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IRS Issues Guidance on “North-South” Transactions

On May 3, the Internal Revenue Service (the IRS) issued Revenue Ruling 2017-09 (the “Ruling”), which helpfully clarifies that the separate steps of a typical “north-south” spinoff transaction will be respected, and announced that it would once again issue private letter rulings on north-south transactions.

In a north-south spinoff transaction, a shareholder contributes property to a corporation and the corporation distributes the stock of another subsidiary to the shareholder in a transaction that is intended to be a tax-free spinoff. If the contribution and distribution are treated as separate steps, then the distribution would qualify as tax-free under section 355 but if the steps are combined under the “step transaction doctrine” so that the contribution is received in exchange for the distribution, the distribution would be taxable.

The IRS had issued private letter rulings respecting the separate steps until January 2013, when it stopped issuing the rulings and announced that it was reconsidering the issue.

The Ruling resolves the issue and quite possibly alters the application of the step transaction doctrine going forward.[1]

The Ruling, under the facts set forth under Situation 1, spells out the paradigmatic case of a “north-south” transaction. A parent corporation (P) owns all the stock of a subsidiary (D), which in turn owns all the stock of its controlled subsidiary (C). P and C have engaged in separate active businesses for the requisite five years, but D does not conduct its own active business. Although D wants to spin C off to P, it needs its own separate active business to meet the requirements of Section 355. For the purpose of meeting this requirement, P contributes its separate active business to D in exchange for additional shares of D stock. At some point thereafter, D distributes all the C stock to P in a transaction intended to be a tax-free spinoff.

The issue considered by the IRS in 2013 is whether the contribution of the P business assets to D should be stepped together with the distribution of (some of) the stock of C by D, and thus a portion of the C shares distributed by D would actually be treated as being exchanged (in a taxable exchange) by D for the business assets contributed by P. Such a recharacterization would have several negative consequences: taxable gain recognized on the business assets and the C shares deemed sold, and, in fact, the possible inapplicability of Section 355 itself to the entire transaction (including the C shares that are still treated as being distributed by D). This would occur if more than 20% of the C shares are caught by the “north-south” recharacterization. In this case, the distribution as a whole would not satisfy the Section 355 requirement that an amount of stock constituting “control” (i.e., 80%) of C be distributed.

The Ruling, however, makes it clear that the two transactions will not be stepped together, without many caveats or other restrictions that would significantly limit the Ruling’s applicability. Thus, it seems that in most spinoff transactions, the “north-south” issue should no longer be a problem. The Ruling, therefore, is a welcome clarification with respect to one long-standing area of concern in the tax-free spinoff area.

But perhaps of more interest is the approach the Ruling takes to the step transaction doctrine. Rather than one of the more common formulations for the step transaction doctrine used in the past, the Ruling adopts a somewhat new, and potentially very beneficial, formulation suggested in part by the Tax Section of the New York State Bar Association in a 2013 report.[2] In particular, the Ruling states that the “tax treatment of a transaction generally follows the taxpayer’s chosen form unless (1) there is a compelling alternative policy; (2) the effect of all or part of the steps of the transaction is to avoid a particular result intended by otherwise-applicable Code provisions; or (3) the effect of all or part of the steps of the transaction is inconsistent with the underlying intent of the applicable Code provisions.” This formulation focuses on the taxpayer’s chosen form and substantive policy considerations underlying the applicable Code provisions with respect to a series of transactions rather than applying a mechanical test. It appears that the IRS intends the formulation to apply generally (although the Ruling is limited to the specific facts described in it).

At the very least, the Ruling clears up the long-standing concerns with the “north-south” issue in tax-free spinoffs. At the very most, the Ruling reflects a new IRS approach to the step transaction doctrine that could apply generally. We may have to wait to see how far reaching the Ruling is intended to be—whether the IRS will apply the Ruling’s formulation in other fact patterns, or whether the IRS reverts to one of the earlier formulations of the doctrine.

[1] Situation 2 of the Ruling also addresses a step-transaction fact pattern dealing with distributions—namely, whether a cash (and other property) distribution made from a controlled corporation to a distributing corporation before a series of transactions including a contribution of property from the distributing corporation to the controlled corporation and a spinoff of the controlled stock (all transactions being part of the same plan) should be integrated. The Ruling concludes that the distribution, spinoff and should be stepped together, and thus the distribution is part of the “boot” of the spinoff and contribution taken together (and thus the “boot” is taxed under Section 361) rather than a separate Section 301 distribution.

[2] New York State Bar Association Tax Section, Report on the Role of the Step Transaction Doctrine in Section 355 Stock Distributions: Control Requirement and North-South Transactions 8-12 (November 5, 2013),

© 2020 Proskauer Rose LLP. National Law Review, Volume VII, Number 136


About this Author

Richard Corn, Tax, Private Equity Funds, Proskauer Rose Law Firm

Richard M. Corn is a partner in the Tax Department. He focuses his practice on corporate tax structuring and planning for a wide variety of transactions, including:

  • mergers and acquisitions

  • cross-border transactions

  • joint ventures

  • structured financings

  • equity and debt issurances

  • restructurings

  • bankruptcy-related...

David S Miller, Proskauer, derivatives issuance lawyer, cross border lending transactions attorney

David Miller is a partner in the Tax Department. David advises clients on a broad range of domestic and international corporate tax issues. His practice covers the taxation of financial instruments and derivatives, cross-border lending transactions and other financings, international and domestic mergers and acquisitions, multinational corporate groups and partnerships, private equity and hedge funds, bankruptcy and workouts, high-net-worth individuals and families, and public charities and private foundations. He advises companies in virtually all major industries, including banking, finance, private equity, health care, life sciences, real estate, technology, consumer products, entertainment and energy.

David is strongly committed to pro bono service, and has represented more than 300 charities. In 2011, he was named as one of thirteen “Lawyers Who Lead by Example” by the New York Law Journal for his pro bono service. David has also been recognized for his pro bono work by The Legal Aid Society, Legal Services for New York City and New York Lawyers For The Public Interest.


Bowon Koh is an associate in the Tax Department. She works primarily on U.S. federal corporate, partnership and international tax matters and represents corporate, private equity and investment fund clients with inbound and outbound mergers and acquisitions, cross-border bank financing arrangements, debt restructurings, securities issuances, cross-border investments and REIT and other specialized real-estate transactions. Matters representative of her work include acting for an international data service company in its cross-border restructuring, for a global...