PLR 1030005: Internal and external section 355 distributions approved

Plain-English summary

The IRS approved a corporate separation involving an internal distribution of a controlled subsidiary and a later external distribution of the distributing corporation's stock to the parent's shareholders. The plan also included a reincorporation, a recapitalization, a contribution of cash to support the distributing corporation's capital structure and note repurchases, and employee transfers. The IRS ruled that the internal and external distributions and related contribution would receive the requested nonrecognition treatment, with corresponding basis, holding-period, and earnings-and-profits rules. The ruling was based on the taxpayer's representations and did not decide whether the distributions satisfied the business-purpose, device, or section 355(e) requirements. It also did not address other tax consequences, including the treatment of any conditions or effects not specifically covered.

Ruling snapshot

• Question: Would the proposed internal and external distributions and related restructuring qualify for the requested tax treatment?
• Outcome: Approved
• Key authorities: IRC §§ 312, 355, 357, 358, 361, 368, 1032, 1223, and 6110

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201030005 Third Party Communication: None
Release Date: 7/30/2010 Date of Communication: Not Applicable
Person To Contact:
Index Number: 355.00-00, 355.01-00, 368.00- ----------------------------
00, 368.04-00 ID No. -----------------
Telephone Number:
--------------------
--------------------------- Refer Reply To:
---------------------------------------------- CC:CORP:02
--------------------------- PLR-107989-10
-------------------------- Date:
--------------------- April 28, 2010

                                                 LEGEND

Parent = ---------------------------

Distributing = ------------------------------------------

Sub 1 = ------------------------------------

Sub 2 = ------------------------------

Sub 3 = -------------------------------------------------------------

Sub 4 = -------------------------------------------------

Sub 5 = ----------------------------------------------

PLR-107989-10 2

Controlled = ------------------------

Exchange = -----------------------------------

Industry X = -------------------------------

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

Business B = -----------------------------------------------------

Business C = ---------------------------------------------------------------------------------
---------------------------

State A = ------

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

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

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

c = ----------------

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

This letter responds to your February 18, 2010 request, submitted by your authorized
representatives, for rulings on certain federal income tax consequences of the Proposed
Transactions (described below). The information provided in that request and in later
correspondence is summarized below.

The rulings contained in this letter are based upon facts and representations submitted
by the taxpayer and accompanied by a penalties 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 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 Internal Distribution and the External
Distribution (each as defined below): (i) satisfy the business purpose requirement of
PLR-107989-10 3

Treas. Reg. § 1.355-2(b); (ii) are being used principally as a device for the distribution of
the earnings and profits of the distributing corporation or the controlled corporation or
both (see section 355(a)(1)(B) and Treas. Reg. § 1.355-2(d)); or (iii) are 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 section 355(e) and Treas. Reg.
§ 1.355-7).

                             STATEMENT OF FACTS

Parent is a State A holding company and the common parent of an affiliated group of
corporations filing a consolidated federal income tax return. Parent has approximately a
shares of common stock outstanding, which is publicly traded on the Exchange. It has
no other classes of stock and no securities outstanding.

Parent directly owns all of the stock of Distributing, Sub 1, and Sub 2. Distributing is a
State A holding company that directly owns all of the stock of Sub 3, Sub 4, Sub 5, and
Controlled. Distributing has approximately $b of notes (the “Notes”) outstanding, which
were issued in four separate series. Because the Proposed Transactions will likely
result in a change of control and a credit-rating downgrade of Distributing under the
terms of the Notes, each Note holder will have the right to require Distributing to
repurchase all or any part of such holder’s Note.

Parent, through its separate affiliated group as defined in section 355(b)(3)(B) (the
“Parent SAG”), operates three different businesses that are segments of Industry X.
Sub 1 and Sub 2 are engaged in Business A. Distributing, through its separate affiliated
group as defined in section 355(b)(3)(B) (the “Distributing SAG”), is engaged in
Business B. Controlled, a wholly owned subsidiary of Distributing, is engaged in
Business C. Financial information has been submitted indicating that each of
Business A, Business B, and Business C have had gross receipts and operating
expenses representing the active conduct of a trade or business for each of the past
five years.

Because Controlled’s economic model is more closely aligned with that of Business A
and its business is largely dedicated to supplying Sub 2 (pursuant to the terms of a
comprehensive agreement (the “Controlled Agreement”) entered into by Sub 2,
Controlled, and certain state regulatory agencies) there are significant operational and
managerial reasons why Parent wants to continue to own and operate Controlled after
the Proposed Transactions.
PLR-107989-10 4

                           PROPOSED TRANSACTIONS

For what are represented to be valid business reasons, Parent has proposed the
following transactions (the “Proposed Transactions”):

(i) Parent will issue up to $c of new debt.

(ii) Distributing will merge with and into a newly formed, State B corporation that
is wholly owned by Distributing (the “Distributing Reincorporation”). The
newly formed, State B corporation will hold no more than a nominal amount of
assets prior to the merger. Parent has represented that the Distributing
Reincorporation qualifies as a reorganization within the meaning of section
368(a)(1)(F). References to “Distributing” will be to the reincorporated entity
unless the context otherwise requires.

(iii) Distributing will effect a stock split in which each share of Distributing
common stock held by Parent will be exchanged at a specified conversion
ratio for a greater number of shares, resulting in Parent holding the same
number of shares of Distributing stock immediately prior to the External
Distribution as the number of outstanding shares of Parent stock at that time
(the “Distributing Recapitalization”). In connection with the Distributing
Recapitalization, cash will be distributed for any fractional share of
Distributing stock. Parent has represented that the Distributing
Recapitalization qualifies as a reorganization within the meaning of section
368(a)(1)(E).

(iv) Distributing will distribute all of its Controlled stock to Parent (the “Internal
Distribution”).

(v) Parent will transfer up to $c of cash to Distributing (the “Contribution”) in order
to establish the appropriate capital structure for Distributing and to assist
Distributing in satisfying its repurchase obligations under the Notes.

(vi) Parent will distribute all of its Distributing stock to Parent’s shareholders (the
“External Distribution”).

Because of differing retirement benefits, certain employees who perform services at
Controlled are employed by a subsidiary of Distributing. In connection with the
Proposed Transactions, these employees will be transferred to Controlled or an indirect
subsidiary of Parent.

Pursuant to the Controlled Agreement, Sub 2 owns certain economic interests with
respect to real property governed by the Controlled Agreement, while Controlled owns
all other interests and rights with respect to the property. Notwithstanding that title to
PLR-107989-10 5

the real property is held by Sub 3, Parent has consistently operated the property in
accordance with the terms and conditions of the Controlled Agreement and the
ownership rights described above, and for tax purposes, has treated Sub 2 as owning
an economic interest in the property and Controlled as holding beneficial ownership of
all other interests and rights with respect to the property since the execution of the
Controlled Agreement. Parent intends to correct the title to Controlled’s interests and
rights in the real property, but any action taken will not affect how ownership of the
interests and rights is reported for tax purposes.

Following the Proposed Transactions, Parent, Distributing, Controlled, and their
subsidiaries will continue to provide certain operating services to other members of the
Parent group and the Distributing group that are now being provided between the
companies under existing contracts. All such services will be provided pursuant to
arm’s length contracts. In addition, in connection with the Proposed Transactions,
Distributing anticipates entering into a tax sharing agreement and a transition services
agreement with Parent and its subsidiaries.

Further, to reassure investors and facilitate a smooth transition following the Proposed
Transactions, Parent and Distributing may share a common chairman of the board for a
period of time. At a minimum, Parent expects the chairman’s term to be consistent with
the guidance provided in Rev. Rul. 2003-74, 2003-2 C.B. 77.

                             REPRESENTATIONS

                              Internal Distribution

The following representations are made regarding the Internal Distribution:

(1a) 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.

(1b) The five years of financial information submitted on behalf of Business B
conducted by the Distributing SAG is representative of the present operations
of the business, and with regard to such business, there have been no
substantial operational changes since the date of the last financial statements
submitted.

(1c) The five years of financial information submitted on behalf of Business C
conducted by Controlled is representative of the present operations of the
business, and with regard to such business, there have been no substantial
operational changes since the date of the last financial statements submitted.
PLR-107989-10 6

(1d) The Distributing SAG neither acquired Business B nor acquired control of an
entity conducting Business B during the five-year period ending on the date of
the Internal Distribution in a transaction in which gain or loss was recognized
(or treated as recognized) in whole or in part, excluding in each case
acquisitions that constitute expansions, as contemplated by Treas. Reg.
§ 1.355-3(b)(3)(ii), of Business B. Throughout the five-year period ending on
the date of the Internal Distribution, the Distributing SAG will have been the
principal owner of the goodwill and significant assets of Business B and it will
continue to be the principal owner following the Internal Distribution.

(1e) Controlled neither acquired Business C nor acquired control of an entity
conducting Business C during the five-year period ending on the date of the
Internal Distribution in a transaction in which gain or loss was recognized (or
treated as recognized) in whole or in part. Throughout the five-year period
ending on the date of the Internal Distribution, Controlled will have been the
principal owner of the goodwill and significant assets of Business C and it will
continue to be the principal owner following the Internal Distribution.

(1f) Following the Internal Distribution, the Distributing SAG and Controlled will
each continue the active conduct of its business, independently and with its
separate employees.

(1g) The Internal Distribution is carried out for the following corporate business
purposes: to facilitate the External Distribution. The Internal Distribution is
motivated, in whole or substantial part, by one or more of these corporate
business purposes.

(1h) The Internal Distribution is not used principally as a device for the distribution
of the earnings and profits of Distributing or Controlled or both.

(1i) For purposes of section 355(d), immediately after the Internal Distribution, no
person (determined after applying section 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 section 355(d)(5) and (8)) during the five-year period
(determined after applying section 355(d)(6)) ending on the date of the
Internal Distribution.

(1j) For purposes of section 355(d), immediately after the Internal Distribution, no
person (determined after applying section 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 classes of Controlled stock, that was either (i) acquired
PLR-107989-10 7

     by purchase (as defined in section 355(d)(5) and (8)) during the five-year
     period (determined after applying section 355(d)(6)) ending on the date of the
     Internal Distribution, or (ii) attributable to distributions on Distributing stock
     that were acquired by purchase (as defined in section 355(d)(5) and (8))
     during the five-year period (determined after applying section 355(d)(6))
     ending on the date of the Internal Distribution.

(1k) No intercorporate debt will exist between Distributing and Controlled at the
time of, or subsequent to, the Internal Distribution.

(1l) Immediately before the Internal Distribution, items of income, gain, loss,
deduction, and credit will be taken into account as required by the applicable
intercompany transaction regulations (see Treas. Reg. §§ 1.1502-13 and
1.1502-14 as in effect before the publication of T.D. 8597, 1995-2 C.B. 147,
and as currently in effect; Treas. Reg. § 1.1502-13 as published by T.D.
8597).

(1m) Immediately before the Internal Distribution, Distributing will not have an
excess loss account (within the meaning of Treas. Reg. § 1.1502-19(a)(2)) in
Controlled’s stock.

(1n) 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.

(1o) No two parties to the Internal Distribution are investment companies as
defined in section 368(a)(2)(F)(iii) and (iv).

(1p) The Internal Distribution is not part of a plan or series of related transactions
(within the meaning of Treas. Reg. § 1.355-7) pursuant to which one or more
persons will acquire, directly or indirectly, stock representing a 50-percent or
greater interest (within the meaning of section 355(d)(4)) in Distributing or
Controlled (including any predecessor or successor of any such corporation).

(1q) Immediately after the Internal Distribution, either (1) no person will hold a 50-
percent or greater interest (within the meaning of section 355(g)(3)) in the
stock of Distributing or Controlled who did not hold such an investment
immediately before the transaction, or (2) neither Distributing nor Controlled
will be a disqualified investment corporation (within the meaning of section
355(g)(2)).

(1r) There is no regulatory, legal, contractual, or economic compulsion or
requirement that the Contribution be made as a condition of the Internal
Distribution. The fact that the value of Distributing will decrease as a result of
PLR-107989-10 8

      the Internal Distribution was not a consideration in the decision to contribute
      property to Distributing. The Internal Distribution is not contingent on there
      being contributed to Distributing assets having a specified (or a roughly
      specified) value.

                     Contribution and External Distribution

The following representations are made regarding the Contribution and External
Distribution:

(2a) No part of the consideration to be distributed by Parent will be received by a
shareholder as a creditor, employee, or in any capacity other than that of a
shareholder of Parent.

(2b) The five years of financial information submitted on behalf of Business A
conducted by the Parent SAG is representative of the present operations of
the business, and with regard to such business, there have been no
substantial operational changes since the date of the last financial statements
submitted.

(2c) The five years of financial information submitted on behalf of Business B
conducted by the Distributing SAG is representative of the present operations
of the business, and with regard to such business, there have been no
substantial operational changes since the date of the last financial statements
submitted.

(2d) The Parent SAG neither acquired Business A nor acquired control of an entity
conducting Business A during the five-year period ending on the date of the
External Distribution in a transaction in which gain or loss was recognized (or
treated as recognized) in whole or in part. Throughout the five-year period
ending on the date of the External Distribution, the Parent SAG will have been
the principal owner of the goodwill and significant assets of Business A and it
will continue to be the principal owner following the External Distribution.

(2e) The Distributing SAG neither acquired Business B nor acquired control of an
entity conducting Business B during the five-year period ending on the date of
the External Distribution in a transaction in which gain or loss was recognized
(or treated as recognized) in whole or in part, excluding in each case
acquisitions that constitute expansions, as contemplated by Treas. Reg.
§ 1.355-3(b)(3)(ii), of Business B. Throughout the five-year period ending on
the date of the External Distribution, the Distributing SAG will have been the
principal owner of the goodwill and significant assets of Business B and it will
continue to be the principal owner following the External Distribution.
PLR-107989-10 9

(2f) Following the External Distribution, the Parent SAG and the Distributing SAG
will each continue the active conduct of its business, independently and with
its separate employees.

(2g) The External Distribution is carried out for the following corporate business
purposes: (1) to facilitate equity and debt financing by Distributing to
capitalize on a number of significant growth opportunities available to
Business B, and (2) to improve the fit and focus of Business A and
Business B by resolving inherent internal managerial and operational
conflicts. The External Distribution is motivated, in whole or substantial part,
by one or more of these corporate business purposes.

(2h) The External Distribution is not used principally as a device for the distribution
of the earnings and profits of Parent or Distributing or both.

(2i) For purposes of section 355(d), immediately after the External Distribution, no
person (determined after applying section 355(d)(7)) will hold stock
possessing 50 percent or more of the total combined voting power of all
classes of Parent stock entitled to vote, or 50 percent or more of the total
value of shares of all classes of Parent stock, that was acquired by purchase
(as defined in section 355(d)(5) and (8)) during the five-year period
(determined after applying section 355(d)(6)) ending on the date of the
External Distribution.

(2j) For purposes of section 355(d), immediately after the External Distribution, no
person (determined after applying section 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 either (i) acquired
by purchase (as defined in section 355(d)(5) and (8)) during the five-year
period (determined after applying section 355(d)(6)) ending on the date of the
External Distribution, or (ii) attributable to distributions on Parent stock that
were acquired by purchase (as defined in section 355(d)(5) and (8)) during
the five-year period (determined after applying section 355(d)(6)) ending on
the date of the External Distribution.

(2k) The total adjusted basis of the assets that will be transferred to Distributing in
the Contribution will equal or exceed the sum of (i) the total liabilities assumed
(within the meaning of section 357(d)) by Distributing and (ii) the total amount
of any money and the fair market value of any other property (within the
meaning of section 361(b)) received by Parent from Distributing and
transferred to Parent’s shareholders or creditors pursuant to the plan of
reorganization.
PLR-107989-10 10

(2l) The total fair market value of the assets transferred to Distributing in the
Contribution will exceed the sum of (i) the amount of any liabilities assumed
(within the meaning of section 357(d)) by Distributing in the Contribution and
External Distribution, (ii) the amount of any liabilities owed to Distributing by
Parent that are discharged or extinguished in the Contribution and External
Distribution, and (iii) the amount of any cash and the fair market value of any
other property (other than stock and securities permitted to be received under
section 361(a) without the recognition of gain) received by Parent in the
Contribution and External Distribution. The fair market value of the assets of
Distributing will exceed the amount of its liabilities immediately after the
exchange.

(2m) Any liabilities assumed (within the meaning of section 357(d)) by Distributing
in the Contribution were incurred in the ordinary course of business and are
associated with the assets being transferred.

(2n) No intercorporate debt will exist between Parent and Distributing at the time
of, or subsequent to, the External Distribution.

(2o) Immediately before the External Distribution, items of income, gain, loss,
deduction, and credit will be taken into account as required by the applicable
intercompany transaction regulations (see Treas. Reg. §§ 1.1502-13 and
1.1502-14 as in effect before the publication of T.D. 8597, 1995-2 C.B. 147,
and as currently in effect; Treas. Reg. § 1.1502-13 as published by T.D.
8597). Further, Parent’s excess loss account, if any, with respect to the
Distributing stock will be included in income immediately before the External
Distribution (see Treas. Reg. § 1.1502-19).

(2p) Payments made in connection with all continuing transactions, if any,
between Parent and Distributing will be for fair market value based on terms
and conditions arrived at by the parties bargaining at arm’s length.

(2q) No two parties to the External Distribution are investment companies as
defined in section 368(a)(2)(F)(iii) and (iv).

(2r) The External Distribution is not part of a plan or series of related transactions
(within the meaning of Treas. Reg. § 1.355-7) pursuant to which one or more
persons will acquire, directly or indirectly, stock representing a 50-percent or
greater interest (within the meaning of section 355(d)(4)) in Parent or
Distributing (including any predecessor or successor of any such corporation).

(2s) Immediately after the External Distribution either (1) no person will hold a 50-
percent or greater interest (within the meaning of section 355(g)(3)) in the
stock of Parent or Distributing who did not hold such an investment
PLR-107989-10 11

      immediately before the transaction, or (2) neither Parent nor Distributing will
      be a disqualified investment corporation (within the meaning of section
      355(g)(2)).

                                    RULINGS

                               Internal Distribution

Based solely on the information and representations submitted, we rule as follows on
the Internal Distribution:

(1) No gain or loss will be recognized by Distributing on its distribution of the
Controlled stock in the Internal Distribution (section 355(c)).

(2) No gain or loss will be recognized by (and no amount will be included in the
income of) Parent upon its receipt of the Controlled stock in the Internal
Distribution (section 355(a)(1)).

(3) The aggregate basis of the Distributing stock and the Controlled stock in the
hands of Parent immediately after the Internal Distribution will be the same as
the basis of the Distributing stock in the hands of Parent immediately before
the Internal Distribution (section 358(a) and Treas. Reg. § 1.358-1(a)). Such
basis will be allocated between the Distributing stock and the Controlled stock
in proportion to the fair market value of each in accordance with Treas. Reg.
§ 1.358-2(a)(2) (section 358(b)(2) and (c)).

(4) The holding period of the Controlled stock received by Parent in the Internal
Distribution will include the holding period of the Distributing stock with
respect to which the Internal Distribution will be made, provided that such
Distributing stock is held as a capital asset on the date of the Internal
Distribution (section 1223(1)).

(5) Earnings and profits will be allocated between Distributing and Controlled in
accordance with section 312(h) and Treas. Reg. §§ 1.312-10(b) and
1.1502-33(f)(2).

                      Contribution and External Distribution

Based solely on the information and representations submitted, we rule as follows on
the Contribution and External Distribution:

(6) The Contribution, together with the External Distribution, will constitute a
reorganization under section 368(a)(1)(D). Parent and Distributing will each
be “a party to a reorganization” under section 368(b).
PLR-107989-10 12

(7) No gain or loss will be recognized by Parent on the Contribution (section
361(a)).

(8) No gain or loss will be recognized by Distributing on the Contribution (section
1032(a)).

(9) No gain or loss will be recognized by Parent on the External Distribution
(section 361(c)(1)).

(10) No gain or loss will be recognized by (and no amount will be included in the
income of) the shareholders of Parent upon the receipt of the Distributing
stock in the External Distribution (section 355(a)(1)).

(11) The aggregate basis of the Parent stock and the Distributing stock in the
hands of each Parent shareholder immediately after the External Distribution
will be the same as the basis of the Parent stock in the hands of such Parent
shareholder immediately before the External Distribution (section 358(a) and
Treas. Reg. § 1.358-1(a)). Such basis will be allocated between the Parent
stock and the Distributing stock in proportion to the fair market value of each
in accordance with Treas. Reg. § 1.358-2(a)(2) (section 358(b)(2) and (c)). If
a Parent shareholder that purchased or acquired shares of Parent stock on
different dates or at different prices is not able to identify which particular
share of Distributing stock (or portion thereof) is received with respect to a
particular share of Parent stock, the shareholder may designate which share
of Distributing stock is received with respect to a particular share of Parent
stock, provided the terms of the designation are consistent with the terms of
the External Distribution (Treas. Reg. § 1.358-2(a)(2)(vii)).

(12) The holding period of the Distributing stock received by Parent shareholders
in the External Distribution will include the holding period of the Parent stock
with respect to which the External Distribution will be made, provided that
such Parent stock is held as a capital asset on the date of the External
Distribution (section 1223(1)).

(13) Earnings and profits will be allocated between Parent and Distributing in
accordance with section 312(h) and Treas. Reg. §§ 1.312-10(a) and
1.1502-33(e)(3).

                                   CAVEATS

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax treatment of the Proposed Transactions under other provisions of the Code or the
regulations, or the tax treatment of any conditions existing at the time of, or effects
PLR-107989-10 13

resulting from, the Proposed Transactions that are not specifically covered by the above
rulings. In particular, no opinion is expressed regarding:

  (i)     Whether the Internal Distribution and the External Distribution satisfy the
          business purpose requirement of Treas. Reg. § 1.355-2(b);
  (ii)    Whether the Internal Distribution and the External Distribution will be used
          principally as a device for the distribution of the earnings and profits of the
          distributing corporation or the controlled corporation or both; and
  (iii)   Whether the Internal Distribution and the External Distribution will be part of a
          plan (or series of related transactions) under section 355(e)(2)(A)(ii).

                            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.

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

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.

                                      Sincerely,



                                      Frances L. Kelly
                                      Assistant to the Branch Chief, Branch 2
                                      Office of Associate Chief Counsel (Corporate)

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