Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 75-94

1975-1 C.B. 111

Sec. 354
Sec. 368

IRS Headnote

Reorganization; solely for voting stock; additional transfer. The non-recognition of gain or loss provisions of section 354 of the Code apply to additional voting stock transferred within one year of a section 368(a)(1)(B) reorganization to former shareholders of the acquired corporation to fulfill the original terms of the plan after discovery that the fair market value of the acquiring corporation's stock had been erroneously computed.

Full Text

Rev. Rul. 75-94

Advice has been requested whether, under the circumstances described below, the nonrecognition of gain or loss provisions of section 354 of the Internal Revenue Code of 1954 are applicable to the receipt of stock of the acquiring corporation by former shareholders of a corporation all of the stock of which was previously exchanged for stock of the acquiring corporation in a reorganization under section 368(a)(1)(B).

X corporation wanted to acquire all of the outstanding stock of Y corporation from the Y shareholders in exchange solely for voting stock of X in a transaction qualifying as a reorganization under section 368(a)(1)(B) of the Code. In negotiating the exchange, the Y shareholders asked for X stock in an amount equal to 1,000x dollars in exchange for all of their Y stock, which had a total fair market value of 1,000x dollars. X agreed. During the negotiations X represented that its earnings for the then current year (1973) would be approximately 6x dollars per share. This earnings representation was relied upon by the Y shareholders in the negotiations and was made part of a final agreement. The agreement stated the representation was taken into consideration by the Y shareholders in determining that 100x shares of X voting stock had a total fair market value of 1,000x dollars. In 1973 the Y shareholders exchanged all of their Y stock for a total of 100x shares of X voting stock pursuant to a plan of reorganization that required X to exchange shares with a total fair market value of 1,000x dollars. The transaction qualified as a reorganization under section 368(a)(1)(B) and no gain or loss was recognized to the Y shareholders on the exchange under section 354(a).

In 1974 the former Y shareholders discovered that X's representation concerning its earnings was based on an improper accounting practice. X corrected this practice for 1973. Its earnings were reduced to 4x dollars per share for that year. The former Y shareholders asserted that they were entitled to additional shares of X voting stock in order to satisfy the negotiated price of 1,000x dollars in value of X voting stock. This assertion was supported by federal and state securities laws.

Extensive negotiations between the former Y shareholders and X followed. As a result and by way of settlement of the dispute, an agreement was entered into between X and the former Y shareholders in 1974 pursuant to which X transferred additional shares of its voting stock to the former Y shareholders in that year in order to fulfill the original terms of the plan which called for X to transfer voting stock with a total fair market value of 1,000x dollars. The additional stock was received by the former Y shareholders within one year of the date of the 1973 reorganization exchange.

Section 354(a)(1) of the Code 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 a plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a part to the reorganization.

The issue is whether the additional shares of X voting stock were received by the former Y shareholders in pursuance of the plan of reorganization so that the nonrecognition provisions of section 354(a)(1) of the Code apply.

Section 1.368-2(g) of the Income Tax Regulations states, in part, that the term "plan of reorganization" is to be construed as limiting the nonrecognition of gain or loss to exchanges or distributions that are directly a part of the reorganization described in section 368(a) of the Code.

Since the shares of X voting stock were received by the former Y shareholders to fulfill the original exchange price which called for 1,000x dollars in value of X voting stock, such stock was directly a part of, and received pursuant to, the plan of reorganization within the meaning of section 1.368-2(g) of the regulations and Section 354(a)(1) of the Code.

Accordingly, section 354(a)(1) of the Code applies to the receipt of the additional X voting stock by the former Y shareholders and no gain or loss is recognized to them on the receipt of such stock. Because the additional shares were received within one year after the reorganization exchange, section 483 will not apply to the receipt (see 1.483-1(e)(1) of the regulations). Pursuant to section 358 (a)(1), the basis of the shares of X voting stock received by the former Y shareholders, including the additional X voting stock received, is the same as the basis in the shares of Y stock exchanged therefor.