The IRS issued its annual no-ruling revenue procedure, Rev. Proc. 2013-3, which added several items relating to Section 355 distributions.
The IRS is studying, and therefore, will not rule on (1) whether “control” is distributed if the distributing corporation acquired control by virtue of some transaction involving stock of the controlled corporation having different voting power, and (2) whether debt is exchanged for stock of the controlled corporation under Section 355 if the debt was issued in anticipation of the spinoff.
In addition the IRS is studying and will not rule on the related or separate nature of “north-south” transactions involving a distribution and a purportedly separate contribution, whether or not involving Section 355.
Significance. These changes are significant. The no-ruling revenue procedure is watched because it can signal when the IRS thinks a transaction is problematic, and will not rule for that reason. Alternately, the IRS sometimes uses the no-rule announcement to identify “safe” transactions on which no ruling should be needed (because it would be a “comfort ruling”). It is fairly certain the three transactions described do not fall in the “safe” category, because the procedure says they are under IRS study.
This change reflects the first administrative (as contrasted with legislative) cut back on the ever-burgeoning expansion of Section 355 as the go-to tax relief Section in a long, long, time.
Background. Distributing corporations began some time ago to recap into control of a subsidiary corporation in order to spin it off under Section 355. The typical technique was to create a new high vote class of stock and give it to the parent corporation. The peculiar definition of control in Section 368(c) facilitates this technique.
This technique was not problematic so long as the recap was “permanent.” Then, taxpayers began noticing that high and low vote common stock did not trade at the same price in the public markets after a spin-off. They purported to be surprised and did not like the result. This led to requests for supplemental rulings that a post-spin recap back to the original capital structure would not affect the tax treatment of the spin. Then, taxpayers threw caution to the wind and stopped repping in ruling requests that the original recap would be permanent and the IRS went along, presumably on the theory that transitory control was good enough, with vague references to Section 368(a)(2)(H)(ii) and congressional intent.
Similarly, the IRS had backed itself into a corner by agreeing to rule that spun-up stock of the controlled corporation could be used to pay off corporate debt that had been outstanding for some minimum period—like ten days. Parent corporations used this technique to raise cash to be retained by the parent. It also might be used to recap nonsecurity debt into security debt.
Finally, the north-south transactions had been much discussed on panels and generally tolerated by the IRS, which treated the contributions as separate from the distributions.
Now, all three types of transactions are in a state of uncertainty, with taxpayers left to their proofs of factual issues, until the Treasury resolves its concerns.