On September 14, 2015, the Internal Revenue Service (“IRS”) issued Rev. Proc. 2015-43, which formally expanded the IRS no-rule policy to include the areas discussed below, and companion Notice 2015-59 (together with Rev. Proc. 2015-43, the “Guidance”), which announced that the Treasury is studying various tax issues in connection with the new no-rule areas.

The Guidance indicates that Treasury is concerned that spin-offs with one or more of the characteristics discussed below may not satisfy section 355 because they may present evidence of device for the distribution of earnings and profits, may lack an adequate business purpose, or may fail the active trade or business (“ATB”) requirement.

I. Areas Where the IRS Ordinarily Will Not Rule

The Guidance provides that, absent unique and compelling circumstances, the IRS ordinarily will not rule on any issue regarding the qualification, under section 355 and related Code provisions, of a spin-off if:

  • the ATB of the distributing corporation (“Distributing”) or the controlled corporation (“Spinco”) is less than 5% of the total fair market value (“FMV”) of the gross assets of such corporation; or
  • as part of a plan with the spin-off, Distributing or Spinco becomes a regulated investment company (“RIC”) or real estate investment trust (“REIT”).

Prior IRS guidance had required for advance ruling purposes that no less than 5% of the gross assets of a corporation be part of an ATB. This 5% requirement was revoked in 2003. The Guidance resurrects this 5% requirement for ruling purposes. It states that Treasury and the IRS have concluded that, “under current law, distributions involving small [ATBs] may have become less justifiable.”

The no-rule policy applies if, immediately after the spin-off, the FMV of the gross assets of the trade(s) or business(es) on which Distributing or Spinco relies to satisfy the ATB requirement is less than 5% of the total FMV of the gross assets of such corporation.

The gross assets calculation includes the gross assets of all members of the corporation’s affiliated group. In addition, if Distributing or Spinco relies on the ATB of a partnership, such corporation is treated as owning its ratable share of the gross assets of the partnership.

The no-rule policy with respect to small ATBs is not absolute. The Guidance provides that the IRS will still rule where “unique and compelling circumstances” justify the issuance of a ruling. This “unique and compelling circumstances” determination takes into account all the facts and circumstances, including whether a substantial portion of the non-ATB assets would be ATB assets but for the 5-year requirement of section 355(b)(2)(B) and whether there is a relationship between the business purpose for the spin-off and the ATB of Distributing or Spinco.

In addition, Treasury is concerned that an increasing number of spin-offs intended to qualify under section 355 involve a Distributing or Spinco that elects to be a REIT. The no-rule policy does not apply if, immediately after the date of the spin-off, both Distributing and Spinco will be RICs, or both of such corporations will be REITs, and there is no plan or intention on the date of the spin-off for either Distributing or Spinco to cease to be a RIC or a REIT.

II. Areas Where the IRS Will Not Rule Until Study Is Completed

The Guidance further provides that, until the IRS has completed its study of certain underlying tax issues, the IRS will not rule on any issue regarding the qualification, under section 355 and related Code provisions, of a spin-off if:

  • either Distributing or Spinco has a substantial amount of “investment assets,” within the meaning of section 355(g)(2)(B) (as modified in the manner described below).

The Guidance indicates that Treasury is most concerned with spin-offs where investments assets are substantial in relation to other assets or where one of the corporations has a significantly higher ratio of investment assets to non-investment assets than the other corporation.

The no-rule policy applies if, immediately after the spin-off, all of the following conditions exist:

  1. the FMV of the investment assets of Distributing or Spinco is 2/3 or more of the total FMV of its gross assets; 
  2. the FMV of the gross assets of the trade(s) or business(es) on which Distributing or Spinco relies to satisfy the ATB requirement is less than 10% of the FMV of its investment assets; and 
  3. the ratio of the FMV of the investment assets to the FMV of the assets other than investment assets of Distributing or Spinco is three times or more of such ratio for the other corporation (i.e., Spinco or Distributing, respectively).

For purposes of the Guidance, the definition of “investment assets” is borrowed from section 355(g)(2)(B) and substantially modified. Under section 355(g)(2)(B), “investment assets” generally would include cash, stock or securities in a corporation, interests in a partnership, debt instruments, options or other derivatives, foreign currencies, and similar assets. Look-through rules may apply with respect to certain 20% or more owned corporations and partnerships (if the ATB of such partnership is taken into account by Distributing or Spinco, or would be so taken into account without regard to the 5-year requirement of section 355(b)(2)(B)). However, the Guidance provides for the following modifications of these rules:

  1. publicly traded stock is an investment asset unless Distributing or Spinco owns 50% (by vote and value) of such stock (increased from the 20% threshold noted above); 
  2. except as provided in clause (iv), an interest in a publicly traded partnership is treated in the same manner as publicly traded stock; 
  3. except as provided in clause (iv), an interest in a partnership that is not a publicly traded partnership is treated in the same manner as stock which is not publicly traded stock (i.e., the 20% threshold noted above applies); and 
  4. an interest in a partnership (other than a publicly traded partnership treated as a corporation pursuant to section 7704(a)) is not an investment asset if the ATB of such partnership is taken into account by Distributing or Spinco, or would be so taken into account without regard to the 5-year requirement of section 355(b)(2)(B). For this purpose, the ATB of a partnership generally may be taken into account by Distributing or Spinco if Distributing or Spinco owns at least a 20% interest in such partnership and certain other requirements are satisfied.

Similar to the small ATB no-rule test, the gross assets calculation includes the gross assets of all members of the corporation’s affiliated group. In addition, if Distributing or Spinco relies on the ATB of a partnership, such corporation is treated as owning its ratable share of the gross assets of the partnership.

Rev. Proc. 2015-43 applies to all ruling requests that are postmarked or received on or after September 14, 2015, and relate to spin-offs that occur after such date.