Things are not always what they appear. Witness the seemingly identical tax rule verbage regarding reorganizations and spinoffs.
For a transaction—specifically a reorganization or a spinoff—to receive nonrecognition treatment, the deal must be undertaken for a business purpose. Thus, Reg. Sec. 1.368-2(b) states that the purpose of the reorganization provisions “is to except … certain specifically described exchanges … as are required by business exigencies and which effect only a re-adjustment of continuing interests in property under modified corporate forms.”
By the same token, Reg. Sec. 1.355-2(b), dealing with spinoffs, tells an identical story: “The principal reason for this business purpose requirement is to provide non-recognition treatment only to distributions that are incident to re-adjustments of corporate structures required by business exigencies and that effect only a re-adjustment of continuing interests in property under modified corporate forms.”
Despite the similarity (in fact, the virtual identity) in language, it is well known that the business purpose requirement as applied to acquisitive reorganizations is substantially less stringent than the requirement as applied to spinoffs. Thus, with respect to the latter, the regulations point out that a transaction is carried out for a corporate business purpose if it is motivated in whole, or substantial part, by one or more corporate business purposes.
In addition, in these cases, the potential for avoidance of federal income taxes by either the distributing or controlled corporations is relevant in determining the extent to which an existing corporate business purpose motivated the distribution.* Moreover, the avowed business purpose must be the last resort for solving the business problem. In other words, the problem may not be solved by another tax-free transaction, one not involving a distribution, that is neither impractical nor unduly expensive. If it is, the distribution will not satisfy the business purpose requirement imposed with respect to spinoffs (see Rev. Rul. 72-530).
Conversely, in the case of an acquisitive reorganization, the business purpose condition is not applied with nearly as much rigor. Thus, in each case, a valid corporate (as opposed to personal shareholder) purpose is necessary. However, in the world of acquisitive reorganizations, the concomitant presence of tax-avoidance motives is not proscribed.
Moreover, it is well settled that the valid business purpose advanced to support reorganization treatment need not be, as is decidedly the case in the world of spinoffs, the primary motivation for the transaction. All that is necessary, as Professors Ginsburg and Levin confirm, is that the corporate business reason(s) supporting the transaction be “real and substantial.”
Thus, although the regulations would lead one to believe that the business purpose requirements animating reorganizations and spinoffs are identical, practice has confirmed that the requirement imposed with respect to the nonrecognition transaction related to spinoffs is applied more stringently. Most notably, in the case of a spinoff, the mere presence of tax-avoidance motives, even though subsidiary, will almost certainly poison the atmosphere.
In the reorganization case, however, tax-avoidance motives are not proscribed. Therefore, the motives can comfortably coexist with one or more corporate business purposes, as long as the business purpose, not necessarily predominant, is real and substantial.
Thus, in Rev. Rul. 2001-29, where the Internal Revenue Service confirmed that a REIT participating in a spinoff can satisfy the active business requirement, the IRS noted that, due to the extraordinary potential for tax avoidance that exists in a spinoff—in which one of the participants will convert to REIT status—corporations attempting such a transaction may have difficulty satisfying the business purpose condition.