PLR 201935009 reinforces limited employee overlap in a spin-off

May 09, 2019
May 09, 2019
0 min. read

Private Letter Ruling 201935009 (the Ruling) is a good example of some of the factors that a taxpayer should consider when planning a spin-off. The Ruling addresses the issue of managerial and operational overlap under the active trade or business (ATOB) requirement for nontaxable spin-offs. In the Ruling, the IRS considered whether the overlap of employees and management of the two resulting corporations for a period of up to 12 months post spin-off satisfied the ATOB requirement. The IRS also considered whether a single individual may serve on the board of directors of both of the corporations after the spin-off. The IRS generally ruled that the spin-off qualified for nonrecognition treatment under section 355, thereby reiterating limited overlap, both in duration and function is permissible.

The Transaction

Under the Ruling, a U.S. consolidated group owned several foreign subsidiaries, one of which was a partner in a joint venture with an unrelated party. The distributing corporation (D) was the common parent of the consolidated group. 

The consolidated group conducted two lines of business, Business A and Business B. As part of the proposed transaction, D would form controlled (C) and contribute to C all of the assets and liabilities and the stock of the entities that comprise Business B in exchange for all of C's stock. Subsequently, D would distribute the stock of C pro rata among D's shareholders in a transaction described in sections 368(a)(1)(D) and 355.

In addition to the other applicable representations under Rev. Proc. 2017-52, the taxpayer represented that after the spin-off, the operational and managerial overlap of D and C would only continue for up to 12 months. In those 12 months, each corporation intended to assemble its own resources to perform its administrative and managerial functions, including a new CEO and Chairperson for D. D’s CEO and Chairperson would become the CEO and Chairperson for C but remain a member of D’s board of directors. The taxpayer further represented that other than that one-shared board member, the members of each board of directors would not otherwise overlap.1  The taxpayer moreover represented that any continuing relationship between D and C would be the provision of services offered to the public that the companies would transact at arm's length.

The ATOB Requirement

When assessing whether a proposed distribution of a corporation would qualify for nonrecognition treatment under section 355, there are several requirements that must be satisfied. These requirements include, inter alia, a valid non-tax business purpose, distribution of control, and the requirement that each of distributing and controlled are engaged in the active conduct of a trade or business.

One often-problematic requirement to satisfy is the ATOB requirement. Under the ATOB requirement, Distributing and Controlled must both carry on an ATOB immediately after the transaction.2  The ATOB of each company must carry on for-profit activities that have been conducted for at least five years before the spin-off3 and cannot have been acquired within that five-year period in a taxable transaction.4 The ATOB requirement also mandates that each corporation itself perform active and substantial managerial and operational functions.5  Each Company must have its own employees to perform these functions and its own board of directors with minimal overlap. Typically, however, the Service has allowed limited employee overlap often accompanied by a representation that any overlap is limited in duration. The Service has typically allowed this limited overlap when it is not otherwise inconsistent with the taxpayer’s business purpose.  

Taking into consideration the taxpayer’s representations around temporary overlap of the companies’ functions, the minimal extent of any ongoing overlap, and the arm’s length nature of any future dealings, the Service ruled in favor of the taxpayer holding that the transaction qualified for nonrecognition treatment under section 355.


PLR 201935009 reiterates that in order for a spin-off to qualify for nonrecognition treatment, there cannot be more than a minimal amount of overlap in the two resulting corporations’ essential functions and governance. It also underscores that two corporations must conduct any continuing relationships at arm's length. 

1 In Rev. Rul. 2003-74, the Service ruled that the board of directors for each of the resulting corporations may overlap where the overlap represents a minority of the board.

2 Section 355(a)(1)(C), (b)(1), and (b)(2)(A)

3 Section 355(b)(2)(B) 

4  Section 355(b)(2)(C) and (D).

5 Reg. section 1.355-3(b)(2)(ii) and (iii).

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