In preparation for a tax-free spin-off, a parent corporation often contributes one or more of its businesses to a subsidiary in exchange for subsidiary stock and potentially debt and cash.  When parent subsequently spins-off the subsidiary stock to its shareholders, it may also seek to exchange the subsidiary debt, stock and cash it received for a like amount of its own outstanding debt, allowing parent to retire its debt in a tax-efficient manner.  Historically, the guideposts for structuring a tax-free spin-off with a debt exchange came primarily from private rulings that taxpayers had obtained approving specific transactions. The government’s release of Revenue Procedure 2018-53 on October 3, 2018 provides welcome insight for taxpayers into the government’s current view of this valuable transaction technique.

The revenue procedure requires that a taxpayer requesting a private ruling involving a spin-off debt exchange, where the parent debt is non-contingent and payable only in cash, make the following representations, including the following:

• Use of Intermediary: Where parent utilizes an intermediary, such as an investment bank, to purchase existing parent debt for exchange: (i) the intermediary will not acquire the parent debt from parent, subsidiary or a related person, (ii) parent, subsidiary and related persons will not participate in any profit of the intermediary and no agreement will limit the profit, and (iii) the intermediary will not receive subsidiary stock, debt or cash that exceeds by value the intermediary’s entitlement as a holder of the parent debt.
  • These representations are notable because they do not reference the so-called “5-14” representations required by the government in prior debt exchange private rulings, i.e., the intermediary would acquire and hold the parent debt at least five days before signing the debt exchange agreement with parent and at least 14 days before the consummation of the debt exchange.
• Historic Parent Debt: Generally, parent will incur the debt to be exchanged prior to the private ruling request and at least 60 days prior to the earliest of the following:
  • The first public announcement date of the tax-free spin-off,
  • The date of entry into a binding agreement to execute the tax-free spin-off, and
  • The approval date of the tax-free spin-off or similar transaction by parent’s board of directors.
• Debt Exchange Timing: Generally, the debt exchange will occur within 30 days of the spin-off unless there are “substantial business reasons” for the delay and will occur in any event within 180 days of the spin-off except where the taxpayer demonstrates that the exchange is part of a “plan” that includes the tax-free spin-off.
• Debt Exchange Amount: The amount of exchanged parent debt will not exceed the historic average of third party debt of the parent’s group (determined as an eight-quarter average ending on the approval date of the tax-free spin-off by parent’s board of directors).
• Replacement of Exchanged Parent Debt: Parent will not replace the amount of exchanged parent debt with a pre-committed borrowing, other than ordinary course borrowing under a revolving credit agreement.

While the revenue procedure may be more limiting than the government’s prior ruling practice, the revenue procedure does not necessarily prevent the government from ruling on debt exchanges that cannot satisfy the requirements described above so long as the taxpayer provides additional representations or information required by the government.  In addition, even where a taxpayer is not anticipated to request a private ruling from the government, taxpayers should carefully consider the guidelines provided by the revenue procedure as they will likely form the basis for planning any spin-off debt exchanges going forward.