The IRS today posted a statement on its website announcing that the IRS and Treasury Department are considering guidance to address whether a business can qualify as an “active trade or business” 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.
The IRS statement (September 25, 2018) informs taxpayers of the IRS study regarding the active trade or business requirement under section 355(b). The IRS has requested comments.
Also, the IRS indicated that it will entertain requests for certain private letter rulings.
The IRS statement notes that section 355 generally 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 a requirement under section 355(b) that the distributing corporation and the controlled corporation each be engaged in an active trade or business. The regulations under section 355(b) provide that an active trade or business “ordinarily must include the collection of income and the payment of expenses.”
The IRS reported that it has observed a “significant rise in entrepreneurial ventures” that have activities consisting of research and development in lengthy phases. During these phases, the ventures often collect no income (or negligible income) but incur significant financial expenditures and perform day-to-day operational and managerial functions that historically have evidenced an “active” business.
The IRS noted that, 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 Treasury Department are considering guidance to address whether a business can qualify as an active trade or business 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 active trade or business “ordinarily must include the collection of income” including:
The IRS said that it does not contemplate industry-specific guidance.
The IRS statement continues by noting that while the study is on-going, the IRS will entertain requests for private letter rulings regarding the active trade or business qualification of corporations that have not collected income. The IRS release encourages taxpayers and their advisers to request pre-submission conferences to discuss requests for rulings on these matters.
© 2020 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.KPMG International Cooperative (“KPMG International”) is a Swiss entity.
Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm.
The KPMG logo and name are trademarks of KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent member firms. KPMG International provides no audit or other client services. Such services are provided solely by member firms in their respective geographic areas. KPMG International and its member firms are legally distinct and separate entities. They are not and nothing contained herein shall be construed to place these entities in the relationship of parents, subsidiaries, agents, partners, or joint venturers. No member firm has any authority (actual, apparent, implied or otherwise) to obligate or bind KPMG International or any member firm in any manner whatsoever. The information contained in herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG's Federal Tax Legislative and Regulatory Services Group at: + 1 202 533 4366, 1801 K Street NW, Washington, DC 20006.