A Reverse Morris Trust is a transaction that combines a divisive reorganization (spin-off

Spin out

A spin-out, also known as a spin-off or a starburst, refers to a type of corporate action where a company "splits off" sections of itself as a separate business....

) with an acquisitive reorganization (statutory merger

Mergers and acquisitions

Mergers and acquisitions refers to the aspect of corporate strategy, corporate finance and management dealing with the buying, selling, dividing and combining of different companies and similar entities that can help an enterprise grow rapidly in its sector or location of origin, or a new field or...

) to allow a tax-free transfer (in the guise of a merger) of a subsidiary under United States law.

Structure

A Reverse Morris Trust is used when a parent company

Parent company

A parent company is a company that owns enough voting stock in another firm to control management and operations by influencing or electing its board of directors; the second company being deemed as a subsidiary of the parent company...

 has a subsidiary

Subsidiary

A subsidiary company, subsidiary, or daughter company is a company that is completely or partly owned and wholly controlled by another company that owns more than half of the subsidiary's stock. The subsidiary can be a company, corporation, or limited liability company. In some cases it is a...

 (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

Internal Revenue Code section 355

Section 355 of the Internal Revenue Code allows a corporation to make a tax-free distribution to its shareholders of stock and securities in one or more controlled subsidiaries. If a set of statutory and judicial requirements are met, neither the distributing corporation nor its shareholders...

, 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.

History

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

Stock

The capital stock of a business entity represents the original capital paid into or invested in the business by its founders. It serves as a security for the creditors of a business since it cannot be withdrawn to the detriment of the creditors...

, 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

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

Pringles

Pringles is a brand of potato and wheat based snacks originally developed by Procter & Gamble. Pringles are sold in more than 140 countries and have yearly sales of more than...

 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

Folgers

Folgers Coffee is a major brand of coffee in the United States, part of the food and beverage division of The J.M. Smucker Co.-Company history:...

 coffee to J.M. Smucker in 2008.