Subsequent dropdowns to partnerships in corporate reorganizations.

• Author: Mahoney, Edward J.

Often a corporation enters into an acquisition of a target company with a desire to use the acquired assets or stock in a joint venture with an unrelated party. Under current IRS policy, this type of transaction can be an obstacle for corporations trying to qualify the acquisition as tax-free under Sec. 368.

The Service recently released proposed regulations under Sec. 368 that would allow an acquiring corporation in certain types of reorganizations to transfer the target assets or stock to controlled corporations and, under certain circumstances, to partnerships. Such transfers would not disqualify the transaction from satisfying the continuity-of-interest or continuity-of-business doctrines required in all reorganizations.

Continuity of Interest

Dropdowns into controlled corporations or partnerships after a reorganization often have been disqualified by the IRS because of the "remote continuity of interest doctrine" described in Groman, 302 US 82 (1937), and Helvering v. Bashford, 302 US 454 (1938). These Supreme Court decisions held that stock consideration received by a target corporation's shareholders did not provice continuity, unless the target's assets or stock were ultimately held by the corporation that issued the stock.

As discussed in the preamble to the proposed regulations, the Service has, in prior years, issued several revenue rulings disqualifying an otherwise qualifying reorganization for failure to meet the "remote continuity of interest" doctrine because of subsequent transfers to corporations; in response to these rulings, Congress enacted legislation that would allow these particular transactions. However, these rulings and legislative responses all involved situations in which the ultimate recipients of the target's assets or stock were corporations, not partnerships.

Except in very limited situations, the IRS has persisted in applying the remote continuity doctrine to circumstances involving partnerships. For example, in GCM 35117 (1972), corporation U was to merge into corporation S in a statutory merger under state law. Pursuant to the plan of reorganization, the assets and liabilities of former corporation U were to be transferred by S to P, a limited partnership in which S was the sole general partner. The Service concluded that the proposed merger would not qualify as a tax-free reorganization, because S would not be a"party to the reorganization" within the meaning of Sec. 368(b).

The IRS reasoned that, under...