In new guidance, the Internal Revenue Service signaled its discomfort with a range of corporate spinoffs, specifically calling out deals in which companies split their real estate and other physical assets from their mainstream operations. The agency said it was concerned that some of these transactions may violate rules meant to ensure that companies don’t disguise dividends and other taxable transactions as spinoffs to avoid paying taxes.
These spinoffs “involve significant concerns,” the IRS said, adding it will largely stop giving preapproval for such deals while it examines the issue more closely.
The increased scrutiny could apply to pending deals including Darden Restaurant Inc.’s plan to spin off most of its restaurant properties, a move championed by activist investor Starboard Value LP, which controls the company. It also could give pause to companies including Macy’s Inc. and McDonald’s Corp., which are under shareholder pressure to make similar moves.
“The message is, proceed with caution,” said David Burton a tax partner at law firm Akin, Gump, Strauss, Hauer & Feld LLP.
The IRS doesn’t comment on specific transactions, but occasionally issues new rules or informal guidance to reflect its thinking.
Separating real-estate assets has become a popular move over the past few years among retailers, restaurant chains, casino operators and telecommunications companies. The idea is that markets often don’t give full credit for land and buildings when they are embedded in an operating company and that companies can get a higher valuation by putting the assets into a separate structure like a real-estate investment trust, or REIT.
Activist investors have latched onto the idea. Since the start of 2013, they have launched 21 campaigns aimed at pressing companies to separate their real estate, up from 11 in the previous six years combined, according to FactSet.
Low interest rates have spurred the trend. REITs pay out most of their income in dividends, making them similar to debt investments but with higher returns than many bonds offer today.
These deals are generally tax-free, subject to a few IRS rules. One is that the spun-off company must include an “active trade or business.” Simply collecting rent, as many REITs do, doesn’t qualify. Companies typically include a small business alongside the properties to meet the test.
The IRS said in its guidance Monday that it is concerned these qualifying businesses may be too small when compared with the size of the real estate. The guidance echoes comments in May from IRS official Isaac Zimbalist, who likened the practice to companies dropping hot-dog stands into a bucket of investment assets or cash then trying to spin off the entire business tax-free.
The posture has also caught up Yahoo Inc., which had planned to spin off its stake in Chinese e-commerce company Alibaba Group Holding Ltd. Yahoo sought a ruling from the IRS that its spinoff would be tax-free. The IRS declined Sept. 2 to grant Yahoo’s request, meaning that if the company goes forward with the deal, it risks an IRS challenge.
Yahoo has said it is considering its options.
Yahoo’s plan has been to include a small-business-services unit with roughly 100 employees and $50 million in earnings before interest, taxes, depreciation and amortization in its Alibaba spinoff.
Darden plans to include six LongHorn Steakhouses in San Antonio, out of about 480 it owned nationally as of Dec. 31, in its real-estate spinoff.
Darden also sought the IRS’s blessing, but the status of that request is unclear. Rich Jeffers, a spokesman for Darden, said the company “is confident that its proposed transaction will satisfy all of the requirements of applicable law.”
Starboard didn’t immediately respond to a request for comment.
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