Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 76-15

1976-1 C.B. 98

Section 306
Section 356
Section 368

IRS Headnote

Recapitalization; exchange involving section 306 stock and cash. In a recapitalization qualifying under section 368(a)(1)(E) of the Code, shareholders who exercise no control of a corporation whose stock is widely held and traded and, in arms length transactions, exchange their common stock for new common stock plus cash and also section 306 nonvoting preferred stock for new section 306 voting preferred stock are not considered as exchanging section 306 stock for money under section 356(e).

Full Text

Rev. Rul. 76-15

Advice has been requested concerning the treatment of cash received in a recapitalization, qualifying as a reorganization under section 368(a)(1)(E) of the Internal Revenue Code of 1954, under the circumstances described below.

Corporation X had outstanding 4,000x shares of common stock and 400x shares of nonvoting preferred stock. The preferred stock, when originally issued, was "section 306 stock" as defined in section 306(c) of the Code. Both the common and preferred stock of X were widely held and traded in the over-the-counter market. The ownership of the common and preferred stock was substantially disproportionate and those shareholders who held both classes of stock did not exercise any control of X.

For good business reasons, X consummated a recapitalization pursuant to a plan of reorganization that qualified as a reorganization under section 368(a)(1)(E) of the Code. The plan of reorganization, which was the result of extensive negotiations between the X shareholders and X, provided that each share of old X common stock was exchanged for 2 shares of new X common stock plus cash and the shares of old X preferred stock was exchanged for shares of new X preferred voting stock. The new preferred stock is section 306 stock, pursuant to section 306(c)(1)(B), to the extent that it was received in exchange for section 306 stock.

Section 354(a)(1) of the Code provides, in part, that no gain or loss will be recognized if stock in a corporation a party to the reorganization is, in pursuance of a plan of reorganization exchanged solely for stock in such corporation or in another corporation a party to the reorganization.

Section 356 of the Code provides rules for treating gain or loss where property (or money) is received as part of the exchange of stock described in section 354(a)(1).

Section 356(e) of the Code provides that notwithstanding any other provisions of section 356, to the extent that any of the other property (or money) is received in exchange for section 306 stock, an amount equal to the fair market value of such other property (or the amount of such money) shall be treated as a distribution of property to which section 301 applies.

Section 1.356-4 of the Income Tax Regulations states, in part, that the determination of whether section 306 stock is surrendered for other property (including money) is a question of fact to be decided under all of the circumstances of each case and that, ordinarily, the other property (including money) received will first be treated as received in exchange for any section 306 stock owned by a shareholder prior to such transaction.

In the instant case, the facts show that the exchange of the old section 306 stock for new preferred stock was negotiated at arms length between the X shareholders and X with such shareholders exercising no control of X. Furthermore, the section 306 stock does not disappear in the transaction since the new preferred stock is section 306 stock.

Accordingly, under the facts and circumstances of the instant case, the old section 306 stock is not considered as exchanged for money under section 356(e) of the Code.

Compare Rev. Rul. 76-14, page 97, this Bulletin, where a shareholder, who controls a corporation, exchanges, pursuant to a recapitalization under section 368(a)(1)(E) of the Code, common stock and preferred stock, which is section 306 stock, for cash and nonvoting common stock. Rev. Rul. 76-14 concludes that even though the exchange agreement stated that the cash was in exchange for the old X common stock this identification is meaningless because the exchange was not negotiated at arms length between unrelated parties but was directed by the shareholder who controlled the corporation.  Rev. Rul. 76-14 holds, pursuant to section 356(e) and 1.356-4 of the regulations, that the cash will first be considered as received in exchange for the section 306 stock.