On May 17, 2019, the Internal Revenue Service (IRS) published private letter ruling 201920008 (the PLR), which concluded that a transaction qualifies as a tax-free spin-off under Section 3551 despite the fact that the distributed corporation "may not generate revenue" in the future (although it would "continue to seek to generate future revenue").2
Historically, the U.S. Department of the Treasury's and the IRS's position has been that the "active trade or business" test for tax-free spin-offs under Section 355 (the ATB Test) required, except in extraordinary circumstances, both the distributing corporation and controlled corporation to collect income throughout the five-year period preceding the spin-off, as well as immediately after the spin-off (the Income Collection Requirement).
However, on September 25, 2018, the IRS announced a study of the ATB Test as applied to entrepreneurial ventures whose activities consist of lengthy phases of research and development without the generation of income, such that the venture would not satisfy the Income Collection Requirement. Pending the completion of the study, the IRS indicated that it would consider requests for private letter rulings regarding satisfaction of the ATB Test by corporations that have not generated income.3
On March 21, 2019, the IRS released Revenue Ruling 2019-9, which suspended the application of two earlier IRS revenue rulings4 pending completion of the study of the ATB Test, on the grounds that the rulings "could be interpreted as requiring income generation" to satisfy the ATB Test.
Then, on May 6, 2019, the IRS released a public request for information to "assist in identifying what types of entrepreneurial ventures should qualify as [active trades or businesses] absent a five-year track record of income collection" in order to facilitate the study of the ATB Test.
The PLR. The PLR relates to a distributing corporation (distributing) that is engaged in a business with multiple segments. One segment was historically conducted by distributing, with the remaining segments representing an expansion following a change in the business environment. The transaction described in the PLR involves the contribution by distributing of one of the expansion segments to a newly formed controlled corporation (controlled), followed by a distribution of the stock of controlled pro rata to distributing's shareholders. Following the distribution, distributing would conduct its historical business and one of the expansion segments, and controlled would conduct the contributed expansion segment.
The PLR states that following the distribution, controlled would provide services to distributing, but that "[o]nce controlled ceases providing [s]ervices to distributing, controlled may not generate revenue, but it will continue to seek to generate future revenue..." The PLR concluded that Section 355 applied to the contribution and distribution transactions, even in light of the specific statement that controlled may cease to generate revenue in the future following the distribution.
The issuance of a favorable ruling even though a lack of revenue in the future is specifically contemplated may be a positive indication of the IRS's willingness to relax the application of the Income Collection Requirement to entrepreneurial businesses, as described in the September 2018 release. However, the facts of the ruling provide that controlled will generate revenues immediately after the distribution by virtue of continued services to distributing, and accordingly, the extent of any such relaxation remains to be seen, particularly where distributing, controlled or both have not generated any revenues prior to the distribution or will not generate revenues immediately after the distribution.
For further information, please contact Greg Broome (gbroome@wsgr.com, 415-947-2139); Myra Sutanto Shen (msutantoshen@wsgr.com, 650-565-3815); Hershel Wein (hwein@wsgr.com, 212-497-7771); Jonathan Zhu (jzhu@wsgr.com, 650-849-3388); or any member of the tax practice at Wilson Sonsini.
Derek Wallace contributed to the preparation of this alert.
