Table of Contents
Table of Contents

Tax Implications of a Public Company Divestiture

In finance, divestiture is defined as a reduction of a company's assets as a result of asset closures or the selling of business units, subsidiaries, divisions or assets to other corporations or individuals. A selling company typically receives consideration for assets such as cash, securities or other assets.

Divestitures take the form of spinoffs, equity carve-outs, subsidiary stock sales and subsidiary asset sales. Spinoffs and equity carve-outs are usually not taxable events for the divesting company and its shareholders. Capital gains on subsidiary stock sales and subsidiary asset sales are usually taxable for the divesting corporation. If a parent company distributes proceeds from the sale to its shareholders in the form of dividends, such proceeds are taxable for shareholders.

When a company engages in a divestiture, it disposes of some asset or subsidiary in order to cut costs or raise capital.

Key Takeaways

  • Depending on how the divestiture is structured, there will be different tax implications for the parent company.
  • Spinoffs and carve-outs, for example, may be carried out with no tax liability so long as existing shareholders maintain a controlling interest in the new company.
  • Meanwhile, asset sales and acquisitions of subsidiaries will often trigger a taxable event subject to capital gains.

Spinoffs

Spinoffs involve a parent company distributing shares of its subsidiary to shareholders on a pro rata basis. Spinoffs involve a no-cash exchange and are tax-free for the parent company and its shareholders if certain requirements regarding control of the subsidiary and timing of the spinoffs are satisfied. To be tax-free, spinoffs must involve a distributing controlling package of shares to investors, continuing interest and control requirements, and the subsidiary must not have been acquired by the parent company in the previous five years in a taxable transaction. An example of a tax-free spinoff is AOL, which was spun off from Time Warner in 2009.

Equity Carve-Outs

An equity carve-out, sometimes called a partial initial public offering (IPO), involves a parent company selling a percentage of the equity of a subsidiary on the stock market. Usually, parent companies sell a little less than 50% of the total common shares and retain control over the subsidiary. The carve-out transactions are tax-free for the parent company and its shareholders. An example of a successful equity carve-out is the sale of ThermoLase by Thermo Electron Corporation.

Subsidiary Stock Sale

A subsidiary stock sale involves a parent company selling secondary shares of the subsidiary to the public on the stock market. The parent company must recognize taxable gain equal to the difference between the cash proceeds and the tax cost basis in the subsidiary's shares. If the parent company does not distribute sale proceeds to its shareholders in the form of a regular dividend, the subsidiary stock sale is tax-free for the shareholders of the parent company. Otherwise, investors must pay taxes on any proceeds received from the divesting company.

Subsidiary Asset Sale

A parent company may sell a portion of the subsidiary's assets, such as equipment, real estate or patents, recorded on the balance sheet of the subsidiary. Such asset sales almost always trigger gains that are taxable for the parent company. If the parent company does not distribute proceeds to its shareholders from the asset sale, there are no tax implications for investors. However, if the company makes a dividend distribution, the divesting company's shareholders must pay taxes on such proceeds.

Article Sources

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  1. Securities and Exchange Commission. "Spin-Offs." Accessed Feb .7, 2020.

  2. Internal Revenue Service. "Publication 550: Investment Income and Expenses," Page 46. Accessed Feb. 7, 2020. 

  3. Internal Revenue Code. "26 IRC Section 355," Pages 996-997. Accessed Feb. 7, 2020.

  4. Warner Media. "Time Warner Inc. Completes Spin-off of AOL Inc." Accessed Feb. 10 2020.

  5. United States Code. "26 U.S.C Section 1032." Accessed Feb. 10, 2020.

  6. McKinsey Quarterly 1997 Number 1. "Equity carve-outs: A New Spin on the Corporate Structure," Page 172. Accessed Feb. 10, 2020.

  7. Corporate Finance Institute. "Basics of Section 338." Accessed Feb. 10, 2020.

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