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Whether a transfer of assets to a corporation (the “first corporation”) in exchange
for an amount of stock in the first corporation constituting control satisfies the control
requirement of § 351 of the Internal Revenue Code if, pursuant to a binding agreement
entered into by the transferor with a third party prior to the exchange, the transferor
transfers the stock of the first corporation to another corporation (the “second
corporation”) simultaneously with the transfer of assets by the third party to the second
corporation, and immediately thereafter, the transferor and the third party are in control
of the second corporation.
Corporation W, a domestic corporation, engages in businesses A, B, and C. The
fair market values of businesses A, B, and C are $40x, $30x, and $30x, respectively. X,
a domestic corporation unrelated to W, also engages in business A through its wholly
owned domestic subsidiary, Y. The fair market value of X’s Y stock is $30x. W and X
desire to consolidate their business A operations within a new corporation in a holding
company structure. Pursuant to a prearranged binding agreement with X, W forms a
domestic corporation, Z, by transferring all of its business A assets to Z in exchange for
all of the stock of Z (the “first transfer”). Immediately thereafter, W contributes all of its Z
stock to Y in exchange for stock of Y (the “second transfer”). Simultaneous with the
second transfer, X contributes $30x to Y to meet the capital needs of business A after
the restructuring in exchange for additional stock of Y (the “third transfer”). After the
second and third transfers, Y transfers the $30x and its business A assets to Z (the
“fourth transfer”). After the second and third transfers, W and X own 40 percent and 60
percent, respectively, of the outstanding stock of Y. Viewed separately, each of the first
transfer, the combined second and third transfers, and fourth transfer qualifies as a
transfer described in § 351.
Section 351(a) provides that no gain or loss shall be recognized if property is
transferred to a corporation by one or more persons solely in exchange for stock in such
corporation and immediately after the exchange such person or persons are in control
(as defined in § 368(c)) of the corporation.
As described above, courts have held that the control requirement of § 351 is not
satisfied where, pursuant to a binding agreement entered into by the transferor prior to
the transfer of property to the corporation in exchange for stock, the transferor loses
control of the corporation by a taxable sale of all or part of that stock to a third party that
does not also transfer property to the corporation in exchange for stock. Treating a
transfer of property that is followed by such a prearranged sale of the stock received as
a transfer described in § 351 is not consistent with Congress' intent in enacting § 351 to
facilitate the rearrangement of the transferor's interest in its property. Treating a
transfer of property that is followed by a nontaxable disposition of the stock received as
a transfer described in § 351 is not necessarily inconsistent with the purposes of § 351.
Accordingly, the control requirement may be satisfied in such a case, even if the stock
received is transferred pursuant to a binding commitment in place upon the transfer of
the property in exchange for stock. For example, in Rev. Rul. 84-111, Situation 1, the
partnership's transfer of property to the transferee corporation qualified as a transfer
described in § 351, even though the partnership relinquished control of the transferee
corporation within the meaning of § 368(c) pursuant to a prearranged plan to transfer
the transferee stock.
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