Reform of Section 355

Abstract

Section 355 is one of the most important provisions in the US corporate tax laws because, after the 1986 Tax Reform Act, it remains the principle means of allowing for a tax-free spin-off and disposition of businesses in the publicly traded corporate context. Yet, the provision has received very limited scholarly attention. The article addresses a gap in the existing literature by addressing the normative goals of this provision and its deficiencies. Section 355 has had a curious and troubled history.

In 1986, Congress enacted major tax reform legislation, but Section 355 was not reformed as part of the Tax Reform Act of 1986. In 2017, Congress again enacted major tax reform legislation, but similar to 1986 Congress did not reform Section 355 in 2017 either. In the intervening years from 1987 through 2016, Section 355 was amended eleven times, making it the most amended provision in Subchapter C during this period. The policy goals that motivated these amendments have been remarkably consistent, namely these reforms sought to ensure that Section 355 did not provide taxpayers with an inappropriate device for circumventing the intended scope of Congress’ repeal of the General Utilities doctrine.

In addition, Congress provided the Treasury Department with broad regulatory authority to ensure that its purpose in repealing the General Utilities doctrine would not be circumvented through any other provision of law (including Section 355), and the Treasury Department has issued regulatory guidance in an effort to effectuate this goal. But, in like manner, the Treasury Department’s proposed amendments to its Section 355 regulations also have fallen short of the appropriate mark, as the analysis in Part II.C. will demonstrate.

The result of these Congressional amendments and of the Treasury Department’s ongoing regulatory efforts is that Section 355 has become needlessly complex and subjective. Section 355’s needless subjectivity creates an administrative working law that is close to unfathomable to many experienced tax professionals. And yet, the added complexity and subjectivity does not forestall Section 355 from affording tax-free treatment to corporate separations that are more akin to a disposition of an historic business to new shareholders. Seen in its proper context, Section 355’s nonrecognition treatment is justifiable only in the limited scenario of a corporate separation (motivated by business necessities) among historic shareholders who seek to continue their interest in the corporation’s historic businesses albeit in modified corporate form. The effectiveness of Section 355 in providing a vehicle to side-step Congress’ General Utilities repeal is now widely understood and has caused some to laud Section 355 as “the heartbeat of mergers and acquisition activity in the United States.” In short, Section 355 is a mess.

But, why has Section 355 become such a mess and what must be done to reform Section 355? The article seeks to answer both of these organizing questions and then sets forth a reform proposal that, if adopted, would finally allow Section 355 to fulfill its core mission without creating an inappropriate means to avoid Congress’ repeal of the General Utilities doctrine.

Keywords: Section 355, General Utilities Doctrine, General Utilities Repeal, Spin-Offs, Section 368(a)(1)(D)