September 25, 2017
On September 21, 2017, the IRS announced in Revenue Procedure 2017-52 (the “Pilot Program Rev. Proc.”) that it is expanding the scope of spin-off private letter ruling requests that it will consider. The pilot program is effective immediately until March 21, 2019. The pilot program temporarily reverses a policy adopted by the IRS in 2013 pursuant to which the scope of spin-off rulings was limited to specific significant issues.
Prior to 2003, the IRS issued complete rulings on spin-offs, including with respect to the business purpose and non-device requirements and the application of section 355(e) (the anti-Morris trust provision). Revenue Procedure 96-30 had been the most recent guidance from the IRS with respect to the specific factual information, representations and other items that must be included in a spin-off ruling request. In 2003, the IRS issued Revenue Procedure 2003-48 stating that it would no longer rule on business purpose, device or section 355(e) issues. Following Revenue Procedure 2003-48, taxpayers continued to obtain spin-off rulings from the IRS, and there was a general view in the tax community that these rulings provided some comfort or a halo effect for the entire spin-off transaction.
Beginning in 2013, the IRS imposed a series of additional restrictions on private letter ruling requests for spin-offs. First, in Revenue Procedure 2013-3, the IRS announced three “no-rule” areas for spin-offs: (i) delevering debt-for-debt exchanges where debt was issued in anticipation of the spin-off, (ii) where the controlled corporation’s stock was recapitalized into a high-vote/low-vote structure in anticipation of the spin-off and (iii) “north-south” transactions involving transfers of property between a corporation and its shareholder in connection with a spin-off transaction. Second, in Revenue Procedure 2013-32, the IRS further restricted spin-off ruling requests to one or more “significant issues” based on resource constraints and a concern regarding the comfort or halo effect of more expansive rulings. Third, as a result of certain publicly-announced spin-offs involving investment assets and an increasing number of REIT spin-offs, the IRS announced three more no-rule areas in Revenue Procedure 2015-43: (i) spin-offs involving a small active trade or business (frequently referred to as the “hot dog stand” issue), (ii) spin-offs involving significant and disproportionate amounts of cash and investment assets and (iii) spin-offs involving REITs (sections 355 and 856 were later amended to generally prevent spin-offs of REITs by non-REIT corporations).
Since these restrictions were imposed, the IRS has taken action with the intent of providing more guidance to taxpayers and reversing some of these restrictions. In Revenue Procedure 2016-40, the IRS eliminated the no-rule area relating to high-vote/low-vote structures and provided safe harbors for subsequent collapses of the stock structures. In Revenue Procedure 2016-45, the IRS announced that it would issue rulings with respect to significant issues involving the business purpose and device requirements, so long as the issue is a legal issue and not inherently factual in nature. Furthermore, the IRS issued proposed regulations with respect to (i) the device requirement, including new device factors regarding the ownership of nonbusiness assets and a per se device rule for significant disproportionate ratios of nonbusiness assets and (ii) the active trade or business requirement generally requiring each of the distributing and controlled corporations to have a 5-year active trade or business equal to 5% of their gross assets. In Revenue Procedure 2017-38, the IRS eliminated the spin-off ruling restriction for certain debt-for-debt exchanges. Finally, in Revenue Ruling 2017-9, the IRS lifted the no-rule area on north-south transactions and provided guidance on whether certain north-south transactions would be treated as transactions separate from the spin-off.
Overall, the Pilot Program Rev. Proc. is helpful to taxpayers as it generally allows taxpayers to obtain more comfort on spin-offs, including areas that were restricted under the prior IRS ruling policy.
Under the Pilot Program Rev. Proc., a taxpayer may request a letter ruling with respect to the general U.S. federal income tax consequences of a section 355 transaction, subject to certain restrictions described below.
The Pilot Program Rev. Proc. continues to restrict rulings on (i) business purpose and device except to the extent that there is a significant issue that is a legal issue and not inherently factual in nature and (ii) section 355(e) except with respect to the effect of certain redemptions on shareholder ownership pending the issuance of temporary or final regulations regarding redemptions under section 355(e). Taxpayers will still need to provide key facts and representations regarding business purpose and device to obtain a ruling on a section 355 transaction. The willingness of the IRS to rule on spin-offs generally, together with requiring information with respect to device and business purpose, could serve to create comfort for taxpayers that obtain a favorable general spin-off ruling.
A taxpayer is required to describe all related transactions, tax consequences and legal issues as part of its ruling request. The taxpayer must also provide sufficient factual information and legal analysis to allow the IRS to determine whether a ruling will be issued. As a result, the Pilot Program Rev. Proc. is intended to be less burdensome for the IRS as it helps the IRS manage its resources and does not require the IRS to issue spot.
Although the Pilot Program Rev. Proc. expands the scope of spin-off rulings, the IRS asks taxpayers to carefully consider which transactions will be covered in a ruling request. If the spin-off involves several transactions, a taxpayer may request a general ruling on one spin-off transaction and only a ruling on a significant issue for a second spin-off transaction. In addition, if a spin-off transaction involves preliminary internal spin-off transactions within a consolidated group, taxpayers are asked to consider whether to exclude the internal spin-off transactions from the ruling request or limit the request to any significant issues.
The Pilot Program Rev. Proc. also updates the information required for spin-off transactions that was previously set forth in Revenue Procedure 96-30. The factual information required to be provided generally remains the same, and taxpayers are not required to provide all the information if such information is not relevant to the requested ruling such as a limited significant issue ruling. The Pilot Program Rev. Proc. also contains a list of 46 representations that a taxpayer is required to make in its ruling request. In general, the representations are the same as those set forth in recent private letter rulings but contain certain additional representations relating to the recent no-rule areas described above and the proposed device and active trade or business regulations. If a taxpayer is unable to provide a particular representation, the taxpayer is required to explain why it is unable to provide the representation and provide a modified version of the representation.The Pilot Program Rev. Proc. does not change the general no-rule policy of the IRS with respect to international spin-off transactions, such as consequences under section 367.
The IRS announced that the pilot program will expire on March 21, 2019. At that time, the IRS will evaluate the effectiveness and sustainability of the program and consider whether the program should be extended.
The pilot period is a welcome temporary expansion to the IRS’s ruling policy and may ultimately result in a more permanent return to expansive rulings on spin-off transactions.
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If you wish to receive more information on spin-offs, mergers and acquisitions or the IRS letter ruling process generally, you may contact your regular Shearman & Sterling contact person or any contact person listed in this publication.