Yahoo has been much in the news of late – although Yahoo probably wishes that such were not the case. Yahoo’s stock plummeted and then mostly recovered in late May, as the result of some curious and perhaps even unguarded remarks by an IRS official at a Washington D.C. Bar Association event.
Back in the good old days, the IRS was just a gray and ominous presence – the true eminence grise. Nowadays, however, the IRS has turned into a veritable Chatty Cathy – often dropping the “T-bomb” (that is the “tax” bomb, not the F-bomb) at luncheons, seminars and other informal gatherings. Although the IRS’s informal remarks are never off-color, they can sometimes leave certain people seeing red.
The IRS official’s comments in this case were interpreted as casting doubt on whether Yahoo's proposed spinoff of its huge and valuable stake in Alibaba, with a then-estimated value of $35-$40 billion, could be implemented tax-free under Code section 355. Yahoo’s announced plan is to stick its Alibaba stock into a spinoff company (“SpinCo”) together with a comparatively inconsequential business called Yahoo Small Business. Yahoo Small Business is estimated to have earnings before interest, taxes, depreciation and amortization (“EBITDA”) of about $50 million, and even the most generous valuation of Yahoo Small Business, based on EBITDA, would probably put the company’s worth at $500 million or so (and probably less) and that would make Yahoo Small Business worth – at best – between 1% and 2% of the value of Alibaba holdings.
Spinning off a large stake in a publicly traded company together with a relatively small business interest has been a tried-and-true tactic for many years. One recent example was the spinoff by Liberty Interactive of its valuable stake in TripAdvisor.com, which it packaged with the (comparatively) smaller active on-line retail business called BuySeasons.
The TripAdvisor SpinCo was valued at about $3 billion, while the TripAdvisor stock by itself was valued at about $2.65 million, according to some reports. Liberty also reportedly stuck some debt into the TripAdvisor SpinCo (lowering the overall value) so the tagalong business in the Liberty Interactive spinoff was small but not minuscule – arguably making the transaction distinguishable from the proposed Yahoo spinoff.
IRS Is Spinning on Spin-Offs
The IRS has clearly been rethinking the whole area of corporate spinoffs, which are governed primarily by Code section 355.
The general requirements of Code section 355 include the following:
- Parent must hold 80% or more control of SpinCo immediately before the distribution.
- Both Parent and SpinCo must each hold an active business that has been conducted for more than five years immediately prior to the distribution transaction.
- The transaction must meet the usual non-statutory requirements, including continuity of interest, continuity of business enterprise and a business purpose.
Back in 1996, in Rev. Proc. 96-30, the IRS announced that, for purposes of issuing rulings, it would not rule on a 355 spinoff unless the active business included in the SpinCo was worth at least 5% of the total value of theSpinCo assets.
Seven years later, in Rev. Proc. 2003-48, the IRS backed away from the 5% ruling standard, and erased that very clear benchmark – which, as a practical matter, was viewed by practitioners as kind of informal “safe harbor” since the IRS viewed that as a minimum threshold over which it would consider issuing a ruling.
Then, in 2013, the IRS announced two significant limitations on the ability to obtain private letter rulings in connection with divisive D reorganizations (which includes the 355 spinoffs). In Rev. Proc. 2013-3, the IRS announced that it would no longer issue PLRs related to three particular transactions that may arise in connection with a divisive D reorganization. Even more significant was Rev. Proc. 2013-32, in which the IRS announced that it would no longer issue any rulings on whether a transaction satisfies Code section 355, although the IRS would continue rule on one or more issues related to section 355 to the extent the issue is “significant.”
The effect of these IRS announcements, coupled with the “luncheon announcement” that recently occurred at the D.C. Bar Association, is that spinoff transactions now generally need to proceed on the basis of a tax opinion rendered by learned counsel.
The key question, in turn, is whether learned counsel will be able to deliver a “will” opinion in a variety of factually difficult or complicated circumstances – including the Yahoo situation.
The reason why a “will” opinion seems both appropriate and necessary is that the divisive D reorganization is a self-inflicted event: A corporation wants to be pretty darn sure that the spinoff transaction will be tax free, or else it will have to look long and hard at the potential adverse tax consequences. A taxable spinoff has the potential to produce an outright tax disaster, triggering a tax recognition event without generating any corresponding cash to pay the tax liability. Indeed, a failed 355 transaction is taxed as both a disposition of assets at the corporate level, and as a dividend distribution to shareholders – the dreaded double tax whammy. No one – or almost no one – wants a double whammy, and certainly no one wants a double whammy without the cash to pay the tax.