Company proposes to eliminate the various series of the old special stock by reclassifying the capital structure into three general management series. The shares of all previously existing series of special stock will be reclassified according to the type of investment represented thereby into shares of one of the three new categories. The conversion privileges of the old series will be eliminated. However, the plan provides that for a limited period of 90 days after the effective date of the recapitalization a holder of shares of any of the three new series may convert them into shares of either of the other series at net asset value. Immediately prior to the reorganization all accumulated income and net realized capital gain in each of the old series will be declared payable to the stockholders as ordinary income and as capital gain dividends.
The question presented is whether (1) the reclassification of the existing classes of special stock at the date of recapitalization and (2) the conversion of the new stock into shares of either of the other series of new stock within 90 days after the effective date of the recapitalization will constitute exchanges of property within the meaning of sections 112(a), (b)(2), and (b)(3) of the Code which read as follows:
SEC. 112. RECOGNITION OF GAIN OR LOSS.
(a) GENERAL RULE.-Upon the sale or exchange of property the entire amount of the gain or loss, determined under section 111, shall be recognized, except as hereinafter provided in this section.
(b) EXCHANGES SOLELY IN KIND.-
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(2) STOCK FOR STOCK OF SAME CORPORATION.-No gain or loss shall be recognized if common stock in a corporation is exchanged solely for common stock in the same corporation, or if preferred stock in a corporation is exchanged solely for preferred stock in the same corporation.
(3) STOCK FOR STOCK ON REORGANIZATION.-No gain or loss shall 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 such corporation or in another corporation a party to the reorganization.
On the basis of the foregoing it is held that the reclassification of the existing classes of special stock pursuant to the plan described will constitute a reorganization within the meaning of section 112(g) of the Code. Accordingly, under the provisions of section 112(b)(3) of the Code, no taxable gain or deductible loss will be recognized to a holder of special stock as the result of the exchange by him, pursuant to the plan, of such stock for the new reclassified stock, except that gain will be recognized in an amount not in excess of cash received in lieu of fractional shares.
With respect to the rights granted under the plan of reorganization to convert new stock into either of the other series of new stock within 90 days after the effective date of the recapitalization it is held that such exchanges will not qualify for tax-free treatment under section 112(b)(3) of the Code. Section 39.112(g)-1 of Regulations 118 provides in part that a plan of reorganization must contemplate a transaction specifically described as a reorganization in section 112(g) to claim nonrecognition under section 112(b)(3). In the instant case the conversion privilege granted to holders of new stock to exchange such stock for other stock of a different series within a limited time after the effective date of the plan does not appear to be an essential part of the plan of reorganization but rather an independent transaction whereby the stockholders are given the election to exchange their holdings for others of their choice. In this connection see ACF-Brill Motors Co. v. Commissioner , 14 T.C. 263, affirmed 189 Fed.(2) 704, certiorari denied, 342 U.S. 886, and American Bantam Car Co. v. Commissioner , 11 T.C. 397, affirmed, 177 Fed.(2d) 513, certiorari denied, 339 U.S. 920.
It is held further that the exchange of the new stock in the instant case for new stock of another series does not meet the requirements of section 112(b)(2) of the Code. The right of conversion granted by the plan of reorganization is not the right to convert the stock held, share for share, for stock of another series, but only the right to obtain the number of shares of another series equal in value to the market value of the shares to be exchanged. Moreover, the exception to recognition of gain or loss provided by section 112(b)(2) of the Code is applicable only when common or preferred stock is exchanged for like stock in the same corporation.
The special stock in the instant case, both before and after the recapitalization is not common stock since the holders thereof do not share ratably either in the earnings of the corporation or in its assets on liquidation, it being specifically provided that the holders of shares of any designated series have no interest in the assets or income of any other series. Furthermore, the certificate of incorporation provides for the issuance of common stock, which stock has the normal characteristics of common stock and is entirely separate and distinct from any of the classes of special stock therein considered. Neither is the special stock a preferred stock since the holders thereof are not preferred as to dividends out of the entire earnings of the corporation and are restricted to the earnings of the segregated assets representing his particular class of special stock. Likewise the holder of special stock has no preference in the general assets of the corporation on liquidation, excepting the right to share ratably with other members of his class in the segregated assets representing that particular class of special stock. Consequently an exchange of special stock for special stock of a different series represents a taxable exchange of property, the gain or loss from which would not be precluded from recognition for Federal income tax purposes by section 112(b)(2) of the Internal Revenue Code.