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"Control" plays a key role in a wide range of tax-free corporate transactions: for purposes of reorganizations (e.g., Sections 368(a)(1)(B), (a)(2)(E)); for tax-free spin-offs (Section 355(a)(1)(D)); and of course for transfers of property for stock in the transferee corporation (Section 351 (a)). In each case, the definition of control generally looks to the relatively antiquated concepts of voting control as set forth in Section 368(c), but the actual application of the control test is not confined by definitions; instead, issues of direct and indirect attribution, step-transaction doctrine, and up-chain and down-chain movements of stock in connection with various parts of reorganizations impact the question of whether "control" has been satisfied.
There also are a number of situations in which taxpayers are more interested in avoiding Section 351 than in qualifying for tax-free treatment. In those cases, given that Section 351 treatment is not elective, violating the control test is a principal means of avoiding carryover basis on transfers of property, and deferral of losses to the transferor. Furthermore, where the taxpayer is planning an acquisitive transaction that is supposed to be a "qualified stock purchase" (QSP) under Section 338, avoidance of Section 351 treatment may be critical. Thus, for example, where one of the parties to an acquisition intends to "roll over" his or her shares in an S corporation target by transferring them to the acquiring corporation (Newco), the ability to make a Section 338(h)(10) election for the entire transaction could be put in jeopardy if the rollover shares constitute part of a Section 351 transaction with Newco.
In a ruling issued on 5/5/03,1 the IRS has expanded the scope of "control" for purposes of Section 351 (a) in a manner that clearly contemplates dilution of control through successive drop downs of stock received in connection with transfers of assets to one corporation in a related transaction with another corporation. By permitting attenuated control through such related transactions, the ruling appears to go beyond traditional "bright line" concepts of the control requirement in the Section 351 setting.
This column examines the new ruling and the expanded interpretation of the control requirement evidenced by the IRS, as well as the analysis of some long-standing prior published rulings, and notes the potential impact of this...