Will Post Holdings’ Distribution of BellRing Be Tax-Free?

By Stuart E. Leblang, Michael J. Kliegman and Amy S. Elliott

Post Holdings, Inc. (NYSE:  POST) (Post), a holding company of various consumer packaged goods businesses (including many iconic cereal brands such as Grape-Nuts), controls 67 percent of its publicly traded subsidiary BellRing Brands, Inc. (NYSE:  BRBR) (BellRing or BRBR).  Post used to own 100 percent of the BellRing businesses (which specialize in protein shakes and nutrition bars such as PowerBar).  But in 2019, Post raised about $520 million by taking a minority stake in BellRing public by way of a so-called Up-C transaction.^[1] Today, Post owns 97.5 million of the 137 million (71.2 percent) membership units of BellRing Brands, LLC (BellRing LLC), which are exchangeable into shares of BRBR Class A common stock.

As a result of the 2019 Up-C transaction, Post holds the only high-vote Class B share of BRBR, giving it 67 percent of the combined voting power of the outstanding common stock of the publicly traded BellRing Brands, Inc.^[2]so long as it owns more than 50 percent of the BellRing Brands, LLC units (which it currently does).  Sixty-seven percent is not enough for a spin-off.

In an August 5 filing,^[3]Post stated that it plans to distribute a significant portion of its interest in BellRing to Post’s shareholders (potentially retaining less than 19.5 million of its BellRing LLC units to exchange for existing debt of Post).  The transaction, which will be governed by agreements between Post and BellRing, is expected to be completed in the first half of calendar year 2022.  While noting that it was an open question as to whether the distribution would be pro rata, pursuant to an exchange offer or a combination of the two, the announcement notably does not indicate whether the company expects that the distribution will be tax-free to it and to its shareholders.  That said, a comment made by Post’s President and CEO Robert Vitale on the company’s quarterly earnings call August 6 supports the inference that Post intends for the distribution to be tax-free.

Specifically, Vitale explained that the 19.5 million units “is a maximum position that we can retain,” later noting that “in order to qualify as a tax-free distribution, we have to distribute 80 percent of our position.”^[4]  As it turns out, 19.5 million is exactly 20 percent of Post’s current BellRing LLC unit holding of 97.5 million.  So it sounds as if—at least in the “base case plan of distribution”—Post intends to distribute an amount of stock—presumably in SpinCo—possessing an 80-percent or greater voting interest^[5]so that the distribution can be tax-free.  Post is itself the product of a tax-free spin-off, having started trading on its own in 2012 after being separated from Ralcorp Holdings, Inc., which was later acquired by what is now ConAgra Brands, Inc. (NYSE:  CAG), in a tax-free Internal Revenue Code (IRC) Section 355 spin-off to shareholders (even receiving a private letter ruling from the Internal Revenue Service confirming the tax treatment).^[6]

We do not have any more information than what has been publicly disclosed, but we offer our observations and suggestions as to what a BellRing distribution by Post might look like.  While the base case might be a tax-free spin, we will also consider other possibilities.

Nominally, Post says it will distribute interests in the Up-C operating partnership to its shareholders (presumably without first redeeming them for shares of BRBR Class A common stock).  A distribution of partnership interests does not, of course, qualify for tax-free treatment under IRC Section 355.  However, even if Post were to engage in such a distribution without any thought as to the tax consequences (not that we are suggesting this is the case), as a publicly traded partnership (PTP),^[7]BellRing LLC would be treated as a corporation for U.S. tax purposes.^[8] Ostensibly, Post would be treated as distributing partnership interests to the shareholders and, under the PTP rules, the partnership would be treated as contributing all of its assets and liabilities to a new corporation in exchange for the corporate stock and distributing that stock to the partners in liquidation of the partnership.^[9] Note that this effective conversion of the partnership to a corporation would impact not only the public shareholders of BellRing LLC (now a PTP), but also BRBR (the minority owner of BellRing LLC).

There is a tempting ruling by the IRS addressing a situation where a corporation distributes assets constituting an active trade or business (ATB) to its shareholders, who promptly contribute the business to a new corporation.  The ruling recharacterizes the transaction by reordering the steps to have the distributing corporation first incorporating the business and then distributing stock in the new subsidiary to the shareholders.  Finding that the reordered transaction meets the requirements under Section 355, the IRS treats the transaction as a qualifying tax-free Section 355 distribution.^[10] This ruling could well apply if Post held and distributed an 80-percent voting equity interest in BellRing LLC.  However, in this circumstance, the ruling by itself cannot convert a bare distribution of Post’s less-than-80-percent BellRing LLC interest into a tax-free transaction.^[11]

Post can, in fact, meet the requirements of Section 355 by first contributing its interest in BellRing LLC to a newly formed, wholly owned corporate subsidiary (SpinCo) and then distributing the stock of SpinCo out to its shareholders (this is likely what is contemplated in the base case plan of distribution).  Because Post will own and distribute at least 80 percent of the SpinCo stock to its shareholders, the formal requirements of Section 355 can be met.^[12] What about the ATB requirement? ^[13]Under Revenue Ruling 2007-42,^[14]a corporation can satisfy the ATB requirement by owning a “significant interest” in a partnership that satisfies the ATB requirement.  The ruling indicates that a one-third interest in a partnership is considered significant, so clearly a 71.2 percent interest—or even a 57 percent interest (e.g., if Post retains 19.5 million LLC units)—would qualify.^[15]

Taxes aside, however, it doesn’t make much sense to have two publicly traded vehicles for investing in the BellRing businesses (the new BellRing SpinCo and the existing BRBR).  What would make a lot more sense is for Post to negotiate a merger between its new BellRing SpinCo and the publicly traded corporation BRBR.  This could be effected by way of a Reverse Morris Trust (RMT) transaction, combining BellRing SpinCo and BRBR such that the Post shareholders that receive BellRing SpinCo stock would own a majority of the vote and value of the post- merger company.^[16] When the dust settles, the BellRing businesses will be consolidated into one public company^[17]that is completely separate from Post, but Post shareholders will continue to hold an interest in BellRing.

Regardless of whether there is a post-spin merger between BellRing SpinCo and BRBR, there are presumably issues to be negotiated between Post and BRBR.  Without some agreement between the two companies, BellRing SpinCo would retain a majority economic interest in BellRing LLC, which would, however, continue to be controlled by BRBR.^[18]  While not entirely clear, Post could transfer its high-vote Class B share in BRBR to its affiliate BellRing SpinCo such that the SpinCo would control BRBR.

And then there is the tax receivable agreement (TRA).  The TRA provides that BRBR generally must pay Post 85 percent of the amount of cash savings that BRBR realizes as a result of (among other things) the increase in the tax basis of LLC assets attributable to LLC unit redemptions by Post.  As is typical of an Up-C TRA, there is an acceleration of payments upon a change of control or certain other termination events.  While a distribution of Post’s retained BellRing LLC interests to Post shareholders by means of a spin-off or split-off is explicitly not considered a change of control, it is oddly possible that a subsequent merger of BellRing SpinCo with BRBR could constitute a change of control.^[19] Such a payment could be material.  When the TRA was first entered into in 2019, it was estimated that such a TRA termination payment (if triggered at the time) would be about $561 million.^[20]

Presumably, the parties would negotiate an exchange ratio building first upon the relative equity interests in BellRing LLC and the benefits to both sides of merging all interests under a single public company, but also taking into account the fact that Post will avoid recognizing taxable gain on the disposition of its retained interest and the benefit to BRBR of eliminating the overhang of the TRA.

Finally, what are we to make of Post’s statement that it “currently contemplates retaining less than 19.5 million of its BellRing LLC units, which it ultimately expects to exchange for existing debt of Post”?  Well, nominally, it means just what it says, which is that it may decide to hold back up to 19.5 million units and will “ultimately” (i.e., not immediately) transfer such units to creditors to pay down its debt.  On the other hand, it may be more straightforward for Post to simply exercise its right to exchange its LLC units for BRBR stock that it would then transfer to its creditors.  This would also enable Post to trigger TRA payments from BRBR.

Importantly, Post may be able to monetize all or a portion of its BellRing interest as part of a tax- free spin-off transaction.  Instead of retaining BellRing LLC units and transferring them to creditors, Post could exchange all of the LLC units for BellRing SpinCo stock and, while distributing 80 percent of SpinCo to the shareholders, transfer the remaining 20 percent of SpinCo to pay down its debt (indeed, this scenario seems to be what was contemplated by Vitale on the August 6 earnings call).^[21] Alternatively, the “boot” rules would generally allow Post to transfer its BellRing LLC units to BellRing SpinCo in exchange for BellRing SpinCo stock and cash to be used to pay down Post debt, up to the amount of its tax basis in the transferred LLC interests.^[22] If the amount of debt to be paid down exceeds that basis amount, a more complex but very viable technique is available in which longer-term debt securities are issued to Post in the transaction that it can effectively use to pay down its debt.

^{[1] Post Quarterly Report (Form 10-Q) at 25, filed Feb. 5, 2021 (https://www.sec.gov/ix?doc=/Archives/edgar/data/1530950/000153095021000046/post-20201231.htm).}

^{[2] BellRing Quarterly Report (Form 10-Q) at 6, filed Feb. 5, 2021 (https://www.sec.gov/ix?doc=/Archives/edgar/data/1772016/000177201621000018/brbr-20201231.htm).}

^{[3] Post Form 8-K filed Aug. 5, 2021 (https://www.postholdings.com/investor-relations/sec-filings/docs/id_14831_accessionNo_0001530950-21-000253_ciks_0001530950); Press Release, Post, Post Holdings Announces Plan to Distribute Interest in BellRing Brands to Post Shareholders (Aug. 5, 2021) (https://www.postholdings.com/investor-relations/sec-filings/docs/id_14831_accessionNo_0001530950-21-000253_ciks_0001530950#ex99-2xbrbrpr.htm).}

^{[4] Earnings Call, Post, Q3 2021, Aug. 6, 2021, transcript provided by Motley Fool but transcription errors corrected after listening to earnings call webcast playback (https://www.fool.com/earnings/call-transcripts/2021/08/06/post-holdings-inc-post-q3- 2021-earnings-call-trans/).}

^{[5] IRC §368(c).}

^{[6] Post Registration Statement (Form S-4) at 28, filed Nov. 9, 2012 (https://www.sec.gov/Archives/edgar/data/1480529/000153095012000229/post-sx42012exchangeoffer.htm).}

^{[7] This presupposes that Post would only distribute BellRing LLC units out to its shareholders if BellRing LLC is publicly traded (has its own ticker, etc.), however Post could conceivably do a non pro rata distribution of the BellRing LLC units out to a small group of its shareholders and not have the units trade.}

^{[8] IRC §7704 treats publicly traded partnerships as corporations, except for those meeting certain prescribed passive-type income requirements.}

^{[9] IRC §7704(f).}

^{[10] Rev. Rul. 77-191, 1977-2 CB 94.}

^{[11] IRC §355(a)(1)(D)(ii), which provides, in part, that as part of the distribution, the distributing corporation distributes “an amount of stock in the controlled corporation constituting control within the meaning of section 368(c)”; IRC §368(c), which provides, in part, that “the term ‘control’ means the ownership of stock possessing at least 80 percent of the total combined voting power of all classes of stock entitled to vote and at least 80 percent of the total number of shares of all other classes of stock of the corporation.”}

^{[12] The drop-down would be a “D” reorganization under IRC §368(a)(1)(D) followed by the distribution under IRC §355.}

^{[13] IRC §355(b)(1)(A) provides, among other things, that “the distributing corporation, and the controlled corporation . . . , is engaged immediately after the distribution in the active conduct of a trade or business.”}

^{[14] Rev. Rul. 2007-42, 2007-2 CB 44.}

^{[15] BellRing’s three major brands are:  Premier Protein®, Dymatize® and PowerBar®.  Post acquired Premier Nutrition Company (Premier Protein maker) in Sept. 2013, Post acquired Dymatize Enterprises in Feb. 2014 and Post acquired PowerBar in Oct. 2014.}

^{[16] IRS §355(e)(2)(A)(ii).}

^{[17] There is the possibility that an issue under the §197(f)(9) anti-churning rules could arise if any significant amount of units (generally more than 20%) are swapped.}

^{[18] BellRing Inc. (BRBR) holds the voting membership unit of BellRing LLC giving it authority to appoint the members of the BellRing LLC Board of Managers and, therefore, controls BellRing LLC (https://www.sec.gov/ix?doc=/Archives/edgar/data/1772016/000177201620000070/brbr-20200930.htm).}

^{[19] See page 48:  https://www.sec.gov/Archives/edgar/data/1772016/000119312519263070/d727525ds1a.htm.  For the TRA itself, see https://www.sec.gov/Archives/edgar/data/1772016/000119312519250692/d727525dex106.htm.}

^{[20] The payment amount depends on the price of the BRBR Class A common stock, which at $17.50 at the time of the IPO in 2019.}

^{[21] It seems that Post wants to ensure that at least 80% of the SpinCo stock is distributed to shareholders as required by IRC §355(a)(1)(D).}

^{[22] IRC §361(b) provides that receipt of “boot” may be nontaxable to the extent the cash distributed to creditors does not exceed the tax basis in the contributed assets.}