Cooperative restructuring avoids the section 337 change-in-status rule

Plain-English summary

A tax-exempt member-owned cooperative planned to collapse several taxable subsidiaries into one legal entity and offer both its traditional and expanded services at cost. After the restructuring, nonmember income was expected to exceed 15 percent, causing the cooperative to lose section 501(c)(12) exemption. The IRS ruled that the section 337 change-in-status rule would not apply to the liquidation of the holding-company subsidiary if that income threshold was exceeded in the relevant year. It also ruled that a later return to exemption solely because the cooperative again satisfied the annual 85-percent member-income test would not establish an anti-abuse purpose and would qualify for the regulatory exception. The IRS did not decide whether the liquidation qualified under section 332, whether a later exemption change would be a section 368 reorganization, or whether the organization followed cooperative principles.

Ruling snapshot

• Question: Would the subsidiary liquidation trigger the section 337 change-in-status rule, and would a later return to cooperative exemption violate its anti-abuse rule?
• Outcome: approved
• Key authorities: IRC §§ 337 and 501(c)(12); Treas. Reg. § 1.337(d)-4

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201725017                                              Third Party Communication: None
Release Date: 6/23/2017                                        Date of Communication: Not Applicable
Index Number:
                                                               Person To Contact:
  337.14-00, 337.00-00
                                                               ---------------------------,
------------------------------                                 ID No. -----------------
-------------------------------------------------              Telephone Number:

-----------------                                              ---------------------
--------------------------------                               Refer Reply To:
                                                               CC:CORP:B02
                                                               PLR-132018-16
                                                               Date:
                                                               March 16, 2017


LEGEND

Cooperative                =         ------------------------------------------------------
---------------------------------------------------------------
-----------------------------------------------------------

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

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

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

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

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

Sub 6                      =         ----------------------------
----------------------------------------------------------------------------------

State 1                    =        --------
PLR-132018-16                                     2

State 2                 =   ------------


Business                =   -----------------------

Core Services           =   ------------------------------------------------------------------

a                       =   -------

b                       =   --------

c                       =   ------

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

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

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

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

Closing Date            =   -----------------------

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

       This letter responds to your letter dated September 30, 2016, requesting rulings
on certain U.S. federal (“Federal”) income tax consequences of the Proposed
Transaction (describe below). 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 penalties of perjury statement
executed by the 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.

       This letter is issued pursuant to section 6.03 of Rev. Proc. 2016-1, 2016-1 I.R.B.
1 and 19, regarding one or more significant issues under section 332. The rulings
contained in this letter only address one or more discrete legal issues involved in the
transaction. This Office expresses no opinion as to the overall tax consequences of the
transactions described in this letter or as to any issue not specifically addressed by the
rulings below.
PLR-132018-16                               3

                                  Summary of Facts

       Cooperative was incorporated in State 1, on Date 1. Cooperative is a privately
held, member owned, cooperative with approximately a members. Cooperative was
originally organized to provide in rural Northeast State 1 certain services to customers
on a cooperative basis that are allowed tax-exempt treatment under section 501(c) (12).
Over time, Cooperative has expanded its operations to certain additional services that
are not eligible for tax-exempt treatment under section 501(c) (12) or otherwise.

       The additional services are provided to customers through subsidiaries of
Cooperative. The annual accounting period for each entity is the fiscal year ending Date

3. Since the additional services are now an increasingly greater portion of
Cooperatives’ total business operations, Cooperative has decided to consolidate its
business operations to one legal entity and provide all its services at cost on a
cooperative basis, which will allow Cooperative to bundle its services and charge its
customers a single price on a single bill. It will also have the effect of Cooperative no
longer qualifying for tax-exempt treatment under section 501(c) (12).

      Cooperatives’ present business structure is as follows:

       Cooperative owns 100% of the single class of stock of Sub 1, a Subchapter C
corporation. Sub 1 was incorporated in State 2 on Date 2. Sub 1 is an intermediary
holding company that was organized to hold investments in subsidiaries formerly held
by Cooperative.

         Sub 1 owns 100% of the single class stock of both Sub 2 and Sub 4, each a
Subchapter C corporation. Sub 2 provides services to both members and non-
members. Sub 4 provides services through Sub 5, which is a wholly owned limited
liability partnership and disregarded as an entity separate from Sub 4.

      Sub 1 also owns a b limited partnership interest in Sub 3 and 100% of the
membership interest in Sub 6. Sub 6 is disregarded as an entity separate from Sub 1.
Sub 6 owns a c general partnership interest in Sub 3. Thus Sub 1 effectively owns
100% of the stock of Sub 3, which is taxed as a Subchapter C corporation. Sub 3
provides services to customers who are not members of the Cooperative.

                               Proposed Restructuring

       Cooperative, Sub 3, Sub 2, Sub 1 and Sub 6 will engage in the following
transactions (the Proposed Restructuring) on a single designated date (the Closing
Date).

      (i)    At 11:55 P.M., Sub 3 will convert from a limited partnership classified as
             an association and taxable as a corporation, into a limited liability
PLR-132018-16                                 4

              company and make an election to be treated as disregarded as an entity
              separate from Sub 1 for federal tax purposes (the Sub 3 Conversion).

      (ii)    At 11:56 P.M., Sub 6 will merge with and into Sub 1 with Sub 1 surviving.
              (the Sub 6 Merger).

      (iii)   At 11:57 P. M., Sub 2 will convert from a corporation into a limited liability
              company treated as disregarded as an entity separate from Sub 1 under
              the default classification rules (the Sub 2 Conversion).

      (iv)    At 11:58 P. M., Sub 1 will liquidate pursuant to State 2 law, distributing all
              of its assets to the Cooperative (the Sub 1 Liquidation).

      (v)     At 11:59 P. M., Sub 2 (now disregarded as an entity separate from
              Cooperative) will distribute the Core Services and related assets to
              Cooperative (the Sub 2 Distribution).

                                     Representations

      (a)     Sub 1 will adopt a plan of liquidation under State 2 law, and the Sub 1
              liquidation will occur pursuant to the Sub 1 liquidation plan.

      (b)     On the date of the adoption of the Sub 1 liquidation plan and at all times
              thereafter until the Sub 1 liquidation is complete, Cooperative will own
              100% of the single outstanding class of Sub 1 stock.

      (c)     Upon the Sub 1 liquidation, Sub 1 will cease to exist for federal income tax
              purposes.

      (d)     All liquidating distributions from Sub 1 to Cooperative pursuant to the Sub
              1 liquidation will be made on the Closing Date.

      (e)     After the Proposed Restructuring beginning in Cooperative’s fiscal year
              ending Date 4, and for all foreseeable future fiscal years of Cooperative,
              Cooperative expects that it will not be an organization that is exempt from
              federal income tax under section 501 or any other provision of the Code.

                                          Rulings

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

      (1)     Provided that Cooperative’s non-member income for the fiscal year ending
              Date 4 will exceed 15% of Cooperatives income following the Proposed
PLR-132018-16                                  5

              Restructuring, section 1.337(d)-4(a)(1) will not apply to the Sub 1
              liquidation.

       (2)    If after the Proposed Restructuring has been completed, Cooperative’s
              status changes to be a tax-exempt cooperative under section 501(c)(12)
              of the Code solely by meeting the annual 85% member income test,
              Cooperative will not be considered to have had a principal purpose of
              avoiding the application of the change in status rules under the anti-abuse
              rule in section 1.337(d)-4(a)(3)(iii), and Cooperative’s return to tax-exempt
              status will qualify for the exception from the change in status rule under
              section 1.337(d)-4(a)(3)(i)(E).

                                          Caveats

       Except as expressly provided herein, no opinion is expressed or implied on (a)
whether the Liquidation qualifies for no recognition of gain or loss under § 332; (b)
whether the change in status of Cooperative to a tax-exempt entity, if it occurs, is a
reorganization under section 368(a) (1) (E) or (F), and (c) whether Cooperative is
operated according to cooperative principles. We also express no opinion on the
federal income 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.

                                 Procedural Statements

      This ruling letter is directed only to the taxpayers who requested it. Section
6110(k) (3) 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.

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

                                           Sincerely


                                           Mark S. Jennings
                                           Senior Technician Reviewer
                                           Branch 1
                                           Office of Associate Chief Counsel (Corporate)