On May 3, 2017, the IRS released Revenue Ruling 2017-9, which addresses two so-called "north-south" transactions in connection with spin-offs that are intended to be nontaxable under Section 355 of the Internal Revenue Code. North-south transactions involve both the contribution of assets to and the distribution of assets from a corporation pursuant to the same overall plan. In both situations addressed in the ruling, the resulting tax consequences depend on whether several related steps are integrated or instead respected as separate for federal income tax purposes.
Prior to 2013, the IRS had ruled privately that similar north-south transactions would not be integrated so long as there was "no regulatory, legal, contractual, or economic compulsion or requirement" that the contribution be made as a condition of the spin-off. In Revenue Procedure 2013-3, however, the IRS announced that it would no longer rule on whether any north-south transactions would be respected as separate for federal income tax purposes. Revenue Procedure 2013-3 also designated these transactions as "under study," introducing significant uncertainty for taxpayers and their advisers as to whether potentially related "north" and "south" transfers would be integrated for federal income tax purposes.
Revenue Ruling 2017-9 should reduce some of the uncertainty that taxpayers and their advisers confront when considering transactions similar to those addressed in the ruling. In addition, the ruling provides that north-south transactions are no longer "under study," meaning that the IRS will consider ruling requests on the integration of steps in such transactions.
Contributions to "Distributing" Corporations
In the first situation of Revenue Ruling 2017-9, a parent corporation ("Parent") contributed certain properties and activities constituting a business to its wholly owned corporate subsidiary ("Distributing") so that Distributing would be treated as engaged in an "active trade or business" for purposes of Code Section 355(b). Pursuant to an overall plan, Distributing subsequently distributed its wholly owned corporate subsidiary ("Controlled") to Parent. This situation is a north-south transaction because it involves a contribution of property to Distributing by Parent (a transfer south) followed by a distribution to Parent of Controlled stock by Distributing (a transfer north). If the north and south transfers in the first situation were integrated, the contribution would fail to qualify as tax-free under Code Section 351, and the distribution would fail to qualify as tax-free under Code Section 355.
In determining that the steps of the north-south transaction in the first situation should not be integrated, the IRS considered the "scope and intent" of the relevant provisions of the Code, and stated that "[t]he tax treatment of a transaction generally follows the taxpayer's chosen form unless: (1) there is a compelling alternative policy; (2) the effect of all or part of the steps of the transaction is to avoid a particular result intended by otherwise-applicable Code provisions; or (3) the effect of all or part of the steps of the transaction is inconsistent with the underlying intent of the applicable Code provisions." The IRS found that the transfer of property permitted to be received by Distributing in a nonrecognition transaction had "independent significance" from the distribution of the stock of Controlled, regardless of whether the purpose of the transfer was to qualify the distribution under Code Section 355(b). In ruling that the initial contribution would not be integrated with the subsequent distribution, the IRS has provided helpful clarity regarding the treatment of certain transfers between distributing corporations and their shareholders.
Distributions by "Controlled" Corporations
In the second situation, Controlled distributed money and other property to Distributing in pursuance of a plan of reorganization that included both a subsequent contribution of property by Distributing to Controlled and, thereafter, a tax-free distribution to Parent of Controlled stock by Distributing.
This situation also involves a north-south transaction in the form of a distribution of money and other property to Distributing by Controlled (a transfer north) followed by a contribution of property to Controlled by Distributing (a transfer south). However, unlike the first situation, the second situation assumes that the transfer north occurs in pursuance of the plan of reorganization that includes the transfer south and the spin-off. As a result, the IRS concluded that the distribution of money and other property would be taxable as "boot" in the reorganization, rather than as a separate dividend, because Distributing retained the money and other property and it was not further distributed to Distributing's shareholders or creditors in pursuance of the plan of reorganization.
Revenue Ruling 2017-9 leaves open the possibility that a distribution of cash retained by the recipient may not be treated as boot in the reorganization if "the facts establish that the distribution is in substance a separate transaction." In such a case, the recipient may be able to receive all or a portion of such distribution without incurring federal income tax. The ruling, however, does not describe the circumstances in which a distribution would be treated as a separate transaction.
No-Rule Position
As noted above, Revenue Ruling 2017-9 eliminates the IRS's "no-rule" position on north-south transactions. Accordingly, the IRS will consider ruling requests from taxpayers that the steps in such transactions would not be integrated. The IRS reiterated, however, that it may decline to issue such a ruling "when appropriate in the interest of sound tax administration or on other grounds when warranted by the facts and circumstances of a particular case," leaving it unclear whether private letter rulings will regularly be issued. In particular, if the determination requested is "primarily one of fact," or the transaction does not present a "significant issue" (for example, because it is already addressed in the ruling), the IRS may decline to issue a private letter ruling.
For more information on Revenue Ruling 2017-9 or any related matter, please contact Greg Broome or any member of the tax practice at Wilson Sonsini.
