IRS statement regarding the active trade or business requirement for section 355 distributions


Notice: Historical Content

This is an archival or historical document and may not reflect current law, policies or procedures.

Sept. 25, 2018

The IRS is providing this statement to inform taxpayers and their advisers of a study regarding the active trade or business (ATB) requirement under section 355(b) of the Internal Revenue Code, to request comments on the matters under study, and to indicate that the IRS will entertain requests for private letter rulings as described below.

In general, section 355 permits a corporation to distribute to its shareholders or security holders the stock and securities of a controlled subsidiary without recognition of gain to itself, its shareholders, or its security-holders.  To qualify for tax-free treatment, various requirements must be satisfied, including the requirement under section 355(b) that the distributing corporation and the controlled corporation each be engaged in an ATB.  The regulations under section 355(b) provide that an ATB “ordinarily must include the collection of income and the payment of expenses.”

The IRS has observed a significant rise in entrepreneurial ventures whose activities consist of research and development in lengthy phases.  During these phases, the ventures often collect no income or negligible income but nonetheless incur significant financial expenditures and perform day-to-day operational and managerial functions that historically have evidenced an “active” business.  For instance, a venture in the pharmaceutical or technology field might engage in research to develop new products with the purpose of earning income in the future from sales or licenses.  The venture might even forgo current income opportunities to obtain increased future income by developing products on its own.  The nature and duration of the research phases is often dictated by regulatory agencies, which require complex review processes that can span multiple years and cost millions of dollars.

Due to the emergence of these ventures, the IRS and the Treasury Department are considering guidance to address whether a business can qualify as an ATB if entrepreneurial activities, as opposed to investment or other non-business activities, take place with the purpose of earning income in the future, but no income has yet been collected.  Comments are requested regarding all aspects of the requirement that an ATB “ordinarily must include the collection of income,” including (1) the scope of the requirement under current law and administrative guidance, (2) whether any applicable administrative guidance should be withdrawn, revoked, modified, or declared obsolete, and (3) whether the requirement should be modified, for example, whether an exception should apply to any particular business model due to its unique characteristics.  The IRS and the Treasury Department do not, however, contemplate industry-specific guidance.

Pending completion of this study, the IRS will entertain requests for private letter rulings regarding the ATB qualification of corporations that have not collected income. Taxpayers and their advisers are encouraged to request pre-submission conferences to discuss requests for rulings on these matters.  For further information, please call Lisa A. Fuller, Acting Deputy Associate Chief Counsel (Corporate), at 202-317-7700.