The U.S. Internal Revenue Service (“IRS”) released Revenue Procedure 2016-45 (the “Revenue Procedure”) on August 26, 2016, permitting taxpayers once again to seek private letter rulings on issues of “corporate business purpose” and “device” under Section 355 of the U.S. Internal Revenue Code of 1986, as amended (dealing with tax-free spin-offs and related transactions). The corporate business purpose and device requirements under Section 355 have long been matters on which the IRS has preemptively declined to issue letter rulings or determination letters (these are commonly referred to as “no-rule” areas, the full list of which is reissued annually; see, e.g., Rev. Proc. 2016-3). The Revenue Procedure states that the IRS has determined that there are a number of unresolved legal issues relating to the corporate business purpose and device requirements that may be germane to determining the tax consequences of a transaction. As a result, the IRS will consider ruling requests, dated on or after August 26, 2016, related to the corporate business purpose and device requirements, subject to the overall standard requiring that the request present a “significant issue” and the general latitude of the IRS not to rule if, in their view, the facts and circumstances so warrant.

By removing these issues from the no-rule list, the IRS offers corporations considering a tax-free spin-off the possibility of significantly greater comfort on the U.S. federal income tax treatment of the transaction. The change in position may also reflect recognition by the IRS that while existing published and non-published guidance on corporate business purpose and device addresses many open issues in respect of these requirements of Section 355, significant issues remain that may merit seeking an IRS determination before a transaction proceeds.

The removal of corporate business purpose and device from the no-rule list follows on the heels of the July issuance of proposed regulations under Section 355 addressing the “device” and “active trade or business” requirements of Section 355. Notably, the Revenue Procedure does not specifically discuss whether questions about the application or interpretation of the new proposed regulations relating to device are amenable to ruling requests (indeed, the Revenue Procedure does not mention these proposed regulations at all). Click here for our client alert on the proposed regulations on “device” and “active trade or business”.

A brief background on private letter rulings and no-rule areas under Section 355 follows.

Background on Private Letter Rulings.

Generally, a taxpayer seeking a private letter ruling must pose specific questions on which the IRS is asked to rule. The usual standard is that the questions presented must involve significant unresolved legal issues – that is, legal (and not factual) issues for which the Internal Revenue Code, the Treasury Regulations and other published guidance do not settle the issue. Rulings on settled issues are commonly referred to as comfort rulings, and the IRS normally declines to provide comfort rulings to taxpayers. The IRS’s annual list of no-rule areas (and a second list of areas on which the IRS will not “ordinarily” rule) announces those areas that the IRS believes are either inherently factual in nature or for some other reason are not amenable to a ruling. As a practical matter, a taxpayer desiring comfort on a no-rule matter must seek an opinion of counsel instead. Although not without precedent, it is relatively uncommon for the IRS to remove a particular issue from the list of no-rule matters, and so the Revenue Procedure is notable on that basis alone.

No-rule areas under Section 355.

The IRS no-rule list for 2016, consistent with prior years, announced both a general limitation on private letter rulings on matters relating to various tax-free corporate transactions, including spin-offs, and specific no-rule areas relating to spin-offs. The general limitation is that the IRS only rules on “significant issues” involving these tax-free corporate transactions – meaning issues of law not “essentially free from doubt” and germane to determining the tax consequences of the transaction. The specific no-rule and “ordinarily” no-rule areas for Section 355 included:

  • the “corporate business purpose” requirement set forth in Treasury Regulations Section 1.355-2(b), which generally requires that a transaction intended to qualify as tax-free under Section 355 must have a corporate business purpose;
  • the “device” requirement set forth in Section 355(a)(1)(B), which generally requires that a transaction intended to qualify as tax-free under Section 355 not be principally a device for distributing the earnings and profits of the distributing corporation;
  • except for certain specific situations, whether a “plan” exists under Section 355(e), which generally requires gain recognition in connection with transactions where there is a plan to acquire 50%-or-greater control in either the distributing or controlled corporation (so-called Morris Trust transactions);
  • ordinarily, whether the “five year active business” requirement of Section 355(b) is met when cash (or other liquid or inactive assets) is transferred to the controlled corporation in a transaction intended to qualify as tax-free under Sections 351(a) or 368(a)(1)(D);
  • ordinarily, any issue relating to certain “conversion transactions” under Treasury Regulations Section 1.337-1(d) if property owned by any distributing corporation or any controlled corporation becomes the property of a regulated investment company (RIC) or a real estate investment trust (REIT) in a conversion transaction;
  • ordinarily, except for certain specific situations, whether the “active trade or business” requirement of Section 355(b) is met where the gross fair market value of the assets of the trades or businesses on which the distributing corporation or the controlled corporation relies to satisfy the active trade or business requirement is less than 5% of the gross fair market value of the assets of such corporation; and
  • ordinarily, any “non-plan” issue under Section 355(e), except for certain specific situations where an adverse ruling on a non-plan issue would result in the existence of a plan under Section 355(e).

The Revenue Procedure announced that, subject to the significant issue standard applicable to tax-free corporate transactions generally, the IRS will accept requests for rulings (dated on or after August 26, 2016) on the “corporate business purpose” and “device” requirements. The other areas noted above (“plan” and “non-plan” under Section 355, “five-year active business,” “conversion transactions,” and “active trade or business”) remain on the no-rule / ordinarily no-rule list.

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Photo of Amanda H. Nussbaum Amanda H. Nussbaum

Amanda H. Nussbaum is the chair of the Firm’s Tax Department as well as a member of the Private Funds Group. Her practice concentrates on planning for and the structuring of domestic and international private investment funds, including venture capital, buyout, real estate…

Amanda H. Nussbaum is the chair of the Firm’s Tax Department as well as a member of the Private Funds Group. Her practice concentrates on planning for and the structuring of domestic and international private investment funds, including venture capital, buyout, real estate and hedge funds, as well as advising those funds on investment activities and operational issues. She also represents many types of investors, including tax-exempt and non-U.S. investors, with their investments in private investment funds. Business partners through our clients’ biggest challenges, Amanda is a part of the Firm’s cross-disciplinary, cross-jurisdictional Coronavirus Response Team helping to shape the guidance and next steps for clients impacted by the pandemic.

Amanda has significant experience structuring taxable and tax-free mergers and acquisitions, real estate transactions and stock and debt offerings. She also counsels both sports teams and sports leagues with a broad range of tax issues.

In addition, Amanda advises not-for-profit clients on matters such as applying for and maintaining exemption from federal income tax, minimizing unrelated business taxable income, structuring joint ventures and partnerships with taxable entities and using exempt and for-profit subsidiaries.

Amanda has co-authored with Howard Lefkowitz and Steven Devaney the New York Limited Liability Company Forms and Practice Manual, which is published by Data Trace Publishing Co.

Photo of Martin T. Hamilton Martin T. Hamilton

Martin T. Hamilton is a partner in the Tax Department. He primarily handles U.S. corporate, partnership and international tax matters.

Martin’s practice focuses on mergers and acquisitions, cross-border investments and structured financing arrangements, as well as tax-efficient corporate financing techniques and the tax…

Martin T. Hamilton is a partner in the Tax Department. He primarily handles U.S. corporate, partnership and international tax matters.

Martin’s practice focuses on mergers and acquisitions, cross-border investments and structured financing arrangements, as well as tax-efficient corporate financing techniques and the tax treatment of complex financial products. He has experience with public and private cross-border mergers, acquisitions, offerings and financings, and has advised both U.S. and international clients, including private equity funds, commercial and investment banks, insurance companies and multinational industrials, on the U.S. tax impact of these global transactions.

In addition, Martin has worked on transactions in the financial services, technology, insurance, real estate, health care, energy, natural resources and industrial sectors, and these transactions have involved inbound and outbound investment throughout Europe and North America, as well as major markets in East and South Asia, South America and Australia.

Photo of Stuart Rosow Stuart Rosow

Stuart Rosow is a partner in the Tax Department and a leader of the transactional tax team. He concentrates on the taxation of complex business and investment transactions. His practice includes representation of publicly traded and privately held corporations, financial institutions, operating international…

Stuart Rosow is a partner in the Tax Department and a leader of the transactional tax team. He concentrates on the taxation of complex business and investment transactions. His practice includes representation of publicly traded and privately held corporations, financial institutions, operating international and domestic joint ventures, and investment partnerships, health care providers, charities and other tax-exempt entities and individuals.

For corporations, Stuart has been involved in both taxable and tax-free mergers and acquisitions. His contributions to the projects include not only structuring the overall transaction to ensure the parties’ desired tax results, but also planning for the operation of the business before and after the transaction to maximize the tax savings available. For financial institutions, Stuart has participated in structuring and negotiating loans and equity investments in a wide variety of domestic and international businesses. Often organized as joint ventures, these transactions offer tax opportunities and present pitfalls involving issues related to the nature of the financing, the use of derivations and cross-border complications. In addition, he has advised clients on real estate financing vehicles, including REITs and REMICs, and other structured finance products, including conduits and securitizations.

Stuart’s work on joint ventures and partnerships has involved the structuring and negotiating of a wide range of transactions, including deals in the health care field involving both taxable and tax-exempt entities and business combinations between U.S. and foreign companies. He has also advised financial institutions and buyout funds on a variety of investments in partnerships, including operating businesses, as well as office buildings and other real estate. In addition, Stuart has represented large partnerships, including publicly traded entities, on a variety of income tax matters, including insuring retention of tax status as a partnership; structuring public offerings; and the tax aspects of mergers and acquisitions among partnership entities.

Also actively involved in the health care field, Stuart has structured mergers, acquisitions and joint ventures for business corporations, including publicly traded hospital corporations, as well as tax-exempt entities. This work has led to further involvement with tax-exempt entities, both publicly supported entities and private foundations. A significant portion of the representation of these entities has involved representation before the Internal Revenue Service on tax audits and requests for private letter rulings and technical advice.

Stuart also provides regular advice to corporations, a number of families and individuals. This advice consists of helping to structure private tax-advantaged investments; tax planning; and representation before the Internal Revenue Service and local tax authorities on tax examinations.

A frequent lecturer at CLE programs, Stuart is also an adjunct faculty member of the Columbia Law School where he currently teaches Partnership Taxation.

Photo of Stephen Severo Stephen Severo

Stephen Severo is a partner in the Tax Department. Stephen represents corporate, private equity and investment fund clients in connection with all tax-related aspects of their businesses, including fund formation, secondary transactions, taxable and tax-free mergers and acquisitions, tax-free spin-offs, taxable divestitures, domestic…

Stephen Severo is a partner in the Tax Department. Stephen represents corporate, private equity and investment fund clients in connection with all tax-related aspects of their businesses, including fund formation, secondary transactions, taxable and tax-free mergers and acquisitions, tax-free spin-offs, taxable divestitures, domestic and cross-border bank financing arrangements, investments, partnerships and joint ventures, debt restructurings, securities issuances and REIT and other specialized real estate transactions. He provides tax advice and planning for U.S. inbound and outbound investments, including treatment of U.S. shareholders under the PFIC and CFC regimes, foreign tax credit issues, treaty issues and reporting obligations. Additionally, he provides ongoing federal income tax counsel to clients in connection with tax structuring and strategy to minimize tax liability and effective tax rate, improve tax efficiencies, and ensure proper tax treatment and reporting.

Prior to joining Proskauer, Stephen was an associate in the tax department of Cravath, Swaine & Moore LLP.