Tax Aspects of Corporate Division

W. Eugene Seago

• Publisher: Business Expert Press
• Year: 2021
• ISBN:
  9781953349415
• Topic: Business
• Subtopic: Tassazione
• Index: Business

This book explains and illustrates each of the requirements for a nontaxable corporate division and the methods for mitigating the tax consequences when those requirements cannot be satisfied.

For a variety of reasons, corporations can achieve business efficiencies by dividing into two or more entities. The tax consequences of the division could be that both the corporation and the shareholders must recognize taxable income, which often renders the division unfeasible.

In order to neutralize the tax effects of business-motivated decisions to divide the corporation, the tax law provides the means for the division to be accomplished without immediate tax consequences for the corporation and its shareholders. The enabling provisions are necessarily complex so as to prevent their exploitation and bring together several other corporate tax concepts dealing with dividends and reorganizations. Moreover, the rules have often changed.

This book explains and illustrates each of the requirements for a nontaxable corporate division and the methods for mitigating the tax consequences when those requirements cannot be satisfied. The author also provides numerous diagrams that summarize actual transactions.

CHAPTER 1

Corporate Division: Uses and Abuses

Introduction

This book is about the tax consequence of dividing a corporation into two or more corporate entities. The division usually takes the form of a spin-off, split-off, or a split-up.

In a spin-off, a corporation distributes to its shareholders a controlling in the stock of a subsidiary. In another form of a spin-off, a corporation may transfer some of its assets to a newly formed corporation in exchange for all of the corporation’s stock, which the parent corporation distributes to its shareholders. For the shareholder, the spin-off is equivalent to a dividend in the form of stock in another corporation, and for the distributing corporation, the spin-off is economically equivalent to paying a dividend to its shareholders in the form of stock in another corporation.

A split-off is the same as a spin-off, except that not all of the shareholders participate: That is, the parent corporation transfers its stock that is a controlling interest in a subsidiary to one or a limited group of its shareholders in exchange for their stock in the distributing corporation. The split-off is essentially a stock redemption.

A split-up is similar to a spin-off, except that all the assets of a corporation are divided between two new corporations in exchange for all of their stock. Then the original corporation distributes to its shareholders the stock in the two corporations, and the original corporation dissolves. For the shareholders, the split-up is similar to a stock dividend.

In each of these three types of transactions, the corporation and the shareholders have altered their property rights through exchanges and distributions. Therefore, under the general rules of taxation, realized gains or losses must be recognized.1 However, the tax law contains specific rules for these transactions that provide the corporation the unique ability to distribute property to its shareholders without the corporation and its shareholders incurring a tax liability.

Rationale for the Exception

The Spin-Off

In a multitude of situations, corporate management may determine that for good business reasons, the shareholders should directly own the corporation’s subsidiary or that the corporation should be divided into two or more corporations. If the general rules for the taxation of corporations and their shareholders were applied, a substantial tax burden could accompany the implementation of the business decision. Thus, the tax laws would not be neutral in regard to this type of business decision. The lack of neutrality in the tax laws can also work in the other direction: That is, the tax laws can also create benefits such that actions will be undertaken primarily to achieve the tax benefit, rather than to achieve a business purpose. Thus, over the past 100 years, the tax laws regarding corporate division have undergone substantial changes in an attempt to make the tax laws neutral in the sense of not interfering with business-motivated decisions but without creating tax-motivated transactions.

The need to neutralize the tax laws in regard to business decisions is illustrated by an early case, Rockefeller v. United States,2 where a vertically integrated oil company produced, refined, and transported (through its pipelines) petroleum products. The transportation business was subject to regulatory controls that complicated the other corporate operations. These complications could be eliminated by transferring the transportation business to a newly formed subsidiary corporation and distributing the stock to the parent corporation’s shareholders. Therefore, the oil company created a new corporation and transferred the transportation assets to the new corporation in exchange for all of the new corporation’s stock, which was distributed to the oil company shareholders. Thus, the shareholders previously owned a corporation that included the transportation and oil production businesses, and after the transactions, the shareholders owned stock in two corporations conducting the same businesses formerly combined in one corporation. The Court noted that the shareholders did not experience an increase in wealth as a result of receiving the stock. This was true because the value of parent corporation that included the oil and transportation assets was equal to the sum of the value of the oil business retained by the parent and the new corporation with the transportation assets.3 Moreover, the shareholders continued their investment, although in a different form, but the shareholder’s legal rights changed from indirect to direct owners of the transportation business. Thus, for example, as a result of the distribution of the transportation business stock, the individual shareholder could sell his or her ownership in the transportation business but keep the oil stock, which was not possible when both businesses were lodged in one corporation. At the time of the distribution, the changes in property rights resulting from the distribution of the transportation corporation stock met the tax definition of a corporate dividend, which was taxable income to the shareholder as an increase in wealth that had been realized.4

Some shareholders in Rockefeller may have depended upon the corporate dividends for their ordinary living expenses. The tax on the value of the stock distributed could necessitate the shareholder selling some of the stock to pay the tax. However, the stock sale could give rise to more tax on the gain and, thus, it would be necessary to sell more stock, which, in turn, would create a still greater tax liability. The point is that it was not difficult to build the case that taxing the...