The IRS has issued a private letter ruling (PLR 202009002
) concluding that the absence of income collection does not prevent a taxpayer from satisfying the active trade or business requirement under Section 355.
In the ruling, a publicly traded corporation, Distributing, was in Business 1, producing items for commercialization, a process that requires four steps. Each step consisted of subparts, with the second step consisting of four subparts (e.g., 2A, 2B, 2C, and 2D) and step 2C consisting of steps 2C1 and 2C2. Historically, Business 1 consisted of only developing items through step 2C1. Later steps were performed by third parties pursuant to license and collaboration agreements. The business consistently generated income related to items from these research-oriented contracts or licensing agreements.
More than five years prior to the proposed transaction in the ruling, Distributing began conducting research, development, testing and regulatory functions for a particular item that was developed in the business. Distributing intended to develop the item through Step 3 in Business 2, and then partner or collaborate with a third party for the remaining steps after Step 3. Distributing allocated managerial and operational employees and devoted employees full-time to Business 2 and incurred significant salary and wage expenses in connection.
Business 2 never generated income, but Distributing believed that it had the ability to do so because it could have entered into a partnership or collaboration agreement with respect to the item. Distributing also believed that it would be easier to obtain income from the item as it progressed further through the steps toward commercialization, and that it decided to forgo immediate collection of income from Business 2 in favor of the prospect of collecting greater income after Step 3 was completed for the item.
In the ruling, Distributing proposed to form a new corporation, Controlled, and contribute the assets of Business 2 in exchange for all of the stock of Controlled and the assumption of Business 2’s liabilities. Distributing then proposed to distribute all of the stock of Controlled pro rata to its shareholders. Such distribution was intended to qualify as a tax-free distribution under Section 355(a).
Section 355(b)(1) provides that Section 355(a) applies to a distribution if, in addition to other requirements, the distributing corporation and the controlled corporation were engaged in the active conduct of a trade or business immediately after the distribution.
Distributing represented that the distribution would qualify under Section 355 except for the particular issue whether the absence of income collection prevented Business 2 from constituting a trade or business.
The IRS ruled that the absence of income collection did not prevent Business 2 from constituting a trade or business within the meaning of Treas. Reg. Sec. 1.355-3(b)(2)(ii) and thus did not prevent Distributing from satisfying the active trade or business requirement in Section 355 if it did so otherwise.
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