Cash Rich Split Off
A tax-efficient method used in mergers or acquisitions involves a parent company exchanging shares for stock in a subsidiary with excess cash to distribute cash to its shareholders.
What is a Cash Rich Split Off?
The Cash-rich Split-off is a tax-efficient method used in mergers or acquisitions. It involves a parent company exchanging shares for stock in a subsidiary with excess cash to distribute cash to its shareholders.
If all legal conditions are completed, a parent business can use the merger and acquisition tactic known as a "cash-rich split off" to swap its shares for stock in a subsidiary of the firm without paying taxes on the transaction.
Companies can use this strategy to sell non-core assets and come out on the other side with cash without actually selling anything. Since the transactions just reorganize the company's assets, split-offs are thought to be non-taxable.
Yahoo's intention to sell its holdings in Yahoo! Japan and Alibaba without having to pay a significant capital gains tax is an example of a cash-rich split-off.
The assets are estimated to be worth $20 billion, and the corporation would have to pay more than $7 billion in taxes in connection with this sale. Yahoo, on the other hand, might sell its Asian holdings without paying taxes if it used a cash-rich split-off approach.
Key Takeaways
- A cash-rich split-off is a type of corporate restructuring in which a parent company exchanges a subsidiary or a portion of its assets for cash or other assets with a shareholder or another company.
- This results in the shareholder or the acquiring company receiving the subsidiary or assets while the parent company retains the cash or assets it received in return.
- The primary purpose of a cash-rich split-off is to optimize resources, improve tax efficiency, and focus on core businesses.
- Specific examples of cash-rich split-offs may vary, but they often involve large corporations divesting significant subsidiaries or asset portfolios to streamline operations and improve financial flexibility.
The process of a cash-rich split-off
In order for a cash-rich split-off transaction to be legitimate, a third party would need to establish a new business with operational assets and cash or cash equivalents equal to or greater than 66 percent of the firm.
Licenses, companies, and other assets worth more than or equivalent to 33 percent of the company's total value are included in the operational assets.
The corporation must have owned and run the firm for at least five years. Subsequently, the assets of the seller would be swapped for this firm.
After the switch, the purchaser will have to run the new business for at least two years. However, the money received is instantly usable or monetizable.
For a cash-rich split-off transaction to be legitimate, a third party would have to establish a new business with cash or cash equivalents larger than or equal to 66% of the firm's operational assets.
Licenses, companies, and other assets worth more than or equivalent to 33% of the company's total value are included in the operational assets. The firm must have been owned and run by the corporation for at least five years. The assets of the seller would subsequently be swapped for this firm.
After the switch, the purchaser will have to run the new business for at least two years. However, the money received is instantly usable or monetizable.
Structural requirements of a cash-rich split-off
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- Trading or commercial activity: According to IRC Section 355, SplitCo must include a Company "active trade or business" (i.e., an active business that the Company has owned and maintained for at least five years).
- The enterprise value of SplitCo should be at least 5–10% active trade or company.
- Cash constraint: No more than 66 percent in cash or cash equivalents may be held by SplitCo.
- Non-core assets that qualify: Other assets that might "fill up" SplitCo's non-cash bucket in addition to the 5-year Company assets could be licenses, equipment, 20 percent or more stock stakes in corporations, sizable equity interests in partnerships, and other non-cash equivalents.
- Business purpose: Split-off must accomplish a significant non-tax business purpose for the Company; precedents included eliminating overhang on the stock, improving regulatory position, minimizing commercial conflicts, and others.
Benefits of a cash-rich split-off
Internal Revenue Code (IRC) Section 355 controls a spinoff's taxable status. The majority of spinoffs are tax-free because the parent firm and its shareholders do not register taxable capital gains, therefore satisfying the conditions of Section 355 for tax exemption.
In general, a shareholder is taxed as a dividend payout when a parent firm distributes shares of a subsidiary to its shareholders. Fractional shares in the spinoff that are substituted with cash are typically taxable to shareholders.
To avoid taxes, such a trade would need to be set up as a "cash-rich split-off." Cash-rich split-offs are prevalent in M&A and are controlled under section 355 of the tax law, as the Journal article reminds us.
These agreements are frequently made when one firm has stock in another and allows the other to give a particular group of shareholders a chance to trade their shares for stock in a "split-off" corporation that has access to cash and other assets.
Both the seller and the company's "cash wealthy" subsidiary profit from the tactic. The sale of the company's assets for cash benefits the seller because it is tax-free.
Additionally, the seller has the opportunity to bargain with the subsidiary to have it contribute any operational assets it intends to buy.
The subsidiary gains from a cash-rich split-off by selling a non-core asset without paying taxes on the proceeds. Additionally, it has the option to repurchase shares at a favorable price.
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