The following article is reprinted from The M&A Tax Report, Vol. 12, No. 3, October 2003, Panel Publishers, New York, NY.


By Robert W. Wood and Dominic L. Daher

I've always thought that Section 351 transactions were relatively easy. Indeed, while there can be traps especially where there is debt, in the vast majority of cases, the Section 351 part of the transaction is a non-event. Not infrequently, taxpayers don't even ask for a ruling on the Section 351 transfers associated with a deal (for example, a spinoff).

Still, questions occasionally do arise, and a recent published ruling illustrates one of them. In Revenue Ruling 2003-51, 2003-21 IRB 1, Tax Analysts Doc. No. 2003-11263, 2003 TNT 87-16, the IRS ruled that the control requirement in a Section 351 transaction is satisfied when a corporation transfers controlling stock to a second corporation. The ruling is important because this subsequent transfer occurred under a prearranged and binding agreement. The transfer was accomplished to the second corporation at the same time that a third party also transferred assets to it. That leaves the transferor corporation and the third party in control of the second corporation.

The facts of the ruling involved two domestic corporations that were engaged in the same business. Seeking to consolidate their operations in a new holding company structure, they entered into a binding agreement. Under the agreement, one company transferred all of its business assets in exchange for all of the stock of the new corporation. This transferor then contributed all of that Newco stock to a subsidiary of the second domestic corporation.

The next step (and I use that term advisedly), involved the second domestic corporation contributing capital to its subsidiary in exchange for stock. The subsidiary exchanged the capital with the new corporation for stock. The Service noted that viewed independently, all four of these transfers satisfied Section 351 of the Code. The Service concluded, though, that the second transfer does not cause the first transfer to fail the control requirements. In fact, this blessing continues even though the second transfer was undertaken under a prearranged binding agreement.

Why? The Service reasoned in Revenue Ruling 2003-51 that treating a transfer of property that is succeeded by a nontaxable disposition of the stock received in a Section 351 transaction is not necessarily inconsistent with the purposes of Section 351. Consequently, the control requirement may be satisfied, even if the stock received in is transferred pursuant to a binding commitment in place upon the transfer of the property in exchange for stock.

Bye Bye Love, Bye Bye Happiness: Is Giving Up Flow-Through Taxation to Go Public Really Worth It?, by Robert W. Wood and Dominic L. Daher, Vol. 12, No. 3, The M&A Tax Report (October 2003), p. 5.