Private Letter Ruling 202322015, 06/02/2023, IRC Sec. 355
Summary: Entity “A” is a corporation from country A and is the parent company of a global group. “A” owns all the stock of Corporation “B”. “A” and “B” own all the outstanding stock of Distributing. Distributing owns various corporations, disregarded entitites under Treas. Reg. § 301.7701-3 for U.S. tax purposes and partnerships. Distributing and its eligible members file a consolidated U.S. federal income tax return as a group (“Distributing Group”). “A” and “B” financed the purchase and operations of Business B through intercompany advances (“Shareholder Advances”). The Shareholder Advances were made over several years and were not formally documented and no interest or principal payments were made. The IRS examined the Distributing Group’s 1 to 4 fiscal years tax returns and determined that the Shareholder Advances should be treated as equity rather than debt for tax purposes. The Shareholder Advances were recorded as paid-in capital on Distributing’s returns. On tax years 5 to 7, “B” made additional advances to Controlled and it intends to treat those advances as paid-in capital contributions. Distributing will depend on Business A, and Controlled will depend on Business B to meet the active trade or business criteria. See 26 U.S.C. § 355(b) and Rev. Proc. 2017-52.
Key Issue: Whether, pursuant to 26 U.S.C. § 355(b), Distributing may qualify as a valid corporate business? Does the separation of the business result in a gain or loss?
Primary Holdings and Support:
Yes, if Distributing complies with the separation requirements to be a valid corporate business under 26 U.S.C. § 355(b). Such as, (1) “B” is treated as a DRE for U.S. federal income tax purposes by filing a “check-the-box” election. See Treas. Reg. § 301.7701-3(c)(1). (2) “A”, “B”, and Distributing have an agreement in place. “A” directs Distributing to transfer all of the Controlled stock that “A” would have received from Distributing directly to “B”. Distributing transfers all of the Controlled stock directly to “B”. Distributing distributes all of the Controlled stock to “B”. (4) Distributing and Controlled will be responsible for their respective expenses related to the Distribution, if any. See Rev. Rul. 73-54, 1973-1 C.B. 187.
No gain or loss is realized under the following scenarios, when (1) A receives the Controlled stock during the Separation, in accordance with Section 355(a), (2) Distributing distributes the Controlled stock during the Separation, as specified in Section 355(c)(1). Moreover, if Distributing has any earnings and profits, they will be divided between Distributing and Controlled following the guidelines set out in 26 U.S.C. § 312(h), Treas. Reg. § 1.312-10(b), and Treas. Reg. § 1.1502-33(e)(3).
Key Points of Law:
Distribution of stock and securities of a controlled corporation. Under 26 U.S.C. § 355(a) it is provided that if a corporation, referred to as the “distributing corporation,” distributes solely stock or securities of a corporation it controls, known as the “controlled corporation,” to its shareholder or security holder, and this distribution is not primarily intended to distribute earnings and profits of either the distributing corporation or the controlled corporation, then no gain or loss will be recognized. Additionally, no amount will be included in the income of the shareholder or security holder upon receiving such stock or securities. It should be noted that the subsequent sale or exchange of stock or securities by the distributees, except under a pre-existing arrangement, should not be interpreted as evidence that the distribution was primarily intended as a means to distribute earnings and profits.
Requirements as to active business. Under 26 U.S.C. § 355(b), provides that subsection (1) applies if the distributing corporation and the controlled corporation (or, in the case of multiple controlled corporations receiving stock, each of those corporations) are actively involved in conducting a trade or business immediately following the distribution, or (2) prior to the distribution, the distributing corporation held no assets except for stock or securities in the controlled corporations, and each of the controlled corporations is actively engaged in conducting a trade or business immediately after the distribution.
Insights: IRS private letter rulings are not binding on any taxpayer except the taxpayer in issue in the PLR. However, the PLR presented here provides insight to potential tax consequences for recognition of gain or loss upon distribution of stock and securities of controlled corporations. The PLR offers an example of the necessary steps to prevent the imposition of taxes when transferring the stock of controlled corporations. It is recommended that shareholders seek tax advice prior to making any such corporate or tax-triggering decisions and to gain better understanding of whether the intended actions may result in undesirable tax liabilities, such as generating gains or losses.
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