MORRIS TRUST REGULATIONS AT LAST
The so-called "anti-Morris Trust provision." Sec. 355(e) was enacted
back in 1997. It applies to a spinoff that otherwise qualifies for tax-free
treatment, rendering it taxable (at the distributing corporation level),
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% or greater
interest (measured by ownership of stock possessing either voting power
or value) in the distributing corporation or any controlled corporation.
This statute contains a presumption that any such acquisition that
occurs within the four-year period beginning two years prior to the date
of distribution is part of a plan or series of related transactions. Proposed
Regulation Section 1.355-7 defines the circumstances under which this presumption
can be rebutted so that the mere presence of an acquisition will not serve
to render the spinoff taxable.
Acquisitions After Spinoffs
The proposed regulations reiterate the proposition that where a distribution
occurs within two years of an acquisition, the events are presumed part
of the bad plan or series of related transactions. If the acquisition occurs
after the distribution, the presumption can be rebutted if:
Alternative Rebuttal
If the presumption cannot be rebutted under this rule, the taxpayer
can turn to an alternative which will be substantially more difficult to
satisfy. This alternative is satisfied only if, at the time of the distribution,
it can be established that: (a) the distributing corporation did not intend
that one or more persons would acquire the requisite 50% or greater interest
during the two-year period or (b) the distribution was not motivated by
an intention to facilitate such an acquisition and (c) at the time of the
distribution, the distribution corporation would not have reasonably anticipated
that it was more likely than not that one or more persons would acquire
a 50% interest in the distributing corporation or the controlled corporation
within two years, who would not have acquired such interests if the distribution
had not occurred and the distribution is not motivated by an intention
to decrease the likelihood of the acquisition of one or more businesses,
by separating these businesses from other businesses that are themselves
likely to be acquired.
That's a mouthful. Basically, it seeks to identify acquisitions that
would not have occurred but for the distribution. It seems to sanctify
the notion that a plan can exist on the strength of mere expectations regarding
the likelihood of an acquisition. Plus, it seems to reject the theory that
a plan can only be found to exist where negotiations have been conducted.
The importance of rebutting the Sec. 355(e) presumption using the
general rebuttal apparatus can be seen in Example 4 in the proposed regulations.
A spinoff was undertaken for a valid business purpose but, within six months
thereafter, the controlled corporation was acquired. Thus, the general
rebuttal rule could not be satisfied. The example concludes that the taxpayer
cannot rely on the alternative rebuttal rule either.
Why? At the time of the distribution, the taxpayer would reasonably
anticipate that if the controlled corporation is separated, an acquisition
of an interest in such corporation is more likely than not to occur by
persons who would not have acquired a proportionate interest in the distributing
corporation if the distribution had not occurred. Yuck!
Basically, this alternative rebuttal test cannot be met unless you
can show that the spinoff does not make an acquisition of either party
more likely to occur compared to the potential for such an acquisition
absent the spinoff. This may be an impossible hurdle to surmount. In most
cases, taxpayers will surely rely on the general rebuttal rule. Once the
regulations are finalized and effective, a six-month embargo on acquisitions
following spinoffs may evolve. Moreover, during that same six-month period,
it may be imprudent to initiate all but the most innocuous of contacts
with the distributing or controlled corporation.
Take Example 5 in the proposed regulations. There, a parent effected
a spinoff for a valid business purpose. At the same time, it believed it
would become a more attractive acquisition candidate if the spinoff was
undertaken. The hoped-for acquisition occurred about a year after the spinoff,
and it was not undertaken pursuant to an agreement in place during the
six-month period following the spinoff. The example concludes that the
presumption can be rebutted, under the general rebuttal rule, if the spinoff
was in substantial part motivated by the non-acquisition business purpose.
However, the transaction cannot satisfy the alternative rebuttal rule because
the distributing corporation cannot establish that, at the time of the
spinoff, it did not intend that one or more persons would acquire the requisite
50% interest during the two-year period referred to in Sec. 355(e). Yuck
again!
Acquisitions Before Spinoffs
Where an acquisition precedes a spinoff, the presumption can be rebutted
only if it can be established that, at the time of the acquisition, the
distributing corporation and its controlling shareholders did not intend
to effectuate a distribution. A controlling shareholder is a person who
possesses voting power representing a "meaningful voice" in corporate governance.
For a publicly-traded corporation, a controlling shareholder is a person
who owns 5% or more of any class of stock and who actively participates
in the management or operation of the corporation.
Alternatively, the presumption can be rebutted if it can be established
that the distribution would have occurred at approximately the same time
and under substantially the same terms (regardless of the acquisition),
provided no person acquiring an interest in that acquisition becomes a
controlling shareholder before the end of the two year period beginning
on the date of distribution. If a new controlling shareholder arises from
the acquisition (preceding the distribution) the alternative rebuttal mechanism
thus provides no solace.
Safe Harbors?
Suppose an acquisition occurs more than two years after a distribution.
The distribution and acquisition are presumed part of a plan only if there
was an agreement, understanding or arrangement concerning the acquisition
at the time of the distribution, or within the two years thereafter. On
the other hand, if an acquisition occurs more than two years before the
distribution, the acquisition and distribution are not presumed part of
a plan unless the IRS establishes that a person acquiring an interest in
that acquisition becomes a controlling shareholder before the end of the
two year period beginning on the date of distribution.
Note the burden shift! If an acquisition creates a new controlling
shareholder, it is not clear that a subsequent spinoff will ever be safely
seen as not undertaken pursuant to the requisite plan or series of related
transactions.
The regulations confirm that if the distributing corporation is acquired
in a manner that invokes Sec. 355(e) it will be taxed on the distribution
of all controlled corporations involved in the transaction. However, if
several corporations are distributed in a spinoff, and fewer than all are
so acquired, the distributing corporation is not taxed on the distribution
of those corporations that remain sufficiently independent. These regulations
will only affect distributions that occur subsequent to the time the regulations
(now in proposed form), are finalized.
The state of the law during the interim is unclear. Most taxpayers
believe that no "plan" can be found to exist if at the time of the spinoff,
the parties to the business combination did not contemplate such a transaction
and there were no negotiations or discussions regarding a business combination
until some time after the spinoff had been consummated. See Rev. Rul. 96-30.
What, me worry? If you read the proposed regulations, you'll worry.
Morris Trust Regulations at Last, Vol. 8, No. 3, M&A Tax
Report (October 1999), p. 7.
The definition of an "agreement" is intentionally left vague. An agreement
can exist even though all its terms have not been finalized. More unsettling
is the possibility that merely contacting an investment banker during the
relevant six-month period, or having a banker contact potential acquirers
on behalf of the distributing or controlled corporation during the six-month
period, might itself constitute the requisite agreement. The IRS is soliciting
comments on whether contacts, in and of themselves, should rise to the
level of an agreement. Let's just say no!