Tax-free rulings for a multi-step corporate reorganization and spin-off of a controlled subsidiary

Plain-English summary

A publicly traded parent corporation that files a consolidated return
with its subsidiaries planned to reorganize its corporate structure and
then spin off one subsidiary to its shareholders. The reorganization ran
through 18 steps: internal mergers, contributions, conversions between
corporations and LLCs, and a chain of four distributions that ended with
the parent handing out the stock of the controlled subsidiary to its
public shareholders pro rata. The parent asked the IRS to confirm the
tax consequences at each stage. The IRS issued 29 rulings, all favorable,
holding that the internal contribution-and-distribution qualifies as a
"Type D" reorganization under section 368(a)(1)(D), that the four
distributions are tax-free spin-offs under section 355, and that no gain
or loss is triggered for the distributing entities or the shareholders,
with the usual basis and holding-period carryover rules applying. The
IRS also ruled that a deferred intercompany gain sitting inside the
consolidated group would not be accelerated by the spin-off, and that a
cash distribution funded by new borrowing would be treated as a section
301 distribution. The ruling matters because a botched corporate
separation can generate large taxable gains at the corporate and
shareholder level; a favorable section 355 ruling gives the company
certainty that the separation stays tax-free.

Ruling snapshot

• Question: Do the proposed internal reorganization steps and the
  four distributions culminating in the spin-off of the controlled
  subsidiary qualify for tax-free treatment, and does the transaction
  accelerate a deferred intercompany gain?
• Outcome: Approved (29 rulings granted; several standard issues,
  such as business purpose and device, expressly not ruled on)
• Key authorities: IRC §§ 355, 368(a)(1)(D), 361, 357, 358, 361(c),
  355(c), 301, 312(h); Treas. Reg. §§ 1.1502-13, 1.358-2, 1.312-10

Full text (IRS public release)

Internal Revenue Service                                      Department of the Treasury
                                                              Washington, DC 20224

Number: 202236007                                             Third Party Communication: None
Release Date: 9/9/2022                                        Date of Communication: Not Applicable
Index Number: 355.00-00, 355.01-00,
              368.00-00, 368.04-00,                           Person To Contact:
              1502.00-00, 1502.13-00                          -------------------------------, ID No. -----------
                                                              Telephone Number:
--------------------                                          --------------------
----------------------------------------------                Refer Reply To:
------------------------------------------                    CC:CORP:2
-----------------------------                                 PLR-125408-21
-----------------------------------                           Date:
                                                              June 14, 2022

Legend

Distributing                    =     [redacted]

Controlled 1                    =     [redacted]

Controlled 2                    =     [redacted]

Sub 1                           =     [redacted]

Sub 2                           =     [redacted]

Sub 3                           =     [redacted]

Sub 4                           =     [redacted]

New Sub 4               =   [redacted]

LLC 1                   =   [redacted]

Exchange                =   [redacted]

Distributing Common     =   [redacted]
Stock

Business 1              =   [redacted]

Business 2              =   [redacted]

Property 1              =   [redacted]

Property 2              =   [redacted]

Controlled 1            =   [redacted]
Receivable

Distributing            =   [redacted]
Receivable

Continuing              =   [redacted]
Relationships

Transitional Services   =   [redacted]
Agreement

 Distributing Bonds        =   [redacted]

 Equity Awards             =   [redacted]

 a                         =   ------

 b                         =   --

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

 Year 1                    =   -------

 State A                   =   -------------

 State B                   =   ------------

 State C                   =   ---------------

 State D                   =   ------------------

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

This letter responds to the letter from your authorized representative dated December
14, 2021, as supplemented by subsequent information and documentation, submitted
on behalf of Distributing, requesting rulings on certain U.S. federal income tax
consequences under the Internal Revenue Code of 1986, as amended, of the proposed
transactions described below (collectively, the "Proposed Transaction"). The material
information submitted 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. While this office has not verified any of the material
submitted in support of the request for rulings, it is subject to verification on
examination.

This letter is issued pursuant to Rev. Proc. 2021-1, 2021-1 I.R.B. 1, and Rev. Proc.
2017-52, 2017-41 I.R.B. 283, regarding a Transactional Ruling for a Covered
Transaction. 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.

This office has made no determination regarding whether any of the Distributions (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 § 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
§ 355(e)(2)(A)(ii) and Treas. Reg. § 1.355-7).

Summary of Facts

Distributing is the common parent of an affiliated group of corporations that join in filing
a consolidated U.S. federal income tax return on a calendar year basis (the "Distributing
Group"). Each member of the Distributing Group uses the accrual method of
accounting. The outstanding capital stock of Distributing consists solely of Distributing
Common Stock, which is publicly traded on Exchange.

Distributing wholly owns LLC 1, which is disregarded as an entity separate from
Distributing for U.S. federal income tax purposes, and Controlled 1. Controlled 1 wholly
owns Sub 1 and New Sub 4. Sub 1 wholly owns Sub 2. Sub 2 wholly owns Sub 3. Sub 3
wholly owns Sub 4. New Sub 4 wholly owns Controlled 2. Controlled 1, Sub 1, Sub 2,
Sub 3, and Sub 4 each is a member of the Distributing Group. New Sub 4 and
Controlled 2 each is disregarded as an entity separate from its owner for U.S. federal
income tax purposes.

The separate affiliated group, within the meaning of § 355(b), of Distributing (the
"DSAG") is engaged in Business 1 through various subsidiaries other than Controlled 1
and its subsidiaries. LLC 1 is engaged in Business 1 in State B, State C, and State D
(such business, "Business 1a"). The separate affiliated group, within the meaning of
§ 355(b), of Controlled 1 is engaged in Business 2 through Sub 4 and various
subsidiaries of Sub 4.

Financial information has been submitted in accordance with Rev. Proc. 2017-52
indicating that Business 1, Business 1a, and Business 2 each has had gross receipts
and operating expenses representing the active conduct of a trade or business for each
of the past five years.

In Year 1, Sub 4 transferred Property 1 to Distributing in a transaction pursuant to which
Sub 4 recognized gain (the "Intercompany Gain"). The Intercompany Gain constitutes
an "intercompany item," within the meaning of Treas. Reg. § 1.1502-13(b)(2), and was,
and continues to be, deferred under Treas. Reg. § 1.1502-13(c).

Proposed Transaction

For what are represented to be valid business purposes, Distributing and its affiliates
propose to undertake the Proposed Transaction through the following steps (each a
"Step").

        1.     Pursuant to a consent solicitation that commenced on Date 1, Distributing
          solicited and received the consent of the holders of Distributing Bonds to
          eliminate or modify certain financial and non-financial covenants of such
          bonds to permit Distributing to distribute the stock of Controlled 1 pursuant to
          Distribution 4, as defined in Step 18 below, and made (and will make) certain
          payments to the holders who agreed to such amendments.

        2.     New Sub 4 will distribute all of the issued and outstanding membership
          interests of Controlled 2 to Controlled 1.

        3.     Sub 2 will merge upstream into Sub 1 pursuant to State A law, with Sub 1
          surviving (the "Sub 2 Liquidation").

        4.     Sub 1 will merge upstream into Controlled 1 pursuant to State A law, with
          Controlled 1 surviving (the "Sub 1 Liquidation," and, together with the Sub 2
          Liquidation, the "Liquidations").

        5.     Controlled 1 will contribute all of the issued and outstanding membership
          interests in New Sub 4 to Sub 3.

        6.     Sub 3 will transfer all of the issued and outstanding stock of Sub 4 to New
          Sub 4, and New Sub 4 will convert from a limited liability company to a
          corporation pursuant to State A law (together, "Contribution 1").

        7.     Sub 4 will convert, pursuant to State A law, to a limited liability company that
          is disregarded as an entity separate from New Sub 4 for U.S. federal income
          tax purposes (the "Conversion," and Sub 4 after the Conversion, "Sub 4
          LLC").

        8.     Controlled 1 will transfer all of the issued and outstanding membership
          interests in Controlled 2 to Sub 3, and Sub 3 will transfer all of the issued and
          outstanding membership interests in Controlled 2 to New Sub 4.

        9.     Sub 4 LLC will distribute Property 2 and the Controlled 1 Receivable to New
          Sub 4.

        10.    Controlled 1 will repay a portion of the Controlled 1 Receivable with the
          Distributing Receivable.

        11.    Distributing will transfer all of the issued and outstanding membership
          interests in LLC 1 to New Sub 4 in exchange for the Distributing Receivable
          and, to the extent the fair market value of LLC 1 exceeds the fair market value
          of the Distributing Receivable, a note payable of New Sub 4 (the "LLC 1
          Transfer").

        12.    New Sub 4 will transfer all of the issued and outstanding membership
          interests in Sub 4 LLC to Controlled 2, and Controlled 2 will convert from a
          limited liability company to a corporation pursuant to State A law (together,
          "Contribution 2").

        13.    New Sub 4 will distribute all of the issued and outstanding stock of Controlled
          2 to Sub 3 ("Distribution 1").

        14.    Sub 3 will distribute all of the issued and outstanding stock of Controlled 2 to
          Controlled 1 ("Distribution 2").

        15.    Controlled 1 will distribute all of the issued and outstanding stock of Sub 3 to
          Distributing ("Distribution 3").

        16.    Controlled 1 will enter into new revolving and term loan facilities with third-
          party lenders and will declare and pay a dividend of the proceeds thereof to
          Distributing in an amount not in excess of Distributing's basis in the stock of
          Controlled 1 (the "Controlled 1 Cash Distribution").

        17.    Controlled 1 will recapitalize its issued and outstanding common stock
          through a forward or reverse stock split or a common stock dividend into the
          number of shares of common stock necessary to effect Distribution 4, as
          defined in Step 18 below, as recommended by Distributing's financial
          advisors.

        18.    Distributing will distribute pro rata to its shareholders all of the issued and
          outstanding stock of Controlled 1 ("Distribution 4," and, collectively with
          Distribution 1, Distribution 2, and Distribution 3, the "Distributions").

In connection with Distribution 4, Equity Awards held by employees of Distributing who
become employees of Controlled 1 will be converted into equivalent awards relating to
stock of Controlled 1.

Representations

Except as set forth below, Distributing makes all of the representations in section 3 of
the Appendix to Revenue Procedure 2017-52 with respect to each Distribution.

        1.     Distributing does not make the following representations, which are
          inapplicable to the Distributions: Representations 7, 20, and 25.

        2.     Distributing makes the following representations only with respect to
          Distribution 1: Representations 17, 18, and 19.

        3.     Distributing makes the following representations with respect to Distribution 1,
          Distribution 2, and Distribution 3: Representations 13, 32, and 33.

        4.     Distributing makes the following modified representations with respect to
          Distribution 4:

          a. Representation 13: With respect to Distribution 4, Distributing has
             acquired approximately a percent of the stock of Controlled 1 over the
             past five years in transactions that were taxable in whole or in part;
             however, Controlled 1 has been a member of the DSAG at all times for at
             least five years.

          b. Representation 32: No intercorporate debt will exist between Distributing
             and Controlled 1 at the time of, or subsequent to, Distribution 4, except for
             payables and receivables arising in connection with the Continuing
             Relationships or in the ordinary course of business.

          c. Representation 33: Payments made in connection with all continuing
             transactions, if any, between Distributing and Controlled 1 after
             Distribution 4, will be for fair market value based on arm's length terms,
             other than payments for services under the Transitional Services
             Agreement, which may be provided at cost or cost-plus for a period of up
             to b years following Distribution 4.

        5.     Distributing makes the following modified representations with respect to each
          Distribution:

          a. Representation 24: Distributing, Controlled 1, Sub 3, and Sub 4 each
             uses, and Controlled 2 and New Sub 4 each will use, the accrual method
             of accounting.

          b. Representation 34: Distributing, Controlled 1, Controlled 2, Sub 3, and
             New Sub 4 will each pay its own expenses, if any, incurred in connection
             with the Proposed Transaction, except for legal and accounting expenses,
             appraisal fees, administrative costs of Controlled 1 (such as those
             incurred for printing and clerical work), security underwriting and
             registration fees and expenses, transfer taxes, and transfer agents' fees,
             in each instance only to the extent that they are solely and directly related
             to the Proposed Transaction, all of which will be paid by Distributing.

        6.     Distributing makes the following alternative representations:

          a. With respect to each Distribution: Representations 3(a), 11(a), 15(a),
             22(a), 31(a), and 41(a).

          b. With respect to Distribution 1, Distribution 2, and Distribution 3:
             Representation 8(a).

          c. With respect to Distribution 4: Representation 8(b).

Additional Representations

Distributing also makes the following additional representations:

        7.     There is no plan or intention for New Sub 4 or Controlled 2 to divest of any of
          the historic business assets of New Sub 4 before or after Distribution 1,
          except dispositions of assets in the ordinary course of business.

        8.     Each Liquidation will qualify for nonrecognition treatment to the applicable
          transferee and transferor under §§ 332 and 337, respectively.

        9.     The Controlled 1 Receivable and the Distributing Receivable each constitutes
          debt for U.S. federal income tax purposes.

Rulings

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

        1.     Distribution 4 will not accelerate the remaining Intercompany Gain under
          Treas. Reg. § 1.1502-13(d), and such gain will continue to be taken into
          account by the Distributing Group under Treas. Reg. § 1.1502-13(c).

        2.     Contribution 2 and Distribution 1, together, will constitute a reorganization
          within the meaning of § 368(a)(1)(D). New Sub 4 and Controlled 2 each will
          be a "party to a reorganization" within the meaning of § 368(b).

        3.     No gain or loss will be recognized by New Sub 4 on Contribution 2. Sections
          357(a) and 361(a), (b).

    4.    No gain or loss will be recognized by Controlled 2 on Contribution 2. Section
        1032(a).

    5.    Controlled 2's basis in each asset received in Contribution 2 will be the same
        as the basis of that asset in the hands of New Sub 4 immediately before its
        transfer, increased by the amount of gain, if any, recognized by New Sub 4
        pursuant to § 357(c) on the transfer. Section 362(b).

    6.    Controlled 2's holding period in each asset received in Contribution 2 will
        include the period during which New Sub 4 held the asset. Section 1223(2).

    7.    No gain or loss will be recognized by New Sub 4 on Distribution 1. Section
        361(c).

    8.    No gain or loss will be recognized by (and no amount will otherwise be
        included in the income of) Sub 3 on its receipt of the stock of Controlled 2 in
        Distribution 1. Section 355(a).

    9.    Sub 3's basis in its New Sub 4 common stock (as adjusted under Treas. Reg.
        § 1.358-1) will be allocated between the New Sub 4 common stock with
        respect to which Distribution 1 is made and the Controlled 2 common stock
        received in Distribution 1 with respect to the New Sub 4 common stock in
        proportion to their fair market values. Section 358(b) and (c); Treas. Reg.
        § 1.358-2.

    10.   Sub 3's holding period in the Controlled 2 common stock received in
        Distribution 1 will include the holding period of the New Sub 4 common stock
        with respect to which the distribution of the Controlled 2 common stock is
        made, provided that the New Sub 4 common stock is held as a capital asset
        on the date of Distribution 1. Section 1223(1).

    11.   Earnings and profits (if any) will be allocated between Controlled 2 and New
        Sub 4 in accordance with § 312(h) and Treas. Reg. §§ 1.312-10(a) and
        1.1502-33(e)(3).

    12.   No gain or loss will be recognized by Sub 3 on Distribution 2. Section 355(c).

    13.   No gain or loss will be recognized by (and no amount will otherwise be
        included in the income of) Controlled 1 on its receipt of the stock of Controlled
        2 in Distribution 2. Section 355(a).

    14.   Controlled 1's basis in its Sub 3 common stock (as adjusted under Treas.
        Reg. § 1.358-1) will be allocated between the Sub 3 common stock with
        respect to which Distribution 2 is made and the Controlled 2 common stock
        received in Distribution 2 with respect to the Sub 3 common stock in
        proportion to their fair market values. Section 358(b) and (c); Treas. Reg.
        § 1.358-2.

    15.   Controlled 1's holding period in the Controlled 2 common stock received in
        Distribution 2 will include the holding period of the Sub 3 common stock with
        respect to which the distribution of the Controlled 2 common stock is made,
        provided that the Sub 3 common stock is held as a capital asset on the date
        of Distribution 2. Section 1223(1).

    16.   Earnings and profits (if any) will be allocated between Controlled 2 and Sub 3
        in accordance with § 312(h) and Treas. Reg. §§ 1.312-10(b) and 1.1502-
        33(e)(3).

    17.   No gain or loss will be recognized by Controlled 1 on Distribution 3. Section
        355(c).

    18.   No gain or loss will be recognized by (and no amount will otherwise be
        included in the income of) Distributing on its receipt of the stock of Sub 3 in
        Distribution 3. Section 355(a).

    19.   Distributing's basis in its Controlled 1 common stock (as adjusted under
        Treas. Reg. § 1.358-1) will be allocated between the Controlled 1 common
        stock with respect to which Distribution 3 is made and the Sub 3 common
        stock received in Distribution 3 with respect to the Controlled 1 common stock
        in proportion to their fair market values. Section 358(b) and (c); Treas. Reg.
        § 1.358-2.

    20.   Distributing's holding period in the Sub 3 common stock received in
        Distribution 3 will include the holding period of the Controlled 1 common stock
        with respect to which the distribution of the Sub 3 common stock is made,
        provided that the Controlled 1 common stock is held as a capital asset on the
        date of Distribution 3. Section 1223(1).

    21.   Earnings and profits (if any) will be allocated between Sub 3 and Controlled 1
        in accordance with § 312(h) and Treas. Reg. §§ 1.312-10(b) and 1.1502-
        33(e)(3).

    22.   The Controlled 1 Cash Distribution will be treated, for U.S. federal income tax
        purposes, as a distribution of property under section 301, and will be treated
        as having been made immediately prior to Distribution 3.

    23.   No gain or loss will be recognized by Distributing on Distribution 4. Section
        355(c).

        24.    No gain or loss will be recognized by (and no amount will otherwise be
          included in the income of) Distributing's shareholders upon their receipt of
          Controlled 1 stock in Distribution 4. Section 355(a).

        25.    Each Distributing shareholder's basis in its Distributing Common Stock (as
          adjusted under Treas. Reg. § 1.358-1) will be allocated between the
          Distributing Common Stock with respect to which Distribution 4 is made and
          the Controlled 1 stock (or allocable portions thereof) received in Distribution 4
          with respect to such Distributing Common Stock in proportion to their fair
          market values. Section 358(b) and (c); Treas. Reg. § 1.358-2.

        26.    Each Distributing shareholder's holding period in the Controlled 1 common
          stock received in Distribution 4 will include the holding period of the
          Distributing Common Stock with respect to which the distribution of Controlled
          1 common stock is made, provided that the Distributing Common Stock is
          held as a capital asset on the date of Distribution 4. Section 1223(1).

        27.    Earnings and profits (if any) will be allocated between Distributing and
          Controlled 1 in accordance with § 312(h) and Treas. Reg. §§ 1.312-10(b) and
          1.1502-33(e)(3).

        28.    A Distributing shareholder that receives cash in lieu of a fractional share of
          Controlled 1 common stock will recognize gain or loss measured by the
          difference between the basis of the fractional share received and the amount
          of cash received. Section 1001. Any gain or loss will be treated as capital gain
          or loss, provided the fractional share of stock is held as a capital asset on the
          date of Distribution 4. Sections 1221 and 1222.

        29.    Except for purposes of § 355(g), any post-Distribution 4 payments made by
          Distributing or any of its affiliates to Controlled 1 or any of its affiliates, or vice
          versa, that (i) have arisen or will arise with respect to a taxable period ending
          on or before Distribution 4 or for a taxable period beginning on or before and
          ending after Distribution 4 and (ii) will not have become fixed and
          ascertainable until after Distribution 4 will be treated as occurring immediately
          before Distribution 4. See Arrowsmith v. Comm'r, 344 U.S. 6, 73 (1952); 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.

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representative.

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,

                                       _____________________________________
                                       Katherine H. Zhang
                                       Senior Counsel, Branch 5
                                       Office of Associate Chief Counsel (Corporate)

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