Revenue Ruling 98-27 and New Spin-off Control Provision in IRS Restructuring Bill

Originally published May 27, 1998

1. Revenue Ruling 98-27 Renders Rev. Rul. 96-30 and 75-406 Obsolete

On May 14, 1998, the Internal Revenue Service ("Service") issued Revenue Ruling 98-27, which renders obsolete Rev. Rul. 96-30, 1996-1 C.B. 36, and Rev. Rul. 75-406, 1975-2 C.B. 125, and modifies Rev. Rul. 70-225, 1970-1 C.B. 80.

In Rev. Rul. 96-30,1 a subsidiary was spun off tax-free pursuant to section 355 of the Internal Revenue Code and then was acquired by an unrelated corporation in a tax-free reorganization in which the subsidiary's former shareholders received 25% of the acquirer's stock. The Service ruled that the spin-off qualified as a tax-free section 355 transaction followed by a tax-free acquisition, provided that (i) there was a separate and independent shareholder vote after the spin-off approving the acquisition and (ii) the distributing corporation had not entered into negotiations with the acquirer before the spin-off. If either of those conditions were not satisfied, however, the Service indicated that it could reorder the two transactions (so that the acquisition would precede the spin-off distribution) pursuant to the step-transaction doctrine of Commissioner v. Court Holding Co., 324 U.S. 331 (1944). Pursuant to such a reordering, the distributing corporation would be treated as exchanging the stock of its subsidiary for 25% of the acquiring corporation's stock, and then distributing that 25% stock interest to the shareholders of the distributing corporation. Thus, the distributing corporation would not "control" the distributed corporation immediately before the distribution, and would be deemed not to have distributed "control" of the distributed corporation as required by section 355(a)(1)(D). Therefore, the distribution would be fully taxable.

In 1997, Congress added section 355(e), which imposed a corporate-level tax on section 355 distributions that are part of a plan (or series of related transactions) pursuant to which one or more persons acquire stock representing at least a 50 percent or greater interest in the distributing or controlled corporation.2 The legislative history under section 355(e) indicated that the Service should not apply the section 355 control test to impose additional restrictions on post-distribution restructurings of the controlled corporation, if such restrictions would not apply to the distributing corporation.

Due to the addition of section 355(e) and the legislative history...