IRS approves tax-free spin-off and domestic treatment of foreign controlled company

Plain-English summary

A publicly traded domestic corporation proposed separating one business from another through a pro rata distribution of a newly formed company incorporated abroad. The transaction included contributions of domestic and foreign subsidiaries to the new company, which the taxpayer intended to be treated as domestic for federal tax purposes. Based on the submitted facts and representations, the IRS ruled that the separation would qualify as a tax-free reorganization and distribution under IRC §§ 368(a)(1)(D) and 355. The IRS also ruled that the new company would be a surrogate foreign corporation with at least 80 percent continuity of ownership and would therefore be treated as a domestic corporation under § 7874(b). It further approved the specified nonrecognition, basis, holding-period, earnings-and-profits, and consolidated-group consequences.

Ruling snapshot

• Question: Would the proposed foreign-company spin-off qualify for tax-free treatment and cause the new foreign company to be treated as domestic under § 7874?
• Outcome: Approved
• Key authorities: IRC §§ 355, 361, 367, 368, 1504, and 7874; Treas. Reg. §§ 1.355-2, 1.7874-2, 1.7874-3, and 1.7874-6

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                                Washington, DC 20224

Number: 202107009                                               Third Party Communication: None
Release Date: 2/19/2021                                         Date of Communication: Not Applicable
Index Number: 355.01-00, 9411.10-00
                                                                Person To Contact:
----------------------------                                    -------------------, ID No. -----------------
--------------------------                                      Telephone Number:
------------------------------                                  --------------------
-------------                                                   Refer Reply To:
----------------------------------                              CC:CORP:B05
                                                                PLR-112406-20
                                                                Date:
                                                                November 23, 2020

Legend

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

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

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

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

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

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

FSub 1                                     = --------------------------
                                              ------------------------

FSub 2                                     = -------------------------------------

Foreign DE                                 = ---------------

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

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

Investor                           = ---------------------

Series A Stock                     = -------------------------------------------------------

Series B Stock                     = -------------------------------------------------------

State X                            = -------------

Country Y                          = --------

Country Z                          = -----------

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

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

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

c                                  = --

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

e                                  = ---

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

This letter responds to your letter dated May 22, 2020 requesting rulings on certain
federal income tax consequences of a series of transactions (the “Proposed
Transaction,” as defined below). The material information submitted in that request and
subsequent correspondence is summarized below.

This letter is issued pursuant to Rev. Proc. 2017-52, 2017-41 I.R.B. 283, regarding one
or more “Covered Transactions” under section 355 and section 368 of the Internal
Revenue Code (the “Code”). This letter also contains rulings under section 1504 and
section 7874 of the Code. This office expresses no opinion as to any issue not
specifically addressed by the rulings 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.

This office has made no determination regarding whether the Distribution (as defined
below): (i) satisfies the business purpose requirement of Treas. Reg. § 1.355-2(b); (ii) is
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) 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 the distributing corporation or the
controlled corporation, or any predecessor or successor of the distributing corporation
or the controlled corporation, within the meaning of Treas. Reg. § 1.355-8 (see section
355(e)(2)(A)(ii) and Treas. Reg. § 1.355-7).

                                    Summary of Facts

Distributing, a publicly traded, widely held, State X corporation, is the parent company of
a worldwide group of domestic and foreign affiliates (the “Distributing Group”).
Distributing and its domestic affiliates join in the filing of a consolidated U.S. federal
income tax return.

Distributing owns all of the stock of Sub 1, Sub 2, and Sub 3, all State X corporations
that are all treated as corporations for federal income tax purposes.

Distributing owns all of the stock of FSub 1, a Country Y entity treated as a corporation
for federal income tax purposes.

Distributing owns all of the stock of FSub 2, a Country Z entity treated as a corporation
for federal income tax purposes.

The Distributing Group is engaged in Business A and Business B. Business A is
conducted by various direct and indirect subsidiaries of Distributing, including Sub 3.
Business B is conducted by Sub 1, Sub 2, FSub 1, FSub 2, and certain other
Distributing direct and indirect subsidiaries.

                                  Proposed Transaction

For what are represented to be valid corporate business purposes, Distributing
proposes to separate Business A from Business B, such that following the separation
Distributing will conduct Business A and a newly formed entity (“Foreign Controlled,” as
defined below) will conduct Business B. For non-tax reasons, Foreign Controlled will be
incorporated in Country Y. For reasons including federal income tax reasons,
Distributing intends for Foreign Controlled to be treated as a domestic corporation for
federal income tax purposes.

Distributing proposes to effectuate the separation through the following transaction (the
“Proposed Transaction”). Some of the steps of the Proposed Transaction have already
been completed.

   (i)      On Date 1, Investor purchased Distributing Series A Stock for $a.

   (ii)     Distributing forms Foreign Controlled, an entity incorporated in Country Y that
            makes an initial election to be classified as a corporation for federal income
            tax purposes, by contributing cash or other property the amount or value of
            which equals $b to Foreign Controlled in exchange for all of the stock of
            Foreign Controlled (the “Foreign Controlled Formation”).

   (iii)    Distributing forms Foreign DE, a limited liability company under the laws of
            Country Y, and Foreign DE makes an initial election to be classified as a
            disregarded entity for federal income tax purposes.

   (iv)     Distributing transfers c percent of the stock of Sub 1 to Foreign DE in
            exchange for interests of Foreign DE.

   (v)      Sub 1 converts to a limited partnership under State X law (hereinafter, Sub 1
            is referred to as “New Sub 1”), and New Sub 1 makes an initial election to be
            classified as a corporation for federal income tax purposes. New Sub 1
            registers under Country Y law as a foreign partnership.

   (vi)     Distributing contributes 100 percent of the stock of Sub 2 to New Sub 1 in
            exchange for New Sub 1 stock of equal value (the “Sub 2 Contribution”).

   (vii)    Distributing contributes 100 percent of the stock of FSub 1 to New Sub 1 in
            exchange for stock of New Sub 1 of equal value (the “FSub 1 Contribution”).

   (viii)   In exchange for stock of Foreign Controlled, Distributing transfers 100 percent
            of the stock of FSub 2 to Foreign Controlled (the “FSub 2 Contribution”), and
            Distributing enters into a contractual obligation to transfer 100 percent of the
            stock of New Sub 1 and 100 percent of the interests of Foreign DE to Foreign
            Controlled immediately following the pro rata distribution of 100 percent of the
            stock of Foreign Controlled to the common shareholders of Distributing (the
            “Distributing Common Shareholders”) in the External Spin (defined below)
            (the contractual obligation, the “Sub 1 Contribution Obligation”).

   (ix)     Distributing distributes 100 percent of the stock of Foreign Controlled pro rata
            to the Distributing Common Shareholders (the “External Spin”).

   (x)      In satisfaction of the Sub 1 Contribution Obligation and for no additional
            consideration, Distributing transfers 100 percent of the stock of New Sub 1
            and 100 percent of the interests of Foreign DE to Foreign Controlled (the
            “Sub 1 Contribution”).

   (xi)     Following the External Spin, Investor purchases Distributing Series B Stock
            for $d.

                                       Representations

With respect to the Distribution, except as set forth below, Distributing has made all of
the representations in Section 3 of the Appendix to Rev. Proc. 2017-52.

Distributing has made the following alternative representations set forth in Section 3 of
the Appendix to Rev. Proc. 2017-52:

          Representations 3(a), 8(b), 11(a), 15(b), 22(a), 31(a), and 41(a).

Distributing has not made the following representations, which do not apply to the
Proposed Transaction:

          Representations 19, 20, 24, and 25.

Distributing has not made the following representations:

          Representation 44.

Distributing has made the following additional representations:

          Sub 1 is not in a title 11 or similar case (as defined in section 368(a)(3)) and its
liabilities do not exceed the value of its assets.

        For purposes of section 7874(a)(2)(B)(i), the Proposed Transaction does not
result in the direct or indirect acquisition by Foreign Controlled of substantially all of the
properties held directly or indirectly by Distributing.

        At all times relevant to the Proposed Transaction, Foreign DE will not hold any
properties other than (i) its stock of New Sub 1, and (ii) a de minimis amount of assets
to facilitate its organization or maintain its legal existence (the “De Minimis Foreign DE
Assets”).

       At all times relevant to the application of section 7874 to the Proposed
Transaction, after the completion of the Sub 2 Contribution and FSub 1 Contribution, the
value of the stock of New Sub 1 will represent at least e percent (which is at least 80
percent) of the aggregate value of the following: the stock of New Sub 1, the stock of
FSub 2, and the De Minimis Foreign DE Assets.

       For purposes of Treas. Reg. § 1.7874-3(b)(3), the group income derived in
Country Y will not be at least 25 percent of the total group income during the testing
period.

                                           Rulings

Based solely on the information submitted and representations made, we rule as follows
with respect to the Covered Transactions:

    1. For federal income tax purposes, Steps ii, vi, vii, viii, ix, and x of the Proposed
      Transaction will be treated as if:

          1(i). Distributing transfers 100 percent of the stock of Sub 2 to New Sub 1 in
          exchange for stock of New Sub 1 (pursuant to the Sub 2 Contribution);

          1(ii). Distributing transfers 100 percent of the stock of FSub 1 to New Sub 1 in
          exchange for stock of New Sub 1 (pursuant to the FSub 1 Contribution);

          1(iii). Distributing transfers 100 percent of the stock of FSub 2 and 100
          percent of the stock of New Sub 1 and the De Minimis Foreign DE Assets to
          Foreign Controlled in exchange for stock of Foreign Controlled (pursuant to
          the FSub 2 Contribution and the Sub 1 Contribution, respectively); and
          thereafter,

          1(iv). Distributing distributes 100 percent of the stock of Foreign Controlled
          pro rata to the Distributing Common Shareholders.

    2. The External Spin will qualify as a tax-free reorganization and distribution
      pursuant to sections 368(a)(1)(D) and 355. Foreign Controlled and Distributing
      will each be a “party to a reorganization” within the meaning of section 368(b).

    3. No gain or loss will be recognized by Distributing in each of the Foreign
      Controlled Formation, the FSub 2 Contribution, and the Sub 1 Contribution under
      sections 361(a) or 357.

    4. No gain or loss will be recognized by Foreign Controlled in each of the Foreign
      Controlled Formation, the FSub 2 Contribution, and the Sub 1 Contribution under
      section 1032(a).

    5. Foreign Controlled’s basis in each asset received in each of the Foreign
      Controlled Formation, the FSub 2 Contribution, and the Sub 1 Contribution will be
      the same as the basis of that asset in the hands of Distributing immediately
      before the Foreign Controlled Formation, the FSub 2 Contribution, and the Sub 1
      Contribution, respectively, under section 362(b).

    6. Foreign Controlled’s holding period in each asset received from Distributing in
      each of the Foreign Controlled Formation, the FSub 2 Contribution, and the Sub
      1 Contribution will include the period during which Distributing held that asset
      under section 1223(2).

    7. No gain or loss will be recognized by Distributing on the External Spin under
      section 361(c)(1).

    8. No gain or loss will be recognized by (and no amount will be included in income
      of) Distributing Common Shareholders upon receipt of Foreign Controlled stock
      in the External Spin under section 355(a).

    9. The aggregate basis of the Distributing stock and the Foreign Controlled stock in
      the hands of the Distributing Common Shareholders immediately after the
      External Spin will be the same as the aggregate basis of the Distributing stock
      held by the Distributing Common Shareholders immediately before the External
      Spin under section 358(a). Such basis will be allocated between the Distributing
      stock and the Foreign Controlled stock in proportion to the fair market value of
      each in accordance with Treas. Reg. § 1.358-2(a)(2) under section 358(b)(2) and
      (c).

    10. The holding period of the Foreign Controlled stock received by the Distributing
       Common Shareholders in the External Spin will include the holding period of the
       Distributing stock with respect to which the External Spin is made, provided that
       such Distributing stock is held as a capital asset on the date of the External Spin
       under section 1223(1).

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

Based solely on the information submitted and representations made, we rule as follows
with respect to section 7874 and section 1504 of the Code:

    12. The Proposed Transaction will result in a domestic entity acquisition (as defined
       in Treas. Reg. § 1.7874-12(a)(5)) with respect to which Foreign Controlled will be
       the foreign acquiring corporation (as defined in Treas. Reg. § 1.7874-12(a)(10)).

    13. With respect to the domestic entity acquisition, the ownership percentage
       described in section 7874(a)(2)(B)(ii) will be at least 80 (by vote or value),
       because:

          13(i). At least 80 percent (by vote or value) of the stock of Foreign Controlled
          treated as received by Distributing pursuant to the transfers described in
          Ruling 1(iii) will be described in section 7874(a)(2)(B)(ii) and will not cease to
          be so described as a result of the External Spin. Treas. Reg. §§ 1.7874-
          2(f)(1)(i), (2)(i) and 1.7874-5(a).

          13(ii). The stock of Foreign Controlled described in section 7874(a)(2)(B)(ii)
          will be transferred stock (as defined in Treas. Reg. § 1.7874-6(f)(2)), which
          will not be treated as held by members of the expanded affiliated group (as
          defined in Treas. Reg. § 1.7874-12(a)(7)) for purposes of applying section
          7874(c)(2)(A) and Treas. Reg. § 1.7874-1 and, as a result, will be included in
          the numerator and denominator of the ownership fraction (as defined in
          Treas. Reg. § 1.7874-12(a)(17)). Treas. Reg. § 1.7874-6(b).

    14. On the completion date (as defined in Treas. Reg. § 1.7874-12(a)(3)) with
       respect to the domestic entity acquisition, the expanded affiliated group will not
       be considered to have substantial business activities in Country Y when
       compared to the total business activities of the expanded affiliated group for
       purposes of section 7874(a)(2)(B)(iii). Treas. Reg. § 1.7874-3(b).

    15. Foreign Controlled will be treated as a surrogate foreign corporation (other than
       for purposes of section 7874(a)(2)(A)) and, pursuant to section 7874(b) (and
       notwithstanding section 7701(a)(4)), a domestic corporation for all purposes of
       the Code. Section 7874(a)(2)(B), (a)(3), and (b). Nothing in section 894 or
       7852(d), or in any other provision of law, will be construed as permitting an
       exemption, by reason of any treaty obligation of the United States, from Foreign
       Controlled being treated as a domestic corporation for all purposes of the Code
       pursuant to section 7874(b). Section 7874(f).

    16. Except for purposes of determining whether Foreign Controlled is treated as a
       surrogate foreign corporation, the conversion of Foreign Controlled to a domestic
       corporation by reason of section 7874(b) constitutes a reorganization described
       in section 368(a)(1)(F) that occurs immediately after the formation of Foreign
       Controlled. Treas. Reg. § 1.7874-2(j)(1).

    17. Section 367 does not apply to any transfer of property by Distributing to Foreign
       Controlled as part of the Proposed Transaction but does apply to the conversion
       of Foreign Controlled to a domestic corporation. Treas. Reg. § 1.7874-2(j)(3).

    18. Foreign Controlled will be treated as an includible corporation in Distributing’s
       affiliated group under section 1504 prior to the External Spin. As a result, New
       Sub 1 and Sub 2 will not cease to be includible corporations in Distributing’s
       affiliated group under section 1504 by reason of the transfers described in Ruling
       1(iii).

                                         Caveats

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax treatment of the proposed transactions under any provision of the Code or
regulations or the tax treatment of any condition existing at the time of, or effects
resulting from, the proposed transaction that is not specifically addressed by this letter.

                                          Procedural Statements

This ruling is directed only to the taxpayer requesting 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 representatives.

                                                        Sincerely,


                                                        _Douglas C. Bates______________
                                                        Douglas C. Bates
                                                        Chief, Branch 4
                                                        Office of Associate Chief Counsel (Corporate)

cc:

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