Insights & News

Tax Insights, July 27, 2016
Tracking Tax News You Need to Know

July 27, 2016

IRS Announces Safe Harbors Clarifying When Acquisition of Control for Tax-Free Distribution Has Substance
The IRS issued Revenue Procedure 2016-40, 2016-31 IRB, which provides fact patterns to illustrate situations in which the IRS will not assert that a distributing corporation fails to satisfy the “control” requirement for a tax-free distribution of a controlled corporation’s stock and securities under Section 355 (section references are to the Internal Revenue Code of 1986, as amended). The guidance is intended to clarify when a pre-distribution acquisition of control lacks substance, which, according to the IRS, can be a difficult and fact-intensive inquiry.

For a distribution to qualify for nonrecognition treatment under Section 355, the distributing corporation (Distributing) must distribute stock or securities of the corporation that it “controls” (Controlled) immediately before the distribution (the “control requirement”). For this purpose, “control” is defined by cross-reference to Section 368(c) as ownership of stock possessing at least 80 percent of the total combined voting power of all classes of stock entitled to vote and at least 80 percent of the total number of shares of each other class of stock of the corporation.

Revenue Procedure 2016-40 applies to transactions in which:

  1. Distributing owns Controlled stock in amounts insufficient to satisfy the control requirement;
  2. Controlled issues shares of one or more classes of stock to Distributing and/or to other Controlled shareholders with the result that Distributing satisfies the control requirements with respect to Controlled;
  3. Distributing distributes its Controlled stock in a transaction that otherwise qualifies under Section 355; and
  4. Controlled subsequently engages in a transaction that, actually or in effect, substantially restores (i) Controlled’s shareholders to the relative interests, direct or indirect, they would have held in Controlled (or a successor to it) had the issuance not occurred, and/or (ii) the relative voting rights and value of the Controlled classes of stock that were present prior to the issuance (an unwind).

The Revenue Procedure provides that the IRS will not assert that a transaction described above lacks substance, and that therefore Distributing failed to satisfy the control requirement immediately before the distribution, if the transaction is also described in one of the safe harbors below:

  1. No action is taken (including the adoption of any plan or policy) at any time prior to 24 months after the distribution, by Controlled’s board of directors, management or any of its controlling shareholders that would, if implemented, actually or effectively result in an unwind (see item d. above).
  2. Controlled engages in a transaction with one or more persons (e.g., a merger) that results in an unwind, regardless of whether the transaction takes place more or less than 24 months after the distribution, provided that:

    1. There is no agreement, understanding, arrangement, or substantial negotiations or discussions concerning the transaction or a similar transaction at any time during the 24-month period ending on the date of the distribution (i.e., it is unplanned); and
    2. no more than 20 percent of the interest in the other person (e.g., the other corporation in a merger), in vote or value, is “owned” by the same persons that own more than 20 percent of the stock of Controlled (with ownership determined by application of the constructive ownership rules of Section 318(a), as modified). 

IRS Rules That REIT Shareholders Are Taxable on Cash-or-Stock Dividend and Convertible Debt Adjustment
The IRS ruled in Private Letter Ruling 201629003 that both a dividend that a REIT corporation’s shareholders could elect to receive either in cash or stock and an adjustment made to the terms of the corporation’s convertible stock resulted in distributions to shareholders to which Section 301 applies. A stock or rights distribution is treated as a (taxable, in most cases) Section 301 property distribution if the distribution is, at the election or option of any shareholder, payable either in stock or in property. This is true regardless of whether the election or option is exercisable before or after the dividend is declared. Under Section 305(b)(2), if a distribution (or series of distributions) by a corporation has the result of a receipt of property by some shareholders and an increase in the proportionate interests of other shareholders in the assets or earnings and profits of the corporation, all the distributions are treated as distributions of property to which Section 301 applies. Regulations under Section 305(c) treat changes in the conversion ratio of instruments convertible into stock, and other events having similar effects, as distributions to those shareholders whose proportionate interests in the assets or earnings and profits of the corporation are increased by such events.

IRS Issues Final Regulations on Arbitrage Restrictions
The IRS issued final regulations (T.D. 9777) that cover a wide range of subjects with respect to the Section 148 arbitrage restrictions applicable to tax-exempt bonds and other tax-advantaged bonds issued by state and local governments. The final regulations cover a wide variety of rules, including:

  1. Working capital expenditures. Existing regulations impose a number of restrictions to limit arbitrage incentives for excessive use of tax-exempt bond financing for working capital expenditures rather than capital projects. Proposed regulations provided that for the part of an issue that would be used to finance restricted working capital expenditures, a safe harbor applies if that part is outstanding no longer than 13 months after the issue date. Restricted working capital expenditures are working capital expenditures that are accounted for using a certain prescribed method. The final regulations extend this safe harbor to all working capital expenditure financings rather than to just those for restricted working capital expenditures. (Treasury Regulation Section 1.148-1(c)(4)(i)(B)(1).)

    In addition, the proposed regulations provided an objective safe harbor for working capital financings that have terms longer than the proposed 13-month safe harbor. Under this objective safe harbor, an issuer would have to (i) determine the first year in which it expects to have amounts available for working capital expenditures, (ii) monitor for actual available amounts in each year beginning with the year it first expects to have such amounts and (iii) apply such available amounts in each year either to redeem or to invest in (or some combination of redeeming and investing in) certain tax-exempt bonds (eligible tax-exempt bonds).

    The final regulations liberalize the rules of this second safe harbor in several ways, including allowing an issuer to spend amounts previously invested in eligible tax-exempt bonds within 30 days of the date on which they cease to be so invested, either (i) to make expenditures for a governmental purpose on any date on which the issuer has no other available amounts for such purpose or (ii) to redeem eligible tax-exempt bonds. (Treasury Regulation Section 1.148-1(c)(4)(ii)(C).)
  2. Calculation of the arbitrage rebate. Existing regulations allow an issuer to take a credit against any required arbitrage rebate to help offset the cost of computing that rebate. The proposed regulations suggested increasing the credit and adding an inflation adjustment to this credit. The final regulations adopt these changes as proposed. (Treasury Regulation Sections 1.148-3(d)(1)(iv) and 1.148-3(d)(4).)

    Generally, under the existing regulations, an issuer computes the amount of arbitrage rebate that it owes under a method that sets the future values of payments and receipts on investments using the yield on the bond issue. (Treasury Regulation Section 1.148-3(b).) In an example in the final regulations, the IRS has broadened the scope of recovery of overpayments of arbitrage rebates to permit future valuing of the amount actually paid in computing the amount of the overpayment. (Treasury Regulation Section 1.148-3(j), Example (2)(iii)(D).)
  3. Calculation of the arbitrage rebate. The proposed regulations suggested simplifying the yield calculations for certain callable bonds issued with significant amounts of bond premium (sometimes called “yield-to-call bonds”) to focus on the redemption date that results in the lowest yield on the particular premium bond (rather than the more complex existing focus on the lowest yield on the issue). The final regulations adopt this change as proposed. (Treasury Regulation Section 1.148-4(b)(3).)
  4. Valuation of investments. Various arbitrage bond rules vary based on the extent to which the proceeds of the issue are used for purpose, versus non-purpose, investments. A purpose investment is an investment that is acquired to carry out the governmental purpose of an issue. A non-purpose investment is any investment property that is not a purpose investment.

    Under the final regulations, a purpose investment must be valued at present value, and subject to several exceptions, a yield-restricted non-purpose investment must be valued at present value. (Treasury Regulation Section 1.148-5(d)(2).) Under one such exception, a non-purpose investment must be valued at fair market value on the date that it is first allocated to an issue or first ceases to be allocated to an issue as a consequence of a deemed acquisition or deemed disposition. (Treasury Regulation Section 1.148-5(d)(3)(i).)

The final regulations generally apply to bonds that are sold on or after Oct. 16. Certain provisions related to hedges on bonds apply to hedges that are entered into or modified on or after Oct. 16. The final regulations also permit issuers to apply certain of the amended provisions to bonds sold before Oct. 16.

IRS Issues Temporary Regulations on Income Inclusion Rules for Lessees of Investment Credit Property
The IRS has issued temporary regulations (T.D. 9776), the text of which also serves as the text of contemporaneously issued proposed regulations, that provide guidance on the income inclusion rules under Section 50(d)(5) applicable to a lessee of investment credit property when a lessor of such property elects to treat the lessee as having acquired it. They also coordinate such rules with the recapture rules under Section 50(a). In addition, they provide rules regarding income inclusion upon a lease termination, lease disposition by a lessee, or disposition of a partner’s or S corporation shareholder’s entire interest in a lessee partnership or S corporation outside the recapture period.

Georgia-U.S. FATCA IGA Competent Authority Arrangement Available
The Georgian and U.S. competent authorities have signed an arrangement under the two nations’ 2015 intergovernmental agreement to implement the information reporting and withholding tax provisions of FATCA.

IRS Releases Additional International Practice Units
The IRS has released International Practice Units covering the following topics:

  1. Nonfunctional Currency Transactions.
  2. Foreign Currency Transactions.
  3. Qualified Business Units

NAREIT Seeks Withdrawal of Proposed Regulations on Transfers to REITs, RICs
The National Association of Real Estate Investment Trusts has urged the IRS to withdraw and modify proposed regulations that impose corporate-level tax in connection with some C corporation-to-REIT conversion transactions (see prior coverage here), recommending that the regulations maintain REIT and S corporation parity for the built-in gain recognition period.

Pennsylvania Updates: Governor Signs Revenue Bill; Abandoned and Unclaimed Property Law Amended
Pennsylvania Gov. Tom Wolf has signed a revenue bill that imposes tax on tobacco products; increases the rate of cigarette tax; increases the rate of tax on financial institutions (the rate of tax imposed on financial institutions is increased to 0.95 percent for tax years starting Jan. 1, 2017, and thereafter); exempts timbering from sales tax; makes the purchase, installation or use of sales suppression devices, zappers and phantomware a criminal offense; provides a method for filing amended corporate net income tax returns; provides a number of new tax credits; and amends or extends existing tax credits. L. 2016, H1198 (Act 84), effective Aug. 13.

The revenue bill also includes a provision for a 60-day tax amnesty program. The Pennsylvania Department of Revenue (DOR) will provide details on the program in the future. However, the program’s features, based on the provisions included in the bill, will be as follows:

  1. The program must start by May 1, 2017, and will run for 60 days;
  2. Taxes eligible for amnesty include any tax administered by the PA DOR, which is delinquent as of December 31, 2015. This means that 2016 tax liabilities will not be eligible for the program;
  3. There will be a five-year look-back period, prior to Dec. 31, 2015, for “unknown liabilities.” “Unknown liabilities” include any liability where no return or report has been filed, no payment has been made and the taxpayer has not been contacted by the PA DOR, or if a return or report has been filed, the tax was underreported and the taxpayer has not been contacted by the PA DOR concerning the underpayment and is not already under audit when the amnesty period begins;
  4. Taxes paid within the 60-day amnesty period will qualify for 100 percent penalty abatement and 50 percent interest abatement (assuming all program guidelines are satisfied);
  5. Taxpayers participating in the program must timely file all tax returns and pay their tax liabilities during the two years following their program participation;
  6. The PA DOR will notify, in writing, all known tax delinquents at the taxpayers’ last known valid address about program details and eligibility; and
  7. Subject to certain exceptions, a 5 percent non-participation penalty may apply to unpaid liabilities eligible for the program that remain unpaid at the end of the amnesty period.

Pennsylvania also has enacted legislation amending its abandoned and unclaimed property law to clarify when certain property is considered abandoned, establish specific notification requirements for holders of property, and allow the state treasurer to obtain possession of unredeemed and unclaimed U.S. savings bonds. L. 2016, H1605 (Act 85), generally effective July 13.

Delaware Revises Abandoned and Unclaimed Property Handbook
The Delaware Department of Finance, Office of Unclaimed Property has revised its handbook, which provides information to holders of abandoned and unclaimed property regarding the preparation of abandoned and unclaimed property reports. The handbook provides guidance on who must report, when to report and remit payment, what to report, electronic reporting, paper reporting, property type codes with applicable dormancy periods, due diligence and advertising requirements, reciprocal reports, and negative agreements. The handbook also provides form instructions. (Del. Dept. of Finance, Office of Unclaimed Property, Escheat Handbook —Instructions for Preparing Unclaimed Property Reports, July 1.)

Ohio Permits Deduction for Contribution to ABLE Accounts
Ohio law creates a personal income tax deduction for contributions to an Achieve a Better Living Experience (ABLE) savings account, which is used to pay qualified disability expenses of a beneficiary. L. 2016, H483, effective on the 91st day after filing with the secretary of state.

Illinois Permits State Treasurer to Accept ABLE Account Contributions
Illinois law provides that the state treasurer may accept ABLE account contributions once the IRS issues its final regulations or interim guidance on ABLE accounts. ABLE accounts could previously be established only for a beneficiary who is a resident of Illinois; however, the bill amends that provision so that an ABLE account may be established for a resident of any other state. L. 2016, S2268 (P.A. 99-0563), effective July 15.

Information contained in this publication should not be construed as legal advice or opinion or as a substitute for the advice of counsel. The articles by these authors may have first appeared in other publications. The content provided is for educational and informational purposes for the use of clients and others who may be interested in the subject matter. We recommend that readers seek specific advice from counsel about particular matters of interest.

Copyright © 2016 Stradley Ronon Stevens & Young, LLP. All rights reserved.

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