IRS Rules Parent Company's Separation of Two Businesses Is Tax Free

In Private Letter Ruling (“PLR”) 200843004, the Internal Revenue Service (“IRS”) determined that a publicly traded parent corporation may restructure its holdings to spin off one of its businesses in a series of tax-free transactions under sections 368(a)(1)(D) and 355 of the Internal Revenue Code (“IRC”). The IRS issued this non-precedential ruling on July 15, 2008.  The background of this PLR stated as follows.

As indicated in this PLR, Parent is the common parent of an affiliated group of corporations that file a consolidated Federal income tax return. Parent owns all of the stock of Corp 1 and Corp 2. Corp 1 owns the sole membership interest in LLC 1, a disregarded entity. Corp 1 (through LLC 1) and Corp 2 each own d% of LLC 2, an entity treated as a partnership for Federal income tax purposes. Corp 2 owns the sole membership interest in LLC 3, a disregarded entity. Corp 1 (through LLC 1) owns c%, and Corp 3 owns f%, of LLC 4, an entity treated as a partnership for Federal income tax purposes. Corp 3 is unrelated to Parent.

Distributing is a corporation engaged in Business X and Business Y. Distributing has outstanding three classes of common stock, Class A, Class B and Class C, of which only Class A is voting. Corp 1 (through LLC 1) owns all of the Class A stock and Corp 2 owns all of the Class B stock. LLC 2 owns b%, Corp 2 (through LLC 3) owns e%, and LLC 4 owns a%, of the Class C stock.

Controlled is a corporation created to effectuate the described transaction. Prior to the transaction described below, the authorized capital stock of Controlled will consist of the same number and classes of stock as Distributing.

The IRS found that Business X and Business Y each have had gross receipts and operating expenses representing the active conduct of a trade or business for each of the past five years.

Distributing desires to separate Business X and Business Y. The separation is proposed to be accomplished by the following steps:

(i) Distributing will transfer the assets comprising Business Y (including cash and cash equivalents for working capital) to Controlled in exchange for all of the Controlled stock and the assumption by Controlled of the liabilities associated with the transferred assets (“Contribution”). Controlled will not transfer any cash or any other property to Distributing as part of the Contribution.

(ii) Distributing will distribute all of the Controlled stock pro rata to the Distributing shareholders, with each shareholder receiving the same number of shares of a class of the stock in Controlled as such shareholder owns of the corresponding class of the stock in Distributing (“Distribution”).

Based on the foregoing representations of the taxpayer’s representative, the IRS made the following determination:

1. The Contribution, followed by the Distribution, will constitute a reorganization under § 368(a)(1)(D). Distributing and Controlled will each be “a party to a reorganization” within the meaning of § 368(b).

2. Distributing will not recognize any gain or loss on the Contribution (§§ 357(a) and 361(a), (b)).

3. Controlled will not recognize any gain or loss on the Contribution (§ 1032(a)).

4. Controlled’s basis in each asset received from Distributing in the Contribution will equal the basis of that asset in the hands of Distributing immediately before the Contribution (§ 362(b)).

5. Controlled’s holding period in each asset received from Distributing in the Contribution will include the period during which Distributing held that asset (§ 1223(2)).

6. Earnings and profits, if any, will be allocated between Distributing and Controlled in accordance with § 312(h) and §§ 1.312-10(a) and 1.1502-33.

7. Distributing will not recognize any gain or loss on the Distribution (§ 361(c)).

8. The shareholders of Distributing will not recognize any gain or loss (and will not otherwise include any amount in income) on the Distribution (§ 355(a)).

9. The aggregate tax basis of the Controlled stock and the Distributing stock in the hands of a shareholder of Distributing will be the same as the aggregate tax basis of the Distributing stock held by that shareholder immediately before the Distribution, allocated in the manner described in § 1.358-2 (§ 358(a)(1), (b) and (c) and § 1.358-1(a)).

10. A Distributing shareholder’s holding period in the Controlled stock received will include that shareholder’s holding period for the Distributing stock with respect to which the Distribution is made, provided that the Distributing stock is held as a capital asset on the date of the Distribution (§ 1223(1)).

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