Tax 4022/5022
Federal Income Tax II
Corporate Divisions
Chapter: None
Dr. Robert R. Oliva
Professor and Chairperson
Department of Accounting
University of Arkansas at Little Rock
Divisions
TIP
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Presentation Guidelines
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Agenda
• Reasons for Division: Need to segregate
ownership
• ABC v. D type
• Elements and Requirements
• Restrictions of some unintended benefits
Why segregate ownership?
• Business
• Legal
Business
• Shareholder disputes
• Insulation
• Discontinue part of a business
• Need to transfer some of its assets
• Split operations
• Single focus; Wall Street
Legal
• Compliance requirements
• Estate planning
– Beware: Is the reason for the reorganization
personal or business?
ABC v. D
• A, B, and C: Corporate combinations
• D reorganization: Corporate divisions
– Tax free if IRC 354, 355, or 356 satisfied.
Elements: IRC 368(a)(1)(d)
• a transfer by (transferor) corporation of
all or part of its assets to (transferee)
corporation if immediately after the
transfer the transferor (and/or) one or
more of its shareholders … is (are) in
control of the (transferee) corporation...;
but only if … stock and securities of the
(transferee) corporation … are distributed
in a transaction which qualifies under
section 354, 355, or 356.
• Transferor must transfer all or part of its
assets to transferee corporation
• If “substantially all”, then also meet “C” but
treated as “D”
• Transferor or its shareholders end up in
control of transferee
• Transferee’s “stock and securities”
distributed pursuant to IRC 354, 355, or
356.
Note:Two steps or one step
• IRC 368(a)(1)(D): comes into play if
there is a need to create a new sub with
a view to have a division.
– Transfer of assets: tax free: IRC 361(a)
– Assumption of liabilities: IRC 357;
particularly IRC 357( c)(1)
– IRC 362(b); basis
• If subs in place, IRC 355 takes effect
Requirements
• Common law
• Statutory: Effect on shareholders and
Security Holders
– IRC 354; 355; 356
Common law requirements
Business purpose
• Transferor must have a substantial
business purpose
CPI
• Pre-transaction shareholders need a
continuing equity interest in posttransaction corporations.
Statutory requirements to D
reorganizations
• Requirements pursuant to IRC
368(a)(1)(D) applicable to all D type:
– Transferor must transfer all or part of its
assets to transferee corporation
– Transferor or its shareholders end up in
control of transferee
Types
• Spin-offs
• Split-offs
• Split-ups
Spin-offs: Works in the form
of a dividend of subsidiary
stock to parents’ shareholders
• Transferor transfers part of its business
to a new controlled corporation.
– An IRC 351 transaction by itself
• S/S in a controlled corporation
transferred to transferor’s shareholders
– Recently created or preexisting subsidiary
– Shareholders do not pay any consideration
in return.
Spin-off
• Results: Transferor’s shareholders end up
owning stock in 2 different corporations.
Split-offs: Works in the form
of a redemption of parent
stock.
• Transferor transfers part of its business to a
new controlled corporation.
• S/S in controlled corporation transferred to
some (not all) transferor’s shareholders
• However, shareholders pay consideration
• Transferor’s shareholders surrender part of their
parent stock in return for stock in the controlled
corporation.
Split-off
• Results: Some of transferor’s
shareholders may own
– the transferor only
– the subsidiary only
– both transferor and subsidiary
Split-ups: Works in the form
of a liquidation of parent
stock
– Transferor transfers part of its assets to two
or more new controlled corporation.
– S/S in controlled corporations transferred to
transferor’s shareholders
– However, transferor’s shareholders pay
consideration
– Transferor’s shareholders surrender all of
their parent stock in return for stock in the
controlled corporations; transferor liquidates
Split-up
• Result: Transferor does not survive
Additional requirement
playing a role on the tax
effect on shareholders:
• Transferee’s “stock and securities” are to
be distributed by transferor pursuant to
IRC 354, 355, or 356.
IRC 354(a); (b): No gain or
loss recognition by
shareholders when
• S/S in one party to the reorganization is
exchanged for S/S of that corporation
or another party to the reorganization.
• Transferee corporation acquires
substantially all of the transferor’s assets.
• Transferor’s distribution to its
shareholders: complete divestment
Exchange
• No gain/loss recognized if S/S exchanged
solely for S/S
• Exceptions:
– nonqualified preferred stock received in
exchange for
• stock is not considered S/S
• other nonqualified preferred stock is
considered S/S
– Principal securities: received > surrendered
Acquisition
• A party to the reorganization (e.g.,
controlled transferee) acquires
substantially all of the transferor assets
Distribution
• Transferor corporation distributes
– S/S and properties received by transferor
and
– other property in the hands of transferor are
distributed.
IRC 355(a)(1)
• Solely S/S for S/S
• Device restriction
• “Active Trade or Business” limitation
• “Distribution” requirement
Solely S/S for S/S
• Distributing corporation distributes to a
shareholder … or a security holder…
solely S/S … in (a)… controlled
corporation
Device restriction
• transaction … not used principally as a
device for the distribution of EP of the
distributing and/or the controlled
corporations
– A device to bail out EP of any of the
corporations.
• Strong evidence: Prearranged sales of
property to third parties after the
reorganization to claim c/g treatment.
“Active Trade or Business”
limitation: IRC 355(a)(1)(c );
IRC 355(b)
• distributing and controlled
corporation(s) engaged in an active
trade or business
– All corporations must be engaged in an
ATOB, or
– S/S received are of corporation(s) engaged
in an ATOB.
– Cannot spin-off liquid assets or passive
assets.
ATOB: “Active trade or
business”
• Who?
• How long?
• How acquired?
Who must be engaged in
ATOB?
• A corporation must be engaged in ATOB
or
• its assets are its controlled corporation’s
S/S and it is engaged in ATOB
For how long?
• Must have been engaged in a ATOB for
the 5-year prior to reorganization.
How was ATOB acquired?
• 5 year “look back”: ATOB could not have
been acquired in a taxable transaction in
prior 5 years.
“Distribution” requirement
• Distributing corporation distributes
– all S/S held in controlled corporation, or
– at least control, if the retention of any
controlled corporation stock by distributing
corporation was not part of plan having as
one of its principal purposes to avoid FIT
• 80% voting; 80% of each nonvoting class
The following shall not
prevent the nonrecognition of
gain (loss): IRC 355(a)(2)
• non pro rata distribution with respect to
the shareholders of the distributing
corporation
• distributing corporation shareholders
surrender their stock
• distribution is not in pursuance of a plan
of reorganization
Note
• Shareholders do not need to hold their
stock
– but may be considered a “device” if there is
a prior binding agreement to sell
• Distributing corporation (TOR) mat
become TEE’s minority shareholder
because it does not have to distribute
100% of stock,only “control”.
Gain (loss) recognized: IRC
355(a)(3)(A)
• Principal amount of securities received >
principal amount of securities
surrendered
• Boot
Gain (loss) recognized: IRC
355(a)(3)(B)
• IRC 355(a)(1) requires that distributing
corporation exchange its S/S for the S/S
of its controlled corporation.
• However, stock acquired within 5 years
prior in a taxable transaction shall be
considered as “other property”.
• Such stock is “boot”
Gain (loss) recognized: IRC
355(a)(3)(D)
• nonqualified preferred stock received in
exchange for
– stock is not considered S/S
– other nonqualified preferred stock is
considered S/S
Tax effect
• Transferor corporation
• Transferor’s shareholders
Consider IRC
351/301/302:
• Transferor corp (TOR) creates a
Transferee corp (TEE).
• No gain (loss) when TOR gets TEE stock.
– Except: assumption of liabilities by TEE >
AB; boot property distributed
• But if TOR wants to transfer TEE stock to
TOR’s shareholders there is either a 301
or 302 distribution.
Transferor corporation: IRC
355/361
• Consider IRC 361(c) if transaction
preceded by a type D drop down
• If not preceded by Type D, then IRC
355(c)
IRC 361
• IRC 361: Prevents recognition if TOR
transfers TEE’s S/S to TOR’s
shareholders.
– No gain recognition on distributions of
appreciated “qualified property”
• But like IRC 351, recognize
– assumption of liabilities by TEE > AB [IRC
357(c)(1)(B)]
– boot property distributed
Transferor’s shareholders
• No g/l if TEE stock is exchanged for TOR
stock.
• No g/l if TEE securities is (swapped)
exchanged for TOR securities
• Unless
– principal received > principal surrendered
– device
– boot received (o/t S/S)
Shareholders’ AB & HP:
• No Boot: AB: IRC 358(b); (c)
– Aggregate AB on TOR’s S/S before the
distribution is allocated among the S/S after
the distribution, on the basis of their FMV.
• HP: IRC 1223(1)
– Includes the HP of the S/S of distributing
corp held by shareholders
Boot: AB: Nonrecogniton
property:
• IRC 358(a)(1): c/o AB + gain recognized
- boot
• IRC 358(b)(2): Aggregate AB allocated
among S/S in proportion to FMV
Boot
• money
• cash equivalent
• tainted stock or securities
• property other than “stock and securities”
Character of the boot
recognized
• Alleged spin off treated as a dividend
• C/G: Other
• AB and HP: FMV; day of distribution
Prevention of disguised sales
of subsidiaries
• Purchaser of <80% of a parent may use
IRC 355 to acquire a subsidiary
– without the parent having pay any taxes
– having the buyer use stepped-up FMV AB in
sub’s c/s
How: Alleged split-off
• Purchaser buys parent stock with same
value to the desired subsidiary
• Purchaser agrees to exchanges his stock
for stock of subsidiary.
Prevention: IRC 355(d): Gain
recognized by distributing
corporation if,
• immediately after distribution,
• shareholder holds a => 50% interest in a
distributed subsidiary
• that is attributable to a stock
• that was acquired by purchase within 5
years prior ending on the date of
distribution.
Distributing corporation
recognizes gain
• disqualified distribution of stock
Disqualified distribution of
stock
• Any IRC 355 distribution, if after
distribution, any person holds
“disqualified stock” in parent or
subsidiary corporations
• constituting a >=50% interest in such
corporation
“disqualified stock”
• stock in distributing corporation or in
controlled corporation
• acquired by purchase
• during five year period ending on date of
distribution.
IRC 355 attribution rules
• 50% or greater ownership determined
using attribution from related parties.
– IRC 267(b): family; ind shareholder>50% =
1 person
– IRC 707(b)(1): partner and partnership
where partner owns > 50% of partnership =
1 person
– IRC 318(a)(2) [AFE]: shareholder and
corporation owned = > 10% of corporation.
IRC 355(e): Additional
limitation
• Restricts tax free spin-offs to new
shareholders
• Spin-offs distributions are NOT
considered “qualified property” under IRC
355(c)(2) or 361(c)(2)
• Acquisitions by purchase as well as other
means
• Where 1 or more persons acquire 50% or
Operation:
• Distributing corporation recognizes gain
if:
– controlled or distributiong corporation stock
is acquired,
– pursuant to a plan or arrangement in
existence on the distribution date.
• Exception: > 50% shareholders of
historical shareholders retain ownership
Pursuant to a plan or
arrangement
• Acquisitions within 4 year period
beginning 2 years before distribution are
presumed to have occurred pursuant to
such a plan or arrangement.