Businesses requesting letter rulings on spinoff transactions should be wary of evidence that could implicate the device prohibition rules even though the IRS won’t rule on factual issues.
The IRS generally doesn’t weigh the factors in taxpayers’ transactions and conclude whether the carveout of a business violates the prohibition on distributions being used principally as a device for distributing earnings and profits to shareholders, said Mark Weiss of the IRS Office of Associate Chief Counsel (Corporate). He spoke during a June 30 webinar hosted by the District of Columbia Bar Taxation Community.
But if the IRS observes “a strong device flavor, we will ask questions [and] . . . have discretion if something looks particularly bad,” Weiss said, adding that if that’s the case, other aspects of the ruling could be affected.
Weiss warned that in those situations taxpayers should expect fervent discussions on the device aspects while the IRS works through the submissions.
Under section 355, a corporation may generally distribute the stock of a controlled corporation to its shareholders without recognizing gain or loss if requirements are met. One hurdle to nonrecognition treatment of the transaction is the device prohibition.
According to Rev. Proc. 2021-3, 2021-1 IRB 140, the IRS will rule on a significant issue on the device question only if it’s a legal issue and not inherently factual in nature.
However, Weiss observed that it’s sometimes tricky to distinguish between a legal issue and a factual issue. He recommended that practitioners and taxpayers discuss their device questions with the IRS during a pre-submission conference to ensure consistent views.
Practitioners’ Presumptions
Jasper L. Cummings, Jr., of Alston & Bird LLP wondered what readers can draw from positive letter rulings on spinoff transactions with fact patterns that might indicate device, but the IRS didn’t rule on it.
Cummings pointed to a recent letter ruling (LTR 202118004, dated February 11 and released May 10) in which a foreign parent of a worldwide group that owned foreign subsidiaries and a U.S. parent of a consolidated group essentially “busted up the consolidated group” aligning nine U.S. corporations under nine separate foreign subsidiaries of the foreign parent.
The IRS ruled favorably on the multiple outbound spins and some of the other related restructuring transactions, but “the most interesting aspects of the transaction described in the ruling are possible device factors,” Cummings said.
Practitioners will likely observe possible device factors in the facts of letter rulings and may assume that the IRS wouldn’t have ignored them if it had been concerned, according to Cummings.
“Does the fact that the IRS will not rule on device mean that it disregards device factors . . . that may appear on the face of the ruling?” Cummings asked.
Cummings found interesting, for example, that the foreign corporation in LTR 202118004 set up nine U.S. subsidiaries to sell some or all of them tax-free, which couldn’t have been done outside the group, but noted it’s a common fact pattern in probably dozens of similar letter rulings.
That raises the question of “how the IRS polices the possibility that the purpose of the spin was to enable the foreign parent to sell one or more of the U.S. [subsidiaries],” Cummings said. The taxpayer represented that the transaction didn’t violate section 355(e) and wasn’t a device for shifting E&P, which the IRS apparently relied on.
Cummings pointed to another device factor in the letter ruling — that is, the post-spin section 304 sales of “the U.S. corporations by a foreign holder to another foreign holder that were subsidiaries of the ultimate foreign parent.” The taxpayer made an applicable representation for those sales, which again the IRS didn’t rule on.
Despite the evidence of device factors in the facts, the taxpayer got a favorable ruling, Cummings observed.
No-Rule Peculiarities
The IRS considers the device factors when evaluating transactions, Weiss reassured practitioners, which he said means the analysis of the transaction isn’t limited to the section 355(e) post-spin rules.
The IRS will ask taxpayers to represent that their transactions involve none of the no-rule fact patterns in Rev. Proc. 2021-3 for both full transactional and significant issue letter rulings under Rev. Proc. 2017-52, 2017-41 IRB 283.
The IRS has said it could decline to rule on any aspect of the transaction if a taxpayer’s fact patterns involve one of the two nuclear no-rules. Those situations are: (1) failing to meet the 5 percent active trade or business requirement for the distributing and controlled corporations, and (2) having evidence that the transaction would be principally used as a device for distributing earnings to shareholders as determined by specific asset tests.
Weiss acknowledged the inherent peculiarities in the ruling process because the IRS can ask questions and perform a device analysis but ultimately won’t rule on the issue.