“Cross-Border” Spin-offs Can Be Tax-Free

If a company successfully jumps through an impressive – and complex – set of hoops, it can reap the rewards.

The final exception, however, precisely describes the distribution example provided by the IRS, with the result that Delta will not recognize gain on the distribution of ChiCorp’s stock to Psi, as per Section 355. The final exception provides that a gain is not recognized by a domestic corporation making a distribution of stock of a domestic corporation to a foreign distributee if there are 10 or fewer foreign distributees for which nonrecognition is claimed — and each such distributee is either an individual or a corporation

If the foreign distributee for which nonrecognition is claimed is a foreign corporation, as is the case here, the foreign distributee must be directly or indirectly engaged in the active conduct of a trade or business. (Note that the distributee must be considered a foreign corporation immediately after the distribution, and at all times until the close of the 60-month period following the end of the taxable year of the distributing corporation in which the distribution is made.)

In addition, for this exception to apply, immediately after the distribution the stock of the distributing corporation must have a value at least equal to the value of the distributed stock of the controlled corporation.

Further, immediately after the distribution — and at all times until the close of the aforementioned 60-month period — the foreign distributee must be incorporated in a foreign country that maintains a comprehensive income-tax treaty with the United States. Moreover, at all times until the close of the 60-month period, the foreign distributee must own all of the stock of each of the distributing and controlled corporations that it owned immediately after the distribution.

What’s more, the distribution cannot be one in which the distributing corporation goes out of existence. Finally, the distributing corporation, in order to take advantage of this exception, must file an agreement (“a gain recognition agreement”) to recognize gain (should the terms of the gain recognition agreement be breached) with its tax return for the year in which the distribution is made.

This is an impressive array of requirements that must be met to avail a company of this final exception to gain recognition. Each requirement was satisfied here, with the result that Delta’s distribution of ChiCorp’s stock to Psi, under Section 355, did not give rise to the recognition by Delta of the gain inherent in its ChiCorp stock.

Contributing editor Robert Willens, founder and principal of Robert Willens LLC, writes a weekly tax column for CFO.com.

1 See LTR 200922028, February 20, 2009.
2 Under Section 355.




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