As I have previously written in a blog, Google and its alphabet soup, it appears as if it is Yahoo’s turn to play alphabet soup. As of Monday, Yahoo disclosed that it was “spinning off” its stake in the Alibaba Group (the Chinese internet giant) into a separately publicly traded company. See the New York Times article.
As stated in the NYT article, the spinoff is a way for Yahoo to benefit from the sale of the Alibaba stake without paying taxes on the gain from the sale. Note, if Yahoo had simply sold its stake in Alibaba, it could face a potential tax liability of approximately $9,000,000,000.
So the question is how can Yahoo use an alleged tax free scheme to offset this $9 billion liability? The answer is a tax free reorganization in which Yahoo spins off the shares of Alibaba with other assets allegedly focused on small businesses. Under the existing tax laws, reorganizations may be tax free or taxable, depending on whether the companies follow certain rules.
Normally, if Yahoo had distributed the share of Alibaba to its shareholders, without using a tax free spinoff, Yahoo would have faced a tax liability for the “built in gains” attributable to the appreciation of the Alibaba shares. The shareholders would have then been taxed on the value of the property received by Yahoo as a distribution.
Code Section 355, the Tax code provision which permits the “tax free spinoff”, instead, allows Yahoo to distribute the stock of a subsidiary that is controlled by another corporation to avoid taxation at the corporate level (Yahoo’s liability for the built-in gain of the Alibaba shares) and at the shareholder level (Yahoo’s Shareholders’ liability for the distribution of the value of the Alibaba shares).
As noted in the NYT article, the IRS has not officially blessed the transaction, and Yahoo faces a future audit and possible payment of taxes down the road. This is because under Code Section 355 and the regulations there under, the distribution of the spun off corporation’s stock to the existing corporation’s shareholders cannot be merely a device to for distributing the earnings and profits of the distributing corporation or of the controlled corporation.
Yahoo’s position is clearly that the distribution is not merely raiding Yahoo of the earnings and profits of the Alibaba shares, but that the distribution of the shares of the new company is a going concern. However, another plausible position, one the IRS should review, is that Yahoo is passing on its earnings on the Alibaba share to its shareholders and avoiding tax. This position obviously will change depending on what else Yahoo packages with the Alibaba shares and whether it truly will be a separate business.
If you have specific and credible information of a company using a spinoff, split-up, or split-off, as a means to minimize its U.S. tax liabilities, you may want to contact us about filing an IRS tax whistleblower claim, as the IRS may challenge the corporation’s use of Code Section 355 to effectuate a tax free transfer that would otherwise be taxable. This could increase your chances of getting paid an award for alerting the IRS to the manipulation of corporate earnings and profits to its shareholders.