The IRS ruled, in LTR 201015028, on January 4, 2010 (and released on April 16), that Newco’s acquisition of Target’s stock did, in fact, constitute such a qualified stock purchase. Further, the IRS determined that the parent company and Newco will be eligible to make the election under Section 338(h)(10) in respect of Newco’s acquisition of Target.
In the IRS letter, Newco acquired 100% of the stock of Target (from Seller) within a period not exceeding 12 months. As a result, if the stock was acquired by “purchase,” the acquisition of the stock will constitute a qualified stock purchase. (See Sec. 338(d)(3).)
Central to the question of whether the acquisition constituted a purchase is the notion of whether the stock acquired by Newco was from a related person. Indeed, stock acquired by a purchasing corporation from a related corporation is generally not acquired by purchase.
But as described in the letter, at the time Newco acquired the Target stock from Seller, Seller owned more than 50% of the value of Newco’s stock. Therefore, the stock would be viewed as acquired from a related person — and not acquired by purchase.
At the time the stock was acquired, Seller — because of its ownership of more than 50% of the value of Newco’s stock — is considered a person “the ownership of whose stock would be attributed, under Section 318(a) to the person (Newco) acquiring such stock.” (See Sec. 338(h)(3)(A)(iii).)1
However, in the case laid out in the IRS letter, the parties are permitted to measure Seller’s ownership of Newco after the additional public offerings or other alternative (divestiture) transactions are completed. This is so because the sale of stock to the purchaser and the IPO are merely steps in a single integrated transaction which encompasses the additional public offerings and/or other alternative transactions. Once those steps are taken, Seller and Newco will cease to be related parties, since the Seller’s ownership of Newco’s stock will dip below 50%. (See Sec. 318(a)(3)(C). )
The parent company stated that a sale to the purchaser and the public of less than 50% of Newco would not achieve the objectives of the parent in connection with the publicly announced divestiture of the businesses involved in an industry the parent wants to exit. In addition, the parent and the seller would not, based on advice received from their financial advisers, complete the transfers and the IPO without being “reasonably certain” that they would be able to effect a disposition of sufficient additional shares of Newco to reduce Seller’s ownership of Newco below 50%.
Therefore, the step-transaction doctrine properly applies to integrate the steps. It can be concluded, based on the parent’s representations, that the initial steps of the transaction would have been entirely fruitless without a completion of the entire series of transactions. In short, the parent’s business objectives could not have been accomplished if its interest in Newco exceeded 50%.
The regulations provide that, for purposes of determining whether an acquisition of stock constitutes a qualified stock purchase, a purchasing corporation is treated as related to another person if the relationship exists “in the case of a series of transactions effected pursuant to an integrated plan to dispose of the target’s stock, immediately after the last transaction in the series.” (See Reg. Sec. 1.338-3(b)(3).) In the IRS instance case, immediately after the last transaction in the series, Seller owned less than 50% of the value of Newco’s stock.
Since Seller owned less than 50% of the value of Newco’s stock at the point in time the regulations deem relevant, Newco’s acquisition of Target’s stock from the parent constituted a purchase of such stock.
Contributor Robert Willens, founder and principal of
Robert Willens LLC,
writes a weekly tax column for CFO.com.
1In addition, because of the presence of non-voting preferred stock, Newco’s acquisition of Target’s stock is not an “exchange to which Section 354 applies” — the acquisition, due to such nonvoting stock, cannot constitute a ‘B’ reorganization. Moreover, the acquisition is not an exchange to which Section 351 applies because, taking into account the prearranged sale of Newco’s preferred stock to purchaser, the “transferor” of property (Seller) to Newco with respect to its stock is not in control of Newco (within the meaning of Sec. 368(c)) immediately after the exchange.