Rev. Rul. 78-383

The Internal Revenue Service has been asked to amplify Rev. Rul. 76-13, 1976-1 C.B. 96, wherein a corporate spin-off was held to satisfy the business purpose requirement of sections 355 and 368 of the Internal Revenue Code of 1954, by considering whether the spin-off was a device to distribute earnings and profits within the meaning of section 355(a)(1)(B). The facts set forth below include those set forth in Rev. Rul. 76-13, but facts relating to the device question have been added.

For more than 5 years, P, a domestic corporation, owned all of the outstanding stock of S1, which was incorporated under the laws of foreign country X. S1 was engaged in a manufacturing business in country X and, through branch operations, in foreign country Y. S1 had conducted its business for more than 5 years and the business was an active trade or business within the meaning of section 355(b) of the Code.

Country X issued a decree that commenced a program of nationalization directed at foreign-owned businesses and income-producing assets located in country X. In order to minimize the amount of its assets subject to nationalization, S1 formed a new wholly owned subsidiary, S2, under the laws of country Y. S1 transferred to S2 assets related to its manufacturing business in country Y. S1 also transferred to S2 liquid and other movable assets not needed for its operations within country X. In exchange for these transfers, S1 received all the stock of S2. In order to prevent the government of country X from nationalizing the stock of S2 or otherwise obtaining the assets transferred to S2, S1 immediately distributed all the stock of S2 to P. Immediately after the distribution, both S1 and S2 were engaged in the active conduct of a trade or business within the meaning of section 355(b) of the Code. No arrangement had been negotiated or agreed to prior to the transaction for the sale or exchange of the stock or the assets of either S1 or S2. The requirements of section 367(b) and the applicable regulations thereunder are satisfied.

Section 368(a)(1)(D) of the Code defines one of the categories of corporate reorganizations for tax law purposes. A transfer by a corporation of all or a part of its assets to another corporation may qualify under section 368(a)(1)(D) if immediately after the transfer the transferor, or one or more of its shareholders (including persons who were shareholders before the transfer), or any combination thereof, is in control of the corporation to which the assets are transferred and if, pursuant to the reorganization plan, stock or securities of the corporation to which the assets are transferred are distributed in a transaction that qualifies under section 354, 355 or 356.

Section 355(a)(1) of the Code provides generally that no gain or loss shall be recognized to (and no amount shall be includible in the income of) certain shareholders and security holders taking part in corporate separation transactions described in section 355(a). In order to qualify for nonrecognition treatment, certain conditions must be met. One of those conditions is that the transaction must not have been used principally as a device for the distribution of the earnings and profits of the distributing corporation, or the controlled corporation, or both corporations, within the meaning of section 355(a)(1)(B).

Section 1.355-2(b)(3) of the Income Tax Regulations provides that, in determining whether a transaction was used principally as a device for the distribution of the earnings and profits of the distributing corporation or of the controlled corporation or of both, consideration will be given to all the facts and circumstances of the transaction.

The fact that S1 transferred liquid and other movable assets to S2 is evidence that the transaction may have been used principally as a device for the distribution of earnings and profits. However, the facts and circumstances of Rev. Rul. 76-13, as amplified above, indicate that the transaction was not a device. The threat of imminent nationalization of S1 made it imperative to insulate the operations in country Y. Furthermore, because country X could reach the assets of S2 through nationalization of its parent, S1, it was also necessary to distribute the stock of S2 to P so that S2 was no longer a wholly owned subsidiary of S1. Both the transfer of assets from S1 to S2 and the distribution of the stock of S2 to P were carried out for valid business purposes within the meaning of section 1.355-2(c) of the regulations.

Moreover, immediately after the distribution, both S1 and S2 were engaged in the active conduct of a trade or business within the meaning of section 355(b) of the Code. No arrangement had been negotiated or agreed to prior to the transaction for the sale or exchange of the stock or assets of S1 or S2.

Accordingly, the separation transaction was not a device to distribute earnings and profits within the meaning of section 355(a)(1)(B) of the Code. The other requirements of section 355 are satisfied and the transfer of assets from S1 to S2 is a reorganization under section 368(a)(1)(D). No gain or loss will be recognized on the reorganization under section 355. For additional rules relating to this transaction, see section 367(b) and the regulations under that section.

Rev. Rul. 76-13 is amplified and superseded.