United States

IRS pauses section 355 rulings going forward, may halt ones in progress

INSIGHT ARTICLE  | 

As noted in our March 31, 2015, article, Yahoo spinoff poses more questions than answer, there has been much discussion about section 355 spinoffs as a result of Yahoo's announced spinoff of its Alibaba stake earlier this year. As the article states, numerous questions remain regarding whether the Alibaba distribution could satisfy the requirements of a tax-free spinoff. In its announcement of the planned spinoff, Yahoo stated that the spinoff would occur after the receipt of a private letter ruling from the IRS. However, on May 19, and in all likelihood as a response to Yahoo's announcement, an IRS representative for the Chief Counsel's office announced that the IRS had decided to reassess their ruling policy on spinoff transactions such as Yahoo's spinoff of Alibaba. In explaining the reasoning for the reassessment, complaints from outside the IRS as to the size of the active trade or business (ATB) in approved section 355 rulings were cited. The concern is whether having too small of an ATB inside the distributed company would cause the transaction to run afoul of the device test within section 355. This test prohibits transactions that are merely “devices” for the distribution of corporate earnings and profits tax-free. Currently there is no minimum ATB value required by section 355. Section 355(g) limits investment assets (cash, stocks, bonds, etc.) to two-thirds of the value of the corporation. However, stock of a subsidiary that is more than 20 percent owned by the corporation is not an investment asset, hence Yahoo's greater than 20 percent ownership in Alibaba is not an investment asset. This concern could also be present in the recent private letter rulings provided in the spinoff of real estate investment trusts (REITs) that relied upon a relatively small and unrelated business to satisfy the ATB requirement. REIT assets are not generally considered investment assets, yet they have represented the vast majority of the value in many REIT spinoffs.  

The IRS representative stated that it will decide whether to issue guidance on this in the next few months.  For Yahoo shareholders and companies looking to take advantage of section 355 REIT spinoffs, the next couple months could bring some substantial changes to their tax planning. At this point it is unclear whether Yahoo would go ahead with the spinoff relying on their tax advisors, but indications are that they may go ahead without a private letter ruling. 

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