Tax-free spin-off of an early-stage product line into a new subsidiary

Plain-English summary

A privately held company does research and development on two products
that both need regulatory approval before they can be sold. One product
is further along and needs fresh capital to reach commercialization, so
the company wants to split the two product lines apart. It plans to drop
the earlier-stage product's assets and liabilities into a newly formed
subsidiary in exchange for all of that subsidiary's stock, then hand out
(distribute) the subsidiary's stock to its own shareholders pro rata.
The IRS ruled that this contribution-plus-distribution qualifies as a
tax-free reorganization under Section 368(a)(1)(D) combined with a
Section 355 spin-off: neither the parent, the new subsidiary, nor the
shareholders recognize gain or loss, and the shareholders split their
existing basis and holding period between the old and new stock. The IRS
did not rule on the business-purpose, device, or Section 355(e)
"anti-Morris Trust" questions, leaving those open. This is a standard
corporate separation blessing that lets a company spin out a business
line without triggering an immediate tax bill.

Ruling snapshot

• Question: Does contributing one product line to a new subsidiary and distributing that subsidiary's stock to shareholders qualify as a tax-free spin-off?
• Outcome: Approved (10 rulings granted; business-purpose, device, and § 355(e) issues expressly not decided)
• Key authorities: IRC §§ 355(a), 368(a)(1)(D), 361, 357(a), 358, 362(b), 1032(a), 1223; Treas. Reg. § 1.358-2(a); Rev. Proc. 2017-52

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 202246008                                              Third Party Communication: None
Release Date: 11/18/2022                                       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:
-----                                                          --------------------
---------------------------------------------                  Refer Reply To:
-------------------------------                                CC:CORP:2
                                                               PLR-111555-22
                                                               Date:
                                                               August 22, 2022




                                                   Legend

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

Controlled                            = -----------------------------------------------------------------------
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                                        -----------

Business                              = -----------------------------------------------------------------------
                                        ------------

Product X                             = -----------------------

Product Y                             = -----------------------------------------------------------------------
                                        -------------------------

Government Regulatory                 = -----------------------------------------------------------
Agency

Stage A                               = -----------------------------------------------------------------------
                                        -------------------------------------------------------

Development                           = -----------------------------------------------------------------------
                                        -----------------------------------------------------------------------
                                        -----------------------------------------------------------------------
                                        ------------------------
PLR-111555-22                                    2

 Continuing Agreements         = -----------------------------------------------------------------------
                                 -----------------------------------------------------------------------
                                 -----------------------------------------------------------------------
                                 -----------------------------------------------------------------------
                                 -----------------------------------------------------------------------
                                 -----------------------------------------------------------------------
                                 -----------------------------------------------------------------------
                                 ----------


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

This letter responds to your authorized representatives' letter dated June 9, 2022, as
supplemented by subsequent information and documentation, requesting rulings on
certain federal tax consequences of a series of transactions (the "Proposed
Transaction," as defined below). The material information submitted in that letter and
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 sections 355 and 368 of the Internal Revenue
Code (the "Code") and Rev. Proc. 2022-10, 2022-6 I.R.B.473. This Office expresses no
opinion 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 penalties 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.

This Office has made no determination regarding whether the Distribution (defined
below): (i) satisfies the business purpose requirement of Treas. Reg. § 1.355-2(b); (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 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. § 1.355-8 (see section
355(e)(2)(A)(ii) and Treas. Reg. § 1.355-7).

                                             Facts

Distributing is a privately held corporation engaged in Business, which includes
conducting research and development activities for the production of Product X and
Product Y. Before these products may be marketed or sold to the public, they must go
PLR-111555-22                                   3

through a series of steps in order to receive approval from the Government Regulatory
Agency. Product X is further along in this process than Product Y, which is at an earlier
stage of development.

For more than five years, Distributing employees have engaged in regular, continuing
operational and managerial activities with respect to each of Product X and Product Y.
Distributing has not yet collected income associated with either Product X or Product Y
but submitted information in accordance with Rev. Proc. 2017-52 indicating that it had
incurred substantial, continuing operating expenses representing the active conduct of a
trade or business with respect to researching and developing Product X and Product Y
for each of the past five years. While Distributing has received grants from
governmental and non-governmental agencies and organizations in the past, it has not
received grants with respect to either Product X or Product Y in the past five years.

Based on favorable results that Product X achieved in Stage A of the regulatory
process, Distributing anticipates a need for capital to enter the next phase of
Development to transition Product X to the commercialization stage. In order to raise
capital for Product X, Distributing intends to separate the activities of Product X from
Product Y.

                                  Proposed Transaction

For what are represented to be valid business reasons, Distributing proposes to engage
in the following steps (collectively, the "Proposed Transaction"):

   (i) Distributing will form a new corporation ("Controlled") and contribute the assets of
       Business associated with Product Y and the assumption of liabilities associated
       with the transferred assets to Controlled in exchange for all of the issued and
       outstanding stock of Controlled (the "Contribution").

   (ii) After the Contribution, Distributing will distribute the stock of Controlled to its
        shareholders on a pro rata basis (the "Distribution").

In connection with the Proposed Transaction, Distributing and Controlled will enter into
certain Continuing Agreements.

                                      Representations

With respect to the Distribution, except as otherwise set forth below, Distributing has
made all the representations in section 3 of the Appendix to Rev. Proc. 2017-52.

Distributing has made the following alternative representations:

       Representations 3(a), 8(a), 11(b), 15(a), 22(a), 31(a), and 41(a).
PLR-111555-22                                 4

Distributing has not made the following representations, which do not apply to the
Distribution:

       Representations 7, 19, 20, 24, 25, 35, 36, 37, 38, 39, and 40.

Distributing has made the following modified representations:

       Representation 32: No intercorporate debt will exist between Distributing and
       Controlled at the time of, or subsequent to, the Distribution of Controlled stock,
       other than payables that arise from to the Continuing Agreements.

                                         Rulings

1. The Contribution and Distribution, together, will constitute a reorganization within the
   meaning of section 368(a)(1)(D). Distributing and Controlled will each be a "party to
   a reorganization" within the meaning of section 368(b).

2. Distributing will not recognize gain or loss on the Contribution. Sections 357(a) and
   361(a).

3. Controlled will not recognize gain or loss on the Contribution. Section 1032(a).

4. Controlled's basis in each asset received in the Contribution will be the same as the
   basis of the asset in the hands of the Distributing immediately before the
   Contribution. Section 362(b).

5. Controlled's holding period in each asset received in the Contribution will include the
   period during which Distribution held the asset. Section 1223(2).

6. Distributing will not recognize gain or loss on the Distribution. Section 361(c).

7. The shareholders of Distributing will not recognize gain or loss (and no amount
   otherwise will be includable in their income) upon receipt of Controlled stock in the
   Distribution. Section 355(a).

8. The aggregate basis of the Distributing stock and the Controlled stock in the hands
   of each shareholder immediately after the Distribution will equal the aggregate basis
   of the Distributing stock held by such shareholder immediately before the
   Distribution, allocated between the Distributing stock and the Controlled stock in
   proportion to the fair market value of each immediately following the Distribution in
   accordance with Treas. Reg. § 1.358-2(a). Section 358(a)(1) and (b).

9. Each shareholder's holding period in the Controlled stock received will include the
   holding period of the Distributing stock with respect to which the Distribution is
PLR-111555-22                                  5

      made, provided that such Distributing stock is 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
regulations or the tax treatment of any condition existing at the time of, or effects
resulting from, the proposed transaction that is 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 representative.

                                        Sincerely,


                                        __________________________
                                        Mark J. Weiss
                                        Branch Chief, Branch 2
                                        Office of Associate Chief Counsel (Corporate)



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