EY Tax Free Spin Off Roadmap
EY Tax Free Spin Off Roadmap
EY Tax Free Spin Off Roadmap
roadmap
Improving capital allocation,
operations and investor focus
C r e a ti n g v a l ue by s p i n n i n g of f
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T h e c h a lle n g e s
In its operational, regulatory and strategic
complexity, a tax-free spin-off is something of
a three-headed beast: as demanding as any
business carve-out, with added requirements
akin to those of an initial public offering
(IPO), plus the close involvement of tax
authorities and the Securities and Exchange
Commission (SEC).
All this adds up to an undertaking whose
challenges, costs and pitfalls are not to be
underestimated. Challenges can include lost
synergies, potentially high transaction and tax
costs, separation of talent, SpinCo/RemainCo
conflicts of interest, regulatory hurdles and
business disruption.
T h e a n s w e r
Considering the vast dispersion of returns
that companies experience post-spin, here we
outline the most critical steps to understanding
whether or not a spin-off is feasible and how
to complete a successful deal.
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S p i n - of f ti m e l i n e
F e a s i bi l i ty of D e c i d e / a n n oun c e F or m 1 0
ta x - f r e e tr e a tm e n t p ubl i c l y initialfiling
T r a n s a c ti on Communicate to stakeholders,
including internal clearance story Select SpinCo management
g ov e r n a n c e
Determine costs of
restructuring debt Propose capital structure for each company
Determine ParentCo Forecast cash flow and develop a view of standalone costs,
versus SpinCo and estimate one-time costs
C a p i ta l
m a r k e ts a n d
Develop equity story
s tr uc tur e
Determine tax basis, earnings and profits and fair Resolve intercompany agreements
market value and settle accounts
Tax feasibility
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F or m 1 0 T S A e x i ts /
e f f e c ti v e d a te S p i n d a te f ul l s ta n d - a l on e
T a x - f r e e s p i n - of f r oa d m a p 5
C r i ti c a l s te p s to m a n a g i n g
a s uc c e s s f ul d e a l
F e a s i bi l i ty of a s p i n s ta x - f r e e tr e a tm e n t
T a x - f r e e s p i n - of f s a r e e x tr e m e l y c om p l e x a n d m us t s a ti s f y Do you have a valid corporate business purpose for the spin-off?
m a n y l e g a l a n d r e g ul a tor y r e q ui r e m e n ts . F a i l i n g a n y of th os e The spin-off must be motivated in whole or substantial part by
r e q ui r e m e n ts c a n r e s ul t i n s h a r e h ol d e r a n d / or c or p or a te - l e v e l ta x . a real and substantial non-federal tax purpose germane to the
U n d e r s ta n d i n g p ote n ti a l s p i n - of f c a p i ta l s tr uc tur e a n d a s s oc i a te d business of RemainCo, SpinCo, or their respective affiliates
c os ts i s a l s o c r i ti c a l i n m a k i n g a tr a n s a c ti on d e c i s i on . B e l ow a r e (i.e., a shareholder purpose alone does not qualify as a corporate
k e y a n a l y s e s to d e te r m i n e i f a tr a n s a c ti on i s f e a s i bl e f r om a ta x business purpose).
a n d c a p i ta l s tr uc tur e p e r s p e c ti v e . The corporate business purpose needs to clearly demonstrate the
need for the spin-off.
Will a tax-free spin-off achieve your business objectives?
A spin-off must effectuate a complete operational separation of Do RemainCo and SpinCo each have an ATB?
RemainCo and SpinCo, and RemainCo generally must distribute Both companies must have at least one qualifying ATB, which
all of its stock of SpinCo. means more than simply conducting a business.
Both RemainCo and SpinCo must have at least one qualifying The ATBs key business functions must be performed by
active trade or business (ATB) that has been conducted employees of RemainCo, SpinCo or their affiliates; independent
continuously for five years immediately prior to the spin-off. contractors are excluded from the analysis.
A tax-free spin-off cannot be part of a shareholder plan to dispose
of a controlling interest in either RemainCo or SpinCo, which can Can you restructure your outstanding debt in a tax-
significantly restrict post-spinoff M&A activity. efficientway?
A spin-off can require a company to restructure its debt,
Spin-offs present only a limited ability to monetize SpinCo value.
potentially at a large or prohibitive cost.
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T r a n s a c ti on g ov e r n a n c e C a p i ta l m a r k e ts a n d s tr uc tur e
Establish a spin-off transaction governance model dont C a p i ta l s tr uc tur e
underestimate the importance executing these seemingly
routine tasks: Propose capital structure for each company based on its cash
flowandgrowthprofile
Define spin-off game plan, form transaction team and
Review terms of outstanding debt; consider debt to target
communicate objectives to kick off the transaction efficiently
for exchanges and restructuring in order to minimize
and avoid a slow start
transaction costs
Decide which internal and external stakeholders should know
Determine how historical liabilities will be split
about the transaction and strategic plans before they are public,
(e.g., pension obligations)
and develop messaging accordingly
Assess Day 1 cash requirements because the companies existing
Set targets, delegate and monitor progress through
cash may not be sufficient for working capital needs
reporting in order to manage the complexity of a spin-off
and maintain accountability
Forecastcashflowanddevelopaviewofstandalonecosts
Define the separation timeline and align work streams to key
Will be an input into the pro forma Form 10 disclosures and debt
deadlines and milestones to maintain momentum, track progress
and equity roadshows
and target the desired close date
Helps determine interest and dividend payments available
Consider the appropriate role of SpinCo management; SpinCo
to the market
management is typically involved in SpinCo organizational design
and setting the strategic vision because it will be responsible Determine one-time costs and who will pay in order to assess
for execution funding needs
Establish board of directors oversight and knowledge of key
events through the entire process; there should be routine W h a t s be i n g d i s tr i bute d
dialogue between the board and management Determinewhichbusinesswillberetained(i.e.,RemainCo)
andwhichbusinesswillbedistributed(i.e.,SpinCo)
Legal and/or regulatory restrictions may limit asset/
stock transfers
Distributing business with lower inherent tax gain may
be preferred
Determineprofileofthestocktobedistributed(e.g.,voting
rights,distributionratio,dividendpolicy)
Consider the distribution ratio and a reverse stock split if the
anticipated share price is suboptimal
A split-off may benefit from a subsidiary IPO to set the market
price, allowing for an exchange offer
Developtheequitystoryforroadshowstogarnersufficient
market interest and avoid post-close sell-off
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C r i ti c a l s te p s to m a n a g i n g
a s uc c e s s f ul d e a l
T a x
Develop legal entity step plan Develop scope and duration of Transition Services Agreements
Mitigates potential business, operational, financial and tax (TSAs),atax-sharingagreementandotherarrangements
impediments and costs Companies may not be able to operate completely independently
Legal entities with commingled operations, multiple non-US immediately following the spin-off
jurisdictions, and legal or regulatory restrictions on transferability Continuing relationships between RemainCo and SpinCo must
of assets drive transaction complexity be of limited scope and duration and generally must be priced at
Legal and/or regulatory restrictions may limit asset/ arms length
stock transfers
Prepare supporting documentation for tax-free treatment
Determinetaxbasis,earningsandprofits(E&P)andfairmarket Contemporaneous support is generally required for tax-free
value(FMV) treatment and future audits
Appreciation (i.e., excess FMV over tax basis) of the existing A tax opinion is necessary in nearly all circumstances the IRS
businesses may drive the decision regarding the identity of does not generally issue private letter rulings (PLRs) pertaining to
RemainCo and SpinCo spin-off matters
RemainCo can generally monetize its investment in SpinCo to If a company requests a PLR, the tax opinion may address only
the extent of the tax basis in SpinCo stock those matters not covered by the PLR
The FMVs govern allocation of tax basis and E&P (required for a
dividend distribution) Preparepublicdocumentationandrelateddisclosures(e.g.,tax
returndisclosures,IRSForm8937)
Refineproposedcapitalstructuretooptimizetaxefficiencies Required to ensure the company is compliant with IRS and other
Allocating existing debt may result in an inefficient governmental disclosure requirements
capital structure
May need to issue new debt to avoid tax costs of assuming
existing debt
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F i n a n c i a l r e p or ti n g
InvesttimeupfronttoproperlyplanforpreparingSEC- Compileproformafinancialinformation
complianthistoricalcarve-outfinancialstatements Adjustments can include impact of new capital structure, impacts
Timely completion of the audited carve-out financial statements of various transaction agreements, asset/liability transfers,
(generally a four- to six-month process) is critical to achieve employee liabilities triggered upon sale and distribution, and ratio
transaction timelines and being able to complete other financial on earnings-per-share calculations
reporting work streams (e.g., MD&A, pro forma financial Do not underestimate effort required and potential stakeholder
information, credit rating agency/investor information, etc.) scrutiny of standalone and one-time cost disclosures
Empower a project manager that understands SEC reporting
requirements, sets interim milestones and globally aligns
PlanforSECregistrationandreview
interdependent functions (e.g., management, tax, attorneys,
Put forward your best effort into completing the initial Form 10
bankers and auditors) in order to prepare carve-out financial
filing and initial comment letter response to avoid a prolonged
statements and complete audits on time
review process
Longer lead time items include basis of presentation, corporate
Understand anticipated timing for initial filing, SEC review process
cost allocations, push-down of certain assets and liabilities,
and amendments, reporting deadlines, holidays and stale dates
historical SpinCo acquisitions, goodwill and intangible impairment
It can take four to five months (and four to five amendments)
testing and carve-out tax provisions
from initial Form 10 filing to SEC declaring your filing effective
important to adhere to publicly communicated timelines
DevelopanITsolutionthataggregatesdata,postsadjustments
and supports statement preparation Anticipate SEC hot-topic matters (e.g., revenue recognition,
Having one place to store all data for multiple outputs segments, executive compensation, MD&A)
(e.g., audited and pro forma financial statements, rating agency
financials, discontinued operations) can minimize version control Anticipate post-spin reporting matters
issues, data problems and re-work Plan early as preparation for post-spin filings has to run
Align with tax to track and compile adjusted information at concurrent to SpinCos SEC registration process
a granular enough level to enable carve-out tax provisions RemainCo may have numerous reporting requirements,
by jurisdiction including reporting SpinCo within discontinued operations and
filing Form 8-K within four business days from spin date
Complete external audits of historical carve-out SpinCo must file its first Form 10-Q for the quarter following
financialstatements the most recent period included in the Form 10 (later of 45
Address basis of presentation matters as audited financial days after the effective date or the date the Form 10-Q would
statements may not necessarily equal SpinCo deal basis otherwise be due)
Involve auditors early and often to align on management
conclusions and approaches to audit testing and support
Lower levels of materiality lead to unaccustomed depth
of audit testing
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C r i ti c a l s te p s to m a n a g i n g
a s uc c e s s f ul d e a l
O p e r a ti on a l s e p a r a ti on
Definetheoperatingmodelofbothcompanies Assesstimerequiredtoestablishnewlegalentities
Understanding current state operations in detail is key to Requirements to establish new legal entities vary by jurisdiction
minimizing delays and cost overruns and industry and can take over a year to complete
Define the Day 1 and future state operating model, Failure to act expediently can delay establishing bank accounts,
including employee allocation, and align it to post-spin contracting with vendors, configuring systems, establishing
strategic objectives processes, selling product and other activities, and can
Right-size the organizations an optimized future operating delay closing
model can enhance deal value
Develop public-company governance and corporate infrastructure
Determine level of separation on Day 1 Management and the board must be prepared for public-company
Different transaction rationales call for different degrees responsibilities e.g., they must be ready to file financial
of separation on Day 1 (e.g., short timeline, complexity to statements with the SEC post-close
separate systems) SpinCo can set new corporate governance structure to eliminate
Regulatory bodies generally look for complete separation within legacy challenges
two years (IT can be the exception)
A high degree of separation will accelerate the need to manage
RemainCos stranded costs
DefineTSArequirementsandgovernancemodel
Understand requirements and cost to deliver services on Day 1,
as well as exit strategy
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O p e r a ti on a l s e p a r a ti on Functional separation considerations
IT HR/benefits
IT is often the most entangled functional area; SpinCo generally needs to create a new HR and
it requires the most lead time; and its one of benefits infrastructure:
the most expensive to separate. Key activities Transferring employees may require union
include assessing the current system consultations, new country-specific payroll
landscape; allocating systems, capabilities and benefits setups
and infrastructure; segregating access and
An employee communications strategy
data; defining the Day 1 IT operating model;
should address transition arrangements,
and, at times, creating separate IT system
time off, compensation, year-end processes
architectures for SpinCo and RemainCo.
and changes to health or pension benefits
F in a n c e
A spin-off puts strain on the finance S up p l y c h a i n a n d m a n uf a c tur i n g
organization. Form 10 preparation, separation Interdependencies can significantly affect
accounting, as well as SpinCo standup SpinCos Day 1 operating model and separation
and SEC reporting, create double duties efforts. Key impacted areas include:
for an organization that still has ongoing Order-to-cash and purchase-to-pay processes
business responsibilities. Corporate organization and principal
company/TESCM model
Long-term supply agreements with RemainCo
and facilities and logistics networks
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S um m a r y
Below we suggest some guiding principles as you navigate the ManageRemainCoandSpinCoconflictsofinterest RemainCo,
critical steps of a tax-free spin-off: which has responsibility to shareholders and decision power
T h e s p i n - of f m us t be m oti v a te d by a c or p or a te bus i n e s s until close, should make decisions that best enhance the
p ur p os e The IRS has the benefit of hindsight, so make long-term combined value of both future companies. However,
sure that the actions of RemainCo and SpinCo through and SpinCo management needs to be aligned with decisions as it is
following the spin-off are consistent with the stated corporate responsible for execution.
business purpose.
U n d e r s ta n d ta x a ttr i bute s a n d v a l ue Effective tax structuring
D on t un d e r e s ti m a te F or m 1 0 p r oc e s s ti m i n g a n d c om p l e x i ty may enable you to monetize a portion of your investment in
Form 10 work is not limited to the finance team. It takes a SpinCo prior to the spin-off.
collaborative effort across the organization to complete the
U n d e r s ta n d op e r a ti on a l s e p a r a ti on c h a l l e n g e s Start early
registration statement and navigate through a rigorous SEC
and dont underestimate the lead time or resources needed to
review process that requires form updates until the SEC declares
separate your business, especially in the Finance and IT functions.
it effective.
Keeping these principles top-of-mind as you manage the five critical
work streams will help you control the process and drive toward a
successful tax-free spin-off.
G ui d i n g p r i n c i p l e s
Spin-off must be motivated by a corporate Manage RemainCo and SpinCo conflicts of interest
business purpose Understand tax attributes and value
Dont underestimate Form 10 process timing Understand operational s e p a r a ti on challenges
and complexity
G ov e r n a n c e
Maintaindeadlinesandmitigaterisks
C a p i ta l m a r k e ts T a x F i n a n c i a l r e p or ti n g O p e r a ti on a l
a n d s tr uc tur e Separate RemainCo and Manage the c a r v e - out s e p a r a ti on
Optimize the capital SpinCo in a tax-free manner audit and Form 10 process; Define operating model
structure of both companies establish financial reporting changes and their impact on
based on their separated function in SpinCo standalone cost structure;
cash flow profiles implement separation and
TSAs for Day 1
Optimizechangestooperatingmodel(people,processesandsystems)
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EY c on ta c ts
Paul Hammes
EY Global Divestiture Leader
Chicago, IL
+1 312 879 3741
paul.hammes@ey.com
Rich Mills
EY Americas Divestiture Leader
Atlanta, GA
+1 404 817 4397
rich.mills@ey.com
Blake Pilgrim
Chicago, IL
+1 312 879 6719
blake.pilgrim@ey.com
Regina Balderas
Houston, TX
+1 713 750 1232
regina.balderas@ey.com
Philippe Leroy
New York, NY
+1 212 773 0037
philippe.leroy@ey.com
Mark Schmidt
San Jose, CA
+1 408 947 6678
mark.schmidt@ey.com
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N ote s
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