Replies to post #129009 on Biotech Values

[mouton29]

<<If the successor company were acquired close in time to when the spinoff is implemented, the IRS could deem the spinoff a sham transaction intended to evade a capital-gains tax and punish ABT accordingly.>>

There is zero chance that the IRS would successfully assert the "sham transaction" doctrine to attack a spin-off of a public company followed by a merger. The sham transaction doctrine is reasonably narrow; there are other doctrines that apply more broadly such as "substance over form". But the two doctrines that by statute apply in the case of spinoffs are "business purpose" and "device" -- under Code Section 355, a spinoff will qualify as tax-free only if thee is a valid non-tax business corporate business purpose and it is not a "device for the distribution of the earnings and profits of the distributing corporation or the controlled corporation or both." See http://www.law.cornell.edu/uscode/26/355.html

Indeed, spinoff followed by mergers of either the distributed or distributing company have long been an acepted tax strategy and are known after a famous 1966 case which first validated a spin followed by a merger of the distributing company, Morris Trust. The two variations are a "Morris Trust" and "Reverse Morris Trust" transaction, depending on which entity merges. See http://macabacus.com/strategies/morris-trust for a short explanation with diagrams and http://www.sutherland.com/files/Publication/81586399-b1d3-4733-9ed6-373926382e45/Presentation/PublicationAttachment/5a79c22e-ad1e-4df8-af76-f8223ef16559/TAX355.PDF for a more learned discussion.

There are probably dozens of examples of large public spins followed by mergers, see for example the P&G spin of Pringles followed by a merger, described at http://phoenix.corporate-ir.net/phoenix.zhtml?c=104574&p=irol-newsArticle&ID=1546670&highlight=.

In fact, as I mentioned, one of the requirements for a spin to qualfiy as tax-free is that there be a non-tax business purpose and one of the time honored business purposes is to prepare either the distributing company or distributred company for a merger. The IRS used to rule on these matters and gave guidelines for what constituted a valid business purpose -- and one such purpose was facilitating an acquisition. From Revenue Procedure 96-30:

.

07 Facilitating an acquisition of Distributing. To establish that a Corporate Business Purpose for the distribution is to
tailor Distributing’s assets to facilitate a subsequent tax-free acquisition of Distributing by another corporation (the
‘‘acquiring corporation’’), ordinarily, the taxpayer must demonstrate to the satisfaction of the Service that:
(1) The acquisition will not be completed unless Distributing and Controlled are separated.
(2) The acquisition cannot be accomplished by an alternative nontaxable transaction that does not involve the
distribution of Controlled stock and is neither impractical nor unduly expensive.
(3) The acquiring corporation is not related to Distributing or Controlled. If the taxpayer contends that the Service
should rule favorably, notwithstanding the fact that the acquiring corporation is related to Distributing or Controlled,
explain the relationship and why the Service should disregard the relationship.
(4) The acquisition will be completed, and, except in unusual circumstances, will be completed within one year of the
distribution.

.08 Facilitating an acquisition by Distributing or Controlled. To establish that a Corporate Business Purpose for the
distribution is to tailor Distributing’s assets or Controlled’s corporate structure to facilitate a subsequent tax-free acquisition
of another corporation (the ‘‘target corporation’’) by Distributing or Controlled, ordinarily, the taxpayer must demonstrate to
the satisfaction of the Service that:
(1) The combination of the target corporation with Distributing or Controlled will not be undertaken unless Distributing
and Controlled are separated.
(2) The acquisition cannot be accomplished by an alternative nontaxable transaction that does not involve the
distribution of Controlled stock and is neither impractical nor unduly expensive.
(3) The target corporation is not related to Distributing or Controlled. If the taxpayer contends that the Service should
rule favorably, notwithstanding the fact that the target corporation is related to Distributing or Controlled, explain the
relationship and why the Service should disregard the relationship.
(4) The acquisition will be completed, and, except in unusual circumstances, will be completed within one year of the
distribution.

Congress decided some time ago that this had gone a bit too far and established some rules in section 355(e) of the Code, which I referred to in my prior post, and which are governed by detailed regulations, summarized in this memo http://www.willkie.com/files/tbl_s29Publications%5CFileUpload5686%5C2060%5CNew_Reg_Under_IRC_355.pdf Under these rules, a spin followed by a planned acquisition of 50% of distributing or distributed is taxable BUT ONLY to the distributing company. If a spin-off qualifies as tax-free under 355, it is not taxable to the shareholders and is not taxable to the distributing company, but under 355(e), if there is a planned acquisition of more than 50% of distributing or distributed, the transaction is taxable to distributing but not to the shareholders. Thus the Pringles transaction was structured so that the P&G shareholders ended up with a majority of the stock of the distributed company after the merger (57%) and so 355(e) was not triggered. If the transaction were treated as a "sham" then the tax law would disregard it, not treat it as partially taxable.

Anyhow, the point of all of this is that an otherwise valid spin-off transaction that survives 355(e) is very unlikely to be disqualified by a subsequent merger, especially if that merger is tax-free.