IRS issues guidance on Sec. 355 active-trade-or-business test.

• Author: Simpson, Kirsten

The Service issued Notice 2006-81, providing guidance on newly enacted Sec. 355 (b)(3).

The notice addresses the continuing applicability of the "holding company" test of Sec. 355(b)(2)(A), as well as the transition rule of Sec. 355(b)(3)(C).

Background

The Tax Increase Prevention and Reconciliation Act of 2005, signed into law May 17, 2006, added Sec. 355(b) (3)(A), providing that, for distributions made after that date and before 2011, a corporation will be treated as meeting the active-trade-or-business requirement of Sec. 355(b)(2)(A) "if and only if such corporation is engaged in the active conduct of a wade or business" For purposes of the new rule, all members of a corporation's separate affiliated group are treated as one corporation. A corporation's separate affiliated group is defined as the affiliated group determined under Sec. 1504(a) as if such corporation were the common parent and Sec. 1504(b) did not apply.

Under Sec. 355(b)(3)(C), the following transactions are excluded from the new rule: those (1) made under an agreement binding on May 17, 2006, and at all times thereafter; (2) described in a ruling request submitted to the IRS before May 18, 2006; and (3) described before May 18, 2006, in a public announcement or in a filing with the Securities and Exchange Commission. However, the distributing corporation may make an irrevocable election not to apply the transition rule to its distributions.

Notice 2006-81

Holding-company test: Sec. 355(b) (2)(A) provides generally that, for Sec. 355(b)(1) purposes, a corporation is treated as being in the active conduct of a trade or business if and only it is engaged in the active conduct of a wade or business, or if substantially all of its assets consist of stock and securities of a corporation controlled by it (immediately after the distribution) that is so engaged. The latter test is referred to as the holding-company test. For this purpose, one corporation is "controlled" by another if the parent owns stock possessing at least 80% of the total combined voting power of all classes of stock entitled to vote, and at least 80% of the total number of shares of all other classes.

The continuing applicability of the holding-company test was not clear in light of new Sec. 355(b)(3)(A). However, Notice 2006-81 states that "in light of the restrictive language in [section] 355(b)(3), the Holding Company Test does not apply to any distribution for which [section] 355(b)(3) applies." Thus...