What Is the 368(c) Definition of Corporate Control?

In United States tax law, “control” is a precisely defined term for structuring major corporate transactions in a tax-efficient manner. Companies undertaking significant changes, such as mergers or internal restructuring, must understand its meaning to avoid an immediate tax liability on gains from the exchange of property or stock. The Internal Revenue Code provides a mathematical test for what constitutes control, and satisfying this test is a gateway to tax deferral.

Defining Corporate Control

The definition of “control” is laid out in Internal Revenue Code (IRC) Section 368(c). It establishes a two-part test that a person or group of persons must satisfy. Both components of this test must be met simultaneously for control to exist. The first part of the test focuses on voting power, requiring the ownership of stock that possesses at least 80% of the total combined voting power of all classes of stock entitled to vote.

The second part of the test pertains to the ownership of all other types of stock. It mandates the ownership of at least 80% of the total number of shares of all other classes of the corporation’s stock. This means that one cannot simply hold a majority of voting shares and ignore other forms of equity. The term “voting power” generally refers to the ability to elect the corporation’s board of directors.

Corporations can issue different types of stock with varying rights. For instance, a company might have Class A voting common stock and Class B non-voting preferred stock. To meet the control definition, a shareholder group would need to own at least 80% of the voting power vested in the Class A stock and also own at least 80% of the total shares of the Class B stock. Failure to meet either of these 80% thresholds means control has not been achieved for tax purposes.

Application in Tax-Free Transactions

The definition of control is a requirement for some of the most common tax-deferral provisions in corporate tax law. One of the primary applications is in Section 351 transfers. This provision allows corporations to transfer property to a corporation in exchange for its stock without recognizing any gain or loss on the transfer, but only if the transferors are in “control” of the corporation immediately after the exchange.

This control requirement is also central to certain types of corporate reorganizations that qualify for tax-free treatment. For example, a “Type B” reorganization involves one corporation acquiring the stock of another corporation solely in exchange for its own voting stock. For the transaction to be tax-free, the acquiring corporation must have control of the target corporation immediately after the acquisition.

The control definition is also critical for “Type D” reorganizations, though the standard can change based on the transaction’s structure. For divisive reorganizations, where a corporation transfers part of its assets to a new subsidiary and distributes that subsidiary’s stock (a “spin-off”), the 80% control test applies. However, for other “Type D” reorganizations, such as when one corporation acquires substantially all the assets of another, a lower 50% control threshold is used.

Meeting the Control Requirement

Satisfying the control test requires careful planning around the timing and substance of the transaction. A critical element, particularly for Section 351 transfers, is the “immediately after the exchange” requirement. This means the transferors must collectively be in control of the corporation at the moment the transaction concludes. The IRS and courts scrutinize these transactions to ensure the control is genuine and not merely a temporary step in a larger, pre-arranged plan.

For instance, if a person transfers property to a new corporation for 100% of its stock but had a pre-existing, binding agreement to sell 30% of that stock to another party, the control test would likely fail. The pre-arranged plan to dispose of shares that breaks control would be integrated with the initial transfer, disqualifying it from tax-free treatment under Section 351. This is referred to as the step transaction doctrine, where separate steps of an integrated plan are viewed as a single transaction for tax purposes.

The non-voting stock test is interpreted with precision. It requires owning 80% of the shares of each individual class of non-voting stock, not just 80% of the total number of non-voting shares in aggregate. Imagine a corporation has two classes of non-voting stock: 100 shares of Class A preferred and 100 shares of Class B preferred. A transferor who acquires 90 shares of Class A (90%) but only 70 shares of Class B (70%) would fail the control test, even though they own 160 of the 200 total non-voting shares (80%).