Cash payout of a sold business's proceeds is a partial liquidation, giving shareholders exchange (capital-gain) treatment

Plain-English summary

A publicly traded corporation sold off one of its three businesses and planned to distribute the net cash proceeds pro rata to its shareholders under a formal plan of partial liquidation, while continuing to run its two remaining (foreign) businesses. The company asked the IRS to confirm the tax treatment. The IRS ruled that the distributions qualify as distributions in partial liquidation under section 302(e)(2), because they reflect a genuine corporate contraction and meet the five-year active-business tests; it fixed the maximum amount that counts as a partial liquidation; and it held that shareholders receive exchange treatment under section 302(a). As a result, noncorporate shareholders recognize capital gain or loss on the stock deemed redeemed, and the corporation recognizes no gain or loss on distributing the cash under section 311(a). It matters because a partial liquidation is the classic route for a company that sells a business line to return the cash to shareholders as capital gain (recovered against their stock basis) rather than as an ordinary dividend.

Ruling snapshot

• Question: Does a pro rata cash distribution of the proceeds from selling one business line qualify as a partial liquidation, giving shareholders exchange treatment?
• Outcome: Approved (distributions treated as a partial liquidation under section 302(e)(2); exchange treatment under section 302(a); no gain or loss to the corporation under section 311(a))
• Key authorities: IRC §§ 302(a), 302(e), 311(a); Rev. Rul. 75-3; Rev. Rul. 60-232; Rev. Rul. 77-245

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202146006 Third Party Communication: None
Release Date: 11/19/2021 Date of Communication: Not Applicable
Index Number: 302.04-00, 346.00-00,
302.04-02, 302.04-03 Person To Contact:
------------------, ID No. -----------------
--------------------------------- Telephone Number:
-------------------------------------- ---------------------
--------------------------------- Refer Reply To:
--------------------------- CC:CORP:03
--------------------------------- PLR-108090-21
Date:
August 23, 2021

Legend

Taxpayer = ---------------------------------
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Buyer = ----------------------------------------
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Target = ---------------------------------
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Target Sub = -------------------------------
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CFC1 = --------------------------------------------------------
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CFC2 = ---------------------------------------------------------------------
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CFC3 = --------------------------------------------------
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CFC4 = ------------------------------------------------------------------------
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PLR-108090-21 2

DRE1 = -------------------------------------------------
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DRE2 = -------------------------------------------------------
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Country A = ----------------
Country B = ------
Country C = ----------
Country D = ------------
Country E = ------------------
Country F = --------
Country G = -------
Business 1 = ------------------------------------------------------------------------
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Business 2 = ------------------------------------------------------------------
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Business 3 = ------------------------------------------------------------------
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Industry A = -----------------------------------------------------
Regulator = ----------------------------------------
Month 1 = -----------
Month 2 = ---------------
Year1 = -------
Year2 = -------
Year3 = -------
Year4 = -------
Gross Proceeds = ----------------
X= --------------
Y= --------------
A= ---
PLR-108090-21 3

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

This letter responds to your authorized representative’s April 7, 2021 request for rulings
on certain federal income tax consequences of a proposed transaction (the “Proposed
Transaction”). The material information submitted in that request 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 penalty of perjury statements 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

Taxpayer is a publicly traded domestic corporation that owns Target. Target owns
Target Sub. Target and Target Sub are each treated as disregarded entities for federal
income tax purposes. Target Sub directly operates Business 1. Taxpayer also wholly
owns, directly and indirectly through a chain of disregarded entities, CFC1, a Country A
entity treated as a corporation for federal income purposes. CFC1 wholly owns, through
a chain of foreign disregarded entities, CFC2, CFC3 and CFC4, each a Country B entity
treated as a corporation for federal income tax purposes. CFC2, CFC3 and CFC4
directly operate Business 2. CFC1 also wholly owns, thorough a chain of foreign
disregarded entities, DRE1, a Country C entity treated as a disregarded entity for
federal income tax purposes. DRE1 wholly owns DRE2, a Country C entity that is
treated as a disregarded entity. DRE1 and DRE2 directly operate Business 3.

Taxpayer has two outstanding equity-linked compensation plans (the “Equity-Linked
Compensation Plans”). Collectively, the plans have stock options, stock appreciation
rights and restricted stock units (collectively, the (“ELIs”)) outstanding. Each Equity-
Linked Compensation Plan provides that, in the event of an extraordinary distribution of
cash or other property, the plan administrator must make adjustments to the terms of
the ELIs to ensure that the holders of the ELIs are made economically whole.

In Month 1, Year 1, Taxpayer’s board of directors decided to reconsider its strategic
options with respect to each of its businesses. In particular, businesses in Countries B,
C, D, E, F and G and Business 1. Before the end of Year 1, the businesses operated in
Countries D, E, and G were fully divested to unrelated third parties. Further, in Month 2,
Year 1, Taxpayer entered into definitive, binding agreements with unrelated third parties
to sell its Country F business and Business 1. The sale of the Country F business
closed in Year 2. The sale of Business 1 is expected to close later in Year 2. Further,
upon closing of the sale of Business 1, restricted cash Taxpayer has on deposit to
satisfy certain federal regulatory requirements relating to Business 1 will be eligible to
be returned to Taxpayer.
PLR-108090-21 4

In Month 1, Year 2, after a thorough evaluation of all strategic options, Taxpayer’s board
of directors decided to continue to operate Business 2 and Business 3 under Taxpayer
management. Taxpayer’s board of directors further concluded that this decision did not
preclude further engagement with potential buyers for the two businesses.

As of the beginning of Year 2, Taxpayer has a net operating loss (“NOL”) carryforward
of approximately $X. Taxpayer has never declared or paid a dividend since its initial
public offering in Year 3.

                             Proposed Transaction

Taxpayer proposes to enter into the following transactions (collectively, the “Proposed
Transaction”):

1. Taxpayer will close the sale of Business 1 whereby Taxpayer will transfer all of its
   interests in Target to Buyer in exchange for the Gross Proceeds in cash, a portion of
   which will be held in escrow (“Escrow Account”) unless and until such portion is
   released to Taxpayer. The rest of the Gross Proceeds will be transferred directly to a
   newly-formed Taxpayer bank account that will only hold sale proceeds (“Segregated
   Account”).

2. Taxpayer will seek release of the approximately $Y of restricted cash related to its
   collateralized regulatory obligations.

3. Taxpayer’s board of directors will formally adopt a plan of partial liquidation pursuant
   to which Taxpayer will declare a pro rata dividend distribution with respect to its
   outstanding shares.

4. Taxpayer will distribute the Net Proceeds (defined below) from the sale of
   Business 1 pro rata to its shareholders through one or more distributions that will
   occur no later than the end of Year 4 (the “Distributions”). Appropriate adjustments
   or substitutions will be made under the Equity-Linked Compensation Plans to
   account for the Distributions as required pursuant to the terms of those plans. None
   of the proceeds of the other divestitures described above will be distributed pursuant
   to this plan of partial liquidation.

                               Representations
   

5. Throughout the period beginning five years prior to the date that the sale of Business
   1 closes (“Closing Date”) and continuing up until the date of the last of the
   Distributions, CFC2, CFC3 and CFC4, in the aggregate, will have continuously and
   actively conducted Business 2. Treas. Reg. section 1.355-3(b) and section 355(b).
   Throughout this period, CFC2, CFC3 and CFC4, in the aggregate, will have been
   directly engaged in Business 2. There is no plan or intention for Taxpayer to sell or
   PLR-108090-21 5

otherwise dispose of, directly or indirectly, one or more of CFC2, CFC3 and CFC4
and there is no plan or intention for one or more of CFC2, CFC3 and CFC4 to cease
being directly engaged in Business 2.

2. Throughout the period beginning five years prior to the Closing Date and continuing
   up until the later of the date of the last of the Distributions, CFC1 will have
   continuously and actively conducted Business 3. Treas. Reg. section 1.355-3(b)
   and section 355(b). Throughout this period, CFC1 will have been directly engaged in
   Business 3. There is no plan or intention for Taxpayer to sell or otherwise dispose,
   directly or indirectly, of one or more of DRE1 and DRE2 and there is no plan or
   intention for one or more of DRE1 and DRE2 to cease being directly engaged in
   Business 3.

3. Taxpayer acquired Business 1 over A years ago. Taxpayer, through its ownership of
   Target Sub, will have continuously and actively conducted Business 1 throughout
   the five-year period prior to the Closing Date. Treas. Reg. section 1.355-3(b) and
   section 355(b).

4. Financial information has been submitted indicating that Business 1, Business 2,
   and Business 3 had income and expenses indicative of business activity in every
   year in the period beginning five years prior to the Closing Date up until the present
   (or, with respect to Business 1, until the Closing Date).

5. All the assets of Business 1 deemed to be sold by Taxpayer either: (i) were actively
   used by Business 1 throughout the five-year period ending the Closing Date; or (ii)
   were replacements of actively used assets. These replacement assets consisted
   primarily of fixed assets used in Business 1 that were acquired to replace similar
   fixed assets that had worn out or reached the end of their projected or anticipated
   useful lives. Each of the replacement assets (when considered together with the
   asset it replaced) was actively used in Business 1 throughout the five-year period
   ending on the Closing Date.

6. Taxpayer has not acquired, and has no plan or intention of acquiring, either directly
   or indirectly: (i) equity in Buyer, Target or Target Sub; or (ii) any part of Business 1
   sold to Buyer.

7. Taxpayer has no plan or intention to re-enter Business 1. In addition, it is not
   anticipated that there would be any expansion of activities in Industry A.

8. Taxpayer has no plan or intention to completely liquidate, and it will continue to be
   engaged in Business 2 and Business 3.

9. The only asset that will be distributed in the Distributions will be cash.

10. The Distributions in partial liquidation will consist of all the net proceeds from the
    termination of Business 1. “Net Proceeds” means the entire amount received from
    PLR-108090-21 6

Buyer for Business 1 plus any other assets properly attributable to Business 1
including the cash on deposit pursuant to a letter of credit no longer required by
Regulator after the Closing Date and the portion of Taxpayer’s working capital
attributable to Business 1, less: (i) cash used to pay liabilities properly attributable to
Business 1; (ii) taxes and expenses of the Taxpayer attributable to the sale of
Business 1 to Buyer; (iii) taxes and expenses of the Taxpayer incident to the
proposed distribution in partial liquidation; and (iv) any loss on the proceeds as a
result of being temporarily invested while placed in the Segregated Account (or while
placed in the Escrow Account).

11. None of the Net Proceeds will be used in any manner by the Taxpayer, except for
    the placement of the Net Proceeds (including cash left from the Escrow Account, if
    any) into the Segregated Account. The Segregated Account assets will at all times
    be invested in nothing other than savings accounts, money market certificates,
    certificates of deposit and similar limited-risk short-term investments. Similarly, none
    of the cash in the Escrow Account was used in any manner except for paying
    liabilities associated with Business 1, or for investment in the same type of assets as
    the Segregated Account.

12. The Net Proceeds (including cash left from the Escrow Account, if any) are proceeds
    from the sale of business assets that were actively used in Business 1. None of the
    amount distributed in partial liquidation is, or is attributable to, any of the following: (i)
    a reserve for expansion that is no longer needed; (ii) a mere decline in, or loss of,
    business; (iii) a mere decrease in working capital, or in the need for working capital;
    (iv) mere proceeds of a sale which is nominal in relation to the entire business of
    Taxpayer (v) a business operated at a loss; or (vi) Taxpayer entering into a non-
    compete agreement with Buyer or any related entity.

13. The assets sold represent assets that were actively used in Business 1 and not
    passive or investment assets and were not substituted assets.

14. The Distributions will be made during the taxable year in which the plan of partial
    liquidation is adopted or in the succeeding taxable year.

15. Taxpayer will distribute the Net Proceeds pro rata to the Taxpayer shareholders. No
    shares will be surrendered by a Taxpayer shareholder.

16. The amount of cash distributed by Taxpayer to each shareholder will in each
    instance be approximately equal to the fair market value of the stock deemed
    surrendered by such shareholder in exchange therefor.

17. There are no declared but unpaid dividends on any shares of Taxpayer stock, and
    none will be declared before the Distribution.

18. There is no plan or intention on the part of any shareholder to reinvest in Taxpayer
    any of the amount distributed in partial liquidation.
    PLR-108090-21 7

19. None of the amounts distributed by Taxpayer to its shareholders in one or more of
    the Distributions will be received by a shareholder as a debtor, creditor, employee or
    in any capacity other than that of a Taxpayer shareholder.

20. The partial liquidation will not be preceded or followed by the reincorporation or
    transfer of such cash to a recipient corporation where persons holding more than 20
    percent in value of the stock of Taxpayer also hold more than 20 percent in value of
    the stock of the recipient corporation. For purposes of this representation, ownership
    will be determined by application of the constructive ownership rules of section 318
    as modified by section 304(c)(3).

21. The terms of each ELI outstanding under the Equity-Linked Compensation Plans will
    be adjusted to eliminate the effect on the value of those equity-linked instruments
    caused by the Distributions.

                                     Rulings
    

Based solely on the information submitted and the representations set forth above, we
rule as follows regarding the Proposed Transaction:

1. The Distributions will be treated as distributions in partial liquidation under section
   302(e)(2), provided the distributions are made in the taxable year in which the plan
   of partial liquidation is adopted or in the next succeeding taxable year.

2. The maximum amount considered distributed in partial liquidation will equal the
   entire amount received from Buyer in exchange for Business 1 plus any other assets
   properly attributable to Business 1 including the cash on deposit pursuant to a letter
   of credit no longer required by the Regulator after the Closing Date (Rev. Rul. 75-3,
   1975-1 C.B. 108) and the portion of Taxpayer’s working capital attributable to
   Business 1 (Rev. Rul. 60-232, 1960-2 C.B. 115), less: (i) cash used to pay liabilities
   properly attributable to Business 1; (ii) taxes and expenses of the Taxpayer
   attributable to the sale of Business 1 to Buyer; (iii) taxes and expenses of the
   Taxpayer incident to the proposed distribution in partial liquidation; and (iv) any loss
   on the proceeds as a result of being temporarily invested while placed in the
   Segregated Account (or while placed in the Escrow Account). This amount will not
   include any earned or accrued investment earnings on the sale proceeds while in
   the Segregated Account.

3. The Distributions will be treated as in full payment in exchange for the stock deemed
   to have been redeemed (Section 302(a)). Gain or loss will be recognized to
   Taxpayer’s non-corporate shareholders to the extent of the difference between the
   amount distributed in the partial liquidation and the adjusted basis of the shares
   deemed surrendered in exchange therefor. Provided that Taxpayer stock is a capital
   asset in the hands of Taxpayer’s shareholders, gain or loss, if any, will be
   PLR-108090-21 8

   considered capital gain or loss subject to the provisions and limitations of
   Subchapter P of Chapter 1 of the Code.

4. No gain or loss will be recognized to Taxpayer on the distribution of the Net
   Proceeds consisting solely of cash in partial liquidation. (Section 311(a)).

5. For purposes of rulings (1) and (3) above, the number of shares that will be
   considered to be constructively redeemed for the purpose of determining gain or
   loss will be determined in accordance with the principles set forth in Rev. Rul. 77-
   245, 1977-2 C.B. 105.

                                      Caveats
   

No opinion is expressed or implied about the tax treatment of the Proposed Transaction
under any other provisions of the Code or regulations, or effects resulting from the
Proposed Transaction 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.

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

                                     Sincerely,



                                     Richard K. Passales
                                     Senior Counsel (Branch 4)
                                     Office of Associate Chief Counsel (Corporate)

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