More liberal Morris Trust rules.

• Author: Packard, Pamela
• Position: Ownership changes and limits on safe harbor transactions

Before Sec. 355(e)'s enactment, it was possible to have an ownership change in connection with a Sec. 355 distribution by combining the distribution with a tax-free reorganization, thereby avoiding some limits on tax-free Sec. 355 distributions. These transactions were referred to as Morris Trust transactions after the case that permitted them (Mary Archer W. Morris Trust, 367 F2d 794 (4th Cir. 1996)).

Sec. 355(e) was enacted to limit such distributions. A spin-off (as defined in the item, "Final Sec. 355(d) Regulations," p. 296) is disqualified under Sec. 355(e) if both the spin-off and an ownership change of 50% or more (by voting power or value) in either the distributing corporation (Distributing) or the controlled corporation (Controlled) occurs as part of a plan or series of related transactions.

Such a plan or series is presumed to exist if this ownership change occurs within two years before or after the spin-off. The spin-off is disqualified whether such ownership change occurs pursuant to a taxable acquisition or tax-free reorganization.

Sec. 355(e) was enacted to prevent perceived "disguised sales" or removal of assets from corporate solution without the taxes usually incurred--such as those under Sec. 311(b). However, practitioners consistently complained that these rules adversely affected spin-offs normally used for valid business purposes. For example, spin-offs used to facilitate a taxable or tax-free acquisition, a public offering or simply to create an attractive structure to provide equity compensation to key employees of a particular business, could potentially cause corporate-level taxes.

After considering practitioners' comments, the IRS withdrew the old proposed regulations and issued new ones on Jan. 2, 2001--which will apply to distributions after the final regulations are published. The old proposals (issued in 1999) provided the exclusive means for a taxpayer to show that a distribution and acquisition were not part of a plan. That guidance required the taxpayer to establish a plan's absence with clear and convincing evidence.

The new proposed regulations allow a taxpayer to use facts and circumstances to demonstrate that a distribution and acquisition are not part of a plan for Sec. 355(e) purposes. In the case of an acquisition after a distribution, a plan exists if, on the distribution date, Distributing, Controlled or their controlling shareholders intended that the acquisition or a similar acquisition occur...