PLR 200029032: Internal business separation qualifies as a D reorganization

Plain-English summary

A corporate group planned to move unregulated business activities into a controlled subsidiary while leaving regulated activities in the distributing company. The distributing company would transfer specified assets and related liabilities, and the controlled company's stock would then be distributed to the common parent. The IRS ruled that the specified transfers and distribution qualified as a section 368(a)(1)(D) reorganization, with the stated nonrecognition, basis, and holding-period results. The ruling covered only the first six steps of a larger restructuring. The IRS expressly gave no opinion on eleven later steps or other unaddressed tax consequences.

Ruling snapshot

• Question: Do the first six internal restructuring steps qualify for reorganization and distribution treatment?
• Outcome: Approved for those steps only.
• Key authorities: IRC §§ 355(a)(1), 357, 361, and 368(a)(1)(D).

Full text (IRS public release)

Internal Revenue Service       Department of the Treasury


Index Number: 0355.00-00       Washington, DC 20224



Number: 200029032              Person to Contact:
Release Date: 7/21/2000        Telephone Number:

                               Refer Reply To:
                               CC:DOM:CORP:5 PLR-119206-99
                               Date:
                               April 19, 2000




Re:


Parent                     =




PSub1                      =




Subsidiary 1               =



PSub2                      =



PSub2-LLC                  =



PSub2-LLC-A                =




Subsidiary 2               =

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LLC-A2                =



LLC-A2’s Subsidiary   =



LLC-A1                =




PSub2-LLC-B           =




LLC-B1                =



LLC-B2                =




LLC-C1                =




LLC-C2                =




PSub3                 =

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PSub4           =



Subsidiary 4    =



PSub5           =



PSub6           =



PSub7           =




Subsidiary 7A   =



Subsidiary 7B   =



Subsidiary 7C   =



PSub8           =



Distributing    =

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DSub1                  =



DSub1’s Subsidiaries   =




DSub2                  =



DSub3                  =



Corporation            =



D-LLC1                 =




D-LLC-A1               =



D-LLC-A2               =



D-LLC 2                =

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Controlled      =




CSub 1          =



CSub 2          =




CSub3           =



CSub4           =



CSub4’s LLC     =



C-LLC1          =



C-LLC2          =



C-LLC4          =



C-LLC3          =



C-LLC5          =

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ServiceCo       =



New LLC         =



State X         =

State Y         =

Business A      =

Activity A1     =



Activity A2     =



Activity A3     =



Asset Group 1   =

Asset Group 2   =


Asset Group 3   =

Asset Group 4   =


Asset Group 5   =


Asset Group 6   =

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Asset Group 7              =


Asset Group 8              =


Asset Group 9              =


Agreements                 =

State Commission           =

Federal Commission         =

d                          =

e                          =

f                          =

$g                         =

$h                         =

i                          =

j                          =



        We reply to your letter dated December 7, 1999, in which you request rulings as
to the federal tax consequences of a proposed transaction. Additional information was
received in subsequent submissions. The information provided is summarized below.

       Parent, an accrual basis taxpayer, is a holding company and the common parent
of an affiliated group of corporations filing consolidated federal income tax returns.
Parent’s common stock is publicly traded on national exchanges. Parent has no
preferred stock outstanding. Parent conducts its various businesses through directly
and indirectly owned subsidiaries and limited liability companies.

      Parent owns 100 percent of the stock of PSub1, PSub2, PSub3, PSub4, PSub5,
PSub6, PSub7, and PSub8. PSub1 wholly owns the stock of Subsidiary 1. PSub2
owns various subsidiaries and PSub2-LLC, which owns the limited liability companies

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and subsidiaries that comprise Group 1 and Group 2. Specifically, Group 1 includes
wholly-owned PSub2-LLC-A, which holds all of the stock of Subsidiary 2. Subsidiary 2
holds an f percent interest in LLC-A2, which in turn wholly owns the stock of LLC-A2’s
Subsidiary. PSub2-LLC-A also wholly owns LLC-A1. Group 2 includes PSub2-LLC-B,
which wholly owns LLC-B1 and LLC-B2. LLC-B2 in turn wholly owns LLC-C1 and LLC-
C2. PSub4 owns d percent of the stock of Subsidiary 4. PSub7 owns all of the stock
of Subsidiary 7A, Subsidiary 7B, and Subsidiary 7C.

       Parent also owns all of the outstanding common stock of Distributing, a State X
corporation. The outstanding preferred stock of Distributing is publicly traded, and its
market value represents approximately e percent of the total value of all outstanding
capital stock of Distributing.

         Distributing is engaged in all aspects of Business A, including Activity A1, Activity
A2, and Activity A3. Distributing operates Business A directly and through a wholly-
owned limited liability company, D-LLC1, for which Distributing has elected treatment as
a disregarded entity. Activity A1 is accomplished through the operation of certain
facilities in State X (Asset Group 1, Asset Group 2, Asset Group 3, Asset Group 4, and
Asset Group 5). Activity A2 involves the provision of services to approximately i
customers in State X, utilizing Asset Group 9. Distributing conducts the retail aspects of
Activity A3 through D-LLC1 and Asset Group 8 and the wholesale aspects through a
division of Distributing (Division) and Asset Group 7.

      Distributing also owns all of the stock of DSub1, DSub2, DSub3, D-LLC2, and j
percent of the stock of Corporation. DSub1 owns all of the stock of each of DSub1’s
Subsidiaries.

      Controlled, a wholly-owned subsidiary of Distributing, is a State X corporation.
Controlled currently owns all of the outstanding stock of CSub1 (a group finance
subsidiary), CSub2 (which owns Asset Group 6), CSub3 (which is currently dormant),
and CSub4 (which provides cash management services and intragroup loans to
members of the Distributing group).

        Distributing is subject to regulation by State Commission and certain of its
activities are subject to regulation by Federal Commission. Parent’s objective in this
proposed transaction is to restructure its operations and assets related to Business A
through a series of steps to place all of its unregulated activities (Activity A1 and Activity
A3) in Controlled. Distributing will continue to own and operate the regulated Activity
A2. Controlled will become, and Distributing will remain, a first-tier subsidiary of Parent.

       Thus, Parent has proposed the following steps:

       (i)    Controlled has formed a number of limited liability companies in State Y of
              which it will be the sole owner and member. Each limited liability

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                company will be a disregarded entity treated as a division of Controlled for
                federal income tax purposes.

       (ii)     Distributing will transfer assets associated with Activity A1 and the
                liabilities associated with those assets to each of Controlled’s new limited
                liability companies formed in step (i) in constructive exchange for
                Controlled stock. Specifically, Distributing will transfer Asset Group 1 to
                C-LLC1, Asset Group 2 to C-LLC2, Asset Group 3 to C-LLC3, Asset
                Group 4 to C-LLC4, and Asset Group 5 (which includes Distributing’s j
                percent stock ownership in Corporation) to C-LLC5.

       (iii)    Controlled has formed New LLC in State Y of which it will be the sole
                owner and member and which will be a disregarded entity treated as a
                division of Controlled for federal income tax purposes. Controlled will
                transfer C-LLC1, C-LLC2, C-LLC3, C-LLC4, and C-LLC5 to New LLC.

       (iv)     Distributing will transfer Division, which currently holds all of Distributing’s
                assets associated with the wholesale aspect of unregulated Activity A3
                and its related liabilities to D-LLC1. Distributing then will transfer D-LLC1
                and all of its stock interests in DSub1, DSub2, and DSub3 to Controlled in
                constructive exchange for Controlled stock. Controlled then will transfer
                DSub1, DSub2, and DSub3 to New LLC.

       (v)      In connection with these transfers, Controlled will assume Distributing’s
                obligation under two debt instruments (the Debt Assumption): (1) Note 1


 with a remaining principal balance of approximately $g and (2) Note 2 payable to
PSub3 in the amount of approximately $h, which evidences a loan to be made by
PSub3 to Distributing in connection with the proposed transaction. PSub3 will fund the
loan with cash borrowed from unrelated third parties, and Distributing will use the cash
to retire existing debt.

       (vi)     Distributing will distribute the stock of Controlled to Parent.

       In order to fully accomplish its internal restructuring, Parent proposes the
following additional steps:

       (vii)    Prior to Distributing’s distribution of the Controlled stock, subject to State
                Commission approval, Controlled will distribute the stock of CSub3 to
                Distributing. CSub3 will be converted into a limited liability company.

       (viii)   Controlled will transfer the stock of CSub2 to New LLC, which in turn will
                transfer that stock to C-LLC2, C-LLC3, and C-LLC4. CSub2 owns Asset

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               Group 6, which is associated with the assets held by C-LLC2, C-LLC3,
               and C-LLC4.

      (ix)     PSub2 will be converted into a limited liability company by merger into a
               limited liability company newly formed by Parent.

      (x)      PSub2-LLC, a wholly-owned limited liability company of PSub2, will
               distribute all of its ownership interests in Group 1 and Group 2 to PSub2.

      (xi)     PSub2 will distribute all of its ownership interests in Group 1 and Group 2
               to Parent.

      (xii)    Parent will transfer its interests in Group 1 and Group 2 to Controlled,
               which will transfer those interests to New LLC.

      (xiii)   Parent will transfer all of its ownership interest in PSub2 and all of the
               outstanding stock of PSub1, PSub4, PSub6, PSub8, and PSub5 to
               Controlled.

      (xiv)    Controlled will transfer all of the stock of PSub1, PSub4, PSub5, PSub6,
               and PSub8 to D-LLC1.

      (xv)     PSub1 will distribute the stock of its wholly-owned Subsidiary 1 to D-LLC1.

      (xvi)    Parent will transfer certain contracts and other assets related to Activity
               A3 to Controlled. Controlled then will transfer those items to D-LLC1.

      (xvii) Parent will form a new subsidiary ServiceCo, which will perform certain
             administrative services for all members of the Distributing group.

       We have received financial information indicating that Business A has had gross
receipts and operating expenses representing the active conduct of a trade or business
for each of the past five years.

      The taxpayer has not made any representations nor requested any rulings with
respect to, and we express no opinion about, steps (vii) through (xvii). Taxpayer has
made the following representations with respect to steps (i) through (vi):

      (a)      Other than amounts owing from time to time under the Agreements, no
               intercorporate debt will exist between Distributing and Controlled (or
               Controlled subsidiaries) at the time of, or subsequent to, the transaction.
               None of such obligations are or will be stock or securities.

      (b)      No part of the consideration distributed by Distributing will be received by

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           Parent as a creditor, employee, or in any capacity other than as a
           shareholder of Distributing.

     (c)   The five years of financial information submitted on behalf of Distributing
           represents the corporation’s present operations, and, with regard to such
           corporation, there have been no substantial operational changes since the
           date of the last financial statement submitted.

     (d)   Following the transaction, Distributing and Controlled each will continue
           the active conduct of its business, independently and with its separate
           employees.

     (e)   The distribution of the stock of Controlled is motivated, in whole or
           substantial part, by the corporate business purpose of fit and focus. No
           securities (other than stock) of Controlled will be distributed.

     (f)   There is no plan or intention by Parent to sell, exchange, transfer by gift,
           or otherwise dispose of any Distributing or Controlled stock after the
           transaction.

     (g)   Except for periodic sinking fund redemptions of Distributing’s publicly
           traded preferred stock, there is no plan or intention by either Distributing
           or Controlled, directly or through any subsidiary corporation, to purchase
           any of its outstanding stock after the transaction, other than through stock
           purchases meeting the requirements of § 4.05(1)(b) of Rev. Proc. 96-30,
           1996-1 C.B. 696, 705.

     (h)   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.

     (i)   The total adjusted basis and the fair market value of the assets
           transferred to Controlled by Distributing will equal or exceed the amount of
           the liabilities assumed (as determined under § 357(d) of the Internal
           Revenue Code) by Controlled.

     (j)   The liabilities assumed (as determined under § 357(d)), in the transaction,
           except for Note 1 and Note 2, were incurred in the ordinary course of
           business and are associated with the assets being transferred.

     (k)   Immediately before the distribution, items of income, gain, loss, deduction,
           and credit will be taken into account as required by the applicable
           intercompany transaction regulations (see § 1.1502-13 and

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             § 1.1502-14 as in effect before the publication of T.D. 8597, 1995-2 C.B.
             147, and as currently in effect; § 1.1502-13 as published by T.D. 8597).
             Distributing will not have an excess loss account with respect to the
             Controlled stock immediately before the distribution.

      (l)    None of the assets transferred from Distributing to Controlled will be
             subject to investment tax credit recapture.

      (m)    No two parties to the transaction are investment companies as defined in
             § 368(a)(2)(F)(iii) and (iv).

      (n)    The distribution is not 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 combined voting power of all
             classes of stock of Distributing or Controlled entitled to vote, or 50 percent
             or more of the total value of shares of all classes of Distributing or
             Controlled stock, within the meaning of § 355(e).

      (o)    Payments made in connection with all continuing transactions between
             Distributing and Controlled will be at arm’s length prices determined with
             reference to market conditions, subject to, where applicable, terms and
             conditions approved by the State Commission and/or Federal
             Commission.

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

      (1)    The transfer of assets described in steps (ii) and (iv) by Distributing in
             constructive exchange for the stock of Controlled and Controlled’s
             assumptions of Note 1 and Note 2 will qualify as a reorganization within
             the meaning of § 368(a)(1)(D). Distributing and Controlled each will be a
             “party to a reorganization” within the meaning of § 368(b).

      (2)    No gain will be recognized by Distributing upon the transfers of assets to
             Controlled in constructive exchange for stock of Controlled and
             Controlled’s assumptions of Note 1 and Note 2 (§§ 361(a) and 357(c)).

      (3)    No gain or loss will be recognized by Controlled on the receipt of the
             assets from Distributing in constructive exchange for Controlled stock
             (§ 1032(a)).

      (4)    The basis of the assets to be received by Controlled in the transaction will
             be the same as the basis of such assets in the hands of Distributing
             immediately prior to the transfer of such assets to Controlled (§ 362(b)).

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       (5)    The holding period of each asset to be received by Controlled will include
              the period during which such assets were held by Distributing (§ 1223(2)).

       (6)    No gain or loss will be recognized to Distributing on the distribution of all
              of the Controlled stock to Parent (§ 361(c)(1)).

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

       (8)    The basis of the stock of Distributing and Controlled in the hands of
              Parent will be the same as the basis of the Distributing stock held by
              Parent immediately before the distribution, allocated between the
              Distributing stock and the Controlled stock in proportion to the fair market
              value of each in accordance with §1.358-2(a)(2) of the Income Tax
              Regulations (§ 358(a) and (b)(2)).

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

       (10)   Proper allocation of earnings and profits between Distributing and
              Controlled will be made in accordance with §§ 312(h)(1), 1.312-10(a) and
              1.1502-33(f)(2).

        We express no opinion on the federal income tax treatment of the proposed
transaction under other provisions of the Code or regulations (including the
consolidated return 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. Specifically, the taxpayer understands that the National
Office of the Internal Revenue Service, as requested by the taxpayer, has considered
and rules on only steps (i) through (vi). The taxpayer acknowledges that all other steps
including, but not limited to, steps (vii) through (xvii) have not been reviewed or ruled
upon by the National Office. The taxpayer further acknowledges that the federal
income tax consequences of these other related steps may be examined and
determined by the appropriate District Director’s office on audit of the federal tax returns
filed by Parent and its affiliates in which these steps are reported.

        Temporary or final regulations relating to one or more of the issues addressed in
this ruling (including regulations under § 358(g)) have yet to be adopted. Therefore,
this ruling letter may be modified or revoked if adopted temporary or final regulations
are inconsistent with any provision conclusions reached herein. See section 12.04 of
Rev. Proc. 2000-1, 2000-1 I.R.B. 4, 46, which addresses, in greater detail, when a

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ruling will be revoked or modified. However, when the criteria in section 12.05 of Rev.
Proc. 2000-1 are satisfied, a ruling is seldom revoked or modified retroactively, except
in rare or unusual circumstances.

       This ruling is directed only to the taxpayer that requested it. Section 6110(k)(3)
provides that it may not be used or cited as precedent.

       Each taxpayer involved in the transaction should attach a copy of this letter to
the taxpayer’s federal income tax return for the taxable year in which the transaction is
completed.

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

                                                  Sincerely,

                                                  Assistant Chief Counsel (Corporate)

                                                  By:
                                                  Filiz A. Serbes
                                                  Assistant to the Chief, Branch 5