FURTHER SPINOFF THOUGHTS, THIS TIME DUN & BRADSTREET!

Here at The M&A Tax Report, we are often criticized for covering Section 355 ad nauseum. After all, hardly an issue goes by that there isn't some report about Section 355 being availed of by someone. For example, see Wood, "Devices Under Section 355: Who Me?," Vol. 8, No. 3, M&A Tax Report (October 1999), p. 6; Wood, "Morris Trust Regulations at Last," Vol. 8, No. 3, M&A Tax Report (October 1999), p. 7 (Part I) and Vol. 8, No. 4, M&A Tax Report (November 1999), p. 7 (Part II); and Wood, "Spinoff Business Purpose: Two is Better Than One," Vol. 8, No. 6, M&A Tax Report (January 2000), p. 7.

One of the more closely-watched Wall Street deals (in some way it is the quintessential Wall Street deal), is the multiple spinoff of Dun & Bradstreet. From a technical viewpoint, the biggest issue about the spinoff of Moody's by Dun & Bradstreet is the potential application of Section 355(e). That section can render a spinoff taxable at the corporate level (to Dun & Bradstreet) if the spinoff is part of a plan or series of related transactions pursuant to which one or more persons acquire stock representing a 50% interest in either corporate party to the spinoff.

Level, as in Playing Field?

First, let's look at what we mean by taxable at the corporate level, since it can be a terrible consequence. The gain at the parent level is normally measured by the excess of the value of the distributed subsidiary (generally the mean between the high and low trading prices of its stock of a public company on the date of the distribution) over the parent's tax basis in the hands of the distributing entity. What is perhaps surprising is that there is a presumption (albeit a rebuttable one) that any acquisition that meets this percentage test noted above occurring within the four year period beginning two years prior to the spinoff will be considered undertaken pursuant to a prohibited plan or series of related transactions.

In August 1999, just a few months back, the IRS proposed regulations to give at least a little bit of guidance about the circumstances in which an acquisition would be viewed as pursuant to a requisite plan or series of related transactions. There is an important safe harbor under which an acquisition occurring more than six months after the spinoff will not be seen as part of a plan which includes the spinoff, as long as the spinoff was motivated by a nonacquisition-related corporate business purpose and if, within the six- month period, there are no agreements, arrangements, understandings or "substantial negotiations" with respect to that acquisition.

Aw, There's the Rub...

If one thinks about the traditional step transaction doctrine, much of this seems pretty much okay. What is really troubling is this six-month period of intense scrutiny during which even substantial negotiations (no matter how fruitless they apparently are!) can give rise to the presumption rearing its ugly head again. Not surprisingly, these proposed regulations have been subject some pretty harsh criticism. Even if they survive in this form, though, they would only effect distributions that occur subsequent to the time these regulations are finalized.

When will they be finalized? Well, probably not in time to adversely impact the proposed Dun & Bradstreet spinoff of Moody's. Whether Section 355(e) is a problem for Dun & Bradstreet is a function of current law, which is not as clear as it might be. Some of the recent transactions we have witnessed suggest that even under the presumption period described above (any acquisition occurring within the four year period beginning two years prior to the spinoff), some transactions within this period have been viewed as okay.

Indeed, most advisors I've talked to seem to believe that no prohibited plan (or series of related transactions) will be found to exist if, at the time of the spinoff itself, the parties to the business combination did not contemplate such a transaction (and there were no negotiations or discussions regarding such a business combination) until some time after the spinoff had been consummated. (On this point, see Revenue Ruling 96-30, 1996-1 C.B. 36.) This may sound like a tall order. It does require that someone with tax savvy stop the parties from discussing and negotiating an acquisition until after the spinoff occurs.

Business Purpose(s)

Of course, don't forget that a good old business purpose can rebut the presumption, if one has to go down that road. We recently noted the growing phenomenon of back-up business purposes, so you shouldn't necessarily limit yourself to just one business purpose. See Wood, "Spinoff Business Purpose: Two is Better Than One," Vol. 8, No. 6, M&A Tax Report (January 2000), p. 7.

Spinoff Taxable at Shareholder Level?

The above discussion deals with corporate-level tax, not tax on the shareholders. A separate subject is what happens if a spinoff is taxable at the shareholder level. There, as we all know, there is perhaps an even greater problem. The distribution will likely be treated as a dividend under Section 301 if the spinoff is found to be a prohibited device for the distribution of earnings and profits.

This amorphous "device" test will not be met in cases where a parent distributes the stock of a subsidiary on a pro rata basis to shareholders who, pursuant to a pre- arranged plan, sell the stock of either corporation, while maintaining ownership of the other. This may seem counterintuitive, but the Service has long viewed this kind of situation as not abusive (and indeed it isn't). But, where a spinoff is followed by a sale of either corporation, the sale may be sufficient to invoke Section 355(e), yet not bear a sufficient relationship to the distribution to trigger a finding that the spinoff was used principally as a device to distribute earnings and profits.

Hence, it is possible (although it doesn't seem to happen too often) that the spinoff can be taxable at the corporate level (as in the discussion above about the potential for the Dun & Bradstreet/Moody's transaction), and yet not be taxable at the shareholder level.

Finally, it should certainly be noted that the IRS generally does not seek to invoke the device rules in the case of widely held corporations engaged in spinoff activity, at least where the spinoff is motivated by a nonacquisition-related business purpose. And, of course, as we all know, to get a ruling from the Service, one has to have a good business purpose. Thus, the device rules for shareholders are relatively unlikely to be a problem (at least in the public company context).

Mutual Fund Foray?

I can't close without noting that Dun & Bradstreet Corp. may actually be turning into a mutual fund, as observed by the Wall Street Journal. Given the number of publicly traded companies that have been spawned by Dun & Bradstreet, perhaps that is effectively what the shareholders of Dun & Bradstreet have been part of. See Lipin and White, "Multiple Spinoffs Turned D&B Into a Mutual Fund," Wall Street Journal Europe, December 29, 1999, p. 16. Various publicly traded companies have been spun off from Dun & Bradstreet over the years, leaving the credit analysis business as the largest remaining piece.

The intended spinoff of Moody's will effectively unwind years of mergers and acquisitions by Dun & Bradstreet, which started back in the 1960s, and kept going like a freight train through the '80s. Most analysts see the shareholders having profited handsomely from the various deals over the years, including the Moody's spinoff that is currently in the news. Id.

Further Spinoff Thoughts, This Time Dun & Bradstreet!, Vol. 8, No. 7, M&A Tax Report (February 2000), p. 5.