The U.S. Internal Revenue Service (IRS) and the Department of the Treasury (“Treasury”) have published proposed regulations that would modify the device and active trade or business requirements for tax-free spin-offs under section 355 of the Code in three important respects.
First, the proposed regulations clarify the “device” test and its relationship to the “business purpose” requirement. Second, the proposed regulations would prohibit a tax-free spin-off if (1) two-thirds or more of the assets of the distributing corporation or the controlled corporation consist of nonbusiness assets and (2) the percentage of the distributing corporation’s nonbusiness assets differs significantly from those of controlled, under three specified tests. Third, the proposed regulations would require that the assets constituting an active trade or business must represent at least 5% of the total assets of the distributing corporation and the distributed corporation in order for the spin-off to be tax-free. Thus, the proposed regulations would effectively repeal the so-called “hot dog stand” rule, under which a de minimis active trade or business could support a spin-off of a relatively much larger collection of passive assets.
If promulgated as proposed, the proposed regulations will affect distributing corporations and their shareholders and security holders in spin-offs, split-offs, and split-ups that occur on or after final regulations are published.
For more on this topic, please see our client alert here.