S holding companies and F reorgs.

• Author: Brandt, Melanie

In yet another in a series of F reorganization rulings, the IRS issued Letter Ruling 200701017, holding that the formation of a new corporation, followed by the contribution of S stock and an immediate qualified subchapter S subsidiary (QSub) election, will be treated as an F reorganization (i.e., a mere change in identity, form or place of organization under Sec. 368(a)(1)(F)). The new corporation was created so that the existing one could distribute assets up to the new holding company to protect them from the existing corporation's potential liabilities. A mere distribution of the assets would have exceeded the accumulated adjustments account and created a taxable distribution of C corporation earnings and profits and, potentially, Sec. 311(b) gain.

Definition

Under Prop. Regs. Sec. 1.368-2(m) (1)(i), a mere change occurs if, as a result of a transaction or series of transactions:

1. All the stock of the resulting corporation, including stock issued before the transfer, is issued in respect of the transferring corporation's stock.

2. There is no change in the corporation's ownership in the transaction, except a change that has no effect other than that of a redemption of less than all of the corporation's shares.

3. The transferring corporation completely liquidates in the transaction.

4. The resulting corporation does not hold any property or have any tax attributes (including those specified in Sec. 381(c)) immediately before the transfer.

Prop. Regs. Sec. 1.368-2(m)(1)(ii) (A) allows an exception to the third item above, in that the transferring corporation is not required to legally dissolve. However, the regulation remains in proposed form; Treasury continues to examine the appropriate definition of a "mere change."

Application of Step-Transaction Doctrine

Prop. Regs. Sec. 1.368-2(m)(3)(i) also adopts historical application of the step-transaction doctrine to F reorganizations, treating a series of related transactions that together result in a mere change as an F reorganization. Further, the fact that an F reorganization occurs within a larger transaction that results in more than a mere change will not cause failure of the otherwise qualifying F reorganization; see Prop. Kegs. Sec. 1.368-2(m)(3)(ii). Precedent for this application is found in Rev. Ruls. 2003-48, 96-29, 79-250, 69-516 and 61-156.

These rulings generally discuss application of the step-transaction doctrine to the continuity-of-interest (COI) requirement. In Rev. Rul...