IRS blesses a tax-free corporate split separating two businesses through a divisive merger and a chain of spin-offs

Plain-English summary

A corporate group that runs two separate businesses (Business A and Business B) through a tall chain of subsidiaries wants to split them apart. The plan converts an operating subsidiary into an LLC that elects corporate status, does a "divisive merger" (demerger) that drops the Business B assets into a new corporation ("Controlled"), and then spins Controlled up the chain through three successive distributions until it reaches an LLC owned by the shareholders. The taxpayer asked the IRS to confirm the tax-free nature of these steps. The IRS issued 27 favorable rulings: the demerger qualifies as a "D" reorganization under § 368(a)(1)(D), and none of the demerger or the three distributions triggers gain or loss to the corporations involved under §§ 355 and 361, with carryover basis and tacked holding periods. The IRS did not rule on the overall business purpose, device, or § 355(e) plan questions, and expressed no view on whether the split otherwise qualifies for tax-free treatment beyond the specific rulings.

Ruling snapshot

• Question: Do the divisive merger and the three successive distributions separating the two businesses qualify for tax-free treatment under §§ 355 and 368?
• Outcome: Approved (27 rulings; reorganization and distributions are tax-free, subject to the stated caveats)
• Key authorities: IRC §§ 355, 368(a)(1)(D), 357(a), 361, 358, 362(b), 1032(a), 1223, 312(h); Rev. Proc. 2017-52; Rev. Rul. 77-191

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202035009 Third Party Communication: None
Release Date: 8/28/2020 Date of Communication: Not Applicable
Index Number: 355.00-00, 355.01-00,
368.00-00, 368.04-00 Person To Contact:
--------------------, ID No. -----------------
-------------------- Telephone Number:
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------------------------------------------------------------ Refer Reply To:
---------------- CC:CORP:2
-------------------------------- PLR-128459-19
------------------------ Date:
May 29, 2020

Legend:

Parent = -----------------------------------------------------------------------------------------------
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Controlled = -----------------------------------------------------------------------------------------------
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Date 1 = -----------------------

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

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

State C = ---------

Country X = ---------------------

Country Y = --------------------------------------

Business A = -----------------------------------------------------------------------------------------------
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PLR-128459-19 2

Business B = -----------------------------------------------------------------------------------------------
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Distributing 3 = -----------------------------------------------------------------------------------------------
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Distributing 2 = -----------------------------------------------------------------------------------------------
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Distributing 1 = -----------------------------------------------------------------------------------------------
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Sub 1 = -----------------------------------------------------------------------------------------------
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Sub 2 = -----------------------------------------------------------------------------------------------
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Sub 3 = -----------------------------------------------------------------------------------------------
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Sub 4 = -----------------------------------------------------------------------------------------------
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Sub 5 = -----------------------------------------------------------------------------------------------
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Sub 6 = -----------------------------------------------------------------------------------------------
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Sub 7 = -----------------------------------------------------------------------------------------------
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PLR-128459-19 3

Sub 8 = -----------------------------------------------------------------------------------------------
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Sub 9 = -----------------------------------------------------------------------------------------------
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FSub 1 = -----------------------------------------------------------------------------------------------
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FSub 2 = -----------------------------------------------------------------------------------------------
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Shareholder A = -----------------------------------------------------------------------------------------------
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Shareholder B = -----------------------------------------------------------------------------------------------
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Remaining = -----------------------------------------------------------------------------------------------
Shareholders -------------------------------------------------

LLC 1 = -----------------------------------------------------------------------------------------------
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LLC 2 = -----------------------------------------------------------------------------------------------
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a = --------------

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

c = -----------------------------------------------------------------------------------------------
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PLR-128459-19 4

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d = --

e = --

f = ----------

g = --------------

Senior Credit = -----------------------------------------------------------------------------------------------
Facility -----------------------------------------------------------------------------------------------
Assumption -----------------------------------------------------------------------------------------------
Agreement -----------------------------------------------------------------------------------------------
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Transition = -----------------------------------------------------------------------------------------------
Services -----------------------------------------------------------------------------------------------
Agreement -------------------------------------------------

Facilities = -----------------------------------------------------------------------------------------------
Agreement -------------------------------------------------

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

This letter responds to your representative’s November 26, 2019, letter requesting
rulings on certain federal income tax consequences of the Proposed Transaction
(defined below). The information provided in that letter and in later correspondence is
summarized below.

This letter is issued pursuant to Rev. Proc. 2019-1, 2019-1 I.R.B. 1, and 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 several “Covered Transactions” under sections 355 and 368 of the
Internal Revenue Code (the “Code”). This office expresses no opinion as to the overall
tax consequences of the transactions or as to any issue not specifically addressed by
the rulings below.

The rulings contained in this letter are based upon facts and representations submitted
by the taxpayer and accompanied by a penalty of perjury statement executed by an
appropriate party. This office has not verified any of the material 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-128459-19 5

This office has made no determination regarding whether any of the Demerger,
Distribution 1, Distribution 2, or Distribution 3 (each 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 the controlled corporation or both (see section 355(a)(1)(B)
and § 1.355- 2(d)); or (iii) is part of a plan (or a 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 § 1.355-8 (see section 355(e) and § 1.355-7).

                                Summary of Facts

Parent is a State A corporation and the common parent of an affiliated group of
corporations that files a consolidated federal income tax return (“Parent Group”). Parent
has a single class of stock outstanding that is owned by Shareholder A, Shareholder B
and the Remaining Shareholders (collectively “the Shareholders”). Parent conducts
Business A and Business B through its subsidiaries and its foreign affiliates.

Parent owns all the stock of Distributing 3, a holding company organized under the laws
of State A.

Distributing 3 owns all the stock of Distributing 2, a company organized under the laws
of State A.

Distributing 2 owns all the stock of Distributing 1, an operating company organized
under the laws of State A. Distributing 2 is engaged in each of Business A and Business
B, directly and indirectly through its subsidiaries.

Distributing 1 owns all the stock of (i) Sub 1, an operating company organized under the
laws of State A, (ii) Sub 2, a holding company organized under the laws of State C, (iii)
Sub 3, a holding company organized under the laws of State A, (iv) Sub 4, a holding
company organized under the laws of State A, (v) Sub 5, a holding company organized
under the laws of State A, and (vi) Sub 6, a holding company organized under the laws
of State A. Sub 1 is engaged in Business B. Sub 4, Sub 5, and Sub 6 have no business
activities and do not hold any assets or liabilities.

Sub 1 owns all the stock of Sub 7, an operating company organized under the laws of
State A and is engaged solely in Business B. Sub 7 owns all the stock of Sub 8, an
operating company organized under the laws of State B that is primarily engaged in
Business B, except for certain employees who provide services to Sub 9. Sub 9 is
engaged in Business A.
PLR-128459-19 6

Sub 2 owns all the stock of Sub 9, an operating company organized under the laws of
State A and is engaged solely in Business A. Sub 9, owns all of the equity interests of
FSub 1, a Country X entity classified as an association taxable as a corporation for U.S.
federal income tax purposes that is engaged solely in Business A.

Sub 3 owns all the stock of FSub 2, a Country Y entity classified as an association
taxable as a corporation for U.S. federal income tax purposes that is engaged solely in
Business A.

Financial information has been received indicating that each of Business A and
Business B have had gross receipts and operating expenses representing the active
conduct of a trade or business for each of the past five years.

Senior Credit Facility

On Date 1, Distributing 2, and some of its subsidiaries, entered into an amended and
restated credit agreement (the “Senior Credit Facility”), which allows for borrowings of
up to $a. Pursuant to the Senior Credit Facility and unrelated to the Proposed
Transaction, Distributing 2 has borrowed approximately $b. As parties to the Senior
Credit Facility and to a Guaranty and Security Agreement required thereby, most of
Distributing 2’s domestic subsidiaries (including Sub 1, Sub 7, and Sub 8) have
guaranteed Distributing 2’s borrowing and have pledged certain of their assets in
support of such borrowing. Certain aspects of the Proposed Transaction would violate
certain covenants set forth in the agreement governing the Senior Credit Facility.
Because the cost of refinancing the Senior Credit Facility currently would exceed any
savings realizable from resetting the terms of borrowing, the parties to the Senior Credit
Facility will obtain the consent of the lenders thereunder to effectuate the Proposed
Transaction to avoid accelerating repayment of Distributing 2’s borrowing. The Senior
Credit Facility, the Guaranty and Security Agreement required thereby, and the Senior
Credit Facility Assumption Agreement will remain outstanding for a maximum length of
time of f following the completion of the Proposed Transaction.

                             Proposed Transaction

For what are represented to be valid corporate business reasons, Parent proposes to
engage in the following steps to separate Business A from Business B (the “Proposed
Transaction”):

 (i)    The Shareholders will organize LLC 1, a State A limited liability company
        that will elect to be classified as a partnership for U.S. federal income tax
        purposes (the “LLC 1 Formation”).

 (ii)   The Shareholders will contribute all their Parent common stock to LLC 1 in
        exchange for all the equity of LLC 1 (the “LLC 1 Contribution”).

PLR-128459-19 7

(iii)    Sub 1 and Sub 9 will enter into an agreement pursuant to which Sub 9: (a)
         will directly employ those personnel who currently provide services to Sub 9
         and whose costs are reimbursed thereby to Sub 1, and (b) will lease from
         Sub 1 on an arm’s-length basis warehouse space for which it currently
         reimburses Sub 1.

(iv)     Distributing 1 will convert to a limited liability company pursuant to the
         applicable State A conversion statute and will change its name to LLC 2
         (the “Distributing 1 Conversion”). Following the Distributing 1 Conversion,
         LLC 2 will make an election under Treas. Reg. § 301.7701-3(c) to be
         classified as an association taxable as a corporation for U.S. federal income
         tax purposes effective from the time of conversion (the “LLC 2 Election,”
         and collectively with the Distributing 1 Conversion, the “Distributing 1
         Restructuring”).

(v)      LLC 2 will engage in a divisive merger (demerger) under the laws of State
         A, resulting in the creation of Controlled, a State A limited liability company,
         which will make an election under Treas. Reg. § 301.7701-3(c) to be
         classified as an association taxable as a corporation for U.S. federal income
         tax purposes effective from the time of formation (the “LLC 2 Demerger”).
         Pursuant to the LLC 2 Demerger, Controlled will acquire all the Business B
         assets formerly owned by LLC 2, including all the outstanding stock of Sub
         1 and will become obligated with respect to all the Business B liabilities with
         respect to which LLC 2 was formerly obligated, if any. Controlled will
         employ the personnel associated with Business B who were formerly
         employed by LLC 2. Pursuant to the Senior Credit Facility, Controlled will
         become a party to the Senior Credit Facility and the Guaranty and the
         Security Agreement required thereby.

(vi)     Distributing 2 and Controlled will enter into the Senior Credit Facility
         Assumption Agreement (the “Senior Credit Facility Assumption”) (see
         representations (8) and (9)).

(vii)    Distributing 2 will distribute 100% of the outstanding equity of Controlled to
         Distributing 3 (“Distribution 1”).

(viii)   Distributing 3 will distribute 100% of the outstanding equity of Controlled to
         Parent (“Distribution 2”).

(ix)     Parent will distribute 100% of the outstanding equity of Controlled to LLC 1
         (“Distribution 3”).

Continuing Arrangements
PLR-128459-19 8

In connection with the Proposed Transaction, Controlled and its subsidiaries (entities
engaged in Business B) and Parent and its subsidiaries (entities engaged in Business
A) will enter into certain business arrangements, including (i) a Transition Services
Agreement, (ii) a Facilities Agreement, and (iii) the Senior Credit Facility, the Guaranty
and Security Agreement required thereby, and the Senior Credit Facility Assumption
Agreement, that will continue after the completion of the Proposed Transaction (the
“Continuing Arrangements”). All such relationships will be based on arm’s-length terms
and conditions. Except with respect to the Senior Credit Facility, the Guaranty and
Security Agreement required thereby, and the Senior Credit Facility Assumption
Agreement, these arrangements are expected to terminate within g following the
competition of the Proposed Transaction.

Director Overlap

Parent's board of directors currently has d members. Following the Proposed
Transaction, it is expected that the boards of directors of Controlled and its subsidiaries,
and Parent and its subsidiaries, will each be composed of e members. Less than half of
the members of the boards of directors of Controlled and its subsidiaries will also be
members of the boards of directors of Parent and its subsidiaries, and vice versa (the
“Overlapping Directors”). The presence of the Overlapping Directors, if any, is intended
to provide continuity. Overlapping Directors are expected to remain on the respective
boards no longer than f.

                                 Representations

The LLC 2 Demerger

With respect to the LLC 2 Demerger, except as set forth below, Taxpayer makes all the
representations in section 3 of the Appendix to Rev. Proc. 2017-52 in the form set forth
therein.

(1) Taxpayer does not make the following representations: Representations 7,19,
20, 24, 25, 35, 39, and 40.

(2) Taxpayer has made the following alternative representations set forth in section
3 of the Appendix to Rev. Proc. 2017-52: 3(a), 8(a), 11(a) (except as noted in the
Continuing Relationships section above), 15(a), 22(a), 31(a), and 41(a).

Distribution 1, Distribution 2 and Distribution 3

With respect to each of Distribution 1, Distribution 2, and Distribution 3, except as set
forth below, Taxpayer makes all the representations in section 3 of the Appendix to Rev.
Proc. 2017-52 in the form set forth therein.

(3) Taxpayer does not make the following representations:
PLR-128459-19 9

  Representations 7,17,18, 19, 20, 22, 24, 25, 35, 39, and 40.

(4) Taxpayer has made the following alternative representations set forth in section 3
of the Appendix to Rev. Proc. 2017-52: 3(a), 8(a), 11(a) (except as noted in the
Continuing Relationships section above), 15(a), 31(a), and 41(a).

                           Other Representations

(5) LLC 1 will be treated as a partnership for U.S. federal income tax purposes. The
LLC 1 Formation and LLC 1 Contribution together is a tax-free contribution under
section 721.

(6) The Distributing 1 Restructuring is a reorganization within the meaning of
section 368(a)(1)(F).

(7) None of the Business B liabilities for which Controlled will be the obligor for
U.S. federal income tax purposes as a result of the LLC 2 Demerger are
evidenced by a debt instrument, and none constitute Distributing Debt within
the meaning of § 3.01 of Rev. Proc. 2018-53, 2018-43 I.R.B. 667.

(8) Distributing 2 and Controlled will each treat the Senior Credit Facility
Assumption as a distribution of property in the amount of c by Controlled to
Distributing 2 to which section 301 applies and will reduce Distributing 2’s basis
in its shares of Controlled pursuant to §§ 1.1502-13(f)(2) and 1.1502-32.

(9) The Senior Credit Facility Assumption will occur separately from the LLC 2
Demerger and Distribution 1, and therefore Controlled will not assume
Distributing Debt within the meaning of § 3.01 of Rev. Proc. 2018-53, 2018-43
I.R.B. 667 in a transfer to which section 357(a) applies. Distributing 2 will not
receive any boot that could be subsequently distributed in satisfaction of a
Distributing 2 debt obligation to which section 361(b) and/or (c) applies in
connection with the Senior Credit Facility Assumption.

(10) At no point during the Proposed Transaction, will a member of the Parent
Group that is distributing the stock of Controlled pursuant to the Proposed
Transaction have an excess loss account (within the meaning of § 1.1502-19)
in the stock of Controlled.

                                    Rulings

Based solely on the information submitted and representations made, we rule as
follows:
PLR-128459-19 10

The LLC 2 Demerger

1. For U.S. federal income tax purposes, the LLC 2 Demerger is treated as if LLC 2
   transferred the Business B assets to Controlled in exchange for all the equity of
   Controlled and Controlled’s assumption of any liabilities associated with the
   Business B assets, and, immediately thereafter, distributed all of the Controlled
   equity to Distributing 2. Cf. Rev. Rul. 77-191, 1977-1 C.B. 94.

2. The LLC 2 Demerger will be a reorganization within the meaning of section
   368(a)(1)(D). LLC 2 and Controlled each will be a “party to a reorganization”
   within the meaning of section 368(b).

3. No gain or loss will be recognized by LLC 2 upon the deemed contribution of the
   Business B assets to Controlled pursuant to the LLC 2 Demerger. Sections
   357(a) and 361(a).

4. No gain or loss will be recognized by LLC 2 upon the deemed distribution of the
   equity of Controlled to Distributing 2 pursuant to the LLC 2 Demerger. Section
   361(c).

5. No gain or loss will be recognized by Controlled as a result of the LLC 2
   Demerger. Section 1032(a).

6. The basis in each asset received by Controlled as a result of the LLC 2
   Demerger will be the same as the basis of that asset in the hands of LLC 2
   immediately before its transfer. Section 362(b).

7. The holding period in each asset received by Controlled as a result of the LLC 2
   Demerger will include the period during which LLC 2 held the asset. Section
   1223(2).

8. No gain or loss will be recognized by (and no amount will be included in the
   income of) Distributing 2 upon receipt of the Controlled equity as a result of the
   LLC 2 Demerger. Section 355(a)(1).

9. The aggregate basis of the LLC 2 equity and the Controlled equity in the hands
   of Distributing 2 immediately after the LLC 2 Demerger is the same as
   Distributing 2’s basis in the LLC 2 equity held immediately before the LLC 2
   Demerger allocated in the manner described in § 1.358-2(a)(2). Section 358;
   § 1.358-1(a).

10. Distributing 2’s holding period in the Controlled equity received in the LLC 2
    Demerger includes the holding period of the LLC 2 equity held by Distributing 2
    with respect to which the distribution of the Controlled equity was made, provided
    PLR-128459-19 11

    that the LLC 2 equity is held as a capital asset on the date of the LLC 2
    Demerger. Section 1223(1).

11. The earnings and profits of LLC 2, if any, will be allocated between LLC 2 and
    Controlled in accordance with section 312(h) and §§ 1.312-10(a) and 1.1502-
    33(f)(2).

Distribution 1

12. No gain or loss will be recognized by Distributing 2 in Distribution 1. Section
    355(c).

13. No gain or loss will be recognized by (and no amount will be included in the
    income of) Distributing 3 in Distribution 1. Section 355(a)(1).

14. The aggregate basis of the Distributing 2 stock and the Controlled equity in the
    hands of Distributing 3 immediately after Distribution 1 is the same as Distributing
    3’s basis in the Distributing 2 stock held immediately before Distribution 1,
    allocated in the manner described in 1.358-2(a). Section 358; § 1.358-1(a).

15. The holding period of the Controlled equity received by Distributing 3 in
    Distribution 1 will include the holding period of the Distributing 2 stock held by
    Distributing 3, provided that such Distributing 2 stock is held as a capital asset on
    the date of Distribution 1. Section 1223(1).

16. The earnings of profits of Distributing 1, if any, will be allocated between
    Controlled and Distributing 2 in accordance with section 312(h) and §§ 1.312-
    10(b) and 1.1502-33(f)(2).

Distribution 2

17. No gain or loss will be recognized by Distributing 3 in Distribution 2. Section
    355(c).

18. No gain or loss will be recognized by (and no amount will be included in the
    income of) Parent in Distribution 2. Section 355(a)(1).

19. The aggregate basis of the Distributing 3 stock and the Controlled equity in the
    hands of Parent immediately after Distribution 2 will be the same as Parent’s
    basis in the Distributing 3 stock immediately before Distribution 2, allocated
    between the Distributing 3 stock and the Controlled equity in the manner
    described in 1.358-2(a). Section 358; § 1.358-1(a).
    PLR-128459-19 12

20. The holding period of the Controlled equity received by Parent in Distribution 2
    will include the holding period of the Distributing 3 stock held by Parent, provided
    that such Distributing 3 stock is held as a capital asset on the date of Distribution

    2. Section 1223(1).

21. Earnings and profits, if any, will be allocated between Controlled and Distributing
    3 in accordance with section 312(h) and §§ 1.312-10(b) and 1.1502-33(f)(2).

Distribution 3

22. No gain or loss will be recognized by Parent in Distribution 3. Section 355(c).

23. No gain or loss will be recognized by (and no amount will be included in the
    income of) LLC 1 in Distribution 3. Section 355(a)(1).

24. The aggregate basis of the Parent stock and the Controlled equity in the hands of
    LLC 1 immediately after Distribution 3 will be the same as LLC 1’s basis in the
    Parent stock held immediately before Distribution 3, allocated between the
    Parent stock and the Controlled equity in the manner described in Treas. Reg.
    § 1.358-2(a). Section 358; § 1.358-1(a).

25. The holding period of the Controlled equity received by LLC 1 in Distribution 3
    will include the holding period of the Parent stock held by LLC 1, provided that
    such Parent stock is held as a capital asset on the date of Distribution 3. Section
    1223(1).

26. Earnings and profits, if any, will be allocated between Controlled and Parent in
    accordance with section 312(h) and §§ 1.312-10(b) and 1.1502-33(e)(3).

27. Following Distribution 3, Controlled will not be treated as a “successor” to Parent
    for purposes of section 1504(a)(3). Therefore, Controlled and its direct and
    indirect subsidiaries that are “includable corporations” under section 1504(b) and
    satisfy the ownership requirements of section 1504(a)(2) will be members of an
    affiliated group of corporations entitled to file a consolidated federal income tax
    return with Controlled as the common parent.

                                     Caveats
    

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax treatment of the Proposed Transaction under other provisions of the Code or
regulations or the tax treatment of any condition existing at the time of, or effects
resulting from the Proposed Transaction that are not specifically covered by the above
rulings. In particular, no opinion is expressed or implied concerning the tax treatment of
the LLC 1 Formation, the LLC 1 Contribution, or the Distributing 1 Restructuring.
PLR-128459-19 13

                              Procedural Statements

The 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 returns that provides the date on and control number
(PLR-128459-19) of the letter ruling.

Pursuant to a power of attorney on file with this office, a copy of this letter is being sent
to your authorized representatives.

                                    Sincerely,



                                    Douglas C. Bates
                                    Branch Chief, Branch 4
                                    Associate Chief Counsel (Corporate)

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