IRS Not Bound to Limits Listed in Its Spinoff Proposal

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By Laura Davison

Sept. 27 — The IRS is open to revising some of the bright-line tests that make it harder for corporations to undergo a tax-free spinoff, an agency official said.

“There is a lot of line drawing in this process. We are not wedded to any of those lines,” Internal Revenue Service Associate Chief Counsel (Corporate) Robert Wellen said Sept. 27 at a District of Columbia Bar Association event. “It’s the process of line drawing that I think is really important, not so much the lines themselves. We are certainly open to thinking where those lines are drawn.”

The IRS issued proposed rules (REG-134016-15) in July that include a requirement for the amount of nonbusiness assets and investment assets each company can hold after a spinoff in order for the deal to be tax-free. The regulations also say the active trade or business must amount to at least 5 percent of the company (136 DTR G-5, 7/15/16).

The rules came after IRS officials said companies were overly aggressive in using spinoffs under tax code Section 355. The IRS sought to clarify the boundaries about what is and isn't appropriate for tax-free treatment under the tax code. Some practitioners have criticized the rules for including bright-line tests that are arbitrary and too restrictive.

‘Trump Hotel' Plan

The rules include one example that says cash held by a company to potentially buy a building two years in the future doesn’t count as a business asset. This example has drawn a lot of scrutiny, but the IRS didn’t intend to create hard and fast rules for time periods, Wellen said.

“Were trying to make it so that our examiners weren’t faced with some pie-in-the-sky plan of ‘someday we might buy the Trump Hotel, the one that’s next to the White House.’ That is really what this is about,” Wellen said.

The IRS resumed advising corporations on some spinoff issues in August, after a 13-year pause. These rulings will address legal issues, not factual ones, which can involve a “fuzzy” line, Wellen said (167 DTR G-4, 8/29/16).

The IRS might consider answering questions about whether state tax savings meet the business purpose requirement, he said. However, some more fact-intensive scenarios, such as the continuing relationship between the distributing and controlled company after the transaction, might be beyond what the agency is willing to entertain, Wellen said.

Unwinding Voting Structure

Wellen also clarified spinoff guidance (Revenue Procedure 2016-40) dealing with spun-off companies that create two classes of stock prior to spinoff so that the parent company can gain control, which is known in tax circles as recapitalizing into control. The IRS said the recapitalization can be undone 24 months after the spinoff, as long as the company doesn't take any legal action to undo the voting structure before that.

Corporations tend to dislike high-low voting structures because they aren't optimal for trading. Wellen said that companies can tell investors via a news release that they are considering undoing the two classes of stock once the laws permit it, without losing any of the tax benefits.

“In my mind, an action would require something practically or legally binding,” Wellen said. “By practically binding I mean if a company makes a public announcement and their securities lawyers tell them, ‘and now you better do what you say you’re going to do.’ The concept behind this safe harbor, if you’re willing to live with the high-low vote structure for 24 months, that’s good enough for us.”

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