Transaction tax

Navigating a spin-off without tax risks spiraling out of control

For more than 40 years, companies that span multiple industries or operate in multiple geographies have explored potential derivative transactions in response to activist investing. Whether it’s the current trend of separating e-commerce businesses from their physical counterparts, the separation of operations from the properties on which business is conducted – the so-called “OpCo/PropCo” spinoffs – or similar transactions, the intention is that the aggregate value of the businesses after separation exceeds the value of the businesses when they were operated together.

Complex transactions

What is rarely considered by the investor, and rather left to the recipient companies and their advisers, is the complexity and global tax issues inherent in the. A derivative public transaction is often made up of hundreds of smaller transactions essential to achieving public separation, each with its own level of complexity, uncertainty, and business and tax cost. Often, difficult valuation considerations, local tax consequences, and intertwined transactions can create significant economic and operational frictions for a successful spinoff.

To resolve and mitigate the tax complexities and costs of spin-off, companies typically use a combination of in-house professionals, tax and legal advisory services, private letter ruling requests, and tax assurance programs. Creative and often complicated tax structuring is often required to design the series of transactions, and where tax risks may be uncertain, mitigation in the form of bespoke tax insurance may be available to effectively transfer that risk to a third party.

Value of transactions

When it comes to spillovers that effect a separation of retail operations from an e-commerce business, it’s often unclear if any lasting additional value is being created. Often, the “value” created in these transactions is not sustainable growth in one or both businesses, but rather an increase in the value of the stock of the e-commerce business. Since the higher trading multiple applicable to online businesses compared to their retail counterparts becomes attached to the e-commerce business once it is separated and split, the overall effect may be a net price increase combined stocks of retail and e-commerce companies. The sustainability of rising stock prices often depends on how well each of the companies has been prepared to succeed as a stand-alone operation.

If customers are able to engage in “showroomingwhere they see an item in a retail store but end up buying it online, often from another seller, retail businesses will struggle after the separation. Standalone retail and e-commerce businesses may face further headwinds if one or both of them grapple with additional debt from the spin-off, face higher prices from suppliers and wholesalers due to reduced economies of scale and/or face potential customer and brand confusion as each business attempts to establish its distinct identity.

Risk management

Efforts to address some of these potential operational risks and inefficiencies by maintaining the relationship between the retail and e-commerce businesses post-separation, such as maintaining the bulk purchasing of raw materials or the possibility of other income or cost sharing, may threaten tax exemption. treatment of the spin-off itself. Unless the spin-off effects a complete business separation, the IRS may conclude that the entity being distributed does not conduct its own “active business or business”, which is a requirement for a spin-off to enjoy a tax-exempt treatment. A delicate balance must therefore be struck between separating the businesses sufficiently to maintain the tax exemption of the division and maintaining efficient operations for the two separate businesses.

There are risks and opportunities in designing and executing derivative transactions. The collective efforts and ideas of internal professionals, external advisors, tax risk mitigation specialists and governmental authorities must be considered and balanced in designing an economical and tax efficient separation of businesses.

This article does not necessarily reflect the views of the Bureau of National Affairs, Inc., publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Doug Brody is Managing Director of Tax Business Development and began his career at Aon in December 2020. Previously, Doug was Director of EY’s Transaction Advisory Services practice, where he led the Divestiture Advisory Services tax practice for the Midwest region. In addition to his divestiture-related roles, during his 20-year career with EY, Doug has advised Fortune 500 clients on the tax aspects of acquisitions and internal restructuring transactions, carveouts and spinoffs, primarily in media and entertainment, life sciences, manufacturing and consumer sectors. Product industries.

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