Corporate Taxation Chapter Ten: Corporate Divisions Professors Wells

Presentation:

April 3, 2017

2

1.  Spinoff: pro rata; cf., §301 dividend.

Chapter 10 §355 & §368(a)(1)(D) Corporate Divisions p.457

D

S/Hs

C

Div B

Div A

Div A

D

S/Hs

C

Div B

Div A

3

Chapter 10 §355 & §368(a)(1)(D) Corporate Divisions p.458

D

S/H X

C

Div B

Div A

Div A

2.  Split-off: non-pro rata; cf., redemption - §302.

S/H Y

D

C

Div B

Div A

S/H Y

S/H X

4

Chapter 10 §355 & §368(a)(1)(D) Corporate Divisions p.458

D

S/Hs

C-1

Div B

Div A

Div A

3.  Split-up: distribute stock of 2+ corporations; cf., §331 liquidation.

C-2

Div B

D Liquidates

C-2

C-1

Div B

Div A

S/Hs

5

§355 Overview

1.  Early Evolution of §355 was focused on preventing the use of §355 to beat the shareholder dividend / ordinary income tax. Casebook pages 455-507 give us the statutory framework that developed with this thought first and foremost in mind.

2.  Since 1986, with the repeal of the General Utilities doctrine, §355 has become an important means to move assets out of the Distributing Corporation’s ownership without triggering corporate level tax. §355(d) and §355(e) evidence a relatively new goal for §355 created as a result of the 1986 tax law changes: prevent §355 from being used as a means to effectuate a sale of Distributing or Controlled in a manner that beats the corporate level tax.

6

Gregory v. Helvering, Disguised Dividend p.461

FACTS: Gregory owns 100% of United Mortgage. United Mortgage creates Averill, transfers Monitor shares to Averill, distributes Averill shares to Gregory. Gregory liquidates Averill liquidated with Monitor shares distributed to Gregory. Gregory sells Monitor stock. Held: Equivalent of a dividend distribution. No business or corporate level purpose. Only a distribution from the corporation.

United Mortgage

Gregory

Averill

1000 shs Monitor

Stock

Averill

Gregory Li

quid

ate

Buyer

1000 shs Monitor Stock

1000 shs Monitor

Stock

$133,333 Cash

7

Code §355 Requirements p.465

1)   Parent must control subsidiary before distribution (i.e., at least 80 percent). §355(a)(1)(A).

2)   Distributing must distribute all of Controlled’s stock or establish that no tax avoidance purpose. §355(a)(1)(D)(ii).

3)   Active Trade or Business. Both Distributing and Controlled must be engaged in an active trade or business. §355(b). Also, each trade or business must have been actively conducted during the five year period ending on the acquisition date and not acquired within the five year period. §355(b)(2)(C).

4)   Arrangement must not be principally a “device” for the distribution of earnings and profits of distributing corporation or a controlled corporation. §355(a)(1)(B).

5)   Judicial requirements must be satisfied: (a) business purpose, and (b) continuity of interest.

continued

8

Active Trade or Business Requirement p.468

Lockwood’s Estate: §355(a)(1)(C), (b) Spinoff of a corporation holding the Maine business – was separately incorporated for the spin-off.

Issue: Is the 5 year active business requirement met?

Tax Court: Said No.

Lockwood

Thorval & Margaret

Lockwood Maine

Maine Div

8th Circuit: Said “yes.” The 8th Circuit stated that it was okay to divide a single business into two corporations. The spin-off segment was part of the business that Lockwood had always performed. Not a newly acquired business.

9

Rev. Rul. 2003-38 p.474 Expansion to Internet

Facts: Dropdown of an internet business into a sub and the distribution of that sub stock within two years after organization.

Held: The internet site is (1) an expansion of current retail business and (2) not a new or different business.

D

S/Hs

C

Retail Shoes

Implication: Changes in a business are disregarded as long as such changes are of a character as to not constitute the acquisition of a new or different business. What makes this new activity the “same business?” Same shoes, same principle activities. Website sales

drew on pre-existing business experiences. Thus, the website is a “business expansion” of the historic business.

Internet Shoes

Year 10 Year 8

Year 1

10

Rev. Rul. 2007-42 p.476 Active Business through LLC?

FACTS: Corp. D owns minority interest in LLC engaged in office building leasing and management enterprise (for more than five years). Corp. D also holds stock in Corp. C which has an unrelated business – proposed to be distributed.

D

S/Hs

C

LLC

33% 20%

Code §355(a)(1)(C) and §355(b) require D & C to have been engaged in the active conduct of a trade or business for the prior five years. Can a partner be so engaged? IRS says “yes” if D owns 33 1/3 but “no” if D owns 20%.

11

Issues Concerning Business Requirement p.482

1)   Factual issue re continued conduct of two active businesses with a five year history.

2)   Vertical division of single integrated business is OK, e.g., based on geography.

3)   Functional/horizontal division – supply corp. research corp., may be OK.

4)   Expansion of trade or business OK – e.g., suburban store. 5)   Real estate? Are significant management services being

conducted?

12

New Section 355 Proposed Regulations (2016) p.482

Proposed Regulations announced policy concerns with a spin-off of a controlled subsidiary with a relatively small active trade. 1.  Minimum Active Trade or Business

Requirement: Each of distributing and controlled must have active trade or business assets > 5% of total assets.

2.  Per Se Devise Requirement. Two part test. Test #1: Either distributing or controlled has nonbusiness assets that comprise 66 2/3 or more of its total assets and Test #2 (i) C1 nonbusiness assets (66 2/3% to 80%; C2 nonbusiness assets < 30%); (ii) C1 nonbusiness assets 80% > x > 90%; C2 nonbusiness assets < 40%); and (iii) C1 nonbusiness assets > 90%; C2 nonbusiness assets < 50%

3.  Evidence of Device: At least 20% of either distributing’s or controlled’s assets are nonbusiness assets or the disparity in ratio

of nonbusiness assets is > 10 percentage points.

13

Problem 1(a) Active Trade or Business Requirement p.486

Lemon contributes assets and research of Boston division to Peach, Inc. & distribution of all Peach stock to Mr. Chips in redemption of his Lemon stock. Ms. Micro as sole shareholder of Lemon. This split-off satisfies the §355(b) active business requirement. Each entity is engaged in the active conduct of a computer business immediately after the distribution. Vertical division of an integrated business.

Lemon

Mr. Chips

Peach

San Jose Div

Boston Div

Ms. Micro

Mr. Chips Ms. Micro

Peach Lemon

Boston Div

San Jose Div

14

Problem 1(b) – Three Year Research Activity p.487

FACTS: Same as (a) except that the Boston branch was opened only three years ago. New activity in the same line of business actively conducted by the distributing corp. for 5 years pre-distribution period is not a separate trade or business. Reg. §1.355-3(b)(3)(ii). Similarity to the Lockwood case.

Lemon

Mr. Chips

Peach

San Jose Div

Boston Div

Ms. Micro

Mr. Chips Ms. Micro

Peach Lemon

Boston Div

San Jose Div

Opened 3 yrs ago

15

Problem 1(c) Taxable Acquisition p.487

FACTS: Same as (b) except Lemon acquired Peach three years ago for cash. Peach operates the Boston facility. See §355(b)(2)(C) regarding acquisition in a transaction where gain or loss recognized in whole or in part.

Lemon will contend that a single computer business conducted for more than five year period.

Yes: Prop. Reg. §1.355-3(b)(1)(ii). Acquisition of Peach is an expansion of Lemon’s active trade or business. See Prop. Reg. §1.355-3(d), Ex. 20.

Lemon

Mr. Chips

Peach San Jose Div

Boston Div

Ms. Micro

Mr. Chips Ms. Micro

Peach Lemon

Boston Div

San Jose Div

Purchased 3 yrs ago

16

Problem 1(d) Taxable Acquisition p.487

Similar to Problem 1(c), but Peach stock only acquired to enable control (§368(c)) but not “separate affiliated group” (SAG) status (under §1504(a)(2) – measured by voting power and value). E.g., failure to acquire 80% of total value of Peach stock. IRS position: Prop. Reg. §1.355-3(d), Example 21, specifies that §355(b)(3) not satisfied.

Lemon

Mr. Chips

Peach San Jose Div

Boston Div

Ms. Micro

Mr. Chips Ms. Micro

Peach Lemon

Boston Div

San Jose Div

Purchased 3 yrs ago

17

Problem 1(e) p.487 Divestiture Order

Horizontal/functional division of a single business. Reg. §1.355-3(b)(2)(ii) provides that a “trade or business” must consist of a specific group of activities carried on for purpose of earning income.

Regulations do not require that the activity must independently produce income, i.e., from outside sources. See Reg. §1.355-3(c), Ex. 9.

Functional divisions also must withstand scrutiny under the §355(a)(1)(B) “device” limitation (see later problem). Reg. §1.355-2(d)(2)(iv)(C).

Lemon

Mr. Chips

Research

San Jose Div

Research Div

Ms. Micro

Mr. Chips Ms. Micro

Research Lemon

Research Div

San Jose Div

18

Problem 1(f) p.487 New Business?

Three years ago Lemon purchased stock of Floppy Disk, Inc. (software co.) in a taxable transaction. Pursuant to a regulatory decree Lemon distributes Floppy Disk stock to its shareholders pro rata.

Floppy Disk failing to qualify as an active business – acquisition within 5 year period. Software and hardware are different, and therefore, not expanding an existing business. Rev. Rul. 2003-38 (p.515) not helpful here.

Lemon

Shareholders

Floppy Hardware Div

Shareholders

Floppy Lemon

Purchased 3 yrs ago

Hardware Div

19

Problem 1(g) p.487 Tax-free Acquisition

Floppy Disk merged into Lemon three years ago in an “A” reorganization for nonvoting preferred stock (80%) and S.T. Notes (20%) (i.e., “boot”). Transaction is not an expansion of the existing Lemon trade or business.

§355(b)(2)(C) permits the acquisition of business in a wholly tax-free transaction as meeting 5 year rule.

The use of boot means that gain is recognized in the transaction. Even though gain is recognized to the shareholders, not to Floppy Disk, the current regulations

suggests that this fails the 5-year rule.

Lemon

Shareholders

Floppy 2

Hardware Div

Software Div

Lemon

Floppy Merge

80% Stock 20% Boot

Shareholders

80% Stock 20% Boot

20

Problem 2(a) p.487 Rental Real Property

FACTS: DC transfers 10 story building to a Rentals and distributes Rentals stock pro rata to shareholders. DC leases the six floors that it occupies. Rental employees actively manage the building.

Issue: is the real estate activity an active “trade or business”?

DC

Shareholders

Rentals

Mfgr Div

Building

Properties

Net Leases

ANSWER: Real estate rentals is an active trade or business if significant management activities concerning the property.

21

Problem 2(b) p.488 Mostly Independent Rental

DC occupies only one floor and the remaining space is leased to unrelated tenants. Real estate rental activities will likely qualify as an active trade or business – premised upon Rental employees engaged in active management of the business. See Reg. §1.355-3(c), Example 12.

DC

Shareholders

Rentals

Mfgr Div

Building

Properties

Net Leases

22

Problem 2(c) p.488 Long-term Lease

FACTS: Same as (b) except that nine of the ten floors are rented to outsiders on a long term net lease. ISSUE: is Rental engaged in an active business? ANSWER: No. A long-term net lease arrangement is not an active trade or

DC

Shareholders

Rentals

Mfgr Div

Building

Properties

Net Leases

business. Rental probably is not performing any significant services concerning the operation and maintenance of the building and is not satisfying the active business test.

23

Problem 2(d) p.488 Distribution of Properties

FACTS: The stock of Properties, Inc. is distributed to the DC shareholders on a prorata basis. Assume the terms of the long-term net lease do not require Properties to engage in any significant activities other than the collection of rent. RESULT: This spin-off is unlikely to qualify because Properties, inc. is unlikely to have an active trade or business business even though the buildings are rented to outsiders.

DC

Shareholders

Rentals

Mfgr Div

Building

Properties

Net Leases

24

Judicial & Statutory Limitations p.488

Business Purpose See Reg. §1.355-2(b), including (b)(1), which indicates that the business purpose requirement is independent of other §355 requirements.

Examples: Resolution of shareholder disputes; reduction of state and local tax.

Can the objective be met through an alternative to a stock distribution? p.486. E.g., drop to sub?

“Fit and focus” analysis is applicable. p.491.

25

Judicial & Statutory Limitations p.491

Continuity of Interest Reg. §1.355-2(c). Old shareholders must own 50% of each corporation after the division of the several corporations. Limit on rearranged post-distribution sales arrangements. But, can have a division of ownership among old shareholders to enable the break-up of the enterprise. Continuity of interest must also be maintained after the distribution. Cf., acquisitive reorganizations requirement as modified.

26

Judicial & Statutory Limitations p.493

The “Device” Limitation Reg. §1.355-2(d). Code §355(a)(1)(B) provides that a corporate division is not to be “used principally as a device for the distribution of the earnings and profits” of the distributing corporation. Device factors (p.490): (1) prorata distribution; (2) subsequent stock sale (evidence of bailout?); (3) nature and use of the corporate assets after the division (e.g., excess cash transferred). Non-device factors (p.493): (1) corporate business purpose; (2) wide shareholding distribution; no Acc. E&P; distribution would be entitled to redemption under §302(a) or §303.

27

Problem (a) p.502 Two Equal Shareholders

Distribution of all the stock of Floppy to Mr. Chips in complete redemption of his Lemon stock. Resolution of a shareholder dispute is a recognized corporate business purpose. Reg. §1.355-2(b)(5), Example (2). Not a prorata distribution; finding of “device” is unlikely.

Lemon

Mr. Chips

Floppy

Mfgr Div Research

Div

Ms. Micro

28

Problem (b) p.502 Mother & Son as Shareholders

Result should be the same as in (a) above. A redemption would not qualify as a complete redemption without a waiver of family attribution under §302(c)(2). Reg. §1.355-2(d)(5)(iv) says ten year look forward rule in Code §302(c)(2)(A)(ii) and (iii) are not relevant in this context.

Lemon

Mr. Chips (son)

Floppy

Mfgr Div Research

Div

Ms. Micro (mother)

29

Problem (c) p.502 Pre-distribution Stock Sale

FACTS: Mr. Modem buys all Ms. Micro’s stock shortly before split-off.

RESULT: Mr. Modem is not a historic shareholder for “continuity of interest” purposes with the consequence that the continuity of interest requirement would not be satisfied.

Lemon

Mr. Chips

Floppy

Mfgr Div Research

Div

Mr. Modem

The historic shareholders must own at least 50% of both the distributing and the controlled corporations. Reg. §1.355(c)(2). Ex. 3. Lemon has no historic shareholders after the split-off of Floppy.

30

Problem (d) p.502 Different Retirement Plans?

FACTS: Transfer of research division to new corporation (Research, Inc.) and spin-off to enable companies to adopt two different retirement plans. Assuming a valid business purpose, no purpose for the stock distribution.

RESULT: This spin-off likely fails §355 due to an inadequate business purpose.

Lemon

Mr. Chips

Research

Mfgr Div Research

Div

Mr. Modem

Floppy

Need not have a distribution to achieve this objective. Could be achieved merely through separate subsidiaries. See Reg. §1.355-2(b)(5), Examples 3 & 4. If business purpose is flunked, never get to question of device.

31

Problem (e) p.502 Compliance with Decree

Same as (d) except that the purpose of the spin-off is to comply with a regulator decree. Business purpose is satisfied (see Problem 1(e) on p.483), but does this functional division past muster under the “device” test?

RESULT: Device factors include the prorata nature of the distribution. Critical inquiry is whether Research could be sold without adversely affecting the business of Lemon. See Reg. §1.355-2(d)(2)(iv)(C).

Lemon

Mr. Chips

Research

Mfgr Div Research

Div

Mr. Modem

Floppy

32

Problem (f) p.502 Subsequent Stock Sale

Issue: Do sales subsequent to the division constitute evidence of a device?

RESULT: The spin-off likely fails the “device” requirement. §355(a)(1)(B) indicates that the “mere fact” that sale or exchange occurs is not construed as a “device,” but Reg. §1.355-2(d)(2)(iii)(A) states that the sale of either distributing or controlled after the distribution is evidence of a device. Reg. §1.355-2(d)(2)(iii)(B) also provides that post-spin sell that was negotiated before the spin-off is “substantial evidence” of a device.

Lemon

Shareholders

Floppy

Mfgr Div Research

Div

Shareholders Suitor

Floppy

Cash

33

Problem (g) p.503 Rejected Deal & Delayed Sale

FACTS: Lemon rejects Suitor offer. Pro rata distribution of the Floppy stock. Subsequent sale to White Knight, Inc.

RESULT: Likely passes the “device” test. The sale to White Knight is not a prearranged sale and therefore protected by the §355(a)(1)(B) parenthetical. It is true that a subsequent sale is evidence of a device (see Reg. §1.355-2(d)(2)(iii)(C)), but the overall facts here re subsequent sale as evidence of a device.

Lemon

Shareholders

Floppy

Mfgr Div Research

Div

Shareholders White Knight

Floppy

Cash

34

Problem (h) p.503 Subsequent Shareholder Sale

FACTS: same as (g) except that the sale is made to Suitor. RESULT: If no understanding was reached, then there is not “substantial evidence of device,” but the fact that a sale was made represents “evidence” of a device. See Reg. §1.355-2(d)(iii)(A). Also, even if the “device” test were met, the sale may violate post-distribution continuity of interest.

Lemon

Shareholders

Floppy

Mfgr Div Research

Div

Shareholders Suitor

Floppy

Cash

35

Consequences to Distributing Corporation p.503

A corporate division may be preceded by a Type D reorganization – the formation of a corporation to facilitate the stock distribution.

Distributing corporation treatment: 1)   Distributing has no gain (or loss) on asset transfer to Controlled per §361(a) 2)   Distributing takes a substitute tax basis for the Controlled stock per §358(a) 3)   Distributing tacks its holding period for the new Controlled stock received per

§1223(1). Assume Unwanted is worth $3 million and zero basis and D wants to do a share buy-back like Rev. Rul. 99-58. §355 is significantly better (discuss CBS split-off of CBS Outdoor Americas 6/12/2014)

D

S/H X

C Unwanted

S/H Y

D

S/H X

C Unwanted

S/H Y

Buyer

$3 million

$1.95 million

$3 million

36

Consequences to the Shareholders p.504

Receipt of Controlled stock – no gain or loss to the shareholder per §355(a)(1).

The Shareholder’s old tax basis in Distributing is allocated between the Distributing and Controlled stock owned after the distribution based on the relative fair market values. See §358(b).

Shareholders have a tacked holding period for its Controlled stock.

Treatment of “boot” – does not invalidated the basic transaction as being tax-free but is taxable (see §356(a); §355(a)(3)); the tax status depends on distribution form.

1.  Prorata spin-off, then dividend. 2.  Split-off/Split-Up that §356(a)(1) requires realized gain to be

recognized to the extent of boot. 3.  Boot takes FMV basis per §358.

37

Rev. Rul. 93-62 p.507 Cash Boot as “Dividend”?

Code §356(a)(2) – treatment of cash boot as a dividend if having the effect of a dividend (i.e., to the extent of the ratable share of accumulated earnings and profits). Dividend equivalence test is applied by reference to §302 principles (i.e., a meaningful reduction of the shareholder’s proportionate interest). Cf., the Clark case in the reorganization – boot context.

D

A

C

Other S/Hs

D

C

A Other S/Hs

38

Consequences to Distributing & Controlled Corporation p.510

1)   If part of a “D” reorganization plan, then §361(c) controls for distributee: a)   No recognition on distribution to shareholders of “qualified

property” per §361(c)(1) & (2); i.e., no corporate level gain. b)  §311(b) is not applicable to a spinoff – since not a dividend. c)   §336 is not applicable to the equivalent of a liquidating

distribution when part of a tax-free reorganization. 2)   If no preliminary “D” reorganization, then §355(c) controls for

distributee: a)   §355(c) provides the distributing corporation recognizes no

gain or loss on the distribution of qualified property, i.e., stock or securities of the distributing corporation.

b)  Gain recognized, however, on distribution of other than “qualified property”, i.e., appreciated “boot”. §355(c)(2).

c)   Receipt of the distribution – no gain or loss - §355(a)(1).

39

Consequences to Distributing & Controlled Corp. Cont. p.511

Earnings and profits are allocated between the several corporations per §312(h) and Reg. §1.312-10(a) or (b). Other Section 381 carryover rules are not applicable (the tax history of the distributing corporation remains in tact).

40

Failed Divisions p.512

Tax consequences depend upon the form of the transaction: 1)   1st segment as a qualifying Section

351 organization if new Controlled is created.

2)   Distribution of Controlled stock causes any built-in gain to be recognized per §311(b)

3)   Shareholders are taxed on receipt of distribution. a.  Spin-off taxed §301 distribution b.  Split-off – tested under stock

redemption rules. c.   Split-up – examine under

complete liquidation rules.

D

S/H X

C Unwanted

S/H Y

$3 million

✔

ý

41

Problem p.513 Father’s Estate Planning

FACTS: Father as sole shareholder in Store Corp (Father’s Basis=$200x FMV=2,000). Store has $400,000 accumulated E&P. Suburb store represents 25 percent of total FMV. Proposal to organize Branch Corp for stock & debt & distribute Branch stock & debt to Father who gives Branch to children.

Store

A

Branch (FMV=400x) $100x boot

Branch

B=200x FMV=2,000x

RESULT: Estate planning may be valid business purpose. If a valid §355 spin-off, then: 1.  S has no gain or loss on transfer of assets to B. §361(a) 2.  S takes substitute basis in B stock and securities (§358(a)(1)). 3.  E&P attributable to B is 100x (25%) per §312(h). 4.  S recognizes no gain on distribution of B stock and securities (which are qualified property per

§361(c)(2)(B)) to A. See §361(c)(1) & (2). 5.  S has no issues under §355(d) since stock purchased 15 years ago. 6.  B recognizes no gain on issuance of its stock per §1032(a). 7.  B takes transferred basis in assets (per §362(b)) and a tacked holding period (per §1223(2)). 8.  F has 100x of boot per §355(a)(3)(A) / §356(d)(1) and takes a FMV basis in the boot per §358(a)(2). 9.  F allocates basis of 200x based on relative FMV of 400x and 1,500x. 10.  F has no gain on gift to children and they take carryover basis per §1015 and tacked holding

period per §1223(2).

42

§355 & Corporate Acquisitions p.513

Limitation on use of §355 in taxable acquisitions.

§355(b)(2)(D) – dispositions of recently acquired businesses.

Five year holding period applies to enable satisfying active trade or business requirements. Target recognizes gain on distribution of Sub stock to Purchaser – but DRD on distribution to corporate parent. Example (see p. 514) that §355(b)(2)(D) was designed to address:

T

S Unwanted

T Shareholders

Purchaser (“P”)

Cash

80% T stock

P

T

S Unwanted

43

§355 & Corporate Acquisitions (11/13/2014)

(Cash-Rich Split-offs) p.514 But, patient investors can overcome the time period

Berkshire Hathaway held P&G stock for more than 5 years and the P&G stock was substantially appreciated. P&G has a low basis in its Duracell stock. 1. P&G contributes $1.7 billion cash to Duracell subsidiary to

fatten it up. 2. P&G exchanges Duracell stock for P&G stock.

§355(b)(2)(D) five year holding period met. §355(g) inapplicable because Duracell is not an investment company

P&G

Berkshire Hathaway

P&G

Duracell Duracel

+ $1.7B

Berkshire Hathaway

44

Problem (a) Bust-Up Base Case p.516 Buyer Wants S. Purchaser Wants T.

FACTS: T sells S stock to buyer – gain on the stock sale. T shareholders sell T stock to P – gain to be recognized on this stock sale.

A §338 election by P is not likely.

T

T Shareholders

S

Buyer

S stock

Cash

Purchaser Cash

T stock

RESULT: 1.  Buyer and Purchaser both have FMV basis in their stock. 2.  T recognizes corporate level gain on sell of S stock. 3.  T shareholders recognize gain on sell of T stock.

45

Problem (b) p.516 Purchaser not Wanting Sub

2005: P purchases T stock from T shareholders. Shareholders have gain recognition.

2007: Distribution of Sub stock to purchaser and then Purchaser sells Sub stock to Buyer. Issue: Does this reordering allow P to avoid shareholder level gain on Sub stock?

RESULT: Failed §355 because P does not satisfy 5 year active business rule as to the S stock.

T

Shareholders

S

Purchaser Cash

T stock

T

Purchaser Buyer Cash

S stock

2005

2007 9 mos

S

46

Problem (c) p.516 Purchaser not Wanting Sub

Same as (b) except P is an individual. RESULT: §355(b)(2)(D) is not a barrier because P is not a corporate distributee. Assuming a valid business purpose, the subsequent sale of S stock raises a device problem that may be overcome. §355(d) in next section is now relevant to this technique.

T

Shareholders

S

Purchaser Cash

T stock

T

Purchaser Buyer Cash

S stock

2005

2007 9 mos

S

47

Problem (d) p.516 Purchaser not Wanting Sub

Same as (b) except P acquired T in a B reorganization. RESULT: §355(b)(2)(D) is not violated if T was acquired in a nonrecognition transaction. Abuse is less obvious here, however, as P is likely to have low-basis when it sells S stock.

T

Shareholders

S

Purchaser Stock

T stock

T

Purchaser Buyer Cash

S stock

2005

2007 9 mos

S

48

Problem (e) p.516 Purchaser not Wanting Sub

Same as (b) except P acquired 50% of the T stock from T Shareholders and B purchases 50% from T shareholders. 2 years later, T distributes S to B in exchange for all of B’s stock in T. RESULT: This is the transaction that potentially safely navigated §355(b)(2)(D) and was viewed as an inappropriate avoidance of the General Utilities repeal. Congress responded by enacting §355(d).

T

Shareholders

S

Cash

Purchaser 50% T stock

T

Purchaser Buyer

2011

2017

S

Buyer

S stock

T stock

49

Divisions in Change in Control p.516

§355(d) imposes corporate level tax (but not shareholder level tax) on a distribution if any person holds disqualified stock and such stock constitutes a 50% or greater interest in either distributing or controlled.

Disqualified stock includes any stock of Distributing or Controlled acquired by purchase during the five year period before the distribution. Purchase transaction occurs if basis is not a transferred basis or a §1014 date-of-death basis.

T

Shareholders

S

Cash

Purchaser 50% T stock

2005

Buyer T

Purchaser Buyers 2007

S stock

S

S stock

50

Anti-Morris Trust Technique p.521 And Progeny

D

S/Hs

C

Div A

Div A

A Reorg P

Morris Trust Transaction: Transfer of Unwanted Division A to C followed by Spin-off of C allowed D to retain only wanted business. D then merged into P in a tax-free transaction where D shareholders kept 50+% of combined entity shares.

Fourth Circuit held this was a valid transaction. Further, subsequent enactment of §355(d) could be safely navigated. Levered Morris Trust: Viacom, GM, and Disney Transactions. Same as above, but now D borrows cash to lever-up the controlled subsidiary.

51

§355(e) The Anti-Morris Trust Provision p.522

D

S/Hs

C

Div A

Div A

A Reorg P

§355(e) requires D to recognize gain as if it had sold C stock for its fair market value if the distribution of C was part of a plan for one or more persons to acquire a 50% or greater interest in D or C within 2 years before or after the distribution.

§355(e) does not apply if P was not in discussions with D within 6 months of C’s distribution.

Planning Point: Rev. Rul. 2005-65 announced spin-off before negotiations. B/E Aerospace press release (June 2014) announced its intention to separate its business into a manufacturing and separate service business.

52

Problem (a) p.524 Acquirer not Wanting Sub

Leisure

Shareholders

Motel

Apparel Div

Motel Div

Leisure

Apparel Div

C Reorg Denim

If integrated, the transaction fails as a C reorganization because “substantially all” of the assets were not transferred to Denim. If not integrated, then probably represents a device. Even if the above gauntlet were passed, §355(e) would be violated.

53

Problem (b) p.524 Acquirer not Wanting Sub

Same as (a) except that Leisure merges into Denim and receives Denim nonvoting preferred stock. RESULT: Effective before §355(e) but now Leisure is taxable on its distribution of the Motel stock as if Leisure had sold it for its FMV.

Leisure

Shareholders

Motel

Apparel Div

Motel Div

Leisure

Apparel Div

A Reorg Denim

54

Problem (c) p.524 Acquirer not Wanting Sub

Leisure

Shareholders

Cords

Motel Div

Apparel Div

Cords

Apparel Div

A Reorg Denim

FACTS: Leisure transfers apparel business to new Cords and distributes Cords. Cords then merges into Denim and receives Denim in exchange for Denim voting stock. RESULT: Cords distribution qualifies for §355 but unless historic Leisure shareholders own more than 50% of Denim then §355(e) applies to cause Leisure to be taxable on its distribution of the Cords stock.

55

Problem (d) p.525 Acquirer not Wanting Sub

Leisure

Shareholders

Cords

Motel Div

Apparel Div

Cords

Apparel Div

A Reorg Denim

FACTS: Same as (c) except that Leisure shareholders receive more than 50% of the Denim stock. RESULT: Tax-free to all concerned as §355(e) no longer applies.

56

Problem (e) p.525 Acquirer not Wanting Sub

FACTS: Same as (b) except that the merger of Leisure into Denim occurred one year after the spin-off. RESULT: §355(e) contains a rebuttable presumption that a plan exists. This is rebuttable if there were no negotiations with Denim within 2 years of the Motel Spin-off. Another means to rebut the presumption is if it can be shown the distribution occurred more than 6 months earlier and there was a corporate business purpose other than to facilitate the Denim acquisition.

Leisure

Shareholders

Motel

Apparel Div

Motel Div

Leisure

Apparel Div

A Reorg Denim

1 Year Later

57

Problem (f) p.525 Acquirer not Wanting Sub

Leisure

Shareholders

Motel

Apparel Div

Motel Div

Leisure

Apparel Div

A Reorg Denim

3 Year Later

FACTS: Same as (b) except that the merger of Leisure into Denim occurred three years after the spin-off and had a business purpose other than Leisure’s acquisition. RESULT: §355(e)’s rebuttable presumption should be able to be overcome in this fact pattern.

58

Recent Announcement: (1/9/2015) (MeadWestvaco Spin-Off of Specialty Chemicals Business)

MWV

MWV S/Hs

SpinCo

1.  MWV announces plan to contribute specialty chemical business to SpinCo with debt equal to SpinCo stock basis (levered contribution) and spins-off SpinCo. But MWV announces it is “open” to other options.

2.  Does Pre-Announced Spin-Off “Turn-Off” Section 355(e) as to the subsequent purchase even if prearranged before the spin-off is completed? See Rev. Rul. 2005-65.

Chemical Specialty Business +

Debt = SpinCo stock basis

Buyer

Merger S

100% MWV

Less than 50% of Buyer Stock MWV S/Hs

SpinCo

MWV S/Hs

MWV

SpinCo

59

Recent Transaction: (4/29/2014) (Comcast Divestiture to Charter After Time Warner Acquisition)

Com

Com S/Hs

SpinCo

1.  Comcast contributes unwanted historic Comcast customers to SpinCo with debt equal to SpinCo stock basis (levered contribution) and spins-off SpinCo.

2.  Charter Communications (CC) acquires 49.25% of SpinCo and agrees to 2 year stand-still. This is done to divest in a manner that avoids §355(e).

3.  Comcast will exchange 3 million COM customers in exchange for 1.6 million CC customers and cash.

2.5 million customers +

Debt = SpinCo stock basis

Com

CC

Merger S

49.25% or less of SpinCo stock

CC Stock

CC Stock Com S/Hs

Com

CC

Com S/Hs

< 49.25 > 50.75

CC

Com 1.6 million customers

+ Cash

3 million customers