Consolidated Corporation Treasury Regulations and Subchapter C Considerations. E.J. Forlini Principal Deloitte Tax LLP

Transcription

1 Consolidated Corporation Treasury Regulations and Subchapter C Considerations E.J. Forlini Principal Deloitte Tax LLP December 9, 2015

2 Agenda Section 355 Spin-Offs Background Technical developments: Small ATB Spin-Offs Final F Reorganization Regulations Treas. Reg (m) Proposed Next Day Rule Regulations Treas. Reg Strategic Tax Conference Copyright 2015 Deloitte Development LLC. All rights reserved.

3 Section 355 Spin-Offs

4 Background

5 Section 355 In general In general, a spin-off involves the legal separation of one or more of a company s business lines (Distributing) through a distribution of stock of a company holding the unwanted business lines (Controlled) to the company s shareholders. A spin-off that qualifies under section 355 is a narrow exception to the generally applicable rules that require a corporation to recognize gain on the distribution of appreciated property (section 311) and a shareholder to recognize income or gain (section 301). Section 355 spin-offs have become increasingly popular in recent years due to activist investors, investment bankers, and market demands to tailor investment growth and risk of companies to investor preferences, e.g., by breaking up conglomerates with diversified holdings. Section 355 only applies where the relevant statutory and non-statutory requirements are met. Copyright 2015 Deloitte Development LLC. All rights reserved

6 Section 355 In general In general, these requirements are intended to prevent the use of section 355 as an inappropriate means of: Avoiding corporate level tax on the distribution of appreciated property following the repeal of General Utilities; or Avoiding shareholder level tax on the distribution of earnings and profits. The IRS had an active letter ruling (PLR) practice that provided guidance to taxpayers planning to undertake a spin-off, a necessity in certain instances due to the complexity of the tax-free spin-off rules and the stakes involved. The IRS has significantly scaled back its ruling practice through recent guidance, although opportunities remain to obtain certainty with respect to certain aspects of a section 355 spin-off. As a result of this changed ruling policy, and because qualifying a distribution under section 355 is critically important to both the distributing corporation and its shareholders, companies generally obtain an opinion from their tax advisor that the transaction will be tax-free (and a significant issue ruling from the IRS on related issues, if available). Copyright 2015 Deloitte Development LLC. All rights reserved

7 Section 355 In general Because an opinion requires substantial documentation, numerous management representations, and a detailed technical analysis, 2-3 months are generally required for its preparation. Obtaining a ruling is likely to take somewhat longer, given reduced staffing at the IRS. Further, Treasury and the IRS are considering certain substantial changes to the requirements under section 355, particularly with respect to distributions involving a relatively small active trade or business (an ATB) and with respect to regulated investment companies (a RIC) or real estate investment trusts (a REIT). These substantive changes may impact more routine section 355 distributions. Copyright 2015 Deloitte Development LLC. All rights reserved

8 Section 355 Principal Requirements and Provisions Business Purpose The Spin-Off must be motivated by a real and substantial corporate-level business purpose or purposes. Active Trade or Business Distributing and Controlled must each have its own five-year active trade or business ( ATB ). Device Prohibition The Spin-Off must not be used principally as a device to distribute the E&P of Distributing or Controlled (e.g., to sell stock of either Distributing or Controlled). Pre-Spin Control and Distribution of Control Distributing must distribute at least 80-percent of the Controlled stock to its shareholders. Any retention of Controlled stock must not be part of a plan having as one of its principal purposes the avoidance of federal income tax tax, to the satisfaction of the IRS. Continuity of Shareholder Interest ( COI ) The historical Distributing shareholders must own and retain at least 50 percent of each corporation after the distribution. Continuation of Business Each corporation must intend to continue operating its ATB. Copyright 2015 Deloitte Development LLC. All rights reserved

9 Section 355 Principal Requirements and Provisions Section 355(d) Disqualified Distributions Immediately after the distribution, no person can hold 50 percent or more of the Distributing or Controlled stock the ownership of which is attributable to Distributing or Controlled stock purchased within the preceding five years. If applicable, the Spin-Off is taxable at the corporate level (but not at the shareholder level). Section 355(e) Prohibited Acquisitions The distribution cannot be part of a plan that results in the acquisition of 50 percent or more of either Distributing or Controlled. This provision is applicable if section 355(d) does not apply, and also causes the Spin-Off to be taxable at the corporate level (but not at the shareholder level). Section 355(g) Disqualified Investment Corporation Investment assets cannot represent 2/3 or more of the total value of either Distributing or Controlled. Copyright 2015 Deloitte Development LLC. All rights reserved

10 Section 355 IRS Ruling Guidelines Rev Proc set forth a checklist of information that had to be included in a ruling request under section 355. Pre- Rev. Proc : The IRS issued PLRs on whether the transaction as a whole qualified under section 355. Rev. Proc : The Service stated that it would no longer rule on the Business Purpose Requirement, Non-Device Requirement, or section 355(e) plan issues. Rev. Proc : The Service announced three new no-rules: (i) recapitalizations into control in a spin-off; (ii) North-South Transactions (applicable beyond just spin-offs); and (iii) debt issued in anticipation of a spinoff. Rev. Proc : The ruling program for section 355 spin-offs was substantially withdrawn, leaving only rulings on significant issues. Significant is defined as an issue that is (i) not essentially free from doubt and (ii) germane to the tax consequences of the transaction. Rev. Proc : The Service announced the three new no-rules discussed below for PLR requests postmarked or received on or after September 14, 2015, that relate to spin-offs occurring after that date. Copyright 2015 Deloitte Development LLC. All rights reserved

11 Technical developments: Small ATB spin-offs

12 Small ATB spin-offs: In general Treasury and the IRS are currently studying issues under section 337(d) (granting authority to issue rules related to GU-repeal) and section 355 for spin-offs where: Distributing or Controlled has a relatively small active trade or business (ATB) in relation to all of its assets; Distributing or Controlled holds investment assets with a substantial FMV in relation to FMV of all of its assets and ATB assets; The ratio of investment assets to non-investment assets differs significantly between Distributing and Controlled; or An election is made by Distributing or Controlled to be treated as a RIC or a REIT. See Notice In Notice , the government provides that spin-offs that exhibit one or more of the above characteristics may raise section 355 issues under the ATB Requirement, the Business Purpose Requirement, and the Non-Device Requirement. The government has publicly stated that any future guidance with the form of such guidance undecided will be prospective. In the meantime, the IRS has scaled back its ruling practice through three new norules and, in general, will not issue PLRs on spin-offs that exhibit the characteristics listed above. See Rev. Proc Copyright 2015 Deloitte Development LLC. All rights reserved

13 Small ATB spin-off Spin-Off Post-Spin-Off Public 2 Public <20% Company X 1 Company X NewCo <20% Company Z NewCo Company Z Company X owned less than 20 percent of Company Z, a publicly traded company, with the portfolio stock representing a substantial asset of Company X. Transaction: Step 1: Company X forms NewCo and transfers its minority interest in Company Z and a small ATB to NewCo. Step 2: Company X distributes NewCo to its shareholders. At the time of the spin-off, it is anticipated that the FMV of the ATB assets in NewCo would represent, e.g., less than 5 percent, of the FMV of NewCo s assets. Copyright 2015 Deloitte Development LLC. All rights reserved

14 ATB Requirement: Rev. Proc and Notice No-Rule # 1. In Rev. Proc , the IRS set forth a no-rule that ordinarily applies to a spin-off if the gross assets of the ATB has a FMV less than 5 percent of the FMV of the gross assets of Distributing or Controlled (measured immediately after the spin-off). For the 5 percent threshold, all members of a separate affiliated group (a SAG ) are treated as a single corporation and may attribute gross assets of a partnership if rely on partnership business for ATB Requirement. The 5 percent no-rule generally does not apply to internal spin-offs. The no-rules apply to any issue relating to the spin-off s qualification under section 355 and related provisions (or to another spin-off which is part of the same plan or series of related transactions). Not ordinarily means that unique and compelling reasons must be demonstrated to issue the PLR. In Notice , the IRS states that Treasury and the IRS have concluded that, under current law, distributions involving a small ATB may have become less justifiable (noting that such transfers were common under the prior holding company rule in section 355(b)(2)(A)). Do Rev. Proc and Notice indicate a change in the IRS position that may be seen in IRS audit and exam? Copyright 2015 Deloitte Development LLC. All rights reserved

15 The Non-Device Requirement: Rev. Proc and Notice No-Rule # 2. In Rev. Proc , the IRS includes as a no rule that will apply until further study is completed, a distribution where: The FMV of the investment assets of Distributing or Controlled is 2/3 or more of the FMV of its gross assets; The FMV of the gross assets of the ATBs on which Distributing or Controlled relies is less than 10 percent of the FMV of its investment assets The ratio of the FMV of the investment assets to the FMV of the non-investment assets of Distributing or Controlled is three times or more of such ratio for the other corporation. All members of a SAG treated as a single corporation and can attribute the gross assets of a partnership if rely on partnership business for ATB Requirement. Investment assets are defined by reference to section 355(g)(2)(B), with modification. The no-rule generally does not apply to internal spin-offs. The no-rule applies to distributions in which investment assets are disposed of or ATB assets are acquired for a principal purpose of avoiding the no-rule. The IRS provides in Notice that Treasury and the IRS believe that characteristics of the spin-offs described in the no-rules may overcome certain nondevice factors : (i) public trading and (ii) non-pro rata distribution. Copyright 2015 Deloitte Development LLC. All rights reserved

16 Final regulations for reorganizations under Section 368(a)(1)(F)

17 Final F reorganization regulations On September 18, 2015, the IRS and the Treasury published final regulations (T.D. 9739) (the Final Regulations ) that provide guidance on the qualification of a transaction as a reorganization under section 368(a)(1)(F) (an F Reorganization ) Generally adopt the provisions of the 2004 proposed regulations Effective for transactions occurring on or after September 21, 2015 Six requirements for an F Reorganization Test begins when the transferor corporation begins transferring its assets to the resulting corporation, and ends when the transferor corporation has liquidated 16 Strategic Tax Conference Copyright 2015 Deloitte Development LLC. All rights reserved.

18 F reorganization requirements 1. Resulting corporation stock distributed in exchange for transferor corporation stock 2. Identity of stock ownership 3. Resulting corporation has no prior assets or attributes De minimis assets permitted as well as proceeds of borrowings 4. Liquidation of transferor corporation But can retain de minimis assets to preserve legal existence 5. Resulting corporation is the only acquiring corporation No other corporation may hold property of transferor corporation if that corporation could succeed to attributes under 381(c) 6. Transferor corporation is the only acquired corporation Resulting corporation must not have succeeded to attributes under section 381(c) 17 Strategic Tax Conference Copyright 2015 Deloitte Development LLC. All rights reserved.

19 Example 1: Cash redemption Treas. Reg (m)(4) example 2 The management of X, a State A corporation, determines that it would be in the best interest of X to reorganize under the laws of State B X forms Y, a State B corporation, and X merges into Y In the merger, A surrenders X stock and receives cash, and B surrenders X stock and receives all of the stock of Y As the change in ownership results from a distribution and exchange described in Treas. Reg (m)(1)(ii), A s surrender of X stock for cash is treated as a transaction, separate from the reorganization, to which section 302(a) applies The merger of X into Y qualifies as an F Reorganization A 75 % X Y B 25 % Merges into Y 18 Strategic Tax Conference Copyright 2015 Deloitte Development LLC. All rights reserved.

20 Example 2: Other acquiring corporation Treas. Reg (m)(4) example 9 A and the management of P determine that it would be in the best interest of S to completely liquidate while A continues to operate part of the business of S in corporate form S distributes 80 percent of its assets to P and 20 percent of its assets to A, S dissolves, and A contributes the assets it receives from S to newly incorporated New S in exchange for all of the stock of New S S s distribution of 80 percent of its property to P as part of the complete liquidation of S meets the requirements of section 332 P 80% 20 % A S New S 19 Strategic Tax Conference Copyright 2015 Deloitte Development LLC. All rights reserved.

21 Example 2: Other acquiring corporation (cont d) Treas. Reg (m)(4) example 9 As section 381(a)(1) applies to P s acquisition of 80 percent of the property held by S immediately before the transaction, the potential F Reorganization in which 20 percent of the property held by S immediately before the transaction is transferred to New S cannot be a mere change of S Therefore, sections 331 and 336 apply to A s acquisition of property from S and the distribution by S of property to A, and section 351 applies to A s contribution of that property to New S P 80% S 20 % A New S 20 Strategic Tax Conference Copyright 2015 Deloitte Development LLC. All rights reserved.

22 Other rules Related events rule Related events that precede or follow a potential F Reorganization generally will not cause the potential F Reorganization to fail to qualify as an F Reorganization Qualification of certain steps as an F Reorganization will not alter characterization of other transactions Step transaction principles may apply to other transactions without regard to whether certain steps qualify as an F Reorganization Overlap rules New fifth and sixth requirements address potential overlap of a potential F Reorganization or step thereof with other reorganizations Another new rule provides that a potential F Reorganization will not qualify as an F Reorganization if it (or a step thereof) qualifies as a reorganization or part of a reorganization under another provision of section 368(a)(1), and if a corporation in control of the resulting corporation is a party to such other reorganization 21 Strategic Tax Conference Copyright 2015 Deloitte Development LLC. All rights reserved.

23 Example 3: Series of related transactions Treas. Reg (m)(4) example 13 P acquires all of the stock of T in exchange for consideration consisting of $50 cash and P voting stock with a value of $50 X P No election is made under section 338 As part of the same plan, P forms S, and T merges into S T T Although the merger of T into S, viewed individually, appears to constitute a mere change, when viewed together with the acquisition of the T stock by P, the steps qualify as a reorganization under section 368(a)(1)(A) by reason of section 368(a)(2)(D) P s momentary ownership of T is disregarded, and the transfer from T to S does not qualify as an F Reorganization T P Merges into S S 22 Strategic Tax Conference Copyright 2015 Deloitte Development LLC. All rights reserved.

24 Proposed Next Day Rule Regulations

25 Proposed Next Day Rule Guidance Development: Proposed Regulations under Treas. Reg Treas. Reg prescribes rules for determining the taxable period in which items of income, gain, deduction, loss and credit ( tax items ) of a corporation that joins in filing a consolidated return are included. Affects: Corporate taxpayers and the consolidated groups they join or leave The proposed regulations are intended to address uncertainty regarding the appropriate allocation of tax items between consolidated return and separate return years under the so-called Next Day Rule. Effective date: The proposed regulations have a prospective effective date (i.e., they would become effective upon finalization). Tax professionals with clients that are considering relevant transactions should be mindful of the proposed regulations and make inquiry whether they have been finalized. 24 Strategic Tax Conference Copyright 2015 Deloitte Development LLC. All rights reserved. 24

26 Taxable year of consolidated group: (Current law) Timing Departing/Joining member leaves/enters group at close of the day for all U.S. federal income tax purposes Appropriate adjustments must be made if another provision of the Code or the underlying regulations contemplate the event occurring before the change in status of S Next day rule: Certain items incurred on the day of change in status are deemed to occur on next day 25 Strategic Tax Conference Copyright 2015 Deloitte Development LLC. All rights reserved.

27 Next day rule: (b)(1)(ii)(B) If on the day of change in status of S as a member, a transaction occurs that is properly allocable to the portion of S s day after the event resulting in the change, S and all persons related to S under section 267(b) immediately after the event must treat the transaction for all Federal income tax purposes as occurring at the beginning of the following day. A determination as to whether a transaction is properly allocable to the portion of S s day after the event will be respected if it is reasonable and consistently applied by all affected persons. 26 Strategic Tax Conference Copyright 2015 Deloitte Development LLC. All rights reserved.

28 Proposed regulations: On March 5, the Service released Proposed Regulations that would modify and clarify the rules under , including a replacement of the Next Day Rule These regulations are generally proposed to be effective for corporations joining/leaving a consolidated group after the regulations are finalized The preamble observes that the regulations are necessary in order to resolve uncertainty regarding the appropriate application of the current Next Day Rule and to tailor the rule to clearly reflect taxable income 27 Strategic Tax Conference Copyright 2015 Deloitte Development LLC. All rights reserved.

29 Proposed Regulations: (cont d) The Proposed Regulations would remove the current Next Day Rule and replace it with a rule that Applies only to extraordinary items resulting from transactions on the day of the change in status but AFTER the event causing the change Is mandatory in its application Expressly excludes an extraordinary item that occurs simultaneously with the event causing the change in status Under the current regulations, however, the IRS has disputed the application of the Next Day Rule to compensation-related deductions arising simultaneously with S s change in status. See GLAM ; TAM Applies only to the reporting of the joining/departing member s tax items Modifies the treatment of items recognized on the acquisition date for purposes of Section 382(h) relating to the treatment of NUBIG and NUBIL 28 Strategic Tax Conference Copyright 2015 Deloitte Development LLC. All rights reserved.

30 Example S P Facts: P purchases the stock of S on June 30 pursuant to a stock purchase agreement. S has outstanding nonqualified stock options issued to certain employees. Under the option agreements, S is obligated to pay its employees certain amounts in cancellation of their stock options upon a change in control of S. P s purchase of S s stock causes a change in control of S, and S s obligation to make option cancellation payments to its employees becomes fixed and determinable upon the closing of the stock purchase. S pays its employees the amounts required under the option agreements. S 29 Strategic Tax Conference Copyright 2015 Deloitte Development LLC. All rights reserved. 29

31 Example: Analysis Analysis: P s purchase of S s stock causes S to become a member of the P group at the end of the day on June 30. S s liability to pay its employees in cancellation of their stock options in connection with S s change in status is an extraordinary item and must be allocated to June 30. The Proposed Next Day Rule is inapplicable to this deduction because S s liability to pay its employees becomes deductible on the day of S s change in status simultaneously with the event that causes S s change in status. Under current law there likely is some flexibility on whether the Next Day Rule applies in this situation. A deduction for the option cancellation payments must be reported under the end of the day rule on S s tax return for the period ending June Strategic Tax Conference Copyright 2015 Deloitte Development LLC. All rights reserved. 30

32 Contact info E.J. Forlini Principal Washington National Tax Deloitte Tax LLP Copyright 2015 Deloitte Development LLC. All rights reserved.