Yahoo’s Spinoff Plan Does Not Change Its Tax Risk


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Marissa Mayer, the chief of Yahoo.

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Jean-Christophe Bott/European Pressphoto Agency

Does the direction of the spin matter? Not for tax purposes.

Yahoo called off its plans to spin off its stake in Alibaba in a statement on Wednesday. The Yahoo board did not say that it was concerned about the tax risk. Instead, the board did a peculiar little dance. It reaffirmed its view that the transaction, a “forward” spin, would have been tax-free to the company and its shareholders. And then it acknowledged that the change of plans reflected concern about “the market’s perception of tax risk.”

The board’s careful choice of words — perception of tax risk, not actual tax risk — reveals that it is a true believer in sophisticated tax planning as the path to salvation. Instead of a “forward” spin, Yahoo is now planning a “reverse” spinoff, with the company’s core business assets and its stake in Yahoo Japan to be placed in a newly formed subsidiary distributed to shareholders, leaving its stake in Alibaba behind.

I’m flummoxed. With respect to the relevant tax issues, the direction of the spin does not matter. Corporate tax can be exceedingly formalistic, but not in this case.

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Yahoo’s Core Business

In addition to its stock ownership in Alibaba and Yahoo Japan, Yahoo owns a cluster of operating units that are considered the core business of the company.

As I explained in a Standard Deduction column in May, separating the Alibaba shares from the rest of Yahoo raises two main tax issues.

First, both the controlled subsidiary (SpinCo) and the distributing company (RemainCo) must have an “active trade or business.” Yahoo’s original plan would have placed Yahoo’s small-business services unit in SpinCo, and many analysts questioned whether the unit was large enough in relation to the large stake in Alibaba. In reversing the direction of the spin, Yahoo will have to leave behind an active trade or business in RemainCo. Yahoo has not indicated what assets it intends to leave behind.

Second, the transaction cannot be principally a “device” — another term of art — for the distribution of corporate earnings and profits to shareholders. In other words, the structure of the deal cannot be chiefly defined by corporate-level tax avoidance. It helps that there is a real business purpose for the plan — isolating the core business — but the other relevant factors mostly point to tax avoidance. After all, compared with a sale, the whole point of the spinoff is to avoid paying tax on the appreciation in value of its stake in Alibaba.

The I.R.S. issued a notice in October to warn companies that it was aware of some proposed spinoffs that may fail the “device” test. The notice states, in relevant part (my emphasis added):

The Treasury Department and the Service are most concerned about transactions that result in (i) the distributing corporation or the controlled corporation owning a substantial amount of cash, portfolio stock or securities, or other Investment Assets, in relation to the value of all of its assets and its Qualifying Business Assets, and (ii) one of the corporations having a significantly higher ratio of Investment Assets to Non-Investment Assets than the other corporation.

The direction of the spin has no legal relevance; the tax problem arises when either the distributing corporation (RemainCo) or the controlled corporation (SpinCo) has mostly investment assets in relation to operating assets.

So, if the direction of the spin does not matter, legally speaking, what can explain Yahoo’s thinking? I can think of five possibilities:

1. I could be wrong about the law, or wrong about my understanding of how the I.R.S. will apply the law in this case.

2. The details of the proposed reverse spin, once known, will somehow mitigate the tax risk in ways that are not immediately obvious. (In a conference call, Yahoo described the reverse spin as the mirror image of the forward spin, suggesting it does not have significant changes in mind.)

3. The Yahoo board believes what it said — that the problem with the forward spinoff was not the tax risk, but the market’s perception of the tax risk. Perhaps they believe changing the direction of the spin will magically change the market’s perception of the tax risk, even though the tax risk is, in substance, the same as before.

4. Yahoo plans to change the rules. In its statement released Wednesday, Yahoo noted that “it is advised that complex transactions of this kind can take a year or more to conclude.” That gives Yahoo and its tax adviser, Skadden, Arps, Slate, Meagher & Flom, some more breathing room to change hearts and minds at the I.R.S., or to get some friends into key places in a new administration.

It may be a coincidence, but the legislation cracking down on real estate investment trust spinoffs, proposed on Tuesday by Representative Kevin Brady, the Texas Republican who is chairman of the House Ways and Means Committee, would curb many of the spinoff deals that have rankled the I.R.S.

If Yahoo becomes the only deal in the pipeline that’s problematic, it would be easier for the I.R.S. to look the other way and focus its attention on areas, like corporate inversions, that pose more of a systemic threat to the tax base.

5. Yahoo is hedging its bets. Or it might just keep it simple and propose the reverse spinoff as a taxable transaction. If the forward spin turned out to be a taxable transaction, the tax consequences would have been catastrophic: more than $10 billion in potential tax liability for the company and its shareholders. If the reverse spin is taxable, only the unrealized gains inside Yahoo would be taxed at the company level. That liability, mostly related to the company’s equity stake in Yahoo Japan, might be about $2 billion. Shareholders would recognize less tax liability as well, as they would be taxed on the value of the Yahoo stub and not the Alibaba shares.

Yahoo has not responded to a request for comment.



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