On May 1, 2024, the Treasury Department and Internal Revenue Service (the “Treasury” and “IRS,” respectively) issued Revenue Procedure (“Rev. Proc.”) 2024-24 and Notice 2024-38 (collectively, the “Guidance”). The Rev. Proc. provides procedures for requesting private letter rulings from the IRS relating to certain matters pertaining to transactions intended to qualify under Section 355 and related provisions of the Internal Revenue Code of 1986, as amended (the “Code”).[1] Notice 2024-38 describes the views and concerns of the Treasury and IRS regarding certain matters addressed in the Rev. Proc. The Guidance modifies Rev. Proc. 2017-52 and supersedes Rev. Proc. 2018-53.

In general, a transaction intended to qualify under Section 355 may occur either as (i) a separate distribution that qualifies under Section 355(a) (or so much of Section 356 as relates to Section 355) and Section 355(c) or (ii) as part of a series of transactions that qualifies as a reorganization described in Section 355(a) and Section 368(a)(1)(D) (a “Divisive Reorganization”, and each, a “Section 355 Transaction”). The distributing corporation (“Distributing”) may distribute all its controlled corporation (“Controlled”) stock and securities (if any) or may retain some Controlled stock or securities after the distribution of control, provided certain requirements are met. Section 355 Transactions may occur without recognition of gain or loss to Distributing, and without gain, loss, or income to Distributing’s shareholders, if the requirements of Section 355 and other relevant provisions are satisfied.

The New Guidance – Revised Scope and Procedures

Delayed Distributions

The Guidance provides procedures for requesting a ruling that a series of distributions of Controlled stock or securities over a period of time (a so-called “delayed distribution”) is afforded non-recognition treatment, either because each of the distributions is “part of the distribution” (within the meaning of Section 355(a)(1)(D)) or “in pursuance of the plan of reorganization” (within the meaning of Section 361). The Guidance requires the taxpayer to establish that each distribution occurring after the date of the initial distribution—regardless of its temporal proximity to the initial distribution—is part of the distribution or in pursuance of the plan of reorganization, with the amount of time between the distributions being a primary (but not determinative) factor. This represents a shift from Rev. Proc. 2018-53, which generally presumed those requirements are satisfied for delayed distributions occurring within 180 days of the initial distribution. Further, under the Guidance, any distribution made more than one-year after the initial distribution will not be considered part of the distribution or in pursuance to the plan of reorganization—and thus cannot qualify for a non-recognition ruling. In the event that the final distribution is to occur more than 90 days after the initial distribution, the taxpayer is required to submit additional information, including the business reasons for such delay. In addition, if a distribution to a creditor will occur more than 90 days after the initial distribution, the Guidance requires the taxpayer have one or more “substantial business purposes” for such delay.

Weil Tax Observation: The 12-month date provided in the Guidance for delayed distributions is generally consistent with recent IRS ruling policy.

Retention of Controlled Stock or Securities

If Distributing distributes an amount of stock in Controlled constituting “control” (i.e., 80% of the total combined voting power of all classes entitled to vote and 80% of all other classes of stock), but retains, including through a “related person”, any Controlled stock or securities (i.e., such stock or securities are not distributed as part of the distribution or in pursuance of the plan of reorganization) (a “Retention”), the Section 355 Transaction will not qualify for nonrecognition treatment unless it is established to the satisfaction of the Secretary of the Treasury that the Retention is not in pursuance of a plan having as one of its principal purposes the avoidance of federal income tax (such a plan, a “Tax Avoidance Plan”). The Guidance frames any Retention as creating a rebuttable presumption that there is a Tax Avoidance Plan.

The Guidance provides that the IRS will only issue a ruling that a Section 355 Transaction involving a Retention qualifies under Section 355, if (i) the Controlled stock will be widely held, (ii) there is a business purpose for the Retention (a “Retention Business Purpose”) that currently exists and is not speculative or otherwise contingent on future events, (iii) there are no overlapping key employees (“Overlapping Key Employees”) or overlapping directors or officers (“Overlapping Directors or Officers”) between Distributing and Controlled while the Controlled stock or securities are retained, except for a limited amount of overlap for a limited duration solely to accommodate Controlled’s business needs, (iv) the Controlled stock will be disposed of as soon as warranted consistent with the Retention Business Purposes, but no event later than five years after the initial distribution, and (v) Distributing will vote any Retained stock in proportion to the votes cast by Controlled’s other shareholders.

As a general matter, these requirements are consistent with prior IRS ruling practice, as well as the requirements set forth in Rev. Proc. 96-30—the most recent Section 355 ruling procedure that addressed Retentions. However, the Guidance suggests that the IRS is taking a stricter approach than it has previously taken—including by explicitly requiring that the Retention Business Purpose not be speculative or contingent on future events.

Moreover, the Guidance sets forth the following four indicia that a Retention is in pursuance of a Tax Avoidance Plan: (i) the existence of a federal income tax benefit or advantage relating to the federal income tax treatment of the Retention and disposition of Controlled stock or securities (e.g., use of an expiring capital loss to offset capital gain on such a disposition), (ii) Overlapping Key Employees, (iii) Overlapping Officers and Directors, and (iv) continuing contractual agreements between Distributing and Controlled that include non-arm’s length provisions (“Continuing Non-Arm’s Length Agreements”). Where one of these factors exists, the IRS will apply “significantly increased scrutiny” to a ruling request. Where two or more of such factors exist the taxpayer will be required to establish that (i) a “business exigency” exists that outweighs those factors and directly causes the need for the Retention and (ii) in light of that exigency, the Retention should not be viewed as having a Tax Avoidance Purpose.

Weil Tax Observation: Based on the Guidance, the presence of more than one factor (e.g., Overlapping Key Employees, Overlapping Officers and Directors and Continuing Non-Arm’s Length Agreements) requires the Retention Business Purpose to outweigh the Tax Avoidance Purpose that is deemed to exist due to the heightened level of connection between Distributing and Controlled following the Section 355 Transaction.

IRS Will Not Entertain Backstop Retention Rulings

In a significant change to IRS ruling practice, the Guidance provides that the IRS will not simultaneously entertain ruling requests involving a delayed distribution and Retention for the same stock or securities. In recent years, the IRS has provided so-called “backstop” Retention rulings in the event that market conditions, or other unanticipated events or conditions, following the initial distribution make an intended delayed distribution unfeasible. Such rulings provided assurance to taxpayers that the initial distribution of control would continue to qualify as a Section 355 Distribution despite Distributing’s continued ownership or taxable disposition of Controlled stock or securities.

Solvency and Continuing Viability of Distributing and Controlled

The Guidance requires the taxpayer to establish the solvency and continuing viability of Distributing and Controlled. Thus, consistent with previous ruling guidelines, the taxpayer is required to represent that the fair market value of the assets of Distributing and Controlled will, in each case, exceed the amount of its liabilities.

However, in a change from previous ruling guidelines, the Guidance also requires the taxpayer to represent (and provide supporting evidence) that

Immediately after the Control Distribution Date, Controlled will be adequately capitalized and, therefore, is expected to (A) have the means to satisfy all its Liabilities incurred as part of the Plan of Reorganization with regard to the Divisive Reorganization, including any securities and other Debt issued as Section 361 Consideration and any Distributing Liabilities that Controlled Assumes, and (B) continue as an economically viable entity, taking solely into account solely the Liabilities described in clause (A) (including, in the case of a pre-existing Controlled, any pre-existing Liabilities) as they come due.

The Guidance states that, for purposes of this representation, (i) the expectations described in clauses (A) and (B) above are the expectations of the taxpayer and (ii) a liability that is refinanced is not treated as satisfied.

Weil Observation: Under the Guidance, taxpayers need to establish that Controlled has the ability to satisfy any debt that it assumes from Distributing or issues pursuant to the Divisive Reorganization. The Guidance, however, is silent as to what a taxpayer must provide in this respect. Accordingly, uncertainty exists as to what types of information—e.g., cash flow projections, income forecasts, asset valuations, etc.—must be provided to the IRS to satisfy the evidentiary requirements set forth in the Guidance. In addition, liabilities are often refinanced. Presumably the taxpayer need only show that it has sufficient value to repay a liability as opposed to sufficient liquid assets.

Plan of Reorganization Requirements for Divisive Reorganizations and related Transactions

The Guidance significantly expands the types of representations, information and analysis a taxpayer must provide to the IRS to establish compliance with the plan of reorganization requirement (the “Plan Requirement”) in respect of a purported Divisive Reorganization and certain related transactions. Treasury and the IRS believe such guidance is necessary to provide consistency and clarity as to the standards applicable for the administration and enforcement of the Plan Requirement to Divisive Reorganizations and correct a perceived misconception that the temporal flexibility of section 3.04(6) of Rev. Proc. 2018-53 obviated the Plan Requirement.

In particular, a taxpayer seeking rulings on a Divisive Reorganization must submit additional representations, information and analysis to establish that each step, including steps that are a contemplated possibility, is part of the plan of reorganization and necessary and appropriate to effectuate the corporate business purposes for the transaction. For transactions involving “delayed distributions” and transactions involving debt exchanges, taxpayers are also required to submit additional representations, information and analysis supporting why such steps, as applicable, are either “part of the distribution” (within the meaning of Section 355(a)(1)(D)) or “in pursuance of the plan of reorganization” (within the meaning of Section 361).

The Guidance also requires taxpayers to submit a copy of the “Plan of Reorganization” as an exhibit to the ruling request that provides an adequate description of each specific step and parties associated therewith.

Weil Tax Observation: As discussed above, the Guidance significantly expands what a taxpayer must establish in respect of the Plan Requirement to obtain a private letter ruling from the IRS. In the context of a Section 355 Transaction, documentation (even in draft form) may not otherwise be ready at the time of a ruling submission and, consequently, taxpayers may be required to produce such documentation much earlier than anticipated. Additionally, taxpayers will need to consider what types of agreements (or other documentation) will be sufficient to satisfy the IRS in this context.

Intermediated Exchanges and Direct Issuance Transactions and Application of Substance Over Form, Agency, and other Relevant Theories

The IRS’s ruling position on debt-for-debt and debt-for-equity exchanges has fluctuated significantly over time, particularly as related to “Direct Issuances” and “Intermediated Exchanges”.

Prior to Rev. Proc. 2018-53, debt exchanges were often structured using the Intermediated Exchange framework whereby a bank would buy historic Distributing debt for its own account, with Distributing then using Controlled stock or securities to repay such debt. Under this framework, banks typically held the debt for at least five days before the bank and Distributing would enter into an exchange agreement, with the exchange occurring at least 14 days after the initial purchase (the “historic 5/14 ruling practice”). However, Rev. Proc. 2018-53, and its implicit support of reallocations of historic Distributing debt between Distributing and Controlled, reopened the door for taxpayers to structure exchanges using a Direct Issuance, which has since become the market standard. Under this framework, Distributing typically issues short-term debt directly to a bank, with Distributing then using (i) the cash proceeds from the issuance to repay historic debt and (ii) Controlled stock or securities to repay the newly issued short-term debt (with such exchange occurring as soon as one day after the issuance) (“Market Standard Direct Issuances”).

Consistent with the historical trends described above, the Guidance fundamentally changes the landscape for debt exchanges once again, with the most significant departure being the effective prohibition for ruling purposes on Market Standard Direct Issuances. Specifically, under the Guidance, all debt that will be retired in a debt exchange must be incurred by Distributing by the “Earliest Applicable Date”, which is defined as 60 days before the earlier of: (i) the date of the first public announcement of the Divisive Reorganization (or a similar transaction), (ii) the date of entry by Distributing into a binding agreement to engage in the Divisive Reorganization (or a similar transaction), and (iii) the date of approval of the Divisive Reorganization (or a similar transaction) by the board of directors of Distributing. Thus, a taxpayer would need to issue debt to a bank far in advance of the Divisive Reorganization so as to comply with the Earliest Applicable Date standard. Accordingly, the concept of a “Direct Issuance”, as used in the Guidance, is a fundamentally different transaction from a Market Standard Direct Issuance.

The Guidance also requires taxpayers engaging in a debt exchange to provide representations and supporting analysis intended to ensure that the financial intermediary is not an agent of Distributing. For example, these representations generally require that: (i) the historic debt acquired by the bank will not be held for the benefit of Distributing, Controlled or any related persons, (ii) the exchange will be on arm’s length terms, (iii) Distributing and Controlled will not benefit from any profit gained by the bank on the exchange, and (iv) the bank will act for its own account and bear any risk of loss on the debt or in respect of the exchange. Such representations, while not necessarily identical, are similar to those provided in Rev. Proc. 2018-53.

The Guidance also indicates that Treasury and the IRS are considering the application of the Code, as well as general principles of federal income tax law (including substance over form, agency or other relevant theories), to Intermediated Exchanges and Direct Issuance transactions and requests comments on these topics to ensure that future guidance is responsive to the business and market-risk considerations informing the mechanics of such transactions. Currently, Treasury and the IRS’s view is that (i) banks may not be viewed as a “creditor” of Distributing in a Market Standard Direct Issuance transaction due to the recast risk associated with the close temporal proximity between the debt issuance and subsequent exchange; and (ii) banks may be viewed as an “agent” of Distributing in an Intermediated Exchange.

Weil Tax Observation: The Guidance represents a major reversal in the IRS’s ruling position on Direct Issuance transactions by negating a taxpayer’s ability to obtain a favorable ruling from the IRS on Distributing’s use of newly incurred short-term debt to facilitate such an exchange. The Guidance, therefore, significantly restricts the types of debt exchanges with respect to which a taxpayer can receive a private letter ruling and subjects these taxpayers to increased uncertainty as to transaction mechanics, cost and market risk. Additionally, Treasury and the IRS’s comments on the application of agency theory to Intermediated Exchanges calls into question whether the historic 5/14 ruling practice will be acceptable to the IRS.

Post-Distribution Payments

The Guidance requires payments of Section 361 Consideration (i.e., consideration received by Distributing from Controlled as part of the Divisive Reorganization) made by Controlled to Distributing after the date of the distribution of 368(c) control of Controlled stock, or of Controlled stock and securities (the “Control Distribution Date” and with respect to such payments, “Post-Distribution Payments”), to be deposited in a segregated account and distributed (including any interest earned on the segregated account) to Distributing’s shareholders and/or creditors within 90 days of receipt of such Post-Distribution Payments. The Guidance also requires taxpayers to submit information and analysis to establish: (i) that each Post-Distribution Payment constitutes Section 361 Consideration, (ii) that the fair market value of Distributing’s “right” to receive Post-Distribution Payments was not (or will not be) “reasonably ascertainable” as of the earliest distribution effecting the Divisive Reorganization, and (iii) whether the installment method will be used by Distributing to account for its right to receive any such Post-Distribution Payments.

In the Notice, Treasury and the IRS indicated that it is their view that a Post-Distribution Payment is treated for tax purposes as Section 361 Consideration “only if” the taxpayer is able to clearly establish the requirements set forth in (i) through (iii) above. The principles of Arrowsmith v. Commissioner, 344 U.S. 6 (1952), apply in making this determination. Treasury and the IRS are, however, considering whether to study the treatment of Post-Distribution Payments and have requested comments on the treatment of such payments.

Modifying Controlled’s Securities and Impacts to Transactions Related to the Divisive Reorganization

The Guidance includes a new required representation with respect to any transaction related to the Divisive Reorganization which may affect the terms of any Controlled securities received by Distributing in pursuance of the “Plan of Reorganization”. This representation relates to the impact of Controlled’s modification (including refinancing) of any of its securities or other debt on the qualification of those securities or other debt as Section 361 Consideration. The Guidance requires that the taxpayer (i) provide descriptions of any change resulting from, or in connection with, the related transaction, in the terms of any Controlled securities or other qualified property received by Distributing pursuant to the “Plan of Reorganization,” and (ii) submit an analysis supporting the conclusion that no such change will constitute a deemed exchange pursuant to Treasury Regulations Section 1.1001-3. In addition, the taxpayer must submit additional analysis supporting the conclusion that Controlled will continue as the obligor of any such securities or other qualified property after any such transaction or series of transactions.

Weil Tax Observation: The new representation reflects the IRS’s view of the application of substance over form principles to acquisitions related to the Divisive Reorganization. Specifically, if such related acquisition resulted in a modification of Controlled’s securities (e.g., in a “reverse Morris Trust” transaction in which Controlled issued Controlled securities that were treated by the taxpayer as purported Section 361 Consideration in exchange for Distributing debt), the Notice states that the IRS could recast the transactions, precluding qualification under Section 361(c)(3).

No Replacement of Distributing Debt

Under the Guidance, a taxpayer requesting a ruling on matters pertaining to a Divisive Reorganization must submit the applicable representation indicating that neither Distributing nor any related person to Distributing (determined immediately after the Control Distribution Date), will replace, directly or indirectly, any amount of Distributing debt that will be satisfied with Section 361 Consideration with borrowing that Distributing, or any related person to Distributing, anticipates or is otherwise committed to, directly or indirectly, before the Control Distribution Date. To the extent no such representation can be made, the IRS will consider issuing a favorable ruling only if the taxpayer establishes one of the following: (i) the borrowing is incurred in the ordinary course of business pursuant to a revolving credit agreement or similar arrangement that is unrelated, and would have been incurred without regard, to the Section 355 Transaction or any transaction related to the Section 355 Transaction or (ii) the borrowing results from an event, unrelated to the Section 355 Transaction and not in the ordinary course of business of Distributing, directly arising from changed circumstances that were not anticipated prior to the Control Distribution Date (that is, unrelated to the Section 355 Transaction or any transaction related to the Section 355 Transaction).

Weil Tax Observation: The new representation regarding the replacement of debt appears to be rooted in the IRS’s concern regarding situations in which Distributing, as of the date of the contribution of assets to Controlled, anticipates entering into a borrowing that reverses the de-leveraging that Distributing effectuated through the use of Section 361 Consideration as part of the Divisive Reorganization. The Treasury and IRS are of the view that, in certain circumstances, the replacement of Distributing Debt satisfied with Section 361 Consideration can be used as an artifice for increasing the aggregate debt and other liabilities of Distributing and Controlled. Treasury and the IRS state that result, in effect, replicates a tax-free sale of a portion of Controlled, which the Treasury and IRS are of the view should not qualify for nonrecognition treatment under Section 361.

Assumption of Distributing Liabilities and the Separate and Distinct Relevance of Sections 357 and 361.

Section 357, which addresses the assumption by Controlled of a liability of Distributing, generally functions to provide that the assumption is not treated as the receipt by Distributing of money or other property from Controlled under Section 357(a). In contrast, Section 361 generally permits Distributing to qualify for nonrecognition treatment on the transfer to Distributing’s creditors in connection with a Divisive Reorganization of money, other property, or Controlled securities received from Controlled in the transaction under Section 361(b)(3) and (c)(3). Treasury and the IRS “clarified” in the Guidance that, in situations in which Section 361 Consideration is used to satisfy Distributing liabilities (that do not qualify as debt), such Section 361 Consideration would not qualify for nonrecognition treatment under Section 361.

[1] All references to Sections herein are to Sections of the Code or Treasury regulations promulgated thereunder.