Introduction to Section 355 Spin Off
A Section 355 spin off is a tax-free distribution of stock of a controlled corporation to the shareholders of the distributing corporation. This type of transaction allows companies to separate their businesses into distinct entities, enabling them to focus on specific markets or industries.
To qualify for tax-free treatment, the spin off must meet certain requirements, including a five-year active business requirement and a continuity of interest test. The distributing corporation must also have control of the controlled corporation immediately before the distribution.
Requirements for a Tax-Free Spin Off
The requirements for a tax-free Section 355 spin off are complex and multifaceted. The distributing corporation must have a legitimate business purpose for the spin off, and the transaction must not be used principally as a device for the distribution of earnings and profits.
Additionally, the controlled corporation must be engaged in an active trade or business, and the distributing corporation must distribute all of the stock of the controlled corporation.
Continuity of Interest Test
The continuity of interest test is a critical requirement for a tax-free Section 355 spin off. This test requires that the shareholders of the distributing corporation retain a continuing interest in the controlled corporation after the spin off.
The continuity of interest test is met if the distributing corporation's shareholders retain at least 80% of the total combined voting power of all classes of stock and at least 80% of the total number of shares of all other classes of stock of the controlled corporation.
Five-Year Active Business Requirement
The five-year active business requirement is another key requirement for a tax-free Section 355 spin off. This requirement mandates that both the distributing corporation and the controlled corporation must have been engaged in an active trade or business for at least five years before the spin off.
The active trade or business requirement can be met if the corporation has been engaged in a business that has generated gross income and has been conducted with the intention of generating a profit.
Conclusion and Next Steps
In conclusion, a tax-free Section 355 spin off can be a valuable tool for companies seeking to separate their businesses and create distinct entities. However, the requirements for a tax-free spin off are complex and require careful planning and execution.
Companies considering a Section 355 spin off should consult with experienced tax and corporate law attorneys to ensure that they meet all of the necessary requirements and comply with all applicable laws and regulations.
Frequently Asked Questions
What is the purpose of a Section 355 spin off?
The purpose of a Section 355 spin off is to allow companies to separate their businesses into distinct entities, enabling them to focus on specific markets or industries.
What are the requirements for a tax-free Section 355 spin off?
The requirements include a five-year active business requirement, a continuity of interest test, and a legitimate business purpose for the spin off.
How does the continuity of interest test work?
The continuity of interest test requires that the shareholders of the distributing corporation retain a continuing interest in the controlled corporation after the spin off.
What is the five-year active business requirement?
The five-year active business requirement mandates that both the distributing corporation and the controlled corporation must have been engaged in an active trade or business for at least five years before the spin off.
Can a Section 355 spin off be used to distribute earnings and profits?
No, a Section 355 spin off cannot be used principally as a device for the distribution of earnings and profits.
How can companies ensure compliance with Section 355 rules?
Companies should consult with experienced tax and corporate law attorneys to ensure that they meet all of the necessary requirements and comply with all applicable laws and regulations.