The following article is adapted and reprinted from the M&A Tax Report, Vol. 9, No. 4, November 2000, Panel Publishers, New York, NY.


By Robert W. Wood

In our regular review of spinoffs, several recent announcements are worthy of note. Sara Lee, the Chicago-based food giant, has announced a plan to spinoff its Coach Leather Handbags business, which it acquired in 1985. Although Sara Lee had expanded the Coach brand enormously, its plan is now to focus on certain core businesses — which do not include the leathermaker. See Bowe, "Sara Lee Streamlining Means Spin-off for Classy Coach," Financial Times Weekend (London), Sept. 16-17, 2000, p. 10.

Elsewhere, AT&T has proposed a spinoff that would be yet another significant step in breaking up this giant telecommunications company. The idea is to spinoff the consumer long-distance business owned by AT&T, something that has been struggling financially for quite some time. Although AT&T has been courting buyers for its consumer long-distance business for months, apparently it has not obtained the price it wanted. As a result, a spinoff as an alternative emerged.

As we have noted in The M&A Tax Report many times before, post-spinoff contractual relationships must be monitored. This is something that the Service looks at closely. One issue AT&T continues to discuss is how to structure agreements with the spun-off entity that would allow AT&T to continue to offer bundled services to its customers. Those services include cable, high-speed internet access and wireless. See Solomon and Deogun, "AT&T Proposes Long-Distance Spinoff," Wall Street Journal, Oct. 4, 2000, p. A3.

If the AT&T spinoff happens, it will sit in the ranks of the most enormous restructurings, along with the original 1984 break-up of AT&T, which spun-off the regional Bell Companies. History buffs will recall that also in the ranks of huge spin transactions were the 1996 spinoffs of Lucent Technologies, Inc. and NCR Corp.

Interestingly, AT&T has considered spinning off its long-distance business with Liberty Media Group, a content and programming concern that trades as a tracking stock of AT&T. Apparently those plans are on hold, though, and some have noted that Liberty Media may separately be the subject of a spinoff. As The Wall Street Journal noted "there could be tax implications for such a spinoff, however." Id.

That's the trouble with so many of these grand ideas, someone then needs to consider whether a ruling under Section 355 will be available. At the same time, many of these transactions are inherently far simpler than a third party sale. As for the AT&T consumer long-distance business, spinning it off would be easier to do now since it, by definition, would not require negotiations with other parties, and apparently has the support of management and at least some of the board.

Buybacks and Post-Spin Share Retentions

Finally, Equifax, a company which collects the credit histories of consumers, may be considering an attempt to boost its share price. Equifax has another (albeit lesser known) unit, one which processes checks and credit cards and is increasing revenue at a far greater rate than the traditional Equifax credit history unit. Recently, various commentators and investors have decided that maybe it was time for Equifax to spinoff this unit. See Mollenkamp, "Some Investors Give Equifax Its Own Report: Spin Off Payment Business to Boost the Stock," Wall Street Journal, Sept. 29, 2000, p. C2.

On the other side of the spinoff corridor, Alza Corp. has announced that it will acquire all of the Class A Common Shares outstanding in its spinoff, Crescendo Pharmaceuticals Corp., for $100 million. Crescendo was spun-off from Alza in 1997. See "Deal to Repurchase Spinoff is Set to $100 Million," Wall Street Journal, Oct. 3, 2000, p. A10. This Alza/Crescendo deal should focus attention on share retentions and share buy-backs after spinoffs.

For a spinoff to qualify, the distributing corporation must distribute all of the stock or securities it owns in the controlled corporation, or at least an amount sufficient to represent control. If it does the latter, the company must establish that the retention of the controlled corporation stock and/or securities is not part of a plan that has tax avoidance as one of its principal purposes. It is typically difficult to justify a stock retention, although perhaps the regulations go overboard in saying that ordinarily the business purpose for the distribution will mandate that all stock and securities be distributed. See Reg. §1.355-2(e)(2).

The classic ruling on stock retentions in the wake of a spinoff is Revenue Ruling 75-321, where the IRS permitted a retention of 5% of the stock in a controlled corporation in a case where eleven of the shareholders of the distributing corporation each owned between 1-5% of its stock. The reason the IRS gives for approving this stock retention was that the retention had an independent business purpose — to provide collateral for short-term financing for the distributing corporation's other businesses. The idea is that a business purpose for the retention (which should be different from the business purpose for the spin!) must be shown.

In Revenue Ruling 75-321, the IRS was also able to say that the stock retention by the distributing corporation was not sufficiently large to enable the distributing corporation to maintain "practical control" of the controlled corporation. Admittedly, this is a somewhat amorphous test. Nevertheless, some thought should be given to whether even a small percentage of stock, relatively speaking, might be considered to imply practical control.

More recently, the IRS has blessed certain retentions by more widely-held entities. The Service has suggested that rulings on Section 355 transactions may be appropriate where:

The volume of letter rulings on this topic is not exactly staggering, but there have been a few that are certainly worthy of note. One was Letter Ruling 9909027, where a spinoff and IPO were to occur. In the ruling, both the parent and its subsidiary needed equity capital. They devised a spinoff followed by an IPO of stock of the controlled corporation. The parent distributed 80% of the subsidiary's stock to its shareholders, retaining the remaining 20%. Investment bankers advised that retaining this 20% would lower the cost of raising capital.

After the spinoff, the subsidiary undertook the IPO. The ruling contemplates that the parent would make a sale of the remaining stock (either in the public offering or shortly thereafter), but in any event no later than five years following the distribution. Noting the valid business purpose for the retention, the ruling was favorable.

Last Word

Finally, U.S. Industries has announced a plan to spinoff several divisions to shareholders by the end of this year. U.S. Industries, a maker of building products, announced a plan to spinoff its lighting and industrial tools businesses as a special dividend. Although no names are set yet, the two businesses to be distributed consist of the Lighting Corp. of America unit, European lighting fixture maker SiTeco, and Spear & Jackson, an international maker of industrial handtools. See "U.S. Industries Plans Spinoff of Divisions as Special Dividend," Wall Street Journal, Sept. 15, 2000, p. A8.

Additional Spins, Vol. 9, No. 4, The M&A Tax Report (November 2000), p. 6.