Today in taxation: Structures derived from mergers and acquisitions | Miller Nash LLP

Brief commentary on related federal tax cases, rulings, opinions and guidance from the past week.

Companies authorized to rely on publicly available shareholder data to confirm their eligibility for a tax-free spin-off and subsequent merger

Tax-exempt spin-off transactions are subject to strict rules regarding how and when they can be used in conjunction with a subsequent sale or divestiture. This latest IRS ruling provides guidance on how to apply a qualifying methodology to help determine whether a pre-sale spin-off will qualify for tax-free treatment. There is a high cost in not qualifying a derivative transaction as tax exempt, so it is helpful to obtain rulings in support of the proposed qualification.

In a recent ruling (PLR 202145020), the IRS dealt with a proposed spin-off transaction in which the split subsidiary would be immediately acquired by a third party as part of a reverse triangular merger. In this situation, one would expect the subsidiary to be separated from its parent company because the parent company distributes to its shareholders all of the shares of the subsidiary held by the parent company. If it were qualified as a tax-exempt spin-off, this distribution would not result in the recognition of a taxable gain by the parent company or the shareholders. In the event that the spin-off transaction was not eligible for tax-exempt treatment, the distribution of subsidiary shares would then be taxable. Since the subsequent acquisition is also intended to be a tax-exempt transaction, a taxable spin-off would be an unwanted surprise to shareholders who might otherwise have expected not to recognize taxable income in the transaction.

The gist of the decision lies in a particular restriction on the use of a tax-free reorganization to transfer ownership of a company to a third party. Specifically, a split that results (directly or through a series of transactions) in a change of more than 50% of the ownership of the parent company Where subsidiary shares (measured by vote and value) will be treated as a taxable dividend, rather than a tax-exempt reorganization. There is, however, a special calculation rule that allows the taxpayer to disregard any shareholding that does not decrease (for example, shares held by a minority owner who, after acquisition, would hold a larger share of the capital). Combined entity that in the acquiree would not be included in the calculation to determine whether a 50% change in ownership has occurred (this is called the “net decrease method”).

To establish that the proposed split and subsequent merger did not result in a 50% transfer of ownership based on the net decrease methodology, the taxpayer proposed to identify the ultimate beneficial owners based on actual knowledge key personnel within companies and on any available information disclosed in securities filings and on investor or investment advisor websites. In this case, the IRS accepted this approach. It’s a bit of an expansion in the sense that in previous decisions (e.g. PLR 201603005), the IRS approved the application of the net decrease methodology but did not go so far as to endorse a methodology. particular identification of the shareholders concerned (probably because the taxpayer in this decision did not request such a decision).

Reorganization on the heels of business sale meets certain continuity requirements for tax-free treatment

There are a lot of details we don’t know about the taxpayer in this ruling and the options available to them. Nevertheless, this decision illustrates that while there are many legal and regulatory constraints on tax-free reorganizations in the context of a sale transaction, there are generally several options available to you. A knowledgeable tax advisor can often find creative ways to achieve client goals. This decision also clarifies that a prior deconsolidation or sale of a business segment is not incompatible with subsequent planning for a tax-free reorganization.

On November 12, 2021, the IRS issued Private Letter Ruling 202145025 (PLR 202145025), in which the requesting taxpayer intended to undertake a series of transactions to deconstruct their organizational structure and divest one of their businesses. The general purpose of splitting this deal often lends itself to a tax-free spin-off (for example, as stated in PLR 202145020 above), but there were likely undisclosed factors in the decision that prevented such an approach. Instead, the organization has essentially consolidated its two lines of business into a lower-level parent company and a subsidiary. The lower-level parent company merged into a newly formed LLC, the Surviving LLC. The resulting LLC made a tax-free distribution of the subsidiary’s shares to a higher-level parent owner, and was then sold as part of what we expect to be a taxable share sale. The final step in this transaction involved the creation of an LLC subsidiary, 100% owned by the subsidiary, into which the upper-tier parent company would be merged in a downstream merger. Once the dust settled, the ultimate owner would be the sole owner of the branch, no problem.

One of the questions addressed in this ruling is whether the final downstream merger would be considered a tax-exempt reorganization, given the deconsolidation of the original taxpayer’s consolidated reporting group and the sale of a line of business. important activity. One of the requirements of a tax-free reorganization is that there must be “business continuity“, that is, the historical activities and assets of the organization must be be preserved in whatever form resulting from the planned reorganization. Due to this requirement, the deconsolidation and sale of business lines could be fatal to the tax exemption in certain circumstances. Although the IRS ruled in favor of the taxpayer, the ruling does not clearly explain why. Presumably, this is because the taxpayer ultimately retained an entire historical line of business without modification (other than the capital structure).

As an interesting counterpoint, business enterprise continuity requirements are generally not enforced in divisive reorganization and split contexts. Specifically, the preamble to TD 8760 states that the IRS did not extend the regulations governing the continuity of “D” business reorganizations, “F” reorganizations, or Section 355 transactions because more study Thorough is needed to determine whether such requirements are justified. Thus, there may be instances where, if the facts permit, a spin-off might be a preferable approach.

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