What Is a Reverse Morris Trust?
A reverse Morris trust (RMT) is a tax-optimization strategy in which a company wishing to spin-off and subsequently sell assets to an interested party can do so while avoiding taxes on any gains from such asset disposal.
A reverse Morris trust is a form of organization that allows an entity to combine a subsidiary that was spun off with a strategic merger or combination with another company free of taxes, provided that all legal requirements for spinoff are met. To form a reverse Morris trust, a parent company must first spin off a subsidiary or other unwanted asset into a separate company, which is then merged or combined with a firm that is interested in acquiring the asset.
A reverse Morris trust (RMT) allows a company to spin off and sell assets while avoiding taxes.
The reverse Morris Trust starts with a parent company looking to sell assets to a third-party company.
After a reverse Morris trust is formed, stockholders of the original company own at least 50.1% of the stock by vote and value of the combined or merged firm.
How a Reverse Morris Trust Works
Reverse Morris trusts originated as a result of a 1966 ruling in a lawsuit against the Internal Revenue Service (see C.I.R. v. Morris Trust), which created a tax loophole to avoid taxes when selling unwanted assets.
The reverse Morris trust starts with a parent company looking to sell assets to a third-party company. The parent company then creates a subsidiary, and that subsidiary and the third-party company merge to create an unrelated company. The unrelated company then issues shares to the original parent company's shareholders. If those shareholders control at least 50.1% of the voting right and economic value in the unrelated company, the reverse Morris Trust is complete. The parent company has effectively transferred the assets, tax-free, to the third-party company.
The key feature to preserve the tax-free status of a reverse Morris trust is that after its formation, stockholders of the original parent company own at least 50.1% of the stock by vote and value of the combined or merged firm. This makes the reverse Morris trust only attractive for third-party companies that are about the same size or smaller than the spun-off subsidiary.
Also, the third-party company in a reverse Morris trust has more flexibility in acquiring control of its board of directors and appointing senior management, despite a non-controlling stake in the trust.
The difference between a Morris trust and a reverse Morris trust is that in a Morris trust, the parent company merges with the target company and no subsidiary is created.
Example of a Reverse Morris Trust
A telecom company that wishes to sell old landlines to smaller companies in rural areas could use this technique. The telecom company might not wish to spend the time or resources to upgrade those lines to broadband or fiber-optic lines, so they could sell those assets using this tax-efficient transfer.
In 2007, Verizon Communications announced a planned sale of its landline operations in certain lines in the Northeast region to FairPoint Communications. To meet the tax-free transaction qualification, Verizon transferred unwanted landline operation assets to a separate subsidiary and distributed its shares to its existing shareholders.
Then, Verizon completed a reverse Morris trust reorganization with FairPoint, under which the original Verizon shareholders owned a majority stake in the newly merged company, while FairPoint's original management ran the new company.
In another example, Lockheed Martin divested from its Information Systems & Global solutions (ISGS) business segment in 2016. Like Verizon, it underwent a reverse Morris trust, where it formed a new offshoot company then merged with Leidos Holdings, a defense and information technology company.
Leidos Holdings paid a $1.8 billion cash payment, while Lockheed Martin reduced approximately 3% of its outstanding common shares. Lockheed Martin stockholders involved in the transaction then owned a 50.5% stake in Leidos. Overall, the transaction was valued at an estimated $4.6 billion.
How Do Reverse Morris Trust's Work?
A reverse Morris trust is a strategic way to divest a division tax-free, granted that all legal requirements are met. To undergo a reverse Morris Trust, a company will create a new company for this division, then merge with another company. Importantly, shareholders of the parent company must own over 50% of the newly created company.
Why Do Companies Choose a Reverse Morris Trust?
When a company is looking to focus on its core operations and sell assets in a tax-efficient manner, it may choose a reverse Morris Trust. This allows the parent company to raise money and help reduce its debt while selling unwanted business assets. This type of transaction can be useful to companies that are highly indebted.
Are Reverse Morris Trust's Commonly Used?
Most often, only a few reverse Morris trusts take place each year. In contrast, dozens of conventional spin-offs are announced.1 Part of the reason behind this is that certain requirements follow for reverse Morris trusts: only certain companies can apply, and they must have generated positive income in the five years prior to the transaction, among others.