Navigating a Spinoff Without Tax Risks Spinning Out of Control

For over 40 years, companies that conduct multiple business lines or operate in multiple geographies have explored potential spinoff transactions in response to activist investment. Whether it is the current trend of spinning off e-commerce businesses from their brick-and-mortar 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 for the aggregate value of the businesses post-separation to exceed the value of the businesses when they were operated together.

Complex Transactions

What is rarely considered by the investor, and instead left to the investee businesses and their advisors to address, is the level of complication and global taxation inherent in the transactions necessary to facilitate the spinoff. A public spinoff transaction is often comprised of hundreds of smaller transactions integral to effectuating the public separation, each of which has its own level of complexity, uncertainty, and business and tax cost. Often, difficult valuation considerations, local country tax consequences, and intertwined operations can create significant economic and operational friction to a successful spinoff.

To address and mitigate the tax complexities and costs of the spinoff, businesses typically use a combination of in-house professionals, tax advisory and legal services, private letter ruling requests, and tax insurance programs. Creative and often complicated tax structuring is often needed to design the series of transactions, and where tax risks can be uncertain, mitigation in the form of bespoke tax insurance may be available to efficiently transfer such risk to a third party.

Value in Transactions

With respect to spinoffs that effectuate a separation of retail operations from an e-commerce business, it is often unclear whether sustainable additional value is being created. Often the “value” created in these transactions is not sustainable growth in one or both of the businesses, but rather an increase in the value of the stock of the e-commerce business. As the higher trading multiple applicable to online businesses over retail counterparts becomes attached to the e-commerce business once it is separated and spun off, the overall effect can be a net increase in the combined stock prices of the retail and e-commerce businesses. Whether the stock price increase is sustainable is often a function of whether and how each of the businesses have been prepared for success as a stand-alone operation.

If customers are able to engage in “showrooming,” where they view an item in a retail store but ultimately purchase it online—often from another seller—the retail businesses will struggle post-separation. The stand-alone retail and e-commerce businesses may face further headwinds if one or both of them are saddled with additional indebtedness in connection with the spinoff, 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 separate identity.

Addressing Risks

Efforts to address some of these potential operational risks and inefficiencies by maintaining relationships between the retail and e-commerce businesses post-separation, such as maintaining combined purchasing of raw materials or allowing for other revenue or cost-sharing, can threaten the tax-free treatment of the spinoff itself. Unless the spinoff effectuates a complete separation of the businesses, the IRS may conclude that the entity being distributed does not conduct its own “active trade or business,” which is a requirement for a spinoff to receive tax-free treatment. A delicate balance must therefore be struck between separating the businesses sufficiently to maintain tax-free treatment for the spinoff and maintaining efficient operations for both of the separated businesses.

There are risks and opportunities in designing and executing spinoff transactions. The collective efforts and insights of in-house professionals, external advisers, tax risk mitigation specialists, and governmental authorities need to be considered and balanced to design an economical and tax-efficient separation of the businesses.

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

Author Information

Doug Brody is a Managing Director of Tax Business Development and began his career at Aon in December 2020. Previously, Doug was a Principal in 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, over his 20-year career at EY Doug advised Fortune 500 clients on the tax aspects of acquisitions and internal restructuring transactions, carveouts and spinoffs, primarily in the Media & Entertainment, Life Science, Manufacturing and Consumer Products industries.

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