Watch Your Step Transactions

Kimbell-Diamond doctrine still applicable in certain asset purchase transactions.
Robert WillensOctober 11, 2001

In Rev. Rul. 2001-46 a corporation acquired (via a reverse merger) the stock of another corporation. In the transaction, the shareholders of the target received both stock and cash, in a 70/30 ratio. As part of the plan, the target was merged with and into the acquirer.

In Rev. Rul. 90-95, where the consideration conveyed in an identical transaction was exclusively cash, the transaction was regarded as a “qualified stock purchase” that was followed by a Sec. 332 liquidation (of the target into the acquirer). There, the acquisition of stock was accorded “independent significance” from the subsequent liquidation.

On the other hand, if the principles espoused in the King case (and in Rev. Rul. 67-274) were applicable, the “integrated asset acquisition” would be a reorganization under Sec. 368(a)(1)(A). Under this view of the transaction, the target shareholders would not be taxed on their receipt of acquirer stock. The transaction, when tested as an ‘A’, meets the continuity of interest requirement because at least 50 percent of the consideration conveyed to the target’s shareholders consists of stock in the issuing corporation–a substantial part of the value of the proprietary interests in the target is, thus, preserved.

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At issue, therefore: does Rev. Rul. 90-95 apply where the “step transaction” doctrine would otherwise treat the integrated transaction as a reorganization?

The answer is a resounding no. The IRS explained that Rev. Rul. 90-95 treats the acquisition of stock as a qualified stock purchase followed by a separate carryover basis transaction (the Sec. 332 liquidation), which precludes any non-statutory treatment of the steps as an asset purchase. Why? To carry out Congress’ will, Sec. 338 (enacted in 1982) replaces any non-statutory treatment of a stock purchase as an asset purchase under the Kimbell-Diamond doctrine. Under Sec. 338, which is triggered by a qualified stock purchase, asset purchase treatment turns exclusively on whether an election (a “Sec. 338 election”) is made following such a qualified stock purchase — and not on whether the target is amalgamated with the acquirer as part of the overall plan.

The policy underlying Sec. 338 is not violated by treating the transaction addressed in Rev. Rul. 2001-46 as a statutory merger (of the target with and into the acquirer) because this treatment results, harmlessly, in a carryover basis for the target’s assets under Sec. 362. In other words, the normal application of the step-transaction doctrine is only interdicted in cases where such application conflicts with the policy underlying Sec. 338 — and such policy is violated where, and only where, such application would give rise to a cost basis with respect to the target’s assets. Thus, Kimbell-Diamond (as reflected in Rev. Rul. 67-274 and King) still has vitality in cases where the application of the doctrine results in a reorganization where the acquirer obtains a carryover basis in the target’s assets.