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.
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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 sub-company to the parent company's shareholders. Under Internal Revenue Code section 355, this could be tax-free if certain criteria are met. The sub-company (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 sub-company is considered as the "buyer" in the M&A. The sub-company is the "buyer" if its shareholders (also the original parent company's shareholders) own more than 50% of the merged company. Thus, the sub-company usually has a bigger market capitalization than the target company. The target company's managers generally run the merged company.
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 sub-company 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.
Verizon spun off access lines to Fairpoint. These access lines could not stand alone, they needed a company to run them. Thus, they completed a Reverse Morris Trust with Fairpoint where the original Verizon shareholders had a majority ownership however the Fairpoint management ran the new company. Verizon was able to divest their access lines in a tax free manner as they continue to focus on higher growth wireless business.
Procter & Gamble Co. sold its Pringles line of snacks to Diamond Foods in a leveraged, reverse Morris Trust split-off. The Pringles business was transferred to a separate subsidiary which assumed approximately $850 million of debt.
Procter & Gamble used a similar transaction structure when it sold Folgers coffee to J.M. Smucker in 2008.
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