The closely held Distributing corporation was able to:
- Accomplish a split off of a public traded Controlled corporation that Distributing did not initially control;
- Get rid of some charities that held Distributing stock by exchanging Controlled stock;
- Pay off some creditors by exchanging Controlled stock with investment banks that presumably acquired the debt, and arrange for the investment banks to sell Controlled stock in a series of public offerings;
- Arrange for the charities to sell some Controlled stock in a public offering;
- Avoid a section 355(e) change of control despite multiple possible stock ownership changes;
- Accomplish a section 351 exchange of Controlled, despite subsequent related dispositions of Controlled stock other than to shareholders of Distributing.
Facts: Charities, a foundation and family and trusts owned Distributing. It has its own trade or business and also owns less than 80 percent of Controlled Sub; the public owns the rest of Controlled Sub.
Controlled Sub owns Controlled, which creates a new corporation, Merger Sub, and it merges into Controlled Sub. This inverts the original public corporation underneath Controlled, which is now the public corporation. The reason for the inversion is to allow Distributing to exchange its stock in Controlled Sub for shares of a high vote class of Controlled, which gives it the control needed to engage in a section 355 distribution of Controlled stock.
This is 355 TRICK #1: Recapping into control. It’s really an old trick, used in likely hundreds of section 355 transactions to enable a corporation to become Distributing by gaining 80 percent of all of the voting stock, without having 80 percent of the value. And then if you want to you can recap back out of control (which did not occur in this case).
355 TRICK # 2: Paying off creditors of Distributing with Controlled stock without recognizing the gain in the Controlled stock. Section 361(c) protects Distributing from recognition. This trick also is well used in split-offs.
355 TRICK #3: Avoiding a 50 percent change of control in two years, which would trigger section 355(e). The IRS and taxpayer were acutely aware of the potential for such to occur in this case due to the multiple public offerings.
355 TRICK #4: Distributing retained some Controlled stock and was allowed to keep it for up to five years. This is a little unusual.
355 TRICK # 5: Avoiding “device” A sale of stock of Distributing or Controlled after the split-off is evidence of a “device” and can cause section 355 not to apply. Here Distributing “sold” Controlled stock to creditors, which didn’t count toward device, but the creditors planned to sell the stock in public offerings, as did the charities and perhaps others. The IRS accepted this representation:
“The aggregate number of shares of Controlled Common Stock to be sold by the Charities and the Investment Banks in the Public Offerings, any sale to a private investor, any Shelf Sale, any sales of Residual Charity Shares or any other sale of Controlled stock prior to the second anniversary of the Split-Off is not expected to exceed approximately ee shares, representing an approximately ff interest, which is an economic value of less than 50 percent, in Controlled.”
Presumably this meant less than 50 percent of the shares in Controlled owned by Distributing. Presumably this means that selling up to but less than half of the stock of Controlled is not evidence of device, at least in this case?
355 TRICK #6: Using a section 351, section 368 overlap transaction. The IRS ruled that Distributing and the public shareholders of Controlled Sub engaged in a section 351 exchange with Controlled. This was necessary to give the public shareholders nonrecognition treatment.
But as to Distributing, it exchanged some of its assets, the stock of Controlled Sub, for stock of Controlled, which it distributed under section 355. Therefore, Distributing engaged in a section 368(a)(1)(D) reorganization at the same time it was part of a section 351 exchange. This technique also is used in the Double Dummy Drop Down, as when Daimler Benz acquired Chrysler Corporation.
Conclusion: These two letter rulings utilized a collection of relatively tried and true methods that are part of the massive section 355 law and lore. Yet putting them all together took a lot of ingenuity. Section 355 remains the best bargain box in the tax law, but usually necessitates a letter ruling.
