Blog: The Step Transaction Doctrine Meets Brexit – Bloomberg Tax

One consequence of Brexit is that EU branches of EU-regulated U.K. financial services companies no longer benefit from EU directives which, pre-Brexit, gave such U.K. financial service companies the right to conduct branch business throughout the EU. With their U.K. subsidiaries losing their “passports” to conduct branch business in the EU, many multinationals have transferred their EU-regulated EU financial service activities from U.K. subsidiaries to subsidiaries incorporated in an EU country. Some, to centralize activities in a single operating entity, may also have transferred their U.K. branch and other non-EU branches to the new EU subsidiary.

For example, U.S.-based The Travelers Companies, Inc. (Travelers), a Minnesota corporation, in response to Brexit, announced in 2019 it will use its Dublin-based Irish insurance subsidiary to service customers across Europe. Press reports from 2019 indicated that Travelers’ U.K. subsidiaries’ branches in France, Germany, and Holland, and, when necessary, business of its U.K. branch, would be transferred from Travelers’ U.K. insurance subsidiary to Traveler’s Irish subsidiary, which had already started writing Irish business. Travelers 2020 Form 10-K states: “As a result of the U.K.’s exit from the EU, Travelers is conducting its insurance operations in the Republic of Ireland and across Europe through an insurance subsidiary that is incorporated in the Republic of Ireland . . . Certain operations are conducted in the U.K. through a U.K. branch of the Irish subsidiary.”

In regulated financial services industries, such as insurance, the cross-border transfer of branch assets and liabilities (e.g., a transfer from a U.K. subsidiary to an EU subsidiary) may require pre-transfer regulatory approvals in the country (e.g., U.K.) of the transferor subsidiary, in the (e.g., EU) countries of the transferred branches, and in the (e.g., EU) country of the transferee. Obtaining any necessary pre-transfer regulatory approvals could require an extensive period of time.

Drop-down and Liquidation

One method that a U.S. parent corporation could consider, if its business objective is to shift its EU, its U.K., and its non-EU and non-U.K., branch operations, from its U.K. subsidiary (UKSub) which now operates those branches, to an existing EU subsidiary (EUSub), is through a drop-down and liquidation transaction. The stock of UKSub could be dropped down to EUSub. If and when regulatory approvals are obtained, UKSub could then make the corresponding approved liquidating distributions to EUSub.

The desirability and feasibility of this drop-down and liquidation approach would need to be confirmed by the U.S. parent’s, UKSub’s, and EUSub’s, business, corporate, regulatory, and tax advisers in the U.S., U.K., EU, and any other affected country. This drop-down and liquidation approach is being used in Private Letter Ruling 202128001, discussed below.

If this drop-down and liquidation approach is desirable and feasible, the U.S. parent would typically, as a business matter, like the liquidating transfers of UKSub’s branches to EUSub to proceed as quickly as possible, in order to avoid duplicative costs and inefficiencies. However, due to the need for regulatory approvals, it is possible that the liquidation of UKSub may need to proceed either on a branch-by-branch, or asset-and-liability by asset-and-liability basis, depending on applicable regulations. The required approvals may considerably delay the liquidation.

Such a drop-down and liquidation transaction can provide U.S. corporate income tax efficiencies to the U.S. parent. PLR 201250004 holds that if the stock of a foreign subsidiary is dropped down to another existing foreign subsidiary, and the dropped-down subsidiary liquidates pursuant to a plan of reorganization, the transaction is treated as a tax code Section 368(a)(1)(D) (“D”) asset reorganization of the liquidated foreign subsidiary with and into the successor foreign subsidiary.

Revenue Ruling 2015-10 allowed a drop-down, followed by a check-the-box deemed liquidation election under Treasury Regulation Section 301.7701-3 for the dropped-down subsidiary, to qualify as a “D” reorganization. However, where UKSub is an insurance company, such a deemed liquidation is unavailable. Treas. Reg. Section 301.7701-2(b)(4) treats insurance companies as per-se corporations, which are precluded from making such a deemed liquidation election.

Under the reorganization rules, generally neither the liquidated foreign subsidiary, nor the acquiring foreign subsidiary, nor the U.S. parent group, recognizes income. Thus, favorably, generally no GILTI, Subpart F income, nor direct income is triggered to the U.S parent group from the “D” reorganization of a U.K. subsidiary.

Step Transaction Issue

To achieve “D” reorganization status, it is crucial that the drop-down and the liquidating distributions be viewed as pursuant to a plan of reorganization. See Treas. Reg. Section 1.368-1(c). In determining whether a series of steps, such as a drop-down and a liquidation, are considered a single plan of reorganization, the IRS and courts apply the step transaction doctrine.

There are various formulations of the step transaction doctrine, such as the binding commitment test, the interdependence test, and the end result test. Where the boards of directors of the U.S. parent of UKSub, UKSub, and EUSub all approve the UKSub drop-down and liquidation plan, it is arguable the binding commitment test is met. See Minnesota Tea Co. v. Helvering. Because the UKSub drop-down, without the complete liquidation, would not accomplish the desired business objective of transferring the former UKSub assets to a single EUSub, arguably the interdependence test is satisfied. Because the drop-down and liquidation are component parts of a single transaction intended from the outset to produce the ultimate result of transferring UKSub’s former assets to a single EUSub, arguably the end result test is satisfied.

Nevertheless, the step transaction is not uniformly applied by the IRS and the courts. In particular, IRS advance ruling positions in the reorganization area call into question whether the IRS will find the step transaction doctrine applicable to integrate steps that occur more than five years apart. For example, in Revenue Procedure 86-42, Section 7.03(14), the IRS looked back to certain potentially disqualifying stock acquisitions for no more than five years.

In Rev. Rul. 66-23 (declared obsolete on other grounds by Treasury Decision 8760 and Rev. Rul. 2003-99), the IRS said notwithstanding a binding court order to take an otherwise disqualifying second step more than five years after an otherwise qualifying reorganization exchange, the second step is not integrated. Thus, a question exists as to whether the IRS will integrate a liquidation of a dropped-down U.K. insurance company with the drop-down of that U.K. insurance company, which occurred more than five years earlier.

In Douglas v. Commissioner, the court found that a 60-month delay in liquidating the asset-transferor corporation, resulting from non-assignability of contracts and disputed claims, did not prevent reorganization treatment. In Wilson v. Commissioner, the U.S. Tax Court, in approving reorganization treatment despite a three-year delay in completing the transferor’s liquidation, cited Douglas, and stated: “The mere lapse of time is not decisive. The important thing is that the steps which are taken evidence a consistent performance of the reorganization plan and purpose.”

In PLR 9422035, the IRS found that a “D” reorganization occurred, notwithstanding that, due to environmental damage on a retained property, such property could not be repaired and disposed of, so the transferor corporation could not be liquidated, until after about six years after the date the damage was discovered. Douglas and PLR 9422035, however, relied on the lack of business activity during the period of the delay in complete liquidation, whereas UKSub would presumably continue the business activity on its not-yet-transferred accounts until UKSub’s complete liquidation.


An arguably analogous issue is whether or not an actual liquidation of a U.K. insurance subsidiary into its parent, which liquidation was delayed beyond five years because of U.K. legal requirements, causes such liquidation to be ineligible for non-recognition under Section 332. Section 332(b)(3) imposes a time limit, generally between three and four years, in order for the planned liquidation of a subsidiary into the parent to be governed by Section 332.

In Cherry-Burrell Corp. v. United States, the U.S. Court of Appeals for the Eighth Circuit held that where the time limit in the predecessor of Section 332(b)(3) could not be satisfied by a liquidating U.K. subsidiary because of U.K. law restrictions, nonrecognition under the predecessor of Section 332 was nevertheless available. The Eighth Circuit stated: “Only the barrier of the English law prevented what is, at most, technical compliance with the statute’s requirements. We are not inclined to impose a forfeiture of tax consequences because of this.” The IRS cited Cherry-Burrell with approval in General Counsel Memorandum 34820 (1972). The U.S. parent would point out that ignoring a statutory time limit in Cherry-Burrell was a stronger pro-taxpayer step than ignoring a possible five-year non-statutory administrative guideline.

However, Cherry-Burrell involved the liquidating U.K. corporation holding only cash in a segregated account, between the third and sixth year following the commencement of its plan of liquidation, in order to be able to resolve one pending lawsuit. By contrast, in the Brexit situation UKSub would presumably continue the business activity on its not-yet-transferred business until UKSub’s complete liquidation. Compare Rev. Rul. 84-2, cited in PLR 9714031, involving the liquidation of an insurance company subsidiary into an insurance company parent (if liquidated subsidiary has retained any assets for the purpose of continuing the operation of its present business, there has been no Section 332 liquidation of that insurance company).

PLR 202128001

PLR 20218001 involved the fact pattern of a direct U.S. parent of a foreign-regulated Country A foreign financial institution (A). A may have been an insurance company. A operated branches both in Country A and in three other foreign countries. Simplifying, pursuant to a plan approved by the boards of directors of the various entities involved, the U.S. parent transferred the stock of A to a first-tier foreign subsidiary (B Holdings) located in foreign country B. Neither Country A, Country B, nor the countries of A’s three other branches were identified. B Holdings, in turn, transferred the stock of A to a Country B subsidiary of B Holdings (B). A was to be liquidated into B, as quickly as regulatory approvals were obtained. However, due to the need for regulatory approvals, this drop-down and liquidation plan was not expected to be completed for “approximately 5 years.”

Despite the extended period of the plan, the IRS favorably ruled that each of the steps would be treated as occurring in pursuance of a plan of reorganization as required by Treas. Reg. Section 1.368-1(c). No case or ruling is cited in PLR 202128001.


Perhaps the most famous opening sentence in English literature concerns, like Brexit, the turbulent political situation facing the U.K. and its European neighbors: “It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of light, it was the season of darkness, it was the spring of hope, it was the winter of despair.”

When the executives of the U.S. parent involved in PLR 202128001 learned that liquidation of the subsidiary could extend somewhat beyond the U.S. corporate income tax safety zone, no doubt the words “worst,” “foolishness,” “incredulity,” “darkness,” and “despair” came to their mind. Thanks to the favorable ruling of the IRS National Office in PLR 202128001, hopefully the words “best,” “wisdom,” “belief,” “light,” and “hope” have replaced those words in their mind.

This column doesn’t necessarily reflect the opinion of The Bureau of National Affairs Inc. or its owners.

Author Information

Alan S. Lederman is a shareholder at Gunster, Yoakley & Stewart, P.A. in Fort Lauderdale, Fla.

Bloomberg Tax Insights articles are written by experienced practitioners, academics, and policy experts discussing developments and current issues in taxation. To contribute, please contact us at

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