Regulator-required spin-off qualifies as a tax-free section 355/368(a)(1)(D) reorganization

Plain-English summary

A domestic corporation (Distributing) ran two active businesses. Federal and state regulators required it to separate one of them (Business B) from the other (Business A). To comply, Distributing formed a new subsidiary (Controlled), transferred the Business B assets to it in exchange for all of Controlled's stock, and will distribute that stock to its own shareholders on a pro rata basis. The IRS ruled the transaction qualifies as a tax-free "Type D" reorganization under Sections 368(a)(1)(D) and 355. That means neither the parent, the new subsidiary, nor the shareholders recognize gain or loss on the split, and the transferred assets and the new shares keep their old tax basis and holding periods. The ruling also addressed the corporation's foreign shareholders, holding that distributing the stock to them triggers no gain or withholding under the rules for distributions to non-U.S. persons (Sections 367(e), 1441, 897, and 1445). The IRS did not rule on whether the transaction satisfies the separate business-purpose requirement.

Ruling snapshot

• Question: Does a regulator-mandated separation of one business into a new subsidiary, followed by a pro rata distribution of its stock, qualify as a tax-free § 355 / § 368(a)(1)(D) reorganization?
• Outcome: approved (favorable rulings issued)
• Key authorities: IRC §§ 355, 368(a)(1)(D), 361, 357, 358, 362, 1032, 1223, 312, 367(e), 1441, 897, 1445; Treas. Reg. §§ 1.355-2(b), 1.312-10(a)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202438002 Third Party Communication: None
Release Date: 9/20/2024 Date of Communication: Not Applicable
Index Number: 355.00-00, 355.01-00,
368.04-00 Person To Contact:
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Refer Reply To:
CC:CORP:2
PLR-107743-24
Date:
June 13, 2024

Legend

Distributing = ------------------------------
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Controlled = -----------------------------------------
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Business A = -------------------------------------------------------------
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Business B = -------------------------------------------------------------
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Regulatory Agency = ----------------------------------------------------------

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

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

a = ---

b = --

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

This letter responds to a letter dated April 1, 2024, submitted on behalf of the taxpayer,
requesting rulings on certain federal income tax consequences of a series of proposed
transactions (the "Proposed Transactions"). The material information submitted in that
request and subsequent correspondence is summarized below.

This letter is issued pursuant to Rev. Proc. 2017-52, 2017-41 I.R.B. 283, as modified by
Rev. Proc. 2024-3, 2024-1 I.R.B. 143, regarding one or more "covered transactions"
under sections 355 and 368 of the Internal Revenue Code (the "Code"). 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 information and representations
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 materials
submitted in support of the request for rulings, it is subject to verification on
examination.

We have made no determination regarding whether the Proposed Transactions satisfy
the business purpose requirement of Treas. Reg. § 1.355-2(b).

                               Summary of Facts

Distributing is a domestic corporation that operates Business A. Prior to Date 1,
Distributing also directly operated Business B, which currently is operated by Controlled,
a domestic corporation that is wholly owned by Distributing. Distributing has one class
of stock issued and outstanding, all the shares of which are voting common stock.
Distributing has a shareholders, b of whom are individuals who are not United States
persons within the meaning of section 7701(a)(30) (the "non-U.S. Shareholders").

Financial information has been submitted indicating that 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.

                               Proposed Transactions

Applicable federal and state regulations require Distributing to divest itself of Business
B. Accordingly, in order to separate Business B from Business A, Distributing proposes
to engage in the following transactions (the "Proposed Transactions"):

 1. On Date 1, at the direction of Regulatory Agency, Distributing formed a new
    corporation (Controlled) under the laws of State A. Thereafter, Distributing
    transferred the Transferred Assets to Controlled in exchange for all of the issued
    and outstanding shares of Controlled (the "Contribution").

 2. Distributing will distribute to its existing shareholders all of the issued and
    outstanding shares of Controlled on a pro rata basis (the "Distribution").

Following the Distribution, Distributing and Controlled may share certain officers and
employees. However, appropriate cost sharing agreements shall be undertaken
between the entities in respect of such employees, and each corporation also shall have
its own employees.

                                   Representations

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

a) Distributing has not made the following representations, which do not apply to the
Distribution: Representations 7, 36, 37, 38, and 39.

b) Distributing has not made the following representations but provided the required
explanations: Representations 14, 15, 29, and 42.

c) Distributing has made the following alternative representations: 3(a), 22(a), 31(a),
and 41(a).

d) Distributing has made the following modified representations:

    Modified Representation 11(a): Following the Distribution, Distributing and
    Controlled each will continue, independently and with its separate employees,
    the active conduct of the business on which it relies to meet the active trade or
    business requirement of § 355(b). Following the Distribution, Distributing and
    Controlled may share certain employees pursuant to agreements between
    Distributing and Controlled with respect to those employees based on arm's-
    length terms.

In addition, Distributing has made the following additional representations:

1) Immediately after the Distribution, the fair market value of the business assets of
each of Distributing and Controlled will be greater than 80 percent of the fair
mark value of its total assets. For this purpose, the term "business assets" of a
corporation means its gross assets used in one or more businesses. Such assets
include cash and cash equivalents held as a reasonable amount of working
capital for one or more businesses. Such assets also include assets required (by
binding commitment or legal requirement) to be held to provide for exigencies
related to a business or for regulatory purposes with respect to a business.

2) There is no plan or intention by the shareholders or security holders of
Distributing to sell, exchange, transfer by gift, or otherwise dispose of any of their
stock in, or securities of, either Distributing or Controlled after the transaction.

3) There is no plan or intention by Distributing or Controlled, directly or through any
related person (within the meaning of section 267(b) or section 707(b)(1)), to
purchase any of its outstanding stock after the transaction.

4) There is no plan or intention to liquidate either Distributing or Controlled, to
merge either corporation with any other corporation, or to sell or otherwise
dispose of the assets of either corporation after the transaction, except in the
ordinary course of business.

5) There was no agreement, understanding, arrangement, or substantial
negotiations at any point during the two-year period ending on the date of the
distribution regarding an acquisition of either Distributing or Controlled (including
a predecessor or successor within the meaning of § 1.355-8) or a similar
acquisition.

                                     Rulings

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

1. The Distribution, together with the Contribution, will qualify as a reorganization
   under sections 368(a)(1)(D) and 355. Distributing and Controlled will each be a
   "party to a reorganization" within the meaning of section 368(b).

2. No gain or loss was recognized by Distributing upon the Contribution. Sections
   361(a) and 357(a).

3. No gain or loss was recognized by Controlled upon the Contribution. Section
   1032(a).

4. The basis of each asset received by Controlled from Distributing in the
   Contribution was the same as the basis of that asset in the hands of Distributing
   immediately prior to the Contribution. Section 362(b).

5. The holding period of each asset received by Controlled from Distributing in the
   Contribution included the period during which the assets were held by
   Distributing. Section 1223(2).

6. No gain or loss will be recognized by Distributing upon the Distribution. Section
   361(c).

7. No gain or loss will be recognized by–and no amount will be included in the
   income of–the Distributing shareholders upon the Distribution. Section 355(a).

8. Each Distributing shareholder's aggregate basis in Distributing common stock
   before the transaction will equal their aggregate basis in Distributing and
   Controlled common stock after the transaction, except that such basis shall be
   allocated between each shareholder's shares of Distributing common stock and
   Controlled common stock in proportion to their respective fair market values.
   Section 358(a)(1) and (b).

9. The holding period of the shares of Controlled common stock received by each
   Distributing shareholder will include the holding period of the shares of
   Distributing common stock with respect to which the Distribution was made,
   provided that such Distributing common stock was held as a capital asset on the
   date of the Distribution. Section 1223(1).

10. Earnings and profits will be allocated between Distributing and Controlled in
    accordance with section 312(h) and Treas. Reg. § 1.312-10(a).

11. No gain or loss will be recognized by reason of section 367(e) to Distributing
    upon the distribution of the shares of Controlled common stock to the non-U.S.
    Shareholders.

12. Distributing will have no withholding obligation under section 1441 with respect to
    the distribution of shares of Controlled stock to the non-U.S. Shareholders.

13. The non-U.S. Shareholders will not recognize gain under section 897 upon the
    Distribution.

14. Distributing will not have any withholdings obligations under section 1445 with
    respect to the Distribution.

                                  Sincerely,
    
                                  ___________________________
                                  John B. Lovelace
                                  Senior Counsel, Branch 3
                                  Office of Associate Chief Counsel (Corporate)
    

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