IRS approves a tax-free corporate separation involving a spin-off and debt exchange

Plain-English summary

A publicly traded corporation planned to separate one business from another by transferring the second business to a newly formed corporation and distributing the new corporation's stock to its shareholders. The IRS ruled that the contribution and distribution would qualify as a reorganization under sections 368(a)(1)(D) and 355, so the corporations and shareholders generally would recognize no gain or loss. The ruling also addressed the basis and holding periods of transferred assets and distributed stock, earnings and profits, fractional-share cash, and an exchange of debt securities. The IRS relied on the taxpayer's representations but expressly did not rule on several requirements, including business purpose, device, and certain section 355(e) issues.

Ruling snapshot

• Question: Would the proposed contribution, spin-off, and related debt exchange receive the specified federal income tax treatment?
• Outcome: Approved, subject to stated representations and caveats
• Key authorities: IRC §§ 355, 357, 358, 361, 368(a)(1)(D), 1001, 1032, 1221, 1222, 1223, and 312(h); Treas. Reg. §§ 1.355-2, 1.355-7, 1.368-2, 1.1502-13, 1.1502-19, and 1.1502-33

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201409003 Third Party Communication: None
Release Date: 2/28/2014 Date of Communication: Not Applicable
Index Number: 355.01-00, 368.04-00,
361.00-00, 361.02-02 Person To Contact:
---------------------, ID No. ------------------
-------------------- Telephone Number:
----------------------------- ----------------------
------------------ Refer Reply To:
----------------------------- CC:CORP:5
---------------------------- PLR-127008-13
Date:
November 26, 2013

Legend

Distributing = ------------------
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Controlled = --------------------
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LP = -----------------------------
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Sub = --------------------------------------
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LLC 1 = ------------------------------------
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LLC 2 = -------------------------------
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State A = ---------------
PLR-127008-13 2

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

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

Distributing = ---------------------------------------------------------------------------------------------
Notes ---------------------------------------------------------------------------------------------
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Date 1 = -----------------------

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

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

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

d = ----

e = --

f = ----

g = --

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

This letter responds to your June 7, 2013 request for rulings regarding certain federal
income tax consequences of certain proposed transactions. The information provided in
that request and in later correspondence is summarized below.

The rulings in this letter are based upon 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
PLR-127008-13 3

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): (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 any
distributing corporation or any controlled corporation or both (see section 355(a)(1)(B) of
the Internal Revenue Code and § 1.355-2(d)); and (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 any distributing
corporation or any controlled corporation (see section 355(e)(2)(A)(ii) and § 1.355-7).

                                      FACTS

Distributing, a publicly-traded State A corporation with a single class of stock
outstanding , is the common parent of an affiliated group of corporations that files a
consolidated U.S. federal income tax return using the accrual method of accounting.

Distributing directly owns a common and class B limited partner units of LP, a publicly-
traded State B partnership engaged in Business A. Distributing also owns through
LLC 1, a State B limited liability company that is disregarded as an entity separate from
Distributing for federal income tax purposes (a “disregarded entity”), b limited partner
units and all of the general partner interests in LP. Together, this represents c percent
of the outstanding LP partnership interests. Distributing also wholly owns all the stock
of Sub.

LP does not have employees. Rather, in its capacity as general partner and pursuant to
a services agreement entered into with LP, LLC 1 is responsible for managing and
operating all aspects of Business A. In this regard, certain members of Distributing’s
management also serve as officers of LLC 1 and provide managerial oversight with
respect to Business A. All other employees associated with and engaged in Business A
are employed by Distributing and Sub.

Business B is conducted by Distributing and members of its separate affiliated group (as
defined in section 355(b)(3)(B)) (the “Distributing SAG”).

Financial information that has been submitted indicates that Business A and Business
B, as currently conducted, each have had gross receipts and operating expenses
representing the active conduct of a trade or business for each of the past 5 years.

Distributing has outstanding obligations to unrelated creditors (the “Distributing Notes”)
and short-term commercial paper, and has available a revolving line of credit under a
credit facility as a backstop to its commercial paper program (together, the “Distributing
Debt”). None of the Distributing Notes were issued in anticipation of, or in connection
PLR-127008-13 4

with the proposed transaction. Prior to completing the proposed transaction,
Distributing will not issue commercial paper or borrow under the credit facility except in
the ordinary course of business consistent with past practice.

                         PROPOSED TRANSACTIONS

For what are represented to be valid business purposes, Distributing proposes the
following steps, which have been partially consummated (together the “Proposed
Transactions”):

(i) On Date 1, Distributing formed Controlled with one authorized class of stock and
a nominal amount of capital.

(ii) Prior to the consummation of Steps (vi) and (vii) as defined below, Controlled
may enter into an interest rate hedge (the “Interest Rate Hedge”) with a third-
party investment bank (the “Investment Bank”). Distributing will guarantee
Controlled’s obligations under the Interest Rate Hedge until the Contribution (as
defined in Step (vi), below) has occurred. The Interest Rate Hedge is in the
nature of a derivative contract under which Controlled will be required to make
payments to the Investment Bank if interest rates decrease and the Investment
Bank will be required to make payments to Controlled if interest rates increase.
Distributing intends to treat itself, rather than Controlled, as the initial
counterparty to the Interest Rate Hedge. Distributing will then treat Controlled as
receiving or assuming Distributing’s rights and obligations, as the case may be,
under the Interest Rate Hedge for Federal income tax purposes pursuant to the
Contribution.

(iii) At least d days prior to the closing date of the Debt Exchange (as defined in Step
(iv) below), the Investment Bank acting as principal for its own account will
acquire Distributing Notes in the secondary market (the “Distributing Exchange
Debt”).

(iv) Not less than e calendar days following Investment Bank’s acquisition of the
Distributing Exchange Debt, Distributing and Investment Bank expect to enter
into the Exchange Agreement, pursuant to which the Investment Bank will agree
to exchange an amount of Distributing Exchange Debt, to be determined by the
parties bargaining at arms-length, for the Controlled Securities to be received by
Distributing in Step (vi) below (the “Debt Exchange”).

(v) Sub will convert under state law into a limited liability company and will be treated
as a disregarded entity (“LLC 2”). Business B employees that are employed by
Distributing and LLC 2 will become employed by Controlled (and/or one or more
entities disregarded from Controlled) pursuant to the Contribution.
PLR-127008-13 5

(vi) Distributing will contribute all of the assets and liabilities related to Business B
and the rights and obligations under the Interest Rate Hedge to Controlled in
exchange for (i) all of the Controlled stock, (ii) debt securities of Controlled (the
“Controlled Securities”), and (iii) all or a portion of the Controlled Borrowing
Proceeds (defined in Step (vii) below) (together, the “Contribution”).

(vii) Controlled will borrow cash from third-party lenders through capital market
borrowings (the “Controlled Borrowing Proceeds”). Controlled will transfer to
Distributing all or a portion of the Controlled Borrowing Proceeds in partial
exchange for the Business B assets received from Distributing pursuant to the
Contribution. Distributing will deposit the Controlled Borrowing Proceeds into a
segregated account until paid out as described in Step (viii) below.

(viii) Within f months of receiving the Controlled Borrowing Proceeds,
Distributing will use such proceeds to (i) repay Distributing Debt, (ii) repurchase
outstanding shares of Distributing stock, and/or (iii) pay dividends with respect to
Distributing stock.

(ix) No sooner than d days after Step (iii) above, as provided for in the Exchange
Agreement, Distributing and the Investment Bank will consummate the Debt
Exchange, pursuant to which Distributing will transfer all of the Controlled
Securities received by it in the Contribution to the Investment Bank in exchange
for the Distributing Exchange Debt. The Investment Bank expects to immediately
thereafter sell the Controlled Securities to third-party investors.

(x) Distributing will distribute all of the Controlled stock pro rata to its shareholders
(the “Distribution”).

The transfer of certain Business B assets and contractual relationships (the “Delayed
Assets”) may be delayed pending receipt of consents or approvals from unrelated
parties. As soon as practicable after Distributing obtains the consent or approval
necessary to transfer a particular Delayed Asset, Distributing will contribute that
Delayed Asset to Controlled. While awaiting consents, Distributing and Controlled will
enter into contractual arrangements that will provide Controlled with all substantial rights
and obligations associated with the Delayed Assets.

Following the Distribution, Distributing anticipates that there will be g overlapping board
members. None of these members will be involved in the day-to-day operations of
Distributing or Controlled. In addition, in connection with the Proposed Transactions,
Distributing and Controlled will enter into several agreements relating to their separation
and certain continuing transactions between the companies (the “Post-Separation
Agreements”), including a separation agreement, transitional services agreement,
employee matters agreement, and a tax matters agreement.

                               REPRESENTATIONS

PLR-127008-13 6

(a) With the exception of the Controlled Securities to be held by Distributing prior to
the Debt Exchange, any indebtedness owed by Controlled to Distributing after
the Distribution will not constitute stock or securities.

(b) 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.

(c) No part of the consideration to be distributed by Distributing will be received by a
security holder as an employee or in any capacity other than that of a security
holder of Distributing.

(d) Distributing will treat all members of the Distributing SAG as one corporation in
determining whether it meets the requirements of section 355(b)(2)(A) regarding
the active conduct of a trade or business.

(e) Distributing did not acquire Business A or control of any entity conducting
Business A during the five-year period ending on the date of the Distribution in a
transaction in which gain or loss was recognized (or treated as recognized under
proposed § 1.355-3) in whole or in part, excluding: (i) acquisitions that: constitute
expansions of Business A (within the meaning of § 1.355-3(b)(3)(ii)); and (ii)
acquisitions from another member of the same affiliated group (as described in
§ 1.355-3(b)(4)(iii)).

(f) Distributing did not acquire Business B or control of any entity conducting
Business B during the five-year period ending on the date of the Distribution in a
transaction in which gain or loss was recognized (or treated as recognized under
proposed § 1.355-3) in whole or in part, excluding: (i) acquisitions that: constitute
expansions of Business B (within the meaning of § 1.355-3(b)(3)(ii)); and (ii)
acquisitions from another member of the same affiliated group (as described in
§ 1.355-3(b)(4)(iii)).

(g) The 5 years of financial information submitted on behalf of Business A is
representative of its present business operation, and with regard to such
business, there have been no substantial operational changes since the date of
the last financial statements submitted.

(h) The 5 years of financial information submitted on behalf of Business B is
representative of the business’s present operation, and, with regard to such
business, there have been no substantial operational changes since the date of
the last financial statements submitted.

(i) Following the Proposed Transactions and except as contemplated by the Post-
Separation Agreements, Distributing and Controlled will each continue the active
conduct of its business, independently and with its separate employees.
PLR-127008-13 7

(j) The Distribution is being carried out for the following corporate business
purposes: (i) to permit Distributing and Controlled to structure their operational,
technical and cultural approaches to their businesses in a manner that is
consistent with their “pure play” status, which could include a targeted focus on
internal and external growth strategies relating to their own business operations;
(ii) to enhance each of Distributing’s and Controlled’s ability to issue stock in
pursuance of acquisition opportunities; and (iii) to allow each of Distributing and
Controlled to incentivize its employees with targeted stock-based incentive plans.
The Distribution is motivated, in whole or substantial part, by one or more of
these corporate business purposes.

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

(l) The total adjusted basis and the fair market value of the assets transferred to
Controlled by Distributing (including the Delayed Assets) will equal or exceed the
sum of: (i) any liabilities assumed (within the meaning of section 357(d)) by
Controlled plus any liabilities to which the transferred assets are subject
(excluding liabilities to which section 357(c)(3) applies), and (ii) the total amount
of cash and the fair market value of other property (within the meaning of section
361(b)) received by Distributing in the Contribution. For purposes of this
representation, Distributing is treating the Interest Rate Hedge as a liability
described in section 357(c)(3)(A) to the extent that, at the time of the
Contribution, the present value of the payments that are anticipated to be
received from the counterparty to the Interest Rate Hedge is less than the
present value of the payments that are anticipated to be made to the
counterparty to the Interest Rate Hedge.

(m)The liabilities to be assumed (within the meaning of section 357(d)) by Controlled
in the Contribution (if any) were incurred in the ordinary course of business and
are associated with the assets being transferred.

(n) Distributing neither accumulated its receivables nor made extraordinary payment
of its payables in anticipation of the Proposed Transactions.

(o) Distributing, Controlled, and the shareholders of Distributing will each pay their
separate expenses, if any, incurred in connection with the Proposed
Transactions.

(p) No intercorporate debt will exist between Distributing and Controlled at the time
of, or subsequent to, the Distribution, other than: (i) the Controlled Securities or
(ii) indebtedness incurred in the ordinary course of business or pursuant to the
Post-Separation Agreements.
PLR-127008-13 8

(q) 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 (See §§ 1.1502-13 and 1.1502-14 as in effect before the
publication of T.D. 8597, 1995-32 I.R.B. 6, and as currently in effect; § 1.1502-13
as published by T.D. 8597). Further, Distributing's excess loss account with
respect to the Controlled stock, if any, will be included in income immediately
before the Distribution (See § 1.1502-19).

(r) For purposes of section 355(d), immediately after the 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 Distribution.

(s) For purposes of section 355(d), immediately after the 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 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 Distribution or
(ii) attributable to distributions on Distributing stock or securities 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 Distribution.

(t) 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 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).

(u) Payments made in connection with continuing transactions between Distributing
(and its subsidiaries) and Controlled following the Distribution will be for fair
market value based on terms and conditions arrived at by the parties bargaining
at arm's length, other than in connection with the Post-Separation Agreements.

(v) No two parties to the Proposed Transactions are investment companies as
defined in section 368(a)(2)(F)(iii) and (iv).

(w) Immediately after the Distribution, either: (i) no person will hold a 50-percent or
greater interest (within the meaning of section 355(g)(3)) in Distributing or
Controlled; (ii) neither Distributing nor Controlled will be a disqualified investment
PLR-127008-13 9

 corporation (within the meaning of section 355(g)(2)); or (iii) if any person holds a
 50-percent or greater interest (within the meaning of section 355(g)(3)) in any
 disqualified investment corporation (within the meaning of section 355(g)(2)),
 such person will have held such interest in such corporation immediately before
 the Proposed Transactions.

(x) After the Distribution, no officer or key employee of Distributing or any of its
subsidiaries will also be an officer or key employee of Controlled. The board
members who serve on the board of directors of both Distributing and Controlled
after the Distribution will constitute a minority of each board of directors.

(y) The Controlled Securities will qualify as securities within the meaning of section
361(a).

(z) Any payment of cash in lieu of fractional shares of Controlled stock will be solely
for the purpose of avoiding the expense and inconvenience of issuing and
maintaining fractional shares and will not represent separately bargained for
consideration. The total cash that will be paid in connection with the Distribution
in lieu of fractional shares of Controlled stock will not exceed one percent of the
total consideration that will be distributed to holders of Distributing stock. It is
intended that no Distributing shareholder will receive cash in an amount equal to
or greater than the value of one full share of Controlled stock.

(aa) The Distributing Debt was incurred by Distributing in the ordinary course of
business, and the Distributing Notes were not incurred in connection with, or in
anticipation of, the Contribution, the Distribution, or the Debt Exchange.

                                   RULINGS

1. The Contribution together with the Distribution, will qualify as a reorganization
   within the meaning of section 368(a)(1)(D). Distributing and Controlled will each
   be “a party to a reorganization” within the meaning of section 368(b).

2. Distributing's transfer of the Delayed Assets to Controlled will occur pursuant to
   the plan of reorganization that includes the Contribution and the Distribution.
   Section 1.368-2(g).

3. No gain or loss will be recognized by Distributing on the Contribution. Sections
   357(a) and 361(a) and (b).

4. No gain or loss will be recognized by Controlled on the Contribution. Section
   1032(a).
   PLR-127008-13 10

5. The basis in each asset received by Controlled in the Contribution will be the
   same as the basis of the asset in the hands of Distributing immediately before
   the Contribution. Section 362(b).

6. The holding period in each asset received by Controlled in the Contribution will
   include the period during which Distributing held such asset. Section 1223(2).

7. No gain or loss will be recognized by Distributing on the Distribution. Section
   361(c).

8. No gain or loss will be recognized by (and no amount will be included in the
   income of) the shareholders of Distributing stock upon the Distribution. Section
   355(a).

9. The aggregate basis of the Distributing stock and Controlled stock in the hands
   of each Distributing shareholder immediately after the Distribution (including any
   fractional share interest in Controlled stock to which the shareholder may be
   entitled) will equal the basis of the Distributing stock held by such Distributing
   shareholder immediately before the Distribution, allocated in the manner
   described in § 1.358-2, in accordance with section 358(a) through (c).

10. The holding period of each Distributing shareholder in the Controlled stock
    received in the Distribution (including any fractional share interest in Controlled
    stock to which the shareholder may be entitled) will include the holding period of
    the Distributing stock with respect to which the Distribution is made, provided that
    such Distributing stock is held as a capital asset on the date of the Distribution.
    Section 1223(1).

11. A shareholder who receives cash in lieu of fractional shares of Controlled stock
    will recognize gain or loss measured by the difference between the basis of the
    fractional share received and the amount of cash received. Section 1001(a).
    Any gain (or loss) will be treated as capital gain (or loss), provided that such
    fractional shares are held as a capital assets on the date of the Distribution.
    Sections 1221 and 1222.

12. Earnings and profits of Distributing (if any) will be allocated between Distributing
    and Controlled in accordance with Section 312(h) and §§ 1.312-10(a) and
    1.1502-33(e).

13. Distributing will recognize no gain or loss on its transfer of the Controlled
    Securities in the Debt Exchange other than any: (i) deductions attributable to the
    fact that Distributing Exchange Debt may be redeemed at a premium; (ii) income
    attributable to the fact that the Distributing Exchange Debt may be redeemed at a
    discount; and (iii) interest expense accrued with respect to the Distributing
    Exchange Debt. Section 361(c).
    PLR-127008-13 11

14. Payments made between Distributing or any of its affiliates and Controlled under
    the Post-Separation Agreements that (i) have arisen or will arise for a taxable
    period ending on or before the Distribution and (ii) will not become fixed and
    ascertainable until after the Distribution will be viewed as occurring immediately
    before the Distribution. Arrowsmith v. Commissioner, 344 U.S. 6 (1952); Rev.
    Rul. 83-73, 1983-1 C.B. 84.

                                     CAVEATS
    

No opinion is expressed about the tax treatment of the Proposed Transactions 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 Transactions that are not
specifically covered by the above rulings.

In particular, we express no opinion regarding: (i) whether the Distribution satisfies the
business purpose requirement of § 1.355-2(b); (ii) whether the Distribution is being used
principally as a device for the distribution of the earnings and profits of Distributing,
Controlled, or both (see section 355(a)(1)(B) and § 1.355-2(d)); (iii) whether the
Distribution 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 Distributing or Controlled (see section 355(e) and § 1.355-7); (iv).
whether the Interest Rate Hedge is a liability described in section 357(c)(3)(A); and (v)
the Federal income tax treatment of payment for certain services that may be rendered
at other than fair market value under the Post-Separation Agreements.

                          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 representative.

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,



                                   Mark J. Weiss
                                   Reviewing Attorney, Branch 6
                                   Office of Associate Chief Counsel (Corporate)