United States: Spin-Off Revenue Procedure Removes A No-Rule Area And Provides Safe Harbors For Unwinding High Vote/Low Vote Stock Structures

On July 15th, the IRS released Rev. Proc. 2016-40 (the "Rev. Proc.") removing a recent "no-rule" area with respect to transactions undertaken in anticipation of a spin-off involving high vote/low vote stock classes for the spun-off corporation, and providing safe harbors with respect to subsequent adjustments to the stock structures. The Rev. Proc. is a positive development for taxpayers because the safe harbors provide certainty while the removal of the no-rule area gives taxpayers the opportunity to seek further guidance from the IRS through the private letter ruling process.

Background

One of the requirements for a tax-free spin-off under Section 355 is that the distributing corporation ("D") distributes stock of the controlled corporation ("C") representing "control" of C (the "Distribution of Control Requirement"). For purposes of the Distribution of Control Requirement, control means at least 80% of the voting power of all classes of stock entitled to vote, and at least 80% of each class of non-voting stock.

If D did not have control of C, a recapitalization of C could be undertaken to create two classes of voting stock, high vote and low vote, where D could receive the high vote stock and obtain the requisite 80% control. In Rev. Rul. 69-407, the IRS permitted this type of recapitalization where D owned 70% of C's single class of stock prior to the recapitalization and ruled that the spin-off of C by D qualified under Section 355 because the recapitalization resulted in a "permanent realignment of voting control" with respect to C. In contrast, in Rev. Rul. 63-260, the IRS ruled that a spin-off did not qualify under Section 355 where D owned 70% of C's stock, D's shareholder owned the remaining 30% of C's stock and, prior to the spin-off, D's shareholder contributed 10% of the C stock to D because such transfer was transitory in that the contributed C stock was returned to D's shareholder in the spin-off.

In addition, C may undertake an IPO prior to a spin-off. In the IPO, C could issue low vote stock to public shareholders such that more than 20% (but less than 50%) of the value but less than 20% of the voting power of the C stock is issued to investors in the IPO. As a result, D would maintain 80% control of C and could subsequently distribute its C stock in a spin-off that satisfies the Distribution of Control Requirement.

The issue that arises with respect to these recapitalizations (or other transactions) is whether the high vote/low vote structures can be unwound without violating the Distribution of Control Requirement. In particular, if these voting structures are unwound after the spin-off then the IRS could challenge these dual class voting structures as transitory and thus assert that D failed the Distribution of Control Requirement. In 1997, Section 355(e) was enacted, which requires D to recognize gain if C undergoes a change of control as part of a plan that includes the spin-off. The legislative history to Section 355(e) generally provides that post-spin restructurings of C generally should not be taken into account in determining whether the Distribution of Control Requirement was satisfied. Based in part on this legislative history, the IRS issued Rev. Rul. 98-27 providing that transactions with respect to C stock following a spin-off will not be taken into account under the step transaction doctrine in determining whether the Distribution of Control Requirement was satisfied in the spin-off. Consistent with this view, the IRS had privately ruled that certain unwinds were permissible. For example, the Service privately ruled that a spin-off satisfied the Distribution of Control Requirement where there was no binding commitment to unwind the voting structure and the structure could not be unwound without the C board independently determining after the spin-off to hold a shareholder vote but an unwind was nevertheless expected (see, e.g., PLR 201123030). The particular circumstances that the IRS ruled were permissible varied somewhat over time.

More recently, in Rev. Proc. 2013-3, the IRS announced a new no-rule area with respect to these voting structures by providing that private letter rulings will not be issued if, in anticipation of a spin-off, (i) D acquires putative control of C in any transaction (including a recapitalization) in which stock or securities were exchanged for stock having a greater voting power than the stock or securities relinquished in the exchange, or (ii) C issues stock to another person having different voting power per share than the stock held by D.

The no-rule announcement created uncertainty as to the circumstances under which the IRS would take the position that the Distribution of Control Requirement was not satisfied when the voting structure was unwound following the spin-off. In this regard, notwithstanding the Section 355(e) legislative history and Rev. Rul. 98-27, the IRS could assert that the Distribution of Control Requirement was never satisfied in the first place because the changes to the stock of C in recapitalization were transitory and should be disregarded.

The Rev. Proc.

The Rev. Proc. provides that Treasury and the IRS recognize the difficulty of determining whether an acquisition of control of C by D in anticipation of a spin-off will be respected and, to resolve the uncertainty, set forth safe harbors in which the IRS will not assert that an acquisition of control should be disregarded. In addition, the Rev. Proc. removes the dual class stock structure as a no-rule area, meaning that the IRS will consider issuing private letter rulings with respect to recapitalizations and other transactions that result in D acquiring control of C in anticipation of a spin-off.

The Rev. Proc. does not contain safe harbors relating to C issuing low vote stock in a pre-spin IPO, but the removal of the no-rule status for this area should be read to permit taxpayers to submit private letter ruling requests with respect to pre-spin IPOs. The Rev. Proc. applies to transactions pursuant to which (i) D owns less than 80% control of C stock, (ii) C issues stock to D or other C shareholders, thereby creating the high vote/low vote structure and providing D with the requisite 80% control, (iii) D distributes the C stock in a spin-off that otherwise satisfies the requirements of Section 355, and (iv) following the spin-off, C engages in a transaction that, actually or in effect, substantially restores C's shareholders to the relative interests and/or voting rights and value that were present prior to the high vote/low vote structure.

The first safe harbor applies if no action (including the adoption of a plan or policy) is taken at any time during the 24-month period following the spin-off by C's board of directors, C's management or C's controlling shareholders (for a public company, a 5% shareholder who actively participates in the management of the corporation) that would, actually or effectively, result in an unwind of the high vote/low vote structure.

The second safe harbor applies if C acquires or is acquired by a third party in a transaction that results in an unwind of the high vote/low vote structure regardless of whether the transaction occurs during the 24-month period following the spin-off, provided that (i) there was no agreement, understanding, arrangement or substantial negotiations or discussions concerning the transaction or a similar transaction at any time during the 24-month period ending on the date of the spin-off and (ii) no more than 20% (by vote or value) of the stock of the third party acquiror is owned by the same persons that own more than 20% of the C stock (taking into account constructive ownership rules).

Finally, the Rev. Proc. notes that the failure to satisfy a safe harbor has no effect on the determination of whether the Distribution of Control Requirement is satisfied, which will be determined under general US federal income tax principles.

Effective Date

The Rev. Proc. is effective with respect to spin-offs that occur on or after August 1, 2016 but taxpayers may apply the Rev. Proc. to spin-offs that occurred prior to August 1st.

The Rev. Proc. is a welcome addition from the IRS to the spin-off area. By removing the no-rule area, taxpayers have the opportunity to seek guidance from the IRS with respect to the Distribution of Control Requirement. In addition, the safe harbors provide greater certainty to taxpayers with respect to unwinding of high vote/low vote structures following a spin-off.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions