PLR 200333018: Business spin-off qualifies for tax-free reorganization treatment

Plain-English summary

A public company planned to put one of its businesses into a new subsidiary and distribute all of that subsidiary's stock to its shareholders. The businesses had different management and capital needs, and the company represented that each would continue operating after the separation. The IRS ruled that the transfer and distribution would qualify as a § 368(a)(1)(D) reorganization. The companies and shareholders generally would recognize no gain or loss on the specified stock transactions under §§ 361 and 355. Cash paid instead of fractional shares would be treated as payment for a redeemed fractional share under § 302(a).

Ruling snapshot

• Question: Does the proposed transfer and spin-off qualify for reorganization and nonrecognition treatment?
• Outcome: Approved for the specified transactions, with cash for fractional shares treated as an exchange.
• Key authorities: IRC §§ 355(a), 361, 368(a)(1)(D), 302(a).

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury

Number: 200333018
Washington, DC 20224
Release Date: 8/15/2003
Index Number: 355.01-00
Person to Contact:

Telephone Number:

Refer Reply To:
CC:CORP:1-PLR-104590-03
Date:
May 05, 2003

Distributing
=

Controlled
=

State A
=

Business X
=

Business Y
=

Date B
=

p
=

Shareholder C
=

Shareholder D
=

Dear
:

This letter responds to your letter dated January 7, 2003, in which rulings were requested as to the federal income tax consequences of a proposed transaction. Additional information was submitted in letters dated March 13, April 14, and April 21, 2003. The information submitted for consideration is summarized below.

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Distributing is an accrual basis State A corporation and the common parent of an affiliated group of corporations that files a consolidated federal income tax return. Distributing has been directly and indirectly (through its subsidiaries) engaged in Business X for over five years. In the last five years Distributing has created another business - - Business Y - - in the same line of business as Business X.

As of Date B, Distributing had outstanding p shares of a single class of common stock, which is widely held and publicly traded. Each share of Distributing stock also evidences one preferred share purchase right to purchase Distributing stock on the occurrence of certain events involving a change in control of Distributing (the "Distributing Purchase Rights"). Shareholders C and D each own more than five percent of the Distributing Stock. Neither shareholder has a representative on Distributing’s board of directors and neither participates actively in the management of Distributing.

Distributing will form Controlled as a State A corporation and wholly-owned subsidiary of Distributing. As described below, Controlled will acquire Business Y from Distributing and will thereafter directly engage in Business Y. Each share of Controlled stock will evidence a purchase right similar to the Distributing Purchase Rights (the “Controlled Purchase Rights”).

Financial information has been received indicating that Distributing's Business X has had gross receipts and operating expenses representative of the active conduct of a trade or business for each of the past five years. Information has also been submitted indicating that Business Y has evolved from Business X in such a way that presently neither business can achieve its full potential due to systemic problems arising from the fundamental differences in respective management approaches, risk management needs, capital requirements, employee compensation, margin profiles, and product design objectives.

To resolve these management and systemic problems, Distributing proposes the following series of transactions:

(i) Distributing will contribute all of its Business Y assets to Controlled in exchange for all of the issued and outstanding shares of Controlled's single class of common stock and the assumption by Controlled of certain liabilities associated with Business Y (the “Contribution").

(ii) Distributing will distribute, pro rata, all of the issued and outstanding shares of Controlled stock to Distributing's shareholders (the “Distribution"). Cash will be paid in lieu of any fractional share interests in Controlled.

In connection with the Contribution and Distribution, Distributing and Controlled will enter into certain ancillary agreements relating to, among other things, the provision of rental space, information technology services, shipping and receiving services, and human resources.

The following representations have been made with respect to the Contribution

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and Distribution:

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

(b) The five years of financial information submitted on behalf of Business X and Business Y is representative of the present operations of Business X and Business Y, and, with regard to each such business, there has been no substantial operational changes since the date of the last financial statements submitted.

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

(d) The Distribution is carried out for the following corporate business purposes: to enhance the success of Business X and Business Y by enabling Distributing and Controlled to resolve management, systemic, and other problems which result from or are exacerbated by the current conduct of the business of Distributing and Controlled within a single corporate and affiliated group. The Distribution is motivated, in whole or substantial part, by this corporate business purpose.

(e) There is no plan or intention by any shareholder who owns five percent or more stock of Distributing, and the management of Distributing, to its best knowledge, is not aware of any plan or intention on the part of any particular remaining shareholder of Distributing to sell, exchange, transfer by gift, or otherwise dispose of any stock in either Distributing or Controlled after the Distribution.

(f) 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 Distribution, other than through stock purchases meeting the requirements of section 4.05(1)(b) of Rev. Proc. 96-30, 1996-1 C.B. 696.

(g) 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.

(h) The total adjusted bases and the fair market value of the assets transferred to Controlled by Distributing each equals or exceeds the sum of the liabilities assumed (as determined under § 357(d) of the Internal Revenue Code) by Controlled. The liabilities assumed and the liabilities to which the transferred assets are subject were incurred in the ordinary course of business and are associated with the assets being transferred.

(i) The Distributing Purchase Rights are (and the Controlled Purchased Rights, when issued in connection with the Distribution, will be) each of the type described in

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Rev. Rul. 90-11, 1990-1 C.B. 10.

(j) No intercorporate debt will exist between the Distributing and Controlled corporation at the time of or subsequent to the Distribution.

(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. Furthermore, Distributing’s excess loss account with respect to the Controlled stock, if any, will be included in income immediately before the Distribution.

(l) Payments made in connection with all continuing transactions 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.

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

(n) The payment of cash in lieu of fractional shares of Controlled stock is solely for the purpose of avoiding the expense and inconvenience of issuing fractional shares and does not represent separately bargained-for consideration. The method used for handling fractional share interests is designed to limit the amount of cash received by any one shareholder to less than the value of one full share of Controlled stock. The total amount of cash paid in lieu of fractional shares will not exceed 1% of the fair market value of Controlled stock distributed to Distributing’s shareholders in the distribution.

(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 entitled to vote or stock possessing 50 percent or more of the total value of all classes of stock of Distributing or Controlled.

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

(1) The transfer by Distributing to Controlled of the assets of Business Y in exchange for all of the stock of Controlled and the assumption by Controlled of certain liabilities of Distributing, followed by the distribution of the Controlled stock to Distributing's shareholders, will constitute a reorganization within the meaning of § 368(a)(1)(D). Distributing and Controlled will each be "a party to a reorganization" within the meaning of § 368(b).

(2) Distributing will recognize no gain or loss upon the transfer of the assets of Business Y to Controlled in exchange for Controlled stock and the assumption of liabilities. (§§ 357(a) and 361(a)).

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(3) Controlled will recognize no gain or loss upon the receipt of the assets of Business Y in exchange for Controlled stock and the assumption of liabilities (§ 1032(a)).

(4) Controlled's basis in each asset received from Distributing will be equal to the basis of such asset in the hands of Distributing immediately prior to the transfer of assets to Controlled (§ 362(b)).

(5) Controlled's holding period for each asset received from Distributing will include the period during which Distributing held such asset (§ 1223(2)).

(6) Distributing will recognize no gain or loss upon the distribution of the Controlled stock to the Distributing shareholders (§ 361(c)).

(7) Distributing shareholders will recognize no gain or loss (and no amount will be included in the income of the Distributing shareholders) upon receipt of the Controlled stock (§ 355(a)).

(8) The aggregate basis of the Distributing stock and the Controlled stock held by each Distributing shareholder will equal the aggregate basis of such shareholder's Distributing stock immediately before the Distribution, allocated between the Distributing stock and the Controlled stock in proportion to the fair market values of each in accordance with Treas. Reg. § 1.358-2(a)(2) (§ 358(a)(1), (b) and (c)).

(9) The holding period of the Controlled stock received by Distributing's shareholders will include the holding period of the Distributing stock on which the distribution is made, provided that such Distributing 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 Distributing and Controlled will be made in accordance with Treas. Reg. §§ 1.312-10(a) and 1.1502-33(e)(3).

(11) Any payment of cash in lieu of a fractional share interest in Controlled will be treated for federal income tax purposes as if the fractional share interest had been issued in the distribution of Controlled stock and then redeemed by Controlled. The cash payment will be treated as having been received in exchange for the constructively redeemed fractional share under section 302(a).

No opinion is expressed about the tax treatment of the transaction under other provisions of the Code and Income Tax Regulations or about the tax treatment of any conditions existing at the time of, or effects resulting from, the 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.

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A copy of this letter must be attached to any income tax return to which it is relevant.

In accordance with the Power of Attorney on file with this office, a copy of this letter is being sent to your taxpayer.

The rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party. This office has not verified any of the material submitted in support of the request for rulings. Verification of the factual information, representations, and other data may be required as part of the audit process.

Sincerely,

Office of Associate chief Counsel
(Corporate)
By:_________
Michael J. Wilder
Senior Technician Reviewer, Branch1

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