rr-03-55.pdf

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Part I

Section 355.BDistribution of Stock and Securities of a Controlled Corporation

26 CFR 1.355-2(b): Independent Business Purpose.

Rev. Rul. 2003-55

ISSUE
Is the business purpose requirement of § 1.355-2(b) of the Income Tax
Regulations satisfied if the distribution of the stock of a controlled corporation is, at the
time of the distribution, motivated, in whole or substantial part, by a corporate business
purpose, but that purpose cannot be achieved as the result of an unexpected change in
circumstances following the distribution?
FACTS
D is a publicly traded corporation that conducts Business A and Business B
directly and Business C through its wholly owned subsidiary C. Business C needs to
raise a substantial amount of capital in the near future to invest in plant and equipment
and to make acquisitions. D has been advised by its investment banker that the best
way to raise this capital is through an initial public offering of C stock after C has been
separated from D. The investment banker believes, based on its analysis of

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comparable situations, and taking into account the current market climate, that
such an offering would be more efficient than a stock offering by C or D without first
separating from the other because it would raise the needed capital with significantly
less dilution of the existing shareholders’ interests in the combined enterprises.
In reliance on the investment banker=s opinion, D distributes the stock of C to its
shareholders, and C prepares to offer its stock to the public as soon as practicable but
with a target date approximately six months after the distribution. Following the
distribution and before the offering can be undertaken, market conditions unexpectedly
deteriorate to such an extent that, in the judgment of C and its advisors, the offering
should be postponed. One year after the distribution, conditions have not improved
sufficiently to permit the offering to go forward and C funds its capital needs through the
sale of debentures.
Apart from the issue of whether the business purpose requirement of § 1.355-
2(b) is satisfied, the distribution meets all of the requirements of ' 355 of the Internal
Revenue Code.
LAW
Section 355 provides that if certain requirements are met, a corporation may
distribute stock and securities in a controlled corporation to its shareholders and
security holders without causing the distributing corporation or the distributees to
recognize gain or loss.
To qualify as a distribution described in § 355, a distribution must, in addition to
satisfying the statutory requirements of § 355, satisfy certain requirements in the
regulations, including the business purpose requirement. Section 1.355-2(b)(1)

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provides that a distribution must be motivated, in whole or substantial part, by
one or more corporate business purposes. A corporate business purpose is a real and
substantial non-Federal tax purpose germane to the business of the distributing
corporation, the controlled corporation, or the affiliated group to which the distributing
corporation belongs. Section 1.355-2(b)(2). The principal reason for the business
purpose requirement is to provide nonrecognition treatment only to distributions that are
incident to readjustments of corporate structures required by business exigencies and
that effect only readjustments of continuing interests in property under modified
corporate forms. Section 1.355-2(b)(1).
ANALYSIS
To satisfy the business purpose requirement of § 1.355-2(b)(1), a distribution of
controlled corporation stock must be motivated, in whole or substantial part, by a
corporate business purpose. A corporate business purpose is a real and substantial
non-Federal tax purpose germane to the business of the distributing corporation, the
controlled corporation, or the affiliated group to which the distributing corporation
belongs. The regulations do not require that the corporation in fact succeed in meeting
its corporate business purpose, as long as, at the time of the distribution, such a
purpose exists and motivates, in whole or substantial part, the distribution. An
unexpected change in market or business conditions following a distribution that
prevents achievement of the business purpose will not prevent satisfaction of the
business purpose requirement. Hence, notwithstanding the fact that, as a result of the
unexpected deterioration in market conditions, C does not complete the stock offering
that motivated its separation from D, the business purpose requirement of § 1.355-

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2(b)(1) is satisfied.
HOLDING
The business purpose requirement of § 1.355-2(b) is satisfied if the distribution of
the stock of a controlled corporation is, at the time of the distribution, motivated, in
whole or substantial part, by a corporate business purpose, but that purpose cannot be
achieved as the result of an unexpected change in circumstances following the
distribution.
DRAFTING INFORMATION
The principal author of this revenue ruling is Wayne T. Murray of the Office of
Associate Chief Counsel (Corporate). For further information regarding this revenue
ruling, contact Mr. Murray on (202) 622-7700 (not a toll-free call).