Expansion vs. acquisition of an active trade or business for sec. 355 purposes.

• Author: Packard, Pamela

When a business grows, it may treat acquisitions as either an expansion of the existing business or as the creation of a new one. The distinction has important tax consequences for both acquisitions and subsequent dispositions. In clarifying when a business acquisition is an expansion qualifying for gain nonrecognition on a subsequent Sec. 355 stock distribution, the Service recently issued Rev. Rul. 2003-18, continuing its trend of issuing more published guidance.

However, Rev. Rul. 2003-18 provides guidance on only one aspect of the Sec. 355 active trade or business requirement. Thus, for a corporation to spin off a controlled subsidiary so that the distributing corporation and its shareholders receive tax-free treatment, it must meet many other stringent requirements under the Code, regulations and judicial doctrines. Consequently, many taxpayers should obtain a letter ruling when contemplating a spin-off.

Background

To meet the requirements for a tax-free Sec. 355 division, a distributing corporation and a controlled corporation must have been actively conducting a trade or business (through the date of the transaction) throughout the five-year period before the transaction, and they must not have acquired the trade or business in a transaction in which they recognized gain or loss (in whole or part) within the previous five-year period. In determining whether they were conducting an active business throughout this period, it is irrelevant that the business added new products or changed its production capacity, provided that the change did not constitute the acquisition of a new or different business. A corporation actively engaged in one business that purchases, creates or otherwise acquires another business in the same line, is generally treated as having expanded the original business. The expanded business is then treated as having been actively conducted during the previous five-year period, unless the acquisition effected a significant change that constituted the acquisition of a new or different business. In the past, the IRS's determinations of a separate line of business have tended to be subjective; thus, the standard has remained difficult to interpret.

Facts

Rev. Rul. 2003-18 concluded that the IRS would treat an automobile dealer's acquisition of a different or second brand of dealership, under certain circumstances, as an expansion of an existing business, rather than as an acquisition of a new or different one under Sec...