How to count overlapping shareholders and stock buybacks in a spin-off followed by a merger, so the spin-off stays tax-free under section 355(e)
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This page covers one taxpayer's ruling from 2021, which can't be cited as precedent. Ezel answers your situation under the current Code and IRS guidance, with citations.
Plain-English summary
A publicly traded parent company plans to split off one of its businesses into a new corporation (the Spin-off), then immediately merge that new corporation into a subsidiary of a second public company (the Combination). This is a common "Reverse Morris Trust" structure. The risk is section 355(e), which can force the parent to recognize taxable gain on the spin-off if, as part of a plan, one or more persons acquire a 50 percent or greater interest in the spun-off company. Because some investors own stock in both public companies (Overlapping Shareholders), and because the acquirer keeps buying back its own shares, the parent needed IRS blessing on how to count those overlaps and buybacks. The IRS ruled that the parent may use its proposed "Overlap Counting Principles" (looking through funds to ultimate owners, relying on public SEC filings and website postings) when applying the section 355(e) overlap rule. The IRS also ruled that share repurchases by the acquirer, to the extent treated as part of a plan with the spin-off, will be treated as made pro rata from all public shareholders, subject to timing cutoffs tied to when the acquirer actually learns of a large shareholder. The ruling gives the parties a workable method to measure ownership shifts so the spin-off can remain tax-free.
Ruling snapshot
- Question: May the distributing corporation use its proposed overlap-counting method and pro-rata share-repurchase treatment when testing the spin-off against the section 355(e) acquisition rules?
- Outcome: Approved (both requested rulings granted)
- Key authorities: IRC § 355(e), § 355(e)(3)(A)(iv); § 368; Treas. Reg. § 1.355-7; Rev. Proc. 2017-52; Rev. Proc. 2021-1
Full text (IRS public release)
Internal Revenue Service Department of the Treasury
Washington, DC 20224
Number: 202145020 Third Party Communication: None
Release Date: 11/12/2021 Date of Communication: Not Applicable
Index Number: 355.00-00, 355.01-00,
355.10-00, 368.00-00, Person To Contact:
368.01-00 ------------------------, ID No. ---------------
Telephone Number:
------------------------- ---------------------
-------------------------- Refer Reply To:
---------------------------- CC:CORP:3
------------------------------- PLR-106337-21
-------------------------------- Date:
August 13, 2021
Legend
Distributing = ------------------------------
Controlled = -------------------------
Acquiring = -----------------------------------
Merger Sub = ---------------------------
Business A = ---------------------------------------------------------------
Business B = ---------------------------------------------
Business C = ---------------------------------------------------------------
x = ------
Merger Agreement = ---------------------------------------------------------------
PLR-106337-21 2
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Fund A = --------------------------------------------------------------
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Fund B = --------------------------------------------------------------
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Fund A Information = --------------------------------------------------------------
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Fund B Information = --------------------------------------------------------------
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PLR-106337-21 3
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PLR-106337-21 4
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Dear -------------------:
This letter responds to your letter dated March 17, 2021, submitted on behalf of
Distributing, requesting rulings on the application of section 355(e) of the Internal
Revenue Code (the “Code”) to a series of proposed transactions (the “Proposed
Transactions,” as defined herein). The material information submitted in that request
and in supplemental submissions dated April 28, May 18, July 8, July 13, July 30, and
August 11, 2021 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 section 6.03(2) of Rev. Proc.
2021-1, 2021-1 I.R.B. 1, regarding one or more significant issues under section 355.
The rulings contained in this letter only address one or more discrete legal issues
involved in the transactions described in this letter. The Office expresses no opinion as
to the overall tax consequences of the transactions described in this letter or as to any
issue not specifically addressed by the rulings below.
The rulings contained in this letter are based upon information 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.
Summary of Facts
Distributing is a publicly traded corporation and the parent of a worldwide group that
includes both domestic and foreign entities engaged in Business A and Business B.
Distributing is also the common parent of an affiliated group of domestic corporations
PLR-106337-21 5
that file a US consolidated federal income tax return. Distributing has a single class of
common stock outstanding (“Distributing Common Stock”), the shares of which are
publicly traded and widely held by Distributing’s shareholders (the “Distributing
Shareholders”).
Acquiring is a publicly traded corporation and the parent of a worldwide group that
includes both domestic and foreign entities. Acquiring and its subsidiaries are engaged
in the conduct of Business C. Acquiring has a single class of common stock
outstanding (“Acquiring Common Stock”), the shares of which are publicly traded and
widely held by Acquiring’s shareholders (the “Acquiring Shareholders”).
Certain shareholders own both Distributing Common Stock and Acquiring Common
Stock (the “Overlapping Shareholders”).
Proposed Transactions
For what are represented to be valid business reasons, consistent with the Merger
Agreement, Distributing has or will undertake the following Proposed Transactions:
-
Following an internal restructuring to separate Business A from Business B,
Distributing will distribute all of the outstanding stock of Controlled to the
Distributing Shareholders pro rata (the “Spin-off”). -
Immediately after the Spin-off, Controlled will merge with Merger Sub, a wholly
owned subsidiary of Acquiring, with Controlled surviving, and the Controlled
stock will be converted into a right to receive shares of Acquiring Common Stock
(the “Combination”). Under the initial exchange ratio provided under the Merger
Agreement, the Controlled shareholders will receive x percent of Acquiring
Common Stock.
Acquiring has a pre-existing share repurchase program pursuant to which Acquiring
repurchases shares in order to achieve an appropriate capital structure and deliver
attractive cash returns to the Acquiring Shareholders. Following the Combination,
Acquiring may continue to repurchase shares of its stock (the “Share Repurchases”).
The Share Repurchases will be made through (i) open market purchases, (ii) one or
more accelerated share repurchase (“ASR”) programs, (iii) one or more tender offers
open to all holders of Acquiring Common Stock, or (iv) a combination thereof.
Overlap Counting Principles
For purposes of applying section 355(e)(3)(A)(iv) (the “Overlap Rule”) and the
methodology of the example in the 1998 legislative history of section 355(e)(3)(A)(iv)
(the “Net Decrease Methodology”) to determine the extent of Overlapping Shareholders
at the time of the Combination, Distributing will employ the principles described below
(the “Overlap Counting Principles”).
PLR-106337-21 6
(i) Look-Through Approach. In applying the Overlap Rule and the Net Decrease
Methodology, Distributing will look through entities to the ultimate indirect
owners of Distributing Common Stock and Acquiring Common Stock, and will
take into account the identified actual overlap in the ultimate indirect
ownership of Distributing Common Stock and Acquiring Common Stock at
that level, based on actual knowledge, or if Distributing does not have actual
knowledge, then based upon the sources of proof described in paragraph (ii).
Notwithstanding the foregoing, in proving the identity of Overlapping
Shareholders, and the extent of their share ownership for purposes of
applying the Overlap Rule and the Net Decrease Methodology, Distributing
will treat as the ultimate owner of Distributing Common Stock and Acquiring
Common Stock: (i) widely held investment vehicles with public investors (such
as a mutual fund or ETF); (ii) any regulated investment company; (iii) any
domestic pension trust described in Section 401(a) which is exempt from tax
under Section 501(a); (iv) any domestic charitable organization described in
Section 501(c)(3) (including an endowment or private foundation); (v) any
state, local, or foreign government (or agency or instrumentality thereof),
including any fund ultimately owned by a government, and Fund A and Fund
B; and (vi) any foreign trust or pension plan (provided that the beneficiaries of
the trust or pension plan have a pro rata interest in the assets thereof).
(ii) Sources of Proof of Overlapping Shareholders. For purposes of determining
the identity of, and number of shares owned by, the Overlapping
Shareholders, absent actual knowledge at the Relevant Time, Distributing will
rely on information that is “publicly available.” Information shall be deemed as
publicly available when it is available for viewing by the public. Publicly
available information shall include: (i) information filed pursuant to applicable
federal securities laws by institutional investment managers (Form 13F) and
registered management investment companies (Form N-Q, Form N-PORT
and Form N-CSR) (together, “SEC Filings”); or (ii) information voluntarily
posted on the investor’s or the investment adviser’s website (“Website
Posting”). Distributing will rely on the Fund A Information for Fund A and the
Fund B Information for Fund B. In determining the identity of, and number of
shares owned by, Overlapping Shareholders, Distributing shall rely on
Overlapping Shareholder information from SEC Filings or Website Postings at
the Relevant Time.
(iii) Reliance on Actual Knowledge. For purposes of these Overlap Counting
Principles, actual knowledge means the actual knowledge of the Chief
Financial Officer or General Counsel of either Distributing or Acquiring. In
order to determine Overlapping Shareholder information that is not publicly
available on appropriate SEC Filings or Website Postings at the Relevant
Time, Distributing may obtain actual knowledge as of the Relevant Time
through written or oral confirmation from a shareholder (or an authorized
PLR-106337-21 7
representative thereof) with regard to: (i) its ownership of Distributing
Common Stock and Acquiring Common Stock, (ii) whether the beneficiaries
or owners of a shareholder have direct or indirect pro rata interests in the
shareholder’s assets, or (iii) any other relevant information.
Representations
a) The Spin-off is intended to qualify under Section 355.
b) The Combination is intended to qualify under Section 368.
c) Taking into account the rulings issued in this letter, the Spin-off will not be part of
a plan or series of related transactions (within the meaning of Treas. Reg.
§1.355-7) pursuant to which one or more persons will acquire, directly or
indirectly, stock representing a 50 percent or greater interest (within the meaning
of Section 355(d)(4)) in Distributing or Controlled (including any predecessor or
successor of any such corporation).
d) The Share Repurchases will be motivated by a business purpose and the stock
to be repurchased in the Share Repurchases will be widely held.
e) The Share Repurchases will not be motivated to any extent by a desire to
increase or decrease the ownership percentage of any particular shareholder or
group of shareholders.
f) At the time that a Share Repurchase is consummated, Acquiring will not know
the identity of any beneficial shareholder: (i) from which stock is repurchased in
the open market; (ii) in the case of an ASR program, from which the third-party
investment bank borrows stock or purchases stock to fulfill the bank’s obligation
to return borrowed shares; or (iii) that participates in a tender offer (except to the
extent that the shareholder is the record holder of tendered shares or provides an
identifying tax-related form or statement to the repurchasing corporation in
connection with such participation).
g) There is no plan or intention that the aggregate amount of stock purchased in the
Share Repurchases will equal or exceed 20 percent of the outstanding stock of
Acquiring immediately after the Combination.
Rulings
Based solely on the information submitted and the representations set forth above, we
rule as follows:
(1) Distributing may employ the Overlap Counting Principles in applying the Overlap
Rule and the Net Decrease Methodology to the Combination.
PLR-106337-21 8
(2) To the extent that Share Repurchases are treated as part of a plan (or series of
related transactions) with the Spin-off for purposes of section 355(e), the Share
Repurchases will be treated as being made from all “Public Shareholders” of
Acquiring (i.e., shareholders that are not a “controlling shareholder” or “10
percent shareholder,” within the meaning of Treas. Reg. §§1.355-7(h)(3) and
(14), respectively) on a pro rata basis for purposes of testing the effect of the
Share Repurchases on the Spin-off under section 355(e).
For purposes of this Ruling 2, each shareholder of Acquiring will be treated as a
Public Shareholder with respect to any Share Repurchases that occur on or prior
to five business days after either (1) actual knowledge of the Chief Financial
Officer or General Counsel of Acquiring of the existence of a shareholder that is
not a Public Shareholder or (2) the filing of a Schedule 13D, Schedule 13G, Form
3, or Form 4, indicating a shareholder of Acquiring holds enough shares to be
considered a 5 percent shareholder within the meaning of Treas. Reg. §1.355-
7(h)(8) (and it actively participates in the management or operation of the
repurchasing corporation as described in Treas. Reg. §1.355-7(h)(3)) or a 10
percent shareholder within the meaning of Treas. Reg. §1.355-7(h)(14). For
purposes of determining whether a 10 percent shareholder within the meaning of
Treas. Reg. §1.355-7(h)(14) exists, Acquiring may disregard a Schedule 13G
unless Item 6 reports such a shareholder or is left blank, or the filer discloses its
status as a 10 percent shareholder within the meaning of Treas. Reg. §1.355-
7(h)(14) on Form 3 or Form 4.
Caveats
No opinion is expressed about the tax treatment of the Proposed Transactions under
other provisions of the Code or regulations or the tax treatment of any conditions
existing at the time of, or effects resulting from, the Proposed Transactions that are 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.
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-106337-21 9
Pursuant to the Power of Attorney on file with this office, a copy of this letter is being
sent to your authorized representatives.
Sincerely,
______________________________
Mark J. Weiss
Chief, Branch 2
Office of Associate Chief Counsel (Corporate)
cc:
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