Transaction Analysis: Sponsored Spin
CPA practitioners should note that the rules applicable to sponsored-spin transactions are very specific and require careful planning.
by Stephen Musante and Stephen Wegener/The Tax Adviser
Arguably one of the most restrictive and limiting rules imposed on a corporation by the federal income tax system is the corporate-level tax on the sale of business assets or subsidiaries that hold business assets. This inability to sell business assets without a corporate-level tax severely impedes a corporation from monetizing appreciated assets and reinvesting the sale proceeds to expand its retained businesses. Not surprisingly, with limitation comes the inevitable challenge to find a solution. Unfortunately, in this case businesses and their tax advisers often find themselves with an empty toolbox and are unable to overcome the challenge. Nonetheless, the search for tax-efficient exit structures often leads to creative planning and use of the current tax rules to produce economic results otherwise reserved for a tax-free sale of assets.
Sec. 355 allows a corporation (Distributing) to distribute to its shareholders or its security holders the stock or securities of one or more corporations that it controls (Controlled) without triggering income or gain to itself or its shareholders. Following the repeal of the General Utilities doctrine (see General Utilities & Operating Co. v. Helvering, 296 U.S. 200 (1935)), Sec. 355 remains the only reliable way to distribute appreciated assets from a corporation to its noncorporate shareholders without paying a corporate-level tax on the distributed assets.
It should be no surprise that Sec. 355 is a useful tool for mitigating the corporate-level tax on the disposition of business assets. However, in order for a transaction to be governed by Sec. 355, a long list of requirements must be met, some of which specifically target a sale of either Distributing or Controlled (e.g., the device prohibition, continuity of interest, continuity of business enterprise, Sec. 355(d), and Sec. 355(e)). The latter two requirements are generally the most restrictive and require careful planning to produce tax-free results. One transaction that can successfully navigate all the requirements of Sec. 355, yet economically results in a tax-free monetization of appreciated business assets, is known as the "sponsored spin."
Sec. 355(d) causes a spin-off to be taxable at the corporate level if the distribution of a controlled corporation is to any person holding "disqualified stock" constituting a 50 percent or greater interest (by vote or value) of either Distributing or Controlled. Generally, disqualified stock is any stock of the distributing or controlled corporation acquired by purchase within the five-year period ending on the date of the distribution. Under Sec. 355(e), a spin-off is taxable at the corporate level if it is "part of a plan or a series of related transactions" involving an acquisition of 50 percent or more of the stock of either Distributing or Controlled. Accordingly, a sponsored-spin transaction generally limits the acquisition of either Distributing or Controlled to less than a 50 percent interest.
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