Spin-off may retain stock for debt exchanges without defeating control distribution

Plain-English summary

A public company proposed separating one business segment through a multistep domestic and foreign restructuring followed by three distributions. One distributing company would temporarily retain controlled-company stock and use it in exchanges for third-party debt within 12 months, then dispose of any remainder within a stated period. The IRS ruled that the retention was not part of a tax-avoidance plan and that qualifying debt exchanges would be treated as distributions under the reorganization plan for sections 361(c)(1) and 361(c)(3). Investment-bank participation would not prevent that treatment. The IRS also ruled that specified post-distribution payments would relate back to immediately before the relevant distribution and that delayed asset transfers would be treated as occurring on the original contribution dates.

Ruling snapshot

• Question: Would temporary stock retention, later debt exchanges, post-spin payments, and delayed transfers preserve the intended section 355 and 361 treatment?
• Outcome: approved
• Key authorities: IRC §§ 355 and 361(c); Treas. Reg. §§ 1.355-2(e) and 1.368-2(g); Rev. Rul. 83-73; Arrowsmith v. Commissioner, 344 U.S. 6 (1952)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201731004 Third Party Communication: None
Release Date: 8/4/2017 Date of Communication: Not Applicable
Index Number: 355.00-00, 355.01-00,
355.05-01, 361.02-02 Person To Contact:
-------------------------, ID No. -----------------
-------------------------- -----------------------------------------------------
--------------------------- Telephone Number:
-------------------------------- ----------------------
------------------------------------- Refer Reply To:
------------------------------------------- CC:CORP:03
PLR-126172-16
Date:
February 16, 2017

                                                 Legend

Distributing 1 = --------------------------------

Distributing 2 = ---------------------------------------

Distributing 3 = ------------------------------------------------------
----------------------------------------------------------------------------
-------------------------
------------------------

Sub = ---------------------

LLC 1 = -----------------------------------------------------
-------------------------------------------------

U.S. Controlled = -----------------------------------------

Foreign Controlled = -----------------------------------------------------

PLR-126172-16 2

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

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

----------------------------------------------------------------------------------------------------------

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

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

Business D = -------------------------------------------------------------

Business E = ----------------------------------------------------------------------------
----------------------------------------------------------------------------

Segment A Domestic = ---------------------------------------

Segment A Foreign = ---------------------------------------------

State = --------------

Country A = ------------------

Country B = -----------------------

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

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

Month 1 = ---------------

Year 1 = -------

a = --------

b = --------
PLR-126172-16 3

c = --------

d = --------

e = ------------------

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

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

h = ------

i = ----

j = ------

k = ----

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

m = ----------------

n = ----

Person A = ---------------------------------------------------------------------------

Person B = ---------------------------------------------------------------------------

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

  This letter responds to your authorized representatives’ letter dated August 23,

2016, requesting rulings on certain federal income tax consequences of a proposed
transaction (the “Proposed Transaction”). The material information provided in that
request and in subsequent correspondence is summarized below.

    The rulings contained in this letter are based upon information 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
materials submitted in support of the request for rulings. Such materials are 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 section 3.01(50) of Rev. Proc. 2016-3, 2016-1 I.R.B. 126, regarding rulings on
PLR-126172-16 4

one or more significant issues that are presented in a transaction described in section
332, section 351, section 355, section 368, or section 1036 of the Internal Revenue
Code (the “Code”) or that address the tax consequences that result from the
qualification of a transaction under these sections. The rulings contained in this letter
only address discrete legal issues presented by the Proposed Transaction. This Office
expresses no opinion as to the overall tax consequences of the Proposed Transaction.
Except as expressly provided in the Rulings section 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.

                                Summary of Facts

     Distributing 1 is a publicly traded State corporation and the common parent of an

affiliated group that files a U.S. consolidated federal income tax return. Distributing 1
also is the parent of a worldwide group that includes U.S. and foreign entities (the
“Distributing 1 Group”).

    The Distributing 1 Group is engaged in Business. The group’s operations are

divided into 5 segments (Businesses A, B, C, D, and E), each of which comprises
domestic and foreign segments (e.g., Business A comprises Segment A Domestic and
Segment A Foreign). Business A will be spun off pursuant to the Proposed Transaction
(as described below). Businesses B, C, D, and E (each, an “Other Business” and
collectively, the “Other Businesses”) will remain with the Distributing 1 Group.

   Prior to the Proposed Transaction, Distributing 1 directly owned all of the

outstanding stock of Sub (a State corporation) and a percent of the interests in
Distributing 2 (a State limited liability company treated as a corporation for U.S. federal
income tax purposes), and Sub directly owned the remaining b percent of Distributing 2
interests.

   Distributing 2 directly owns all of the interests in LLC 1 (a State limited liability

company treated as a corporation for U.S. federal income tax purposes). Distributing 2
also directly owns c percent of the stock of Distributing 3 (a Country A entity treated as
a corporation for U.S. federal income tax purposes). LLC 1 directly owns the remaining
d percent of Distributing 3 stock. Additionally, Distributing 2 directly owns various other
U.S. entities that are engaged in Business (including Segment A Domestic).

   Distributing 3 owns (directly and indirectly) various foreign entities that are

engaged in Business (including Segment A Foreign). Some of these foreign entities
conduct Other Business operations as well as Segment A Foreign operations (the
“Foreign Mixed Business Entities”).

  Distributing 2 owes approximately e to third-party lenders. Distributing 2 and its

subsidiaries also have intercompany debt outstanding.
PLR-126172-16 5

                             Proposed Transaction

   For what are represented to be valid corporate business purposes (the

“Corporate Business Purposes”), Distributing 1 proposes to separate Business A from
the Other Businesses in a transaction that includes the following steps (among others)
(the “Proposed Transaction”):

1. On Date 1, Distributing 2 formed a new State corporation (“U.S. Controlled”).

2. On Date 2, Sub merged into Distributing 1, with Distributing 1 surviving.

3. In a series of transactions that will include distributions, contributions,
   reorganizations, sales, and other taxable and nontaxable transfers, the assets
   and liabilities of Segment A Foreign held by the Foreign Mixed Business Entities
   will be separated from the assets and liabilities of the Other Businesses held by
   these entities and positioned in regarded entities and DREs for later transfer to
   Foreign Controlled (defined below) (the “Foreign Restructuring”). The Foreign
   Restructuring began in Month 1 of Year 1. As part of the Foreign Restructuring,
   various entity classification elections have been made or will be made.

   As part of the Foreign Restructuring, intercompany debt owed to Distributing 2
   (or to DREs of Distributing 2) or LLC 1 by DREs of Distributing 3 will be repaid,
   capitalized, or otherwise eliminated so that there will be no indebtedness owed
   by Foreign Controlled (or any entity controlled directly or indirectly by Foreign
   Controlled) to Distributing 1 (or any entity controlled directly or indirectly by
   Distributing 1), other than approximately f described in Step 4 below, at the time
   of or after the Distributions (defined below).

4. In a series of transactions, Distributing 3 (through its DREs) will contribute the
   following assets to Foreign Controlled (a newly formed Country B entity initially
   treated as a DRE of Distributing 3 for U.S. federal income tax purposes) in
   exchange for all Foreign Controlled common stock and the assumption by
   Foreign Controlled of related liabilities (including approximately f owed by a DRE
   of Distributing 3 to Distributing 2 (the “Assumed Loan”)): (i) all of the entities
   conducting Segment A Foreign; (ii) any Segment A Foreign assets held directly
   by Distributing 3; and (iii) intercompany agreements to acquire any Segment A
   Foreign entities and assets that cannot be contributed contemporaneously due to
   legal, regulatory, or similar impediments (collectively, “Contribution 1”). No other
   class of Foreign Controlled stock will be authorized. Assets and entities
   transferred to Foreign Controlled and liabilities assumed by Foreign Controlled
   may be further transferred to or assumed by wholly owned subsidiaries of
   Foreign Controlled.

   The amount of the Assumed Loan, if any, has not been finally determined and
   will be based on market conditions. The Assumed Loan will be repaid in Step 6.
   PLR-126172-16 6

   Prior to Step 5, Foreign Controlled will make an election to be treated as a
   corporation for U.S. federal income tax purposes.

5. Distributing 3 will distribute all of the Foreign Controlled stock to Distributing 2 in
   exchange for part of the Distributing 3 stock held by Distributing 2 (the “First
   Distribution”).

6. Following the separation of Segment A Domestic assets and liabilities from Other
   Business assets and liabilities, and following the positioning of these separated
   Segment A Domestic assets and liabilities in regarded entities and DREs held by
   Distributing 2, Distributing 2 will contribute to U.S. Controlled: (i) all of the entities
   conducting Segment A Domestic; and (ii) all stock in Foreign Controlled. In
   exchange for this contribution, Distributing 2 will receive approximately g of cash
   (from borrowings described below) (the “Cash Amount”) and 2 classes of U.S.
   Controlled common stock: (i) Class A, representing h percent of the vote and i
   percent of the value (the “Class A Common Stock”); and (ii) Class B,
   representing j percent of the vote and k percent of the value (the “Class B
   Common Stock”; together with the Class A Common Stock, the “Dual Class
   Structure”). The foregoing exchange is referred to herein as “Contribution 2.”

   U.S. Controlled (possibly together with Foreign Controlled, depending on market
   conditions) will borrow approximately l from one or more third-party lenders on
   customary terms (the “Debt Amount”). From these borrowings, U.S. Controlled
   will distribute the Cash Amount to Distributing 2 and loan approximately m (the
   “Loan Amount”) to Foreign Controlled, which will use the funds to repay the
   Assumed Loan owed to Distributing 2. (If Foreign Controlled borrows funds
   directly from one or more third-party lenders, then U.S. Controlled will not loan
   funds to Foreign Controlled.) U.S. Controlled will use the remaining cash to
   repay amounts owed to Distributing 2 and LLC 1 by U.S. Controlled-owned
   entities. Distributing 2 will use the cash received (totaling approximately l) to
   repay third-party creditors.

   Amounts g, l, and m have not been finally determined and will be based on
   market conditions. If Foreign Controlled directly borrows any of the Debt Amount
   from third-party lenders, Foreign Controlled will use such funds to repay the
   Assumed Loan and will distribute any remaining amount to U.S. Controlled
   (which will distribute such funds to Distributing 2).

7. Distributing 2 will distribute all of the Class B Common Stock to Distributing 1 (the
   “Second Distribution”) and will retain the Class A Common Stock (the “Retention”
   of the “Retained Stock”).

8. Distributing 1 will distribute all of the Class B Common Stock to its shareholders
   on a pro rata basis (the “Third Distribution”; together with the First Distribution
   and the Second Distribution, the “Distributions”).
   PLR-126172-16 7

   Distributing 2 intends to use the Retained Stock to repay a portion of its existing
   

   third-party debt (the “Retention Business Purpose”). By reducing its debt load, the
   Distributing 1 Group expects to (i) achieve its stated leverage target, (ii) achieve a debt
   level comparable to that of its peer group, (iii) avoid the risk of a credit downgrade, and
   (iv) reduce its prospective borrowing costs.

   To this end, after the Second Distribution, one or more investment banks (the
   “Investment Banks”), acting as principals for their own account, will purchase a portion
   of the Distributing 2 third-party debt (each such purchase, a “Relevant Debt Purchase,”
   and such purchased debt, the “Relevant Debt”). No sooner than 5 days after a
   Relevant Debt Purchase, Distributing 2 will enter into an exchange agreement with the
   relevant Investment Bank (each such agreement, an “Exchange Agreement”). Pursuant
   to each Exchange Agreement, Distributing 2 will exchange Retained Stock with the
   Investment Bank for the Relevant Debt (a “Relevant Debt Exchange”). Each Relevant
   Debt Exchange will occur at least 14 days after the Relevant Debt Purchase, and the
   exchange ratio for each Relevant Debt Exchange will reflect arm’s-length terms based
   on the fair market value of the Relevant Debt and the Retained Stock as of the date of
   the exchange. It is expected that, immediately after receiving Retained Stock, the
   Investment Banks will sell the Retained Stock to unrelated third parties in public or
   private offerings.

   All Relevant Debt Exchanges will take place within 12 months after the Second
   Distribution (the “Debt Exchange Period”). In the event that market conditions and
   sound business judgment prevent Distributing 2 from disposing of any or all Retained
   Stock in the Relevant Debt Exchanges, Distributing 2 will dispose of any and all
   remaining Retained Stock as soon as the disposition is warranted, consistent with the
   Retention Business Purpose, but in no event later than 5 years after the Second
   Distribution (the “Remaining Dispositions”). Any proceeds from the Remaining
   Dispositions will be used to repay third-party debt.

   Following the Distributions, Distributing 2 and U.S. Controlled will operate as
   separate corporations, and no ongoing business relationship will exist between the
   Distributing 1 Group on the one hand and U.S. Controlled and its subsidiaries (the “U.S.
   Controlled Group”) on the other hand. However, Distributing 1 and U.S. Controlled will
   enter into a Separation and Distribution Agreement and certain other agreements,
   including a Tax Matters Agreement, that will govern certain rights and obligations of the
   parties after the Distributions. Under the Separation and Distribution Agreement,
   Distributing 1 will be required, following the Distributions, to cause Distributing 3 to
   transfer assets and liabilities to Foreign Controlled or its subsidiaries, and cause
   Distributing 2 to transfer assets and liabilities to U.S. Controlled or its subsidiaries, that
   could not be transferred before the Distributions due to legal, regulatory, or similar
   impediments (the “Delayed Asset Transfers”). Under the Tax Matters Agreement,
   Distributing 3 and Foreign Controlled may be required to make payments to one another
   with respect to certain items arising in taxable years beginning before the Distributions,
   PLR-126172-16 8

and Distributing 2 and Distributing 1 may be required to make payments to U.S.
Controlled, or vice versa, with respect to certain items arising in taxable years beginning
before the Distributions.

                                 Representations

  The taxpayer has made the following representations with respect to the

Proposed Transaction:

a) Distributing 2’s plan to retain the Retained Stock is motivated by the Retention
Business Purpose. The use of the Retained Stock to repay third-party debt is
expected to (i) meaningfully reduce the debt load of the Distributing 1 Group
consistent with its publicly stated goals, (ii) avoid a potential credit downgrade
following the Proposed Transaction, and (iii) reduce borrowing costs.

b) None of the officers or directors of Distributing 1 or Distributing 2 will serve as an
officer of U.S. Controlled. Distributing 1 expects Person A (an officer and director
of Distributing 1 and Distributing 2) and Person B (a director of Distributing 1) to
serve on the initial board of directors of U.S. Controlled. These 2 persons will
constitute a minority of each board of directors, and their presence on the initial
board of U.S. Controlled is intended to (i) reassure investors that U.S. Controlled
will continue to operate under the principles that govern Distributing 1, (ii) provide
a sense of continuity for the employees and customers of the U.S. Controlled
Group, (iii) help the Distributing 1 Group and the U.S. Controlled Group transition
into standalone operating entities, and (iv) give both groups access to the
experience base of the common directors. The overlap of directors is not
inconsistent with the Corporate Business Purposes. With the exception of
Person A and Person B, no officer or director of Distributing 1 or Distributing 2
will serve as a director of U.S. Controlled. Person A will stand for reelection for
the board of U.S. Controlled by its shareholders within n months following the
Third Distribution.

c) All Relevant Debt Exchanges will occur within 12 months after the Second
Distribution. If Distributing 2 continues to own any Retained Stock after the final
Relevant Debt Exchange, Distributing 2 will complete the Remaining Dispositions
as soon as such dispositions are warranted, consistent with the Retention
Business Purpose, but in no event later than 5 years after the Second
Distribution.

d) Distributing 2 will vote, or cause to be voted, the Retained Stock in proportion to
the votes cast by the other U.S. Controlled shareholders, and Distributing 2 may
grant a proxy to U.S. Controlled to effectuate such voting.

e) In no event will the Retention prevent Distributing 2 from distributing an amount
of U.S. Controlled stock that represents control under section 368(c).
PLR-126172-16 9

f) If all of the U.S. Controlled stock were distributed by Distributing 2 to Distributing
1 and by Distributing 1 to its public shareholders in the Second and Third
Distributions, none of the distributed stock would be treated as “other property”
under section 356.

g) No action will be taken (including the adoption of any plan or policy), at any time
before the earlier of (i) the date of the final Relevant Debt Exchange (“Date X”),
or (ii) the date that is 12 months after the date of the Second Distribution (“Date
Y”), by U.S. Controlled’s board of directors, its management, or any of its
controlling shareholders (as defined in § 1.355-7(h)(3)) that would (if
implemented) actually or effectively result in an unwind of the Dual Class
Structure. Distributing 2 may continue to hold Retained Stock after Date X.

h) U.S. Controlled will not engage in a transaction with one or more persons (for
example, a merger of U.S. Controlled with another corporation) that results in an
unwind of the Dual Class Structure within 24 months after the earlier of Date X or
Date Y, unless: (1) There is no agreement, understanding, arrangement, or
substantial negotiations (within the meaning of § 1.355-7(h)(1)) or discussions
(within the meaning of § 1.355-7(h)(6)) concerning the transaction or a similar
transaction (applying the principles of § 1.355-7(h)(12) and (13), relating to
similar acquisitions), at any time during the 24-month period ending on the earlier
of Date X or Date Y; and (2) No more than 20 percent of the interest in the other
party, in vote or value, is owned by the same persons that own more than 20
percent in vote or value of the stock of U.S. Controlled. For purposes of the
preceding sentence, ownership is determined by application of the constructive
ownership rules of section 318(a) as modified by section 304(c)(3), except that
for purposes of applying section 318(a)(3)(A) and (B), the principles of section
304(c)(3)(B)(ii) (without regard to section 304(c)(3)(B)(ii)(I)) apply. In the case of
a corporation the stock of which is listed on an established market (within the
meaning of § 1.355-7(h)(7)), the persons referred to in clause (2) of this
representation (h) are limited to controlling shareholders (within the meaning of
§ 1.355-7(h)(3)(i), taking into account § 1.355-7(h)(8) but without regard to
whether stock of a corporation is transferred) and ten-percent shareholders
(within the meaning of § 1.355-7(h)(14) but without regard to the second
sentence thereof or whether stock of a corporation is transferred). Other than
with respect to a transaction with one or more persons described in clauses (1)
and (2) of this representation (h), no action will be taken (including the adoption
of any plan or policy), at any time prior to 24 months after the earlier of Date X or
Date Y, by U.S. Controlled’s board of directors, its management, or any of its
controlling shareholders (as defined in § 1.355-7(h)(3)) that would (if
implemented) actually or effectively result in an unwind of the Dual Class
Structure.
PLR-126172-16 10

  i) None of the Distributing 2 debt to be exchanged for Retained Stock pursuant to
     the Relevant Debt Exchanges was issued in anticipation of the Proposed
     Transaction.

  j) Any Investment Bank acquiring Relevant Debt in connection with a Relevant
     Debt Exchange (i) will hold the Relevant Debt for at least 5 days before entering
     into an agreement with Distributing 2 to exchange the Relevant Debt for all or a
     portion of the Retained Stock, and (ii) will not complete the Relevant Debt
     Exchange until at least 14 days after the Investment Bank acquired the Relevant
     Debt to be exchanged in such Relevant Debt Exchange.

                                        Rulings

  Based solely on the information provided and the representations set forth

above, we rule as follows:

1. The Retention by Distributing 2 of the Retained Stock will not be in pursuance of
   a plan having as one of its principal purposes the avoidance of Federal income
   tax within the meaning of section 355(a)(1)(D)(ii) and Treas. Reg. § 1.355-2(e).

2. Provided that the Relevant Debt Exchanges occur within 12 months following the
   date of the Second Distribution, and provided that the Second Distribution
   otherwise would satisfy the requirements of section 355 if all Controlled stock
   had been distributed in the Second Distribution, the Retained Stock transferred in
   the Relevant Debt Exchanges will be treated as being distributed pursuant to the
   Second Distribution plan of reorganization for purposes of sections 361(c)(1) and
   361(c)(3).

3. Provided that the Relevant Debt Exchanges occur within 12 months following the
   date of the Second Distribution, the involvement of the Investment Banks in the
   Relevant Debt Exchanges will not preclude the application of section 361(c)(3) to
   the Relevant Debt Exchanges.

4. Any payments from Distributing 3 to Foreign Controlled (or vice versa) following
   the First Distribution, from Distributing 2 to U.S. Controlled (or vice versa)
   following the Second Distribution, or from Distributing 1 to U.S. Controlled (or
   vice versa) following the Third Distribution, that are made pursuant to the
   Separation and Distribution Agreement or the Tax Matters Agreement regarding
   liabilities, indemnities, or other obligations that (i) have arisen or will arise for a
   taxable period ending on or before the date of, or for a taxable period beginning
   before but ending after the date of, the First Distribution, the Second Distribution,
   or the Third Distribution, respectively, and (ii) will not have become fixed and
   ascertainable until after such Distribution, will be treated as occurring
   immediately before the date of such Distribution. See Arrowsmith v. Comm’r,
   344 U.S. 6 (1952); Rev. Rul. 83-73, 1983-1 C.B. 84.
   PLR-126172-16 11

5. Any Delayed Asset Transfer between Distributing 3 and Foreign Controlled will
   be treated as occurring on the same date as Contribution 1, and any Delayed
   Asset Transfer between Distributing 2 and U.S. Controlled will be treated as
   occurring on the same date as Contribution 2. See Treas. Reg. § 1.368-2(g);
   Rev. Rul. 83-73, 1983-1 C.B. 84.

                                   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.

                            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.

    In accordance with the Power of Attorney on file with this office, a copy of this
   

   letter is being sent to your authorized representatives.

                                 Sincerely,
   
                                 _Robert H. Wellen___________________
                                 Robert H. Wellen
                                 Associate Chief Counsel
                                 Office of Associate Chief Counsel (Corporate)
   

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