Rev. Rul. 80-181

ISSUE

Whether the active trade or business requirement of section 355(b) of the Internal Revenue Code is satisfied if the wholly owned subsidiary corporation in the transaction described in Rev. Rul. 79-394, 1979-2 C.B. 141, does not reimburse related corporations for the use of their employees and officers in the conduct of the subsidiary's real estate activities.

ANALYSIS

In Rev. Rul. 79-394 a corporation (P) owned all of the stock of another corporation (Y) for more than 5 years, and during that period Y was engaged in renting real estate to unrelated third parties. Y's business required considerable day to day management and operational functions and also involved acquiring, renovating, refurbishing, and servicing the real estate which it leased. Y had no salaried employees, but its activities were performed by employees of another corporation (X), which was wholly owned by P, who were under the supervision and control of Y's officers who were also officers of P and X. Y reimbursed X for the services performed by X's employees, and Y also reimbursed P and X for the services performed by their officers. P then proposed to distribute the Y stock to one of its (P's) shareholders in a transaction intended to meet the requirements of section 355 of the Code, which, if satisfied, would make the distribution nontaxable to the P shareholders. After the distribution, Y would directly employ most of those employees who had worked on Y's behalf prior to the distribution.

In considering the issue of whether before the distribution Y was engaged in the conduct of an active trade or business within the meaning of section 355(b) of the Code, Rev. Rul. 79-394 states that the presence or absence of formal employment of employees (other than officers) by the controlled corporation (or the distributing corporation) is only one factor to be considered in the determination under section 355(b). Rev. Rul. 79-394 concludes that the scope of Y's management and operation activities was sufficient to distinguish these activities from a passive investment in real estate, even though it had no salaried employees prior to the distribution, and holds that the active trade or business requirement of section 355(b) was satisfied under these circumstances.

The fact that Y reimbursed X and P for the services performed by their employees and officers in connection with Y's rental activities was one of the factors in favor of concluding that Y was engaged in the conduct of an active trade or business within the meaning of section 355(b) of the Code, and the absence of reimbursement is a negative factor in this determination. However, Y's failure to reimburse X and P for the services performed by their employees and officers would not materially change the nature of Y's predistribution management and operational activities, especially since Y would continue to supervise and control X's employees in the conduct of these activities. Moreover, the fact that these services were performed by employees of X, which was wholly owned by Y's parent (P), is significant in determining whether an active business was conducted by the distributing or controlled corporation during the five-year period prior to the distribution. Compare Rev. Rul. 73-234, 1973-1 C.B. 180; Rev. Rul. 73-236, 1973-1 C.B. 183; and Rev. Rul. 73-237, 1973-1 C.B. 184.

HOLDING

The active trade or business requirement of section 355(b) of the Code is satisfied even though Y does not reimburse P and X for the use of their employees and officers in the conduct of Y's real estate activities.

If Y did not reimburse X and P for the services rendered to Y by the employees of X and the officers of X and P, then section 482 of the Code would be applicable to allocate income to X and P in an amount equal to an arm's length charge, pursuant to section 1.482-1(b) and section 1.482-2(b) of the Income Tax Regulations, for the services rendered by the employees of X and the officers of X and P to Y. In addition, Y would then be entitled to a deduction under section 162 provided the amounts deemed paid by Y to X and P for the services rendered represent ordinary and necessary business expenses to Y.

EFFECT ON OTHER REVENUE RULINGS

Rev. Rul. 79-394 is amplified.