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
 
In association with
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
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). 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 & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd 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 or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.