Merger qualifies as tax-free reorganization, despite surviving corporation's immediate sale of assets.

• Author: Fiore, Nicholas J.

Manufacturing corporation P is organized under the laws of state A. T is also a manufacturing corporation organized under A's laws. P organizes corporation S as a wholly owned A subsidiary of P, and S merges with (and into) T in a statutory merger. In the merger, the shareholders of T holding 90% of the T stock exchange their T stock for P voting stock. The remaining T shareholders receive $y for their T stock. Immediately after the merger and as part of a plan that includes the merger, T sells 50% of its operating assets for $z to X, an unrelated corporation. After the sale of the assets to X, T retains the sales proceeds. Without regard to the requirement that T hold substantially all of the assets of T and S, the merger satisfies all the other requirements applicable to reorganizations under Sec. 368(a)(1)(A) and (a)(2)(E).

Analysis

Sec. 368(a)(1)(A) states that the term "reorganization" means a statutory merger or consolidation. Sec. 368(a)(2)(E) provides that a transaction otherwise qualifying under Sec. 368(a)(1)(A) will not be disqualified by reason of the fact that stock of a corporation (the controlling corporation) that, before the merger was in control of the acquiring corporation, is used in the transaction, if (1) after the transaction, the corporation surviving the merger holds substantially all of its properties and the properties of the merged corporation (other than stock of the controlling corporation distributed in the transaction) and (2) in the transaction, former shareholders of the surviving corporation exchanged, for an amount of voting stock of the controlling corporation, an amount of stock in the surviving corporation that constitutes control of such corporation.

Regs. Sec. 1.368-2(j)(3)(iii) provides that the term "substantially all" has the same meaning as in Sec. 368(a)(1)(C). Rev. Rul. 88-48 held that the requirement of Sec. 368(a)(1)(C) that the acquiring corporation acquire "substantially all" of the properties of a target corporation is satisfied when, immediately prior to the target corporation's transfer of assets to the acquiring corporation, the target corporation sells 50% of its historic assets to unrelated parties for cash and immediately transfers that cash, along with its other properties, to the acquiring corporation. Sec. 368(a)(2)(E) uses the term "holds" rather than the term "acquisition" as do Sec. 368(a)(1)(C) and (a)(2)(D), because it would be inapposite to require the surviving corporation...