Control requirement in divisive "D" reorganizations.

• Author: Cohen, Lawrence H.

In two related (but easily overlooked) 1998 legislative changes, Congress again amended the definition of "control" for Sec. 368(a)(1)(D) purposes in connection with a divisive reorganization to which Sec. 355 applies. (Conforming amendments were also made to Sec. 351(c)(2)). The effect of these amendments on the "control" requirement is to prevent a postdistribution change in the ownership of either the distributing or controlled corporation from adversely affecting gain nonrecognition on the transfer of assets from the distributing to the controlled corporation. Consequently, corporations now have greater flexibility in restructuring their businesses.

The "Control" Requirement

To qualify as a divisive D reorganization, the transferor corporation's (Distributing's) shareholders must be in control of the transferee corporation (Controlled) immediately after the property transfer. Control was long defined for this purpose as ownership of 80% or more of a company's voting power, and at least 80% of the total number of shares of all other classes of stock. Any change in stock ownership that occurred soon after the distribution of Controlled was taken into account and could prevent the control requirement from being satisfied; see Rev. Rul. 70-225. Congress changed the definition of control in a divisive D reorganization in 1997, and again in 1998.

Background

In recent years, Congress has tightened the Secs. 355 and 368(a)(1)(D) requirements to prevent potential abuses, including the avoidance of repeal of the General Utilities doctrine. In 1990, Congress added Sec. 355(d) to require Distributing to recognize gain on a "disqualified" distribution (one in which any person owns 50% or more of Distributing or Controlled) if the interest was acquired in a taxable transaction within five years of the distribution.

TRA '97

In the Taxpayer Relief Act of 1997 (TRA '97), Congress added Sec. 355(e), the so-called "anti-Morris Trust" rule. This provision requires Distributing, in an otherwise qualifying tax-free separation, to recognize gain as if it had sold the stock of Controlled if 50% or more of the stock of either corporation was acquired as part of a plan that existed at the time of the distribution. Because Congress was clearly allowing a less-than-50% postdistribution change in ownership of either Distributing or Controlled (in a disposition that does not constitute a prohibited device) without adversely affecting the tax-free qualification of...