On May 3, 2017, the IRS issued Revenue Ruling 2017-09 to provide guidance on certain so-called “north-south” transactions, in which a shareholder’s property is transferred to a corporation and the transfer is shortly followed (or shortly follows) a corporate distribution. Such fact patterns frequently arise in structuring spin-off transactions and similar corporate separations. The revenue ruling, which analyzes whether the transfers and distributions should be treated as separate transactions or be integrated into a single exchange for federal income tax purposes, comes amid a “regulatory freeze” ordered by President Donald Trump. However, the IRS has said it is resuming issuance of “sub-regulatory” guidance, such as revenue rulings and notices, in order to address areas of uncertainty for taxpayers.
In addition to the guidance provided by this revenue ruling, the ruling also generally removed “north-south” transactions from the list of areas under study by the IRS for which rulings or determination letters will not be issued. However, the IRS may still decline to issue a letter ruling addressing these transactions when appropriate in the interest of sound tax administration, when the issues are inherently factual or on other grounds when warranted by the facts or circumstances of a particular case.
Revenue Ruling 2017-09 addresses two separate factual situations, described in more detail below, where a “north-south” transaction arises in connection with a spin-off. Each situation involves a parent corporation (P) that owns all the stock of a second corporation (D), which in turn owns all the stock of a third corporation (C). All references in the discussion below to a “Section” are to the referenced section of the Internal Revenue Code of 1986, as amended (the “Code”).
Situation 1: In Situation 1, P and C have been engaged in Business A and Business B (each of which constitutes the active conduct of a trade or business within the meaning of Section 355(b)), respectively, for more than five years. D is not engaged in the active conduct of a trade or business, directly or through any member of its “separate affiliated group” (within the meaning of Section 355(b)(3)) other than C.
The fair market value of the C stock is $100X. On Date 1, P transfers the property and activities constituting Business A, having a fair market value of $25X, to D in exchange for additional shares of D stock. On Date 2, pursuant to a dividend declaration, D transfers all the C stock to P for a valid corporate business purpose. D retains the Business A property and continues the active conduct of Business A after the distribution. The purpose of P’s transfer of the property and activities of Business A to D is to allow D to satisfy the active trade or business requirement of Section 355(b).
If the Date 1 and Date 2 transfers are respected as separate transactions for federal income tax purposes, P’s transfer of property to D on Date 1 for D stock could qualify as a tax-free exchange under Section 351, and D’s distribution of all the stock of C to P on Date 2 could qualify as a tax-free distribution under Section 355 (assuming, in each case, that the requirements under Sections 351 and 355 are otherwise satisfied). On the other hand, if the Date 1 and Date 2 transfers are integrated into a single exchange for federal income tax purposes, P would be treated as transferring Business A to D in exchange for a portion of the C stock. Under that characterization, (i) both P and D would recognize gain or loss (as applicable) on such exchange and (ii) because D would not have distributed stock constituting Section 368(c) control of C (as required by Section 355(a)(1)(D)), the distribution of the remaining 75 percent of the C stock with respect to P’s stock in D would be governed by Section 301 and Section 311(b), rather than Section 355.
Revenue Ruling 2017-09 provides that the determination of whether steps of a transaction should be integrated requires review of the scope and intent underlying each of the implicated provisions of the Code. The tax treatment of a transaction generally follows the taxpayer’s chosen form unless: (i) there is a compelling alternative policy; (ii) the effect of all or part of the steps of the transaction is to avoid a particular result intended by otherwise-applicable Code provisions; or (iii) the effect of all or part of the steps of the transaction is inconsistent with the underlying intent of the applicable Code provisions.
In this regard, Sections 351, 355, and 368 generally allow continued ownership of property in modified corporate form without recognition of gain. In addition, the intent of Sections 355(b)(2)(C) and 355(b)(2)(D) is to prevent the satisfaction of the “active trade or business” requirement of Section 355(b) through the acquisition of a trade or business by the distributing corporation or the controlled corporation from an outside party in a taxable transaction within the five-year pre-distribution period.
Revenue Ruling 2017-09 concludes that the Date 1 and Date 2 transfers described in Situation 1 will be respected as separate transactions for federal income tax purposes because (i) P’s transfer on Date 1 and D’s distribution on Date 2 are not inconsistent with the congressional intent of Sections 351 and 355, respectively, (ii) analysis of the transaction as a whole does not indicate that P's transfer should be properly treated other than in accordance with its form, (iii) the steps do not resemble a sale, and (iv) none of the interests are liquidated or otherwise redeemed.
Revenue Ruling 2017-09 also states that D’s distribution on Date 2 would qualify under Section 355 if, instead of acquiring an active trade or business in a Section 351 transfer from P to D, D acquired an active trade or business from a subsidiary of P in a cross-chain reorganization under Section 368(a)(1).
Situation 2: In Situation 2, D and C have been engaged in Business A and Business B (each of which constitutes the active conduct of a trade or business within the meaning of Section 355(b)), respectively, for more than five years. On Date 1, C transfers $15X of money and property having a fair market value of $10X to D, pursuant to a dividend declaration, and D retains the money and property. On Date 2, D transfers to C property having a basis of $20X and a fair market value of $100X, and D distributes all the C stock to P in a transaction qualifying as a reorganization under Sections 368(a)(1)(D) and 355. C and D planned and executed the Date 1 transfer “in pursuance of the plan of reorganization.”
If the distribution by C of money and other property on Date 1 is treated as separate from the distribution of C stock, Section 301 would apply to D’s receipt of the money and other property from C, and no gain would be recognized to D upon the transfer of property to C. On the other hand, if the Date 1 distribution is considered to be made in pursuance of the plan of reorganization under Sections 368(a)(1)(D) and 355 that includes the Date 2 distribution of C stock, the money and other property distributed by C to D would constitute boot to D, and, under Section 361(b)(1)(B), gain would be recognized to D on its transfer of property to C to the extent of the amount of the money and the fair market value of the property distributed by C that is retained by D.
Since the distribution of money and property by C to D is made “in pursuance of the plan of reorganization,” Revenue Ruling 2017-09 concludes that such money and property will be treated as boot subject to recognition of gain.