Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 76-42

1976-1 C.B. 102

Section 61
Section 165
Section 368

IRS Headnote

Reorganization; escrowed stock forfeited by acquired corporation's sole shareholder. The return of escrowed stock of an acquiring corporation received, in a reorganization under section 368(a)(1)(B) of the Code, by the sole shareholder of an acquired corporation due to the failure of the acquired corporation to attain specified earning levels does not result in the realization of gain or loss by the shareholder.

Full Text

Rev. Rul. 76-42

Advice has been requested whether, under the circumstances described below, gain or loss is realized by a shareholder on the forfeiture of shares of escrowed stock issued to the shareholder in a reorganization under section 368(a)(1)(B) of the Internal Revenue Code of 1954.

Under an agreement and plan of reorganization entered into on January 1, 1970, the taxpayer, the sole shareholder of X corporation, exchanged all of the shares of stock in X for a specified number of shares of voting common stock of Y corporation. Under the terms of the agreement a total of 300,000 shares of Y common stock were issued to the taxpayer in a transaction that qualified as a reorganization pursuant to section 368(a)(1)(B) of the Code, and no gain or loss was recognized to the taxpayer on the exchange pursuant to section 354(a).

As part of the plan of reorganization, the taxpayer immediately placed 100,000 shares of the Y stock in escrow. All the shares placed in escrow were issued in the name of the taxpayer who was entitled to vote the escrowed shares as well as receive all dividends paid with respect thereto. The taxpayer included in income all dividends paid with respect to the escrowed stock in the year received.

The escrow agreement provided that all or a portion of the escrowed stock was to be returned to Y within three years if X's net profits did not exceed certain reasonably attainable amounts specified in the agreement. The number of shares to be returned was based on their initial negotiated value, and the taxpayer had no right to substitute other property for the escrowed stock in the event of a repossession.

At the end of the escrow period, all 100,000 shares placed in escrow were returned to Y corporation due to the failure of X corporation to attain the earning levels specified in the agreement. At the time of the return of the 100,000 shares of escrowed Y stock, the taxpayer still held the 200,000 shares of Y stock issued on January 1, 1970, in the plan of reorganization.

Section 61(a)(3) of the Code provides that gross income includes gain derived from dealings in property.

Section 165(a) of the Code allows, with certain limitations, deductions for losses sustained.

The question presented is whether the taxpayer realized gain or loss under the foregoing provisions upon return of the escrowed shares to Y corporation.

It is held that the taxpayer realized no gain or loss upon the return of the escrowed shares. Because the number of shares to be returned was based on their initial negotiated value and the taxpayer had no right to substitute other property for the escrowed stock in the event of a repossession, the taxpayer received no benefit or detriment from any change in value of the escrowed shares, and thus the taxpayer did not realize any gain or loss upon their return to Y. In addition, no loss may be claimed based on the fair market value of the returned shares because the return represented an adjustment of the amount of consideration received by the taxpayer for the X stock pursuant to the plan of reorganization. The adjusted basis of the returned shares is added to the adjusted basis of the 200,000 remaining shares of Y stock received by the taxpayer in the reorganization. Compare example (8) of section 1.483-1(b)(6) of the Income Tax Regulations and Rev. Rul. 75-94, 1975-1 C.B. 111.