LTRs 20122014, 20122015, 20122016, and 20122017, are identical rulings showing how the “control immediately after” requirement of section 351 really doesn’t mean that. They also show how to resolve the classic problem of a Bigco Corp. acquiring the corner grocery store tax free for Bigco stock, despite the fact that the grocery owners do not control Bigco and the grocery was not incorporated.
Facts: Three individuals owned LLC, a partnership. Bigco wanted to acquire LLC for Bigco stock in a tax free exchange. We know that the individuals could not incorporate the LLC and reorganize it into Bigco. Rev. Rul. 70-140, 1970-1 C.B. 73. Assuming LLC is smaller than Bigco, we know that the individuals could not acquire 80% control of Bigco by directly exchanging LLC for Bigco stock, so a direct section 351 exchange is not possible. How about an indirect section 351 exchange?
As a preliminary step, Individual B incorporated part of his LLC interest into Newco for some reason. Then the Individuals exchanged their LLC interests and the stock of Newco with newly incorporated Company for some of its stock. Then a mergersub of Company merged into Bigco, with Bigco shareholders receiving Company stock. So in the end the Individuals and the former shareholders of Bigco owned Company, a new public company that looked like Bigco owning LLC.
Rulings: The preliminary incorporation of Newco was a section 351 exchange, and the capitalization of Company was a combined section 351 exchange.
Why This Is Interesting: Although not a new development, these rulings are an important reminder that the inability of property owners to obtain control of a corporation in exchange for their property is not a show-stopper to use of section 351. Although the IRS sometimes asserts that a business purpose is required for a section 351 exchange, it is pretty clear that the only purpose for the creation of Company was to circumvent the control requirement of section 351. Using Company as the section 351 vehicle rather than Bigco allowed Bigco shareholders to join in one big section 351 exchange, after which all the shareholders and Individuals controlled Company.
That is interesting from a structuring standpoint. From a technical standpoint the more surprising point is that the individual that preliminarily incorporated Newco lost control of Newco in the capitalization of Company. Normally an integrated decontrol of a corporation will prevent satisfaction of the section 351 “control immediately after” requirement. The IRS evidently recognizes an exception when the transaction could have been done another way that would satisfy section 351. Rev. Rul. 2003-51 so held, but it is not cited by these letter rulings.
Conclusion: When a public corporation wants to acquire unincorporated property tax-free it can do so, if it is willing to do a big enough deal.
