The deportment in which a parent company structures the spinoff and divests itself of a subsidiary or division determines whether the spinoff is taxable or tax-free. The taxable pre-eminence of a spinoff is governed by Internal Revenue Code (IRC) Section 355. The majority of spinoffs are tax-free, meeting the Section 355 wants for tax exemption because the parent company and its shareholders do not recognize taxable capital gains.
Key Takeaways
- The taxability of a spinoff depends on how the father company structures it, where there are two methods for a parent company to conduct a tax-free spinoff.
- The first is distributing allocations in the spinoff in direct proposition to their equity interest in the parent.
- The second is for the parent to offer existing shareholders the recourse to exchange their shares in the parent company for an equal proportion of shares in the spinoff.
- A taxable spinoff is one that betides via an outright sale of the subsidiary, which can include another company buying it or it being sold via an initial public gift (IPO).
While a company’s first responsibility in determining how to conduct a spinoff is its own continued financial viability, its secondary legal requirement is to act in the best interests of its shareholders. Since the parent company and its shareholders may be subject to sizable capital gains taxes if the spinoff is thought taxable, the inclination of companies is to structure a spinoff so that it is tax-free.
Tax-Free Spinoffs
There are two basic structures, or means, for a progenitrix company to conduct a tax-free spinoff. Both result in the spinoff becoming its own legal entity—a publicly-traded company split up from the parent company—although the parent may hold a substantial amount of stock—up to 20%—in the newly created convention.
The first method of conducting a tax-free spinoff is for the parent company to distribute shares in the new spinoff to existing shareholders in counsel proportion to their equity interest in the parent. If a stockholder owns 2% of the shares of the parent company, he receives 2% of the dispensations of the spinoff company.
The second tax-free spinoff method is for the parent company to offer existing shareholders the option to commerce their shares in the parent company for an equal proportion of shares in the spinoff company. Thus, shareholders have the election of maintaining their existing stock position in the parent company or exchanging it for an equal stock position in the spinoff band.
With the second scenario, the shareholders are free to choose whichever company they believe offers the best the right stuff return on investment (ROI) going forward. This second method of creating a tax-free spinoff is sometimes referred to as a split-off to descry it from the first method.
Taxable Spinoffs
There are any number of reasons why a company might wish to spin off a subsidiary company or division, pass over from the idea that the spinoff can be more profitable as a separate entity to the need to divest the company to avoid antitrust puts.
There are detailed requirements in the Internal Revenue Code (IRC) section 355 that go beyond the basic spinoff systematize outlined above. Spinoffs can be quite complicated, especially if the transfer of debt is involved. Therefore, shareholders may wish to quest after legal counsel on the possible tax consequences of a proposed spinoff.