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IRS describes areas of concern under Code Sec. 355

Notice 2015-59, 2015-40 IRB, Rev Proc 2015-43, 2015-40 IRB

In a Notice, IRS has announced that it is studying issues under Code Sec. 355 (and Code Sec. 337(d)) relating to certain distributions, described in Code Sec. 355, in which property becomes the property of a regulated investment company (RIC) or a real estate investment trust (REIT), in which the active business is small relative to other assets, or in which there is a substantial amount of investment assets. IRS requests comments concerning these transactions. The Notice is issued concurrently with a Revenue Procedure which sets out the areas IRS will not issue letter rulings or determination letters (no-rule areas).

Background. Code Sec. 355 generally provides that, if certain requirements are satisfied, a distributing corporation may distribute the stock (or stock and securities) of a controlled corporation to its shareholders and security holders without the distributing corporation, its shareholders, or its security holders recognizing income, gain, or loss on the distribution. However, Code Sec. 355 does not apply to a distribution if the transaction is used principally as a device for the distribution of the earnings and profits of the distributing corporation or the controlled corporation or both (a device). (Code Sec. 355(a)(1)(B)) Various other requirements must also be satisfied for Code Sec. 355 to apply to a distribution.

One such requirement is that the distributing corporation and the controlled corporation each be engaged in the active conduct of a trade or business immediately after the distribution (active trade or business requirement). (Code Sec. 355(a)(1)(C), Code Sec. 355(b)(1)(A)) For this purpose, Code Sec. 355(b)(3)(A) provides that all members of a corporation’s separate affiliated group are treated as one corporation.

Another such requirement is that the transaction must be carried out for one or more corporate business purposes (business purpose requirement). (Reg. § 1.355-2(b)(1))

IRS has become aware, in part through requests for letter rulings, that some taxpayers are taking the position that certain distributions that have one or more of the characteristics described in Notice 2015-59, Sec. 1, satisfy the requirements of Code Sec. 355. IRS believes that these transactions may present evidence of a device for the distribution of earnings and profits, may lack an adequate business purpose or a qualifying business for purposes of Code Sec. 355(d), or may violate other Code Sec. 355 requirements. In addition, these transactions may circumvent the purposes of Code provisions intended to repeal the General Utilities doctrine (under which the Supreme Court held in General Utilities & Operating Co., (S Ct 1935) 16 AFTR 112616 AFTR 1126, that corporations generally could distribute appreciated property to their shareholders without the recognition of any corporate-level gain).Code Sec. 337(d) permits IRS to prescribe regs that are necessary or appropriate to carry out the purposes of the General Utilities repeal.

Areas of concern. Notice 2015-59 describes the areas that IRS is studying under Code Sec. 337(d) and Code Sec. 355 relating to transactions having one or more of the following characteristics:

1. ownership by the distributing corporation or the controlled corporation of investment assets, within the meaning of Code Sec. 355(g)(2)(B), having substantial value in relation to:
…the value of all of such corporation’s assets, and
…the value of the assets of the active trade(s) or business(es) on which the distributing corporation or the controlled corporation relies to satisfy the requirements of Code Sec. 355(b) (a Qualifying Business or Qualifying Business Assets);
2. a significant difference between the distributing corporation’s ratio of Investment Assets to assets other-than Investment Assets and such ratio of the controlled corporation;
3. ownership by the distributing corporation or the controlled corporation of a small amount of Qualifying Business Assets in relation to all of its assets; and
4. an election by the distributing corporation or the controlled corporation (but not both) to be a RIC or a REIT.

Notice 2015-58 sets out transactions that concern IRS, including transactions in which, while the relevant areas are under study, it ordinarily will not rule under Rev Proc 2015-3, Sec. 4.01(57) and Rev Proc 2015-3, Sec. 4.01(58) (Rev Proc 2015-43, Sec. 3.01) and transactions on which it will not rule under Rev Proc 2015-3, Sec. 5.01(26) ( Rev Proc 2015-43, Sec. 3.02).Rev Proc 2015-43, which is issued concurrently with Notice 2015-59, supplements Rev Proc 2015-3, 2015-1 IRB 129, by adding certain of the transactions described above to the list of no-rule areas.

Notice 2015-58 also requests comments concerning the transactions described in Notice 2015-58.

References: For a device for the distribution of the earnings and profits, see FTC 2d/FIN ¶  F-4701  et seq.; United States Tax Reporter ¶  3554.01; TaxDesk ¶  237,201; TG ¶  5164.

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