17-1 Corporate Divestitures Occur when a corporation disposes of a subsidiary or separate line of business Same 4 alternative structures:  Taxable asset disposition  Taxable stock disposition  Nontaxable asset disposition  Nontaxable stock disposition Includes spin-off, split-off, and split-up transactions

17-2 Taxable Subsidiary Sales Taxable asset sale  Subsidiary recognizes gain or loss on sale of assets Character of gain is ordinary to extent attributable to inventory and depreciation recapture, remainder is capital Gain or loss included in consolidated tax return filed with divesting parent corporation  Divesting parent corporation can liquidate subsidiary after asset sale if desired, without tax cost  Acquirer takes a cost basis in the assets acquired

17-3 Taxable Subsidiary Sales continued Taxable stock sale without Sec. 338(h)(10) election  Parent corporation recognizes gain or loss on the sale of subsidiary stock  Acquirer takes a cost basis in the stock acquired and becomes the subsidiary’s new parent corporation  Subsidiary’s tax basis in its assets is unchanged – no step up or step down to FMV  May produce fewer non-tax costs in comparison to asset sale (title transfer of one asset versus many)

17-4 Taxable Subsidiary Sales continued Taxable stock sale with Sec. 338(h)(10) election – election to treat the sale of controlled subsidiary stock as an asset sale  Acquirer must obtain 80% of subsidiary’s stock within a 12-month period  Election made jointly by acquirer and divesting parent corporation  Subsidiary recognizes gain or loss on difference between purchase price and net asset basis

17-5 Taxable Subsidiary Sales continued Taxable stock sale with Sec. 338(h)(10) election  Subsidiary’s tax basis in its assets is stepped up or down to FMV  Acquirer takes a cost basis in the stock acquired and becomes the subsidiary’s new parent corporation

17-6 Example: Taxable Subsidiary Sales Parent owns the stock of Sub (tax basis $5 million). Tax basis of Sub’s assets is $3 million; it has no liabilities, loss or credit carryovers. Acquirer is willing to pay $9 million for Sub’s assets. At this price, the tax benefits of a basis step-up are worth $1.5 million.  What are the tax consequences of the 3 forms of taxable sale? What do Parent and Acquirer prefer?  At what price without the election is Acquirer indifferent between a stock purchase without a Sec. 338(h)(10) election and making the election? At this price, what does Parent prefer?

17-7 Tax-Free Subsidiary Sales Divesting parent can be the selling shareholder in a Type A, B, or C reorganization  Such a ‘sale’ results in divesting parent owning a large block of stock in the acquirer that may be difficult to sell and will trigger gain recognition on sale Equity carve-out  Sale of part of controlled subsidiary’s stock in an IPO No gain or loss if stock issued by sub versus owned by parent  Typically limited to 20% or less of voting control

17-8 Tax-Free Spin-off Tax free under Sec. 355 if:  Parent has 80% control prior to spin-off and distributes control in the spin-off  Subsidiary and parent must continue to engage in a business that had been conducted for at least 5 years before the distribution  Parent must have held the stock of the subsidiary for at least 5 years before the distribution (unless acquired in a nontaxable transaction)  Must have a valid business purpose  Shareholders of the divesting parent must maintain control of parent and subsidiary post-spin-off  Parent and subsidiary cannot be acquired within 2 years of the spin-off

17-9 Tax Consequences of a Qualifying Spin-off No gain or loss recognized by divesting parent Parent shareholders allocate a portion of tax basis in parent shares to subsidiary shares received Subsidiary’s tax basis in its assets is unchanged