Two-business split-up qualified as tax-free divisive reorganizations

Plain-English summary

A company operated two businesses through separate wholly owned limited liability companies and wanted to separate the businesses among two groups of owners. Each subsidiary would elect corporate tax status, the parent would be treated as contributing the relevant business assets and liabilities to it, and the parent would distribute the two subsidiaries to different owner groups in complete liquidation. Based on the taxpayer’s representations, the IRS ruled that each contribution and distribution would qualify as a section 368(a)(1)(D) reorganization and a section 355 distribution. The ruling also confirmed nonrecognition, transferred bases and holding periods, and allocation of earnings and profits, while reserving judgment on business purpose, device, and section 355(e) acquisition-plan issues.

Ruling snapshot

• Question: Will the separation of two businesses into corporations distributed to different owner groups qualify as tax-free divisive reorganizations?
• Outcome: approved, subject to the stated representations and caveats
• Key authorities: IRC §§ 355, 357, 358, 361, 362, 368, 1032, and 1223; Treas. Reg. §§ 1.355-2, 1.355-7, 1.355-8T, and 301.7701-3; Rev. Proc. 2017-52; Rev. Proc. 2018-53

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201940007                                              Third Party Communication: None
Release Date: 10/4/2019                                        Date of Communication: Not Applicable
Index Number: 355.00-00, 355.01-02,
              355.03-00                                        Person To Contact:
                                                               ------------------------, ID No. --- --------------
----------------                                               ----------------------------------------------------
--------------------                                           Telephone Number:
--------------------------                                     --------------------
--------------------                                           Refer Reply To:
-----------------------                                        CC:CORP:3
                                                               PLR-135178-18
                                                               Date:
                                                               July 9, 2019




                                                     Legend

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

Controlled 1               =         -------------------------
---------------------------------------------------------------------------------
-------------------------------------------------

Controlled 2               =         -----------------------------------
---------------------------------------------------------------------------------
-------------------------------------------------

Member A                   =         -----------------
-----------------------------------------------------------

Member B                   =         ------------------
-----------------------------------------------------------

Member C                   =         --------------------
-----------------------------------------------------------

Member D                   =         -------------------
-----------------------------------------------------------

Person 1                     =      --------------------

Person 2                     =      ------------------

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State                  =   ----------

Business X             =   -----------------------------------------

Business Y             =   ----------------------------------------

Asset 1                =   --------------------------

a                      =   -------------

b                      =   -------------

c                      =   -------------

d                      =   -------------

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

Date 2                 =   ---------------------------

Date 3                 =   -----------------------

Date 4                 =   --------------------------

Year 1                 =   ------

Year 2                 =   ------

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

This letter responds to your letter dated October 31, 2018, as supplemented by
subsequent information and documentation, requesting rulings on certain federal
income tax consequences of the proposed transaction steps described below (such
steps comprise the “Proposed Transaction”). The information submitted 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, as amplified
and modified by Rev. Proc. 2018-53, 2018-43 I.R.B. 667, regarding one or more
“Covered Transactions” (as defined in section 2.03(1)(a) of Rev. Proc. 2017-52) 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.

PLR-135178-18                                  3

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.

This office has made no determination regarding whether any of the Distributions (as
defined below): (i) satisfies the business purpose requirement of § 1.355-2(b) of the
Income Tax Regulations; (ii) is used principally as a device for the distribution of the
earnings and profits of the distributing corporation or of either of the controlled
corporations or of more than one of the three corporations (see section 355(a)(1)(B) and
§ 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, the controlled corporations, or any
predecessor or successor of the distributing corporation or the controlled corporations,
within the meaning of Treas. Reg. § 1.355-8T (see § 355(e)(2)(A)(ii) and Treas. Reg. §
1.355-7).

                                    Summary of Facts

Distributing is a State corporation that was incorporated on Date 1 and converted to a
limited liability company under State law on Date 2. Distributing is treated as a
corporation for U.S. federal income tax purposes. In connection with the Proposed
Transaction, Distributing formed Controlled 1 and Controlled 2 on Date 3. Distributing
wholly owns Controlled 1 and Controlled 2, both State limited liability companies which
are disregarded as separate from their owner for U.S. federal income tax
purposes. Since Date 3, Distributing has transferred all of the assets and liabilities
associated with Business X to Controlled 1 and all of the assets and liabilities
associated with Business Y to Controlled 2. Controlled 1 and Controlled 2 each have
one class of membership units outstanding.

Distributing manages and operates Business X and Business Y through Controlled 1
and Controlled 2, respectively. Distributing’s single class of membership units are
owned as follows: Member A owns a units, Member B owns b units, Member C owns c
units, and Member D owns d units (Member A, Member B, Member C, and Member D
are referred to collectively as the “Members”). Member A and Member B manage
Business X. Member C and Member D manage Business Y.

Additionally, Distributing has certain outstanding obligations, including the liabilities
discussed herein, which constitute “Distributing Debt,” as defined in section 3.02 of Rev.
Proc. 2018-53. Between Date 1 and Date 2, in Year 1, Distributing redeemed certain
Distributing stock held by Person 1 and Person 2 in exchange for promissory notes
secured by certain property. Further, as of Year 2, Distributing has outstanding
liabilities in the form of a line of credit to Controlled 1 from its respective lender and

PLR-135178-18                                  4

secured by Controlled 1’s assets and a line of credit to Controlled 2 from its respective
lender and secured by Controlled 2’s assets (such notes comprise Distributing’s
“Operating Notes”). All proceeds of the Operating Notes are or will be used in
Controlled 1 and Controlled 2’s respective businesses going forward.

For what are represented to be valid business purposes, Distributing proposes to
engage in the following transaction to separate Business X from Business Y:

                                  Proposed Transaction

        1. Controlled 1 and Controlled 2 will each file an election under § 301.7701-3 of the
      Procedure and Administration Regulations to be classified as an association
      taxable as a corporation. Distributing has represented that, as a result of the
      elections, Distributing is deemed to contribute the assets and liabilities of each
      Controlled 1 and Controlled 2 to Controlled 1 and Controlled 2, respectively, in
      exchange for their respective membership units (“Contribution 1” and
      “Contribution 2,” respectively).

        2. Immediately after Contribution 1 and Contribution 2 (each a “Contribution”),
      Distributing will liquidate by making the following distributions in exchange for all
      of the Distributing membership units held by the Members.

          a. Distributing will distribute all of the membership units in Controlled 1 to
             Member A and to Member B in exchange for all of their Distributing
             membership units (“Distribution 1”).

          b. Distributing will distribute all of the membership units in Controlled 2 to
             Member C and to Member D in exchange for all of their Distributing
             membership units (“Distribution 2”).

Immediately after Distribution 1 and Distribution 2 (each a “Distribution”), Distributing will
dissolve.

Following the Proposed Transaction, Controlled 1 and Controlled 2 will jointly own Asset
1 in accordance with a joint agreement between Controlled 1 and Controlled 2.
Distributing represents that this agreement will reflect arm’s length terms and conditions
and will not be inconsistent with the overall business purposes for the separation of
Business X and Business Y.

                                     Representations

With respect to the Proposed Transaction, except as set forth below, Distributing makes
all of the representations in section 3 of the Appendix to Rev. Proc. 2017-52.

PLR-135178-18                                 5

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

             Representations 5; 6; 36; 37; 39; 40.

   (2) Distributing makes the following alternative representations:

             Representations 3(a); 8(a); 11(a); 15(a); 22(a); 31(a); 41(a).

Additionally, except as discussed below, with respect to each Contribution 1 and
Contribution 2 and Distribution 1 and Distribution 2, Distributing has made each
applicable representation under section 3.04 of Rev. Proc. 2018-53.

Distributing has not made the following representations, which do not apply to the
Proposed Transaction: the standard representations in (6) and in (7), and the additional
representation in (3).

Distributing was unable to make the standard representations in (2) and (4); however,
Distributing makes the following modified representations.

   (2) Except for Person 1 and Person 2, no holder of Distributing Debt that will be
       assumed or satisfied is a person related to Distributing, Controlled 1 or
       Controlled 2, within the meaning of section 267(b) or section 707(b)(1).

   (4) Except for the obligations evidenced by the Operating Notes, Distributing
       incurred the Distributing Debt that will be assumed or satisfied, (a) before the
       submission of the October 31, 2018 letter requesting rulings on certain federal
       tax consequences of the Proposed Transaction, and (b) no later than 60 days
       before the earliest of the following dates: (i) the date the first public
       announcement (as defined in § 1.355-7(h)(10)) of the Divisive Reorganization or
       a similar transaction, (ii) the date of the entry by Distributing into a binding
       agreement to engage in the Divisive Reorganization or a similar transaction, and
       (iii) the date of approval of the Divisive Reorganization or a similar transaction by
       the board of directors of Distributing.

                                         Rulings

Based solely on the information submitted and the representations made, we rule as
follows:

        1. Each Contribution, followed by its respective Distribution, will qualify as a
      reorganization within the meaning of section 368(a)(1)(D). Distributing,
      Controlled 1, and Controlled 2, each will be a “party to a reorganization” within
      the meaning of section 368(b).

PLR-135178-18                               6


    2. No gain or loss will be recognized by Distributing on Contribution 1 or
     Contribution 2. Sections 357(a) and 361(a).

    3. No gain or loss will be recognized by Controlled 1 on Contribution 1 or by
     Controlled 2 on Contribution 2. Section 1032(a).

    4. Controlled 1’s basis in each asset received from Distributing in Contribution 1
     and Controlled 2’s basis in each asset received from Distributing in Contribution
     2 will equal the basis of such asset in the hands of Distributing immediately
     before its contribution. Section 362(b).

    5. The holding period for each asset received by Controlled 1 in Contribution 1 and
     by Controlled 2 in Contribution 2 will include the period during which such asset
     was held by Distributing. Section 1223(2).

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

    7. No gain or loss will be recognized by (and no amount will otherwise be included
     in the income of) Member A or Member B upon receipt of Controlled 1
     membership units in Distribution 1 or by Member C or Member D upon receipt of
     Controlled 2 membership units in Distribution 2. Section 355(a)(1).

    8. The aggregate basis of the Controlled 1 and Controlled 2 membership units
     received by each Member immediately after Distribution 1 and Distribution 2 will
     equal the Member’s aggregate basis in the Distributing membership units
     surrendered in Distribution 1 and Distribution 2, allocated in the manner
     described in § 1.358-2. Section 358(a) and (b).

    9. The holding period of the Controlled 1 membership units received by Member A
     and Member B in Distribution 1 and the holding period of the Controlled 2
     membership units received by Member C and Member D in Distribution 2 will
     include the holding period of the Distributing membership units with respect to
     which each Distribution will be made, provided that such Distributing membership
     unit is held as a capital asset on the date of each Distribution. Section 1223(1).

    10. Distributing’s earnings and profits will be allocated between Distributing,
      Controlled 1, and Controlled 2 in accordance with section 312(h) and § 1.312-
      10(a).

PLR-135178-18                                  7


                                          Caveats

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax treatment of any condition existing at the time of, or effects resulting from, the
Proposed Transaction that are 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 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.

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,



                                       Justin O. Kellar
                                       Assistant to the Branch Chief, Branch 3
                                       Office of Associate Chief Counsel (Corporate)