The new anti-Morris trust and intragroup spin provisions.

• Author: Silverman, Mark J.

Introduction

Since the repeal of the General Utilities doctrine in 1986,(1)(*) one of the only ways in which corporations may distribute appreciated property to their shareholders without recognizing corporate-level gain is through the use of spin-off type transactions under section 355 of the Internal Revenue Code.(2) Often, corporations undertake such spinoffs to dispose of unwanted businesses in preparation for a tax-free acquisition by another corporation. For more than 30 years, these so-called Morris Trust transactions have been blessed as tax free under section 355,(3) provided the requirements of section 355 were met. Not anymore. The Taxpayer Relief Act of 1997 (hereinafter cited as "the 1997 Act")(4) added section 355(e) and (f), which severely limit these transactions.

This article analyzes sections 355(e) and 355(f) and other related changes that were made by the 1997 Act. Specifically, the article first describes the new provisions and their history; then it analyzes the language of the statute in the context of several examples and in light of the legislative history; and finally it provides recommendations to Congress and to the Department of the Treasury regarding what issues require additional guidance.

Description of the Statute and Its History

Following is a brief description of the new statutory language and the history of these provisions.

Description of Statutory Language

On August 5, 1997, President Clinton signed the 1997 Act. Section 1012 of the 1997 Act amends section 355 to place new restrictions on the acquisition and disposition of the stock of the distributing or controlled corporation. Section 1012 of the 1997 Act contains four basic provisions: (i) an anti-Morris Trust provision,(5) which is contained in new section 355(e); (ii) an intragroup distribution provision, which is contained in new section 355(f), (iii) a related provision contained in new section 358(g) authorizing the Treasury to issue basis adjustment regulations under section 358; and (iv) a modified control provision, which amends sections 351(c) and 368(a)(2)(H).

Section 355(e) - The Anti-Morris Trust Provision

Under new section 355(e), the anti-Morris Trust provision, a distributing corporation will recognize gain if one or more persons acquire, directly or indirectly, 50 percent or more of the stock (measured by vote or value) of the distributing or any controlled corporation as part of a plan or series of related transactions that was in place at the time of the distribution.(6) The distributing corporation recognizes gain equal to the "built-in" gain in the controlled corporation stock held by the distributing corporation.(7) No adjustment to the basis of the stock or assets of either corporation, however, is allowed by reason of the gain recognition.(8) The statute also creates a rebuttable presumption that any acquisition occurring two years before or after a section 355 distribution is part of such a plan.(9) For purposes of determining whether one or more persons has acquired a 50-percent interest, the section 318(a)(2) attribution rules generally apply (without regard to the 50-percent threshold of section 318(a)(2)(C)), and the aggregation rules of section 355(d)(7)(A) apply so that all related persons are treated as one person.(10) Moreover, except as provided in regulations, if a successor corporation in an A, C, or D reorganization acquires the assets of the distributing or any controlled corporation, the shareholders (immediately before the acquisition) of the successor corporation are treated as if they acquired stock in the corporation whose assets were acquired.(11) In short, section 355(e) essentially eliminates Morris Trust-type transactions and overturns more than 30 years of well-settled tax law.

The statute does, however, include several exceptions. For example, the following acquisitions are not taken into account for purposes of the anti-Morris Trust provision:(12)

* The acquisition of stock in the controlled corporation by the distributing corporation;

* The acquisition of stock in a controlled corporation by reason of holding stock in the distributing corporation;

* The acquisition of stock in any successor corporation of the distributing corporation or controlled corporation by reason of holding stock in such distributing or controlled corporation; and

* The acquisition of stock if the same shareholders own, directly or indirectly, 50 percent or more (measured by vote and value) of either the distributing or any controlled corporation before and after the acquisition.(13)

These exceptions apply only if the stock owned prior to the acquisition was not acquired as part of a plan to acquire a 50-percent or greater interest in either the distributing or controlled corporation.(14)

In addition, a plan (or series of related transactions) will not cause gain recognition under the new provision if, immediately after the completion of the plan or transaction, the distributing and controlled corporations are members of the same affiliated group.(15) The provision also does not apply to a distribution that would otherwise be subject to section 355(d), or a distribution pursuant to a title 11 or similar case.(16)

The anti-Morris Trust provision further authorizes Treasury to issue regulations necessary to carry out the purposes of the legislation, including regulations (i) providing rules where there is more than one controlled corporation, (ii) treating two or more distributions as one distribution, and (iii) providing rules similar to the substantial diminution of risk rules of section 355(d)(6) where appropriate for purposes of the legislation.(17) In addition, it extends the statute of limitations with respect to gain recognized under section 355(e), so that the statute does not expire until three years from the date the taxpayer notifies the Internal Revenue Service that the distribution occurred.(18)

For purposes of the anti-Morris Trust provision, any reference to a distributing or controlled corporation also refers to any predecessor or successor of the corporation.(19) Section 355(e) generally applies to distributions after April 16, 1997, unless certain transition rules apply.(20)

Section 355(f) -- Intragroup Distribution Provision

Under section 355(f), the intragroup distribution provision does not apply to any distribution of stock from one member of an affiliated group (whether or not the group files a consolidated return) to another member of such group, if the distribution is part of a plan or series of related transactions to which section 355(e) applies.(21) Section 1012(b)(2) of the 1997 Act also added section 358(g) to the Code, which authorizes Treasury to issue regulations to provide adjustments to the basis of group members' stock (whether or not section 355(e) applies) in order to reflect the proper treatment of intragroup distributions.(22) The intragroup distribution provision applies to distributions after April 16, 1997, unless certain transition rules apply.(23)

"Control Immediately After" Provision

Section 1012(c) of the 1997 Act relaxes the rule under sections 351 and 368(a)(1)(D) for determining control immediately after a section 355 transaction. Under the provision, shareholders receiving stock in a controlled corporation are treated as in control of the controlled corporation immediately after the distribution if they hold stock representing greater than a 50-percent interest by vote and value of such controlled corporation.(24) The former rule required 80 percent of the vote and 80 percent of each class of nonvoting stock as required by section 368(c). The statute does not, however, change the section 355 requirement that the distributing corporation distribute 80 percent of the voting power and 80 percent of each other class of stock of the controlled corporation in the transaction.(25) The change in the control test generally applies to transfers after August 5, 1997.(26)

History of the Statute

Administration's Budget Proposal

On February 6, 1997, the Clinton Administration, as part of its 1998 budget, proposed anti-Morris Trust legislation to be included in section 355(d).(27) The proposal would have required the distributing corporation (but not its shareholders) to recognize gain on the distribution of the stock of the controlled corporation, unless the direct and indirect shareholders of the distributing corporation, as a group, continued to own at least 50 percent of the total vote and value of both the distributing and controlled corporations at all times during the four-year period beginning two years before and ending two years after the distribution.(28)

In determining whether shareholders retain the requisite ownership of both corporations throughout the four-year period, acquisitions or dispositions of stock that are "unrelated" to the distribution would be disregarded. A transaction would be treated as unrelated if it were not "pursuant to a common plan or arrangement that includes the distribution."(29) For example, public trading of the stock in either the distributing or controlled corporation would be disregarded, even if the trading occurred in contemplation of the distribution.(30) Similarly, a hostile acquisition of the distributing or controlled corporation after the distribution would be disregarded -- but a friendly acquisition would generally be considered related to the distribution if it were pursuant to an arrangement negotiated (in whole or in part) prior to the distribution, even if it were subject to certain conditions (e.g., shareholder approval) at the time of the distribution.(31)

Archer/Roth/Moynihan Bill

On April 17, 1997, Representative Bill Archer, Chairman of the House Ways and Means Committee, introduced legislation in the House of Representatives(32) to restrict the use of section 355. Senator William Roth, Chairman of the Senate Finance Committee, and Senator Daniel Moynihan, Ranking Minority Member of the...