PLR 1024037: IRS approved use of actual ownership knowledge for allocating financing shares

Plain-English summary

The IRS ruled that a private corporation could use its corporate records, written inquiries, and investor interviews to determine actual knowledge of stock ownership for purposes of its section 382 analysis. The company could use that knowledge to allocate shares issued in certain financing transactions to newly segregated public groups instead of using the allocations under the solely-for-cash exception in the regulations. The ruling did not decide whether the company actually experienced an ownership change or whether it correctly applied the methods in its specific testing periods. The ruling was based on the submitted information and representations.

Ruling snapshot

• Question: May the company use corporate records and investor inquiries to allocate financing shares based on actual knowledge for section 382 purposes?
• Outcome: Approved
• Key authorities: IRC § 382(g); Treas. Reg. §§ 1.382-2T(k)(2) and 1.382-3(j)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201024037 Third Party Communication: None
Release Date: 6/18/2010 Date of Communication: Not Applicable
Person To Contact:
Index Number: 382.00-00 ----------------------, ID No. -----------------
Telephone Number:
---------------------
------------------- Refer Reply To:
------------------------------ CC:CORP:03
------------------- PLR-149874-09
------------------------ Date:
------------------------------------- March 11, 2010

Company = --------------------

Business A = ---------------------------------------------------------------

State A = -------------

State B = -------------

Private Offering A = ---------------------------------------------------------------

Private Offering B = ---------------------------------------------------------------

Private Offering C = ---------------------------------------------------------------

Private Offering D = ---------------------------------------------------

Private Offering E = ---------------------------------------------------------------

Private Offering F = ------------------------------------------

PLR-149874-09 2

Private Offering G = ------------------------------------------

Private Offering H = ------------------------------------------

Date 1 = ----------------------

Date 2 = ----------------------

Date 3 = ------------------

Date 4 = --------------

Date 5 = ------------------

Date 6 = --------------

Date 7 = ----------------------

Date 8 = ----------------

Date 9 = ---------------------

Date 10 = --------------

Date 11 = -----------------------

Date 12 = -------------- -----

Date 13 = -----------------------

Date 14 = -------------

Date 15 = ----------------

Tax Advisor = ----------------------

a = -------------

b = -------------

c = -------------
PLR-149874-09 3

d = -------------

e = --

f = -----------

g = ------

h = -------------

i = ------

j = -------------

k = ------

l = ----------------

m = ------

n = -----------

o = ---------------

p = -------------

q = -------------

r = ------------

s = ----

t = -------------

u = ----

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

We respond to your letter dated November 10, 2009, requesting rulings regarding § 382
of the Internal Revenue Code. The relevant information provided in that letter is
summarized below.

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
PLR-149874-09 4

by an appropriate party. While this office has not verified any of the material submitted
in support of the request for rulings, it is subject to verification on examination.

                             SUMMARY OF FACTS

Company was originally incorporated in State A on Date 1 and reincorporated in State B
on Date 14. Company engages in Business A. As discussed in greater detail below,
Company had multiple rounds of private stock offerings from inception through its initial
public offering (“IPO”) on Date 15.

At its inception, Company issued approximately a shares of common stock to its
founders from Date 1 through Date 2. Taking into account stock splits on Date 5 and
Date 8, respectively, the original amount of common stock shares issued through Date
2 increased to b shares as of Date 9. Approximately c additional common stock shares
(adjusted for the Date 5 and Date 8 stock splits) were issued subsequently to the initial
Date 2 issuance and prior to the Private Offering E transaction (discussed below) by
reason of stock option exercises, common stock dividends, and general stock
issuances.

Prior to its IPO, Company was a private corporation that engaged in numerous financing
transactions to support the development of its products and the expansion of its
customer base.

On Date 3, Company issued approximately d shares of Private Offering A at $e per
share. As these shares had substantially higher relative values than the then existing
common stock and were issued to new investor/shareholders, Company determined
that an ownership change within the meaning of § 382(g) occurred on the Private
Offering A issuance date.

On Date 4, Company issued approximately f shares of Private Offering B at $g per
share. Company determined that an ownership change within the meaning of § 382(g)
occurred on the Private Offering B issuance date.

On Date 6, Company issued approximately h shares of Private Offering C at $i per
share.

On Date 7, Company issued approximately j shares of Private Offering D at $k per
share.

On Date 10, Company issued approximately l shares of Private Offering E at $m per
share.

On Date 11, Company issued Private Offering F stock. In connection with the issuance
of Private Offering F, shares of Company’s Private Offering A, Private Offering B,
PLR-149874-09 5

Private Offering C, and Private Offering D were converted into shares of Company’s
common stock. Additionally, the terms of Company’s Private Offering E were modified
in connection with the Private Offering F financing, which reduced the overall liquidation
preferences of the Private Offering E stock.

Company issued Private Offering G and Private Offering H stock on Date 12 and Date
13, respectively.

On Date 15, Company completed its IPO of approximately n shares of common stock.
In connection with Company’s IPO, all of Company’s outstanding preferred stock, the
Private Offering E, Private Offering F, Private Offering G, and Private Offering H stock,
were converted into approximately o shares of Company common stock.

Since Company was private during the Private Offering A through Private Offering H
transactions, Company relied upon a third party advisor to perform valuations to
determine the relative value of each class of stock for purposes of its § 382 analyses at
the times of the Private Offering C, D, E, and F financings. Company engaged Tax
Advisor to perform a § 382 ownership change analysis for the periods from inception
through the Private Offering F financing (the “Section 382 Analysis”). Company's
corporate records included the names of the various entities that had invested in each
of the Private Offering A through Private Offering E financings (the “Participating
Entities”) as well as the amount of shares acquired by these entities in each financing.

In order to get a better understanding of the nature of the Participating Entities,
Company identified representatives of the Participating Entities who were
knowledgeable about a given Participating Entity’s investment in Company stock
(collectively, the “Investor Representatives”). Once identified, Company made written
inquiries (the “Written Inquiries”) of the Investor Representatives concerning:

  (i)     Whether or the extent to which the Participating Entities were economic
          owners of Company’s stock;
  (ii)    The identity of potential indirect 5 percent shareholders of Company stock
          by reason of owning significant percentages of the economic rights in the
          Participating Entities;
  (iii)   Any indirect shifting of Company stock among the owners of Company
          stock (e.g. segregation rules as applied to Participating Entities through
          redemptions, issuances of equity rights, etc.); and
  (iv)    Whether the Participating Entities might be viewed as a single 5 percent
          shareholder under the “entity” rules of § 1.382-3(a) of the Income Tax
          Regulations.

After sending the Written Inquiries, Company arranged teleconferences between Tax
Advisor, Company, and the Investor Representatives to discuss these questions for
PLR-149874-09 6

purposes of the Section 382 Analysis (the “Participating Entity Interviews”). In certain
cases, these discussions were supplemented by one or more emails confirming the
understanding of the responses to the various questions submitted.

As a result of the information received in the Written Inquiries and the Participating
Entity Interviews, Company confirmed that certain Participating Entities that invested in
Company’s Private Offering D and/or Private Offering E stock either did not own shares
of Company’s stock prior to these financing transactions or owned a disproportionately
small amount of Company’s stock.

Among the less than 5 percent shareholders within the Participating Entities, it appears
that approximately p Private Offering D shares and q Private Offering E shares were
acquired by Participating Entities that did not own Company stock prior to the Private
Offering D financing. Under the solely for cash exception of § 1.382-3(j), approximately
r (s%) and t (more than u%) of the shares issued to these new investors would be
treated as Exempted Shares (and treated as acquired by historic public groups) in the
Private Offering D and Private Offering E financing transactions, respectively.

Company, with assistance from Tax Advisor, determined that if it allocated shares to
newly created public groups based on knowledge about actual ownership of those
shares rather than the amount of shares that would be allocated under the solely for
cash exception of § 1.382-3(j), Company would have experienced an ownership change
at the time of the Private Offering E financing (Date 10). If Company allocates the
exempted shares amount under § 1.382-3(j) to the pre-existing public groups, an
ownership change would occur at the time of the Private Offering F financing (Date 11).

The value of Company's stock declined from the time of the Private Offering E financing
to the Private Offering F financing and net operating losses arose between those two
financing transactions, so Company would prefer to be able to allocate shares to newly
created public groups based on knowledge about actual ownership of those shares.

                             REPRESENTATIONS

Company makes the following representations:

  (a)    Company's only classes of outstanding stock during the relevant testing
         periods are the Company common stock and the preferred stock
         described herein.

  (b)    During the relevant testing periods, Company relied on its corporate
         records and information obtained from direct shareholder interviews to
         identify Company’s shareholders who have direct ownership interests of 5
         percent or more of Company stock. Prior to the IPO, Company had no
         other actual knowledge or relevant tracking system of owners.

PLR-149874-09 7

                                     RULINGS

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

   (1)    Company's corporate records and the information obtained from the
          Written Inquiries and Participating Entity Interviews are acceptable
          methods of determining "actual knowledge" under § 1.382-2T(k)(2).

   (2)    Company is permitted to use actual knowledge to determine the allocation
          of shares issued in the financing transactions arising during the testing
          period ending as of the Private Offering E financing to newly segregated
          public group(s) and may make such an allocation in lieu of the allocations
          described in § 1.382-3(j).

                                     CAVEATS

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or referenced in
this letter. In particular, no opinion is expressed regarding whether Company
experienced any ownership change as defined under § 382(g) as a result of any of the
stock issuances described in this letter or whether Company correctly applied the
acceptable methods for establishing actual knowledge of its stock ownership during the
possible testing periods.

                          PROCEDURAL STATEMENTS

This ruling is directed only to the taxpayer 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.
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.
PLR-149874-09 8

In accordance with the Power of Attorney on file with this office, we are sending a copy
of this letter to your authorized representative.

                                 Sincerely,



                                 Filiz A. Serbes
                                 Chief, Branch 3
                                 Office of Associate Chief Counsel
                                 (Corporate)

cc: