Retained spin-off shares qualify for later debt exchange

Plain-English summary

A public company planned to separate one business by contributing it to a new corporation and distributing most of the new corporation's shares to its shareholders. It would temporarily retain a minority block of shares and later exchange some or all of them for existing debt, potentially through investment banks. The IRS ruled that the retention was not part of a principal-purpose tax-avoidance plan under section 355. It also ruled that an exchange completed within the specified post-distribution period would be treated as part of the reorganization plan and as a transfer to creditors under section 361(c).

Ruling snapshot

• Question: Will the temporary share retention and later debt-for-equity exchange receive the requested treatment under sections 355 and 361?
• Outcome: approved
• Key authorities: IRC §§ 355(a)(1)(D)(ii), 361(c), 361(c)(3); Treas. Reg. § 1.355-2(e)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201651010 Third Party Communication: None
Release Date: 12/16/2016 Date of Communication: Not Applicable
Index Number: 355.00-00, 355.01-00,
361.00-00 Person To Contact:
--------------------------, ID No. --------------
--------------- Telephone Number:
------------------------- --------------------
------------------------------------- Refer Reply To:
--------------------------- CC:CORP:4
------------------------------ PLR-116321-16
Date:
September 13, 2016

LEGEND

Distributing = ---------------------------------------------------------------------------------------------
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Controlled = ---------------------------------------------------------------------------------------------
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State A = -------------------

Business B = ---------------------------------------------------------------------------------------------
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-----------------------------------

Business C = ---------------------------------------------------------------------------------------------
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---------------

Sub- = --------------------------------------------------
Business C

d = ------

e = ----

f = --

h = ----
PLR-116321-16 2

i = --

k = ----

Date 1 = ----------------------

Dear ---------------:

This letter responds to your May 18, 2016 letter requesting rulings on certain federal
income tax consequences of a series of transactions (the “Proposed Transaction” as
defined herein). The material information provided in that letter and in subsequent
correspondence is summarized below.

The rulings contained in this letter are based upon information and representations
submitted by the taxpayer and accompanied by a penalties-of-perjury statement
executed by an appropriate party. While this office has not verified any of the material
submitted in support of the request for rulings, it is subject to verification on
examination.

This letter is issued pursuant to section 6.03 of Rev. Proc. 2016-1, 2016-1 I.R.B. 18,
regarding rulings on one or more significant issues that involve the tax consequences of
a transaction (or part of a transaction) occurring in the context of a distribution under
Section 355 of the Internal Revenue Code (the “Code”). This office has not reviewed
any information pertaining to and expresses no opinion as to the overall tax
consequences of the Proposed Transaction (as defined herein), including qualification
under section 355 of the Code, or as to any issue or step not specifically addressed by
this letter. Rather, the rulings contained in this letter only address discrete legal issues
involved in the transaction. Further, except as expressly provided herein, no opinion is
expressed or implied concerning the tax consequences of any aspect of any transaction
or item discussed or referenced in this letter.

                                        FACTS

Distributing is a State A corporation, the stock of which is publicly traded and widely
held. Distributing is the parent of a group of direct and indirect subsidiaries and related
entities (the “Distributing Worldwide Group”). Distributing is also the common parent of
an affiliated group of corporations that files a consolidated U.S. federal income tax
return. The Distributing Worldwide Group conducts Business B and Business C.

Distributing has decided to separate Business C from Business B (the “Separation”).
The Separation is being effected for compelling corporate business reasons.
Specifically, the Separation will: (i) sharpen strategic and management focus; (ii) allow
each business to more effectively pursue its own distinct capital structure and capital
PLR-116321-16 3

allocation strategies; (iii) improve the businesses' ability to use stock as acquisition
currency; (iv) improve the ability to attract, retain, and incentivize employees; and (v)
improve access to equity capital and attract a long-term investor base for each
business.

Distributing intends to effect the Separation through the contribution of the assets and
liabilities associated with Business C to a newly-formed domestic corporation, followed
by a distribution of stock of such corporation to its shareholders.

                           PROPOSED TRANSACTION

Distributing proposes to undertake, pursuant to one overall plan, a number of
transaction steps in connection with the Separation, some which have been partially
consummated (collectively, the “Proposed Transaction”). The relevant steps of the
Proposed Transaction are set forth below:

   1. On Date 1, Distributing formed a new U.S. corporation (“Controlled”).
   Controlled has a single class of stock outstanding, its common stock (“Controlled
   Common Stock”).

   2. The assets and liabilities of, and entities engaged in, Business C will be
   separated from the assets and liabilities of, and entities engaged in, Business B,
   through a series of internal restructuring transactions, including sales,
   contributions, reorganizations, liquidations, and distributions.

   3. Distributing will contribute the assets and liabilities of (including equity interests
   of entities engaged in) Business C to Controlled (the “Controlled Contribution”).

   4. The outstanding shares of Controlled Common Stock held by Distributing will
   be recapitalized into such number of shares of Controlled Common Stock as is
   equal to the sum of (i) the number of such shares to be distributed in the
   Distribution and (ii) the number of such shares representing up to a d% voting
   and economic interest in Controlled (the “Retained Shares”).

   5. Distributing will distribute all of the shares of Controlled Common Stock, other
   than the Retained Shares, to its shareholders (the “Distribution,” and the
   retention of the Retained Shares, the “Retention”). No fractional shares of
   Controlled Common Stock will be distributed in the Distribution. Instead, all
   fractional shares of Controlled Common Stock that Distributing shareholders
   otherwise would be entitled to receive will be aggregated by a distribution agent,
   and as soon as practicable following the effective time of the Distribution will be
   sold in the public market at the prevailing price. The net cash proceeds of these
   sales will be distributed pro rata (based on the fractional share such shareholder

PLR-116321-16 4

  would otherwise be entitled to receive) to those shareholders who would
  otherwise have been entitled to receive fractional shares.
  6. Distributing intends to exchange some or all of the Retained Shares for
  existing debt instruments of Distributing (the “Exchange Debt”) with holders of
  Exchange Debt either directly or through a financial intermediary (the “Debt-for-
  Equity Exchange”). In the event Distributing uses a financial intermediary to
  effect the Debt-for-Equity Exchange, one or more investment banks (the
  “Investment Banks”), acting as principals for their own account, will acquire
  Exchange Debt in a tender offer to existing holders of Exchange Debt (the “Debt
  Tender”). The Debt-for-Equity Exchange may occur up to e months following the
  Distribution, depending on market conditions.

In the event that Distributing engages a financial intermediary, no sooner than i days
following the acquisition of the Exchange Debt by the Investment Banks, Distributing
and the Investment Banks will enter into an exchange agreement (neither being legally
obligated to do so) pursuant to which Distributing will exchange some or all of the
Retained Shares with the Investment Banks for the Exchange Debt held by the
Investment Banks (the “Exchange Agreement”). The Debt-for-Equity Exchange will
occur at least h days after the Debt Tender.

The exchange ratio in the Debt-for-Equity Exchange (which will not be determined
earlier than i days following the Debt Tender) will be at fair market value based on
arm's-length negotiations between Distributing and the Investment Banks. Based on
market practice, the fair market value of the Exchange Debt likely will be determined
taking into account relevant factors that are intended to reflect the costs to the
Investment Banks of acquiring the Exchange Debt (including, for example, the cash
purchase price paid by the Investment Banks in the Debt Tender, accrued but unpaid
interest in respect of the Exchange Debt, and the transaction fees paid by the
Investment Banks in connection with the Debt Tender).

The Investment Banks may finance the Debt Tender in a manner customary for
financing dealer inventory, which may include pledging the Exchange Debt as collateral,
executing repurchase contracts with respect to the Exchange Debt (which may permit
the Investment Banks to re-hypothecate the Exchange Debt), entering into total return
swaps over the Exchange Debt, and engaging in similar financing transactions. The
Investment Banks may hedge all or a portion of their interest and/or credit exposure to
the Exchange Debt in one or more transactions with third parties (other than
Distributing, Controlled, or any member of their respective affiliated groups) prior to
entering into the Exchange Agreement and engaging in the Debt-for-Equity Exchange.
The Investment Banks are not expected to make representations as to the U.S. federal
income tax treatment or status of their customary inventory financing activities. If the
Exchange Agreement is entered into, it is also expected that an underwriting agreement
with the Investment Banks will be entered into at the same time, pursuant to which there
PLR-116321-16 5

will be an offering of the Retained Shares to be exchanged in the Debt-for-Equity
Exchange to investors.

Following the Distribution, Distributing and its direct and indirect subsidiaries and related
entities (the “Distributing Group”) on the one hand, and Controlled and its direct and
indirect subsidiaries and related entities (the “Controlled Group”) on the other hand, will
be parties to certain continuing arrangements and relationships (collectively, the
“Continuing Arrangements”). The Continuing Arrangements will likely include: (i) a
Separation and Distribution Agreement; (ii) an Employee Matters Agreement; (iii) a Tax
Matters Agreement; (iv) a Transition Services Agreement; (v) Intellectual Property
License Arrangements; (vi) Real Estate Arrangements; (vii) a Supply Agreement; (viii)
Sub-Business C Arrangements; (ix) a Spare Parts Loan Agreement; and (x) a
Stockholder and Registration Rights Agreement. These Continuing Arrangements will
be for varied durations, and will be priced either at arm’s length terms or cost or cost-
plus basis.

                               REPRESENTATIONS

   1. The business purpose for the Retention is to: facilitate the implementation of
   appropriate capital structures at both Distributing and Controlled; avoid burdening
   Controlled’s balance sheet; and ensure Distributing has sufficient liquidity,
   flexibility, and financial resources available to fund payment of debt and other
   obligations, as well as investments in the growth of its business necessary to
   successfully execute its growth strategy.

   2. The Retained Shares will be voted in proportion to the votes cast by
   Controlled’s other stockholders. Distributing will grant Controlled a proxy with
   respect to the Retained Shares requiring such manner of voting.

   3. Distributing will dispose of the Retained Shares as soon as a disposition is
   warranted consistent with the business purpose for the Retention (after the
   expiration of any post-Distribution lock-up period that may be agreed to by
   Distributing; such lock-up period shall in no event exceed k days), but in any
   event, not later than the date that is f years following the Distribution (or promptly
   thereafter).

   4. None of Distributing's directors or officers will serve as directors or officers of
   Controlled as long as Distributing retains the Retained Shares.

   5. None of the Exchange Debt was issued in anticipation of the Distribution.

   6. Any Investment Bank acquiring Exchange Debt in connection with the Debt-
   for-Equity Exchange will hold the Exchange Debt for at least i days prior to
   entering into an agreement to exchange it for all or a portion of the Retained

PLR-116321-16 6

   Shares, and will not consummate the Debt-for-Equity Exchange until at least h
   days after such Investment Bank acquires the Exchange Debt.

                                     RULINGS

   1. The Retention by Distributing of the Retained Shares will not be in pursuance

of a plan having as one of its principal purposes the avoidance of U.S. federal income
tax within the meaning of section 355(a)(1)(D)(ii) and Treasury Regulation section
1.355-2(e).

   2. Provided the Retained Shares are transferred by Distributing in the Debt-for-

Equity Exchange within e months following the Distribution, the Debt-for-Equity
Exchange will be treated as distributed pursuant to the plan of reorganization for
purposes of section 361(c), and such Debt-for Equity Exchange will be treated as
transferred to creditors for purposes of section 361(c)(3).

                                     CAVEATS

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax treatment of the proposed transaction under any provision of the Code and
regulations or the tax treatment of any condition existing at the time of, or effects
resulting from the proposed transaction that is not specifically covered by the above
rulings.

                          PROCEDURAL STATEMENTS

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code
provides that it may not be used or cited as precedent.

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representative.

A copy of this letter must be attached to any income tax return to which it is relevant.
Alternatively, taxpayers filing their returns electronically may satisfy this requirement by
attaching a statement to their return that provides the date and control number of the
letter ruling [PLR-116321-16].

                                   Sincerely,



                                   Gerald B. Fleming
                                   Senior Technician Reviewer, Branch 2
                                   Office of Associate Chief Counsel (Corporate)