80 percent of the acquired corporation's outstanding stock and purchases the remaining 20 percent for cash; accordingly, gain or loss is recognized by all stockholders exchanging or selling the acquired corporation shares. Rev. Rul. 75-123 Advice has been requested whether there can be a reorganization under section 368 (a) (1) (B) of the Internal Revenue Code of 1954 under the following circumstances. Corporation X desired to acquire all the stock of corporation Y. Pursuant to a plan, X acquired 80 percent of the only outstanding class of Y stock solely in exchange for X voting stock and purchased the remaining 20 percent for cash from the Y shareholders who did not exchange Y stock for X stock. Section 368 (a) (1) (B) of the Code defines as a reorganization the acquisition by one corporation, in exchange solely for all or a part of its voting stock (or in exchange solely for all or part of the voting stock of a corporation that is in control of the acquiring corporation), of stock or another corporation if, immediately after the acquisition, the acquiring corporation has control of such other corporation (whether or not the acquiring corporation had control immediately before the acquisition). To qualify under section 368 (a) (1) (B) of the Code as a reorganization, the consideration for whatever stock is acquired by the acquiring corporation must be solely its voting stock and nothing else. See Helvering v. Southwest Consolidated Corporation, 315 U.S. 194 (1942), 1942-1 C.B. 218; Rev. Rul. 66-365, 1966-2 C.B. 116, and Rev. Rul. 68-285, 1968-1 C.B. 147, 149. In the instant case, the cash purchases of stock, pursuant to the same plan in which Y stock was exchanged for X stock, constitute additional consideration for the Y stock. Therefore, the "solely for voting stock" require- 26 CFR 1.368-2: Definitions of terms. Reorganization; acceleration of Rev. Rul. 75-237 stock, the plan included an agree- Prior to the date the shareholders were to vote on the acquisition of X by Z, the former Y shareholders and X agreed to invoke the acceleration provision of the contingent stock agreement and X issued to the former Y shareholders X stock in full satisfaction of the agreement. The former Y shareholders had all of the rights of ownership in such shares. They could vote in favor of the proposed acquisition by Z of X's assets, or dissent and exercise their appraisal rights, or they could dispose of the X stock prior to the merger. The ownership of the additional shares of X stock was complete and unconditional and would not revert to X in the event the proposed acquisition by Z was not consummated. In addition, at the time of receipt of the additional shares of Pursuant to a plan of reorganiza-X stock, the former Y shareholders tion, all of the stock of Y corporation was acquired by X, an unrelated corporation, solely in exchange for the voting stock of X. Because of the inability of the parties to agree on the value of Y for the exchange of the Advice has been requested as to the effect of a proposed reorganization on a prior transaction which qualified as a reorganization under section 368 (a) (1) of the Internal Revenue Code of 1954 in the two situations described below. Situation (1). were not under any commitment or obligation to vote in favor of the proposed acquisition or to exchange the shares of X stock for shares of Z stock if the acquisition was consummated. Section 354 (a) (1) of the Code provides that no gain or loss will be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of a plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization. Section 368 (a) (1) (B) of the Code provides, in part, that the term "reorganization" includes the acquisition by one corporation in exchange solely for all or a part of its voting stock, of stock of another corporation if, immediately after the acquisition, the acquiring corporation has control of such other corporation. Section 1.368-2(g) of the Income Tax Regulations states, in part, that the term "plan of reorganization" is to be construed as limiting the nonrecognition of gain or loss to exchanges or distributions that are directly a part of the reorganization described in section 368 (a) of the Code. In the instant case all of the shares of Y stock were acquired from the former Y shareholders solely in exchange for voting stock of X pursuant to the plan of reorganization. Therefore, the transaction qualifies as a reorganization, described in section. 368(a)(1)(B) of the Code. Furthermore, ection 354(a) (1) applies to all of the shares of X stock received by the former Y shareholders, including the additional X stock received pursuant to the contingent stock agreement, and, therefore, no gain or loss is recognized to them on the receipt of such stock except to the extent any portion of such stock is treated as interest under section 483 (see section 1.483-2(a)(2) of the regulations). Pursuant to section 358 (a) (1), the basis of all of the shares of X stock received by the former Y shareholders, including the additional shares of X voting stock received that are not treated as interest, is the same as the basis in the shares of Y stock exchanged therefor. See Rev. Rul. 75-94, page 111, this Bulletin, wherein, due to a material misrepresentation of earnings stated by the acquiring corporation in the plan of reorganization and relied upon by the acquired corporation's shareholders, the acquired corporation's shareholders received additional shares of the acquiring corporation's stock subsequent to the original reorganizasubsequent to the original reorganization exchange. These additional shares were deemed to be a part of, and received pursuant to, the plan of the reorganization within the meaning of section 1.368-2(g) of the regulations and section 354 (a) (1) of the Code. Therefore, the nonrecognition provisions of section 354 applied to the receipt of the additional stock. Situation (2). The facts are the same as those in Situation (1) except that X acquired the assets and liabilities of Y in a reorganization described in section. 368 (a) (1) (C) of the Code and the contingent stock agreement had no provision for the acceleration of the issuance of any contingent shares to which the former Y shareholders were entitled prior to any possible future negotiations for the acquisition of X. Therefore, prior to the date the X shareholders were to vote on the ac quisition of X by Z, the former Y shareholders and X negotiated and agreed upon a plan to accelerate the issuance of the contingent stock and X issued the amount of stock agreed upon in the negotiations to the former Y shareholders. Section 368 (a) (1) (C) of the Code provides, in pertinent part, that the term "reorganization" means an acquisition by one corporation, in exchange solely for all or a part of its voting stock of substantially all of the properties of another corporation. In situation 2, X acquired all of the properties of Y solely in exchange for voting stock of X pursuant to the plan of reorganization. Therefore, the transaction qualifies as a reorganiza tion described in section 368 (a) (1) (C) of the Code. Furthermore, section 354(a) (1) applies to all of the shares of X stock received by the former Y shareholders, including the additional X stock received pursuant to the acceleration plan concerning contingent stock negotiated just prior to the transaction involving Z. Therefore, no gain or loss is recognized to them on the receipt of such stock except to the extent any portion of such stock is treated as interest under section 483 (see section 1.483-2(a) (2) of the regulations). Pursuant to section 358(a) (1), the basis of all of the shares of X stock received by the former Y shareholders, including the additional shares of X voting stock received that are not treated as interest, is the same as the basis in the shares of Y stock exchanged therefor. DEPARTMENT OF THE TREASURY, To Officers and Employees of the Preamble By a notice of proposed rule making appearing in the Federal Register for August 23, 1972 (37 F.R. 16947), amendments to the Income Tax Regulations (26 CFR Part I) were proposed in order to prescribe regulations under section 381 (c) (5) of the Internal Revenue Code of 1954. After consideration of all such relevant matter as was presented by interested persons regarding the rules proposed, certain changes were made, and the proposed amendments of the regulations, subject to the changes indicated below, are adopted by this docu ment. The amendments provide generally that in a transaction to which section 381(a of the Code applies (relating to carryovers in certain corporate acquisitions), the acquiring corporation shall use the same inventory method used by the distributor or transferor corporation, unless different inventory methods were being used by the several parties to the transaction. The amendments generally provide that if different inventory methods were used, the acquiring corporation shall normally use the principal inventory method used for each particular type of goods on the date of the transaction. The principal inventory method shall be determined by comparing the fair market value of each type of goods held by each of the several corporations. Rules are also prescribed for integrating the inventories of the several parties to the section 381 (a) transaction. Adoption of amendments to the regulations Based upon the foregoing, the amendments to the Income Tax Regulations (26 CFR Part 1) as set forth in paragraph 2 of the appendix to the notice of proposed rule making are hereby adopted. The amendments to §1.381 (c) (4)-1 as set forth in paragraph 1 of the appendix to the notice of proposed rule making are not adopted and remain outstanding. There are inserted immediately after sections: §1.381 (c) (4)-1 the following new $1.381 (c) (5) Statutory provisions; carryovers in certain corporate acquisitions; items of the distributor or transferor corporation; inventories. Sec. 381. Carryovers in certain corporate acquisitions. *** (c) Items of the distributor or transferor corporation. The items referred to in subsection (a) are: (5) Inventories. In any case in which inventories are received by the acquiring corporation, such inventories shall be taken by such corporation (in determining its income) on the same basis on which such inventories were taken by the distributor or transferor corporation, unless different methods were used by several distributor or transferor corporations or by a distributor or transferor corporation and the acquiring corporation. If different methods were used, the acquiring corporation shall use the method or combination of methods of taking inventory adopted pursuant to regulations prescribed by the Secretary or his delegate. §1.381 (c) (5) -1 Inventories. (1) (a) Carryover requirement General rule. Section 381 (c) (5) provides that in a transaction to which section 381 (a) applies and in which inventories are received by the acquiring corporation (as defined in $1.381(a)-1(b) (2)) such inventories shall be taken by the acquiring corporation (in determining its income) on the same basis on which such inventories were taken by the distributor or transferor corporation on the date of distribution or transfer unless different inventory methods were used on that date by several distributor or transferor corporations or by a distributor or transferor cor poration and the acquiring corporation. If different methods were used, the acquiring corporation shall use the method or combination of methods of taking inventories adopted pursuant to the provisions of this section. (2) Rules of application. Reference in this section to a method or methods of taking inventories are to be construed as referring to both the method or methods of identifying the goods and the method or methods of valuing the goods. The method or methods of taking inventories shall be determined on the date of distribution or transfer, and any corporation, a party to a section 381 (a) transaction whose taxable year does not end on such date shall be considered as using the method or methods of taking inventories that it would have employed had its taxable year ended on such date. The amount of the adjustments necessary to reflect the change in method of taking inventories pursuant to this section, the manner in which they are to be taken into account by the acquiring corporation, and the tax attributable thereto shall be determined and computed under section 481 and the regulations thereunder, subject to the rules provided in paragraphs (c) and (d) of this section. However, in the case of any party to a section 381(a) transaction which changes its method of taking inventories to the last-in, first-out method of indentification, the adjustments required by section 472(d) shall be applicable. See paragraph (e) of this section. This section shall not be construed as preventing any party to a section 381 (a) transaction from adopting an inventory method which, under the provisions of section 471 or 472, and the regulations thereunder, may be adopted without the consent of the Commissioner. For provisions defining the date of distribution or transfer, see paragraph (b) of §1.381(b)-1. (b) Conditions for continuation of methods of taking inventories—(1) No difference in method of taking inventories. (i) If all the parties to a section 381(a) transaction used the same method of taking inventories on the date of distribution or transfer, the acquiring corporation, whether or not immediately after the date of distribution or transfer it operates separate or integrated trades or businesses, shall continue to use such method of taking inventories, unless the acquiring corporation has, in accordance with paragraph (e) of §1.446-1, obtained the consent of the Commissioner to use a different method of taking inventories. For purposes of this determination, a corporation shall be deemed to be using the last-in, first-out method of taking inventories with respect to a particular type of goods on the date of the distribution. or transfer, if such corporation elects, under the provisions of section 472, to adopt the last-in, first-out method with respect to such goods for its taxable year within which or with which the date of distribution or transfer occurs. (ii) The provisions of this subparagraph may be illustrated by the following example: Example. O and P Corporations are manufacturing companies which compute their entire inventories by the use of the last-in, first-out method of identification and the cost basis of valuation. In applying the last-in, first-out method both corporations use the dollar-value method, use the double-extension method, pool under the natural business unit method, and value annual inventory increases by reference to the actual cost of goods most recently purchased. P Corporation acquires the assets of O Corporation in a transaction to which section 381 (a) applies. Under the provisions of this subparagraph, on and after the date of distribution or transfer P Corporation must continue to use the lastin, first-out method of identification, the cost basis of valuation, and, in applying the last-in, first-out method, must continue to use the dollar-value method, use the double-extension method, pool under the natural business unit method, and value annual inventory increases by reference to the actual cost of goods most recently purchased, unless, in accordance with paragraph (e) of §1.446-1, consent of the Commissioner is obtained to change the method of taking inventories. (2) Separate businesses. (i) If, im mediately after the date of distribution or transfer, any of the trades or businesses of the parties to a section 381 (a) transaction are operated as separate and distinct trades or businesses within the meaning of paragraph (d) of §1.446-1, then the method or methods of taking inventories employed by such parties to the transaction on the date of distribution or transfer with respect to such trades or businesses shall be used by the acquiring corporation, unless the acquiring corporation has, in accordance with paragraph (e) of §1.446-1, obtained the consent of the Commissioner to use a different method of taking inventories. This subparagraph shall not be construed as precluding the Commissioner under section 471 or 472, and the regulations thereunder, from requiring that the method of taking inventories used in a particular trade or business be used in another trade or business with respect to similar types of goods, if, in the opinion of the Commissioner, the use of such method of taking inventories is necessary for a clear reflection of income. (ii) The provisions of this subparagraph may be illustrated by the following example: Example. R Corporation is engaged in the production of radios and television sets and S Corporation is engaged in the production of washers and driers. In computing their inventories both corporations use the cost basis of valuation. R Corporation uses the last-in, first-out method of identification, whereas S Corporation uses the first-in, first-out method. T Corporation acquires the assets of R Corporation and S Corporation in a transaction to which section 381(a) applies. T Corporation operates as a separate and distinct trade or business, within the meaning of paragraph (d) of §1.446-1, each of the businesses formerly operated by R Corporation and S Corporation. Under the provisions of this subparagraph, T Corporation is required to continue to use the method of taking inventories previously used by R Corporation and S Corporation, respectively, with respect to each trade or business, unless, in accordance with paragraph (e) of $1.446-1, consent of the Commissioner is obtained to change the methods of taking inventories, on and after the date of transfer. However, the Commissioner may require T Corporation, in accordance with $1.472-2, to use the last-in, first-out method with respect to that portion of the goods in the trades or businesses formerly operated by S Corporation and T Corporation which are similar to goods in the trade or business formerly operated by R Corporation, if, in his opinion, the use of the last-in, first-out method with respect to such similar goods is necessary for a clear reflection of income. (i) (3) Intergrated businesses Same inventory method. If, immediately after the date of distribution or transfer, any of the trades or businesses of the parties to a section 381 (a) transaction are not operated as separate and distinct trades or businesses within the meaning of paragraph (d) of §1.446-1, then, to the extent that the same methods of taking inventories for particular types of goods were employed on the date of distribution or transfer by the parties to the transaction with respect to any trades or businesses which are integrated or are required to be integrated in accordance with paragraph d) of §1.446-1, the acquiring cororation shall continue to employ such nethods of taking inventories for such types of goods, unless, in accordance with paragraph (e) of §1.446-1, the acquiring corporation has obtained the consent of the Commissioner to use a different method of taking inventories. This subdivision shall not be construed as precluding the Commissioner under sections 471 or 472, and the regulations thereunder, from requiring that the method of taking inventories used with respect to particular types of goods in a particular trade or business operated by the acquiring corporation after the date of distribution or transfer be used with respect to similar types of goods in another trade or business operated by it after such date if, in the opinion of the Commissioner, the use of such method of taking inventories is necessary for a clear reflection of income. (ii) Different inventory methods. If, immediately after the date of distribution or transfer, any of the trades or businesses of the parties to a section 381(a) transaction are not operated as separate and distinct trades or businesses within the meaning of paragraph (d) of $1.446-1, then, to the extent that different methods of taking inventories for particular types of goods were employed on the date of distribution or transfer by the parties. to the transaction with respect to any trades or businesses which are integrated or required to be integrated in accordance with paragraph (d) of §1.446-1, the acquiring corporation shall not be permitted to continue to use such different methods of taking inventories, and shall adopt the method of taking inventories described in paragraph (c) of this section for such types of goods unless, in accordance with paragraph (d) of this section, consent of the Commissioner is obtained to use a different method of taking inventories. (iii) Examples. The provisions of this subparagraph may be illustrated by the following examples: Example (1). O and P Corporations are manufacturing companies which compute their entire inventories by the use of the last-in, first-out method of identification and the cost basis of valuation. In applying the last-in, first-out method both corporations use the dollar-value method and the double-extension method. However, O Corporation pools under the natural business unit method while P Corporation pools under the multiple pool method. In addition, O Corporation determines the cost of its annual inventory increase by reference to the actual cost of goods most recently purchased, whereas P Corporation determines the cost of such increase by reference to the actual cost of the goods purchased during the taxable year in the order of acquisition. P Corporation acquires the assets of O Corporation in a transaction to which section 381 (a) applies and integrates the business formerly operated by O Corporation into the business which was operated by P Corporation before the date of distribution or transfer. Under the provisions of subdivision (i) of this subparagraph (relating to the same inventory methods in an integrated trade or business), P Corporation shall continue to use the last-in, first-out method of identification, the cost basis of valuation, and in applying the last-in, first-out method, shall continue to use the dollar-value method and the double-extension method, unless, in accordance with paragraph (e) of §1.446-1, consent of the Commissioner is obtained to change the method of taking inventories. However, under the provisions of subdivision (ii) of this subparagraph (relating to different inventory methods in an integrated trade or business), P Corporation shall use the method of taking inventories described in paragraph (c) of this section with respect to the method of pooling and the method of determining the cost of annual inventory increases, unless, in accordance with paragraph (d) of this section, consent of the Commissioner is obtained to use a different method of taking inventories. Example (2). Y and Z Corporations are engaged in the manufacture of cereal products. Y Corporation uses the first-in, first-out method of identification and the cost or market, whichever is lower, method of valuing its inventories, including oats. Z Corporation uses the first-in, first-out method of identification and the cost or market, whichever is lower, method of valuing its inventories, except oats which are valued on the cost method. Y Corporation acquires all of the assets of Z Corporation in a transaction to which section 381 (a) applies and integrates the business formerly operated by Z Corporation into the business which was operated by Y Corporation before the date of distribution or transfer. Under the provisions of subdivision (i) of this subparagraph (relating to the same inventory methods in an integrated trade or business), Y Corporation must continue to use the first-in, first-out method with respect to all of its inventories and must continue to use the cost or market, whichever is lower, method of valuing all inventories except oats, unless, in accordance with paragraph (e) of §1.446-1, consent of the Commissioner is obtained to change the method of taking inventories. In addition, under the provisions of subdivision (ii) of this subparagraph (relating to different inventory methods in an integrated trade or business), Y Corporation shall use the method described in paragraph (c) of this section in valuing its inventory of oats, unless, in accordance with paragraph (d) of this section, consent of the Commissioner is obtained to use a different method of valuing its oats. (4) Rules of Application. (i) In any case where the method of taking inventories employed on the date of distribution or transfer is continued, it will be unnecessary for the acquiring corporation to renew any election previously made by it or by any distributor or transferor corporation with respect to such method of taking inventories, and the acquiring corporation is bound by any such elections. If, on the date of distribution or transfer, any party to a section 381 (a) transaction had no inventories of a particular type of goods, or such party came into existence as a result of the transaction, such party shall not be considered to be using a method of taking inventories for the particular type of goods different from that used by the other parties to the transaction. If, on the date of distribution or transfer, any one of the parties to the transaction is using the cash receipts and disbursements method of accounting and is not required to take inventories, the determination as to whether such method of accounting is to be continued by the acquiring corporation shall be made in accordance with section 381 (c) (4) and the regulations thereunder. (ii) The provisions of this subparagraph may be illustrated by the following examples: Example (1). M Corporation is engaged in manufacturing and computes its inventories under the first-in, first-out method of identification and the cost or market, whichever is lower, method of valuation. N Corporation is also engaged in manufacturing and computes its inventories under the first-in, first-out method of identification and the cost method of valuation. M Corporation acquires the assets of N Corporation in a transaction to which section 381 (a) applies and M Corporation integrates the business formerly operated by N Corporation into the business which was operated by M Corporation before the date of distribution or transfer. On the date of distribution or transfer, N Corporation has inventories of sheet steel while M Corporation has no inventories of this particular type of goods. In all other respects the inventories of the two corporations consist of similar types of goods. Under the provisions of this subparagraph, M Corporation must use the first-in, first-out method of identification and the cost method of valuation of inventories of sheet steel, unless, in accordance with paragraph (e) of §1.446-1, consent of the Commissioner is otbained to change the method of taking such inventories. For other goods in its inventories M Corporation must use the first-in first-out method of identification (as required by subparagraph (3) (i) of this paragraph), and, with respect to the method of valuation, must use the method of taking inventories described in paragraph (c) of this section, unless, in accordance with paragraph (d) of this section, consent of the Commissioner is obtained to use a different method of taking inventories. Example (2). W Corporation is engaged in the business of raising cattle and uses |