Tax free spin of transactions

Corporate restructuring in US is a common occurrence which involves selling business of the company or simply reorganizing the management structure. Such restructuring decisions often lead to tax consequences.

A spinoff, one of the ways for corporate restructuring in US, occurs when a corporation carves out and separates part of its business to form a new standalone entity.

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Corporate restructuring in US is a common occurrence which involves selling business of the company or simply reorganizing the management structure. Such restructuring decisions often lead to tax consequences.

A spinoff, one of the ways for corporate restructuring in US, occurs when a corporation carves out and separates part of its business to form a new standalone entity.

Section 355 of the Internal Revenue Code provides an exemption allowing a corporation to spin off business to another company.

How Tax-Free Spin-Off Works?

  • A spinoff occurs when a parent corporation separates part of its business to create a new business subsidiary and distributes shares of the new entity to its current shareholders. Thus, after a spin-off, all the prior shareholders of parent corporation now own stock of both parent and new entity.
  • Normally, if a parent corporation sells its subsidiary to an outside company, the distribution is taxable as a dividend to the shareholder. Also, the built-in gain in the stock of the subsidiary is taxed to the parent corporation.
  • Section 355 of the Internal Revenue Code provides an exemption to these distribution rules, allowing a corporation to spin off or distribute shares of a subsidiary in a transaction that is tax-free to both shareholders and the parent company subject to some conditions. A company can undertake a tax-free spinoff of a business unit in 2 ways:
    • A company can choose to simply distribute all the shares (or at least 80%) of the spun-off company to existing shareholders on a pro rata basis, instead of outright selling the subsidiary to another. For example, an investor would receive 3% of the share’s issues for XYZ, if investor-owned 3% of ABC Corporation and ABC was spinning off XYZ Corporation.
    • Secondly, a company may choose to undertake the spinoff by issuing an exchange offer to current shareholders. Under this method, current shareholders are given the option to maintain their existing stock position in the parent company or for an equal stock position in the spun-off company exchange shares of the parent company.

What are the Requirements for a Tax-Free Spin-Off Under Section 355?

To qualify as tax-free, there are four major requirements for a spinoff:
  1. Control – Voting control is determined by the ability to elect directors. Stock possessing at least 80% of the total combined voting power of all classes of the new entity must be owned by the parent corporation, for the control requirement to be met.
  2. Device – The device requirement means that the spin-off cannot be used merely as a device for the distributions of earnings and profits, a review of all the circumstances surrounding the transaction, including whether the distributions are made pro rata determines, on a case-by-case basis.
  3. Active Trade or Business – The newly spun-off company & the pre-existing company both must qualify as “an active trade or business” immediately after the transaction goes through. Both businesses have to be actively engaged in some sort of business or commerce, for the sub-requirements to be considered an active trade or business.
  4. Distribution – The parent corporation must distribute all the stock or securities of the new entity that it holds or an amount of stock sufficient to constitute control.

Furthermore, aside from the statutory requirements, there are also an array of non-statutory requirements, like continuity of interest, for the spinoff to be considered non-taxable.

Tax-free spinoffs sound quite appealing but can be risky and complicated to properly pull off. We at 4i Advisory can help you to optimize taxes and advise you on the pros and cons of your spin–off transactions.

At 4i Advisory, we provide business and income tax return, accounting, audit support, direct tax, private equity, payroll, assurance, US-India tax and sales tax services to just name a few in the United States of America. To know more please contact us (Urvesh Patel – urvesh.patel@4iadvisory.com) and we would be happy to assist you.

Us Tax Free Spin–Off Transactions

What are the Requirements for a Tax-Free Spin-Off Under Section 355?