The IRS Office of the Associate Chief Counsel (Corporate) announced May 19 that it may hold in abeyance any new letter ruling requests involving some section 355 tax-free spinoff active trade or business (ATB) requirement questions while it studies how much ATB is enough.
The IRS hasn't decided how to handle affected rulings that have already been submitted or whether the change of course will turn into a guidance project. Affected rulings already in-house will "continue to be handled in the normal fashion for now -- but this may change," said Isaac Zimbalist, branch 5 senior technical reviewer, IRS Office of Associate Chief Counsel (Corporate).
"In recent weeks, several practitioners have asked people in Corporate whether we were considering a change to our ruling practice for spinoffs in which the ATB of the distributing corporation or the controlled corporation is small in relationship to other assets," Zimbalist said at a meeting of the District of Columbia Bar Taxation Section. "This aspect of spinoffs has attracted public attention, and we are thinking about it, but we have made no decision as to the current ruling practice, as to whether to issue guidance regarding this aspect and related aspects of spinoffs or to what the substance of any guidance might be."
Zimbalist encouraged practitioners to call with any questions and said that new information on the IRS's thinking should be available "in the next few months."
Impact on Yahoo's Ruling
Yahoo Inc. announced January 27 that it plans to spin off its stake in Alibaba Group Holding Ltd. and disclosed that it was seeking a ruling on the transaction, which could save Yahoo as much as $16 billion in taxes. Yahoo will contribute to so-called Spinco its shares of Alibaba (worth, at the time, almost $40 billion) along with a relatively small legacy operating business (Yahoo Small Business) designed to satisfy the ATB requirement of section 355(b).
On a conference call at the time the transaction was announced, Yahoo CEO Marissa Mayer said, "We believe this to be a unique spinoff transaction. We are not aware of any precedent of an operating company spinning off a registered investment company."
In its quarterly Form 10-Q filed May 7, Yahoo disclosed that its planned spinoff transaction is subject to "receipt of a favorable ruling from the Internal Revenue Service with respect to certain aspects of the transaction and a legal opinion with respect to the tax-free treatment of the transaction." According to Yahoo's January 27 Form 8-K, Skadden, Arps, Slate, Meagher & Flom LLP is serving as the company's legal counsel on the transaction.
Robert Willens of Robert Willens LLC told Tax Analysts that in Yahoo's case, "the active business assets will represent a de minimis percentage of the value of Spinco's total assets, since the Alibaba stock to be conveyed to Spinco is so valuable."
But Willens noted that Yahoo likely would not have pursued its planned transaction in the first place had it not been bolstered by a recent letter ruling (LTR 201435005) blessing what is believed to be the spinoff by Liberty Interactive Corp. of TripAdvisor Inc.
"The only 'weakness' in the Yahoo situation is the potential for the IRS to assert, due to the large percentage of Spinco's assets that will be 'inactive,' that the transaction was used principally as a device. I never felt the active business test was at risk, even though Spinco's active business assets were going to account for a very small percentage of its total assets. This news is not going to be well received by investors," Willens said.
In fact, the price of Yahoo shares dropped nearly 8 percent on the news of the spinoff ruling pause.
Willens pointed out that Rev. Rul. 73-44, 1973-1 C.B. 182, specifically states that "there is no requirement in section 355(b) that a specific percentage of the corporation's assets be devoted to the active conduct of a trade or business." Willens said the ruling goes on to say that the percentage of assets so devoted is a relevant factor in determining whether the transaction was used as a device.
More Details on New Pause
Devon Bodoh of KPMG LLP said the size of an ATB relative to the whole of the business being spun off is an issue that gives pause to many practitioners and "one that impacts real business transactions every day."
Zimbalist said the issue is often framed by using either a hot dog stand or a lemonade stand to represent the ATB. "When you have a hot dog stand [or] a lemonade stand that you're dropping into a business, if the other assets . . . but for the passage of time would become active, that's not the issue."
Zimbalist said the IRS is "getting grief" from those outside the agency about rulings in which a hot dog stand was essentially dropped into a business that primarily consists of publicly traded stocks, cash, and similar assets. "We have to study it. We have to respond to it. And we're putting people on notice that that's what's going on," he said.
Bodoh said there are myriad spinoff rules that serve as a backstop to the ATB requirement in section 355(b), including the device test and section 355(g) "in the case of very cash-rich companies." He said those rules "protect the taxing system against abuse."
Alison Burns, IRS deputy associate chief counsel (corporate), speaking from the audience, said the pause on some ATB rulings didn't come about because of resource concerns. She said the IRS is thinking about issues related to ATBs and wanted to let everyone in the tax bar know at once. "As soon as we know what we're doing, the bar will know what we're doing, and that's as much as we can say right now," she said.
Steve Fattman of EY told Tax Analysts that the agency's "historic flexibility on active trade questions recognizes the fact that a company with real businesses and a compelling business purpose to spin may nevertheless have a technical issue concerning the active trade requirement." Fattman, formerly special counsel to the IRS associate chief counsel (corporate), said that addressing taxpayers' individual situations has been an important part of the private letter ruling program and has an impact on compliance beyond the particular taxpayer that gets the ruling.
Fattman indicated the scope of any ruling policy in the area could be tricky to spell out. "A lot of public spins are the culmination of a larger restructuring that involves a significant number of internal spins. It is a lot easier to substantiate a small ATB than a large ATB in a ruling request, and that burden gets multiplied with the size of the group and the restructuring," he said. "Will the Service be able to easily identify cases where a small ATB is relied on out of convenience?"
Fattman said that if the IRS is concerned about cash-rich companies, "people will be very interested to know how the Service will distinguish between a company that is cash needy and one that is not."
Rethinking Ruling Cutbacks
Zimbalist also indicated that the May 9 announcement that the Corporate office was reconsidering its significant issue ruling policy doesn't necessarily mean that the IRS will rule more broadly on some tax-free spinoffs and reorganizations.
"We may have the opportunity, the possibility of increasing the [private letter ruling] program to make it more responsive to your needs," Zimbalist said. "However, we are just beginning to explore this, and there is no way to determine what budgeting restraints may limit our endeavors."
Zimbalist stressed that "what can we get away with" is "not going to be determined by us."