Supplemental spin-off ruling treats a bank debt-for-equity exchange, with a price "true-up," as tax-free under section 361

Plain-English summary

A corporation ("Distributing") had already received a private letter ruling that a planned separation of a subsidiary ("Controlled") would be a tax-free spin-off under sections 355 and 368. This letter is a supplement to that earlier ruling. It addresses how Distributing will get rid of leftover Controlled shares it still holds after the split: it borrows from a bank, then hands the bank those Controlled shares to pay off (retire) the loan, a "debt-for-equity exchange." Because share prices move, the deal includes a "true-up payment" that adjusts the amount up or down based on Controlled's later trading price. The IRS ruled that a true-up paid by the bank to Distributing in the form of Distributing's own debt, if made within 365 days of the distribution, counts as part of the debt-for-equity exchange under section 361(c). It ruled the new facts do not disturb the earlier rulings (except one), and it modified prior Ruling 9 so that Distributing recognizes no gain or loss on the exchange, except for gain on a cash true-up payment (capped at the lesser of the cash received or the gain that would have been realized on a sale) plus certain premium, discount, and interest items on the debt. The upshot: a corporation can use borrowed cash and its own stock in a spun-off subsidiary to pay down debt without triggering corporate-level tax, even with a market-price adjustment mechanism built in.

Ruling snapshot

• Question: In an already-approved tax-free spin-off, will disposing of leftover subsidiary shares through a bank debt-for-equity exchange (with a true-up payment) still qualify for nonrecognition under section 361, without disturbing the prior rulings?
• Outcome: approved (supplemental rulings granted; prior Ruling 9 modified, all other prior rulings remain in effect)
• Key authorities: IRC §§ 355, 361(c), 368; Rev. Proc. 2017-52 (amplified and modified by Rev. Proc. 2018-53); Rev. Proc. 2022-1

Full text (IRS public release)

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Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202231004 Third Party Communication: None
Release Date: 8/5/2022 Date of Communication: Not Applicable
Index Number: 355.00-00, 355.01-00,
355.01-01, 368.00-00, Person To Contact:
368.04-00, 361.00-00, --------------------------, ID No. ----------------
361.02-00, 361.02-02 -----------------
Telephone Number:
------------------------------ --------------------
-------------------------- Refer Reply To:
------------------------------------------------------------ CC:CORP:1
---------------------------- PLR-105496-22
---------------------------- Date:
May 12, 2022

Legend

Distributing = -----------------------------------------------------------------------
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a = ------------------

Distributing Debt = -----------------------------------------------------------------------
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b = --

Controlled = -----------------------------------------------------------------------
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PLR-105496-22 2

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

This letter responds to your letter dated February 17, 2022, as supplemented by
subsequent information and documentation, requesting a supplemental private letter
ruling to the private letter ruling dated September 24, 2021 (PLR-108911-21) (the “Prior
Letter Ruling”) on certain federal income tax consequences of a series of transactions
(the “Proposed Transaction”). The material information submitted in that request and
subsequent correspondence is summarized below. Capitalized terms not defined in this
letter have the meanings assigned to them in the Prior Letter Ruling.
This letter is issued pursuant to section 3.05 of 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 a
supplemental ruling on one or more Covered Transactions under section 355 and section
368 of the Internal Revenue Code (the “Code”) and pursuant to section 6.03 of Rev. Proc.
2022-1, 2022-1 I.R.B. 1 regarding one or more significant issues under section 355 of the
Code that only address one or more discrete legal issues involved in the transaction.

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 an
appropriate party. This office has not verified any of the materials submitted in support
of the request for rulings. Verification of the information, representations, and other
data may be required on examination.
Supplemental Facts
The facts as described in the Prior Letter Ruling are unchanged, except as described
below.
Distributing may execute the Debt-for-Equity Exchange as follows:
1. Bank will make a loan to Distributing (the “Second Refinancing Debt”) in an
amount based upon the anticipated fair market value of the Remainder
Shares to be transferred (the “Transferred Shares”) with a maturity date of a.
The cash proceeds from the issuance of the Second Refinancing Debt will not
be segregated in a separate bank account or otherwise. Within 365 days
following the date of the Distribution, Distributing will use an amount equal to
the proceeds of the Second Refinancing Debt to pay principal, interest or
premium on the Distributing Debt.
2. At least 1 day after the issuance of the Second Refinancing Debt, Distributing
will enter into an exchange agreement with Bank (the “Debt-for-Equity
Exchange Agreement”) pursuant to which Distributing will transfer the
Transferred Shares to Bank in exchange for (and in retirement of) the Second
Refinancing Debt. The exchange ratio for such exchange will be fixed on the
PLR-105496-22 3

    date Distributing and Bank execute the Debt-for-Equity Exchange Agreement
    (subject to a True Up Payment defined in paragraph 4, below).
 3. Between 3 and 5 days after Distributing and Bank enter into the Debt-for-
    Equity Exchange Agreement and within 365 days of the date of the
    Distribution, Distributing will deliver the Transferred Shares to Bank in
    satisfaction of the Second Refinancing Debt.
 4. In connection with, and on the same date as, entering into the Debt-for-Equity
    Exchange Agreement, Distributing and Bank will enter into another
    agreement (the “True Up Agreement”) pursuant to which either Bank will
    make a payment to Distributing or Distributing will make a payment to Bank
    (each a “True Up Payment”). Any True Up Payment will be based on the
    difference between (i) the reference price as determined below (the
    “Reference Price”) and (ii) the NYSE closing price for a share of Controlled
    stock on the date on which Distributing and the Bank enter into the Debt-for-
    Equity Exchange Agreement. The Reference Price is the average daily
    volume weighted average price per share of Controlled shares beginning 1
    day after the transfer of the Transferred Shares to Bank (the “Effective Date”)
    through a valuation date determined as described below (the “Valuation
    Date”), increased by a premium of up to b percent.
       a.     Under the True Up Agreement, the period of time from the Effective
              Date through the Valuation Date for determining the Reference
              Price may vary within set boundaries, which establish the earliest
              and latest permissible Valuation Date. The latest permissible
              Valuation Date will be set such that in no event would any True Up
              Payment occur more than 365 days after the date of the
              Distribution.
       b.     Beginning with the earliest permissible Valuation Date until the
              latest permissible Valuation Date, Bank will have the right to
              designate an accelerated Valuation Date for some or all of the
              Transferred Shares subject to the True Up Agreement by delivering
              written notice to Distributing within 1 day of the accelerated
              Valuation Date.
       c.     Under the True Up Agreement, any True Up Payment will be made
              in cash, except that Distributing and Bank may agree that the
              payment from Bank to Distributing may be in the form of
              Distributing Debt. In order to effect this True Up Payment, Bank
              may purchase Distributing Debt from third parties.
       d.     Bank may designate sub-tranches of the Transferred Shares and
              set a different Valuation Date for each sub-tranche, but always

PLR-105496-22 4

                 within the confines of the minimum and maximum periods
                 established under the True Up Agreement.

Any Remainder Shares that are not disposed of pursuant to the Debt-for-Equity
Exchange will be disposed of in the manner provided for in the Prior Letter Ruling.
Representations
Distributing reaffirms all of the material information submitted in connection with, and all
the representations contained in, the Prior Letter Ruling, as modified and supplemented
by the representations and information herein.
Distributing has made the following modified representation pursuant to section 3.04 of
Rev. Proc. 2018-53:
1. Representation 3: Except as otherwise described herein, the holder of the
Distributing Debt that will be assumed or satisfied will not hold the debt for the
benefit of Distributing, Controlled, or any Related Person. Bank will not
acquire the Distributing Debt from Distributing, Controlled, or any Related
Person. Except as otherwise described herein, neither Distributing, nor
Controlled, nor any Related Person will participate in any profit gained by
Bank upon an exchange of the §361 Consideration; nor will any such profit be
limited by agreement or other arrangement. The value of the §361
Consideration received by Bank in satisfaction of the Distributing Debt will be
determined pursuant to arm’s length negotiations.

Distributing has made the following additional representations:
2. Distributing will recognize an amount of gain on any True Up Payment paid in
cash from Bank to Distributing equal to the lesser of (a) the amount of cash
received or (b) the amount of gain that would have been realized if the
Transferred Shares had been sold.
3. Distributing will treat any True Up Payment from Distributing to Bank as a
repayment of the Second Refinancing Debt.
Rulings
Based solely on the information submitted and the representations set forth above, we
rule as follows:
1. Any True Up Payment from Bank to Distributing in the form of Distributing Debt
paid within 365 days after the date of the Distribution will be treated as part of
the Debt-for-Equity Exchange. Section 361(c).
2. With the exception of Ruling 9 in the Prior Letter Ruling, the Supplemental
Facts will not adversely affect any of the rulings in the Prior Letter Ruling, and
those rulings remain in full force and effect.
PLR-105496-22 5

   3. Ruling 9 is modified as follows:
      Distributing will recognize no gain or loss, or deductions or items of income,
      on the Debt-for-Equity Exchange, other than (i) the amount of gain on any
      True Up Payment paid in cash from Bank to Distributing equal to the lesser of
      (a) the amount of cash received or (b) the amount of gain that would have
      been realized if the Transferred Shares had been sold, (ii) deductions
      attributable to the fact that the Distributing Debt may be redeemed at a
      premium, (iii) income attributable to the fact that the Distributing Debt may be
      redeemed at a discount, and (iv) interest expense accrued with respect to the
      Distributing Debt. Section 361(c).
                                      Caveats

No opinion is expressed or implied regarding the amount of gain that would have been
realized if the Transferred Shares had been sold for purposes of Ruling 3.
Except as expressly provided in this letter, no opinion is expressed or implied
concerning the tax treatment of the Proposed Transaction under any 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 is not specifically covered by the
above rulings.
Procedural Statements
This letter 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, copies of this letter are
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 returns that provides the date and control number (PLR-
105496-22) of this letter ruling.

                                   Sincerely,

                                   Kelly E. Madigan

                                   Kelly E. Madigan
                                   Senior Counsel, Branch 1
                                   Office of Associate Chief Counsel (Corporate)

cc:
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