Tax Alert - H.R. 1365 and S. 612 - Elimination of Morris Trust Transactions

On April 17, 1997, House Ways and Means Committee Chairman Bill Archer (R-TX), Senate Finance Committee Chairman William V. Roth, Jr. (R-Del), and Senator Daniel Patrick Moynihan (D-NY) introduced legislation in both the House and Senate that would effectively eliminate all future Morris Trust transactions. Although the introductory statements by Chairman Archer, Chairman Roth, and Senator Moynihan cite disguised sales as the abuse the legislation intends to eradicate, the legislation in fact does far more -- imposing a corporate tax when a distributing or controlled corporation in a section 355 transaction is acquired by a third party.

Under the proposed legislation, if there is a section 355 distribution which is part of a plan pursuant to which a person acquires stock representing at least a 50 percent interest in the distributing corporation or controlled corporation, the corporation whose interest is not acquired would recognize gain.  If the acquired corporation is the distributing corporation, gain would be recognized by the controlled corporation in the amount of the net gain that the distributing corporation would have recognized if it had sold its assets for its fair market value immediately after the distribution.  If the acquired corporation is the controlled corporation, the distributing corporation would recognize gain in the amount that it would have recognized had it sold its controlled corporation stock for its fair market value on the date of the distribution. Any gain recognized will be treated as long-term capital gain.

The effective date of the legislation is April 16, 1997, with exceptions for binding contracts and other transactions entered into before the April 16, 1997 effective date.  In addition, the proposed legislation creates a rebuttable presumption that any acquisition occurring two years before or after a section 355 distribution is part of a plan including such distribution.  The proposal also states that section 355 would not apply to a distribution among affiliated group members filing consolidated returns, except as provided in Treasury regulations.  Furthermore, the proposed legislation authorizes the IRS to prescribe regulations necessary to carry out the purposes of the legislation.

In light of the numerous objections expressed by practitioners following Treasury's similar proposal in February, many tax practitioners believed that any Morris Trust legislation introduced this year would more narrowly address disguised sales.  A typical disguised sale transaction is one where a controlled corporation borrows money, distributes the proceeds to its parent, is spun off, and an equity infusion is made by new shareholders which is used to satisfy the debt.  Transactions such as the much publicized General Motors/Raytheon and Viacom/TCI deals were thought to be the intended target of any new legislation.  However, the proposals as written will effectively eliminate all future Morris Trust transactions, not just abusive disguised sales.  If you have any questions about the legislation, please call Mark J. Silverman at 202.429.6450.