Securities exchanges incident to B reorgs.

• Author: Eisenberg, Andrew M.

On Feb. 23,1998, the IRS ended its self-imposed year-long moratorium on issuing subchapter C rulings when it issued Rev. Rul. 9810. Effective for exchanges occurring on or after March 9,1998, Rev. Rul. 98-10 involves the determination of whether the surrender of target debentures in exchange for acquiring debentures is subject to nonrecognition treatment if the acquiring and target corporations are both parties to the same reorganization under Sec. 368(a)(1)(B).

The facts of Rev. Rul. 98-10 (substantially similar to those in Rev. Rul. 69-142) involve Corporation X, which acquires A of the stock of Corporation Y in exchange for voting stock. Pursuant to the reorganization, X acquires all of the outstanding Y debentures in exchange for an equal amount of X debentures. Some of the Y debentures were held by Y shareholders, but a substantially portion were held by nonshareholders. The X and Y debentures are "securities" within the meaning of Sec. 354(a) (1) and, thus, are not equity interests.

In Rev. Rul. 69-142, the Service determined that the parties had undertaken a valid B reorganization, but that the exchange of the debentures was a separate, taxable exchange. The underlying legal memorandum for Rev. Rul. 69-142--GCM 34014--cited GCM 34004 in attempting to articulate the rationale for treating the debenture-for-debenture exchange as "not part of the reorganization exchange for purposes of sections 368(a)(1)(B) and 354(a)(1)." GCM. 34004 provided two theories. The first was that a separately bargained-for debenture-for-debenture exchange should be treated as separate. The facts of Rev. Rul. 69-142 did not indicate, however, whether the debenture-for-debenture exchange therein was separately bargained for. The second (and more plausible) theory was that, although the "solely-for-voting-stock" requirement must be tested by looking at indirect, as well as direct, payments to the transferor, payment of the target corporation's liability was not a receipt of nonstock consideration by a shareholder of the acquired corporation; see Rev. Rul. 68-637, which treated an exchange of options and warrants for options and warrants incident to a C reorganization as the assumption of a liability.

Rev. Rul. 69-142 specifically stated (the same statement appears in Rev. Rul. 98-10) that, although some of the Y shareholders also own Y debentures, a substantial portion of the Y debentures were owned by persons who own no Y stock. This statement, however, only...