The new Section 355 checklist questionnaire.
Usually, the amount of tax at risk, the size and complexity of the transaction, and the presence of public shareholders require obtaining an advance ruling from the Internal Revenue Service when the taxDaver is planning a spin-off. The IRS recently revised its Section 355 Checklist Questionnaire to provide guidelines on the information, representations, and documentation that must be included in a ruling request for the nonrecognition of gain or loss on the distribution of stock or securities in a controlled corporation. Rev. Proc. 96-30, 1996-19 I.R.B. 8, supersedes the prior checklist questionnaire, Rev. Proc. 8641, and related 1991 revenue procedures it also revokes a "no rule" Position on certain corporate business purposes, which was set forth in Rev. Proc. 93-3, 1996-1 I.R.B. 82.
This article is divided into two parts: Part I covers Rev. Proc. 96-30's most important changes to Rev. Proc. 8641, and Part II covers Rev. Proc. 96-30 as a whole, i.e., how to request a private letter ruling under its various provisions.
I. Major Changes
The major changes of Rev. Proc. 96-30 include (1) the detailed information, representations, and documentation required for establishing a valid corporate business purpose; (2) a description of the facts and circumstances that may qualify the business purpose; (3) a description of each purpose for the spinoff, not just the corporate business purpose; (4) the required information and representations from foreign shareholders and foreign corporations; and (5) the required information and representations where Distributing joins in filing a consolidated return. Other changes made by the revenue procedure are discussed in the second part of this article, relating to obtaining a private ruling letter.
Purpose and Effect of the Revenue Procedure
By providing more information through Rev. Proc. 9630, the IRS hopes to speed up the ruling process and narrow the gap between substantive law and the ruling process. The issuance of the revenue procedure has been accompanied by the participation of IRS representatives in discussions with practitioners in various public forums to disseminate widely the IRS's views on the guidelines. The IRS has created an eight-member committee to address novel and significant section 355 issues on a uniform and timely basis. Taxpayers will continue to have pre-submission confereneces hut taxpayers may not meet directly with the committee. According to the IRS representatives, Rev. Proc. 96-30 is likely to increase the number of section 355 ruling requests.
Business Purpose Guidelines
Two of the most significant changes in Rev. Proc.9630 are the addition of guidelines, particularly Appendix A, which describe certain corporate business purposes supporting a favorable private letter ruling, request. and the revocation of that part of Rev. Proc. 96-3 establishing a "no-rule" position on certain corporate business purposes. The guidelines do not contain an exclusive list of corporate business purposes. Where the guidelines are not satisfied, taxpayers are invited to describe other corporate business purposes that may persuade the IRS to issue a private letter ruling. Overall, the IRS must be satisfied that there is a substantial corporate, non-federal tax purpose for the distribution, and that the purpose cannot be achieved through a nontaxable transaction that does not involve the distribution of Controlled stock, and which is neither impractical nor unduly expensive. Losing a favorable tax status, such as an existing S corporation election, will be viewed as unduly expensive by the IRS. The specific corporate business purposes described in Appendix A of Rev. Proc. 96-30 are discussed in the ensuing sections of this article. Generally, the IRS will be taking a more active role in scrutinizing the motivations and purposes of the spin-off than in the past.
1. Key Employee
Providing a key employee with a stock interest in Distributing or Controlled may be a valid business purpose provided the taxpayer can demonstrate (1) a real and substantial corporate business purpose for the stock transfer, (2) why the individual is a key employee, and (3) why it is necessary to give the individual the type and amount of the proposed stock interest. Also, unless it would be prohibitively expensive, a significant amount of voting stock must be transferred,. The transfer to the key employee should occur within one year of the distribution. The terms of acquisition of the stock should also be described in detail.
The purpose in transferring the stock to the key employee should not be attainable in an alternative nontaxable transaction that does not involve the distribution of Controlled stock and is not impractical or unduly expensive. Rev. Proc. 96-30 states that the IRS would consider it unduly expensive to create a controlled corporation that would terminate a Subchapter S election, though the taxpayer must also show that using a partnership or limited liability company would be impractical or unduly expensive.
In general, the IRS expects that the key employees will be given a meaningful voice in the affairs of the corporation. A typical situation that should qualify as a corporate business purpose would exist where employees or a new executive must be offered stock to retain their services in a particular division, and it is not practical to give them an interest in the whole business or more than 20 percent of a subsidiary.(2) In some instances, employee threats to leave the company were mentioned in private rulings, but that should not be required to obtain a ruling.
Rev. Proc. 96-30 states that the IRS will scrutinize situations in which stock issued to the employee is subject to an option or restriction. Presumably, the IRS's concern is whether the employee's stock ownership will be temporary, thereby defeating the purpose of the distribution.
The principles relating to key employees will also apply to employee stock ownership plans (ESOPs). The special rules for ESOPs may also justify the corporate business purpose for the distribution.(3)
2. Stock Offering
If the corporate business purpose for the distribution is to facilitate a stock offering, the taxpayer must show:
* The need for substantial capital in the near future for demonstrated corporate business needs that are met with the funds.
* The funds can be raised with less cost or effort if Distributing and Controlled are separated through a distribution. A professional analysis must be submitted to substantiate this position. The IRS concedes that an offering of publicly traded stock by a widely held corporation with no significant shareholders will raise more funds per share than an offering by the same corporation as a controlled subsidiary.
* The stock offering will be completed within one year of the distribution.
* Substantiation of a purchase by a limited amount of investors that is conditioned on the distribution.
The IRS has issued a number of instructive revenue rulings and private letter rulings relating to public offerings.(4) Caution should be exercised, however, where more than 20 percent of the outstanding stock of the controlled corporation will be issued in a public offering immediately after a transfer of assets and a distribution. The subsequent offering may violate the section 368(c) requirement that at least 80-percent control be distributed. There should be less concern if the public stock offering is by the distributing corporation since no "control" requirement is imposed in respect of its shares. (See discussion of Rev. Proc. 96-39 below.)
In establishing that the corporate business purpose for the distribution is to facilitate borrowing, the taxpayer must meet requirements similar to those imposed for a stock offering and, if the taxpayer asserts that the distribution will permit borrowing at a lower cost, it must meet the "cost savings" test described in the next section.
4. Cost Savings
Where the asserted corporate business purpose of the transaction is "cost savings," the taxpayer must substantiate through a professional analysis that the savings are significant. Significant savings must be demonstrated through the use of a formula set forth in Rev. Proc. 96-30. The formula generally requires a net cost savings of at least one percent of net income of the affiliated group for a three- or five-year period as selected by the taxpayer.
The procedure marks the first time the IRS has formally prescribed a formula for determining "cost savings." The IRS demonstrates its unease in publicly adopting a mechanical rule, hedging it with the comment that the IRS may apply different guidelines in various situations.(5)
5. Fit and Focus
For the first time, the IRS has formally adopted a "fit and focus" corporate business purpose test. The test is satisfied where the separation will "enhance the success of the businesses by enabling the corporations to resolve management, systemic, or other problems that arise (or are exacerbated) by the taxpayer's operation of different businesses within a single corporation, or affiliated group." IRS representatives have emphasized the success of both businesses must be enhanced under this concept. "Fit and focus" examples described by IRS representatives include:
* Emerging businesses may ultimately compete with one another, thus requiring a spin-off in order for each to stand on its own.
* Focusing on a business may cause management to conclude that it should spin off its noncore businesses.
Where Distributing is not publicly traded (or is publicly traded but has a significant shareholder), the "fit and focus" business purpose will not form the basis for a favorable ruling request unless (1) the distribution is non-pro rata to permit a significant shareholder to concentrate on a particular business (see Example 2 of Treas. Reg. [sections] 1.3552(b)(5)), or (2) effects an internal restructuring within an affiliated group.
A "significant" shareholder is generally one who directly or indirectly owns five percent or more of any class of stock and actively participates in the management of Distributing or Controlled. Third-party professional documentation is essential for substantiation of a fit-and-focus business purpose, except for non pro rata distributions. The IRS will scrutinize continuing relationships, cross ownership, and certain internal restructurings. According to IRS representatives, a permissive view of the "fit and focus" business purpose will likely be adopted where an affiliated group lacks a significant minority shareholder since there is less likelihood that the distribution constitutes a "device" for the distribution of earnings and profits. (The "device" issue is discussed below.)
In order to establish that a corporate business purpose for the distribution is to avoid competition with customers or suppliers, the taxpayer must show that--
* there has been, or will be, a significant reduction of business because of the competing business;
* the distribution will significantly and meaningfully increase business; and
* the customers or suppliers do not object to Controlled's ownership by Distributing's shareholders.
Corroboration from customers or suppliers will be required in most cases.
7. Facilitating an Acquisition of Distributing
Tailoring Distributing's assets by distributing Controlled's stock in order to facilitate a subsequent tax-free acquisition of Distributing by another corporation will be permitted where the taxpayer establishes that Distributing and Controlled must be separated because no alternative nontaxable transaction is available. As general requirements, the acquiring corporation must be unrelated and the acquisition of Distributing completed within one year of its distribution. To illustrate, assume Distributing transfers active business assets to Controlled and distributes Controlled's stock to its shareholders. Distributing is then acquired by X corporation in a nontaxable statutory merger. Hence, Rev. Proc. 96-30 confirms Rev. Rul. 68-603, 1968-2 C.B. 148, in which the IRS agreed to follow Commissioner v. Morris Trust., 367 F.2d 794 (4th Cir. 1966), and held the spin-off nontaxable.
On the other hand, Rev. Proc. 96-30 does not discuss the situation in which Controlled, as a preexisting subsidiary, is acquired after the spin-off in a nontaxable acquisition. Rev. Rul. 96-30, 1996-24 I.R.B. 4, ruled that such a spin-off would be nontaxable only if the merger negotiations, agreement, or shareholders' vote occur after the spinoff. This narrows an earlier interpretation that would have treated the spin-off as nontaxable, even if there had been prior negotiations, as long as there was a valid corporate business purpose for the spin-off. Rev. Rul. 75-406, 1975-2 C.B. 125. Rev. Proc. 96-39, 1996-33 I.R.B. 11, amplifies the non-ruling policy of Rev. Proc. 96-30 by providing that no ruling will be issued if there have been negotiations, agreements, or arrangements with respect to transactions or events that, if treated as consummated before distribution, would result in the distribution of less than control.
8. Facilitating an Acquisition by Distributing or Controlled
Tailoring Distributing's assets or Controlled's corporate structure to facilitate a subsequent tax-free acquisition of another corporation by either Distributing or Controlled involves meeting the same requirements as a restructuring to permit an acquisition of Distributing. If the requirements are met, a tax-free spin-off is permitted. For example, assume shareholders of X corporation wish to acquire Controlled but desire no ownership in Distributing. Distributing could distribute the stock of Controlled, which then could acquire X corporation in exchange for stock of Controlled in a tax-free reorganization. If Controlled is a pre-existing subsidiary or X corporation's share
(1) Rev. Proc. 86-41, 1986-2 C.B. 716; Rev. Proc. 91-62, 1991-2 C.B. 61; and Rev. Proc. 91-63, 1991-2 C.B. 61. See also Rev. Proc. 96-1, 1996-1 I.R.B. 8, for the IRS's general procedures for the issuance of letter rulings and determination letters; and Rev. Proc. 96-3, 19961 I.R.B. 82, for the areas in which the IRS will not issue advance letter rulings. (2) See Treas. Reg. [sections] 1.355-2(b)(5), Example 8, Rev. Rul. 88-33, 19881 C.B. 115 (stock interest to attract new president), and Letter Ruling No. 9607014. (3) Letter Ruling No. 9149042. Rev. Rul. 85-122, 1985-2 C.B. 118; Rev. Rul. 82-130, 1982-2 C.B. (4) Letter Ruling No. 9507001 and Letter Ruling No. 93150 (5) Cf. Letter Ruling No.9549032 (avoiding auditing expense was a valid business purpose).
DONALD L. HERSKOVITZ is a senior technical advisor with Deloitte & Touche LLP and an adjunct law professor at Georgetown University Law Center, in Washington, D.C. Mr. Herskovitz served as an acting section chief with the Reorganization Branch of the Internal Revenue Service. He received his A.B. and J.D. from the University of Michigan, and his LL.M. in taxation from Georgetown University Law Center. The author gratefully acknowledges the assistance of Isaac W. Zimbalist, partner, and Mary Ellen Bresciani, director, with Deloitte & Touche LLP, in the review of this article. receive less than 20 percent of Controlled's stock, the IRS should rule favorably on the tax-free spin-off of Controlled. Where Controlled is a newly created subsidiary or the shareholders of X corporation own more than 20 percent of Controlled following the acquisition, however, the IRS likely would not approve a tax-free spin-off. In either case, the historic shareholders of Controlled may be deemed not to be in "control" immediately after the distribution. Hence, the transaction would fail to qualify for tax-free treatment. Caution should prevail in this area.
9. Risk Reduction
If the corporate business purpose is to protect one business from the risks of another, the taxpayer must address the following issues:
* The nature, magnitude, and claims history of the high-risk business, as well as the claims experience of similar businesses.
* The insurance cost, coverages, and value of the high-risk business.
* The manner in which applicable laws will enhance protection from the high-risk business. An opinion from counsel may be required in order to describe how legal risks are mitigated through the spin-off. Alternative nontaxable transactions must also be discussed. The IRS must be persuaded, in a highly factual manner, that risk reduction is a real and substantial purpose for the transaction.
Rev. Proc. 96-30 contains guidelines to persuade the IRS that risk reduction is essential for the distribution. The guidelines reflect a liberalization of the IRS view of risk reduction. Nevertheless, Rev. Proc. 96-30 cautions taxpayers to review Example 3 of Treas. Reg. [sections] 1.355-2(b)(5), which holds that a distribution of a risky toy business affiliate's stock does not meet the business purpose requirement since, in a step preliminary to the spin-off, the toy business assets were transferred to the controlled subsidiary and the existence of the separate corporate shell for the toy business seemingly provides sufficient insulation from its business risks. In the case of environmental and product liability risks, however, a subsidiary corporation may not shield the parent corporation from liability so the justification for a distribution may be much stronger but Rev. Proc. 96-30 does not provide guidance in this situation.
Rev. Proc. 96-30 specifically requires identification and reporting of foreign shareholders. If Distributing has any foreign shareholders, the taxpayer must state whether Distributing or Controlled was a U.S. real property holding corporation either after or during the five-year period prior to the distribution. Also, if Distributing is not publicly traded, it must provide a list of all foreign persons who are shareholders. Where Distributing is publicly traded, the identity of all five-percent-or-more shareholders, both before and after the distribution, must be disclosed.
In addition, under section 367(e)(1) and applicable regulations, a section 355 distribution involving a foreign person may result in gain being recognized to a domestic distributing corporation.
Under Rev. Proc. 96-30, the status of Distributing, Controlled, or any other corporation involved in the transaction as a foreign corporation-as well as whether such corporation is a passive foreign investment corporation or a controlled foreign corporation-must be disclosed. In such a case, the IRS will require the recognition of gain in certain circumstances.(6)
Where Distributing joins in filing a consolidated federal income tax return, a representation must now be made that, immediately before the distribution, items of income, gain, loss, deduction, and credit will be taken into account pursuant to the intercompany transaction regulations under Treas. Reg. [sections] 1.1502. In addition, a representation must now be made that an excess loss account that Distributing may have in respect of Controlled stock will be included in Distributing's income immediately before the distribution.
II. Requesting a Ruling
The following information, representations, and documentation must be submitted in a ruling request.
Standard corporate and tax identification information must be supplied to permit the IRS to identify the parties to the reorganization and the district office with audit jurisdiction over the distributing and controlled corporations.
Stock and Shareholdings
A detailed description of the classes, rights, dividend, and liquidation preferences of each corporation is required. A list of shareholders, together with the amount and percentage of stock ownership, is also required. Corporations with more than 100 shareholders, however, need only identify shareholders owning five percent or more of any class of stock. The requirement that the taxpayer identify its shareholders may deter some corporations, especially those with a significant bloc of foreign shareholders, from obtaining a letter ruling. In addition, the 100-shareholder threshold for limiting identification to significant shareholders (i.e., those possessing 5 percent or more of any class of stock) may prove too high. Taxpayers may view the identification requirement as unwieldy and be deterred from seeking a ruling, especially if all of the affected shareholders must be informed of the letter ruling request.
Agreements affecting shareholders owning directly or, as a result of the agreement, controlling five percent or more of any class of stock must also be described in the ruling request. Bonds, debentures, options, and other securities interests must also be described.
Stock Securities and Property Being Distributed
Rev. Proc. 96-30 requires a complete description of the stock, securities, and other property (including rights, warrants, etc.) being distributed, and their dates of distribution. Similarly, any part of the distribution affecting the control requirements of section 355(a)(1)(D) and 368(a)(1)(D) must be described. Also, the IRS requires disclosure of any transaction in which Distributing obtained control during the five-year period preceding the distribution.
Anticipated post-distribution transactions that affect ownership interests in Controlled by Distributing, its shareholders, or security holders must be disclosed. For example, if Controlled is indebted to Distributing, the indebtedness must be true debt and not stock; otherwise, the requirement that "control" be distributed will be violated. Similarly, any other stock, securities, or options retained by Distributing must be described in great detail, including amount, percentage, time retained, and reasons. This requirement is motivated by concern that retention of an interest by Distributing may be part of a tax-avoidance plan. In particular, the IRS is interested in identifying shareholders who receive other securities, since the distribution is likely to trigger a dividend to the recipient.
A representation must be made that the fair market value of what is being distributed substantially approximates what is being given up. The representation is necessary to allay the IRS's concern that the distribution may be a disguise for another transaction-such as compensation, gift, bargain sale, etc. For example, in connection with a distribution, additional stock may be given to an employee in order to pay a purportedly nontaxable bonus. Alternatively, a distribution may involve an attempt to transfer assets to heirs in order to avoid estate or gift tax.
Representations must also be made where stock is to be distributed to a shareholder or security holder in some other capacity, such as a creditor or an employee. For ex ample, where a shareholder is also a creditor, the transfer of stock may involve an attempt to pay interest on a tax-free basis.
Active Business Requirement
Rev. Proc. 96-30 requires information substantiating that Distributing and Controlled will be conducting the same active business after the distribution as Distributing and Controlled, or Distributing, were conducting during the five-year period prior to the distribution. The procedure also requires a description of each line of business engaged in by Distributing, Controlled, and their respective subsidiaries, whether or not the businesses will be relied on to meet the active business requirements for a spin-off. Substantial managerial and operational activities for the past five years must be shown in order to qualify as an "active" business. A description of the activities of employees and nonemployees must be provided. The use of employees is essential to establish that an active business is being conducted. The use of nonemployees (including independent contractors) will tend to demonstrate the absence of an active business.
Rev. Proc. 96-43, 1996-35 I.R.B. 6, amplifies the no ruling policy of Rev. Proc. 96-30 by providing that the IRS will ordinarily not rule that the active business requirement has been satisfied unless the gross assets of the trade or business relied on to meet the active business test are at least five percent of the total fair market value of the gross assets of the corporation directly conducting the trades or business. The IRS may rule that the active business requirement is satisfied if it can be established that the trades or business relied on are not de minimis compared with other assets or activities of the corporation.
Changes either in ownership of the active business or in the continuous conduct of the active business must be described in detail, giving reasons for the changes. Again, this information bolsters the five-year requirement.
The separation of real property and intellectual or other intangible property must also be described in detail; i.e., the original and ultimate user, the terms, and the reasons for the separation. The IRS is apparently concerned with post-distribution transactions between the parties to the spin-off, e.g., real property or licenses retained by Distributing leased solely or partially to Controlled, which thereby raises an active business or "device" issue.
Complete balance sheets, including a consolidating balance sheet, that include Distributing and Controlled, must be submitted. Separate unconsolidated profit and loss statements (including footnotes) for each of the past five years for each active business must be submitted for Distributing and Controlled. Where there is a transfer of property to Controlled, pro-forma statements must be provided for Controlled. Literally applied, this requirement can result in extensive submissions in respect of each business conducted. Nevertheless, once a taxpayer demonstrates that there is at least one active business being spun-off and one being retained, the need for substantial additional detail on other active businesses should diminish. Finally, a representation must be made that no substantial changes have occurred in the financial position of the companies since the date of the financial statements submitted in support of the ruling request. The IRS may impose a continuing financial statement disclosure representation through the date of distribution of the stock of Controlled.
Indirect Conduct of Business Through Stock Ownership in Other Corporations
The indirect conduct of the active trade or business through another corporation is an area in the IRS will provide some latitude, if the other corporation meets the same active business requirements of Distributing or Controlled. In addition, a representation must be given that, immediately after the distribution, at least 90 percent of the fair market value of the gross assets of the other corporation will consist of the stock and securities of controlled corporations that are engaged in an active business.
Changes in Ownership of an Active Business
If an active business is acquired during the five-year period that ends on the date of the distribution, the identity, relationship, acquisition date, transaction, and tax consequences must be described in detail.
Changes in Stock Ownership Prior to Distribution
Any changes in stock ownership of Distributing, Controlled, or other corporations during the five-year period preceding the distribution must be disclosed. Changes of ownership includes acquisitions, redemptions, recapitalizations, stock dividends, and sales. No information need be submitted about stock sales in a public market or in circumstances where both seller and buyer own less than five percent of the corporation's stock before and after the sale.
Continuation of Businesses
Representations concerning the continuation of the historic businesses must be made to support the ruling request. The form and specifics of the representations may vary depending on whether the spin-off will effect a vertical division of a single business or the separation of two or more active businesses. To establish the continuation of the historic businesses, Rev. Proc. 96-30 does not prohibit the use of shared employees. Nonetheless, it does request information to permit the IRS to determine the degree and scope of sharing.
The multiple ways to establish the business purpose requirement are described in the preceding part of this article. In addition, the taxpayer must submit details about whether estate planning or gifts motivate the distribution. Rev. Proc. 96-30 is seemingly neutral on the issue. Experience teaches that the IRS will rule favorably despite the presence of such transfers as long as estate planning or gifts are not the substantial or principal purpose for the distribution.
Special Tax Status
The special tax status of any corporation involved in a reorganization may trigger specific tax treatment and prompt additional IRS scrutiny. Hence, Rev. Proc. 96-30 requires the taxpayer to disclose the nature of any special tax status of corporations involved in the spin-off including S corporation, real estate investment trust, insurance company, bank, savings and loan, and controlled foreign corporation. The added disclosure does not a signal a IRS reluctance to issue a favorable rule, but does suggest the IRS may add specific conditions.
Reduction in Federal Taxes
The IRS is keenly interested in whether the spin-off will reduce federal taxes. Where this is so, the taxpayer generally must establish strong evidence of another corporate business purposes. The procedure counsels that taxpayers can diminish the IRS's concerns about the taint of federal tax avoidance by making certain representations for example, that the taxpayer will either forgo or exercise an election -- or by removing the other non-corporate purpose. The nonrecognition of federal taxes from the spin-off transaction itself are disregarded.
Substantiation of Business Purpose
Substantiation of the business purpose is a factual area that the IRS appears willing to evaluate in the rulings process. A taxpayer can and should rely on third-party analysis and documentation to substantiate its case. Any documents (e.g., regulatory filings, proxy statements, board of directors minutes, and press releases) that support the corporate business purposes should accompany the ruling request. Where documents are prepared by a third party in connection with the ruling request, the third party must acknowledge its participation in preparing the document for submission. Finally, in addition to the detailed business purposes set forth in Appendix A of the procedure, the procedure lists additional valid corporate business purposes supporting a spin-off, including obtaining regulatory relief, improving credit, or preserving a franchise.
A primary requirement for a nontaxable spin-off is that it not be a "device" for the distribution of earnings and profits. Certain factors provide indicia of a device including a plan or intent to dispose of stock or securities; presence of substantial earnings and profits; a pro-rata distribution; investment or inactive assets; and liquidation, merger, or sale of assets. The absence of many of these factors may rebut the presence of a device. Where some factors are present, Rev. Proc. 96-30 permits a taxpayer to make representations to explain or rebut, in whole or in part, whether the presence of the factors indicates a device. In the end, the IRS will weigh the factors and determine whether the spin-off is a device.
The procedure establishes two safe harbors where the facts or circumstances may otherwise indicate the presence of a device. First, subsequent dispositions of stock by less-than-five-percent shareholders of a publicly held distributing corporation will not establish a device, so long as management does not know that stock or securities holders plan or intend to dispose of their holdings in the distributing corporation. The second safe harbor permits redemptions by either Distributing or Controlled (directly or through a subsidiary) after the transaction, provided there is a sufficient business purpose for the redemption, the stock is widely held, the redemption is made in the open market, and the intent or plan is to redeem less than 20 percent of the outstanding stock.
If representations cannot be made to establish the availability of the safe harbors, the IRS may still rule favorably on the spin-off depending on other facts and circumstances. For example, any planned subsequent dispositions of stock should include details of the transaction including agreements, price, circumstances, etc., that prove the lack of a device. In addition, according to the IRS, proportionate sales of Distributing and Controlled will not be evidence of a device.
Where subsequent dispositions of stock will occur, the taxpayer may still be able to rebut the presence of a device if it represents that (1) there are no current or accumulated earnings and profits, and (2) no distributions or transactions are planned that will create current or accumulated earnings and profits. Hence, corporations that have operated at a loss for some time or that possess few appreciated assets may more readily show that the distribution is not a device. On the other hand, the presence of substantial earnings and profits may necessitate a strong showing on corporate business purpose to rebut the presence of a device.
A non-pro rata distribution that qualifies as a sale or exchange (rather than a dividend) may be conclusive evidence that the spin-off is not a device for the distribution of earnings and profits.
Where the value of investment assets as a proportion of the total assets is high for either corporation, the presence of a device is more likely. As a result, the procedure requires that the amount and proportion of the investment assets be disclosed. The type of investment assets and the reasonable needs of the business are factors the IRS considers in determining the presence of a device. For example, if 90 percent of the value of the assets of the corporation to be spun-off consist of investment assets, it will be difficult to convince the IRS that no device is present even where the balance of the assets constitute an active business.
A planned sale, merger, or liquidation of either the distributing or controlled corporation following the spin-off may cause the IRS to view the spin-off as a device. The IRS, however, regularlY issues favorable rulings on subsequent nontaxable transactions, especially those patterned after the Morris Trust case.
Continuity of Shareholder Interest
The IRS insists that the continuity-of-interest doctrine must be satisfied to obtain a ruling on spin-offs. Consequently, representations must be made that the same persons who were owners of the enterprise before the distribution will own, in the aggregate, 50 percent or more of the stock of Distributing and Controlled after the distribution.
Taxpayers seeking a ruling must establish that the distribution is not of a disqualified stock under section 355(d)(2). For this purpose, "disqualified stock" is generally stock in Distributing or Controlled that is acquired by related persons with a 50-percent or greater interest in such corporation.
Transfers and Transactions Between Distributing and Controlled
Rev. Proc. 96-30 requires substantially the same representations in respect of contributions to capital, liabilities, and investment credit recapture are were required under prior IRS guidance. The procedure clarifies, however, that investment credit claimed on certain building components are subject to recapture under section 47(d).
For the first time, the IRS has included a requirement that the transaction will not result in a mismatching of income and deductions. A representation must also be made that there is no shifting of income or expense from Distributing to Controlled; otherwise, a closing agreement must be entered for those items.
Information must be supplied on related transactions and on unrelated transactions where either (1) stock is to be issued or redeemed subsequently or (2) the legal rights of shareholders in respect of their stock in Distributing, Controlled or any other corporation in the transaction will change.
A copy of the plan of reorganization and any indemnification, and tax-sharing agreements should be submitted with the ruling request.
The taxpayer may request a presubmission conference, particularly where the transaction does not conform to the revenue procedure. At least three business days prior to the conference, the taxpayer must submit a memorandum describing the transaction, names of taxpayers involved, and issues to be addressed. Powers of attorney for the taxpayer's representatives must also be provided. In some cases, the presubmission conference can be accomplished by telephone.
Appendix B -- Retention of Stock or Options by Distributing
Where Controlled is widely held, the IRS will issue a favorable ruling relating to the retention by Distributing of stock or options in Controlled, provided Distributing establishes:
* A sufficient business purpose for the retention.
* Distributing's directors or officers will not similarly serve Controlled during the retention period, unless solely to accommodate Controlled's business needs.
* The retained stock or options will be disposed of as soon as warranted, but no later than five years after the distribution.
* Distributing will vote its retained stock in proportion to the votes cast by Controlled's other shareholders.
The IRS may issue favorable ruling under other facts and circumstances, such as Rev. Rul. 75-321, 1975-2 C.B. 123, which held that Distributing could retain five percent of the outstanding stock of Controlled, since the retained stock could serve as collateral to enable Distributing to obtain short-term financing for its remaining business enterprise, and it did not represent practical control after the distribution.
Appendix C -- S Corporation Status
If Distributing or Controlled is, or may elect, S corporation status, representations can be made to preserve or obtain S corporation status.
In many cases, Rev. Proc. 96-30 liberalizes the ruling process and its issuance should increase both the number of ruling requests and the likelihood of a favorable outcome for taxpayers. The increased information, representations, and documentation required under Rev. Proc. 96-30, however, will demand special attention to detail in preparing the ruling request.
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Enrollment in the course is limited and applications will be processed on a first-come, first-served basis. For more information, contact TEI at (202) 638-5601.
(6) See I.R.C. [sections] 12961a), 367(b), 367(e)(1), 897, and 1248(f).
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|Author:||Herskovitz, Donald L.|
|Date:||Sep 1, 1996|
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