In a Revenue Ruling, IRS has suspended two 1957 Revenue Rulings pending completion of a study on the active conduct of a trade or business (ATB) requirement under Code Sec. 355(a)(1)(C) and Code Sec. 355(b).
Background. Code Sec. 355(a)(1) provides that, if certain requirements are met, a corporation may distribute stock and securities of a controlled corporation to its shareholders and security holders without recognition of gain or loss or income to the recipient shareholders or security holders. Among those requirements, both the distributing corporation and the controlled corporation must be engaged in the active conduct of a trade or business immediately after the distribution. (Code Sec. 355(a)(1)(C), Code Sec. 355(b), Reg §1.355-3(a)(1)(i)) Each trade or business must have been actively conducted throughout the five-year period ending on the date of the distribution. (Code Sec. 355(b)(2)(B), Reg § 1.355-3(b)(3))
Reg § 1.355-3(b)(2)(ii) describes a “trade or business” as “a specific group of activities [that] are being carried on by the corporation for the purpose of earning income or profit, and the activities included in such group include every operation that forms a part of, or a step in, the process of earning income or profit.” In particular, “[s]uch group of activities ordinarily must include the collection of income and the payment of expenses.” (Reg § 1.355-3(b)(2)(ii))
In Rev Rul 57-464, 1957-2 CB 244, IRS held that the separation of a manufacturing business from a group of real estate assets did not satisfy the active trade or business requirement under Code Sec. 355. The group of real estate assets consisted of an old factory building used for storage and four other buildings: a duplex apartment building rented to employees of the corporation, a small office building rented to a single tenant, and two houses, one of which was occupied by a sister-in-law of the president of the corporation. IRS concluded that the use of the old factory building for storage was not in itself the active operation of a business as defined in the regs. The rental activities produced only a nominal rental and negligible net income, and the properties were acquired either as an investment or as a convenience to employees of the manufacturing business.
In Rev Rul 57-492, 1957-2 CB 247, IRS held that a corporation’s exploration and production operation failed to qualify as an active conduct of a trade or business. The corporation, which engaged in refining, transporting, and marketing petroleum products, began a separate operation to explore for and produce oil. The exploration and production operation incurred substantial expenditures but did not include any income producing activity or any source of income until less than five years preceding its separation from the primary refining, transportation, and marketing operation. IRS determined that the exploration and production operation failed to qualify as the active conduct of a trade or business because, before oil was discovered in commercial quantities, the venture did not include any income producing activity or any source of income.
The study IRS is conducting is to determine for purposes of Code Sec. 355 whether a business can qualify as an active trade or business if entrepreneurial activities, as opposed to investment or other non-business activities, take place with the purpose of earning income in the future, but no income has yet been collected. (For a discussion of the study, see “IRS considering guidance on Section 355(b) active trade or business requirement.”) IRS says that the active trade or business requirement analysis underlying the holdings in Rev Rul 57-464 and Rev Rul 57-492 focuses, in significant part, on the lack of income generated by the activities under consideration. Consequently, these rulings could be interpreted as requiring income generation for a business to qualify as an active trade or business.
IRS noted that Internal Revenue Manual (IRM) 18.104.22.168.1, para. 9 (Aug. 11, 2004) provides that a Revenue Ruling can be suspended “only in rare situations to show that previously published guidance will not be applied pending some future action, such as … the outcome of a Service study.”