Tax Planning is Crucial to Achieve Potential Spin-Off Benefits
Today, the Wall Street Journal considers again, on its front page above the fold, the potential benefits of corporate spin-off transactions (https://www.wsj.com/articles/the-reason-investors-love-spinoffs-juicier-returns-1507681008 (subscription required)). The Journal article notes that the S&P Spin-Off Index has outperformed the S&P 500 Index by nearly 190 percentage points in the last ten years. Also discussed are the wide-ranging reasons investors favor spin-off transactions – but that corporate spin-off transactions are also tracking to historic lows this year. While the reasons why spin-off activity has been depressed is not entirely clear, there is no question that tax complexity and tax uncertainty are considerable barriers. To overcome these barriers and to complete a successful corporate spin-off (and potentially to achieve the benefits discussed in the Journal), careful tax planning is essential.
A positive development towards reducing U.S. tax uncertainty for corporate spin-offs has been the IRS’s recent decision to resume issuing “transactional” private letter rulings. Transactional rulings address all the significant U.S. tax issues in a spin-off. Such rulings are much more valuable than more limited “significant issues” rulings, which were the only corporate spin-off rulings available for the last several years (this change in IRS policy was discussed here in detail). In the absence of a transactional ruling, a corporation generally would have to rely on opinions of counsel on all issues affecting the tax-free status of a spin-off unless there was a “significant issue.” An IRS private letter ruling gives the highest level of assurance on the tax treatment of a transaction. The possibility of securing a transactional ruling could provide an opportunity for companies that have been considering spin-offs but have determined that the risk of either shareholder- or corporate-level tax must be reduced to the greatest extent possible.
There is also general uncertainty relating to U.S. tax reform. While the form and timing of any major tax legislation being enacted is uncertain (and beyond the scope of this discussion), no proposal to date would alter fundamentally the U.S. rules governing tax-free spin-offs. While this is positive, in the sense that companies that might benefit from undertaking a spin-off have no immediate need to suspend planning based on the current tax reform framework, the undeniable complexity of the current tax-free spin-off rules in the United States remains a significant challenge.
Any U.S. corporation or other corporation with substantial U.S. shareholders or businesses that believes a spin-off could be beneficial will need, of necessity, to engage with tax advisors at the earliest possible stage, as the required planning is formidable. The importance of tax planning only increases if the potential transaction involves a proposed subsequent combination of the spun-out business with another company, or the separation of businesses located in different countries.
As the Journal article notes, the potential economic benefits of a corporate spin-off (or other separation transaction, such as a split-up or split-off) can be substantial, especially if the transaction is tax-free to the shareholders and the company. Of course, there are situations where a tax-free corporate spin-off may simply not be technically achievable (or only partially achievable) under current U.S. tax laws. However, an ample reward for the investment of time and effort in careful tax planning can be the creation of two separate, stand-alone corporate enterprises in a tax-free transaction.
 There are certain aspects of a spin-off transaction on which the IRS historically has declined to rule, such as whether a spin-off has a good corporate business purposes. However, the ability to get a ruling on all material aspects of a transaction that are not specifically no-rule issues has significant value, particularly in transactions where substantial internal restructuring pre-spin is required or there are complicated ancillary tax issues to consider.
 For thoughts on the latest tax reform framework proposal, see https://www.natlawreview.com/article/some-quick-thoughts-big-six-unified-framework.
 This post focuses on spin-off transactions where both resulting companies are corporations for U.S. tax purposes – this is the transaction type most commonly pursued by U.S. public companies and thus the most common structure for transactions considered in the Journal article. However, where the goal is value creation for a company and where two separate corporations is not the essential result, a spin-off would be one of a variety of transaction structures that might be considered, with a wide variety of tax and non-tax considerations taken into account.