Reverse Morris Trust Structures for Tax-Efficient Separations

Introduction

When Ingersoll Rand wanted to separate its climate business from its industrial technologies business in 2020, a simple sale of the industrial segment would have triggered billions of dollars in capital gains tax. Instead, the company used a Reverse Morris Trust (RMT) structure: it spun off the industrial technologies business to shareholders (tax-free under Section 355 of the Internal Revenue Code), and that spun-off entity immediately merged with Gardner Denver Holdings. Ingersoll Rand's shareholders received a majority stake in the combined industrial technologies company (which took the Ingersoll Rand name), while the retained climate business rebranded as Trane Technologies. The result was a complete portfolio separation with zero capital gains tax, saving shareholders billions that would have evaporated in a taxable sale.

The RMT is one of the most complex deal structures in M&A, sitting at the intersection of tax law, securities regulation, corporate governance, and industrial strategy. For industrials bankers, understanding when an RMT is feasible, how to structure it, and what constraints it imposes on the transaction is essential because RMTs are used in some of the largest and most strategically important carve-outs and separations in the sector.

The RMT combines two transactions that, taken together, achieve a tax-free transfer of a subsidiary from a parent company to a buyer.

Section 355 of the Internal Revenue Code

The tax code provision that allows a corporation to distribute the stock of a controlled subsidiary to its shareholders without triggering taxable gain, provided several conditions are met: (1) both the parent and the subsidiary must be engaged in an active trade or business for at least five years prior to the distribution, (2) the distribution must not be a "device" for distributing earnings and profits (i.e., it must have a valid business purpose beyond tax avoidance), (3) the parent must distribute at least 80% of the subsidiary's stock, and (4) under Section 355(e) (the "anti-Morris Trust" provision enacted in 1997), the parent's shareholders must retain at least 50.1% ownership of the spun-off entity for two years following the distribution to prevent the spin-off from being treated as a disguised sale.

The defining constraint of the RMT is that the parent's shareholders must retain majority ownership of the merged entity. This requirement (imposed by Section 355(e) to prevent companies from using spin-offs as tax-free sales) limits the feasible buyer universe: the buyer must be small enough relative to SpinCo that the merger does not give the buyer's shareholders more than 49.9% of the combined entity.

The ownership requirement also imposes a two-year restriction: for two years following the spin-off, the merged entity cannot undertake significant share repurchases or other transactions that would reduce the former parent shareholders' ownership below 50.1%. This "restrictive covenant" limits the combined company's capital allocation flexibility in the near term.

Ingersoll Rand / Gardner Denver (2020). The most frequently cited industrial RMT. Ingersoll Rand spun off its industrial technologies business, which immediately merged with Gardner Denver. The combined entity (which took the Ingersoll Rand name) became a focused industrial compressor, pump, and blower company, while the retained climate business rebranded as Trane Technologies. IR shareholders received approximately 50.1% of the combined company. Gardner Denver shareholders received approximately 49.9%. Both Trane Technologies (focused on HVAC and climate) and the new Ingersoll Rand (focused on flow creation and industrial technologies) have performed well as focused pure-plays post-separation.

Jacobs Solutions / Critical Mission Solutions (2024). Jacobs used an RMT to separate its Critical Mission Solutions business (government services, defense technology) from its consulting and infrastructure business. The CMS business merged with a partner entity, creating a focused government IT and services company while the remaining Jacobs concentrated on infrastructure consulting.

BD / Waters Corporation (announced 2025). BD announced a combination of its Biosciences and Diagnostic Solutions businesses with Waters Corporation via an RMT structure, creating a focused analytical instruments and life sciences company.

The RMT is recommended when three conditions are met simultaneously: the parent wants to divest a large business unit (where the capital gains tax on a simple sale would be substantial, typically $1+ billion), there is a merger partner of appropriate size (comparable to or smaller than SpinCo), and the five-year active trade or business and other Section 355 requirements can be satisfied. If any of these conditions is not met, the parent must use a taxable sale, a simple spin-off (without the merger), or another structure.

For industrials bankers, identifying RMT opportunities is a high-value advisory skill because the tax savings can represent 10-20% of the total transaction value. A banker who recognizes that a divestiture can be structured as an RMT (rather than defaulting to a taxable sale) creates measurable value for the client and strengthens the advisory relationship. The RMT analysis requires close coordination with tax counsel, but the initial screening (is the business large enough for the tax to be material? is there a feasible merger partner of appropriate size? does the business meet the five-year active trade or business requirement?) is analytical work that the banker can perform.