rr-05-65.pdf

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Part I

Section 355.—Distribution of Stock and Securities of a Controlled Corporation

26 CFR 1.355-7: Recognition of Gain on Certain Distributions of Stock or Securities in
Connection with an Acquisition.

Rev. Rul. 2005-65

ISSUE
Under the facts described below, is a distribution of a controlled corporation by a
distributing corporation part of a plan pursuant to which one or more persons acquire
stock in the distributing corporation under § 355(e) of the Internal Revenue Code and
§ 1.355-7 of the Income Tax Regulations?
FACTS
Distributing is a publicly traded corporation that conducts a pharmaceuticals
business. Controlled, a wholly owned subsidiary of Distributing, conducts a cosmetics
business. Distributing does all of the borrowing for both Distributing and Controlled and
makes all decisions regarding the allocation of capital spending between the
pharmaceuticals and cosmetics businesses. Because Distributing’s capital spending in
recent years for both the pharmaceuticals and cosmetics businesses has outpaced
internally generated cash flow from the businesses, it has had to limit total expenditures
to maintain its credit ratings. Although the decisions reached by Distributing’s senior

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management regarding the allocation of capital spending usually favor the
pharmaceuticals business due to its higher rate of growth and profit margin, the
competition for capital prevents both businesses from consistently pursuing
development strategies that the management of each business believes are
appropriate.
To eliminate this competition for capital, and in light of the unavailability of
nontaxable alternatives, Distributing decides and publicly announces that it intends to
distribute all the stock of Controlled pro rata to Distributing’s shareholders. It is
expected that both businesses will benefit in a real and substantial way from the
distribution. This business purpose is a corporate business purpose (within the
meaning of § 1.355-2(b)). The distribution is substantially motivated by this business
purpose, and not by a business purpose to facilitate an acquisition.
After the announcement but before the distribution, X, a widely held corporation
that is engaged in the pharmaceuticals business, and Distributing begin discussions
regarding an acquisition. There were no discussions between Distributing or Controlled
and X or its shareholders regarding an acquisition or a distribution before the
announcement. In addition, Distributing would have been able to continue the
successful operation of its pharmaceuticals business without combining with X. During
its negotiations with Distributing, X indicates that it favors the distribution. X merges into
Distributing before the distribution but nothing in the merger agreement requires the
distribution.
As a result of the merger, X’s former shareholders receive 55 percent of
Distributing’s stock. In addition, X’s chairman of the board and chief executive officer

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become the chairman of the board and chief executive officer, respectively, of
Distributing. Six months after the merger, Distributing distributes the stock of Controlled
pro rata in a distribution to which § 355 applies and to which § 355(d) does not apply.
At the time of the distribution, the distribution continues to be substantially motivated by
the business purpose of eliminating the competition for capital between the
pharmaceuticals and cosmetics businesses.
LAW
Section 355(c) generally provides that no gain or loss is recognized to the
distributing corporation on a distribution of stock in a controlled corporation to which
§ 355 (or so much of § 356 as relates to § 355) applies and which is not in pursuance of
a plan of reorganization. Section 355(e) generally denies nonrecognition treatment
under § 355(c) if the distribution is part of a plan (or series of related transactions) (a
plan) pursuant to which one or more persons acquire directly or indirectly stock
representing a 50-percent or greater interest in the distributing corporation or any
controlled corporation.
Section 1.355-7(b)(1) provides that whether a distribution and an acquisition are
part of a plan is determined based on all the facts and circumstances, including those
set forth in § 1.355-7(b)(3) (plan factors) and (4) (non-plan factors). The weight to be
given each of the facts and circumstances depends on the particular case. The
determination does not depend on the relative number of plan factors compared to the
number of non-plan factors that are present.
Section 1.355-7(b)(3)(iii) provides that, in the case of an acquisition (other than
involving a public offering) before a distribution, if at some time during the two-year

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period ending on the date of the acquisition there were discussions by Distributing or
Controlled with the acquirer regarding a distribution, such discussions tend to show that
the distribution and the acquisition are part of a plan. The weight to be accorded this
fact depends on the nature, extent, and timing of the discussions. In addition, the fact
that the acquirer intends to cause a distribution and, immediately after the acquisition,
can meaningfully participate in the decision regarding whether to make a distribution,
tends to show that the distribution and the acquisition are part of a plan.
Section 1.355-7(b)(4)(iii) provides that, in the case of an acquisition (other than
involving a public offering) before a distribution, the absence of discussions by
Distributing or Controlled with the acquirer regarding a distribution during the two-year
period ending on the date of the earlier to occur of the acquisition or the first public
announcement regarding the distribution tends to show that the distribution and the
acquisition are not part of a plan. However, this factor does not apply to an acquisition
where the acquirer intends to cause a distribution and, immediately after the acquisition,
can meaningfully participate in the decision regarding whether to make a distribution.
Section 1.355-7(b)(4)(v) provides that the fact that the distribution was motivated
in whole or substantial part by a corporate business purpose (within the meaning of
§ 1.355-2(b)) other than a business purpose to facilitate the acquisition or a similar
acquisition tends to show that the distribution and the acquisition are not part of a plan.
Section 1.355-7(b)(4)(vi) provides that the fact that the distribution would have
occurred at approximately the same time and in similar form regardless of the
acquisition or a similar acquisition tends to show that the distribution and the acquisition
are not part of a plan.

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Section 1.355-7(h)(6) provides that discussions with the acquirer generally
include discussions with persons with the implicit permission of the acquirer.
Section 1.355-7(h)(9) provides that a corporation is treated as having the implicit
permission of its shareholders when it engages in discussions.
ANALYSIS
Whether the X shareholders’ acquisition of Distributing stock and Distributing’s
distribution of Controlled are part of a plan depends on all the facts and circumstances,
including those described in § 1.355-7(b). The fact that Distributing discussed the
distribution with X during the two-year period ending on the date of the acquisition tends
to show that the distribution and the acquisition are part of a plan. See
§ 1.355-
7(b)(3)(iii). In addition, X’s shareholders may constitute acquirers who intend to cause a
distribution and who, immediately after the acquisition, can meaningfully participate
(through X’s chairman of the board and chief executive officer who become D’s
chairman of the board and chief executive officer) in the decision regarding whether to
distribute Controlled. See
id. However, the fact that Distributing publicly announced the
distribution before discussions with X regarding both an acquisition and a distribution
began suggests that the plan factor in § 1.355-7(b)(3)(iii) should be accorded less
weight than it would have been accorded had there been such discussions before the
public announcement.
With respect to those factors that tend to show that the distribution and the
acquisition are not part of a plan, the absence of discussions by Distributing or
Controlled with X or its shareholders during the two-year period ending on the date of
the public announcement regarding the distribution would tend to show that the

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distribution and the acquisition are not part of a plan only if X’s shareholders are not
acquirers who intend to cause a distribution and who, immediately after the acquisition,
can meaningfully participate in the decision regarding whether to distribute Controlled.
See § 1.355-7(b)(4)(iii). Because X's chairman of the board and chief executive officer
become the chairman and chief executive officer, respectively, of Distributing, X's
shareholders may have the ability to meaningfully participate in the decision whether to
distribute Controlled. Therefore, the absence of discussions by Distributing or
Controlled with X or its shareholders during the two-year period ending on the date of
the public announcement regarding the distribution may not tend to show that the
distribution and the acquisition are not part of a plan.
Nonetheless, the fact that the distribution was substantially motivated by a
corporate business purpose (within the meaning of § 1.355-2(b)) other than a business
purpose to facilitate the acquisition or a similar acquisition, and the fact that the
distribution would have occurred at approximately the same time and in similar form
regardless of the acquisition or a similar acquisition, tend to show that the distribution
and the acquisition are not part of a plan. See
§ 1.355-7(b)(4)(v), (vi). The fact that the
public announcement of the distribution preceded discussions by Distributing or
Controlled with X or its shareholders, and the fact that Distributing’s business would
have continued to operate successfully even if the merger had not occurred, evidence
that the distribution originally was not substantially motivated by a business purpose to
facilitate the acquisition or a similar acquisition. Moreover, after the merger, Distributing
continued to be substantially motivated by the same corporate business purpose (within
the meaning of § 1.355-2(b)) other than a business purpose to facilitate the acquisition

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or a similar acquisition (§ 1.355-7(b)(4)(v)). In addition, the fact that Distributing decided
to distribute Controlled and announced that decision before it began discussions with X
regarding the combination suggests that the distribution would have occurred at
approximately the same time and in similar form regardless of Distributing’s combination
with X and the corresponding acquisition of Distributing stock by the X shareholders.
Considering all the facts and circumstances, particularly the fact that the
distribution was motivated by a corporate business purpose (within the meaning of
§ 1.355-2(b)) other than a business purpose to facilitate the acquisition or a similar
acquisition, and the fact that the distribution would have occurred at approximately the
same time and in similar form regardless of the acquisition or a similar acquisition, the
acquisition and distribution are not part of a plan under § 355(e) and § 1.355-7(b).
HOLDING
Under the facts described above, the acquisition and the distribution are not part
of a plan under § 355(e) and § 1.355-7(b).
DRAFTING INFORMATION
The principal author of this revenue ruling is Ross Poulsen of the Office of
Associate Chief Counsel (Corporate). For further information regarding this revenue
ruling, contact Mr. Poulsen at (202) 622-7770 (not a toll-free call).