Reverse Morris Trust

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A Reverse Morris Trust is a transaction that combines a divisive reorganization (spin-off) with an acquisitive reorganization (statutory merger) to allow a tax-free transfer (in the guise of a merger) of a subsidiary under United States law.

Structure[edit]

A Reverse Morris Trust is used when a parent company has a subsidiary (sub-company) that it wants to sell in a tax-efficient manner. The parent company completes a spin-off of a subsidiary to the parent company's shareholders. Under Internal Revenue Code section 355, this could be tax-free if certain criteria are met. The former subsidiary (now owned by the parent company's shareholders, but separate from the parent company) then merges with a target company to create a merged company. Under Internal Revenue Code section 368 (a)(1)(A), this could be largely tax-free if the former subsidiary is considered the "buyer" of the target company. The former subsidiary is the "buyer" if its shareholders (also the original parent company's shareholders) own more than 50% of the merged company. Thus, the former subsidiary will usually have a bigger market capitalization than the target company. The target company's managers generally run the merged company.

History[edit]

The original Morris Trust structure was the result of a favorable ruling in IRS v. Morris Trust in 1966. The original Morris Trust structure is similar to the above Reverse Morris Trust structure, however instead of a former subsidiary merging with a target company, the parent company would merge with target company.

Following several leveraged Morris Trust transactions similar to the original Morris Trust transaction, but involving cash and bank loans rather than mere stock, Congress enacted Internal Revenue Code Section 355(e) in 1997. This imposes additional taxation on the distribution in the spin-off step whenever 50% interest in a spun off company is transferred tax-free in the two years following a spin-off.

Examples[edit]

Verizon wished to sell its access lines to Fairpoint. Rather than simply selling these assets alone to Fairpoint, however, Verizon created a subsidiary (to which it sold these assets) and distributed the shares of this new subsidiary to Verizon's shareholders. They then completed a Reverse Morris Trust with Fairpoint, where the original Verizon shareholders had a majority ownership of the newly merged company and the Fairpoint management ran the new company. Verizon was able to divest their access lines in a tax free manner as they continued to focus on higher growth wireless business.

Procter & Gamble Co. was planning to sell its Pringles line of snacks to Diamond Foods in a leveraged, reverse Morris Trust split-off. The Pringles business would be transferred to a separate subsidiary which would assume approximately $850 million of debt. However, the two companies were unable to finalize the deal, and in February 2012 Procter & Gamble found another buyer in the Kellogg Company.

Procter & Gamble used a similar transaction structure when it sold Folgers coffee to J.M. Smucker in 2008.

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