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Reverse Morris Trust

A tax-free spin-off with a pre-arranged merger.

What is Reverse Morris Trust?

The Reverse Morris Trust is a form of tax-avoidance employed by companies. This tactic enables the company to sell off unwanted assets without incurring tax obligations on gains arising from the sale of these assets. The Reverse Morris Trust technique works in the following manner: a parent company spins off a subsidiary to which it transfers the unwanted assets; a new, unrelated company is formed by a merger of the subsidiary with a third party company; the new company issues at least 50.1% of its voting stock (and thus, control) to the shareholders of the original parent company.

 

Reverse Morris Trust

 

More on a Reverse Morris Trust

The newly merged company holds the unwanted asset, which the parent company has effectively sold tax-free.

The subsidiary spin-off offers an opportunity to the parent company to raise capital, monetize its interest in the segment being spun off, and thereby reduce debt. Companies resort to Reverse Morris Trust deals as they offer the combined benefits of mergers and spin-offs.

Learn more about mergers and acquisitions in CFI’s free introduction to corporate finance course.

 

History of the Reverse Morris Trust

Often, the sole or primary business purpose for a spin-off is to shed an unwanted business and thereby facilitate the planned acquisition of a “wanted” business.

In Commissioner v. Mary Archer W. Morris Trust, 697 F.2d 794 (4th Cir. 1966) (“Morris Trust”), the distributing corporation (“Distributing”) was engaged in two businesses: banking and insurance. Distributing transferred the insurance business to a new corporation and spun off the stock of the new corporation to its shareholders. Distributing then merged, for valid, non-tax business reasons, with another bank. The court determined that the continuity of stockholder interest requirement was satisfied because the historic shareholders of Distributing received 54% of the stock of the merged corporation, and, as a result, the transfer was a nontaxable spin-off. The perception became that, due to the lack of a continuing interest by the historic shareholders, the Morris Trust rule was being used as a device to transfer unwanted corporate assets without incurring a tax at the corporate level.

 

Anti-Morris Trust Rules

For a while after that, companies kept implementing this type of tax-dodging transaction, but Congress moved to eliminate it in 1997 by passing the so-called “anti-Morris Trust” regulations that specifically closed the loophole. The rules are outlined in Internal Revenue Code Section 355(e) and Treasure Regulations 1.355-7.

Under these rules, a spin-off will be taxable at the corporate level (but potentially not at the shareholder level) if the distribution is part of a plan (or series of related transactions) pursuant to which one or more persons acquire 50% or more of the stock of either the distributing company or the spun-off company.

As a result, while it is still possible to effect a Morris Trust transaction (distributing) or Reverse Morris Trust transaction (spin-off), the shareholders of the merger partner must receive less than 50% of the stock of the combined company (meaning that the merger partner must be smaller than the company with which it combines).

 

Additional resources

Thank you for reading this CFI guide to a Reverse Morris Trust and tax efficient M&A transactions.  To help you become a great investment banking analyst, we highly recommend these additional CFI resources:

  • M&A process overview
  • Tax free reorganization
  • Spin off and slit off
  • Financial modeling guide

M&A Modeling Course

Learn how to model mergers and acquisitions in CFI’s M&A Modeling Course!

Build an M&A model from scratch the easy way with step-by-step instruction.

This course will teach you how to model synergies, accretion/dilution, pro forma metrics and a complete M&A model. View the course now!