The IRS has thrown a monkey wrench in Yahoo!’s (YHOO) plans for a tax-free spin-off of its 384 million shares of Alibaba (BABA), worth nearly $40 billion.
In late January, Yahoo! announced a plan for the spin-off of its remaining position in Alibaba into a newly-formed investment company, to be called Aabaco Holdings. Yahoo had planned for the stock of the new company to be distributed pro rata to existing Yahoo shareholders. After the completion of the proposed transaction, Aabaco Holdings would either directly or indirectly own the 384 million shares of Alibaba formerly owned by Yahoo, along with a 100% ownership interest in Aabaco Small Business, which would be a newly-formed entity that owns Yahoo Small Business. Yahoo Small Business currently operates as a division of Yahoo.
In order for the proposed transaction to be tax free, it must satisfy active trade or business requirements; it cannot merely be a vehicle to distribute profits, which is the reason Yahoo included the spin-off of Yahoo Small Business with the disposal of its Alibaba holdings. For all intents and purposes, Yahoo has essentially packaged 384 million shares of Alibaba with a relatively immaterial portion of its current operations in an attempt to avoid billions in taxes.
A similar situation took place in 2014 with Liberty Interactive (QVCA) spinning its holdings of TripAdvisor (TRIP) into a holding company in order to distribute the profits tax-free to its shareholders, and to allow the company to continue trading without the overhanging risk of another publically-traded company on its books. In both cases, the operating division of the parent company involved in the spin-off was small, arguably immaterial. Since Liberty Interactive’s scenario satisfied the active trade or business requirements, one would have thought Yahoo’s case would be accepted as well.
But not so fast.
About a month after the announcement of its plan, Yahoo submitted a request to the IRS for a private letter ruling on whether or not Aabaco’s ownership of Aabaco Small Business would satisfy the active trade or business requirements. Private letter rulings are submitted by a company when it wishes to receive an opinion from the IRS on whether a potential transaction could result in a tax violation; they are not a necessity. A positive private letter ruling from the IRS would mean Yahoo would know for sure the transaction would be completely tax-free to its shareholders and pass muster with the government body.
However, in mid-May, the IRS announced it was reconsidering its ruling policy with respect to the active trade or business requirements. Then in late July, the IRS formally announced that it was “studying potential new administrative guidance with respect to certain issues” that included the active trade or business requirements. This led the IRS to inform Yahoo in early September that it would not grant a ruling on the matter. It is important to note that the IRS did not directly indicate that it was ruling against the tax-free spin-off, but that it had rejected the request for a ruling.
After receiving the news that the IRS had rejected its request for a ruling, Yahoo formally withdrew its request, but the firm continues to work with its counsel on its spin-off plans. The seemingly complex ruling (or lack of a ruling) that took place may have been an indication from the IRS that it had planned to rule adversely on the proposed transaction Yahoo had in place at the time of its request, but that it was not axing it if Yahoo fine-tunes the deal to the IRS’ liking.
In any case, Yahoo is left weighing its options with respect to how it should move forward, as it is becoming increasingly unlikely that it will receive a positive ruling from the IRS with each passing day. Yahoo could still proceed with its spin-off plans without IRS approval and then hope that the IRS would find the company’s actions to be in-line with the active trade or business requirement, but this is fraught with uncertainty and far from guaranteed. As we stated in this video here in January, the tax burden may eventually land in shareholders’ laps.