The following article is adapted and reprinted from the M&A Tax Report, Vol. 11, No. 9, April 2003, Panel Publishers, New York, NY.


By Robert W. Wood

Not too many years ago, it was hard to pick up a single copy of The Wall Street Journal without reading about someone's contemplated, ongoing or recently completed spinoff. The spin mantra traveled across the Atlantic, with The Financial Times (in large part) following suit. True, some of the deals described as spinoffs turned out not to be that at all (and not covered by the hallowed Section 355 language). Yet, all the same, honest to goodness Section 355 transactions were seemingly everywhere.

The Service certainly thought this, turning up its interest in Section 355 as the last bulwark of its own crumbling Berlin Wall of General Utilities. Of course, we at The M&A Tax Report were not immune from this fixation on Section 355. In fact, perhaps we were more infected by the spin bug than most. For recent coverage, see:

If we thumb through the last couple of years of our issues, I admit it's a pretty daunting pile. I suggest — though I don't want to suggest it — that just maybe the Service is right that spinoffs represent an important option for tax planners faced with winnowing tax saving opportunities.

Lately, of course, spins (like everything else) have been battered. Perhaps this is merely due to the economic doldrums. As an illustration of the "what goes around comes around" adage, the latest in this trend seems to be capitalizing on the lack of value of spins after they are "spun." Come again?

How is it that companies newly minted from the spinoff factory are worth less than they were worth as part of the corporate whole? Didn't all the press (and sometimes, even the ruling requests submitted to the IRS) suggest that this company post-spin would be worth a heck of a lot more as a standalone company, once shed of the evil tentacles of the parent? Yeah, maybe.

Some people are now saying that newly spun off companies represent a great investment opportunity. Indeed, more than one study (okay, so they are academic studies!) suggests (and in some cases, outright concludes) that spinoffs significantly outperform the market for several years. Let's take Alcon, a medical products company that climbed about 18% since Nestlé S.A. spun it off in March 2002. See Opdyke, "A New Way to Profit From a Company's Problems," Wall Street Journal (March 4, 2003), p. D1.

The Wall Street Journal reported that 41 spinoffs (with public issuances) occurring in 2002, with an aggregate market value of $103.74 billion. Some important deals have been announced in 2003, and perhaps these might represent value buying opportunities as well. Id.

U.S. Bancorp announced in February 2003 that a spin of its Piper Jaffray unit. Six Continents (based in the UK) announced a contemplated breakup of restaurant and pubs (one chain) from hotels (InterContinental, Holiday Inn and Crowne Plaza). Finally, TMP Worldwide, owner and operator of the monster-sized online job search site,, is spinning off its eResourcing unit. The latter provides staff recruiting services.

What Does This Prove?

Of course, the fact that some are now tracking spinoffs, indicating that they prove to be good buys can be looked at from at least two pairs of glasses. Or, to mix metaphors, is the glass half-empty or half-full? If (as some now say) buying spun off stocks is a really good buy, that means that perhaps they are not worth more on their own, since the market price post-spin, these town criers would suggest, is just too low.

On the other hand, if the newly-minted company's post-spinoff are really good buys, it means they will go up in value so the company promo about the importance of standing alone (and yes, the representations and warranties in the letter ruling request!) turn out to be surprisingly accurate. Which way one comes out will depend in large part on one's investment horizon. There's a danger in any generalization, of course, perhaps even more so today given the enormous market volatility we are experiencing than ever before.

Still, simply put, a spinoff can be an enormously effective way to distribute assets to shareholders in a tax efficient manner. Just how efficient? Well, one Chicago firm, Spin-Off Advisors, runs a hedge fund that buys spinoffs it considers promising. This fund reportedly has lost a cumulative 20% in the past three years. Okay, you may not be rushing to invest, but do bear in mind that the S&P 500 has spiraled down 40% during this same period, and the once beloved NASDAQ has flopped 72% down during that same time period.

How Active Is Active?

Returning to the technical side of Section 355, most recent lore has focused on the "device" prohibition in Section 355. Indeed, bear in mind that it was the device concern that led the IRS and Congress to level its sawed-off shotgun at the Morris Trust transaction, giving birth to the bad seed (or Damien?) of Section 355(e). A Code provision still in its toddler stage (but now replete with regulations that, as we recently noted, have tamed little Section 355(e) down considerably), some of the fundamentals of 355 have been forgotten. It is time to relearn them, in particular the active business requirement.

The active business requirement is actually a couple of distinct requirements. Both the distributing and the controlled corporations must generally be engaged in the active conduct of a trade or business immediately after the distribution. Most companies will directly be engaged in the active conduct of a trade or business. Even those that do not satisfy this direct trade or business test, however, will be considered actively engaged in a trade or business if substantially all of the assets of the company consist of stock and securities of corporations it controls (immediately after the distribution) that are so engaged. Thus, holding companies can also be treated as engaged in an active trade or business.

Historically, one of the lynchpins of the active trade or business test has simply been "activeness." The business cannot merely be the holding of portfolio assets, such as real estate. On the other hand, in recent years, it has become easier to qualify some traditionally suspect activities (such as real estate leasing and management) within the active trade or business moniker.

Spins: Does Anyone Care Anymore?, Vol. 11, No. 9, The M&A Tax Report (April 2003), p. 3.