Section 355(e): corporate spinoffs.

• Position: IRC section 355(e

August 5, 1999

On August 5, 1999, Tax Executives Institute submitted the following comments to the Internal Revenue Service concerning the definition of a "plan" for purposes of Internal Revenue Code section 355(e). TEI's comments were prepared under the aegis of TEI's Federal Tax Committee, whose chair is Philip G. Cohen, General Tax Counsel of Unilever United States, Inc. Contributing substantially to the development of TEI's comments was Gregory G. Postian, Associate General Tax Counsel, Unilever United States, Inc. Subsequent to TEI's submission, the IRS on August 19, 1999, promulgated proposed regulations interpreting the phrase "plan (or series of related transactions)" for purposes of section 355(e). See REG-116733-98.

In order to permit a tax-efficient separation or division of one line of business assets from another, section 355 of the Internal Revenue Code accords tax-free treatment to certain distributions by one corporation (the distributing corporation) to its shareholders of the stock or securities in another corporation (the controlled corporation). To address transactions that were perceived as abusing the tax-free status conferred by section 355, Congress added section 355(e) to the Code in The Taxpayer Relief Act of 1997.(1) A number of related provisions and conforming amendments were adopted at the same time, the cumulative effect of which is to revise substantially the conditions for obtaining a tax-free separation -- whether as a spin-off, split-off, or split-up(2) -- of one corporation from another pursuant to section 355. To date, no regulations have been issued under either section 7805(b) or the more specific grant of section 355(e)(5). These comments set forth the Institute's concerns and recommendations in respect of section 355(e), most especially the need for guidance limiting the potentially broad scope of the phrase "plan (or series of related transactions)."

Background

Tax Executives Institute, Inc. is the preeminent association of business tax executives in North America. Our more than 5,000 members represent 2,800 of the leading corporations in the United States and Canada. TEI represents a cross-section of the business community, and is dedicated to the development and effective implementation of sound tax policy, to promoting the uniform and equitable enforcement of the tax laws, and to reducing the cost and burden of administration and compliance to the benefit of taxpayers and government alike. As a professional association, TEI is firmly committed to maintaining a tax system that works -- one that is administrable and with which taxpayers can comply.

Members of TEI are responsible for managing the tax affairs of their companies and must contend daily with the provisions of the tax law relating to the operation of business enterprises. We believe that the diversity and professional training of our members enable us to bring an important, balanced, and practical perspective to the issues raised by section 355(e).

By combining a tax-free spin-off distribution under section 355 with a subsequent acquisition of either the distributing or controlled corporation by way of one of the methods for taxfree reorganizations (e.g., a statutory merger), a targeted group of assets can be isolated within a corporate group and transferred to a non-group member without incurring a corporate-level tax. That transactional format became commonplace following the IRS's acquiescence in the decision in Mary Archer W. Morris Trust v. Commissioner(3). In Morris Trust, a non-taxable spin-off of a bank's insurance business was followed by a non-taxable merger of the bank with another bank controlled by a new group of shareholders. More recently, the spin-off-and-merger format of Morris Trust transactions was coupled with a pre-distribution borrowing of substantial sums of money by the distributing (or distributed) corporation. Through a pre-arranged sequence of steps, corporate assets were transferred in exchange in part for the assumption of new debt (or a significant shift in existing debt) in a fashion that resembled a leveraged buyout or sale of assets.(4) In response to these transactions, Congress added section 355(e) to the Code to ensure that corporate-level transactions that were considered sufficiently similar to taxable sales or dispositions are treated as such for tax purposes.

Regrettably, the scope of the statutory language in section 355(e) is broader than necessary to thwart the transactions targeted by the legislative changes. In addition, the vague scope of the term "plan (or series of related transactions)" creates substantial uncertainty for taxpayers, which has a chilling effect on legitimate, commercial spin-off transactions. In order to afford taxpayers the guidance necessary to continue to effect tax-free spin-offs under section 355, the IRS and Treasury Department should issue proposed rules under section 355(e) as soon as...