Business separation qualified as a tax-free spin-off

Plain-English summary

A corporate group proposed separating one of its two longstanding businesses into a newly formed controlled corporation. The parent would contribute the separated business's assets and liabilities for controlled stock, then distribute all of that stock pro rata to its shareholders. The IRS ruled that the contribution and distribution would qualify as a section 368(a)(1)(D) reorganization and section 355 spin-off. The parent, controlled corporation, and shareholders would recognize no gain or loss, while asset basis and holding periods would carry over and shareholder basis would be allocated by relative fair market value. The IRS did not determine whether the transaction met the business-purpose, device, or section 355(e) acquisition-plan requirements.

Ruling snapshot

• Question: Would the contribution of one business to a new corporation followed by a pro rata stock distribution qualify for tax-free reorganization and spin-off treatment?
• Outcome: approved, with nonrecognition and carryover basis and holding periods
• Key authorities: IRC §§ 355, 357, 358, 361, 362, 368(a)(1)(D), 1032, and 1223

Full text (IRS public release)

Internal Revenue Service                                         Department of the Treasury
                                                                 Washington, DC 20224

Number: 201935009                                                [Third Party Communication:
Release Date: 8/30/2019                                          Date of Communication: Month DD, YYYY]
Index Number: 355.01-00
                                                                 Person To Contact:
--------------------                                             --------------------------, ID No. ----------------
----------------------------                                     -----------------
--------------------------------                                 Telephone Number:
-------------------------------                                  ----------------------
                                                                 Refer Reply To:
                                                                 CC:CORP3
                                                                 PLR-133666-18
                                                                 Date:
                                                                 May 20, 2019



Legend

Distributing =             ----------------------------
                           --------------------------------
                           -------------------------

State A           =        --------------

State B           =        ---------

Date 1            =        -------

Date 2            =        -------

Date 3            =        -------

Business A =               -------------------------------------

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

Partnership =              --------------------------------------

Partner A         =        --------------------

FSub 1            =        -----------------------------------------

FSub 2            =        -----------------------------------

FSub 3            =        ------------------------------------------------------------------------------------------
PLR-133666-18                                          2

FSub 4           =      ----------------------------------------------------------------------

FSub 5           =      -------------------------------------------------

Sub 6            =      ----------

Jurisdiction A          =        ----------------

Jurisdiction B          =        ----------

Jurisdiction C          =        -------------------------------------

Jurisdiction D          =        -------

a       =        ----

b       =        ----

c       =        ----

d       =        ----

e       =        ----


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

This letter responds to your letter dated November 7, 2018, as supplemented by
subsequent submissions, requesting rulings on certain federal income tax
consequences of the Proposed Transaction (as defined below). The information
provided in that letter and in subsequent correspondence is summarized below.

This letter is issued pursuant to Rev. Proc. 2017-52, 2017-41 I.R.B. 283, regarding one
or more “Covered Transactions” under section 355 and/or section 368 of the Internal
Revenue Code (the “Code”). This Office expresses no opinion as to any issue not
specifically addressed by the rulings below.

The rulings contained in this letter are based on facts and representations submitted by
the taxpayer and accompanied by a penalties of perjury statement executed by an
appropriate party. This office has not verified any of the materials submitted in support
of the request for rulings. Verification of the information, representations, and other data
may be required as part of the audit process.
PLR-133666-18                                 3

This office has made no determination regarding whether the Distribution (as defined
below): (i) satisfies the business purpose requirement of Treas. Reg. § 1.355-2(b); (ii) is
used primarily as a device for the distribution of the earnings and profits of the
distributing corporation or the controlled corporation or both (see section 355(a)(1)(B)
and Treas. Reg. § 1.355-2(d)); or (iii) is part of a plan (or series of related transactions)
pursuant to which one or more persons will acquire directly or indirectly stock
representing a 50-percent or greater interest in the distributing corporation or the
controlled corporation, or any predecessor or successor of the distributing corporation
or the controlled corporation, within the meaning of Treas. Reg. § 1.355-8T (see section
355(e)(2)(A)(ii) and Treas. Reg. § 1.355-7).

                                    Summary of Facts

Distributing was formed on Date 1 as a State A corporation and has its principal place of
business in State B. Distributing is the common parent of an affiliated group of
corporations consisting of both domestic and foreign corporations. The group is
engaged in both Business A and Business B, each of which it has carried on for more
than five years.

Distributing has decided to separate Business A from Business B through the Proposed
Transaction, in which it will spin off Business B in newly formed Controlled. Distributing
has the following corporate business purposes for completing the Proposed
Transaction: (i) it will improve Distributing and Controlled’s ability to use their capital
stock as currency in future transactions; (ii) it will provide cost savings through lower-
cost access to capital for capital expenditures, acquisitions, and other business needs;
(iii) it will resolve management and systemic problems caused by the operation of
Business A and Business B within a single affiliated group; (iv) it will allow for the
alignment of incentive compensation of the respective management teams of the two
businesses; and (v) it will permit Distributing and Controlled to adopt strategies and
objectives that are appropriate to the separate businesses, given their different financial,
investment, and operating characteristics, return profiles, and growth potentials.

Distributing has a single class of stock outstanding. Partnership, a State B limited
partnership, holds a percent of shares (an amount constituting control). Current and
former employees of Distributing hold the remaining b percent of shares, which were
issued through a stock incentive plan. The partners (directly and through trusts) in
Partnership are six members of an extended family; all partners are U.S. citizens.
Partner A is the general partner of Partnership and also serves as Chairperson and
CEO of Distributing. As general partner, Partner A votes all shares held by the
partnership.

Distributing wholly owns FSub 1, which is a Jurisdiction A limited liability company, and
FSub 2, which is a Jurisdiction B limited liability company. FSub 1 wholly owns FSub 3,
a Jurisdiction C branch, and FSub 4, a Jurisdiction C limited liability company.
PLR-133666-18                                 4

Distributing owns c percent of FSub 5, a Jurisdiction D partnership. FSub 1 and FSub 2
are holding companies with no operations. FSub 3, FSub 4, and FSub 5 are all involved
in Business B.

Distributing formed FSub 5 as a joint venture with an unrelated party on Date 2. At the
same time, it contributed all of its directly held businesses to Sub 6, a wholly owned
domestic subsidiary. On Date 3, having determined that it was unnecessary to operate
its businesses through Sub 6 rather than directly, Distributing liquidated Sub 6.

Both Business A and Business B presently have substantial cash holdings. Cash and
cash equivalents currently account for approximately d percent of Business A’s assets
and approximately e percent of Business B’s assets. Distributing hopes to use at least
some of these cash reserves for certain capital projects or to have entered into binding
contracts for such capital projects before the Proposed Transaction. Prior to the
Proposed Transaction, if any cash remains that has not yet been dedicated to capital
expenditures under a binding agreement, Distributing will declare a sufficiently large
cash dividend to its shareholders so that the nonbusiness asset percentage of each of
Distributing and Controlled will be below 20 percent following the distribution of the
dividend.

Distributing has a number of outstanding liabilities. In the Proposed Transaction,
Controlled will assume the liabilities associated with Business B and with Business B’s
property and employees. None of these liabilities is evidenced by a debt instrument.
Controlled therefore will not assume liability for any Distributing Debt within the meaning
of Rev. Proc. 2018-53 § 3.01, 2018-43 I.R.B. 667.

Following the Proposed Transaction, Distributing will have certain continuing business
relationships with Controlled. All such relationships will be based on arm’s-length terms
and conditions. Specifically, Distributing and Controlled will enter into employment
agreements that address issues associated with the employment of Distributing and
Controlled employees and other matters relating to employee benefit plans,
agreements, and arrangements. Some of these services and employees will be shared
by Distributing and Controlled. These relationships will be short-term in nature, and are
expected to terminate within 12 months after the distribution.

Also, for up to 12 months after the distribution, employees of Distributing will continue to
provide accounting, human resource, legal, and treasury services to Controlled, and
employees of Controlled will provide IT and research and development services to
Distributing. During this period, Distributing and Controlled will be assembling their own
resources to handle these services. After the 12-month period, no services will be
shared between Distributing and Controlled, and Distributing and Controlled will have no
further transactions aside from purchases of each other’s publicly available services and
products at the prices charged to unrelated customers.
PLR-133666-18                                  5

                                The Proposed Transaction

To achieve the business purposes described above, the following series of steps is
proposed:

1.     Distributing will form Controlled, a new State A corporation.

2.     In exchange for Controlled stock, Distributing will contribute to Controlled all of
the assets of Business B, including all of its interests in FSub 1, FSub 2, and FSub 5,
and Controlled will assume the liabilities of Business B (the “Contribution”).

3.      Following the Contribution, Distributing will distribute all of the Controlled stock to
its shareholders (the “Distributees”) pro rata, with each shareholder receiving one share
of Controlled stock for each share of Distributing stock held by such shareholder (the
“Distribution”).

4.     After the Distribution, Partner A will serve as Chairperson and CEO of Controlled,
as well as a director of Distributing (Partner A will be the only overlapping board
member). Two of the five remaining current directors of Distributing will continue to
serve as directors of Distributing; the remaining three will serve as directors of
Controlled. Distributing will begin a search for a new CEO and Chairperson.

                                      Representations

With respect to the Distribution, except as otherwise set forth below, Distributing has
made all of the representations in § 3 of the Appendix to Rev. Proc. 2017-52, 2017-41
I.R.B. 283.

(1) Distributing has made the following alternative representations:

       Representations 3(a), 8(a), 11(a), 15(a), 22(a), 31(a), 41(a)

(2) Distributing has not made the following representations, which do not apply to the
Proposed Transaction:

       Representations 7, 24, 25, 35

                                           Rulings

Based solely on the information submitted and the representations set forth above, we
rule as follows:
PLR-133666-18                                 6

1. The Contribution, followed by the Distribution, will qualify as a reorganization under
section 368(a)(1)(D), and Distributing and Controlled will each be “a party to a
reorganization” within the meaning of section 368(b).

2. No gain or loss will be recognized by Distributing on the Contribution (section 361(a)
and section 357(a)).

3. No gain or loss will be recognized by Controlled on the Contribution (section
1032(a)).

4. Controlled’s basis in each asset (including each stock interest) received from
Distributing in the Contribution will be the same as the basis of such asset in the hands
of Distributing immediately before the Contribution (section 362(b)).

5. Controlled’s holding period for each asset received from Distributing in the
Contribution will include the period during which Distributing held that asset
(section 1223(2)).

6. No gain or loss will be recognized by Distributing on the Distribution (section
361(c)(1)).

7. No gain or loss will be recognized by (and no amount will otherwise be included in the
income of) any Distributee upon receipt of Controlled stock in the Distribution
(section 355(a)(1)).

8. The aggregate basis of the Distributing shares and the Controlled shares in the
hands of each Distributee immediately after the Distribution will equal the aggregate
basis of the Distributing shares held by the Distributee immediately before the
Distribution, allocated between the shares of Distributing and Controlled in proportion to
the fair market value of each immediately following the Distribution in accordance with
Treas. Reg. § 1.358-2(a)(2) (section 358(b)(2) and (c)).

9. The holding period of the Controlled shares received by each Distributee in the
Distribution will include the holding period of the Distributing shares on which the
Distribution is made, provided the Distributing shares are held by the shareholder as a
capital asset on the date of the Distribution (section 1223(1)).

10. Earnings and profits, if any, will be allocated between Distributing and Controlled in
accordance with section 312(h) and Treas. Reg. §§ 1.312-10(a).

                                         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
PLR-133666-18                                  7

regulations or the tax treatment of any condition existing at the time of, or effects
resulting from, the Proposed Transaction that is not specifically addressed by this letter.

                                  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.

A copy of this letter should be attached to the federal income tax return of each
taxpayer involved for the taxable year in which the transaction covered by this ruling
letter is consummated. 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 this letter ruling.

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

                                        Sincerely,



                                        __________________________________
                                        Mark S. Jennings
                                        Senior Technician Reviewer, Branch 1
                                        Office of Associate Chief Counsel (Corporate)




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