Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 72-71

1972-1 C.B. 99

Sec. 305
Sec. 307
Sec. 1223

IRS Headnote

Guidelines for determining basis, holding period, and gain or loss with respect to the issuance of transferable rights that entitle shareholders to purchase a debenture imprinted with a certificate for warrants to purchase additional shares of common stock.

Full Text

Rev. Rul. 72-71

Advice has been requested concerning the Federal income tax consequences of the transaction described below.

Corporation X, which has only one class of stock outstanding, issued transferable package rights (Rights) to its shareholders. One Right was issued for each share of X common stock held on the date of record. Upon exercise of thirty-five Rights and payment of $100 the holder received a $100 debenture with a temporary certificate imprinted thereon for two warrants to purchase additional shares of X common stock. The Rights expired thirty days after they were issued. Prior to expiration of a period ending six months after the Rights were issued, transfer of the debentures on the books of X also included transfer of the related warrants.

The debentures are thirty year debentures in the face amount of $100 and multiples thereof and bear interest at the going rate on the date that the Rights were issued. On the date of issuance of the Rights, the fair market value of a $100 debenture standing alone was $100. Therefore, as of the date of the distribution of the Rights their fair market value was attributable solely to the value of the warrants. Also, as anticipated, the fair market value of a $100 debenture standing alone did not vary substantially from $100 before expiration of the Rights. The fair market value of the Rights on the date of distribution was $1.00 each, which was less than 15 percent of the fair market value of a share of X stock on that date.

Six months after the Rights were issued, the warrants were issued to the holders of debentures. Two warrants were issued for each $100 principal amount of debentures owned. Each warrant entitles the holder to purchase one share of X stock from X for cash at a price slightly above the market price for a share of X stock at the time the Rights were issued. The warrants will expire approximately five years after their issuance.

Under the circumstances described above, it is held as follows:

(1) Under the provisions of section 305(d) of the Internal Revenue Code of 1954 the warrants are deemed to be stock of X. Since the fair market value of the Rights as of the date of their distribution was attributable solely to the value of the warrants, and since the distribution of the Rights was made by X with respect to its stock, the distribution of Rights did not result in gross income to the X shareholders under the provisions of section 305(a) of the Code.

(2) Since the fair market value of a Right on the date of distribution was less than 15 percent of the fair market value of a share of X stock on that date, a shareholder may elect to allocate basis to the Rights received if the Rights were exercised or sold. If such an election is made, the basis of the stock of X held by a shareholder is reduced. In the alternative, if no such election is made, no basis is allocated to such Rights and their basis will be zero. Similarly, in the event the Rights were neither sold nor exercised, the basis of the Rights is zero. If an election is made to allocate, the basis of the stock held on the record date is allocated both to the stock held and to the Rights received in proportion to the fair market values of the stock held and the Rights received. See section 307 of the Code and section 1.307-1 of the Income Tax Regulations.

(3) The holding period of the Rights is measured from the date of acquisition of the stock with respect to which the Rights were issued. See section 1223(5) of the Code.

(4) If the Rights distributed by X were sold by the recipient, gain or loss is recognized measured by the difference between the selling price and the basis of the Rights (if any) as determined above. If the Rights were allowed to expire without being exercised or sold, no deductible loss was sustained. No gain or loss is recognized upon the exercise of the Rights.

(5) The basis of each debenture acquired upon the exercise of the Rights is $100. The holding period of the debentures begins with the date the Rights were exercised.

(6) The basis of the warrants is equal to the basis allocated to the Rights (if any) as determined above plus the cost of any additional Rights that were purchased.

(7) The holding period of the warrants acquired upon the exercise of the Rights begins with the date of acquisition of the stock with respect to which the Rights were issued. See section 1223(5) of the Code.

(8) If the Rights were exercised and the warrants acquired are subsequently sold, gain or loss will be recognized measured by the difference between the selling price and the basis of the warrants (if any) as determined above. If the warrants expire without being exercised or sold, loss will be recognized to the extent of the basis allocated to the warrants (if any) as determined above. No gain or loss will be recognized upon the exercise of the warrants. (9) The basis of the stock acquired by exercise of the warrants will be equal to the basis of the warrants (if any) as determined above plus the subscription price paid for the new shares.

(10) The holding period of the stock acquired by exercise of the warrants begins with the date the warrants are exercised. See section 1223(6) of the Code.

(11) If the stock with respect to which the Rights were issued is a capital asset in the hands of the shareholder, any gain or loss specified in the holdings above will be gain or loss from the sale or exchange of a capital asset.