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This Month in M&A / Issue 2 / February 2015
Did you know…? p2 / Private letter rulings p3 / Other guidance p6
M&A tax recent guidance
This month features:

IRS respects taxpayer’s ‘self-help’ measures to avoid adverse basis shift consequences (PLR
201505001)

Momentary ownership of low-vote stock to facilitate spin-off disregarded for purposes of
section 355(e) (PLR 201505007)

Consolidated group continued following inbound reorganization of foreign corporate owner,
and preferred stock with contingent voting rights did not violate section 1504(a)(4) (PLR
201505006)

Obama Administration’s FY2016 budget proposals include significant tax changes for
businesses
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Did you know…?
In a recently released Private Letter Ruling (PLR 201505001), the IRS respected a
taxpayer’s ‘self-help’ steps taken to avoid detrimental basis shifts upon the incorporation
of a partnership.
Background – Section 732
The incorporation of a partnership through nonrecognition transactions (e.g., a section
351 contribution of partnership interests) unexpectedly can cause tax basis to shift among
the partnership’s assets as a result of the mechanics of section 732. This not only creates
administrative burdens but also may result in shifting basis from a favorable asset (e.g., a
receivable) to a non-favorable asset (e.g., land).
These negative basis consequences can be magnified if the partnership holds stock at the
time of its termination. If a corporate partner’s tax basis in its partnership interest is less
than the distributed stock’s basis, then section 732(f) could apply to reduce the basis of
the assets of the distributed corporation by the amount of decrease in the basis to the
corporate stock. This would have the effect of creating a one-sided negative basis
adjustment to the distributed corporation’s assets. However, if section 732 does not
apply to reduce the basis of distributed stock, then section 732(f) becomes inapplicable.
Steps of transaction
In PLR 201505001, perhaps in light of this inequitable basis result, the IRS allowed the
taxpayer to use ‘self-help’ to avoid the shifting of basis among a partnership’s assets
under section 732.
The facts of the ruling indicate that LLC1 was wholly owned by members of a consolidated
group (Parent Group). LLC2 was owned by LLC1 and other members of the Parent
Group. Prior to the planned transaction, LLC1 and LLC2 (each of which were
partnerships for tax purposes) each amended their operating agreements to provide that
in the event of an actual or deemed liquidation, each partner would receive first the builtin gain or loss property which they contributed to the partnership (section 704(c)
property). The remaining assets then would be distributed in accordance with fair
market value.
As part of this transaction, LLC2 made an election to be taxed as a corporation for US
federal tax purposes. Pursuant to this election, LLC2 was deemed to contribute its assets
to a new corporation (Newco) in a section 351 exchange in return for Newco stock and
then was deemed to distribute the Newco stock in connection with its liquidation. The
partners of LLC1 all liquidated into a single owner, causing LLC1 to terminate for US
federal income tax purposes.
In connection with LLC2’s incorporation, LLC2 was considered to engage in two separate
section 351 exchanges with Newco: LLC2 first contributed its section 704(c) property in
exchange for Newco stock that retained the section 704(c) character (704(c) stock); then
LLC2 contributed its remaining assets in exchange for Newco stock without the section
704(c) character (non-704(c) stock). Under the amendments to the operating agreement,
LLC2 was treated as making liquidating distributions to its partners first of the 704(c)
stock equal to the amount of section 704(c) property that the partner or a successor
contributed to LLC2, and then of the non-704(c) stock. As a result of the amendment to
the partnership agreement, the basis of the Newco stock distributed to each partner
should equal each partner’s tax basis in its respective partnership interests, causing
section 732(f) to be inapplicable.
IRS conclusions
In connection with the termination of LLC1, the PLR cited both Rev. Rul. 84-111, situation
3, and Rev. Rul. 99-6, situation 1, to conclude that the remaining owner of LLC1 was
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deemed to acquire the assets of LLC1 after a deemed distribution of the LLC1 assets to its
partners. In concluding that section 732(f) was not applicable to the distribution of
Newco stock, the IRS respected the amendment to the agreement and concluded that first
the 704(c) stock was distributed to the respective contributing partner, and then all non704(c) stock was distributed to the partners. Under this approach, the basis that the
partners took in the distributed Newco stock after LLC1’s termination should equal each
partner’s tax basis in their respective partnership interests, causing section 732(f) to be
inapplicable.
Observations
There are three noteworthy observations from this PLR. First, the IRS appears to be
signaling its willingness to allow partners and partnerships to undertake self-help
measures to avoid certain unintended tax consequences resulting from the termination of
a partnership as part of a nonrecognition transaction. The PLR respected the amendment
to the partnership operating agreement, which specifically identified the assets to be
distributed to each partner in a deemed or actual liquidation.
Second, the PLR affirmatively permitted the use of section 704(c) principles to trace the
basis in assets so that the correct amount of basis is distributed to each partner as part of
the deemed distributions. In doing so, the IRS permitted a bifurcation of the Newco
stock, with some shares considered substitute section 704(c) property, before the deemed
distributions to the partners. This methodology avoids adjustments to the basis of the
distributed property under section 732.
Third, the PLR indicates that the principles of Rev. Rul. 99-6 can apply on non-taxable
transfers of partnership interests. Rev. Rul. 99-6 literally applies on a taxable transfer of
a partnership interest that causes the partnership to be wholly owned. Rev. Rul. 99-6
prescribes a deemed distribution of the partnership’s assets to the partners followed by a
purchase of assets by the buying partner. In contrast, Rev. Rul. 84-111 addresses the
consequences of a tax-free incorporation of a partnership through the transfer of
partnership interests. Rev. Rul. 84-111 does not explicitly require a deemed distribution
of the assets to the partners as part of the incorporation. This approach suggests that the
form of the transaction may be respected, causing the partnership to liquidate into its
single owner (and not create a deemed distribution to all partners). As a result, basis
adjustments under section 732 to the distributed property and gain or loss under the
“mixing bowl” rules of sections 704(c)(1)(B) and 737 may be avoided. However, this PLR
concluded that the deemed distribution included in Rev. Rul. 99-6 also applies to
partnership incorporations described in Rev. Rul. 84-111. The IRS allowed the taxpayer
to avoid the negative basis consequences associated with the deemed distribution under
Rev. Rul. 99-6 by allowing the partnership to dictate which assets are distributed to the
partners as part of the deemed distributions.
For additional information, please contact Karen Lohnes or Elizabeth Amoni.
Private letter rulings
PLR 201505007
The IRS ruled that for purposes of determining whether section 355(e) was violated in a
section 355 spin-off by a corporation (Distributing) with a high-vote/low-vote structure
(the High-Vote Stock and Low-Vote Stock), the momentary ownership of Low-Vote Stock
by converting High-Vote Stock shareholders was disregarded.
Steps of transaction
Distributing was the common parent of a consolidated group that included a wholly
owned subsidiary (Controlled). Distributing’s Low-Vote Stock was publicly traded, while
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the High-Vote Stock was privately held. The High-Vote Stock was convertible, upon the
holder’s election, into Low-Vote Stock on a share-for-share basis.
Distributing’s Articles of Incorporation provided that if the issued and outstanding
High-Vote Stock fell below a specified percentage of all Distributing’s issued and
outstanding stock, every class and share of Distributing’s stock automatically would
become entitled to the same rights, preferences, limitations, and restrictions as the
High-Vote Stock, such that all distinctions between the two classes would be eliminated
(the Stock Unification). Distributing’s Board of Directors determined that the dual-class
structure needed to be collapsed prior to a contemplated spin-off of Controlled.
Accordingly, Distributing entered into an agreement with certain shareholders owning
High-Vote Stock to convert their shares and thereby trigger the Stock Unification
(Converting Shareholders).
Section 355(e)
As a result of the shift in voting rights for the shareholders of Low-Vote Stock, the
question arose whether section 355(e) was violated. Section 355(e) states that in order to
qualify for nonrecognition, a section 355 transaction may not be part of a plan (or series
of related transactions) pursuant to which one or more persons acquire, directly or
indirectly, stock representing a ‘50 percent or greater interest’ in Distributing or
Controlled.
In taking the position that the spin-off qualified under section 355, the taxpayer appears
to have relied on an example in the legislative history underlying an exception in section
355(e)(3)(A)(iv), providing that an acquisition of Distributing (or Controlled) stock is
ignored for purposes of section 355(e) to the extent it equals the acquiror’s interest in
Distributing before the acquisition (the net decrease methodology). See S. Rep. 105-174,
174-75 (June 24, 1998). Under this approach, the taxpayer determined that the Stock
Unification resulted in a shift of greater than 50 percent of the aggregate voting power
with respect to the shareholders that owned the Low-Vote Stock immediately prior to the
spin-off. When analyzed on a shareholder-by-shareholder basis, however, the largest
shift in voting power occurred with respect to shareholders of Low-Vote Stock that were
not Converting Shareholders.
IRS conclusions
The IRS ruled that for purposes of determining whether the spin-off and Stock
Unification violated section 355(e), any increase in the percentage of Distributing stock
owned by any shareholder as a result of the Stock Unification was disregarded (and not
treated as an acquisition) to the extent of any decrease in that shareholder’s percentage
ownership of Distributing stock prior to the Stock Unification.
Observations
Presumably, the taxpayer’s concern in this PLR was that the Converting Shareholders’
ownership of the Low-Vote Stock immediately prior to the Stock Unification contributed
to the aggregate shift in the voting power of Distributing such that section 355(e) was
violated. The IRS appears to have disregarded the Converting Shareholders’ ownership of
Low-Vote Stock because it was transitory and pursuant to the overall plan to engage in
the spin-off. This approach illustrates that despite the seemingly mechanical nature of
analyzing shifts in voting power, all the facts and circumstances must be considered in
determining whether acquisitions of Distributing or Controlled stock violate section
355(e).
For additional information, please contact Rich McManus or Bruce Decker.
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PLR 201505006
The IRS ruled that the domestication of a foreign corporation (Foreign Holding) owning
100 percent of the common stock of the common parent (Parent) of a consolidated group
(Parent Consolidated Group) did not terminate the Parent Consolidated Group and that
preferred stock (Series A Preferred Stock) of Parent with contingent voting rights was
disregarded in determining affiliation.
Steps of transaction
Foreign Holding incorporated as a domestic corporation (Domestic Holding) in a
transaction represented by the taxpayer to be a reorganization described in section
368(a)(1)(F).
Thereafter, Domestic Holding merged into Parent, with Parent surviving. The taxpayer
represented that but for the Series A Preferred Stock, Foreign Holding’s ownership of
Parent’s stock met the requirements for affiliation under section 1504(a)(2). The Series A
Preferred Stock generally had no voting rights for directors but would become entitled to
the right to elect two directors to Parent’s board upon the occurrence of certain dividend
defaults or upon Parent’s failure to maintain the listing of the Series A Preferred Stock on
a national exchange. The taxpayer represented that neither type of default had occurred
between the date that Foreign Holding domesticated and the date Domestic Holding
merged into Parent.
IRS conclusions
Based on these facts, the IRS ruled that the Series A Preferred Stock was disregarded
under section 1504(a)(4) for purposes of determining whether Domestic Holding and
Parent were affiliated. The IRS also ruled that Foreign Holding’s domestication did not
cause a termination of the Parent Consolidated Group, with Domestic Holding being
treated as the common parent of the Parent Consolidated Group until it merged into
Parent.
Observations
Section 1504(a)(4) issue
Stock described in section 1504(a)(4) is not taken into account for purposes of
determining affiliation. In the PLR, Foreign Holding would not have owned the requisite
amount of Parent’s stock for affiliation under section 1504(a)(2) if the Series A Preferred
Stock had not been disregarded under section 1504(a)(4).
Among other criteria, stock must not be entitled to vote to be described in section
1504(a)(4). The PLR illustrates that the determination of whether stock is entitled to vote
for purposes of section 1504(a)(4) may be based on the ability to elect directors and that
such voting rights conditioned on the occurrence of an event that has not yet occurred
generally may not be taken into account for purposes of section 1504(a)(4).
Group continuation issue
The PLR does not specify the basis for the conclusion that the Parent Consolidated Group
continued to exist after Domestic Holding became the common parent. Generally, a
consolidated group ceases to exist when the common parent of the group ceases to be the
common parent.
This general rule is subject to two express regulatory exceptions under Reg. sec.
1.1502-75. One exception deals only with the situation in which the common parent of
the group ceases to exist. The other exception applies if (1) an acquiring corporation (or
any member of a group of which the acquiring corporation is the common parent)
acquires, in exchange for stock of the acquiring corporation, stock of a target corporation,
and as a result the target corporation becomes a member of the affiliated group of which
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the acquiring corporation is the common parent; and (2) as a result of owning stock of the
target corporation, the target corporation’s shareholders own more than 50 percent of the
fair market value of the acquiring corporation’s stock immediately after the transaction.
The inbound reorganization under section 368(a)(1)(F) would be treated as (1) the
transfer by Foreign Holding of all its assets and liabilities to Domestic Holding in
exchange for Domestic Holding stock; and (2) a liquidating distribution by Foreign
Holding to its shareholders of the Domestic Holding stock. See Rev. Rul. 88-25. Thus,
the transaction did not technically meet the requirements of either exception described
above, as Parent remained in existence and Foreign Holding (the target corporation’s
shareholder) did not hold more than 50 percent of the fair market value of Domestic
Holding’s stock immediately after the transaction. However, in similar circumstances the
IRS has ruled that a consolidated group did not terminate when the common parent
ceased to be the common parent, even though the exceptions in Reg. sec. 1.1502-75 were
not technically satisfied. See Rev. Rul. 82-152.
For additional information, please contact Dave Friedel or Pat Pellervo.
Other guidance
Obama Administration 2016 Budget Proposals
The Obama Administration on February 2 submitted its FY2016 budget to Congress, with
a number of new and old tax proposals affecting businesses. The President’s budget
reaffirms support for lowering the maximum federal corporate income tax rate to 28
percent and providing a reduced rate of 25 percent for domestic manufacturing income as
part of business tax reform, but specifies only some of the base-broadening provisions
that would be required to offset the cost of lower rates. If enacted, most would be
effective for transactions occurring or tax years beginning after December 31, 2015.
The Administration’s new budget makes significant additions to and clarifications of the
President’s FY2015 proposals, including:
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
Providing a one-time 14 percent ‘transition tax’ on the accumulated earnings of
controlled foreign corporations (CFCs) not previously subject to US tax, effective
on the date of enactment and applicable to earnings accumulated for tax years
beginning before 2016. A foreign tax credit would be allowed for taxes related to
the foreign earnings, determined by multiplying the amount of the foreign taxes
by the ratio of 14 percent to the highest corporate tax rate for 2015.

Enacting a 19-percent minimum tax applicable to the foreign earnings of US
corporations and their CFCs. The minimum tax would be reduced by 85 percent
of the per-country foreign effective rate. For example, the US tax rate applicable
to the earnings of a CFC operating in a country with a 15 percent tax rate would
be 6.25 percent (19 percent - (85 percent*15 percent)). The minimum rate would
not apply to foreign sourced royalty and interest payments paid to US persons
which would be taxed at the US statutory rates. Other computational rules would
apply.

Treating certain leveraged distributions from a corporation that currently are
treated as a recovery of basis under section 301(c)(2) as the receipt of a dividend
directly from a related funding corporation. The FY2015 budget had proposed to
disregard a shareholder’s basis in stock of a distributing corporation for purposes
of recovering basis in similar situations.

Disregarding a subsidiary’s purchase of ‘hook stock’ for property so that the
property used to purchase the hook stock gives rise to a deemed distribution from
the purchasing subsidiary (through any intervening entities) to the issuing
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corporation. The hook stock would be treated as being contributed by the issuer
(through any intervening entities) to the subsidiary.

Broadening the definition of an inversion under section 7874 by reducing the
historical ownership test from 80 percent to a greater-than-50-percent test, and
eliminating the 60-percent test. In addition, an inversion would be deemed to
occur if, immediately before the transaction, (1) the fair market value of the stock
of the domestic entity is greater than the fair market value of the stock of the
foreign acquiring company; (2) the expanded affiliated group (EAG) is primarily
managed and controlled in the US; and (3) the EAG does not conduct substantial
business activities in the country in which the foreign acquiring corporation is
created or organized.

Repealing the exemption from corporate income tax for publicly traded
partnerships with qualifying income from activities related to fossil fuels,
effective after December 31, 2020.
The Administration’s FY2016 budget also contains various business tax proposals that
have been included in prior-year submissions, including proposals to:

Limit the importation of losses under the related-party loss limitation rules.

Conform corporate ownership standards under sections 368 and 1504.

Tax gain from the sale of a partnership interest on a look-through basis.

Tax ‘carried interest’ partnership income as ordinary income.

Repeal the nonqualified preferred stock designation and related boot provisions.

Repeal the anti-churning rules of section 197.

Prevent the elimination of earnings and profits through distributions of certain
stock.

Expand the definition of ‘substantial built-in loss’ for purposes of partnership
loss transfers.

Repeal the ‘boot-within-gain’ limitation for dividends received in reorganization
exchanges.

Extend partnership basis limitation rules to nondeductible expenditures.

Repeal technical terminations of partnerships.

Limit the shifting of income through intangible property transfers.

Streamline the audit and adjustment procedures for large partnerships.

Repeal the preferential dividend rule for publicly traded and publicly offered real
estate investment trusts.
Observations
The President’s FY2016 budget includes a number of new business tax proposals not
previously presented in previous budgets, in addition to modifications and clarifications
of certain prior proposals. Businesses should consider the potential impact of these tax
proposals in their transaction planning in light of the potential for some of the proposals
to be considered by Congress in the context of tax reform legislation in 2015 or later
years.
For additional information, please contact Tim Lohnes, Rich McManus, or Larry
Campbell.
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Let's talk
For a deeper discussion of how this issue might affect your business, please contact:
Tim Lohnes, Washington, DC
Karen Lohnes, Washington, DC
+1 (202) 414-1686
+1 (202) 414-1759
[email protected]
[email protected]
Dave Friedel, Washington, DC
Rich McManus, Washington, DC
+1 (202) 414-1606
+1 (202) 414-1447
[email protected]
[email protected]
Larry Campbell, Washington, DC
Pat Pellervo, Washington, DC
+1 (202) 414-1477
+1 (415) 498-56190
[email protected]
[email protected]
Bruce Decker, Washington, DC
Jon Thoren, Washington, DC
+1 (202) 414-1306
+1 (202) 414-4590
[email protected]
[email protected]
Jamal Razavian, Washington, DC
Elizabeth Amoni, Washington, DC
+1 (202) 414-4559
+1 (202) 346-5296
[email protected]
[email protected]
Patrick Phillips, Washington, DC
Kristel Glorvigen Pitko, Washington, DC
+1 (202) 414-1358
+1 (202) 312-7651
[email protected]
[email protected]
Adam Furst, Washington, DC
William Byrd, Washington, DC
+1 (202) 312-7901
+1 (202) 346-5115
[email protected]
[email protected]
Brian Loss, Washington, DC
+1 (202) 346-5137
[email protected]
This document is for general information purposes only, and should not be used as a substitute for consultation with professional
advisors.
SOLICITATION
© 2015 PricewaterhouseCoopers LLP. All rights reserved. In this document, 'PwC' refers to PricewaterhouseCoopers (a Delaware
limited liability partnership), which is a member firm of PricewaterhouseCoopers International Limited, each member firm of
8 is a separate legal entity.
PwC
which