DEFINITION of Skinny Down Distribution
Skinny down distribution is the practice of trimming a large domestic corporation's assets and profits in order to make it suitable for acquisition by or merger with a smaller foreign entity. It is a commonly-used practice in corporate inversions.
BREAKING DOWN Skinny Down Distribution
What is the motive for a skinny down distribution? It relates to U.S. corporate tax laws. To avoid paying U.S. taxes, American multinational corporations sometimes restructure themselves by buying a small foreign subsidiary and making it the parent company, at least on paper (and thus, subject only to the taxes of their new national home). However, according to current U.S. Treasury Dept. rules, if the shareholders of the former U.S. company own at least 80% of the combined firm, the new foreign parent is treated as a U.S. corporation (despite the new corporate address) – and so goes on paying taxes to the IRS. This can be a problem when the foreign partner is smaller in size than its U.S. counterpart: It has to be worth more than 20%, in effect, for the corporate inversion to accomplish its tax-avoidance aim.
In such cases, American companies try to reduce, or "skinny down," their financial footprint through a number of measures. For example, they might pay out special dividends to shareholders. Or, they artificially inflate their merger partner's size by transferring assets into the company. The opposite can also happen – that is, the foreign partner can let go of some of its assets by creating a new subsidiary.
Another tactic is that of earnings stripping. This occurs when the U.S. subsidiary of a newly inverted company loads up on debt and avoids taxes on its domestic profits by sending them overseas to the foreign parent in the form of tax-deductible interest payments.
Stopping the Skinny Down
A 2011-2015 wave of inversion deals sent the Treasury department attempting to clamp down on skinny down distributions and other such practices. A notice introduced by the department in 2014, and released as law in 2016, introduced a per se test: Any "non-ordinary course distributions" made 36 months before the acquisition date will be treated as part of a plan to "skinny down" the corporation and will, therefore, be disregarded. The notice included a variety of transactions, including share buybacks, as measures that could be implemented by the company to reduce its balance-sheet numbers. The 2016 legislation went further, and attacked earnings stripping: It reclassified some forms of debt as equity, thus changing tax-exempt interest payments into taxable dividends and making earnings stripping strategies more difficult to pursue.
It is possible that skinny down distributions will dwindle in number as a result of Tax Cuts and Jobs Act of 2017, which reduces the corporate tax rate to 15% – a rate much more in line with other nations' – thus eliminating the fiscal motivation for corporate inversions.