April 23, 2019

Spin-Offs: IRS Eases “Active Trade or Business” Requirements

In order to for a spin-off to qualify under Section 355 of the Tax Code, the parent and the subsidiary must be engaged in an “active trade or business” immediately prior to the transaction & have been engaged in such business for at least five years.  The IRS’s position has long been that in order to satisfy that requirement, a company must ordinarily generate income.

The IRS’s position has made it very difficult for most developmental stage companies to qualify to participate in a spin-off.  Last fall, I blogged about the IRS’s apparent willingness to ease the income requirement while it studied the issue further. This Ropes & Gray memo says that the IRS has recently taken tangible steps in that direction, by suspending 2 problematic revenue rulings.  This excerpt provides the details:

Specifically, the IRS, in Revenue Ruling 2019-09, has suspended the two prior rulings, each issued in 1957, during the pendency of the IRS study, because the rulings “could be interpreted as requiring income generation for a business to qualify” as an active trade or business. The suspension is a concrete step by the IRS with immediate impact, upon which taxpayers and their advisors may rely in evaluating whether the spinoff of an historic R&D-based business will qualify for tax-free treatment, or in seeking a private letter ruling from the IRS.

For now at least, the suspension resolves the tension between the suspended rulings and the regulations that adopt a somewhat more liberal approach. While the suspension is not necessarily permanent, the move provides further evidence that the IRS is prepared to take a more modern approach to the qualification of businesses without revenue as “active trades or businesses.

While it was sometimes possible to work around the 1957 revenue rulings, the memo notes that prior to their suspension, the rulings could have been interpreted as significant obstacles to tax-free spinoffs by life sciences, technology, or other businesses that are research-intensive and are not yet collecting income.

John Jenkins