Investors in 21st Century Fox awaiting $71 billion in dividend payouts from the merger with the Walt Disney Co. will have to make a delicate decision when reporting that income to the IRS.
New Disney, the holding company, considers the distribution taxable. But Fox is essentially inviting shareholders to consider it tax-free. There is some legal precedent to back the latter argument—if shareholders are willing to take that risk.
“This is a classic tax conundrum because investors have evidence that it is taxable and also tax-free,” New York-based tax consultant Robert Willens said. “Are you willing to defend yourself against the assertion that it is taxable? If you have a basis, are you willing to endure the wrath of the IRS?”
Fox has more than once urged investors to seek tax advice before making their decision, giving them the chance to potentially take a contrary position and save money. It most recently flagged the situation, arising from a June deal, in a Jan. 7 Securities and Exchange Commission filing.
Investors that choose to make a tax-free claim have solid legal precedent to fall back on, practitioners said. If the investors can prove to the IRS that the income doesn’t break an anti-abuse rule, the agency could agree it is tax-free.
The taxes for stockholders would apply under code Section 355. It is aimed at ensuring that corporate profits aren’t distributed to shareholders without a tax applying.
Investors would either face a capital gains tax or a tax on dividend income, Willens said.
“Although New Disney intends to report the distribution as taxable to 21CF stockholders, 21CF stockholders will not be prohibited from taking a contrary position,” Fox said in the January filing. “21CF stockholders are urged to consult their tax advisers regarding the U.S. federal income tax consequences of the distribution to them.”
“You often see legal documents, prospectuses, etc., saying that investors should consult their tax advisers, but this takes that disclaimer to a whole new level,” said Andrew Silverman, a Bloomberg Intelligence tax policy analyst.
Companies typically use SEC filings to inform investors about their tax liabilities. Thus, it is unique that Fox is declining to give an opinion, practitioners said.
“Fox is telling its stakeholders that Disney is taking a conservative approach with the IRS by marking the transaction as taxable, and then telling them to do what they want,” said Robert Russell, an attorney at Alliantgroup LP who formerly worked at the Internal Revenue Service and Treasury Department.
Disney didn’t return a request for comment. Fox deferred to the information in its previous SEC filings and declined to comment further.
Because the deal features a substantial amount of cash and not just stock, the ordinary spinoff transaction becomes subject to an anti-abuse measure called the “anti-device” test. Passing that test is a challenge that’s now on the shoulders of shareholders.
To make that case, they will have to present a good business reason for why the deal involves a mix of cash and stock.
A spinoff involves a parent company separating part of its business to create a subsidiary and then distributing those shares to investors.
“There is absolute case law that would support some of the shareholders arguing that the spin-off is tax free, but its an uphill battle,” because it would require taking a view contrary to company IRS filings, Willens said.
An Invitation to Shareholders
The IRS opens an examination and adjusts taxable income when companies and shareholders misstate their taxes. While it isn’t necessarily illegal to accidentally miscalculate taxes, both companies reporting the transaction as taxable could nudge the IRS to take a closer look at how shareholders are treating those gains.
That additional focus could open investors up to burdensome audits in the future.
“It’s not like they’re encouraging investors to do anything, but they are inviting the shareholders to take a contrary position which you do not see often,” Willens said.