S CORPORATION MAY SPIN OFF BUSINESS TAX-FREE.
LTR 199940013
- Institutional AuthorsInternal Revenue Service
- Code Sections
- Subject Area/Tax Topics
- Index Termsreorganizations, controlled firm stockreorganizations, D
- Jurisdictions
- LanguageEnglish
- Tax Analysts Document NumberDoc 1999-32433 (9 original pages)
- Tax Analysts Electronic Citation1999 TNT 196-22
Index Number: 355.00-00
355.04-00
Release Date: 10/8/1999
Date: July 2, 1999
Refer Reply To: CC:DOM:CORP: 1-PLR-100393-99
LEGEND:
Re:
Distributing = * * *
State X = * * *
Shareholder A = * * *
Shareholder B = * * *
Shareholder C = * * *
Shareholder D = * * *
Shareholder E = * * *
Controlled = * * *
Main Business = * * *
n = * * *
Business 2 = * * *
Business 3 = * * *
Dear * * *
[1] This letter responds to your letter dated December 31, 1998, requesting rulings concerning the federal income tax consequences of proposed transactions. A somewhat similar plan approved in a private letter ruling over 10 years ago was never consummated. The information submitted for consideration is summarized below.
[2] Distributing, a State X corporation, is an S corporation that uses the accrual method of accounting and a calendar year. Distributing is engaged in three businesses, Main Business, Business 2, and Business 3. Distributing has outstanding voting Class A and nonvoting Class B common stock, almost all of which is held by Shareholders A and B (the "Controlling Shareholders") and their families. Shareholders A and B were actively engaged in the management and operation of Distributing's businesses for many years. They are now retired from active management but remain directors. At present, Main Business is managed by Shareholder C, Business 2 by Shareholder D, and Business D by Shareholder E. In addition, Shareholder C is the president of Distributing. Shareholders C, D, and E each hold under one percent of the Distributing stock, and each holds an interest in a phantom equity plan. Distributing has no securities outstanding.
[3] The shareholders of Distributing have entered into several agreements with regard to their stock. An Irrevocable Proxy provides that the Controlling Shareholders, though holding different amounts of stock, are each entitled to a nearly identical vote in Distributing. A new Disposition of Common Stock Agreement provides that upon the death of either Controlling Shareholder, the survivor is required to purchase the deceased's estate's Class A stock, and, on the death of the survivor, Distributing is required to purchase the Class A stock from the survivor's estate. Should either Controlling Shareholder desire to sell Class A stock, the stock first must be offered for sale to the other Controlling Shareholder, Distributing, and the managers of Distributing's three businesses, in that order.
[4] Shareholder D, who has significantly contributed to the success of Business 2 and who is uniquely experienced and essential to Business 2, is dissatisfied with the present corporate structure in which he has no significant shareholder vote and no presence on Distributing's Board of Directors. In addition, Shareholder D does not wish to be a shareholder in a subsidiary where Distributing would be the single dominant shareholder and Distributing's president would be involved in decisions regarding the subsidiary's business. Shareholder D's objectives are to currently have a significant shareholder vote in a stand-alone company and to eventually have the opportunity of controlling his own business. Shareholder D has indicated that, if these objectives are not met, he will seriously consider terminating his employment with Distributing. In order to retain Shareholder D as the manager of Business 2, it is planned to terminate Shareholder D's phantom equity plan and, instead, give Shareholder D the opportunity to acquire stock in a stand-alone company engaged in Business 2.
[5] The parties have already completed or intend to complete the following steps in the proposed transaction:
(I) Distributing recently recapitalized, issuing one share of
Class A stock and 99 shares of Class B stock to its
shareholders in exchange for each share of common stock held
by the shareholders.
(II) Distributing will form Controlled, which will have
outstanding voting Class A stock and nonvoting Class B
stock. The Controlled Class B stock will be identical in all
respects to the Controlled Class A stock, except for voting
rights. After the proposed transaction, Controlled will
elect to be an S Corporation. Controlled and its
shareholders will also enter into a Stock Disposition
Agreement similar to Distributing's Stock Disposition
Agreement described above.
(III) Distributing will transfer to Controlled its Business 2
assets and liabilities in exchange for Controlled Class A
and Class B stock. At this point, Distributing will hold all
the outstanding stock in Controlled.
(IV) Distributing will distribute all the Controlled stock to
Shareholders A and B and their families and Shareholder D.
In exchange, Shareholder D will surrender all his
Distributing stock. Shareholders A and B and their families
will receive Controlled stock without surrendering
Distributing stock. Other Distributing shareholders
(employees) will receive no stock in Controlled, but will
receive additional Distributing stock.
(V) Within 30 days of completing step (IV): Shareholder D, in
exchange for a 10-year $n promissory note, will buy from
Controlled an amount of stock constituting at least 10
percent of all the outstanding Controlled stock; and
Shareholder D will become a member of Controlled's three
member board of directors.
(VI) Shareholders C and E will buy additional shares of
Distributing stock.
(VII) In accordance with the Controlling Shareholders' long-
standing practice of charitable giving, Shareholders A and B
likely will donate some of their Distributing and Controlled
Class B stock to charities which stock then likely will be
gradually redeemed from the charities.
[6] Following step (V), the ownership of the Controlled Class A and B stock will be: Shareholder A family, 48.2 percent; Shareholder B family, 35.3 percent; and Shareholder D, 16.5 percent.
[7] Distributing has submitted financial and employee information that indicates that both Main Business and Business 2 had gross receipts and operating expenses representative of the active conduct of a trade or business for each of the past 5 years.
[8] The following representations have been made in connection with the proposed transaction:
(a) Distributing, Controlled, and each of the shareholders will
each pay their own expenses in the transaction.
(b) There is no plan or intention for any Distributing
shareholder to transfer any assets to Distributing,
Controlled, or any related corporation (except for the
shareholders' transfers of Distributing stock to
Distributing).
(c) With regard to each Distributing shareholder, the total fair
market value of all the Distributing stock and Controlled
stock held by such shareholder after step (IV)(before any
stock purchases) will be approximately equal to the fair
market value of the Distributing stock held by such
shareholder prior to such step.
(d) Any gifts by either Shareholder A or B of Class B stock in
Distributing and Controlled to charities will consist of
identical percentages of the outstanding Distributing and
Controlled stock.
(e) None of the consideration being received by any of
Distributing's shareholders in the proposed transaction is
being received by a shareholder as a creditor, employee, or
in any capacity other than that of a shareholder of
Distributing.
(f) The 5 years of financial information submitted on behalf of
Distributing's Main Business and Business 2 is
representative of the corporation's present operations, and
with regard to such corporation, there have been no
substantial operational changes since the date of the last
financial statements submitted.
(g) Following the step (IV) spin-off of Controlled stock,
Distributing will continue to be directly engaged in the
active conduct of Main Business independently and with
its own employees. Main Business will have been
actively conducted (within the meaning of section 1.355-
3(b)) by Distributing independently and with its own
employees at all times in the 5-year period prior to
the distribution of Controlled stock. For each of the past
5 years, Distributing's Main Business has employed
over 50 full-time employees and following the step (IV)
spin-off will continue to have a minimum of 50
full-time employees who will continue to conduct the
operational and managerial activities of Main Business.
(h) Following the step (IV) spin-off, Controlled will be
directly engaged in the active conduct of Business 2,
independently and with its own employees. Business 2 will
have been actively conducted (within the meaning of section
1.355-3(b)) by Distributing independently and with its own
employees throughout the 5-year period immediately preceding
the spin-off. For each of the past 5 years, Distributing's
Business 2 has employed over 50 full-time employees and,
following the proposed transaction, Controlled will have a
minimum of 50 full-time employees who will continue to
conduct the operational and managerial activities of
Business 2.
(i) The distribution of Controlled stock is being carded out for
the corporate business purpose of keeping Shareholder D as
the manager of Business 2. The distribution of Controlled
stock is motivated, in whole or substantial part, by this
corporate business purpose.
(j) There is no plan or intention for any Distributing
shareholder to sell, exchange, transfer by gift, have
redeemed, or otherwise dispose of any stock in either
Distributing or Controlled, except as described in steps
(I), (IV), and (VII) above.
(k) There is no plan or intention by either Distributing or
Controlled, directly or through any subsidiary corporation,
to purchase any of its outstanding stock in conjunction with
or after the transaction, except, possibly, for redemptions
of up to 4 percent annually of the stock held by charities.
(l) There is no plan or intention to liquidate either
Distributing or Controlled, to merge either corporation with
any other corporation, or to sell or otherwise dispose of
the assets of either corporation, except for: (i)
dispositions in the ordinary course of business; (ii)
transfers described in steps (III) and (IV) above; and (iii)
small redemptions of stock held by charities (annually, up
to 4 percent of the amount of stock held by the charity).
(m) The total adjusted basis and the fair market value of the
assets transferred to Controlled by Distributing will each
equal or exceed the sum of the liabilities assumed by
Controlled plus any liabilities to which the transferred
assets are subject.
(n) The liabilities of Distributing assumed by Controlled in the
transaction and the liabilities to which the transferred
assets are subject were incurred in the ordinary course of
business and are associated with the assets transferred.
(o) The property being transferred by Distributing to Controlled
will not be subject to any investment tax credit capture.
(p) No intercorporate debt will exist between Distributing and
Controlled at the time of the proposed transaction, or
subsequent thereto.
(q) It is not expected that there will be any transactions
between Distributing and Controlled after the proposed
transaction, except that Controlled probably will purchase
some raw materials from Distributing. All payments made in
connection with such purchases, or any other transactions
between Distributing and Controlled, will be for fair market
value based on terms and conditions arrived at by the
parties bargaining at arms length.
(r) No two parties to the step (III) transfer are investment
companies as defined in section 368(a)(2)(F)(iii) and (iv).
(s) The transaction will not constitute a disqualified
distribution within the meaning of section 355(d).
(t) The step (IV) spin-off is not part of a plan or series of
related transactions (within the meaning of section 355(e))
pursuant to which one or more persons will acquire directly
or indirectly stock possessing 50 percent or more of the
total combined voting power of all classes of stock in
either Distributing or Controlled, or stock possessing 50
percent or more of the total value of all classes of stock
in either Distributing or Controlled.
(u) Except for transfers to members of the same family as
defined in section 267(c)(4), and except for exchanges or
issuances of Distributing or Controlled stock in exchange
for or as a result of owning stock in Distributing or
Controlled pursuant to a section 355(e)(3)(A) transaction,
Shareholders A and B each have represented that neither he
nor any person related to him within the meaning of section
267(c)(4): (i) has any plan or intention to sell, give,
redeem, transfer, receive, or in any way change his holding
of stock in Distributing or Controlled; or ii has any plan
or intention to take any action that would result in any
other shareholder changing their holding of stock in
Distributing or Controlled. The sole exceptions to the prior
sentence are: (i) the possible transfers by Shareholders A
and/or B of nonvoting stock in Distributing and Controlled
to charities, with the total amount of stock transferred to
charities over the next 5 years not exceeding 10 percent,
for each such shareholder, of the outstanding stock of any
class in Distributing or Controlled; (ii) the step (V) sale
by Controlled to Shareholder D of Controlled stock, but for
each class of stock in an amount constituting no more than
16.5 percent of the Controlled stock outstanding after the
sale; (iii) the step (VI) sale by Distributing to each of
Shareholders C and E of Distributing stock, but for each
class of stock a total for both shareholders of no more than
10 percent of the Distributing stock outstanding after the
sale; and (iv) the possible redemption of stock held by
retiring employees in a total amount for the post-
transaction 5-year period of not more than 5 percent of any
class of Distributing or Controlled stock. In addition, no
more than 4 percent of the Distributing stock was redeemed
in the past 5 years. If the 4 percent of the stock
previously redeemed is aggregated with the other possible or
proposed changes in stock ownership noted in items (i)
through (iv) of the second preceding sentence, these changes
would not, by themselves, result in a 50 percent or greater
acquisition of the vote or the value in either Distributing
or Controlled.
[9] Based solely on the information submitted and the representations set forth above, we hold as follows:
(1) The transfer in step (III) by Distributing to Controlled of
Business 2 assets, in exchange for all the stock in
Controlled and the assumption by Controlled of liabilities
associated with the assets and business transferred followed
by the distribution in step (IV) of all the Controlled stock
to Distributing shareholders constitutes a reorganization
within the meaning of sections 368(a)(1)(D) and 355.
Distributing and Controlled are each a "party to a
reorganization" within the meaning of section 368(b).
(2) No gain or loss is recognized by Distributing on the
transfer of assets, subject to liabilities, to Controlled in
exchange for all the stock in Controlled and the assumption
of liabilities (sections 361(a) and 357(a)).
(3) No gain or loss is recognized by Controlled on its receipt
of assets in exchange for Controlled stock (section
1032(a)).
(4) Controlled's basis in the assets received from Distributing
equals the basis of such assets in the hands of Distributing
immediately prior to the transfer (section 362(b)).
(5) Controlled's holding period for assets received from
Distributing includes the period during which Distributing
held such assets (section 1223(2)).
(6) No gain or loss will be recognized to Distributing upon the
distribution to Shareholders A, B, members of their
families, and D of all the stock in Controlled (section
361(c)(1)).
(7) No gain or loss will be recognized to (and no amount will be
included in the income of) Shareholders A, B, members of
their families, and D upon the receipt of Controlled stock
(section 355(a)(1)).
(8) Shareholder D's basis in the Controlled stock received will
equal his basis in the Distributing stock surrendered in
exchange therefore (section 358(a)(1)).
(9) Shareholder A's, Shareholder B's, and members' of their
families total basis in the Controlled stock and the
Distributing stock held by each shareholder after the
distribution will be the same as the basis of the
Distributing stock held by such shareholder immediately
before the distribution. The total basis will be allocated
in proportion to the relative fair market values of the
Controlled stock and Distributing stock in accordance with
section 1.358-2(a)(2).
(10) The holding period of the Controlled stock received by the
shareholders will include the period during which the
shareholders held the Distributing stock exchanged therefor,
or the Distributing stock with regard to which the
Controlled stock is received, provided that the Distributing
stock is a capital asset in the hands of the shareholders on
the date step (IV) is consummated (section 1223(1)).
(11) As provided in section 312(h), proper allocation of earnings
and profits between Distributing and Controlled will be made
under section 1.312-10(a).
(12) As provided by section 1.1368-2(d)(3), the "accumulated
adjustments account" (as defined in section 1368(e)(1)) of
Distributing immediately prior to the step (IV) distribution
of the Controlled stock will be allocated between
Distributing and Controlled in a manner similar to the
manner in which the earnings and profits of Distributing are
allocated (see ruling (11) above).
[10] No opinion is expressed about the tax treatment of the proposed transaction under other provisions of the Code and regulations or about the tax treatment of any conditions existing at the time of, or effects resulting from, the transaction that are not specifically covered by the above rulings. In particular, no opinion is expressed about the tax treatment of: (i) the step (1) exchange of Distributing voting common stock for Distributing Class A voting common stock and Class B nonvoting common stock; (ii) the proposed termination of the phantom equity plan with regard to Shareholder D (or any other person); (iii) the proposed issuance by Distributing in step (IV) of additional shares of Distributing stock to those Distributing shareholders who do not receive any Controlled stock; (iv) the possible gifts of stock to charities by Shareholders A and B; and (v) the possible redemption by Distributing and/or Controlled of its stock from charities.
[11] In addition, no opinion is expressed as to whether the transfer of any trade name, trademark, know-how, or similar items from Distributing to Controlled constitutes the transfer of property (see Rev. Rul. 69-156, 1969-1 C.B. 101). Further, no opinion is expressed or implied regarding the validity of Distributing's S corporation election under section 1362(a) or the eligibility of Controlled under section 1361(b) to elect S corporation status.
[12] This ruling is directed only to the taxpayers who requested it. Section 6110(k)(3) of the Code provides that it may not be used or cited as precedent.
[13] It is important that a copy of this letter be attached to the federal income tax returns of the taxpayers involved for the taxable year in which the transactions covered by this letter are consummated.
Sincerely yours.
Assistant Chief Counsel
(Corporate)
By: Mark S. Jennings
Senior Technician Reviewer,
Branch 1
- Institutional AuthorsInternal Revenue Service
- Code Sections
- Subject Area/Tax Topics
- Index Termsreorganizations, controlled firm stockreorganizations, D
- Jurisdictions
- LanguageEnglish
- Tax Analysts Document NumberDoc 1999-32433 (9 original pages)
- Tax Analysts Electronic Citation1999 TNT 196-22
