Then in Gilmore, absent an independent business reason for pursuing the merger alternative in lieu of the liquidation approach, the IRS would conclude that the tax consequences flowing from the merger should be identical to those that would attend a liquidation. But the court categorically rejected such a rule. It noted that the cases cited by the IRS in ostensible support of the rule do not, singly or in the aggregate, extend the doctrine of Gregory v. Helvering2, that far. What took place in Gilmore, unlike in Gregory v. Helvering, was a “reorganization in reality.”
As a result, we can safely conclude that a merger of RVI with and into DSW — in which the RVI shareholders are compensated with stock of the DSW — would qualify as a reorganization.3 Accordingly, no gain or loss would be recognized by RVI with respect to the exchange of its property (its shares in DSW and other assets) solely for stock in DSW. That’s because each corporation would be a party to the reorganization. (See Section 361(a) of the Internal Revenue Code.) Moreover, under Section 361(c), no gain or loss would be recognized by RVI on the distribution of the stock in DSW to its shareholders in exchange for, and in retirement of, their RVI stock. Finally, under Section 354(a)(1), the shareholders of RVI would recognize neither gain nor loss on the exchange of their RVI stock for stock in DSW.
Net Operating Losses
Furthermore, under Section 381(a)(2), and as of the date of the distribution or transfer, DSW (the acquiring corporation) would “succeed to and take into account,” the items described in Section 381(c) — most notably the acquired corporation’s NOLs. Thus, DSW would “inherit” its parent company’s NOL. Would the merger give rise to an ownership change? If that were the case, the change in ownership would limit the amount of taxable income the NOL can offset. We think the answer is no.
In the event of a downstairs merger which qualifies as a reorganization, DSW would be the new loss corporation. And thanks to Section 381(a)(2), it would be entitled to use a net operating loss carryover.4
To be sure, there is only is an ownership change if, immediately after any equity structure shift, the percentage of the stock of the loss corporation owned by one or more 5% shareholders has increased by more than 50 percentages points over the lowest percentage of stock of the loss corporation (or any predecessor corporation) owned by the shareholders at any time during the testing period. That period is defined as the three-year term ending on the testing date. In our view, the 5% shareholders in the RVI case will not have experienced the requisite increase in ownership, and therefore the merger will not produce an ownership change.
Note that in the RVI case, there are three 5% shareholders of DSW: (1) the shareholders of SSC (a “first tier entity” with respect to DSW); (2) the non-SSC shareholders of RVI; and (3) the public group comprised of all of the holders of DSW’s Class A (low vote) stock. The percentage of stock of the loss corporation owned by these 5% shareholders will increase by not more than 38 percentage points as a result of the merger. The percentage of stock of the loss corporation owned by the first two 5% shareholders will decline from 100% to 62%, and the percentage owned by the new 5% shareholder — the public group comprised of all of the holders of DSW’s Class A stock — will increase by some 38 percentage points.