IRS rules that gaps in revenue do not stop a research business from being an "active trade or business" for a spin-off

Plain-English summary

A publicly traded company in a highly regulated industry does research and development on two separate product lines. It wanted to split the newer product line into a separate company and give that company's stock to its shareholders in a tax-free spin-off under Internal Revenue Code §§ 355 and 368(a)(1)(D). One requirement for a tax-free spin-off is that both the company keeping a business and the new company must be engaged in an "active trade or business" that has been conducted for at least five years. The wrinkle here is that the business the parent keeps did not collect product revenue in every one of the past five years (its products must clear a long government-approval process before they can be sold), even though it had substantial ongoing operations, employees, expenses, and some revenue. The company asked the IRS to confirm that those revenue gaps do not disqualify the business. The IRS ruled that the absence of income in certain years does not prevent the retained business from being a "trade or business" under Treasury Regulation § 1.355-3(b)(2)(ii) for the active-trade-or-business test. This is a narrow "significant issue" ruling: the IRS addressed only that one question and expressed no view on whether the overall spin-off qualifies.

Ruling snapshot

• Question: Does a lack of collected income in some years prevent a business with continuing operations from being an "active trade or business" for purposes of the § 355 spin-off requirement?
• Outcome: approved (the absence of income in certain years does not prevent the business from constituting a trade or business under Treas. Reg. § 1.355-3(b)(2)(ii))
• Key authorities: IRC §§ 355(b), 368(a)(1)(D); Treas. Reg. § 1.355-3(b)(2)(ii); Rev. Proc. 2021-1

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202150004 Third Party Communication: None
Release Date: 12/17/2021 Date of Communication: Not Applicable
Index Number: 355.03-01
Person To Contact:
--------------------- ------------------------, ID No. -----------------
------------- Telephone Number:
---------------------- --------------------
------------------ Refer Reply To:
---------------------------------- CC:CORP:3
PLR-106680-21
Date:
September 17, 2021

Legend

Distributing = ------------------------------------------------------------------
------------------------------------------------------------------
-----------------------
State A = -------------
Business A = ---------------------------------------------
Business B = -------------------------
Year A = -------
Year B = -------
Stage A = ------------------------------------------------------------------
------------------------------------------
Stage B = --------------------------------

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

This letter responds to your March 3, 2021 letter requesting a ruling on certain federal
income tax consequences of a series of transactions (the "Proposed Transaction" as
described below). The material information submitted in that request and subsequent
correspondence is summarized below.

The ruling contained in this letter is based upon information and a representation
submitted by the taxpayer and accompanied by a penalty of perjury statement executed
by an appropriate party. While this office has not verified any of the material submitted
in support of the request for the ruling, it is subject to verification on examination.

This letter is issued pursuant to § 6.03(2)(b) of Rev. Proc. 2021-1, 2021-1 I.R.B. 1, 19,
regarding a significant issue under section 355 of the Internal Revenue Code. The ruling
contained in this letter only addresses one significant issue involved in the Proposed
Transaction. This office expresses no opinion in this letter as to the overall tax
consequences of the Proposed Transaction or as to any issue not specifically
addressed by the ruling below.

                                        Facts

Distributing is a publicly traded State A corporation. From its incorporation in Year A
(more than five years ago), Distributing has engaged in research and development in
Business A. Later, in Year B (more than five years ago), Distributing began research
and development in Business B. In order to improve management focus, capital
allocation, and employee recruitment and retention, Distributing intends to separate
Business A from Business B.

Business A and Business B involve separate product lines in the same highly regulated
industry. Before these products may be marketed or sold to the public, they must go
through a series of steps in order to receive government approval. Because Business A
has been operated longer, its products are further along in this process and are
generally at Stage A. Business B's products are at an earlier stage of development and
are generally at Stage B (an earlier stage than Stage A).

For more than five years, each of Business A and Business B has had substantial,
continuing operational expenses and each business's employees have engaged in
regular, continuing operational and managerial activities. Each of Business A and
Business B has produced product revenue, entered into revenue-generating
arrangements with third parties, and has held itself out as available to enter into such
arrangements. Business A has had revenue in three of the past five years, while
Business B has had revenue in all five of the past five years. In each year, each
business's expenses have substantially exceeded its revenue.

                              Proposed Transaction

For what are represented to be valid corporate business purposes, Distributing
proposes to engage in the following transaction to separate Business A from Business
B (the "Proposed Transaction"):

1. Distributing will form a domestic corporation ("Controlled") and contribute
   Business B to Controlled in exchange for all of the stock of Controlled and the
   assumption by Controlled of all of Business B's liabilities (the "Contribution").
2. Distributing will distribute all of the stock of Controlled pro rata to Distributing's
   shareholders (the "Distribution").

Following the Distribution, Distributing will continue to conduct Business A, and
Controlled will conduct Business B.

                                  Representation

Distributing makes the following representation with respect to the Proposed
Transaction:

Other than the absence of income collection in certain years, Distributing and Controlled
each satisfy the active trade or business requirement of Section 355(b) and the
Contribution and the Distribution will qualify as a transaction described in Section
368(a)(1)(D) and Section 355

                                      Ruling

Based solely on the facts and information submitted and the representation made, we
rule as follows:

The absence of income collection in certain years does not prevent Distributing's
Business A from constituting a "trade or business" within the meaning of Treas. Reg.
§ 1.355-3(b)(2)(ii) for purposes of determining whether the Distribution satisfies the
active trade or business requirement of section 355.

                                     Caveats

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax treatment of the Proposed Transaction under other provisions 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 covered by the above
ruling.

                            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 federal information and 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, copies of this letter are
being sent to your authorized representatives.

                                   Sincerely,



                                   Richard K. Passales
                                   Senior Counsel, Branch 4
                                   Office of Associate Chief Counsel (Corporate)

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