In a spin-off, a corporation (Distributing) distributes stock of a subsidiary (Controlled) to its shareholders. A spin-off must meet various requirements to qualify for tax-free treatment.
In addition to a distribution of Controlled stock to Distributing’s shareholders, some spin-offs may involve distributions of Controlled stock (or debt securities) to holders of Distributing’s debt securities. A successful leveraged spin-off permits Distributing to pay off some of its debt using Controlled stock without incurring the federal income tax liability that would result from a sale of the stock for cash.
Prior IRS leveraged spin-off practice
The IRS in the past issued a number of private letter rulings approving of leveraged spinoffs involving issuance of debt in anticipation of the spin-off. In 2013, the IRS stopped issuing rulings covering these spin-offs that. In 2017, the IRS announced in that it would resume issuing rulings in this area but did not specify new ruling requirements (see our prior Alert addressing Revenue Procedure 2017-38).
Debt issuance in anticipation of spin-offs under new Rev. Proc. 2017-38
Now the IRS has set out new, detailed ruling requirements for these spin-off transactions in Rev. Proc. 2018-53. Overall, it represents highly welcome guidance – it provides a road map for an important private letter ruling process, and sets out principles to guide analysis of leveraged spinoffs.
The Revenue Procedure sets out standard representations for taxpayers to make regarding debt issued in anticipation of a spin-off. These representations generally would show that:
- Distributing is the obligor in substance on the debt
- The debt holders are not related to distributed or controlled
- The debt holders hold the debt for their own benefit
- The debt was issued before the private letter ruling request is filed and no later than 60 days before the announcement, agreement, or approval of the spin-off (unless an exception is met)
- The debt does not exceed the historic average of distributing’s applicable debt amounts over the past eight fiscal quarters
- The debt repayments (or exchanges) generally will occur no later than 30 days, and
- Distributing will not borrow additional funds outside of the ordinary course of business under existing lending commitments
Rev. Proc. 2018-53 permits taxpayers to satisfy its requirements with the standard representations or, in some instances, with alternative explanations that are consistent with the tax principles it mentions. It applies to ruling requests received by the IRS (or postmarked) after Oct. 3, 2018. Its ruling requirements will also be useful outside of the IRS private letter ruling process, since companies and their tax advisors can apply the requirements and principles where no IRS ruling is sought.
60-day rule for new Distributing corporation debt
The 60-day rule noted above is noteworthy. Under that rule, new Distributing debt that will be satisfied in a spin-off generally must be issued no later than 60 days before the announcement, agreement, or approval of the spin-off.
The IRS formerly had granted rulings that allowed the parent company to issue the new debt to banks that purchased the debt at least five days before the spin-off was declared and 14 days before the actual spin-off. The banks would then hold those debt securities for at least 14 days. These five- and 14-day periods were not set out in binding guidance, but appeared in a number of rulings.
Now, under the 60-day rule noted above, the IRS generally will require the new debt to be issued sooner. However, there are exceptions to this 60-day rule in Rev. Proc. 2018-53. An exception may apply, for example, if the parent company’s new debt securities are issued to pay off old parent debt, or if the spun off company will receive the cash raised by issuance of the new debt.
The IRS has provided specific and welcome guidance for certain leveraged spin-off transactions in Rev. Proc. 2018-53. Taxpayers considering leveraged spin-offs should consult with a qualified tax advisor.