DEFINITION of 'Tax-Free Spinoff'

A corporate action in which a publicly traded company spins off one of its business units as an entirely new company. The spun off company becomes its own publicly traded corporation with its own ticker symbol, board of directors, management team, etc. This type of transaction is deemed to be "tax free" because the parent company is still able to divest the business it wants to separate from; however, the company does not incur capital gains tax on the divestiture, which would be the case in an outright sale of the business unit to another company.

BREAKING DOWN 'Tax-Free Spinoff'

There are typically two ways that a company can undertake a tax-free spin off of a business unit. First, a company can choose to simply distribute shares of the spun off company to existing shareholders on a pro rata basis. For example, if you owned 3% of ABC corporation and it was spinning off XYZ corporation, you would receive 3% of the shares issues for XYZ.

Secondly, a company may choose to undertake the spin off by issuing an exchange offer to current shareholders. With this method, current shareholders are given the option to exchange shares of the parent company for shares of the spun off company.

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