Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 75-3

1975-1 C.B. 108

Sec. 346

IRS Headnote

Partial liquidation; contraction of business. The termination of a contract representing 95 percent of the gross income of a domestic corporation resulted in a genuine contraction of the corporation's business and the distribution of cash, made available by the release of funds from a restricted account established under a credit agreement with a bank and representing the working capital attributable to the terminated business, in redemption of a portion of the corporation stock qualifies as a distribution in partial liquidation under section 346(a)(2) of the Code.

Full Text

Rev. Rul. 75-3

Advice has been requested whether a distribution, under the circumstances described below, qualifies as a distribution in partial liquidation under section 346(a)(2) of the Internal Revenue Code of 1954.

X, a domestic corporation, was engaged in the business of purchasing steel from foreign steel mills for resale to customers in the United States. All of the outstanding stock of X was owned by its president and his family. The major part of X's business consisted of purchasing steel for resale under a contract with a foreign steel manufacturer, Y corporation. X was able to obtain this contract because of its president's contacts, reputation, and relationship with the executive personnel of Y. Y could terminate the contract at will. The income earned by X under the contract accounted for 95 percent of X's gross income.

Upon X's sale of steel to a buyer, X would bill the buyer and the buyer would be required to make payment of the purchase price to X within 30, 45, 60, or 90 pays, depending on the terms of the invoice. Upon arrival of the steel in the United States, X would issue 30-day letter of credit, drawn on a United States bank which made available a line of credit to X for the letters of credit, payable to Y in the amount of the sales price of the steel. When X received payment from the purchaser of the steel, it would repay the amount of the letter of credit to the bank. As a condition for the establishment of the line of credit, the bank required that X keep a specified amount of money in a restricted account with the bank as security for the line of credit.

The president of X retired in July 1972 and Y terminated the contract with X immediately. The termination of the contract eliminated 95 percent of X's gross income and the services of three employees were no longer required. All receivables and all liabilities relating to the contract were satisfied, the credit agreement with the bank was cancelled, and the money in the restricted account was made available to X without restriction.

Pursuant to a plan adopted two months earlier, X in September 1973 made a pro rata distribution of cash to its shareholders in redemption of a portion of their X stock. The cash distributed was made available by the release of the funds in the restricted account established under the credit agreement with the bank and this amount represented working capital (the excess of current assets over current liabilities) attributable to X's activities under the contract with Y. There was no intention to expand the business of X and none of its assets have been sold or transferred to any related corporation.

Section 346(a)(2) of the Code provides, in part, that a distribution shall be treated as a partial liquidation of a corporation if it is not essentially equivalent to a dividend, is in redemption of a part of the stock of the corporation pursuant to a plan and occurs within the taxable year in which the plan is adopted or within the succeeding taxable year.

Section 1.346-1(a) of the Income Tax Regulations provides that a distribution which will qualify as a distribution in partial liquidation of a corporation under section 346(a)(2) of the Code is one which results from a genuine contraction of the corporate business.

Rev. Rul. 60-232, 1960-2 C.B. 115, holds that in a contraction qualifying pursuant to section 346(a)(2) of the Code, the qualifying amounts distributed will include not only the net proceeds derived from the sale of operating assets, or the operating assets themselves, but also includes that portion of the working capital (including cash) reasonably attributable to the business activity terminated.

It is held that the distribution in the instant case resulted from a genuine contraction of X's business and, therefore, the distribution qualifies as a distribution in partial liquidation under section 346(a)(2) of the Code.