Internal Revenue Service
Revenue Ruling
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smRev. Rul. 56-50
1956-1 C.B. 174
Sec. 341
IRS Headnote
Where a corporation holding stock in a collapsible subsidiary corporation sells all of its stock in such subsidiary corporation and the gain on the sale of the stock is taxable as provided for in section 341(a) of the Internal Revenue Code of 1954, the gain realized by the shareholders of the holding corporation upon liquidation of the holding corporation is not taxable in the manner provided for in section 341(a) of the Code.
Full Text
Rev. Rul. 56-50
Advice has been requested as to the application of the provisions of section 341 of the Internal Revenue Code of 1954, relating to collapsible corporations, to a gain realized by stockholders of a corporation upon liquidation under the circumstances described below.
Two individuals, engaged in the construction business, undertook in 1951 to construct and operate five separate apartment buildings as a joint venture through corporations which they would control. Accordingly, they organized one corporation, issuing shares of stock therein to themselves equally, and five additional corporation, transferring to each of the five corporations one-fifth of a tract of land owned by one of the individuals, one F.H.A. mortgage commitment, and other items in exchange for all of the capital stock of each additional corporation. The shares of the five corporations were then transferred to the original corporation by the two shareholders as a contribution to capital. Construction of the first of the apartment buildings was begun in September, 1951, and the fifth and last building was completed in October, 1953. The stock in the five subsidiaries comprised virtually all of the assets of the parent corporation. Due to a dispute between the stockholders of the parent corporation, which resulted in court action, the court entered a judgment in 1954 ordering the dissolution of the joint venture, appointed trustees to take possession of the outstanding stock of the parent corporation, and directed that the assets of the corporation, consisting of the stock of the five subsidiaries, be liquidated and the proceeds of such liquidation be distributed by the trustees at such time and in such manner as the court should direct. The trustees did not cause any of the corporations, parent or subsidiaries, to adopt any resolution with respect to liquidation. Later in 1954, an individual not related in any way to either of the two shareholders purchased from the parent corporation, in a transaction to which section 337 of the Code does not apply, all of the outstanding shares of stock of the five subsidiaries for cash and promissory notes. At the time of the sale, all five apartment buildings were substantially occupied by tenants. The proceeds of the sale are to be distributed in liquidation of the parent corporation and, after payment of expenses and claims, are to be held by the trustees pending court determination of the conflicting rights and obligations of the two shareholders.
Under the provisions of section 341(b) of the Code, a `collapsible corporation' is defined as follows:
(b) DEFINITIONS.-
(1) COLLAPSIBLE CORPORATION.-For the purposes of this section, the term `collapsible corporation' means a corporation formed or availed of principally for the manufacture, construction, or production of property, for the purchase of property which (in the hands of the corporation) is property described in paragraph (3), or for the holding of stock in a corporation so formed or availed of, with a view to-
(A) the sale or exchange of stock by its shareholders (whether in liquidation or otherwise), or a distribution to its shareholders, before the realization by the corporation manufacturing, constructing, producing, or purchasing the property of a substantial part of the taxable income to be derived from such property, and
(B) the realization by such shareholders of gain attributable to such property.
Whether the five subsidiary corporations fall within the definition of a collapsible corporation is primarily a question of fact and hence is for determination upon the audit of the income tax return of the parent corporation for the year in which the stock of the subsidiaries was sold, rather than for issuance of a ruling, under the policy stated in section 6 of Revenue Ruling 57-172, C.B. 1954-1, 394, at 398.
The question has nevertheless been raised whether the parent corporation is a collapsible corporation on the assumption that the subsidiary corporations fall within the definition contained in section 341(b) of the Code. On that assumption, the gain of the parent corporation from its sale of the stock of the subsidiary corporations is required by section 341(a)(1) of the Code to be considered as gain from the sale or exchange of property which is not a capital asset, so that the corporate tax on the realization of ordinary income attributable to the constitution of property by the subsidiaries is not avoided.
It will be noted that section 341(b), supra , defines a collapsible corporation so as to include not only a corporation formed or availed of with a view to the realization by its shareholders of gain attributable to property produced by the corporation, as more fully set out therein, but also to include a corporation formed or availed of `for the holding of stock in a corporation so formed or availed of.' It will be further noted that section 341(b)(1)(A) of the Code refers only to the realization of income by the corporation producing the property. If, prior to such realization, the parent and subsidiary corporations are both liquidated or the stock of the parent corporation is sold, section 341 of the Code is automatically applicable to the parent corporation.
A literal reading of the statute would seem to produce the same result even though the parent corporation had first realized ordinary income by virtue of its sale of the entire stock of the collapsible subsidiary. Since the statute refers only to the realization of taxable income by the corporation producing the property, and not to any realization by the corporation holding its stock, it would appear under the literal language of the statute that the corporation holding stock of a collapsible corporation would still be a collapsible corporation even though it had been taxed as the shareholder of a collapsible corporation.
However, to impose the tax treatment provided for in section 341(a) of the Code twice as to the same underlying collapsible property would extend the statute beyond its intended purpose. The legislative history of section 117(m) of the Internal Revenue Code of 1939, as amended by section 326 of the Revenue Act of 1950, from which section 341 of the 1954 Code originally stems, makes it clear that the objective was to prevent the successful use of a device for converting ordinary income into long-term capital gain through the medium of a corporation. See H.R. Report No. 2319 and Senate Report No. 2375, Eighty-first Congress, C.B. 1950-2, pages 380 and 483, respectively, at pages 422, 449, 516, and 546. Where ordinary income is realized at the corporate level by the sale of the stock of a collapsible subsidiary, the evil at which the statute was aimed is not present and the effect of the literal interpretation suggested earlier would be to impose what would amount to a penalty tax at the shareholder level through requiring the gain attributable to property produced by a collapsible subsidiary to be taxed at both levels as ordinary income. There is no evidence in the legislative history that Congress intended such a result. Thus, it would be unreasonable to adopt the suggested literal interpretation, See Holy Trinity Church v. United States , 143 U.S. 457, at 459; Helvering v. New York Trust Company , 292 U.S. 455, at 464, Ct. D. 840, C.B. XIII-1, 188, at 190 (1934); Haggar Company v. Helvering , 308 U.S. 389, at 394, Ct. D. 1433, C.B. 1940-1, 237, at 239; and United States v. American Trucking Associations, Inc., et al. , 310 U.S. 534, at 543.
Accordingly, it is held that where a corporation holding stock in a collapsible subsidiary corporation sells all of its stock in such subsidiary corporation and the gain on the sale of the stock is taxable as provided in section 341(a) of the Code, the gain realized by the shareholders of the holding corporation upon liquidation of the holding corporation is not taxable in the manner provided for in section 341(a) of the Code.