Spin-offs and Corporate Separations: Issues and Planning ... · • Small ATB’s (“Hot Dog”...

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Spin-offs and Corporate Separations:

Issues and Planning

TEI – Houston Chapter

May 10, 2018

Miriam L. Fisher & Laurence J. Stein

• Last remaining way to get assets out of corporate

solution without paying tax at either the corporate or

shareholder level.

• Basic structural pattern

• P = parent corporation

• S = subsidiary that will be distributed (often newly formed)

• X = unrelated third party

• Spin-offs vs. Split-offs

• Spin-off – P distributes stock of S to P shareholders pro rata

• Split-off – P distributes stock of S to certain P shareholders in

redemption of their stock in P

Spin-Offs – The Final Frontier

2

• Basic Rules – with emphasis on the remarkable

number of developments in recent years (which impact

both substance and process):• Ruling process

• Recap in/out of control

• Small ATB’s (“Hot Dog” stand rule)

• Rethinking of the Device Test

• Spin-off structures – and the issues/pitfalls• Leveraged Spin-Offs

• Morris Trust/Reverse Morris Trust Transactions

• IPO Carve-Outs

• Tax Controversy Elements – living with a spin-off• Tax Matters Agreements (including Tax Contests)

• Repatriation Tax – Diligence issues

Spin-Offs – Panel Agenda

3

Basic Spin-Off Structure

P

Other

Subs

Public

S

Assets

S C/S

S

S C/S

4

Basic Split-Off Structure

P

Assets

S C/S

Other

Subs

A

S

B

P C/S

S

S C/S

5

• Distribution and Control

• Corporate Business Purpose

• 5-Year Active Trade or Business

• Device

• No 50% Ownership Shift as Part of “Plan” (355(e) –

otherwise known as the “Anti-Morris Trust” rules)

• No 50% Purchased Stock within Prior 5 Years (355(d))

• Limitation on Investment-Type Assets (355(g))

• P Shareholders Must Maintain Requisite Continuity of

Interest in both P and S

Overview of Basic Spin-Off Requirements

6

• Pre-2003 -- IRS would issue full spin PLR’s applying

the checklists/guidelines set forth in Rev. Proc. 96-30

• Rev. Proc. 2003-48 – IRS will no longer rule on the

following issues (though taxpayer would still need to

make representations regarding these issues):

• Business purpose

• Device

• Whether spin and acquisition are part of a “plan” under 355(e)

• Rev. Proc. 2013-3 – added the following no-rules:

• Control requirement in high-vote/low-vote situation (removed

by Rev. Proc. 2016-40)

• North-South transactions (removed by Rev. Rul. 2017-9)

• Repayment of P debt issued in anticipation of spin (removed

by Rev. Proc. 2017-38)

7

History of IRS’s Advance Ruling Policy on Spins

• Rev. Proc. 2013-32 – IRS will no longer rule on whether

a spin-off qualifies as tax-free under Section 355, but

rather would only rule on “significant issues”

• Significant change – effectively results in most taxpayers no

longer seeking spin-off rulings, and relying solely on opinions

from tax counsel.

• By contrast, after Rev. Proc. 2003-48, most taxpayers would

still seek rulings and would rely on tax opinions for the issues

not addressed by the IRS.

• Rev. Proc. 2015-43/Notice 2015-59

• Adds two areas to list in which IRS will “ordinarily” not rule:

• RIC/REIT transactions

• Small ATB

• Adds one area to no rule area pending study:

• Substantial investment assets relative to ATB (device concerns)8


• 2016-2017 – removal of the 2013-3 no-rules (see above).

• Rev. Proc. 2016-45 – elimination of the business purpose

and device no-rules

• Willing to issue rulings if there are significant legal issues on these

items

• Rev. Proc. 2017-52 – IRS announces 18 month pilot

program in which it will not only issue “Significant Issue

Rulings” but also “Transactional Rulings” that address the

general tax consequences of certain transactions, including

spin-offs

• Establishes new requirements which are a modified version of the

prior checklist from Rev. Proc. 96-30.

• Does not alter IRS’ policy that limits rulings on device, business

purpose and 355(e).

9


• P must distribute “control” of S = 80% of the vote plus

80% of any nonvoting classes (§355(a)(1)).

• Note that “control” doesn’t have a “value” element => enables

use of high vote/low vote structures in which P retains more

than 20% of S’s value (see “recap” discussion).

• To extent P retains stock of S after the spin-off, P generally

must (i) demonstrate a valid business purpose for the

retention, (ii) lack overlapping directors/officers, (iii) vote

retained stock in proportion to S’s other stock and (iv) dispose

of retained stock within 5 years (see Appendix B, Rev. Proc.

96-30).

Distribution and Control Requirements

10

• Historically, IRS has allowed S to recapitalize its

capital structure to facilitate P acquiring control of S

prior to spin-off if it results in a “permanent realignment

of voting control”

• See Rev. Rul. 69-407; see also Rev. Rul. 56-117, Rev. Rul.

63-260.

• Provided basis for high vote/low vote structures in a number of

PLR’s.

• How long must S retain the two classes after the spin?

• No plan/intent to unwind S’s two classes?

• No “legally binding obligation” to collapse S’s two classes?

• Whither the step transaction doctrine (in this and related areas

in spins) as of late 2012?

S Recapitalizations for P to Acquire “Control”

11

• In January 2013, IRS identified the vote/value

difference as an area warranting further study and will

not issue further PLRs re the control requirement in

this context pending issuance of guidance in the area

(see Rev. Proc. 2013-3).

• IRS issues Rev. Proc. 2016-40 which deletes the no-

rule on the control requirement

• IRS not prevented by legislative history (355(e)) and prior

rulings (Rev. Rul. 98-27) from applying the step transaction

doctrine to take account of all facts and circumstances

(including post-spin events) to determine if a pre-spin

acquisition of control has substance for purposes of satisfying

the “control” requirement of Sec 355.


12

• Focus is on transactions where S issues stock to allow P to

obtain control of S before spin, and then after spin S

effectively unwinds the prior issuance. In that context, Rev.

Proc. 2016-40 provides two safe harbors in which it will not

challenge that P failed the control requirement:

• Safe Harbor #1 – No Action Taken Within 24 Months

• For 24 months after spin, S takes no action (including the

adoption of any plan/policy) that would result in an unwind.

• Safe Harbor #2 – Unanticipated Third Party Transaction

• No “agreement, etc.” regarding the transaction or a similar

transaction during 24 months preceding the spin-off.

• No more than 20% of the third party is owned by same persons

that own 20% or more of S.

• No negative implication intended if outside the safe harbors

– general tax principles apply.

• Does not apply if P already controlled S before S stock issued.


13

• The spin-off must be motivated, in whole or substantial part, by a

“real and substantial non-federal tax purpose germane to the

business of” P or S, and that purpose cannot be achievable

through any other nontaxable transaction “which is neither

impractical nor unduly expensive.” (§1.355-2(b))

• The spin-off must be required by “business exigencies”.

• Must be a benefit at the corporate level. Merely increasing shareholder value

is not sufficient, though it may provide basis for establishing a corporate

business purpose.

• There may be more than one business purpose, but need to meet requisite

standard of proof for at least one business purpose.

• Typically investment bankers would provide a letter which supports the

applicable business purposes being relied upon for the spin-off.

• In a MT/RMT, desire to acquire only a portion of P in a tax-free manner

usually supplies the requisite business purpose.

Business Purpose Requirement

14

• Appendix A from Rev. Proc. 96-30 provides a useful

list of typical business purposes as well as what the

IRS generally required taxpayers to demonstrate

regarding a given business purpose in a ruling context.

• Facilitate Debt/Equity Capital Raise (e.g., “pure play”)

• Cost Savings

• Key Employee/Compensation

• Fit/Focus

• Resolve shareholder dispute (private situation – split-off)

• Facilitate Tax-Free Acquisition of P or S (MT/RMT)

• Facilitate Tax-Free Acquisition by P or S

• Competition

• Risk Reduction

Business Purpose Requirement

15

• Each of P and S must, immediately after the spin, be

engaged in an ATB, which requires:

• Active conduct of ATB throughout 5 years preceding spin.

• Neither ATB nor corporation controlling ATB acquired in

taxable transaction within last 5 years preceding spin (though

expansion doctrine may apply).

• In applying ATB test, all members of a corporation’s “separate

affiliated group” (“SAG”) treated as one corporation.

• Does size of ATB matter?

• No size requirement under current law.

• Prior to 2003, 5% generally required for ruling purposes (Rev.

Proc. 96-43), then abandoned in 2003 (Rev. Proc. 2003-48).

• Now, 5% rule again under proposed regulations (see

subsequent discussion of 2016 proposed regulations) and

new revenue procedure for spin PLR’s.

Active Trade or Business Requirement (“ATB”)

16

• Spin-off must not be used principally as a device for

the distribution of E&P of either P or S (§1.355-2(d)).

• Concern – P’s tax-free distribution of S presents a potential for

P shareholders to avoid the dividend provisions of the Code

through the post-spin sale or exchange of either P or S and

the retention of the remaining corporation.

• Device Test – determined based on all facts and

circumstances, including but not limited to the

presence of various device and non-device factors.

• Device Factors

• Pro rata distribution.

• Sale or exchange of P or S stock after the spin-off.

• Excessive non-business assets (e.g., cash and other liquid

assets not related to reasonable needs of the business).

Device Test

17

• Non-Device Factors

• Corporate business purpose

• P is publicly traded and has no significant (5%) shareholder.

• Distributees are corporations entitled to a DRD.

• “Ordinarily” Not a Device

• No accumulated or current E&P for either P or S (taking account

of the spin as if it were taxable).

• In absence of Sec 355, distribution would have been a

redemption to which Sec 302(a) applied (i.e., exchange treatment

rather than dividend treatment).

Device Test

18

• Background

• Cash-rich spins. At a Spring 2015 DC bar meeting, IRS

official suggested that contrary to longstanding administrative

practice, S’s reliance on a tiny active business where S’s

assets consisted largely of investment assets might be

problematic.

• REIT spins. In effect, P is an OpCo and S is a PropCo and S

elects REIT status after spin. Historically, concerns that a

REIT (being a passive-type entity) couldn’t satisfy the ATB

requirement, but more recent IRS guidance had suggested

foregoing OpCo/PropCo spin was possible and led to a

number of REIT spin transactions.

Device Test -- Developments

19

• Notice 2015-59 – Areas of Concern

• Excessive Investment Assets. Ownership by P or S of Investment

Assets (“IA”) having substantial value in relation to (i) value of all of

such corporation’s assets and (ii) value of ATB assets.

• Differential Investment Assets. Significant difference between P’s

ratio of IA/non-IA to S’s ratio of IA/non-IA.

• Tiny ATB. P’s or S’s ATB being small in relation to all of its assets.

• RIC/REIT. Either P or S (but not both) electing to be a RIC or a

REIT.

• Notice updated the IRS’ 355 no-rule policy by adding

certain transactions with the above characteristics.

• REIT spins addressed by adoption of Sec 355(h) in late

2015.

• In July 2016, IRS issued proposed regs re device and ATB

which in effect adopt the no-rules as the law.

Device Test -- Developments

20

• Modification of Nature/Use of Assets Device Factor

• Focus is on “Business Assets” (“BA”) rather than Investment

Assets (“IA”), and comparison of BA to “Nonbusiness Assets”

(“NBA”).

• IA was viewed as both overinclusive (including cash even though

it may be needed for working capital) and underinclusive

(excluded real estate assets even though they may be unrelated

to the needs of the business).

• BA includes assets used in a business, which includes not only

the ATB used for the spin but also ATB without regard to (i) 5

year active conduct requirement, (ii) collection of income

requirement and (iii) new 5% minimum size requirement.

Device Test – Proposed Regulations

21

• Focus is on both size of NBA% and relative difference

between P’s NBA% and S’s NBA%.

• Ownership of NBA is evidence of device.

• The larger the NBA%, the stronger the evidence of device.

• NBA% is ordinarily not evidence of device if NBA% of each of P and

S is less than 20%.

• Difference between P’s NBA% and S’s NBA% is evidence of

device.

• The larger the difference, the stronger the evidence of device.

• Difference is ordinarily not evidence of device if (i) less than 10% or

(ii) spin not pro rata and difference attributable to need to equalize

value of S stock distributed with value of P stock exchanged.


22

• Separation of BA from NBA – “Per Se” Device

• Per Se Device if each of the following prongs is met:

• NBA% of either P or S is at least 66 2/3%.

• There is a substantial difference between P’s NBA% and S’s

NBA%, using the following 3 bands:

• 66 2/3% < NBA1% < 80% and NBA2% < 30%.

• 80% < NBA1% < 90% and NBA2% < 40%.

• NBA1% > 90% and NBA2% < 50%.

• Two exceptions to this Per Se Device result

• Corporate distributee would be entitled to DRD (absent Sec 355).

• Transaction falls within the list of transactions not ordinarily

considered a device in §1.355-2(d)(5) (e.g., a distribution that

would be a Sec 302(a) redemption if Sec 355 did not apply).


23

• Modification of Corporate Business Purpose Non-

Device Factor

• Concern that taxpayers relying on a weak business purpose

plus the publicly traded non-device factor to offset evidence of

device caused by separation of NBA’s.

• While ownership of NBA’s or difference between P’s and S’s

NBA%’s can be outweighed by a business purpose for such

ownership or difference, a business purpose that relates to a

separation of NBA’s from BA’s is not evidence of nondevice

unless it involves an exigency that requires the use of NBA’s

in one or more businesses of P or S or both.


24

• Value of ATB for each of P and S must be at least 5%

of the value of such corporation’s total assets.

• Includes reasonable amounts of cash/cash equivalents held

for working capital and assets required for business

exigencies or regulatory purposes.

• Value Determinations

• P’s and S’s assets are determined immediately after the spin,

but valuation is made at one of the following points in time:

• Immediately before the spin.

• Any date within 60-day period before the spin.

• Date of binding agreement for the spin.

• Date of public announcement or filing with the SEC regarding the

spin.

• P and S must make consistent determinations, or else value

determined immediately before the spin.

Device & ATB – Proposed Regulations

25

• Note that the representations on device and ATB with

respect to spin-off rulings contained in Rev. Proc.

2017-52 largely reflect the no rule positions of Rev.

Proc. 2015-43 rather than the proposed regulations in

this area.

26

Device & ATB

• Section 355(e) Requirement -- One or more persons cannot acquire 50% or more

(by vote or value) of either P or S as part of a “plan” with the spin-off, or else P’s

distribution of S becomes taxable. Any acquisition that occurs from two years

before spin to two years after spin is presumed to be part of a “plan”, but the

presumption is rebuttable, and there are several helpful safe harbors (see following

slides).

• Each acquisition of either P or S stock is separately tested to determine if it is

part of a “plan” with the spin (i.e., “tainted”).

• All “tainted” acquisitions of P are aggregated, and the aggregate must be

less than 50% of P.

• All “tainted” acquisitions of S are aggregated, and the aggregate must be

less than 50% of S.

• Therefore, an acquisition must either (a) avoid being treated as a “plan” with

the spin-off or (b) be part of a “plan” but not aggregate (together with other

“tainted” acquisitions) to 50%+ of P or S.

• Note that the consequence of violating 355(e) is that the spin-off is taxable at

the P corporate level only, and it remains tax-free to P stockholders.

• Consider Section 336(e) election if 355(e) test is not met.

• 355(e) applies to predecessors/successors of P and S (Dec 2016 regs).

Limitations on 50% Acquisitions of P or S Stock as Part of a “Plan” – Section 355(e)

27

• “Super Safe Harbor”

• X’s post-spin acquisition (other than pursuant to a public

offering) OK if no “agreement, understanding, arrangement or

substantial negotiations” in two years preceding the spin.

• Safe Harbor III

• X’s post-spin acquisition OK if:

• No “agreement, understanding or arrangement” at time of spin.

• No “agreement, understanding, arrangement or substantial

negotiations” within one year after spin.

• Safe Harbor II


• Business purpose was not to facilitate “the” acquisition.

• Occurs more than 6 months after spin and no “agreement,

understanding, arrangement or substantial negotiations” from one

year before spin to 6 months after spin.

• Acquisition (including “agreement, etc.”) limited to 25%.

Limitations on 50% Acquisitions of P or S Stock as Part of a “Plan” – Post-Spin Safe Harbors

28

• Safe Harbor I


• Business purpose was not to facilitate “an” acquisition.

• Occurs more than 6 months after spin and no “agreement,

understanding, arrangement or substantial negotiations” from one

year before spin to 6 months after spin.

• “Similar Acquisition”

• Foregoing safe harbors also contain the notion of a “similar

acquisition” in applying the requirement that there be no

“agreement, understanding, arrangement or substantial

negotiations” regarding an “acquisition”.

• Safe Harbor VII – Acquisitions of publicly traded stock

• Safe Harbor VIII & IX – Certain compensatory-related

acquisitions

Limitations on 50% Acquisitions of P or S Stock as Part of a “Plan” – Post-Spin Safe Harbors

29

• P and S should each avoid initiating a taxable sale for at least one year after the

spin (absent an intervening unexpected change in circumstances).

• A third party may initiate an acquisition of S or P stock at any time post-spin (other

than in a public offering) so long as in the two years prior to the spin, there was no

“agreement, understanding, arrangement or substantial negotiations” between

such third party and P (and facts consistent with device test; e.g., no plan/intent to

sell in a taxable sale). Otherwise, such third party may need to wait until at least

one year after the spin before re-engaging with S or P (and any such discussions

must have ceased at the time of the spin).

• Discussion of significant economic terms with acquirer likely to constitute

“substantial negotiations”.

• Exchange of nonpublic information or draft agreements may also potentially

constitute “substantial negotiations” – which is of particular note if P pursues a

dual track process.

Tax Requirements – Practical Consequences Regarding Acquisitions of P or S Stock

30

• Disqualified Distributions (Sec 355(d))• In effect, to extent there has been a 50% or more “purchase” of P or

S stock, triggers a 5 year holding period.

• Similar to Sec 355(e), consequence is that the spin-off is taxable at

the P corporate level only.

• Purpose is to avoid using a high outside stock basis to (completely)

avoid P’s gain with respect to S.

• Continuity of Interest• Prespin historic shareholders of P must maintain continuity of interest

in both P and S.

• Cash-Rich Split-Offs (Sec 355(g)) – not a good spin if:• Immediately after spin, either P or S is a “disqualified investment

corporation” (≥2/3 investment assets); and

• Any person who did not hold a 50%+ interest in the DIC immediately

before spin hold such an interest immediately after.

Remaining Spin-Off Requirements

31

North-South Issues in Structuring Spin-offs

• The common spin-off North-South fact pattern:

• P owns all of the stock of D and D owns the stock of C.

• P contributes property to D (the southbound transfer).

• D distributes the stock of C to P (the northbound transfer).

• The issue: are the two transfers treated as separate (so that spin is tax-free) or recast as an exchange of the contributed property for some/all of the C stock (in which case spin may be taxable)?

• Occurs frequently as a preliminary step in spin-off transactions.

32

D

C

P

Property

C Stock

North-South Issues

• Prior to 2013, IRS would grant rulings in the context of a Section 355 transaction if each leg was sufficiently separate. Required representations varied.

• Early rulings: No part of the consideration distributed by distributing will be received by a shareholder as a creditor, employee, or in any capacity other than that of a shareholder of the corporation. (Or no rep at all!)

• Revised representations circa 2010: There is no regulatory, legal, or economic compulsion or requirement that the contribution be made as a condition of the distribution. The fact that the value of distributing will decrease as a result of the distribution was not a consideration in the decision to contribute property to distributing. The distribution is not contingent on there being contributed to distributing assets having a specified (or roughly specified) value.

• Most recent representation prior to IRS no-rule: There is no regulatory, legal, contractual, or economic compulsion or requirement that shareholder make part or all of the contribution to distributing as a condition to the distribution.

• In Rev. Proc. 2013-3, IRS announced that it was studying North-South issues and would no longer issue rulings covering North-South transactions.

33

Rev. Rul. 2017-9

• Provides much needed guidance on the application of step transaction principles to north-south steps undertaken in connection with a spinoff.

• Removes north-south transactions from the list of areas under study and on which the Service will not rule.

• Guidance is also notable for the articulation of step transaction principles it applies.

34

North-South Issues and Rev. Rul. 2017-9 (Situation 1)

• Facts (Situation 1)

• On date 1, P transferred Business A, a 5 year ATB with a FMV of $25X, to D for additional D stock.

• D retains Business A.

• The purpose of the transfer was to allow D to satisfy the ATB test.

• On date 2, pursuant to a dividend declaration, D transferred all of C stock, with a FMV of $100X, to P, in a purported 355 spin-off transaction.

• If integrated, the transfer from P to D would be a Section 1001 exchange and the distribution of the C stock would not qualify under Section 355 (not a distribution of “control” since only 75% would be transferred outside of the 1001 exchange).

P

D

C

Bus. A

Bus. B

Bus. A


• Analysis:

• IRS stated that the tax treatment follows the form unless:

• There is a compelling alternative policy;

• The effect of all or part of the transaction is to avoid a particular

result intended by otherwise applicable Code provisions; or

• The effect of all or part of the transaction is inconsistent with the

underlying intent of the applicable Code provisions.

• Applying the foregoing, concluded that the steps should be

respected as separate.• Intent of ATB rules is to prevent satisfying it by acquiring an ATB from an outside

party in a taxable transaction within the five-year pre-distribution period, which is not

implicated here.

• Transfer of property permitted to be received by D in a nonrecognition transaction

has independent significance when undertaken in contemplation of a distribution by

D of the stock of C.

• In addition, the transaction as a whole does not suggest P’s transfer should be

recharacterized.

• Query whether foregoing statement of step transaction doctrine has general

applicability outside of the spin-off area.

36


• Facts (Situation 2)• On date 1, C distributed $15X of money

and $10X of property to D pursuant to a dividend declaration.

• On date 2, D transferred to C property having a basis of $20X and a FMV of $100X, and distributes all of C stock to P in a transaction that qualified as a D/355 reorganization.

• C and D planned and executed the date 1 transfer in pursuance of a plan of reorganization

• If integrated, Section 361 would apply to the date 1 distribution and the distribution would be treated as boot (gain recognized unless purged).

37

P

D

C

$15X +

$10X

Prop.

$100X

FMV/

$20X

Basis


• Analysis• The facts of the ruling stipulate that “C and D planned and executed the

[d]ate 1 transfer in pursuance of the plan of reorganization.”

• Looking to the intent of Section 361, the Tax Court has explained that

the boot rules are the exclusive measure of dividend income provided

by Congress where cash is distributed to shareholders as an incident of

reorganization.

• In this regard, IRS noted that “Section 361 broadly looks to whether

transfers of money or other property occur ‘in pursuance of the plan of

reorganization’ or ‘in connection with the reorganization’.”

• Accordingly, where the distribution by C in Situation 2 was made in

pursuance of the plan of reorganization, it should be treated as boot in

the reorganization, consistent with the Congressional intent underlying

Section 361.

• Query what facts establish that a distribution is

pursuance of a plan of reorganization.

38

• S assumes P debt (limited to P’s basis in S)

• S leverages itself and distributes proceeds to P for

retirement of P debt (limited to P’s basis in S)

• P uses S securities (or S stock) to retire P debt

• Not limited to P’s basis in S

• If P creditors want cash and not S securities, P can use I-Bank

as an intermediary to effectively give cash to P creditors:

• IB acquires P debt for cash at least 2 weeks in advance (and no

agreement with P for at least 5 days after debt is acquired by IB).

• P contributes assets to S for S stock and S securities.

• IB transfers P debt to P in exchange for S securities.

• IB sells the S securities to the public in an offering for cash.

• Use of (relatively) new P debt in this structure? Commercial

paper? Consider limitations set forth in Rev. Proc. 2013-3 re

P debt issued in anticipation of spin (step transaction issue).

Monetization -- Extracting Value from S

39

Monetization – Securities Exchange Technique

P

SOther

Subs

S

IB

P

Creditors

Public

Public S secs

P debt

$P debt

$

Assets

S C/S and

S secs

S C/S

S secs

40

• Rev. Proc. 2017-38 – deletes the no-rule of Rev. Proc.

2013-3 which provided that whether 355 or 361 applies

to P’s distribution of S stock or securities in exchange

for putative debt of P if such P debt is issued in

anticipation of the spin.

• Removal of the no-rule does not necessarily mean the IRS will

return to the prior standards of when to issue rulings.

• IRS says it is continuing to study the area, which suggests that

additional guidance on this topic may be forthcoming.

41

Monetization -- Extracting Value from S

• Concept and Structure• X wants to acquire only some of P’s assets, in exchange for X

stock and some cash (in a transaction that qualifies as a tax-free reorganization).

• P drops the “wanted assets” into S and spins S to the P shareholders, and then X acquires S.

• This is a “Reverse Morris Trust” transaction.

• If instead P drops the “unwanted assets” into S and spins S and X then acquires P, then it is a “Regular Morris Trust” transaction.

• The Anti-Morris Trust Rules (Sec 355(e))• P shareholders must retain 50%+ of the combined X-S entity

(through ownership of X stock) after the acquisition transaction.

• Amount of remaining headroom will affect degree of post-spin flexibility re subsequent acquisitions of X stock.

• Importance of Tax Matters Agreement• Potential limitations on X’s ability to “disturb” S’s ATB for 2

years following the spin.

Morris Trust Transactions

42

Reverse Morris Trust Transaction

P

Public 1

Other

SubsS

S C/S

Wanted

Assets

S C/S

S X

Public 2

X C/S

S C/S

S

43

• Concept

• P wants to take S public in an IPO transaction.

• S issues a portion of its stock to the public, and then P

subsequently distributes the remainder of its S stock in a spin-

off.

• Rationale

• Cash proceeds received by S can be distributed to P (to extent

of basis).

• Establishes a public market valuation for S in preparation for

the subsequent distribution of P’s remaining interest in S.

• Structure

• Primary (S issues stock directly to public for cash) versus

secondary (P sells S stock to public for cash)

• Secondary is taxable => usually do primary and upstream cash to

the extent of basis (subject to any north/south concerns).

IPO Carve-Out Transactions

44

• Structure

• Size of carve-out

• High vote/low vote structure allows >20% offering, but also

deconsolidates S from the P group.

• Forming and then collapsing high vote/low vote structure

• Ability to recapitalize S into a high vote/low vote structure, then

do the offering and the spin, and then collapse the structure back

into a single class of stock after the spin.

• Formerly, so long as “no legally binding obligation” to collapse the

two classes.

• To extent Rev. Proc. 2016-40 applies, may need to wait 2 years

unless an unanticipated third party transaction occurs earlier.

IPO Carve-Out Transactions

45

IPO Carve-Out

P

S

Public

Other

Subs

80%

S C/S

$

IPO

Market$

20%

S C/S

46

Tax Matters Agreement – Responsibility for Tax Liability

• Distributing Company’s (or Spinco’s) Responsibility for

Tax Liability

• Pre- and Post-Distribution Date Liabilities

• Joint and Separate Tax Returns

• Allocations

• Responsibility/Indemnification for Tax Arising from

Breach/Jeopardizing Tax-Free Status

• Related Costs and Expenses

• Other Taxes

• Prior Payments

• Refunds and Credits

• Timing of Tax/Indemnification Payments

• Payment of Tax When Due, including Adjustments Upon Final

Determination

47

Tax Matters Agreement - Tax Return Prep and Filing

• Distributing Company’s (or Spinco’s) Responsibility for

Preparation and Filing

• Pre- and Post-Distribution Date Returns

• Straddle Period Allocations

• Joint and Separate Tax Returns

• Consolidated or Combined Tax Returns

• Consistent Treatment

• Items on tax returns treated in a manner consistent with past

practices

• Transactions reported consistent with tax opinion or

determined by liable party after good faith consultation

• Right of Advance Review and Opportunity to Comment

48

Tax Matters Agreement – Tax Return Prep and Filing

• Filing Adjustment Requests

• Treatment of Carrybacks

• Treatment of Tax Refunds or Credits

• Apportionment of Tax Attributes

• Amended Returns

• Subsequent Adjustment of Tax Attributes by Tax

Authority

49

Tax Matters Agreement – Reps and Warranties

• Distributing Company and Spinco Reps re: Tax-Free Status

• Spinco’s affirms correctness of reps re: plans, proposals, intentions and

policies

• Distributing Company affirms correctness of business purpose for distributions

and of reps re: plans, proposals, intentions and policies

• Each confirm no facts that jeopardize tax-free status or plans to take

inconsistent actions

• Spinco Restrictions Relating to Distributions for Two-Year Period

• Spinco to continue ATB

• No dissolution of Spinco

• No acquisitions or mergers (where Spinco would cease to exist)

• Restrictions on disposal of Spinco assets, stock redemption/repurchase,

affecting voting rights, allowing the acquisition (directly or indirectly) of 50% or

more of the stock of Spinco

Absent Notice and Obtaining a Ruling, Tax Opinion or Waiver by

Distributing Company

• Liability for Tax Losses

50

Tax Matters Agreement – Cooperation and Assistance

• Cooperation and Assistance of Parties in All Tax

Matters

• Prep and filing, determination of liability, exam, admin or

judicial proceeding

• Include agents and advisors

• Extend to information, documents and personnel

• Confirm prior and or obtain new tax opinions

• Maintain confidentiality

• Protect privileged material (no forced waiver)

• Protect commercially sensitive information

• Time is of the essence in the preparation of tax returns

• Upon request, certify accuracy and completeness of info on

which other party must rely

• Retention and access to tax records

51

Tax Matters Agreement – Tax Contests

• Who Controls Tax Contests?

• Involving Joint Returns? Affiliates? Spinco for Pre-Distribution

Period? Straddle Period? Taxes Arising from Jeopardizing

Tax-Free Status? Spinco for Post-Distribution Period?

Indemnification Rights?

• Timely Notice to Other Party

• Information Sharing

• Participation Rights (Provision of POA)/Consequences of

Breach

• Settlement Rights

• Duty of Diligent Defense

• Choice of Advisor

• Costs and Expenses

• Dispute Resolution

52

• Partial Participation Exemption System for Post-2017 Earnings

– Applies to overseas profits of US-based multinationals. No

further friction of a US tax upon repatriation (but caveats remain)

• Global Minimum Tax (GILTI) – 10.5% tax on foreign earnings of

US-based multinationals

• Base Erosion and Anti-Abuse Tax (BEAT) – Essentially limits tax

deductions on transactions between US and non-US affiliated

corporations, for both US and non-US headquartered groups

• One-Time Transition Tax on Historic Accumulated Earnings –

Generally imposed in 2017 on estimated US$2-3 trillion of overseas

historic earnings of US-based multinationals, payable over eight

years, thus allowing repatriation without further US tax (but, again,

caveats)

• Several Other Changes

Sweeping International Tax Changes

53

USP

FS1 FS2 FS3 FS4

Deficit in E&P Positive E&P Cash Third-Party Debt

• 15.5% on E&P to the extent of foreign cash or cash equivalents, and 8%

on all residual E&P. Foreign Tax Credits partially available.

• FS1 deficit in E&P offsets FS2 positive E&P in calculating tax base

• Neither related nor third-party debt decreases the cash E&P subject to

15.5% cash tax rate

• Payable over eight years, without interest charge

• Accelerated in certain events

• Diligence item for years to come if USP or US affiliate of USP is acquired

One Time Transition Tax on Overseas Earnings

54

Section 965 Issues

US Sub

FS1 FS2 FS3 FS4

USP

55

• What if USP spins or otherwise divests US Sub?

• What is “business deal” on who is paying over next 8 years?

• Many items could result in IRS adjustment to Section 965 amount.

E&P calculations, deficits, FTCs, procedural issues, even an

inversion!

• What if there is a FTC adjustment for pre-2017 year? Impacts 965

FTC.

• USP and US Sub need to address in tax sharing and indemnity

agreement.

Section 965 – Some issues to consider over next 8 years

56

Spin-offs and Corporate Separations: Issues and Planning ... · • Small ATB’s (“Hot Dog”...

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