The following article is adapted and reprinted from the M&A Tax Report, Vol. 9, No. 8, March 2001, Panel Publishers, New York, NY.


By Robert W. Wood

There has been quite a bit of buzz about the newly-issued Section 355(e) proposed regulations. As we indicated last month (see Wood, "Now Section 355(e) Rules Save Us!" Vol. 9, No. 7, The M&A Tax Report (Feb. 2001), p. 1), the Revenue Service came out at the end of December with a new set of proposed regulations (REG-107566-00) defining the scope of a "plan" under Section 355(e). A little while later, the IRS issued Announcement 2001-11, 2001-4 I.R.B. 432, indicating that it had withdrawn the previously proposed regulations (proposed way back in August 1999) in view of its new proposed regulations. (See Tax Analysts Doc. No. 2001-2115, 2001 TNT 14-17.)

Now that the new proposed regulations have been released for a little over a month (at this writing), practitioners and the Service alike are talking about them. The District of Columbia Bar's Corporate Tax Committee, for example, held a program at which government, public accounting and private practice lawyers could kibbitz over the regs. The most important point in the proposed regs, according to Eric Solomon, acting Treasury Deputy Assistant Secretary (Tax Policy), is that the new rules tell practitioners on which parties to focus. To determine whether a plan exists, the critical parties are the distributing and the controlled corporations, and any controlling shareholders, Solomon said.

"Reasonable Certainty" Hailed

Others weighed in on various aspects of the rules. Outgoing Associate Tax Legislative Counsel, Karen Gilbreath, emphasized the administrability of the new "reasonable certainty" standard. It provides that there is evidence of a business purpose to facilitate an acquisition if, at the time of the distribution, it was reasonably certain that an acquisition would occur within six months, or that an agreement, understanding or arrangement would exist (or that substantial negotiations would occur). This "reasonable certainty" standard is decidedly different, said most of the panelists, from the "more likely than not" standard replaced.

Of course, since there is not a great body of law interpreting the phrase "reasonable certainty" (as compared with, say, a "preponderance of the evidence," "beyond reasonable doubt," or other similar legal axioms), just how much ease of administration and downright reasonableness this "reasonable certainty" standard will import is not yet clear.

How Safe is Safe?

Last month, we noted that we thought most people would be focusing on the safe harbors in the proposed rules — all six of them. See Wood, M&A Tax Report (Feb. 2001), p. 1. After all, in these days of requesting and obtaining private rulings (both of which are fewer and farther between given the pace of many transactions involving all but the biggest deals), the safe harbors are welcome. As we predicted, a good deal of the focus so far in the tax community has been on these safe harbors.

The first safe harbor provides that an acquisition occurring after the distribution is not part of a plan if:

Okay, this particular safe harbor is a mouthful, deserving to be broken into its various elements. Probably the biggest question, since much of this seems mechanical, is just what this "substantial" nonacquisition business purpose might be. Suppose, for example, that the distributing corporation spins off a controlled corporation for a substantial nonacquisition purpose, such as for regulatory or financing reasons. Let's also suppose that the controlled corporation did not enter into negotiations to merge into an unrelated corporation until six months after the distribution. Yet, at the time of the distribution, it was reasonably certain that the controlled entity would be acquired within six months of the distribution. In fact, the primary reason for the distribution would be the controlled corporation's acquisition.

Actually, this was an example posed by Andrew Eisenberg of KPMG at the recent DC Bar Corporate Tax Committee presentation. Various government panelists tried to apply the "reasonable certainty" rule to this fact pattern. Indeed, one government representative, Phil Levine, deputy to IRS Associate Chief Counsel (Corporate), Jasper Cummings, said that where the primary reason of the transaction is to acquire the controlled corporation, the "reasonable certainty" notion is really a red herring.

Maybe so, but some of the panelists seemed to take issue about whether the safe harbor could be satisfied where the nonacquisition business purpose is "substantial." The government contingent seemed clear that the answer would be no, almost by definition. Both business purposes (remember the comparative business purpose analysis of some Section 355 authority?) have to be taken into account.

Still, Jasper Cummings (IRS Associate Chief Counsel (Corporate)), said that the proposed regs contain nothing about primary and secondary business purposes. So, if you have both good and bad purposes and each are in some sense "substantial," you have to agonize over the provision. Not a very helpful thing when you are trying to clearly delineate the bounds of the safe harbor.

Perhaps the entrance to the safe harbor is filled with rocky shoals and obstacles (sorry, an irresistable metaphor). As if all this wasn't enough, the debate at the DC Bar meeting, some involving the audience, was over good and bad business purposes. One of the government representatives put it plainly that a substantial good business purpose is not sufficient to bring one within the confines of the safe harbor; the good business purpose has to be evaluated in light of the bad one. (Ardent film afficionados would ask: where's the "ugly" business purpose to complete the good, bad and ugly trilogy?)

A Ruling on a Safe Harbor?

Okay, this may sound bizarre, but can one obtain a ruling on such issues such as these? That topic came up in the DC meeting, too, and at least one government official said that the IRS has not yet determined if it will issue rulings on these points.

More Help or More Confusion?

Perhaps the greatest thing to come out of discussions such as these are the identified areas in which we can expect further change. It appears that this new set of proposed regulations is not a static entity. Although it may turn out to be bible-like in its interpretation in differing ways, the government made it clear that before the "next" set of regs comes out, Treasury wants comments and questions. Eric Solomon said that there will be upcoming guidance on the definition of an acquisition, the application of the aggregation and attribution rules (these, I think, are likely to be complex) and the treatment of successors and predecessors (once again, probably a messy area). For further details, see Stratton, "Officials Explain New Proposed Anti-Morris Trust Regs," Tax Notes, Jan. 15, 2001, p. 304.

More on Anti-Morris Trust Regs, Vol. 9, No. 8, M&A Tax Report (March 2001), p. 1.