On January 16, 2025, the Treasury Department (Treasury) and Internal Revenue Service (IRS) published new proposed regulations related to tax-free spin-offs and split-offs (collectively, spin-offs) and other corporate transactions (Proposed Regulations). If finalized, the Proposed Regulations would make a number of major changes to the rules governing spin-offs and related debt allocation transactions, as well as certain acquisitive reorganizations and incorporation transactions.
The Proposed Regulations follow in the wake of a pair of significant spin-off pronouncements by Treasury and the IRS last year:
- Revenue Procedure 2024-24 (2024 Revenue Procedure), which made drastic revisions to the IRS guidelines for private letter ruling (PLR) requests on spin-offs.
- Notice 2024-38 (2024 Notice), which solicited feedback on the “views and concerns” of Treasury and the IRS on a number of spin-off-related topics.
Both were the subject of a May 17, 2024, client alert (Prior Alert) as well as of extensive feedback from the tax practitioner community and other stakeholders.
Main Takeaways
On the whole, Treasury and the IRS seem to have listened to this feedback. Helpfully, the Proposed Regulations walk back some of the more challenging aspects of the 2024 Revenue Procedure’s revised PLR guidelines.
They appear to be more practical and flexible than the 2024 Revenue Procedure in certain key respects, including with respect to so-called “direct issuance” transactions and, more generally, the types of parent company (Parent) debt eligible to be satisfied or reallocated to the spun-off company (Spinco) in connection with a spin-off.
At the same time, the Proposed Regulations perpetuate the generally skeptical view of spin-offs and debt reallocation transactions articulated in the 2024 Revenue Procedure and 2024 Notice. They would impose more stringent standards on issues that were not addressed in the revised PLR guidelines, including limitations on the payment of “boot” to the Parent’s shareholders that are at odds with the predominant understanding of the spin-off rules among tax practitioners and long-standing IRS ruling practice.
Additionally, the Proposed Regulations contain an extensive and onerous set of documentation and reporting requirements for spin-offs and other reorganizations that could introduce significant new compliance burdens and challenges.
Unlike the 2024 Revenue Procedure, which only modified the IRS standards to determine whether or not to grant a PLR with respect to a spin-off, the Proposed Regulations, if finalized, would change (or purport to change) the operative law that governs these transactions. In many instances, the Proposed Regulations appear to be significantly less favorable and more rigid than prevailing interpretations of current law.
The Proposed Regulations would not apply to transactions completed before the date the rules are finalized or to subsequently completed transactions that were publicly announced (or the subject of a written agreement, board approval or a PLR request) on or before that date.
That said, the IRS has indicated that it intends to apply the principles of the Proposed Regulations for PLR purposes in advance of their finalization, making the proposed rules immediately relevant to any spin-off with respect to which a PLR is sought — even if otherwise “grandfathered.” Moreover, some aspects of the Proposed Regulations are likely to inform how advisers interpret the requirements for purposes of opining on spin-offs even before the issuance of final regulations.
As was the case with the 2024 Revenue Procedure, the Proposed Regulations may evolve significantly as Treasury and the IRS receive stakeholder feedback through the notice and comment process, and as the IRS, companies and advisers gain experience with and adapt to the proposed rules through the PLR program.
It is unclear if or how the change in administrations might affect the government’s work on this regulation project.
In light of these developments, it is essential that companies considering spin-offs consult with their advisers as early as possible when planning the transaction.
Background
A typical spin-off involves the separation of a historic business line of a Parent into an independent, separately traded Spinco. Within prescribed limits, the spin-off rules sanction a variety of tax-free methods of allocating group liabilities between the two separated companies, including the:
- Spinco’s assumption of debt or other liabilities from the Parent.
- Parent’s receipt of cash or other property (boot) from the Spinco (typically, proceeds funded by a new Spinco borrowing) if the boot is “purged” through payments to the Parent’s shareholders or creditors (Boot Purge).
- Parent’s use of Spinco stock or debt securities to retire outstanding Parent debt in a debt-for-equity or debt-for-debt exchange (Debt Exchange).1
The Prior Alert provides further background on spin-offs and related debt reallocation transactions.
The discussion below summarizes some of the key changes in the Proposed Regulations, with a focus on the most notable spin-off-specific provisions.
Key Changes
Parent Debt Eligible for Boot Purges and Debt Exchanges
For PLR purposes, the ability to satisfy Parent debt with cash in a Boot Purge, or with Spinco stock or securities in a Debt Exchange, has generally been limited to historic or “old and cold” tranches of Parent debt, defined in both the 2024 Revenue Procedure and its predecessor (Revenue Procedure 2018-53) as Parent debt that was outstanding as of a specified date (Cutoff Date). That date has typically fallen well in advance of the spin-off — generally 60 days prior to the announcement of the transaction.
The PLR guidelines in effect prior to the 2024 Revenue Procedure contained a critical exception for debt incurred after the Cutoff Date if the proceeds were used to retire historic debt that was outstanding as of the Cutoff Date (Refinancing Debt).
In what was roundly viewed as a draconian shift away from that approach, the 2024 Revenue Procedure removed the exception for Refinancing Debt, seemingly creating a hard cutoff for eligible Parent debt and foreclosing the possibility of obtaining a PLR for any Boot Purge or Debt Exchange involving shorter-term Parent debt (e.g., regularly refinanced, short-term commercial paper obligations) or other new debt incurred to refinance longer-term debt that happened to come due after the Cutoff Date.
The Proposed Regulations would generally limit the threshold universe of eligible Parent debt to historic debt, determined by reference to a Cutoff Date (generally the announcement date itself, a somewhat later cutoff than that under the 2024 Revenue Procedure). Much more importantly, the Proposed Regulations contain an explicit Refinancing Debt exception that is generally consistent with the prior PLR guidelines.
On its face, this exception would apply to shorter-term Refinancing Debt such as commercial paper, although it is unclear if the exception extends to a “rolling” commercial paper program in which the specific obligations outstanding on the Cutoff Date were scheduled to mature prior to the spin-off.2
In what may be a drafting error, the Proposed Regulations seem to limit the scope of the exception to Refinancing Debt that is retired in an intermediated exchange or direct issuance transaction — an approach that would effectively preclude the ability to retire Refinancing Debt in a Boot Purge.
A welcome change from the 2024 Revenue Procedure is that the Proposed Regulations would permit the Parent to satisfy trade payables arising in the ordinary course of business, even if the obligations were incurred after the Cutoff Date and did not constitute Refinancing Debt.
Disappointingly, the Proposed Regulations appear to follow the distinction between Parent debt and nondebt liabilities that was asserted in the 2024 Revenue Procedure and 2024 Notice. In particular, the Proposed Regulations would not permit the Parent to satisfy nondebt liabilities — including contingent liabilities (such as pension liabilities) with respect to which the IRS ruled favorably prior to the 2024 Revenue Procedure — in a Boot Purge or Debt Exchange.
This restriction seems to be at odds with the commonly understood meaning of the relevant statutory provisions, which speak of transfers to “creditors” of the Parent more broadly.
Intermediated Exchanges and Direct Issuance Transactions
As discussed in the Prior Alert, Debt Exchanges typically take one of two forms involving a financial intermediary:
- a “traditional” intermediated exchange, in which the intermediary first purchases outstanding Parent debt in the secondary markets and then exchanges the debt for Spinco stock or securities (Intermediated Exchange); or
- a direct issuance transaction, in which the Parent issues new debt directly to the intermediary, uses the proceeds of the new debt to repay historic debt and then transfers Spinco stock or securities to the intermediary in satisfaction of the new debt (Direct Issuance).3
The IRS indicated in the 2024 Revenue Procedure that it would no longer rule on Direct Issuances — which are generally viewed as reducing some of the friction costs associated with Intermediated Exchanges — but would continue to entertain PLR requests on Intermediated Exchanges.
The Proposed Regulations continue to reflect the view of Treasury and the IRS that Intermediated Exchanges and Direct Issuances can, in some circumstances, be adversely recharacterized for tax purposes based on substance-over-form or “agency” principles. But in a mostly positive development, the Proposed Regulations confirm the validity of these intermediation techniques — including Direct Issuances — and provide what appears to be a largely objective framework for determining whether both types of Debt Exchanges are respected and treated as tax-free.
With respect to Intermediated Exchanges, the Proposed Regulations would impose multiple requirements — many of which appear to have been distilled from factors traditionally considered relevant to the tax analysis of Intermediated Exchanges — that must each be satisfied for the transaction to be tax-free.
These requirements include:
- That the Parent debt not be held for the benefit of the Parent or Spinco. Collateral benefits to the Parent, such as market efficiency, are permitted.
- That the intermediary assume all risk with respect to the exchange (Risk Requirement). The intermediary is permitted to hedge its risk with a third party unrelated to the Parent or Spinco.
- Perhaps most notably, that the intermediary hold the historic debt for a period of not less than 30 days ending on the spin-off date (30-Day Ownership Requirement).
In an unexpected and welcome change from the 2024 Revenue Procedure, the Proposed Regulations would also explicitly permit Debt Exchanges structured as Direct Issuances. In addition to a general facts-and-circumstances test, the Proposed Regulations contain a safe harbor pursuant to which a Direct Issuance meeting certain enumerated requirements would be tax-free.
Among other requirements generally in line with those applicable to Intermediated Exchanges, including the Risk Requirement and the 30-Day Ownership Requirement, the safe harbor requires that the Parent not have any control over the proceeds of the new debt in a Direct Issuance (a condition that may be satisfied by depositing the proceeds with a third-party escrow agent for disbursement to holders of the historic debt).
With respect to the 30-Day Ownership Requirement, IRS officials have indicated informally that the minimum holding period is intended to be a 30-day period terminating on the date of the Debt Exchange, rather than the date of the spin-off (the date specified in the Proposed Regulations).
While the 30-Day Ownership Requirement would clearly require the intermediary to face at least 30 days of execution risk, the Proposed Regulations do not specifically address whether the intermediary would need to be exposed to pricing risk (i.e., hold the Parent debt without an exchange agreement in place) for some portion or all of the 30-day period, as was the case with the “5/14” standard formerly used by the IRS for PLR purposes (prior to the 2024 Revenue Procedure and Revenue Procedure 2018-53).4
In any event, the 30-day minimum holding period — substantially longer than what has been accepted under relatively recent IRS ruling practice — is likely to contribute to the transaction costs for Debt Exchanges.
Boot Purges to Shareholders
To qualify as tax-free, a Boot Purge must occur pursuant to the plan of reorganization for the spin-off. The IRS has routinely concluded in PLRs that a Parent may effectuate a Boot Purge to the Parent’s shareholders through dividends (including regular dividends that likely would have occurred even if the spin-off had not) and repurchases of Parent stock (including ordinary course buybacks pursuant to a preexisting repurchase program), as long as the Boot Purge was completed within a specified period (generally 12 months) after the spin-off. The topic of Boot Purges to shareholders was not specifically addressed in the 2024 Revenue Procedure or 2024 Notice.
Echoing concerns expressed in the preamble about transactions perceived as insufficiently connected to the spin-off to be considered part of the plan of reorganization, examples in the Proposed Regulations provide that boot cannot be purged via ordinary course dividend payments that would have occurred in the absence of the spin-off, or through repurchases of Parent stock (if taken literally, no matter how extraordinary in size and timing) pursuant to a previously authorized share repurchase program.5
The Proposed Regulations gloss over the fact that a dividend remains subject to the board’s discretion and does not become an obligation of the Parent until declared — no matter how “expected” it might have been — and that a mere repurchase authorization does not represent an actual decision to implement a share repurchase. Unless modified or removed, these examples would create significant new hurdles for Boot Purges to shareholders.
‘Reborrowings’ by the Parent Following the Spin-Off
Under the PLR guidelines in effect prior to the 2024 Revenue Procedure, the Parent was generally free to “replace” debt that was assumed by the Spinco, or retired in a Boot Purge or Debt Exchange, by issuing new debt following the spin-off, as long as the new debt was not previously committed (Reborrowing).
While the 2024 Revenue Procedure retained an important exception for revolving credit facilities and created a new one for Reborrowings arising in response to unexpected changes in circumstances, it sharply limited the scope of permissible Reborrowings by generally prohibiting a Reborrowing that was either committed or “anticipated” prior to the spin-off.
While the Proposed Regulations would largely adopt a similar framework, the general prohibition would apply to Reborrowings that were committed or anticipated prior to a specified Cutoff Date (generally the date on which the spin-off was announced). Accordingly, it appears that Reborrowings arising in response to changes in circumstances occurring after the announcement date would generally be permissible.
The Proposed Regulations also contain an exception that would permit committed or anticipated Reborrowings in the ordinary course of business — whether or not incurred pursuant to a revolving credit facility or similar arrangement — but only if the borrowing would have occurred without regard to the spin-off or any related transaction.
The Proposed Regulations appear to be somewhat more appropriately tailored than the 2024 Revenue Procedure’s PLR guidelines for Reborrowings. Nevertheless, the inherent ambiguity and overbreadth of these provisions, along with the highly factual nature of establishing that a given Reborrowing is unconnected to the spin-off, are likely to create significant uncertainty for spin-offs involving debt reallocation transactions.
This is so particularly in light of the fact that treasury executives continually evaluate new sources of financing to address real but expected business needs (e.g., due to seasonality or to address debt maturities).
Retentions of Spinco Stock or Securities
Where the Parent distributes “control” of the Spinco (generally, stock representing 80% of the Spinco’s voting power) and retains some Spinco stock or securities following that distribution (Retention), the spin-off rules generally require the Parent to establish that the Retention is not in pursuance of a plan with a principal purpose of avoiding U.S. federal income tax (No-Tax-Avoidance Requirement). If a Retention does not satisfy the No-Tax-Avoidance Requirement, the entire spin-off becomes fully taxable.
The Proposed Regulations would characterize the No-Tax-Avoidance Requirement as a presumption against tax-free treatment that the Parent must rebut in any Retention scenario. Helpfully, the Proposed Regulations provide a safe harbor pursuant to which a Retention would be deemed to comply with the No-Tax-Avoidance Requirement if several enumerated conditions — generally consistent with those the IRS has traditionally evaluated in the PLR context — are satisfied.
Those conditions include:
- The presence of a specific business purpose for the Retention and a definite intent to dispose of the retained shares within five years after the spin-off.
- Limitations on overlapping officers and directors.
- A requirement that any post-spin-off arrangements between the Parent and Spinco be on arm’s length terms or terminated within two years.
In a notable departure from the 2024 Revenue Procedure, the Proposed Regulations would treat any continued ownership of Spinco stock or securities by the Parent following the initial distribution of control as a Retention subject to the No-Tax-Avoidance Requirement, even if the Parent intends to dispose of the retained stock or securities in a Debt Exchange or delayed distribution to shareholders as part of the overall separation transaction (as opposed to taxable sales for cash).
As a result, the Parent would need to establish compliance with the No-Tax-Avoidance Requirement in these situations even though the expected Retention period would typically be relatively short (generally no longer than 12 months for a Debt Exchange, and potentially much shorter).
An example in the Proposed Regulations seems to sanction a contingency plan to sell retained Spinco stock for cash in the event a planned debt-for-equity exchange is not completed on a timely basis (i.e., within 12 months after the spin-off), provided there is a “definite intent” to undertake the debt-for-equity exchange and a contingent commitment to undertake the share sales if the debt-for-equity exchange does not occur.
The 2024 Revenue Procedure had indicated that the IRS would no longer issue “backstop” retention rulings, but it appears that Treasury and the IRS may have reversed course and concluded that contingency plans of this type are permissible if they are spelled out with sufficient specificity and subject to the proposed guardrails applicable to all Retentions.
The Proposed Regulations do not squarely address the more difficult question of what constitutes a sufficient reason to abandon a planned debt-for-equity exchange in favor of a contingency plan to sell.
The Proposed Regulations appear to confirm that a PLR is not necessary to satisfy the No-Tax-Avoidance Requirement, a point that has been the subject of some debate among tax practitioners. Nevertheless, the inherent ambiguity around the safe harbor conditions — especially regarding what constitutes a satisfactory business purpose for a Retention in a particular case — may often weigh in favor of seeking a PLR for a spin-off involving a Retention, particularly before the Proposed Regulations are finalized.
Extensive ‘Plan of Reorganization’ Documentation Requirements
Another aspect of the Proposed Regulations that represents a sea change in existing practice is a requirement that companies engaging in spin-offs (as well as other reorganizations) prepare a single, comprehensive document to be filed with the IRS setting forth the “plan of reorganization” (Plan) for the transaction.6
Among numerous other detailed requirements, the Plan must identify all liabilities of the Parent to be assumed by the Spinco or retired in a Boot Purge or Debt Exchange and describe the intended U.S. federal income tax consequences of, and business purpose for, each component transaction included in the Plan.
As a practical matter, the Parent would almost certainly need to identify a potentially overinclusive list of liabilities to be assumed or retired in the transaction, as it is often impossible to identify in advance of the spin-off date which specific obligations will ultimately be assumed or retired.
As a general matter, the Plan documentation requirements would dramatically expand the scope of information that has historically been considered necessary for a document to constitute a Plan, introducing significant new compliance burdens and challenges for those caught unawares.
While the Proposed Regulations state that a failure to document and file a Plan would not by itself invalidate the tax-free treatment of the underlying transaction, many of the substantive provisions of the Proposed Regulations are explicitly linked to the Plan provisions and seem to be premised on full compliance with them. The Proposed Regulations also provide that the IRS alone has the authority to correct an incomplete or unsubmitted Plan.
From a timing perspective, the Proposed Regulations would require the Plan to be adopted prior to the first step of the transaction and all steps of the transaction to be completed “as expeditiously as possible” (a requirement presumed satisfied if the transaction is completed within 24 months of the first step). At least one party to the transaction would need to exhibit a “definite intent” to carry out the transaction prior to the first step, as evidenced by a written commitment in “official records” substantiating the transaction (Definite Intent Requirement).
While the existence of conditions or contingencies with respect to a transaction would not be fatal for meeting the Definite Intent Requirement, merely contemplating that a transaction may be carried out as one of several possibilities would not be sufficient, even if documented in official records.
Under the Proposed Regulations, a Plan could be amended after adoption only in direct response to an identifiable, unexpected and material change in market or business conditions that occurs after the date the original Plan was adopted. In the absence of any de minimis exception, it appears that even an immaterial amendment to the Plan would be subject to this requirement, which sets a very high bar for amendments and may raise concerns around practicality.
Effective Date and Request for Comments
The Proposed Regulations would generally apply prospectively to spin-offs occurring after final regulations are published. A grandfathering rule provides that a transaction occurring after final regulations are published will not be subject to them if the Parent previously made a public announcement, entered into a written agreement, received board approval or submitted a PLR request with respect to the transaction.
Treasury and the IRS have requested comments on the Proposed Regulations. Comments must be submitted by March 17, 2025.
____________________
1 Under the statute, the ability to reallocate debt on a tax-free basis through a Spinco liability assumption or Boot Purge is generally capped at the tax basis of the assets transferred to the Spinco. Debt Exchanges are not subject to a tax basis limitation.
2 The Proposed Regulations indicate that, to be eligible for a Boot Purge or Debt Exchange, historic Parent debt must have an original term that ends after the date of the Boot Purge or Debt Exchange. On its face, this requirement seems to apply to historic Parent debt that in fact matures and is refinanced prior to the spin-off. It is unclear if this was intended or a drafting error.
3 In either structure, the intermediary typically sells the Spinco stock or securities in a registered offering or private placement shortly after the Debt Exchange.
4 Under the 5/14 standard, the intermediary was required to hold the Parent debt for at least five days before entering into an exchange agreement with the Parent and for at least 14 days in total before consummating the Debt Exchange.
5 Contrasting examples demonstrate that extraordinary dividends and “special repurchases” of Parent stock (apparently pursuant to a new repurchase authorization) are permissible in some circumstances.
6 In addition to the new Plan documentation requirements, the Proposed Regulations would require companies engaging in spin-offs to prepare and file new IRS Form 7216, Multi-Year Reporting Related to Section 355 Transactions. The new form would require the Parent to submit a host of information to the IRS for purposes of monitoring the execution of a spin-off transaction spanning multiple taxable years.
This memorandum is provided by Skadden, Arps, Slate, Meagher & Flom LLP and its affiliates for educational and informational purposes only and is not intended and should not be construed as legal advice. This memorandum is considered advertising under applicable state laws.