Does the IRS's new ruling policy on spin-offs enhance the desirability of tax insurance?

• Author: Perera, Nemo

Various forms of spin-offs remain popular tools for unlocking hidden corporate value and improving financial performance. Under an IRS pilot program, however, those seeking tax-advantaged spin-offs under section 355 of the Internal Revenue Code face new uncertainty in respect of the tax consequences of the transaction.

Specifically, in Revenue Procedure 2003-48, the Internal Revenue Service announced a one-year pilot program under which it will no longer issue advance rulings on key issues arising under -section 355. Previously, such so-called comfort rulings were available to resolve questions such as (i) whether a spin-off has an adequate corporate business purpose, (ii) whether a spin-off will be regarded as used principally as a device for the distribution of earnings and profits, and (iii) whether a spin-off and any prior or subsequent acquisition of stock in the Parent or the Spinco are part of a plan under section 355(e).

According to the revenue procedure, which was released on June 23, 2003, the IRS will continue to issue private letter rulings concluding that transactions qualify under section 355, but will base those rulings on the taxpayer's representations that the foregoing three core requirements are satisfied. Thus, the IRS may later question whether these requirements in fact were satisfied upon an audit of the corporation's or shareholders' tax returns. (The new policy does not apply to ruling requests postmarked or received by August 8, 2003.)

What lies behind the IRS's pilot program? Although the tax agency has generally eschewed the granting of advance rulings on essentially factual issues, section 355 rulings historically have been an exception. The IRS has concluded that it can better serve taxpayers by reallocating resources to promulgating (widely applicable) rulings and regulations to address open questions under section 355, rather than devoting those resources to rulings on specific factual questions relevant to only a single transaction.

The new policy will affect companies that are considering spin-offs, split-offs, reverse Morris Trust transactions or other transactions intended to qualify as tax-free to the corporation or its shareholders under section 355. Companies must now proceed without the assurance provided by an IRS advance determination that the requirements of section 355 are satisfied.

The representation on business purpose requires a company to list each corporate business purpose for the...