On July 15, 2016, the Internal Revenue Service (IRS) released Rev. Proc. 2016-40. This revenue procedure provides safe harbors in which the IRS will not assert that a distributing corporation, D, lacks control of another corporation, C, within the meaning of Code section 355(a)(1)(A) when D acquires putative control of C through C’s issuance of stock and C subsequently engages in a transaction that actually or effectively reserves the effect of the stock issuance. In general, D can only distribute the stock of C to D shareholders in a tax-free spin-off under Code section 355 if D has control of C within the meaning of Code section 368(c) immediately before the spin-off. To satisfy the control requirement of section 368(c), D must have 80 percent of the vote and 80 percent of each nonvoting class of C stock. Historically, in situations in which D owned less than 80 percent of the stock of C, D would satisfy this requirement by having C recapitalize its stock into “high vote” and “low vote” classes of stock immediately before the spin-off. D would then distribute the “high vote” stock with more than 80 percent of the vote of all C stock to D shareholders in a tax-free spin-off under section 355. However, publicly traded corporations often dislike having multiple classes of stock with different voting rights outstanding. As a result, when C becomes an independent publicly traded corporation following the spin-off, it often seeks to recapitalize its “high vote” and “low vote” classes of stock into a single class with identical voting rights. Prior to 2013, the IRS issued a number of private letter rulings permitting C to engage in such recapitalizations following its first regularly scheduled board meeting after a spin-off without retroactively causing the spin-off to fail to be tax-free under section 355. In 2013, the IRS announced it would no longer issue such rulings while it studied the issue.
Although the safe harbors in Rev. Proc. 2016-40 are less helpful to corporations hoping to simplify their capital structures following a tax-free spin-off than the IRS’s prior ruling policy, they do provide certainty to corporations wanting to know when they can simplify their capital structures. In general, the revenue procedure allows C to simplify its capital structure into a single class of stock 24 months after the spin-off if no action is taken (including the adoption of any plan or policy) by C’s board of directors, management or controlling shareholders to simplify C’s capital structure at any time during the 24-month period. The revenue procedure also provides a safe harbor allowing corporations to simplify their capital structures less than 24 months after a tax-free spin-off in the context of certain unanticipated third party transactions. In addition, the revenue procedure also removes the prohibition against issuing letter rulings on transactions involving such an acquisition of control. The guidance is effective with respect to distributions that occur on or after August 1, 2016; however, taxpayers may apply the revenue procedure with respect to a distribution that occurs before August 1, 2016.