*156 Ps were shareholders of M. M was a domestic corporation, and MI was its wholly-owned foreign subsidiary. The boards of directors of M and MI decided to take advantage of the lower income tax rates available in the areas outside the United States in which MI operated by changing the corporate structure so that MI would become the parent corporation and M the subsidiary. To effect the change, MI gave 30 million shares of its common stock plus $ 0.35 per share (a total of $ 10,500,000) to the shareholders of M, including Ps, in return for 30 million shares of the common stock of M. After the exchange, MI held approximately 68 percent of the voting power in M and the former holders of M common stock who participated in the exchange owned approximately 90 percent of the voting power in MI. Held, the shares of MI stock received by Ps do not constitute "property" within the meaning of
*960 OPINION
This matter is before the Court on the parties' cross-motions for partial summary judgment*157 pursuant to
All the facts have been agreed upon (stipulated) for purposes of these
Petitioners Rohinton and Patricia Bhada were residents of Alliance, Ohio, and petitioners Edward and Janice Caamano were residents of New Orleans, Louisiana, when the petitions in these cases were filed. There are approximately 87 docketed cases in this Court involving the same transaction, and these two cases have been identified as test cases for the purpose of resolving*158 the preliminary issue concerning the applicability of
*961 McDermott, Inc. (McDermott), was a Delaware corporation at all relevant times. From 1959 until December 10, 1982, McDermott was the parent corporation to a group of corporations hereinafter referred to as the McDermott Group. From 1959 until December 10, 1982, McDermott International, Inc. (International), was a wholly owned subsidiary of McDermott and a controlled foreign corporation within the meaning of section 957.
Pursuant to a plan of reorganization adopted on October 28, 1982, by the boards of directors of McDermott and International, International made an offer to exchange cash and shares of its own stock (International common) for shares of the common stock of McDermott (McDermott common). International distributed a prospectus dated November 24, 1982 (the prospectus), which stated the terms and conditions on which the offer was made.
The prospectus stated:
The principal purpose of the reorganization is to enable the McDermott Group to retain, reinvest and redeploy earnings from operations outside the United States without subjecting such earnings to United States*159 income tax. This will enable the McDermott Group to compete more effectively with foreign companies by taking advantage of additional opportunities for expansion which require long-term commitments, the redeployment of assets and the reinvestment of earnings. The reorganization will also result in direct shareholder participation in the accumulated and future profits of International earned abroad rather than shareholder participation in such foreign earnings only after they are first distributed to the Delaware Company and subjected to corporate income tax at a rate substantially higher than the average rate prevailing in the areas in which International operates. Finally, the reorganization will permit International to invest its accumulated foreign earnings in the United States without Federal income tax being imposed on the Delaware Company upon the making of such investment.
* * * *
The aggregate amount reported by [McDermott] as Subpart F income of International in the five years ended March 31, 1982 was approximately $ 20,000,000 and the aggregate United States income tax imposed thereon was approximately $ 9,000,000. * * * If, however, the business of International continues*160 in its present form and at levels now anticipated by management for the five succeeding years, it is anticipated that the aggregate Subpart F income generated by International will be approximately $ 585,000,000 for such years and the aggregate United States income tax imposed on that total amount would (at currently prevailing rates) be approximately $ 220,000,000. In the opinion of Davis Polk & *962 Wardwell, United States Counsel to International, the reorganization, under present laws and regulations, will enable the McDermott Group to avoid future Subpart F income tax costs because, after the exchanges pursuant to the offer, International will no longer be a CFC [controlled foreign corporation].
Under the terms of the offer, International was to exchange 1 share of International common plus $ 0.35 for each outstanding share of McDermott common. The offer was conditioned upon the tendering of a minimum of 22 million shares of McDermott common. International also retained the right to refuse to accept more than 30 million shares of McDermott common.
On December 10, 1982, International accepted, pursuant to the terms of the offer, all shares of McDermott common tendered *161 by each shareholder holding 99 or fewer of such shares and accepted a portion of all the shares of McDermott common tendered by each shareholder holding 100 or more of such shares, as was determined on the terms concerning proration stated in the Prospectus. International acquired 30 million shares of McDermott common for which it gave $ 10,500,000 and 30 million shares of International common. As a result of the exchange, International held approximately 68 percent of the voting power in McDermott, and former holders of McDermott common who participated in the exchange held approximately 90 percent of the voting power in International.
Petitioners participated in the December 1982 transactions. In response to the offer, petitioners Rohinton and Patricia Bhada tendered to International 26 shares of McDermott common and received in return 26 shares of International common and $ 9.10 in cash. Petitioners Edward and Janice Caamano tendered to International 50 shares of McDermott common and received in return 50 shares of International common and $ 17.50 in cash. On December 10, 1982, the fair market value of one share of International common was $ 19.
*162 (2) Acquisition by subsidiary. -- For purposes of
(A) in return for property, one corporation acquires from a shareholder of another corporation stock in such other corporation, and
*963 (B) the issuing corporation controls the acquiring corporation,
then such property shall be treated as a distribution in redemption of the stock of the issuing corporation.If
For purposes of this part, the term "property" means money, securities, and any other property; except that such term does not include stock in the corporation making the distribution (or rights to acquire such stock).
The receipt of stock of a corporation which is not stock of the distributing corporation is "property." See H. Rept. 1337, 83d Cong., 2d Sess. A 100 (1954).
*165 Respondent argues that the true nature of the transaction between International and petitioners was an exchange of International common for McDermott common rather than a distribution by International of its stock in exchange for McDermott common. It is respondent's position that the term "distribution" in
The terms "property" and "distribution" are defined in
*965 At first glance, it is difficult to determine whether the term distribution in
(B) Certain assumptions of liability, etc. --
(i) In general. -- In the case of an acquisition described in
(I) assumed by the acquiring corporation, or
(II) to which the stock is subject,
if such liability was incurred by the transferor to acquire the stock. *167 For purposes of the preceding sentence, the term "stock" means stock referred to in paragraph (1)(B) or (2)(A) of subsection (a).
From this it follows that International "distributed" its own stock to petitioners in the December 1982 exchange, and that such stock is not to be deemed property. *168 This is because the International common was the stock of the corporation making the distribution, it was not property, and
*966 Respondent contends, however, that
Paragraph (3) was added to
*171 Before
To prevent such a circumvention of
The conference agreement extends the anti-bailout rules of
[H. Rept. 97-760 (Conf.) (1982), to accompany H.R. 4961 (Pub. L. 97248),
Thus, it appears from the Conference report that Congress was concerned only with the treatment of property *968 received in a transaction that fell under the provisions of both
Respondent maintains that
The legislative history of
(2) Redemption through use of subsidiary corporation. *174 -- If stock of a corporation (hereinafter referred to as the issuing corporation) is acquired by another corporation (hereinafter referred to as the acquiring corporation) and the issuing corporation controls (directly or indirectly) the acquiring corporation, the amount paid for the acquisition of the stock shall constitute a taxable dividend from the issuing corporation to the extent that the amount paid for such stock would have been considered, under paragraph (1), as essentially equivalent to a taxable dividend if such amount had been distributed by the acquiring corporation to the issuing corporation and had been applied by the issuing corporation in redemption of its stock. For the purposes of this paragraph, control means the ownership of stock possessing at least 50 per centum of the total combined voting power of all classes of stock entitled to vote or at least 50 per centum of the total value of shares of all classes of stock of the corporation.
In enacting
Had Congress reenacted the actual language of 115(g)(2), it is arguable that the International common received by petitioners would have to be tested for dividend equivalency under the provisions of
Congress, however, did not adopt the language of
Our conclusion comports with the purpose of
The committee reports reveal Congress' intent to prevent sale or exchange treatment in cases in which assets of a subsidiary are withdrawn from corporate solution in exchange for stock of its parent.
[In Wanamaker,
If the stockholders of a corporation which owns all the stock of a subsidiary corporation obtain cash from that subsidiary, in effect they have received a dividend to the same extent as would be the case if the cash had been * * * distributed by the parent to the stockholders. * * *
[H. Rept. 2319, 81st Cong., 2d Sess. A53 (1950),
See also S. Rept. 2375, 81st Cong., 2d Sess. 42-43 (1950),
In this case, the cash received by petitioners constitutes assets withdrawn from International in exchange for stock of its parent, McDermott, and the parties agree that
Respondent argues, to the contrary, that the abuse in Wanamaker that Congress sought to remedy was the automatic capital gain characterization of an indirect redemption of a parent corporation's stock through an exchange between its subsidiary and its shareholders. Respondent maintains that both
In enacting
Respondent relies on
The issue in Radnitz concerned the receipt of cash for stock of a related corporation. The Second Circuit made no comment concerning the receipt of stock of the acquiring corporation in return for stock of a related corporation. In fact, respondent, himself, has conceded that
Respondent also relies on
Except [for situations not relevant in this case
At first glance
*972 A regulation may not go beyond the purview of the statute or create a rule that is out of harmony with the statute.
We believe that
(a) If a subsidiary acquires stock of its parent corporation from a shareholder*183 of the parent corporation, the acquisition of such stock shall be treated as though the parent corporation had redeemed its own stock. For the purpose of this section, a corporation is a parent corporation if it meets the 50 percent ownership requirements of
The first sentence of
The reference in the fourth sentence of the regulation to "the property" given by the subsidiary makes it evident that
Finally, respondent maintains that if
*186 Moreover, the transaction in this case differs from the exchange envisioned by respondent.
Had McDermott redeemed its stock and issued 30 million shares of International to petitioners, the corporations would have split up. As a result of the redemption, petitioners would have held an equity interest in International and would have given up most of their interest in McDermott.
In this case, however, petitioners exchanged their McDermott stock with International for stock in International. After this transaction, International became the parent of McDermott, and petitioners became the owners of a direct equity interest in the operations of International and an indirect equity interest in the operations of McDermott.
A transaction in which a parent redeems its own stock by distributing the stock of a subsidiary divides the corporations, and assets are withdrawn from the parent. The redeeming shareholders can bail out corporate assets in such a transaction by selling off the stock of the subsidiary. The result can be equivalent to a distribution of a dividend. Accordingly, a division actually effected by such a transaction is generally tested for dividend equivalance under
*976 The transaction in this case, however, was not divisive, and, therefore, the anti-bailout provisions of
Respondent maintains, however, that a holding for petitioners in this case will permit other taxpayers to bail out assets from corporate solution. In support of his argument, respondent presents two hypothetical examples. Respondent's*188 first example involves an exchange of stock as follows:
Assume that P Corp. owns all the stock of its subsidiary, S Corp. S Corp. has no other class of stock. The value of P is ten times greater than the value of S. The P shareholders desire to cash in on the stock of S at capital gains rates. To this end, S offers to exchange newly created shares of itself (the same class of stock) representing 80 percent of the voting power in S to P's shareholders for shares of P on a value-for-value basis. The P shareholders participate in the exchange with the intent of later disposing of the stock of S at capital gains rates. A direct distribution would have been taxed under
Respondent's second example involves the receipt of preferred stock of the subsidiary by shareholder of the parent, as follows:
Suppose P corporation owns all the stock of S corporation and that P and S each have substantial earnings and profits. P's shareholders want to receive the economic benefit of these earnings but * * * want to avoid dividend treatment. To this end, they cause S to acquire from each of them 10 percent of their respective P shareholdings in exchange solely for nonvoting limited preferred stock of S. * * * Sometime after the exchange, the P shareholders sell all of their S preferred stock for cash to unrelated third parties. Absent the application of
Respondent may have discovered a potential for bailout under the provisions of
*191 Moreover, it seems apparent that the bailout potential perceived by respondent in his examples can be achieved by a value-for-value exchange of stock or an exchange of common stock for preferred between brother and sister corporations, and respondent has conceded that
To reflect the foregoing,
An appropriate order will be issued.
Footnotes
1. All Rule references are to the Tax Court Rules of Practice and Procedure. Unless otherwise indicated, all section references are to the Internal Revenue Code in effect during the years in issue.↩
*. The shareholders of P acquired no control of S in the exchange. Control of S continued to be vested exclusively in P. Thus, the control prerequisite to application of
sec. 351 was not satisfied.Sec. 351↩ must apply to the exchange in order for par. 306(c)(3) to be applicable.2.
Sec. 351 does not apply in this case because of the failure to meet the 80-percent control requirement ofsec. 351 . Although the former McDermott shareholders owned 90 percent of the total voting power in International after the December 1982 exchange, they did not own at least 80 percent of the total of all other classes of stock of International. McDermott, at all relevant times, owned all of the shares of a class of nonvoting preferred stock of International. Respondent speculates that ifsec. 304↩ does not apply to the December 1982 transaction, the former shareholders of McDermott will suffer no adverse tax consequences and will in many cases recognize a loss for tax purposes.3. The issue in this case, whether the stock of a subsidiary corporation received in a transaction described by
sec. 304(a)(2) constitutes property, is before this Court for the first time. In the context of a brother-sister transaction described insec. 304(a)(1) , however, one member of this Court has indicated in a "speaking separately" opinion that in his view the stock of the acquiring corporation is not property. SeeHaserot v. Commissioner, 46 T.C. 864">46 T.C. 864 , 874 (1966), affd. sub nom.Commissioner v. Stickney, 399 F.2d 828 (6th Cir. 1968) (Tannenwald, J., speaking separately) (the purpose ofsec. 317(a) was to avoid treating as a distribution undersecs. 301(a) and302(d) the value of stock distributed by the acquiring corporation). Respondent has concurred in the opinion that, in brother-sister transactions described insec. 304(a)(1) , the stock of the acquiring corporation is not property. See, e.g., sec. 5.08,Rev. Proc. 83-22, 1 C.B. 680">1983-1 C.B. 680 , 686; sec. 5.04,Rev. Proc. 82-22, 1 C.B. 469">1982-1 C.B. 469 , 473; sec. 2,Rev. Proc. 81-61, 2 C.B. 683">1981-2 C.B. 683 . ("Property, [for purposes ofsecs. 304 and351 ], is defined insec. 317(a) and, in general, * * * excludes stock of the transferee.") (Respondent insists that these Revenue Procedures refer only to transactions described insection 304(a)(1) even though the Revenue Procedures themselves draw no distinction betweensections 304(a)(1) and304(a)(2) .) See alsoRev. Rul. 73-2, 1 C.B. 171">1973-1 C.B. 171 ;Rev. Rul. 78-422, 2 C.B. 129">1978-2 C.B. 129 .The commentators are split on this issue. Bittker and Eustice conclude that the stock of the subsidiary received in a
sec. 304(a)(2) transaction is not property. B. Bittker & J. Eustice, Federal Income Taxation of Corporations and Shareholders, par. 9.32, at 9-53 - 9-54 (4th ed. 1979). Frost and Burns agree. F. Frost & D. Burns, "Current Tax Problems While Operating as a Corporation," 1958 S. Cal. Tax Inst. 117, 158 (1958).Tiger, on two different occasions, has argued (1) that the stock of a subsidiary received in a
sec. 304(a)(2) transaction is property; and (2) that it is not property. Tiger, "Sales of Stock to Related Corporations: Current Problems UnderSection 304 ,"40 J. Tax 86, 87 (1974) (stock of the acquiring corporation is not property); Tiger, "Redemption Through the Use of Related Corporations: New and Old Problems UnderSection 304 ,"39 Tax L. Rev. 79">39 Tax L. Rev. 79↩ (1984) (stock of a subsidiary issued by the subsidiary to shareholders of the parent in exchange for the parent's stock is property).4. Because we hold for petitioners in this case, we need not address their other arguments.↩
5. Sec. 712(1) of the Deficit Reduction Act of 1984, Pub. L. 98-369, 98 Stat. 494, 953, amended
secs. 304(b)(3)(A) and304(b)(3)(B)↩ . The amendments do not affect the result in this case.6.
Sec. 351 provides in pertinent part:SEC. 351 . TRANSFER TO CORPORATION CONTROLLED BY TRANSFEROR.(a) General Rule. -- No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation and immediately after the exchange such person or persons are in control (as defined in section 368(c)) of the corporation.
(b) Receipt of Property. -- If subsection (a) would apply to an exchange but for the fact that there is received, in addition to the stock or securities permitted to be received under subsection (a), other property or money, then --
(1) gain (if any) to such recipient shall be recognized, but not in excess of --
(A) the amount of money received, plus
(B) the fair market value of such other property received; and
(2) no loss to such recipient shall be recognized.↩
7. Respondent has also concluded that in a transaction involving the overlap of
secs. 304 and351 ,sec. 351 will apply only to the extent that the transaction consists of an exchange of stock for stock in the acquiring corporation. See, e.g.,Rev. Rul. 73-2, 1 C.B. 171">1973-1 C.B. 171 ;Rev. Rul. 78-422, 2 C.B. 129">1978-2 C.B. 129 . Respondent maintains, however, that these Revenue Rulings are applicable only to transactions involving brother-sister corporations described insec. 304(a)(1) and do not apply to parent-subsidiary transactions described insec. 304(a)(2)↩ .8. Both
sec. 115(g)(2) andsec. 304(a)(2)↩ would apply, for example, if a subsidiary were to acquire its parent's stock for cash.9.
Sec. 115(g)(2) applies in terms of "the amount paid" for the parent's stock. Presumably the form of payment could have included the subsidiary's stock, although the legislative history makes it clear that Congress was targeting the stock-for-cash type of transaction exemplified byRodman Wanamaker Trust v. Commissioner, 11 T.C. 365 (1948) , affd.178 F.2d 10">178 F.2d 10 (3d Cir. 1949), when it enactedsec. 115(g)(2) . See discussion in text, infra↩.10.
Sec. 355 provides in pertinent part:SEC. 355 . DISTRIBUTION OF STOCK AND SECURITIES OF A CONTROLLED CORPORATION.(a) Effect on Distributees. --
(1)General rule. -- If --
(A) a corporation (referred to in this section as the "distributing corporation")
(i) distributes to a shareholder, with respect to its stock, or
(ii) distributes to a security holder, in exchange for its securities,
solely stock or securities of a corporation (referred to in this section as "controlled corporation") which it controls immediately before the distribution,
(B) the transaction was not used principally as a device for the distribution of the earnings and profits of the distributing corporation or the controlled corporation or both (but the mere fact that subsequent to the distribution stock or securities in one or more of such corporations are sold or exchanged by all or some of the distributees (other than pursuant to an arrangement negotiated or agreed upon prior to such distribution) shall not be construed to mean that the transaction was used principally as such a device),
(C) the requirements of subsection (b) (relating to active businesses) are satisfied, and
(D) as part of the distribution, the distributing corporation distributes --
(i) all of the stock and securities in the controlled corporation held by it immediately before the distribution, or
(ii) an amount of stock in the controlled corporation constituting control within the meaning of section 368(c), and it is established to the satisfaction of the Secretary that the retention by the distributing corporation of stock (or stock and securities) in the controlled corporation was not in pursuance of a plan having as one of its principal purposes the avoidance of Federal income tax,
then no gain or loss shall be recognized to (and no amount shall be includible in the income of) such shareholder or security holder on the receipt of such stock or securities.
(2) Non pro rata distributions, etc. -- Paragraph (1) shall be applied without regard to the following:
(A) whether or not the distribution is pro rata with respect to all of the shareholders of the distributing corporation,
(B) whether or not the shareholder surrenders stock in the distributing corporation, and
(C) whether or not the distribution is in pursuance of a plan of reorganization (within the meaning of section 368(a)(1)(D)).
(3) Limitations.
(A) Excess principal amount. -- Paragraph (1) shall not apply if --
(i) the principal amount of the securities in the controlled corporation which are received exceeds the principal amount of the securities which are surrendered in connection with such distribution, or
(ii) securities in the controlled corporation are received and no securities are surrendered in connection with such distribution.
(B) Stock acquired in taxable transactions within 5 years treated as boot. -- For purposes of this section (other than paragraph (1)(D) of this subsection) and so much of section 356 as relates to this section, stock of a controlled corporation acquired by the distributing corporation by reason of any transaction --
(i) which occurs within 5 years of the distribution of such stock, and
(ii) in which gain or loss was recognized in whole or in part,
shall not be treated as stock of such controlled corporation, but as other property.
(C) Property attributable to accrued interest. -- Neither paragraph (1) nor so much of section 356 as relates to paragraph (1) shall apply to the extent that any stock, securities, or other property received is attributable to interest which has accrued on securities on or after the beginning of the holder's holding period.
* * *
(b) Requirements as to active business. --
(1) In general. -- Subsection (a) shall apply only if either --
(A) the distributing corporation, and the controlled corporation (or, if stock of more than one controlled corporation is distributed, each of such corporations), is engaged immediately after the distribution in the active conduct of a trade or business, or
(B) immediately before the distribution, the distributing corporation had no assets other than stock or securities in the controlled corporations and each of the controlled corporations is engaged immediately after the distribution in the active conduct of a trade or business,
(2) Definition. -- For purposes of paragraph (1), a corporation shall be treated as engaged in the active conduct of a trade or business if and only if --
(A) it is engaged in the active conduct of a trade or business, or substantially all of its assets consist of stock and securities of a corporation controlled by it (immediately after the distribution) which is so engaged,
(B) such trade or business has been actively conducted throughout the 5-year period ending on the date of the distribution,
(C) such trade or business was not acquired within the period described in subparagraph (B) in a transaction in which gain or loss was recognized in whole or in part, and
(D) control of a corporation which (at the time of acquisition of control) was conducting such trade or business --
(i) was not acquired directly (or through one or more corporations) by another corporation within the period described in subparagraph (B), or
(ii) was so acquired by another corporation within such period, but such control was so acquired only by reason of transactions in which gain or loss was not recognized in whole or in part, or only by reason of such transactions combined with acquisitions before the beginning of such period.↩
11.
Sec. 355 permits tax-free treatment of some divisive redemptions. However, divisive redemptions that do not meet the tests ofsec. 355 must be tested for dividend equivalency undersec. 302 . Distributions by a corporation of its own preferred stock that contain the potential for bailout are usually tax free under sec. 305, but the disposition of such stock must be tested undersec. 302 as provided insec. 306↩ .12. Bittker and Eustice recognize this potential for bailout as a weakness in
section 304↩ as it is presently written. See B. Bittker & J. Eustice, Federal Income Taxation of Corporations and Shareholders, par. 9.32, at 9-53 -- 9-54 (4th ed. 1979).