Internal Revenue Service Limits Rulings on Tax-Free Spinoffs: The Treasury Department and IRS Issue Notice and Revenue Procedure to Expand Area of “No Rule” for Letter Rulings for Certain REIT Spinoffs and “Cash-Rich” Spinoffs

Sullivan & Cromwell LLP - September 15, 2015
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The Treasury Department and the Internal Revenue Service (the “IRS”) issued guidance regarding certain spinoffs, with particular relevance to certain opco/propco spinoffs involving REIT conversions, and to certain so-called “cash-rich” spinoffs.  In Notice 2015-59, the IRS announced a study (and stated its concerns) in respect of certain spinoff transactions (known as Section 355 distributions under the Internal Revenue Code (the “Code”)) with one or more of the following characteristics: (i) ownership by the distributing corporation or controlled corporation of investment assets having substantial value in relation to the value of all of the corporation’s assets and the value of the “active trade or business” (“ATB”) on which the distributing corporation or controlled corporation is relying to meet the requirements for tax-free treatment discussed below; (ii) a significant difference between the ratio of investment assets to non-investment assets of the distributing corporation and such ratio of the controlled corporation; (iii) ownership by the distributing corporation or the controlled corporation of a small ATB in relation to all of its assets; and (iv) a conversion by the distributing corporation or controlled corporation to be a regulated investment company (a “RIC”) or a real estate investment trust (a “REIT”).

Concurrently with the issuance of Notice 2015-59, the IRS issued Revenue Procedure 2015-43, which provides that the IRS will generally not issue letter rulings under Section 355 in respect of the following: (a) Section 355 distributions involving a RIC or REIT conversion, (b) Section 355 distributions involving an ATB that is less than 5% of the gross assets of the relevant corporation, and (c) Section 355 distributions involving substantial investment assets that are “skewed” between the distributing and the controlled corporations and involving an ATB that is less than 10% of the fair market value of such corporation’s investment assets.