PLR 200913007: A shareholder split-off qualified as a tax-free Type D reorganization

Plain-English summary

An S corporation proposed separating part of its operating business into a new controlled corporation to resolve serious disputes between two shareholders. It would contribute business assets and related liabilities to the new corporation, then distribute all of that corporation's stock to one shareholder in exchange for all of that shareholder's stock in the original corporation. Based on the submitted representations, the IRS ruled that the contribution and distribution qualified as a Type D reorganization and that the corporations and exchanging shareholder recognized no gain or loss. The ruling also provided carryover basis and holding periods and required an allocation of earnings and profits. It did not decide the distribution's business purpose, anti-device and acquisition-plan requirements, or the validity of either corporation's S election.

Ruling snapshot

• Question: Would a business contribution followed by a shareholder split-off qualify as a Type D reorganization and receive nonrecognition treatment?
• Outcome: Approved: the transaction qualified under section 368(a)(1)(D), with nonrecognition and carryover treatment under the specified provisions.
• Key authorities: IRC §§ 355(a)(1), 357(a), 358(a)(1), 361, 362(b), 368(a)(1)(D), 1032(a), 1223.

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 200913007
Third Party Communication: None
Release Date: 3/27/2009
Date of Communication: Not Applicable
Person To Contact:
Index Numbers: 355.00-00, 355.01-01,
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Telephone Number:
368.00-00, 368.04-00
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Refer Reply To:
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CC:CORP:B04
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PLR-137248-08
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Date:
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December 04, 2008
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Legend

Distributing = ----------------------------------
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Controlled = ----------------------------------------
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Shareholder A = ----------------------
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Shareholder B = -------------------------
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Shareholder C = ----------------------
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Shareholder D = --------------------------
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Shareholder E = -------------------------------------------
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Business X = ----------

a = ------

b = --------

c = --------

d = ----

e = --------

f = ---

g = -----------------

Dear ----------------:

This letter responds to your August 21, 2008 letter requesting rulings on certain federal income tax consequences of a proposed transaction. The information provided in that letter and in later correspondence is summarized below.

The rulings contained in this letter are based on facts 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 materials submitted in support of the request for rulings. Verification of the information, representations, and other data may be required as part of the audit process. In particular, this office has not reviewed any information pertaining to, and has made no determination regarding, whether the Distribution (defined below in step iii): (i) satisfies the business purpose requirement of § 1.355-2(b) of the Income Tax Regulations; (ii) is used principally as a device for the distribution of the earnings and profits of the distributing corporation or the controlled corporation or both (see § 355(a)(1)(B) of the Internal Revenue Code (the “Code”) and § 1.355-2(d)); or (iii) is part of a plan (or series of related transactions) pursuant to which one or more persons will acquire directly or indirectly stock representing a 50-percent or greater interest in the distributing corporation or the controlled corporation (see § 355(e) and § 1.355-7).

Summary of Facts

Distributing is a calendar year corporation engaged in Business X. Distributing elected to be treated as an S corporation since its formation. Distributing has one class of stock outstanding that is owned as follows: Shareholder A, a percent, Shareholder B,
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b percent, Shareholder C, c percent, Shareholder D, d percent and Shareholder E, e percent. Financial information submitted by Distributing indicates that 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.

Controlled was recently formed by Distributing to implement the proposed transaction described below. Upon completion of the transaction described below, Controlled intends to make an election to be treated as an S corporation.

Proposed Transaction

Shareholder A and Shareholder B disagree on a number of fundamental matters relating to Distributing’s Business X. The conflict between the shareholders is having an adverse effect on the day-to-day operations of Distributing. To eliminate the shareholder disputes, Distributing has proposed the following series of steps (collectively, the “Proposed Transaction”):

(i) Distributing will contribute to Controlled certain assets and related liabilities of Business X in exchange for all of the outstanding Controlled stock (the “Contribution”).

(ii) Shareholder B will purchase from Shareholder E, f shares of Distributing stock in exchange for a note payable to Shareholder E in the principal amount of g.

(iii) Distributing will distribute all of its Controlled stock to Shareholder B in exchange for all of the Distributing stock held by Shareholder B (the "Distribution").

Representations

Distributing has made the following representations with respect to the Proposed Transaction:

(a) The fair market value of the Controlled stock to be received by Shareholder B will be approximately equal to the fair market value of the Distributing stock surrendered.

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

(c) Distributing, Controlled, and Shareholder B each will pay their own expenses, if any, incurred in connection with the Distribution.
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(d) The five years of financial information submitted on behalf of Distributing is representative of its present operations, and with regard to such business, there have been no substantial operational changes since the date of the last financial statements submitted.

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

(f) No intercorporate debt will exist between Distributing and Controlled at the time of, or after, the Distribution.

(g) The Distribution is being carried out for the following business purpose: to end shareholder disputes over the operation of Distributing and to resolve management, systemic and other problems that have arisen because of irreconcilable differences between Shareholder A and Shareholder B. The Distribution is motivated, in whole or substantial part, by this corporate business purpose.

(h) The Distribution is not part of a plan or series of related transactions (within the meaning of § 1.355-7) pursuant to which one or more person will acquire, directly or indirectly, stock representing a 50-percent or greater interest (within the meaning of § 355(d)(4)) in either Distributing or Controlled (including any predecessor or successor of any such corporation.

(i) Immediately after the transaction (as defined in § 355(g)(4)), either (i) no person will hold a 50-percent or greater interest (within the meaning of § 355(g)(3)) in Distributing or Controlled, (ii) if any person holds a 50-percent or greater interest (within the meaning of § 355(g)(3)) in any disqualified investment corporation (within the meaning of § 355(g)(2)), such person will have held such interest in such corporation immediately before the transaction, or (iii) neither Distributing nor Controlled will be a disqualified investment corporation (within the meaning of § 355(g)(2)).

(j) For purposes of § 355(d), immediately after the Distribution, no person (determined after applying § 355(d)(7)) will hold stock possessing 50-percent or more of the total combined voting power of all classes of Distributing stock entitled to vote, or 50-percent or more of the total value of shares of all classes of Distributing stock, that was acquired by purchase (as defined in §§ 355(d)(5) and (8)) during the five-year period (determined after applying § 355(d)(6)) ending on the date of the Distribution.

(k) For purposes of § 355(d), immediately after the Distribution, no person (determined after applying the aggregation rules of § 355(d)(7)) will hold stock possessing 50-percent or more of the total combined voting power of all classes of Controlled stock entitled to vote, or 50-percent or more of the total value of shares of all
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classes of Controlled stock, that was either (i) acquired by purchase (as defined in
§§ 355(d)(5) and (8)) during the five-year period (determined after applying § 355(d)(6)) ending on the date of the Distribution, or (ii) attributable to distributions on Distributing stock that was acquired by purchase (as defined in §§ 355(d)(5) and (8)) during the five- year period (determined after applying § 355(d)(6)) ending on the date of the Distribution.

(l) The fair market value, but not the total adjusted basis, of the assets to be transferred by Distributing to Controlled will equal or exceeds the sum of the liabilities to be assumed by Controlled plus any liabilities to which the transferred assets are subject.

(m) The liabilities to be assumed (as determined under § 357(d)) in the transaction 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.

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

(o) The Distribution is not used principally as a device for the distribution of the earnings and profits of Distributing or Controlled or both.

(p) 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.

(q) The total fair market value of the assets transferred from Distributing to Controlled will exceed the sum of (i) the amount of any liabilities assumed (within the meaning of § 357(d) by Controlled, (ii) the amount of any liabilities owed to Controlled by Distributing that are discharged or extinguished, and (iii) the amount of cash and the fair market value of any other property (other than stock and securities permitted to be received under § 361(a) without the recognition of gain) received by Distributing in the Contribution. The fair market value of the assets of Controlled will exceed the amount of its liabilities immediately after the Contribution.

Rulings

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

(1) The Contribution, followed by the Distribution will qualify as 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).
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(2) No gain or loss will be recognized by Distributing on the Contribution (§ 361(a) and 357(a)).

(3) No gain or loss will be recognized by Controlled on the Contribution (§ 1032(a)).

(4) The basis of each asset received by Controlled will equal the basis of that asset in the hands of Distributing immediately before the Contribution (§ 362(b)).

(5) The holding period of each asset received by Controlled in the Contribution will include the period during which Distributing held that asset (§ 1223(2)).

(6) No gain or loss will be recognized by Distributing on the Distribution (§ 361(c)(1)).

(7) No gain or loss will be recognized by (and no amount will be included in the income of) Shareholder B on the Distribution (§ 355(a)(1)).

(8) The aggregate basis of the Controlled stock in the hands of Shareholder B immediately after the Distribution will equal Shareholder B's aggregate basis in the Distributing stock surrendered in the Distribution (§ 358(a)(1)).

(9) The holding period of the Controlled stock received by Shareholder B will include the holding period of the Distributing stock surrendered by the shareholder in exchange therefore, provided such 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) and § 1.312-10(a).

Caveats

No opinion is expressed about the tax treatment of the Proposed Transaction under other provisions of the Code or 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. In particular, no opinion is expressed regarding whether the Distribution: (i) satisfies the business purpose requirement of § 1.355-2(b), (ii) is used principally as a device for the distribution of the earnings and profits of the Distributing corporation or the Controlled corporation or both (see § 355(a)(1)(B) and § 1.355-2(d), (iii) is part of a plan (or series of related transactions) pursuant to which one or more persons will acquire directly or indirectly stock representing a 50-percent or greater interest in the Distributing corporation or the Controlled corporation (see § 355(e) and § 1.355-7); or whether Distributing’s S election
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is valid or whether Controlled’s election to be an S corporation will be valid under
§ 1362(a).

Procedural Statements

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) provides that it may not be used or cited as precedent. A copy of this ruling letter should be attached to any income tax return to which it is relevant. Alternatively, taxpayers filing their returns electronically may satisfy this requirement by attaching a statement to their return that provides the date and control number of the letter ruling. Pursuant to a power of attorney on file with this office, a copy of this letter is being sent to your authorized representative.

Sincerely,

________
Richard K. Passales
Senior Counsel, Branch 4
Associate Chief Counsel (Corporate)

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