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Lost in Translation: Treatment of Foreign-Law Demergers Under U.S. Federal Tax Law

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Lost in Translation: Treatment of Foreign-Law Demergers Under U.S. Federal Tax Law

At a certain point in the life of a corporation that operates more than one business, management may wish to separate the different businesses into two or more separate corporate entities. In most cases, demergers are structured based on the requirements of the corporate law in the place of domicile of the corporation. Typically, a demerger of a foreign corporation that follows the corporate law provisions of applicable foreign law would also be exempt from tax in the relevant country. However, when one of the shareholders is a U.S. individual or corporation, U.S. Federal tax considerations should be taken into account to prevent unexpected U.S. tax for a U.S. investor. Demergers are given tax-free treatment under U.S. tax law only if the requirements of Code §355 are met. If not met, both the corporation that undergoes the demerger and its shareholders recognize gain in connection with an actual or deemed distribution of appreciated property. While the foreign corporation may have no U.S. tax to pay, the U.S. investor may find that tax would be due in the U.S. if the foreign corporation undergoing the demerger is a C.F.C. Stanley C. Ruchelman and Daniela Shani explain the various categories of tax free demergers under U.S. tax concepts and the consequences of failing to meet the requirements in the context of a corporation formed outside the U.S.

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Proposed Regulations on Nondevice & Active Business Requirements Under Code §355

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Many jurisdictions have special provisions that apply when two businesses owned by a corporation or corporate group are divided and shares of group members are distributed to shareholders.  Sometimes referred to as a “demerger” in Europe and other times as a “butterfly” in Canada, in the U.S. these transactions are called Code §355 spin-offs, split-ups, and split-offs.  In the U.S., several hurdles must be overcome for the transaction to be free of tax at the level of the company making the distribution and the shareholder receiving the distribution.  The I.R.S. recently issued proposed regulations clarifying the application of two of these hurdles: the transaction must not be a “device” to distribute earnings, and companies conducting two or more active business must be involved.  The proposed regulations were motivated by a proposal by Yahoo! to distribute shares of Alibaba.  Rusudan Shervashidze and Andrew P. Mitchel analyze the proposed regulations and how they will apply to circumstances involving a spin-off of a corporation operating a small business but having a large investment asset.

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What Is a Corporate Business Purpose for a Tax-Free Corporate Division?

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As Insights continues to look at various provisions of the Internal Revenue Code applicable to corporate reorganizations and divisions, Elizabeth V. Zanet and Beate Erwin delve deeper into the requirements to address an eternal question relating to a tax-free spin-off.

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Tax 101: How to Structure a Corporate Division

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With all the brouhaha over the announced Alibaba spinoff by Yahoo!, Elizabeth V. Zanet explains the circumstances in which a corporate division – known as a demerger in many countries – can be achieved in a tax-free manner under U.S. tax law. The path is not easy as these divisions are the lone vestiges allowing tax-free corporate distributions of appreciated assets under U.S. tax law.

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Could an I.R.S. Employee's Comment Cause Yahoo! Stock to Fall?

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Recently, the Internal Revenue Service (“I.R.S.”) Office of the Associate Chief Counsel (Corporate) announced that it may hold off on issuing ruling requests to taxpayers seeking assurance on the “active trade or business” requirement (“A.T.B.”) of a tax-free spinoff under Code §355. In light of recent market transactions, the I.R.S. is in the process of considering, how much A.T.B. is enough for a spinoff to qualify for nonrecognition treatment.

YAHOO! CIRCUMSTANCES

The announcement also placed doubt on whether ruling requests already submitted to the I.R.S. would be issued. Speaking at a District of Columbia Bar Association event, a senior technical reviewer at the Office of the Associate Chief Counsel (Corporate) stated that the I.R.S. will hold off on issuing new ruling requests starting on May 19, 2015. He said that requests that were submitted before that date will be reviewed in the normal course, but that position may also change depending on what is decided in the next few months.