When the IRS issued Rev. Ruls. 2015-9 and 2015-10, it expanded the range of transactions that qualify as type D acquisitive asset reorganizations (under Sec. 368(a)(1)(D)) and signaled a greater willingness to accept a taxpayer's chosen form of reorganization transaction. To better understand the significance of these rulings, a little background is necessary.
Rev. Rul. 78-130: Form Controls—Except When It Doesn't
The genesis of Rev. Ruls. 2015-9 and 2015-10 can be traced to 1978, when the IRS issued Rev. Rul. 78-130. In it, a domestic parent (DP) transferred the stock of its foreign operating subsidiary (FS-1) to its foreign holding company subsidiary (FS-2) in exchange for additional FS-2 stock. Next, FS-1 and three subsidiaries of FS-2 (X, Y, and Z) transferred substantially all of their assets to N, a newly formed subsidiary of FS-2, for stock of N. In the last step, the foreign subsidiaries (FS-1, X, Y, and Z) that transferred their assets to N liquidated, distributing the newly issued N stock to FS-2, N's parent.
The IRS ruled that DP's transfer of FS-1 to FS-2 did not constitute an exchange under Sec. 351. The IRS reasoned that DP's transfer of the FS-1 stock to FS-2 followed immediately by N's acquisition of FS-1's assets could not be viewed independently. Accordingly, the IRS ignored DP's transfer of the FS-1 stock to FS-2 and N's issuance of its own stock to FS-1.
Instead, the IRS created the fiction that N had used stock of its parent, FS-2, to effect the acquisition of FS-1's assets. The IRS ruled that the transaction qualified as a parenthetical or triangular C reorganization. Notably, the IRS said that N's acquisition of FS-1's assets in exchange for FS-2 stock (as recast) did not qualify as a D reorganization.
The IRS reasoned that neither FS-1 (the transferor) nor DP (the shareholder) "controlled" N under Sec. 368(c) immediately after the transaction. It should be noted the Sec. 368(c) control rule in effect at the time Rev. Rul. 78-130 was issued was subsequently replaced by the rule in Sec. 368(a)(2)(H). (The term "control" is based on Sec. 304(c) principles, which incorporate augmented Sec. 318 attribution rules.)
The Sec. 368(c) control issue aside, it is doubtful the 1978 transaction as recast would have qualified as a D reorganization under the Code today. By definition, under the stock distribution rules of Secs. 354(b)(1)(B) and 368(a)(1)(D), a D reorganization contemplates that acquirer stock will be used to acquire target assets—not the stock of the acquirer's parent.
The IRS respected the form of the transactions involving FS-2's three subsidiaries (X, Y, and Z) and N. The IRS ruled the X, Y, and Z transactions qualified as type D reorganizations. Perhaps the IRS was persuaded that because FS-2 was the "old and cold" owner of the X, Y, and Z shares, the form chosen for the rollup into N should be respected.
Rev. Rul. 2015-9 Revokes Rev. Rul. 78-130: Form Is Respected
The facts of Rev. Rul. 2015-9 are identical to those in Rev. Rul. 78-130. However, in Rev. Rul. 2015-9, the IRS reverses direction and accepts the form of the taxpayer's transaction.
The IRS tacitly acknowledges that in certain cases, a transfer of property may be respected as a Sec. 351 exchange, even if followed by a subsequent transaction. However, the IRS cautions that a purported Sec. 351 transfer may still be recast if a different treatment is warranted to reflect the substance of the transaction as a whole.
The IRS summarily ruled it would respect DP's transfer of its FS-1 stock to FS-2 as a Sec. 351 exchange, even though DP's transfer of the FS-1 stock to FS-2 and the FS-2 asset transfer to N and subsequent liquidation were steps in a prearranged and integrated plan. The IRS reasoned that DP's transfer satisfied the formal requirements of Sec. 351, including the requirement that DP control FS-2 (within the meaning of Sec. 368(c)) immediately after the transfer.
The IRS also ruled that FS-1's asset transfer to N in exchange for N stock, followed by FS-1's liquidation, was an acquisitive D reorganization. The asset transfers by X, Y, and Z to N, followed by their respective liquidations, also constituted acquisitive D reorganizations.
Significantly, the IRS prospectively revoked Rev. Rul. 78-130.
Rev. Rul. 2015-10: Triple Drop and "Check-the-Box" Liquidation
Rev. Rul. 2015-10 involved a variation of Rev. Rul. 2015-9. In Rev. Rul. 2015-10, P, a domestic corporation, was the sole member of LLC, a domestic limited liability company that made an initial election pursuant to Regs. Sec. 301.7701-3(c) to be treated as an association taxable as a corporation for U.S. federal income tax purposes. P also owned all of the stock of S1, which in turn owned all of the stock of S2, which in turn owned all of the stock of S3, which in turn owned all of the stock of S4. S1, S2, and S3 were each holding companies that were domestic corporations. Although S4 was mentioned in the facts, it does not appear to have participated in any of the transactions.
For valid business purposes and as part of a plan, the members of the P group effected the following transactions:
- P transferred LLC to S1 in exchange for additional shares of voting common stock of S1.
- S1 transferred LLC to S2 in exchange for additional shares of voting common stock of S2.
- S2 transferred LLC to S3 in exchange for additional shares of voting common stock of S3.
- LLC elected pursuant to Regs. Sec. 301.7701-3(c) to be treated as a disregarded entity, effective no sooner than one day after S2's transfer to S3. Thereafter, S3 continued to conduct the business conducted by LLC prior to the transaction.
The IRS applied a similar analysis to the one it used in Rev. Rul. 2015-9 and summarily ruled that even though the transfers of LLC were part of a series of transactions undertaken as part of a prearranged integrated plan, the transfers of LLC from (1) P to S1 and from (2) S1 to S2 satisfied the formal requirements of Sec. 351. The IRS commented that an analysis of the transaction taken as a whole did not dictate that the transfers should be treated as other than in accordance with their form to reflect the substance of the transaction.
However, the IRS said S2's transfer of LLC to S3, followed by LLC's election to be treated as a disregarded entity, was a type D reorganization, based on Rev. Ruls. 67-274 and 2004-83. Under these rulings, if, as part of a prearranged integrated plan, (1) an acquiring corporation acquires a target corporation in an exchange otherwise qualifying as a Sec. 351 exchange, and thereafter, (2) the target corporation transfers its assets to the acquiring corporation in a tax-free liquidation, the transaction is more properly characterized as an acquisitive asset reorganization, to the extent it so qualifies. Accordingly, the IRS ruled that S2's transfer of LLC to S3, followed by LLC's election to be treated as a disregarded entity, was more properly characterized as a reorganization under Sec. 368(a)(1)(D).
IRS Comments at May 2015 ABA Tax Section Meeting
On May 12, 2015, Tax Notes Today reported that the 2015 rulings were discussed by various IRS Chief Counsel Office attorneys and tax practitioners at an ABA Tax Section meeting (Elliott, "ABA Meeting: IRS Rethinking Spin-off and Reorg Letter Cutbacks," 2015 TNT 91-1 (May 12, 2015)). The article reported that Lisa Fuller, an attorney in the IRS Chief Counsel's Office, told attendees that, after due consideration, the IRS decided Rev. Rul. 78-130 "was wrong and should be revoked." The discussion turned to Rev. Rul. 2015-10, which, as described above, considered a "triple drop and check" fact pattern.
One practitioner asked how the IRS might have ruled if stock had not been issued. Fuller said that if stock had not been issued, the IRS "might have deemed it issued." However, Fuller commented that the stock-issuance leg of the transaction might have been more important on the last drop from S2 to S3,to ensure the form aligned with the intended transactional outcome. The article quoted Fuller as saying that if a taxpayer wanted a transaction to be respected as a taxable triangular or parenthetical C reorganization instead of a tax-free D reorganization, then, "you would have to issue the stock [of the parent]." She added, "In that sense, it could be important."
In a follow-up question, the same practitioner asked Fuller if the IRS would treat the transaction as a Sec. 351 exchange followed by a Sec. 332 liquidation if the final step did not qualify as a D reorganization. Fuller said, "It might matter why it's not a D. Could it be a C or some other type of reorg.? If not, it seems likely to me that you would end up with a [Sec.] 351 followed by a [Sec.] 332."
A discussion of how "failed" reorganizations should be treated for tax purposes is beyond the scope of this item. However, the issue has attracted the attention of many respected commentators (see, e.g., Ginsburg, Levin, and Rocap, Mergers, Acquisitions, and Buyouts ¶208.3 (Wolters Kluwer Law & Business March 2015 update), and New York State Bar Association Tax Section Report on the Kimbell-Diamond Doctrine, 2014 TNT 207-53 (Oct. 24, 2014)).
The IRS's issuance of Rev. Ruls. 2015-9 and 2015-10 has been favorably received by many members of the tax community, including this practitioner. Nevertheless, Rev. Ruls. 2015-9 and 2015-10 do not answer the perplexing broader question: Should a transfer of property in an exchange otherwise described in Sec. 351 be recast because a different treatment is warranted to reflect the substance of the transaction? Perhaps the best answer to the question is what Justice Potter Stewart said in his concurring opinion in Jacobellis v. Ohio, 378 U.S. 184, 197 (1964), "I [will] know it when I see it."
Mark Heroux is a principal with the Tax Services Group at Baker Tilly Virchow Krause LLP in Chicago.
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