Hook stock in general.

• Author: Fairbanks, Greg A.
• Position: Tax issues

Regs. Sec. 1.7874-1 defines hook stock for purposes of calculating tax on the inversion gain of expatriated entities. More broadly, the term hook stock is used to describe stock of a corporation that is held by an entity in which the corporation, indirectly or directly, holds an interest. The most common example of hook stock is stock of a parent corporation held by the parent corporation's subsidiary.

Hook stock arises from various types of transactions. For example, an acquiring corporation (most likely a publicly traded one) may purchase a target entity that already holds an interest in the acquiring corporation. An affiliated group may enter into an inversion transaction whereby the old parent continues to hold stock in the new parent. It could also arise when a subsidiary purchases the stock of the parent corporation from a third-party or from the parent.

Because hook stock is commonly parent corporation stock held within a consolidated group, it is often confused with treasury stock. Unlike treasury stock, hook stock provides its owner with the various indicia of stock ownership--vot-ing rights, dividend rights, and liquidation rights (see Himmel, 338 F.2d 815 (1964)), although some states may not allow hook stock to vote. When a corporation makes a pro rata distribution, the distributing corporation makes a distribution to the hook stock shareholders, whereas it would not make a distribution on the treasury stock.

Letter Ruling 201341004

In Letter Ruling 201341004 (the facts and steps have been simplified for purposes of this item), a wholly owned subsidiary (Subsidiary) of a parent corporation (Parent) established a grantor trust under Sec. 671 (at the end of the ruling, the grantor trust is referred to as a "rabbi trust"). The grantor trust held assets on Subsidiary's behalf to satisfy obligations under three unfunded deferred compensation plans. Among the assets the grantor trust held was stock in the parent corporation (i.e., hook stock).

Parent proposed a series of transactions whereby it would spin off one of its business lines to its shareholders. First, Subsidiary formed a new corporation, Controlled, and contributed certain business assets to Controlled in exchange for Controlled's outstanding stock. Next, Subsidiary distributed Controlled's stock to Parent. After entering into certain financing transactions, Parent distributed all of Controlled's stock pro rata to its shareholders. Because Subsidiary held Parent's stock in trust, Subsidiary received Controlled's stock (likely less than 20% of the outstanding stock) as part of the spinoff.

In its ruling, the IRS held that Parent ould recognize no gain or loss on the distribution of Controlled stock to its shareholders. Further, the IRS concluded that the Controlled stock received by Subsidiary was not "in pursuance of a plan having as one of its principal purposes the avoidance of U.S. federal income tax within the meaning of section 355(a)(1)(D)(ii)."

The...