Reverse Morris Trust- What Is It And What Is It Used For?

What is a Reverse Morris Trust?

You may have heard the terms Reverse Morris Trust or Morris Trust used in regards to a spinoff transaction. These terms describe two related types of transactions in which a company is able to sell assets without triggering a tax liability for either the company or shareholders. Naturally, this can be quite attractive to a company and its shareholders. In a Morris Trust transaction, a company spins off some assets and then merges the parent, immediately, with a third company. A Reverse Morris Trust is quite similar except the spinoff merges with a third company immediately. In 1997 Congress passed regulation requiring that shareholders of the spinoff must retain at least 50% of the new combined company in order to preserve the tax free status of the distribution.

What are the advantages of a Reverse Morris Trust?

If a company has an asset, generally an operating division, which it would like to sell, but which it has a large unrealized gain on, it may opt to use a Reverse Morris Trust. By finding a smaller company to “buy” the asset, the company can sell it tax free. It can receive cash by borrowing money against the division and burdening the spin off with the debt. A Reverse Morris Trust can be a very tax-efficient way of selling a division.

The 2016 spinoff of Lockheed Martin’s(LMT) IT division in a Reverse Morris trust transaction with Leidos Holdings(LDOS) is a good example. Lockheed wished to sell its IT division to Leidos. Lockheed received a $1.8 billion dividend from its subsidiary prior to the spin, and offered shareholders the choice of exchanging their Lockheed stock for stock in the spinoff. Lockheed thus received $1.8 billion in cash for the division and exchanged $2.8 billion of Leidos common stock for its own, essentially buying back $2.8 billion in stock. Lockheed paid no taxes on the transaction, nor did Lockheed shareholders who exchanged their stock(Leidos itself was the renamed SAIC after it spun off a new SAIC in 2013). If Lockheed had sold the division to Leidos for $4.6 billion, it would have owed taxes on the difference between $4.6 billion and the carrying value of the business, and it would not have reduced shares outstanding.

Why not spin off the company normally and have the buyer finish the deal afterwards?

As mentioned above, the “buyer” must control less that 50% of the combined entity after the transaction. There are also restrictions on the acquisition of a spinoff for the first two years. Transactions which had been contemplated in the twelve months prior to the spin off will retroactively eliminate the tax free nature of the spinoff.

Why is it called a Reverse Morris Trust?

A 1966 case, C.I.R v. MORRIS TRUST established he tax free status of what became known as Morris Trust transactions.

In 1960, a merger agreement was negotiated by the directors of American Commercial Bank, a North Carolina corporation with its principal office in Charlotte, and Security National Bank of Greensboro, a national bank. American was the product of an earlier merger of American Trust Company and a national bank, the Commercial National Bank of Charlotte. This time, however, though American was slightly larger than Security, it was found desirable to operate the merged institutions under Security’s national charter, after changing the name to North Carolina National Bank. It was contemplated that the merged institution would open branches in other cities.

As a national bank, the merged company would be prohibited from operating an insurance department except in towns with fewer than 5000 residents. The company thus decided to spin off its insurance department to shareholders. The Commissioner of Internal Revenue argued that the subsequent merger abnegated the tax free status of the spinoff. Morris Trust, a shareholder, disagreed. The court ruled in favor of Morris Trust. Later, companies began executing what became know as reverse Morris Trust transactions based on the same case law. That original bill from the IRS to the Mary Archer W. Morris Trust? Just $413.44!

What are some examples of Reverse Morris Trust transactions?

LogMeIn(LOGM)/Citrix(CTXS): Reverse Morris Trust Is GoTo Strategy For Citrix As It Merges Division With LogMeIn

Starwood/Interval Leisure Group(ILG): Time-Shares A Wasting – Starwood’s Vistana Spinoff, Reverse Morris Trust Merger with Interval Slightly Delayed

Tri Pointe Homes(TPH)/Weyerhaeuser(WY):  No Weyerhauser Out? Company Near Deal To Spin WRECO To Tri Pointe Homes In Reverse Morris Trust


Disclosure: The author holds no position in any stock mentioned