rr-03-110.pdf

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Part I

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

26 CFR 1.355-2: Business Purpose

Rev. Rul. 2003-110

ISSUE

In determining whether a distribution of the stock of a controlled corporation
satisfies the business purpose requirement of § 1.355-2(b) of the Income Tax
Regulations that the distribution be motivated, in whole or substantial part, by one or
more corporate business purposes, does the fact that § 355 of the Internal Revenue
Code permits a distributing corporation to distribute the stock of a controlled corporation
without recognition of gain present a potential for the avoidance of Federal taxes under
§ 1.355-2(b)?
FACTS
Distributing is a publicly traded corporation that conducts a pesticides business.
Controlled, a wholly owned subsidiary of Distributing, conducts a baby foods business.
The pesticides business formulates, manufactures, and markets pesticides for
agricultural use. The baby foods business processes and markets baby foods.

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A significant number of potential customers of the baby foods business refuse to
buy from Controlled because of its affiliation with Distributing and its pesticides
business. Distributing’s management consultant has advised Distributing that
separating Controlled from Distributing would relieve the baby foods business of the
adverse market perception caused by its association with the pesticides business.
To solve the market perception problem, Distributing distributes the Controlled
stock to Distributing’s shareholders, pro rata. There is no other nontaxable solution to
the problem. Sale of the Controlled stock by Distributing would have resulted in
recognition of gain. Distributing’s directors expect that the baby foods business will
benefit in a real and substantial way from the improved market perception produced by
the separation.
Apart from the issue of whether the business purpose requirement of ' 1.355-
2(b) is satisfied, the distribution of the Controlled stock meets all the requirements of
§ 355.
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 or include any amount in income.
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 potential for the avoidance of Federal
taxes by the distributing or controlled corporation (or a corporation controlled by either)
is relevant in determining the extent to which an existing corporate business purpose
motivated the distribution. Section 1.355-2(b)(1). 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). If a corporate business purpose can be
achieved through a nontaxable transaction that does not involve the distribution of stock
of a controlled corporation and that is neither impractical nor unduly expensive, then the
separation is not carried out for that corporate business purpose. Section 1.355-2(b)(3).
Section 355(c) provides that no gain or loss will be recognized by a corporation
on any distribution to which § 355 (or so much of § 356 as relates to § 355) applies.
See also
§ 361(c) (to the same effect if the distribution is pursuant to a plan of
reorganization). Absent § 355, such a distribution would be subject to § 311(b), which
provides that, if the fair market value of the distributed property exceeds its adjusted
basis, then gain will be recognized by the distributing corporation as if the property had
been sold to the distributee at its fair market value. Section 355(c)(3).

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ANALYSIS
To satisfy the business purpose requirement, a distribution must be motivated, in
whole or substantial part, by one or more corporate business purposes. Section 1.355-
2(b)(1). The market perception business purpose motivates Distributing’s directors to
approve the distribution, there is no other nontaxable transaction that would solve the
market perception problem, and it is expected that the baby foods business will benefit
in a real and substantial way from the improved market perception produced by the
separation.
Except as provided in § 355(d) and (e), the application of § 355(c) or § 361(c) to
distributions that qualify under § 355 is part of the statutory scheme of § 355 and implicit
in all such distributions. Accordingly, the fact that § 355 permits a distributing
corporation to distribute the stock of a controlled corporation without the recognition of
gain does not present a potential for the avoidance of Federal taxes under § 1.355-2(b).
This is further implied by § 1.355-2(b)(3), which provides that the business purpose
requirement is not satisfied if the purpose can be achieved through a nontaxable
alternative transaction. That is, the distributing corporation is entitled to reject a taxable
disposition in favor of a tax-free distribution.
Therefore, although the distribution of Controlled stock results in the
nonrecognition of gain that otherwise would be recognized under § 311(b) if § 355(c) did
not apply, the distribution is motivated in whole by a real and substantial non-Federal
tax purpose germane to the business of Distributing. Hence, the business purpose
requirement of § 1.355-2(b) is satisfied.

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HOLDING
In determining whether a distribution of the stock of a controlled corporation
satisfies the business purpose requirement of § 1.355-2(b) that the distribution be
motivated, in whole or substantial part, by one or more corporate business purposes,
the fact that § 355 permits a distributing corporation to distribute the stock of a
controlled corporation without recognition of gain does not present a potential for the
avoidance of Federal taxes under § 1.355-2(b).
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 at (202) 622-7700 (not a toll-free call).