PLR 200004035: Two distributions in a proposed corporate split off receive § 355 treatment

Plain-English summary

A public company planned to separate a subsidiary whose suppliers competed with another business in the corporate group. Controlled would issue stock to the public. Distributing would then transfer its remaining Controlled shares to Parent, which would distribute them to Parent shareholders through an exchange offer or a backup distribution. Based on the submitted facts and representations, the IRS ruled that neither distribution would cause gain or loss to the distributing corporation or the recipient shareholders under § 355. It also ruled on stock basis, holding periods, and earnings and profits. A separate ruling states that § 367(e) gain would apply to the extent the stated stock value threshold is missed and recipients are not qualified U.S. persons. The letter gives no opinion beyond its specific rulings.

Ruling snapshot

• Question: What are the federal tax consequences of the two proposed distributions of Controlled stock?
• Outcome: Approved for the stated § 355 treatment and related basis and holding period rulings, based on the submitted facts and representations; § 367(e) gain may apply in the specified case.
• Key authorities: IRC §§ 355, 358, 1223, 312, 367(e)(1).

Full text (IRS public release)

Internal Revenue Service                         Department of the Treasury
Index Number: 355.01-01, 355.04-00               Washington, DC 20224
Person to Contact:
Telephone Number:
Refer Reply To:
CC:DOM:CORP:1-PLR-121117-98
Date: August 3, 1999

Re:
Parent =
Distributing =
Controlled =
Business A =
Business B =
Business C =
Corporation D =
Product A =
Individual E =
Corporation F =
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cc =
dd =
ee =
ff =
gg =
hh =
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jj =
kk =
mm =
nn =
oo =
pp =
qq =
Date 1 =
Date 2 =
Date 3 =
Date 4 =
Date 5 =
Date 6 =
Date 7 =
x =
y =
z =

Dear :

This letter responds to your request dated November 16, 1998, for rulings
concerning the federal income tax consequences of a proposed transaction (the
“Proposed Transaction”). Additional information was provided in submissions dated
January 29, 1999, April 14, 1999, June 10, 1999, June 21, 1999, July 8, 1999, July 13,

1999, July 15, 1999, and July 26, 1999. The facts submitted are summarized below.

Parent is a publicly traded company and the common parent of an affiliated
group of corporations that file a consolidated return for federal income tax purposes.
Parent owns all of the stock of Distributing, which represents substantially all of Parent's
assets. Distributing owns all the stock of Controlled and numerous other direct and
indirect subsidiaries. Distributing is directly engaged in Business A and indirectly
operates a variety of other businesses, including Business C. Controlled is directly
engaged in Business B.

Parent has two classes of common stock outstanding, Parent Class A voting
common stock and Parent Class B nonvoting common stock. Except for voting rights,
the two classes are identical. Both classes of stock are publicly traded. As of Date 1,
there were approximately aa shares of Parent Class A stock outstanding and
approximately bb shares of Parent Class B stock outstanding. As of Date 1,
approximately cc shares of Parent Class A stock, representing dd percent of the
outstanding Parent Class A stock, and ee shares of Parent Class B stock, representing
ff percent of the outstanding Parent Class B stock, were owned by Corporation D. As
of Date 1, approximately gg shares of Parent Class A stock and hh shares of Parent
Class B stock are owned by Individual E, who is the Chief Executive Officer and
Chairman of the Board of Directors of Parent. Individual E and members of his family,
directly and indirectly, also own all of the stock of Corporation D. There are also four
institutional shareholders that through various funds and entities own more than 5
percent of the Parent Class A and Parent Class B stock. To the best knowledge of
Parent, the remainder of the Parent Class A and Parent Class B stock is held by less
than 5 percent shareholders.

Parent acquired ownership of Controlled on Date 2 (more than five years prior to
the date of the Proposed Transaction) in a transaction in which Corporation F, the
former parent of the consolidated group of which Controlled was a member, was
merged with and into Parent (the "Z Merger"). Subsequently, as part of a separate
transaction, several other subsidiaries that were also acquired by Parent in the Z
Merger and that were engaged in Business B were merged with and into Controlled. In
addition, Controlled acquired the stock and/or assets of certain other Parent
subsidiaries that are engaged in Business B outside of the United States.

On Date 3, Controlled declared a dividend to Distributing in the form of a $ii
promissory note (the “Dividend Note”). On Date 4, Controlled entered into term and
revolving credit agreements with unrelated third-party lenders in the aggregate of $jj;
$kk was drawn down on Date 5. Such proceeds were used to pay (i) a portion of the
purchase price for the acquisition of the non-U.S. Business B operations, (ii) the
Dividend Note and other notes owed to Distributing, and (iii) certain fees and expenses
incurred in connection with the draw down of funds.

Controlled derives the majority of its income from the rental of Product A. It
recently developed a new business practice whereby it enters arrangements to procure
Product A from its suppliers at a greatly reduced initial price in return for a portion of the
revenue derived from the rental of Product A over a specific period of time (“the
Revenue Sharing Arrangements”). These new arrangements have resulted in greatly
increasing Controlled’s revenues and profitability. However, this arrangement
necessitates a closer working relationship between Controlled and its suppliers, and
requires its suppliers to share confidential information with Controlled. Its suppliers
have indicated that their relationship with Controlled is strained by Controlled’s affiliation
with Distributing, because one of the major businesses of Distributing is in direct
competition with Controlled’s suppliers. Parent fears that Controlled’s affiliation with a
competitor of the suppliers may cause the suppliers to take action with respect to the
revenue sharing arrangements, which would materially adversely affect Controlled’s
revenues and profitability.

In order to address these issues, management of Distributing and Controlled has
determined that Distributing and Controlled should be separated. Accordingly, they
propose the following Proposed Transaction:

A. Parent and Controlled will enter into several Transaction Agreements (the
“Transaction Agreements”). The Transactions Agreements will provide for sharing of
certain resources until the remainder of the transaction is consummated. The
Transaction Agreements will also allocate tax and other contingent liabilities of the
Parent consolidated group between Controlled and other members of the Parent
consolidated group.

B. Controlled will recapitalize, providing for two classes of common stock: a
Class A with x votes per share and a Class B with y votes per share. This new Class B
common stock will have the following characteristics:

(i) Each share may be converted into a share of Class A stock at the holder's
option prior to the Split-off Transaction described in STEP D and STEP E;

(ii) If z percent or less by value of Controlled’s aggregate outstanding stock is
issued prior to the Split-off Transaction, each share of Class B stock will
automatically convert, pursuant to its terms, into a share of Class A stock.

(iii) Unless approved by the majority of the holders of the Class A stock and
the majority of the holders of the Class B stock, in the event of
Controlled's reorganization or consolidation with one or more corporations
in which Class A Controlled stock and Class B Controlled stock is
converted into or exchanged for shares of stock, other securities or
property (including cash), all holders of Controlled stock, regardless of
class, will be entitled to receive the same kind and number of shares of
stock and other securities and property, except that the relative voting
rights of the Class A stock and the Class B stock may be retained.

C. In an initial public offering shortly after the recapitalization, Controlled will
issue Class A stock representing no more than twenty percent by vote of Controlled's
aggregate outstanding stock, but between mm and nn percent by value. Prior to the
First Distribution, Controlled may also issue Class A Controlled stock in connection with
acquisitions and/or pursuant to a second public offering. In any event, Distributing will
continue to own at least eighty percent by vote and oo percent by value of Controlled’s
aggregate outstanding stock until the First Distribution. The shares issued in a second
offering or in connection with acquisitions may represent sufficient value to disaffiliate
Controlled from the Parent Group under § 1504; however, Distributing will continue to
own stock possessing at least eighty percent of Controlled’s voting power.
Additionally, Controlled will issue compensatory employee stock options for its Class A
stock (“Controlled Stock Options”) that will satisfy the safe harbor for compensatory
options under § 1.1504-4(d)(2)(v).

D. After Date 6, Distributing will distribute all of its Controlled stock to Parent
(the “First Distribution").

E. Immediately after the First Distribution, Parent will make a distribution of all of
the Controlled stock received by Parent pursuant to the First Distribution to certain
Parent shareholders (the "Second Distribution,” together with the First Distribution, the
"Split-off Transaction"). The Second Distribution will be accomplished through the
mechanism of an exchange offer, a “dutch auction” in which Parent offers its
shareholders the opportunity to tender their Parent shares and receive shares of
Controlled in exchange. Neither Corporation D nor Individual E will participate in the
exchange offer. If the amount of Parent stock tendered by Parent shareholders in the
exchange offer is not sufficient to result in a distribution of 100 percent of Parent's
Controlled stock, Parent will distribute as soon as practicable all remaining shares pro
rata to its shareholders of record at the close of business on a record date promptly
after consummation of the exchange offer (a “Backup Distribution”). The terms of the
exchange offer will be structured in such a way as to ensure that, if a Backup
Distribution is necessary, Corporation D and Individual E together will receive no more
than pp percent of the total number of shares of Controlled stock. If Corporation D and
Individual E should receive more than pp percent of the Controlled stock in the Backup
Distribution, the Split-off transaction will not occur and Controlled will remain a
subsidiary of Distributing.

F. After the Split-off transaction, Controlled and Parent may share up to qq
employees until no later than Date 7 (the “Shared Employees”). The Shared
Employees will remain employees of Controlled and will also work for a newly-created
special purpose subsidiary of Distributing to assist in transition services after the
Proposed Transaction, including implementation of Controlled and Parent's obligations
under the Transaction Agreements.

The taxpayer has made the following representations in connection with the
Proposed Transaction:

(a) No part of the consideration to be distributed by either Parent or
Distributing will be received by a shareholder as a creditor, employee, or
in any capacity other than that of a shareholder.

(b) The five years of financial information submitted on behalf of Distributing
and Controlled is representative of each respective corporations’ present
operation, and with regard to each such corporation, there have been no
substantial operational changes since the date of the last financial
statements submitted.

(c) Immediately after the Split-off Transaction, Distributing and Controlled will
each continue, independently and with its separate employees, the active
conduct of their respective businesses, except for the Shared Employees
described above.

(d) Immediately after the Split-off Transaction, at least 90 percent of the fair
market value of the gross assets of Parent will consist of the stock of
Distributing, which is engaged in the active conduct of a trade or business
as defined in § 355(b)(2).

(e) The transaction is being carried out to resolve Controlled’s problems with
suppliers who object to Controlled’s being associated with Distributing,
which is engaged in Business C, a business that directly competes with
such suppliers. The Split-off Transaction is motivated, in whole or
substantial part, by this corporate business purpose.

(f) Except for the disposition of Controlled stock by Distributing in the Split-off
Transaction, there is no plan or intention by Parent to sell, exchange,
transfer by gift, or otherwise dispose of Distributing or Controlled stock
after the First Distribution.

(g) There is no plan or intention by any shareholder who owns 5 percent or
more of the stock of Parent, and the management of Parent, to its best
knowledge, is not aware of any plan or intention on the part of any
particular remaining shareholder or security holder of Parent, to sell,
exchange, transfer by gift, or otherwise dispose of either Parent or
Controlled stock after the Split-off Transaction.

(h) There is no plan or intention by Parent, Distributing or Controlled, directly
or through any subsidiary corporation, to purchase any of its outstanding
stock after the Split-off Transaction, other than through stock purchases
meeting the requirements of Section 4.05(1)(b) of Rev. Proc. 96-30.

(i) There is no plan or intention to liquidate Parent, Distributing or Controlled,
to merge them with any other corporation, or to sell or otherwise dispose
of their assets after the Split-off Transaction, except in the ordinary course
of business.

(j) Except for contingent liabilities arising from the intercompany agreements
governing the separation of Controlled from the Parent group and except
for agreements entered into in the ordinary course of business, no
intercorporate debt will exist between Parent, Distributing, and Controlled
at the time of, or subsequent to, the distribution of the Controlled stock.

(k) Immediately before Controlled is disaffiliated from the Parent Group under
§ 1504, items of income, gain, loss, deduction and credit will be taken into
account as required by the applicable intercompany transaction
regulations. Neither Parent nor Distributing will have an excess loss
account with respect to Controlled stock.

(l) Payments made in connection with all continuing transactions among
Parent, Distributing and Controlled will be for approximate fair market
value based on terms and conditions arrived at by the parties bargaining
at arm's length.

(m) For purposes of § 355(d), immediately after the First and Second
Distributions, no person will hold disqualified stock (under § 355(d)(3)) in
Parent or Controlled possessing 50 percent or more of the total combined
voting power of all classes of Parent or Controlled stock entitled to vote or
50 percent or more of the total value of shares of all classes of Parent or
Controlled stock.

(n) The First and Second Distributions are not (within the meaning of
§ 355(e)) part of a plan or series of related transactions pursuant to which
one or more persons will acquire directly or indirectly stock possessing 50
percent or more of the total combined voting power of all classes of stock
of either Parent or Controlled, or stock possessing 50 percent or more of
the total value of all classes of stock of either Parent or Controlled.

(o) None of Distributing, Parent, or Controlled is (or will be) a foreign
corporation.

(p) To the best knowledge of Distributing, no foreign shareholder is expected
to own 5 percent or more of any class of Distributing or Controlled stock
after the Second Distribution.

(q) Neither Distributing nor Controlled have been (nor will they be) a United
States real property holding corporation (as defined in § 897(c)(2)) at any
time during the 5-year period ending on the date of the First Distribution or
the Second Distribution, and neither of them will be a United States real
property holding corporation immediately after the First Distribution or the
Second Distribution.

Based solely on the information submitted and the representations set
forth above, we rule as follows with respect to the First Distribution:

(1) No gain or loss will be recognized by Distributing on the distribution of the
Controlled stock to Parent (§ 355(c)(1)).

(2) No gain or loss will be recognized by (and no amount will be included in
the income of) Parent on the receipt of the Controlled stock (§ 355(a)(1)).

(3) The aggregate basis of the Controlled stock and the Distributing stock in
the hands of Parent, immediately following the First Distribution, will be
the same as the basis of the Distributing stock held by Parent immediately
before the First Distribution, allocated in proportion to the relative fair
market values of each at the time of the First Distribution in accordance
with § 1.358-2(a)(2) (§§ 358(a)(1), (b)(1), and (b)(2)).

(4) The holding period of the Controlled stock received by Parent will include
the holding period of the Distributing stock with respect to which the
distribution will be made, provided that the Distributing stock is held as a
capital asset on the date of the distribution (§ 1223).

(5) As provided in § 312(h), proper allocation of earnings and profits between
Distributing and Controlled will be made under §§ 1.312-10(a) and
1.1502-33.

Based solely on the information submitted and the representations set
forth above, we rule as follows with respect to the Second Distribution:

(6) No gain or loss will be recognized by Parent on the distribution of the
Controlled stock to the Parent shareholders (§ 355(c)(1)).

(7) No gain or loss will be recognized by (and no amount will be included in
the income of) the Parent shareholders on the receipt of the Controlled
stock (§ 355(a)(1)).

(8) The aggregate basis of the Controlled stock and the Parent stock in the
hands of the shareholders of Parent, immediately following the Second
Distribution, will be the same as the basis of the Parent stock held by
Parent shareholders immediately before the Second Distribution,
allocated in proportion to the relative fair market values of each at the time
of the Second Distribution in accordance with § 1.358-2(a)(2)
(§§ 358(a)(1), (b)(1), and (b)(2)).

(9) The holding period of the Controlled stock received by Parent
shareholders will include the holding period of the Parent stock with
respect to which the distribution will be made, provided that the Parent
stock is held as a capital asset on the date of the distribution (§ 1223(1)).

(10) As provided in § 312(h), proper allocation of earnings and profits between
Parent and Controlled will be made under §§ 1.312-10(a) and 1.1502-33.

(11) Pursuant to the Temporary Regulations under § 367(e)(1) that are
currently in effect, if Distributing does not distribute Controlled stock to its
shareholders having a value of more than 80 percent of the total value of
the total outstanding Class A and Class B common stock in connection
with the Second Distribution, Distributing will recognize gain in connection
with the Second Distribution pursuant to § 367(e)(1) to the extent that the
distributees of the Controlled stock are not qualified U.S. persons within
the meaning of Temporary Regulation § 1.367(e)-1T(b)(1)(i).

Temporary or final regulations pertaining to one or more of the issues addressed
in this ruling letter have not yet been adopted. Therefore, this ruling letter may be
revoked or modified upon the issuance of temporary or final regulations (or a notice with
respect to their future issuance). See section 12.04 of Rev. Proc. 99-1, 1999-1 I.R.B. 6,
which discusses in greater detail the revocation or modification of ruling letters.

However, when the criteria in section 12.05 of Rev. Proc. 99-1 are satisfied, a ruling is
not revoked or modified retroactively except in rare or unusual circumstances. The
rulings contained in this letter are predicated upon the 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 materials
submitted in support of the request for a ruling. Verification of the information,
representations, and other data may be required as part of the audit process.

No opinion is expressed about the tax treatment of the proposed transaction
under any other provisions of the Code and regulations or the tax treatment of any
conditions existing at the time of, or effects resulting from, the proposed transaction that
are not specifically covered by the above rulings.

This ruling is directed only to the taxpayer(s) 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.

A copy of this letter is being sent to your authorized representative.

Sincerely,

Assistant Chief Counsel (Corporate)

Mark S. Jennings
Senior Technician Reviewer
Branch 1