Step-transaction and the plan of reorganization
For various non-tax reasons, such as local country legal requirements or the timing of transaction approvals, taxpayers are often unable to accomplish a specific transaction in a single step. As a result, taxpayers often structure multi-step transactions to accomplish the intended tax and legal result. When those steps occur over a long period of time, questions often arise as to the ability of a taxpayer to step the transactions together into a qualifying reorganization. A recently issued private letter ruling provides taxpayers with helpful insight regarding the ability to structure multi-step transactions as a qualifying tax-free reorganization.
Generally, in the context of a section 368 reorganization, each step of the transaction needs to be treated as occurring in pursuance of the same plan of reorganization in order to qualify for tax-deferred treatment.1 Thus, a plan of reorganization must exist in order for a transaction to qualify as a tax-free reorganization. The plan of reorganization also serves to identify the beginning and end of a reorganization. Where multiple steps occur to satisfy the reorganization requirements, step-transaction doctrine generally applies to determine qualification.
In determining whether each step of a transaction is made pursuant to the same plan of reorganization, the IRS and the courts generally seek to conclude if a particular step is functionally integrated with the reorganization, without regard to time. However, proximity in time is often indicative of whether a series of steps are part of the same plan or rather if they are separate and distinct transactions. Moreover, plans of reorganization often are memorialized in the form of written documents; however, a written document is not required for there to be such a plan.2 In finding a plan of reorganization, the facts and circumstances are determinative, rather than the taxpayer’s assertion that steps were taken pursuant to a plan of reorganization.3
As stated above, the temporal proximity of a series of steps or transactions is not itself decisive in whether a plan of reorganization exists; rather, the surrounding facts and circumstances carry the most weight in this determination. In PLR 202128001, released July 16, 2021, the IRS ruled that an overarching plan of reorganization tied a series of transactions together even though they were anticipated to span over the course of five years. While not an exhaustive list, the following facts helped lead the Service to decide a plan of reorganization had been established, even given the length of time required to complete:
- The business activities of the taxpayer are subject to strict and complex regulatory regimes in multiple countries;
- The taxpayer needs to obtain approval from local regulatory authorities in each jurisdiction with regard to various steps;
- The taxpayer will be subject to lengthy, multi-step court approval processes; and
- The taxpayer is contractually obligated to transfer its business activities in a manner which is expected to take a significant amount of time.
For the reasons listed above, and since the taxpayer was committed to complete the transactions as quickly and reasonably possible for substantial economic reasons, including avoiding duplicative costs, administrative burdens, inefficient operations, potential reputational damage and other economic and practical consequences; the Service ruled that the steps are to be treated as occurring in pursuance of a plan of reorganization. It is worthy of note that five years is a long period of time between steps, and the local country regulatory approval process was a factor in the ruling. The ruling should not be looked at as establishing five years as some sort of guideline for application of step-transaction in structuring a multi-step transaction.
While time, or lack thereof, between different steps is a hurdle that taxpayers must overcome when dealing with tax-free reorganizations, it is not the be-all and end-all. What is novel about this PLR is the substantial amount of time that was required to complete the reorganization and that there was no binding commitment on the taxpayer to effectuate all of the steps. This PLR shows how much weight the Service lends to the factual development around a series of steps in determining if they meet the definition of a plan. On the flip side, taxpayers looking to avoid stepping a series of transactions together need to take extra care with their facts and circumstances, as they cannot simply let the passage of time between steps serve as their saving grace.
1Treas. Reg. section 1.368-1(c).
2Simon v. Commissioner, 644 F.2d 339 (5th Cir. 1981); rev'g and rem'g 71 T.C. 416 (1978).
3Atlas Tool Co. v. Commissioner, 614 F.2d 860 (3d Cir. 1980), aff'g 70 T.C. 86 (1978).