Prearranged stock transfers qualify under Sec. 351.

• Author: O'Driscoll, David

E Corp. engages in businesses A, B and C. X Corp. (unrelated to E) also engages in business A, through Y, its wholly owned domestic subsidiary. E and X want to consolidate their A operations into a new corporation within a holding company structure. The fair market values (FMVs) of E's A, B and C businesses are $4, $3 and $3 million, respectively. The FMV of Y stock is $3 million.

Under a prearranged binding agreement with X:

1. E forms Z Corp. by transferring all of its A assets to g in exchange for all of the Z stock (the "first transfer").

2. E then contributes all of the Z stock to Y in exchange for Y stock (the "second transfer").

3. Simultaneous with the second transfer, X contributes $3 million to Y, to meet the capital needs of the A business, for additional Y stock (the "third transfer"). As a result, E and X own 40% and 60% of Y's stock, respectively.

4. Y then transfers the $3 million and its A assets to Z (the "fourth transfer").

Analysis

When viewed separately, the first transfer, the combined second and third transfers and the fourth transfer each qualifies under Sec. 351. However, became the first and second transfers are undertaken pursuant to a prearranged binding agreement, it is necessary to determine whether the second transfer causes the first one to fail to satisfy the Sec. 351 control requirement.

Sec. 351 is a deliberate attempt by Congress to facilitate the incorporation of ongoing businesses and to eliminate any economically unsound technical constructions (Hempt Bros., Inc., 490 F2d 1172 (3d Cir. 1974), cert. den.). It is intended to apply to "certain transactions where gain or loss may have accrued in a constitutional sense, but where in a popular and economic sense there has been a mere change in the form of ownership and the taxpayer has not really cashed in on the theoretical gain, or closed out a losing venture" (Portland Oil Co., 109 F2d 479 (1st Cir. 1940), cert. den). A transaction described under Sec. 351 "lacks a distinguishing characteristic of a sale, in that, instead of the transaction having the effect of terminating or extinguishing the beneficial interests of the transferors in the transferred property ... the transferors continue to be beneficially interested in the transferred property and have dominion over it by virtue of their control of the new corporate owner of it" (American Compress & Warehouse Co., 70 F2d 655 (5th Cir. 1934), cert. den.).

Courts have held that the Sec. 351 control...