One of the many conditions that Section 355 of the Tax Code imposes on spin-offs is that, immediately before the spin-off, the parent and the subsidiary must be engaged in an “active trade or business” & have been engaged in such business for at least five years. That condition ordinarily includes the collection of income, which makes it difficult for most developmental stage companies to qualify.
This Latham memo suggests that a recent statement suggests that the IRS is considering a possible change to the “active trade or business” condition that would potentially open the door for spin-offs involving developmental stage companies. Here’s an excerpt:
The recent IRS statement addresses the application of the active trade or business requirement to businesses engaged in R&D activities, regardless of whether they currently generate income. The statement notes that the IRS has “observed a significant rise in entrepreneurial ventures whose activities consist of research and development in lengthy phases,” during which no income or negligible income is collected. Despite not collecting income, these businesses expend significant financial resources and perform day-to-day operational and managerial functions — factors that the IRS notes have historically evidenced the conduct of an active business.
The memo says that IRS & Treasury are now considering issuing guidance as to whether entrepreneurial activities — such as R&D — could qualify as an active trade or business, even if those activities haven’t yet generated income. The IRS is soliciting comments on the issue, and the memo also notes that, in the meantime, it will consider requests for private letter rulings on the active trade or business requirement for corporations that have not collected income.
– John Jenkins