PLR 200031050: Split-off of two businesses qualifies for tax-free reorganization treatment

Plain-English summary

A corporation owned equally by two brothers operated two businesses. After management disagreements, it proposed to transfer one business and cash to a new corporation, then give that corporation's stock to one brother in exchange for his shares in the original corporation. The IRS ruled that the transfer and split-off would qualify as a reorganization under IRC § 368(a)(1)(D). Under the cited provisions, neither corporation nor the departing shareholder would recognize gain or loss on the specified exchanges, and tax basis and holding periods would carry over as described in the letter. The ruling relies on the taxpayers' representations, including continued operation of both businesses and no planned stock disposal or liquidation.

Ruling snapshot

• Question: Would the proposed business split-off qualify as a reorganization and permit the specified exchanges without recognized gain or loss?
• Outcome: Approved. The IRS ruled that the transaction qualified under § 368(a)(1)(D), with nonrecognition and carryover basis and holding period consequences under the provisions listed in the letter.
• Key authorities: IRC §§ 355, 368(a)(1)(D), 361, 1032, 362, 358, 1223, and 312; Treas. Reg. § 1.312-10(a).

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury

Index Number: 0355.01-01, 0368.04-00 Washington, DC 20224

Number: 200031050
Person to Contact:
Release Date: 8/4/2000
Telephone Number:

Refer Reply To:
CC:DOM:CORP:5-PLR-106490-00
Date:
May 10, 2000

Re:

Distributing =

Controlled =

State N
=

Business A =

Business B =

X
=

Y
=

Z
=

A
=

B
=

We reply to your representative’s letter dated March 17, 2000, in which rulings were requested as to the federal income tax consequences of a proposed transaction. Additional information was submitted in a letter dated April 17, 2000. The information submitted for consideration is substantially as set forth below.

Distributing is a State N corporation engaged in Business A and Business B at two separate locations. Distributing has outstanding X shares of voting common stock that are owned in equal parts by two brothers (A and B).
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Controlled is a State N corporation formed to effectuate the proposed transaction. Controlled will have issued and outstanding Y shares of voting common stock, all of which initially will be held by Distributing.

Financial information has been received which indicates that Distributing has had gross receipts and operating expenses representative of the active conduct of each of Business A and Business B for each of the past five years.

Because of management disagreements, A and B have decided to divide Distributing’s Business A and Business B assets and go their separate ways. Accordingly, they propose the following transaction:

(i) Distributing will transfer to Controlled all of the assets of Business B.
Distributing will borrow approximately $Z from an unrelated party. This cash will be transferred to Controlled in order to equalize values between the two corporations. Controlled will use the funds to acquire operating assets. In exchange, Distributing will receive all of the Y issued and outstanding shares of Controlled voting common stock. Controlled will not be assuming any liabilities or receiving assets subject to liabilities from Distributing.

(ii) Thereafter, Distributing will distribute the Y shares of Controlled stock to B in exchange for all of his shares of Distributing stock.

The taxpayer has made the following representations in connection with the proposed transaction:

(a) The fair market value of the stock of Controlled received by B, described in step (ii) above, will approximately equal the fair market value of the Distributing stock surrendered by B in the exchange.

(b) No part of the consideration to be distributed by Distributing is being received by a shareholder as a creditor, employee, or in any capacity other than as a shareholder of the corporation.

(c) The five years of financial information submitted on behalf of Distributing is representative of the corporation’s present operations, and there have been no substantial operational changes since the date of the last financial statements submitted.

(d) Following the proposed transaction, Distributing and Controlled will each continue, independently and with their separate employees, the active conduct of the businesses previously conducted solely by Distributing.
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(e) The distribution of the stock of Controlled is carried out for the following corporate business purposes: allows each shareholder the opportunity to pursue the part of the business in which he has the greatest interest and allows each shareholder to adopt his own management philosophy in terms of business risk and hours devoted to the business. The distribution of stock of Controlled is to be carried out for the above mentioned business purposes and is motivated solely for those purposes.

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

(g) There is no plan or intention by either Distributing or Controlled, directly or through any subsidiary, to purchase any of its outstanding stock after the transaction, other than through stock purchases meeting the requirements of section 4.05(1)(b) of Rev. Proc. 96-30.

(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 subsequent to the transaction, except in the ordinary course of business.

(i) No investment tax credit determined under § 46 of the Internal Revenue Code has been or will be claimed with respect to the transfer of any property.

(j) Distributing neither accumulated its receivables nor made extraordinary payment of its payables in anticipation of the transaction.

(k) No intercorporate debt will exist between Distributing and Controlled at the time of or subsequent to the proposed distribution.

(l) Any payments made in connection with all continuing transactions, if any, between Distributing and Controlled will be for fair market value based on terms and conditions arrived at by the parties bargaining at arm’s length.
There has not been, nor is it contemplated that there will be, any transactions between Distributing, Controlled, or the shareholders of each.

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

(n) Distributing is not an S corporation within the meaning of § 1361(a), and there is no plan or intention by either Distributing or Controlled to make an S corporation election pursuant to § 1362(a).
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(o) The distribution is not part of a plan or series of related transactions (within the meaning of §355(e)) 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 Distributing or Controlled, or stock possessing 50 percent or more of the total value of all classes of stock of either Distribution or Controlled.

Based solely on the information submitted and on the representatives set forth above, we hold as follows:

(1) The transfer by Distributing to Controlled of the assets and cash, as described in step (i) above, solely in exchange for all of the outstanding stock of Controlled, followed by the distributing of the Controlled stock by Distributing to B in exchange for all of his Distributing stock will be 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) Distributing will recognize no gain or loss upon the transfer of assets and cash to Controlled in exchange for Controlled stock (§ 361(a)).

(3) Controlled will recognize no gain or loss on the receipt of the assets and cash in exchange for the Controlled stock (§ 1032(a)).

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

(5) Controlled’s holding period for the assets received from Distributing will include the period during which such assets were held by Distributing (§ 1223(2)).

(6) Distributing will recognize no gain or loss upon the distribution of all of its Controlled stock to B in exchange for his Distributing stock (§ 361(c)(1)).

(7) B will recognize no gain or loss (and no amount will be included in his income) upon the receipt of the Controlled stock in exchange for all of his shares of Distributing stock (§ 355 (a)(1)).

(8) B’s basis in the Controlled stock after the distribution will be the same as his basis in the Distributing stock surrendered in exchange therefor (§ 358(a)(1)).
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(9) B’s holding period in the Controlled stock received will include the holding period of the Distributing stock surrendered in exchange therefor, provided that the Distributing stock is held as a capital asset by B on the date of the exchange (§ 1223(1)).

(10) As provided in § 312(h), proper allocation of earnings and profits between Distributing and Controlled will be made under § 1.312-10(a) of the Income Tax Regulations.

We express no opinion about the tax treatment of the transaction under other provisions of the Code and regulations or about 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 who requested it. Section 6110(k)(3) of the Code provides that it may not be used or cited as precedent.

A copy of this letter should be attached to the federal income tax returns of the taxpayers involved for the taxable year in which the transaction covered by this ruling letter is consummated.

Pursuant to a power of attorney on file in this office, a copy of this letter has been sent to your authorized representative.

Sincerely yours,
Assistant Chief Counsel (Corporate)
By:
__
Assistant to the Chief, Branch 5