Basis, retained-share, and debt-exchange rulings for a leveraged spin-off that splits one business from another

Plain-English summary

A corporate group wants to separate two lines of business (call them Business A and Business B) through a chain of steps: an internal split-off that moves a foreign subsidiary in exchange for surrendering shares, followed by an external distribution (a spin-off) of a controlled corporation to the parent's shareholders. To finance the split, the parent takes cash and securities from the controlled company and uses them, along with retained controlled shares, to pay off maturing notes through a set of "debt exchanges." The taxpayer asked the IRS to resolve three specific "significant issues" rather than bless the whole deal. The IRS ruled favorably on all three: the basis of the foreign stock received in the internal split-off carries over from the shares surrendered under § 358(a)(1); retaining some controlled shares (the "Retention") is not a plan with tax avoidance as a principal purpose under § 355(a)(1)(D)(ii); and the parent recognizes no gain or loss under § 361(b) and (c) when it receives the cash and securities and passes them to creditors to satisfy its debt. The IRS expressed no opinion on whether the overall transaction otherwise qualifies under § 355; the taxpayer represented that it does.

Ruling snapshot

• Question: In a leveraged split-off, what is the basis of stock received in the internal split-off, does retaining controlled shares have a principal purpose of tax avoidance, and does the parent recognize gain or loss when it uses the deal's cash and securities to pay off its debt?
• Outcome: Approved (favorable rulings on all three significant issues; no opinion on overall § 355 qualification)
• Key authorities: IRC §§ 358(a)(1), 355(a)(1)(D)(ii), 361(b), 361(c), 368(a)(1)(D); Treas. Reg. §§ 1.358-2(a)(2)(i), 1.355-2(e); Rev. Proc. 2018-53

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202218002 Third Party Communication: None
Release Date: 5/6/2022 Date of Communication: Not Applicable
Index Number: 355.00-00, 355.01-01,
355.05-00, 355.05-01, Person To Contact:

          358.00-00, 358.02-00                           ---------------------, ID No. -----------------
                                                         Telephone Number:

--------------------------------------- --------------------
---------------------------- Refer Reply To:
------------------------- CC:CORP:1
PLR-111605-21
---------------------------- Date:
------------------------------------ November 19, 2021

                                              Legend

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

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

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

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

Controlled = ----------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------
-------------------------

Controlled 1 = ----------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------
-------------------------
PLR-111605-21 2

Foreign = ----------------------------------------------------------------------------------------
Controlled 1 ----------------------------------------------------------------------------------------
-------------------------

Foreign = ----------------------------------------------------------------------------------------
Controlled 2 ----------------------------------------------------------------------------------------
-------------------------

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

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

Block A = ----------------------------------------------------------------------------------------
Shares ----------------------------------------------------------------------------------------
-------------------------------------------------------

Block B = ----------------------------------------------------------------------------------------
Shares ------------------------------------

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

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

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

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

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

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

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

d = ---

e = --

f = --

g = ---
PLR-111605-21 3

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

This letter responds to your authorized representatives’ letter dated May 25, 2021, as
supplemented by subsequent information and documentation (the “Ruling Request”),
requesting rulings on certain federal income tax consequences of the Proposed
Transaction (defined below). The material information submitted in the Ruling Request
is summarized below.

This letter is issued pursuant to Rev. Proc. 2017-52, 2017-41 I.R.B. 283, as amplified
and modified by Rev. Proc. 2018-53, 2018-43 I.R.B. 667, regarding one or more
“Covered Transactions” and one or more significant issues under section 355 and
section 368 of the Internal Revenue Code (the “Code”). This office expresses no
opinion as to the overall tax consequences of the Proposed Transaction or 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 materials submitted in support
of the Ruling Request. Verification of the information, representations, and other data
may be required as part of the audit process.

                                Summary of Facts

Distributing, a publicly traded corporation, is the parent of a worldwide group (the
“Distributing Group”) that is engaged in Business A and Business B. Distributing is the
common parent of an affiliated group of corporations that files a consolidated return for
federal income tax purposes. Distributing owns all of the outstanding stock of
Distributing 1. Distributing 1 owns all of the outstanding stock of Foreign Distributing 1,
a foreign entity that is classified as a corporation for federal income tax purposes. The
stock of Foreign Distributing 1 includes: (i) Block A Shares and (ii) Block B Shares.
Foreign Distributing 1 owns all of the outstanding stock of Foreign Distributing 2, a
foreign eligible entity classified as a corporation for federal income tax purposes.

Distributing has certain outstanding obligations, including (i) notes maturing on Date 1
with an aggregate principal amount of a (the “Date 1 Notes”) and (ii) notes maturing on
Date 2 with an aggregate principal amount of b (the “Date 2 Notes” and, collectively with
the Date 1 Notes, the “Debt Obligations”).

                               Proposed Transaction

For what are represented to be valid corporate business purposes (the “Corporate
Business Purpose” or “Corporate Business Purposes”), the Distributing Group proposes
to engage in the following transactions, some of which have already been
consummated, to separate Business A from Business B (the “Proposed Transaction”).

The Internal Restructuring
PLR-111605-21 4

1. Distributing will form Controlled. Controlled will have outstanding one class of
   common stock (the “Controlled Common Stock”). In connection with the
   Proposed Transaction, Controlled expects to issue debt obligations to third-party
   lenders and may issue debt obligations constituting “securities” for federal
   income tax purposes to Distributing (the “Controlled Securities”).

2. Distributing 1 will form Controlled 1, a domestic limited liability company, which
   will make an election to be classified as a corporation for federal income tax
   purposes. Controlled 1 will have outstanding one class of common stock (the
   “Controlled 1 Common Stock”).

3. Foreign Distributing 2 will form Foreign Controlled 1, a foreign entity, which will
   make an election, effective upon formation, to be classified as disregarded from
   its owner for federal income tax purposes (a “Disregarded Entity”). Foreign
   Controlled 1 will have outstanding one class of common stock (the “Foreign
   Controlled 1 Common Stock”).

4. Foreign Distributing 1 will form Foreign Controlled 2, a foreign eligible entity,
   which will make an election, effective upon formation, to be classified as a
   corporation for federal income tax purposes. Foreign Controlled 2 will have
   outstanding one class of common stock (the “Foreign Controlled 2 Common
   Stock”).

5. In a series of transactions, the assets and liabilities of Business A held by various
   entities within the Distributing Group will be separated from the assets and
   liabilities of Business B held by such entities.

6. Foreign Distributing 2 will contribute the Business A assets (which will consist in
   part of equity in foreign entities that are classified as corporations or Disregarded
   Entities for federal income tax purposes) to Foreign Controlled 1.

7. Foreign Controlled 1 will make an election to be classified as a corporation for
   federal income tax purposes.

8. Foreign Distributing 2 will distribute the Foreign Controlled 1 Common Stock to
   Foreign Distributing 1.

9. Foreign Distributing 1 will contribute the Foreign Controlled 1 Common Stock to
   Foreign Controlled 2 in exchange for Foreign Controlled 2 Common Stock (the
   “Internal Contribution”).

10. Foreign Distributing 1 will distribute the Foreign Controlled 2 Common Stock to
    Distributing 1 in exchange for a percentage of Block B Shares with a value equal
    to the fair market value of the Foreign Controlled 2 Common Stock (the “Internal
    Distribution” and, together with the Internal Contribution, the “Internal Split-Off”).
    PLR-111605-21 5

11. Distributing 1 will contribute the Foreign Controlled 2 Common Stock and other
    entities relevant to Business A to Controlled 1.

12. Distributing 1 will distribute the Controlled 1 Common Stock to Distributing.

The External Distribution

13. Distributing will contribute the Controlled 1 Common Stock to Controlled in
    exchange for: (a) Controlled Common Stock, (b) cash (the “Controlled Dividend”),
    and (c) in certain of the scenarios described below, Controlled Securities
    (clauses (a)-(c) together, the “Asset Contribution”). It is expected that the
    Controlled Dividend will be funded by the issuance of debt obligations to third-
    party lenders.

14. Distributing will distribute to the holders of Distributing common stock at least 80
    percent of the Controlled Common Stock (the “External Distribution”) and will
    retain any shares of Controlled Common Stock not distributed in the External
    Distribution (the “Retained Shares” and, together with the cash proceeds of the
    Controlled Dividend and any Controlled Securities, the “Exchange
    Consideration”).

15. In connection with the Asset Contribution and the External Distribution,
    Distributing expects to satisfy the Date 1 Notes and Date 2 Notes in transactions
    using in part the Exchange Consideration. Such transactions (the “Debt
    Exchanges”) are expected to be undertaken in the manner described below.

Controlled Dividend Proceeds and Controlled Securities

Distributing may use the cash proceeds from the Controlled Dividend and the Controlled
Securities (if issued) to satisfy the Date 1 Notes. However, due to the organizational
complexities required to separate Business A from Business B, it is currently uncertain
whether the External Distribution will occur on or before Date 3 (the day before Date 1).
Accordingly, depending on when the External Distribution occurs or whether Controlled
Securities are issued, Distributing expects to use the cash proceeds from the Controlled
Dividend and the Controlled Securities (if issued) by undertaking the transaction
described in one of the two following scenarios.

In the first scenario, if the External Distribution occurs on or before Date 3 and the cash
proceeds of the Controlled Dividend are not materially less than c, then on or before
Date 1 and no later than d days after the External Distribution, Distributing expects to
use the cash proceeds of the Controlled Dividend and cash on hand to redeem the Date
1 Notes. No Controlled Securities will be issued.
PLR-111605-21 6

If the External Distribution occurs on or before Date 3, but the cash proceeds of the
Controlled Dividend are materially less than c, then Distributing may undertake the
following transaction instead:

1. Controlled will issue Controlled Securities as part of the Exchange Consideration.

2. On or before Date 3, Distributing will issue new debt (the “New Q1 Debt 1”) to
   one or more financial institutions (collectively, the “Financial Institution”) for an amount
   of cash approximately equal to the face amount of the Controlled Securities.

3. On or before Date 1, Distributing will use the cash proceeds from the New Q1
   Debt 1, the cash proceeds from the Controlled Dividend, and cash on hand to redeem
   the Date 1 Notes.

4. At least e days following the issuance of the New Q1 Debt 1, Distributing will
   enter into an exchange agreement with the Financial Institution pursuant to which
   Distributing will transfer the Controlled Securities to the Financial Institution in exchange
   for (and in retirement of) the New Q1 Debt 1. The exchange ratio for such exchange
   will be fixed on the date the exchange agreement is entered into.

5. At least f days following the execution of the exchange agreement and in no
   event later than d days after the External Distribution, Distributing will transfer the
   Controlled Securities (and cash on hand, if necessary) to the Financial Institution in
   exchange for (and in retirement of) the New Q1 Debt 1.

In the second scenario, if the External Distribution occurs after Date 3 and the cash
proceeds of the Controlled Dividend are not expected to be materially less than c, then
Distributing expects to undertake the following transaction, in connection with which no
Controlled Securities will be issued:

1. On or before Date 3, Distributing will borrow via the issuance of new debt (the
   “Refinancing Debt A”) an amount of cash approximately equal to the expected cash
   proceeds of the Controlled Dividend.

2. On or before Date 1, Distributing will use the cash proceeds of the Refinancing
   Debt A and cash on hand to redeem the Date 1 Notes.

3. As soon as practicable and in no event later than d days after the External
   Distribution, Distributing will repay the Refinancing Debt A using the cash proceeds of
   the Controlled Dividend (and cash on hand, if necessary).

If the External Distribution occurs after Date 3 but the cash proceeds of the Controlled
Dividend are expected to be materially less than c, then Distributing may undertake the
following transaction instead:
PLR-111605-21 7

1. On or before Date 3, Distributing will issue new debt to the Financial Institution
   for an amount of cash approximately equal to the expected amount of the Controlled
   Dividend plus the face amount of the Controlled Securities. The new debt will have two
   components: (i) a portion of such debt approximately equal to the face amount of the
   Controlled Securities (“New Q1 Debt 2” and, together with the New Q1 Debt 1, the “New
   Q1 Debt”) and (ii) a portion of the new debt approximately equal to the expected cash
   proceeds of the Controlled Dividend (the “Refinancing Debt B” and, together with the
   Refinancing Debt A, the “Refinancing Debt”).

2. On or before Date 1, Distributing will use the cash proceeds from the New Q1
   Debt 2, the Refinancing Debt B, and cash on hand to redeem the Date 1 Notes.

3. Controlled will issue Controlled Securities as part of the Exchange Consideration.

4. At least e days following the issuance of New Q1 Debt 2, Distributing will enter
   into an exchange agreement with the Financial Institution pursuant to which Distributing
   will transfer the Controlled Securities to Financial Institution in exchange for (and in
   retirement of) the New Q1 Debt 2. The exchange ratio for such exchange will be fixed
   on the date the exchange agreement is entered into.

5. At least f days following execution of the exchange agreement and in no event
   later than d days after the External Distribution, Distributing will transfer (i) the
   Controlled Securities (and cash on hand, if necessary) to the Financial Institution in
   exchange for (and in retirement of) the New Q1 Debt 2 and (ii) the cash proceeds of the
   Controlled Dividend (and cash on hand, if necessary) to the Financial Institution in
   exchange for (and in retirement of) the Refinancing Debt B.

The Retention and Use of the Retained Shares

As noted above, Distributing expects to retain the Retained Shares and any Controlled
Securities (the “Retention”), which it generally will use to satisfy the Debt Obligations
and/or the Intermediate Debt (defined below). Distributing has determined that the
Retention furthers the Corporate Business Purpose of creating two independent capital
structures, in which Distributing continues to target leverage consistent with its
investment grade credit rating (the “Retention Purpose”).

Distributing expects to satisfy the Date 2 Notes using the Retained Shares. Distributing
expects to dispose of the Retained Shares by undertaking the following transactions:

1. On or before Date 4 (the day before Date 2), Distributing will issue new debt (the
   “New Q4 Debt” and, together with the New Q1 Debt and the Refinancing Debt, the
   “Intermediate Debt”) to the Financial Institution for an amount approximately equal to
   and not materially more than the expected value of the Retained Shares.
   PLR-111605-21 8

2. On or before Date 2, Distributing will use the cash proceeds from the New Q4
   Debt to repay a portion of the Date 2 Notes. Distributing may refinance the remaining
   portion of the Date 2 Notes or repay such portion with cash on hand.

3. At least e days after the issuance of the New Q4 Debt, Distributing will enter into
   an exchange agreement with the Financial Institution pursuant to which Distributing will
   transfer the Retained Shares (and cash on hand, if necessary) to Financial Institution in
   exchange for (and in retirement of) all of the New Q4 Debt. The exchange ratio for such
   exchange will be fixed on the date the exchange agreement is entered into.

4. At least f days following the execution of the exchange agreement and in no
   event later than g months after the External Distribution, Distributing will transfer the
   Retained Shares (and cash on hand, if necessary) to the Financial Institution in
   exchange for (and in retirement of) the New Q4 Debt (the “Stock-for-Debt Exchange”).
   If Distributing holds any Retained Shares following the Stock-for-Debt Exchange,
   Distributing expects to dispose of such Retained Shares as soon as disposition is
   warranted consistent with the Retention Purpose, but in no event later than e years after
   the External Distribution.

                                 Representations
   

Distributing has made the following representations with respect to the Proposed
Transaction.

The Internal Split-Off

Distributing has made the following representations with respect to the Internal Split-Off.

1. Other than with respect to the significant issues raised in the Ruling Request, the
   Internal Split-Off will satisfy the requirements of sections 355 and 368(a)(1)(D) as of the
   date of the Internal Split-Off and thereafter as relevant.

2. The fair market value of the Foreign Controlled 2 Common Stock to be received
   by Distributing 1 (which will surrender a percentage of the Block B Shares) will be
   approximately equal to the fair market value of the Foreign Distributing 1 stock
   surrendered by Distributing 1 in the Internal Split-Off.

3. As a foreign entity, Foreign Distributing 1 will not have an Excess Loss Account
   in the Foreign Controlled 2 Common Stock immediately before the Internal Split-Off.

4. The Internal Split-Off is not part of a plan (or series of related transactions)
   resulting in an acquisition described in section 7874(a)(2)(B)(i).

5. Distributing 1 will be a section 1248 shareholder, within the meaning of Treas.
   Reg. § 1.367(b)-2(b), with respect to each of Foreign Distributing 1 and Foreign
   Controlled 2 immediately before and after the Internal Split-Off.
   PLR-111605-21 9

6. Each of Foreign Distributing 1 and Foreign Controlled 2 will be a controlled
   foreign corporation, within the meaning of section 957(a), immediately bef ore and after
   the Internal Split-Off.

7. Neither Foreign Distributing 1 nor Foreign Controlled 2 will be a passive foreign
   investment company, within the meaning of section 1297(a), immediately before or after
   the Internal Split-Off.

8. Neither Foreign Distributing 1 nor Foreign Controlled 2 will hold any United
   States real property interests, as defined in section 897(c)(1), immediately before or
   after the Internal Split-Off.

9. The Internal Split-Off will not result in the transfer of stock of any corporation that
   has been the U.S. transferor, the transferee foreign corporation, or the transferred
   corporation, or successor thereto, with respect to any unexpired “gain recognition
   agreement” within the meaning of section 367(a) and the regulations promulgated
   thereunder, except for transfers for which there is a “triggering event exception” as
   defined under Treas. Reg. § 1.367(a)-8(k).

The Retention

Distributing has made the following representations with respect to the Retention.

10. The Retention will enable Distributing to satisfy the Retention Purpose.

11. The Retained Shares and any Controlled Securities will be disposed of as soon
    as disposition is warranted consistent with the Retention Purpose, but in no event later
    than e years after the External Distribution.

12. No one will serve as a director or officer of both Distributing (or any of its
    affiliates) and Controlled (or any of its affiliates), and any Controlled Securities will not
    provide the power to appoint any director or officer of Controlled (or any of its affiliates).

13. The Retained Shares will be voted in proportion to the votes cast by the other
    shareholders of Controlled, and the Controlled Securities will not have any voting rights.

14. In no event will the Retention prevent Distributing from distributing an amount of
    stock of Controlled that represents control under section 368(c).

15. No indebtedness owed by Controlled to Distributing after the External Distribution
    will constitute stock or securities of Controlled or any other entity, except any Controlled
    Securities.

16. The External Distribution is motivated, in whole or substantial part, by the
    Corporate Business Purposes.
    PLR-111605-21 10

17. Other than with respect to significant issues raised in the Ruling Request, the
    Asset Contribution and the External Distribution will satisfy the requirements of section
    355 and section 368(a)(1)(D) as of the date of the External Distribution and thereafter
    as relevant.

Rev. Proc. 2018-53

Except as discussed below, with respect to the Asset Contribution, External Distribution,
and Debt Exchanges, Distributing has made each applicable representation under
section 3.04 of Rev. Proc. 2018-53.

Distributing was unable to make the following standard representations; however,
Distributing has made the following modified representations.

18. Representation 4: Distributing incurred the Distributing Debt that will be assumed
    or satisfied (a)(i) before the request for any relevant ruling is submitted and (ii) no later
    than 60 days before the earliest of the following dates: (A) the date of the first public
    announcement (as defined in Treas. Reg. § 1.355-7(h)(10)) of the Divisive
    Reorganization or a similar transaction, (B) the date of the entry by Distributing into a
    binding agreement to engage in the Divisive Reorganization or a similar transaction,
    and (C) the date of approval of the Divisive Reorganization or a similar transaction by
    the board of directors of Distributing, or (b) on a date later than any such date described
    in clause (a) and the proceeds of such Distributing Debt were used to repay Distributing
    Debt incurred prior to the relevant date described in clause (a). The terms “Distributing
    Debt” and “Divisive Reorganization” each has the meaning given thereto in Rev. Proc.
    2018-53.

19. Representation 6: There are one or more substantial business reasons for any
    delay in satisfying Distributing Debt with § 361 Consideration beyond 30 days after the
    date of the first distribution of Controlled stock to Distributing’s shareholders. All the
    Distributing Debt that will be satisfied with § 361 Consideration will be satisfied no later
    than 180 days after such distribution, other than the New Q4 Debt, which will be
    satisfied no later than 365 days after such distribution. The term “§ 361 Consideration”
    has the meaning given thereto in Rev. Proc. 2018-53.

The External Distribution

Distributing has made the following additional representations with respect to the
External Distribution.

20. Distributing will not replace any Distributing Debt that will be assumed or satisfied
    with previously committed borrowing, other than borrowing in the ordinary course of
    business pursuant to a revolving credit agreement or similar arrangement.
    PLR-111605-21 11

21. Any other property issued or transferred by Controlled to Distributing in
    pursuance of the plan of reorganization will be transferred by Distributing to its
    shareholders in pursuance of the plan of reorganization or to its creditors in connection
    with the reorganization. For purposes of this representation, “other property” means
    property other than stock and securities of Controlled.

22. Any securities issued by Controlled to Distributing in pursuance of the plan of
    reorganization will be transferred by Distributing to its shareholders in pursuance of the
    plan of reorganization or to its creditors in connection with the reorganization.

23. Pursuant to Treas. Reg. § 1.1502-13(g)(3)(ii), no deemed satisfaction and
    reissuance will occur with respect to securities or other obligations of Controlled
    distributed by Distributing to its shareholders or creditors in pursuance of the plan of
    reorganization or in connection with the reorganization.

24. The total adjusted basis and the fair market value of assets transferred by
    Distributing to Controlled will each equal or exceed the sum of: (a) the total amount of
    the liabilities assumed (within the meaning of section 357(d)) by Controlled, and (b) the
    total amount of any money and the fair market value of other property, if any, received
    by Distributing and transferred to its shareholders and its creditors. As used herein,
    “liabilities” means any liability or other obligation without regard to whether it has been
    taken into account for federal income tax purposes.

                                      Rulings
    

Based solely on the information and representations submitted, we rule as follows
regarding the Proposed Transaction:

1. The basis in the Foreign Controlled 2 Common Stock received by Distributing 1
   in the Internal Split-Off will equal the basis of the Block B Shares surrendered therefor.
   Section 358(a)(1) and Treas. Reg. § 1.358-2(a)(2)(i).

2. The Retention 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).

3. No gain or loss will be recognized to Distributing under section 361(b) or section
   361(c) upon Distributing’s receipt of Exchange Consideration and its distribution of such
   Exchange Consideration in the Debt Exchanges in satisfaction of the Debt Obligations
   and Intermediate Debt.

                                     Caveat
   

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of the Proposed Transaction under any provision of the
Code and regulations or the tax treatment of any condition existing at the time of, or
PLR-111605-21 12

effects resulting from the Proposed Transaction that is not specifically addressed by the
above rulings.

                                Procedural Matters

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 representatives.

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,


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

cc: