Once considered uncommon corporate reorganization transactions pursued by smaller, less wellknown companies in varying degrees of financial distress, tax-free spin-offs have become more mainstream and prominent in recent years among financially sound, blue-chip public companies across a range of industries, such as pharmaceuticals/healthcare, consumer retail products and industrials/ manufacturing.
The latest blue-chip public company rumored to be exploring a potential tax-free spin-off is FedEx Corporation (FedEx). In FedEx's recent fourth quarter 2024 earnings call in June 2024, FedEx CEO Raj Subramaniam announced that FedEx's management, board of directors and external advisors were conducting an assessment of the future role of FedEx Freight, the less-than-truckload (LTL) unit of the multinational transportation conglomerate, in the company's portfolio structure.1
This news prompted widespread speculation among Wall Street LTL analysts that FedEx may soon divest FedEx Freight, the company's best performing business, following the completion of the strategic review in December 2024.2 While the assessment remains ongoing as of the date of this publication, it is widely anticipated that FedEx may pursue a tax-free spin-off with respect to FedEx Freight as early as 2025 in order to maximize shareholder value.3
The speculation surrounding the potential divestiture of FedEx Freight underscores the recent rise of divestitures, and in particular, tax-free spin-offs, in the LTL industry. The divestiture of FedEx, if completed, would represent the latest in a series of recent divestitures in the LTL industry, such as XPO, Inc.'s recent spin-off of its LTL business from its brokered transportation business and TFI International Inc.'s expected spin-off of Daseke, Inc. and other truckload holdings.4 If consummated, FedEx's spin-off of FedEx Freight would represent one of the largest spin-offs completed recently, with analysts estimating that FedEx Freight would command an approximately $50.0 billion market capitalization as a standalone public company.5
Given this expected significant market capitalization, a tax-free partial spin-off, a specific type of spin-off transaction in which FedEx would continue to retain an ownership stake in the freight business once it is spun off into an independent, standalone public company, would be particularly advantageous as it would allow FedEx to effectively "level up." FedEx would stand to benefit from the robust financial performance of the standalone freight business at a time when FedEx is trying to rebound from lackluster first quarter fiscal year 2025 results.
FedEx/FedEx Freight is just one of many recent suitable candidates for tax-free partial spin-offs. Nevertheless, tax-free partial spin-offs remain poorly understood in the marketplace. This article provides an overview of tax-free partial spin-offs, including the business rationale for pursuing such transactions, and offers key threshold considerations for Parent Entity (as defined herein) personnel and advisors to heed when structuring these complex transactions.
Overview
Tax-Free Spin-Offs
In a tax-free spin-off, a public company (Parent Entity) spins off a subsidiary (Subsidiary) by distributing (via a dividend) the Subsidiary's common stock to the stockholders of the Parent Entity. Subsidiary typically is a private, wholly owned subsidiary of Parent Entity. Following the consummation of the tax-free spin-off, Parent Entity and Subsidiary exist separately and independently of one another, and Subsidiary becomes a publicly traded company owned entirely by the stockholders of the Parent Entity—Parent Entity does not retain an ownership stake in Subsidiary. Assuming certain criteria are satisfied (as discussed herein), these transactions often qualify as tax-free distributions under Section 355 of the Internal Revenue Code of 1986, as amended (IRC) and are therefore advantageous transactions to Parent Entity stockholders from a tax perspective.
Tax-Free Partial Spin-Offs
Tax-free partial spin-offs are substantially similar to conventional tax-free spin-offs, but differ in one critical respect: in a tax-free partial spin-off, Parent Entity retains an ownership stake in Subsidiary following the consummation of the tax-free partial spin-off. As a result of its ownership stake in the spun-out Subsidiary, Parent Entity stands to financially benefit if the spun-out Subsidiary performs well as an independent public company.
Business Case
There is no single overarching business rationale for pursuing tax-free partial spin-offs, but in general, the most suitable candidates for tax-free partial spin-offs are Parent Entities who have high performing Subsidiaries. Parent Entities may pursue tax-free partial spin-offs for a variety of reasons, but in all cases, Parent Entities stand to gain from its ownership stake in the spun out high performing Subsidiary assuming the spun out high performing Subsidiary continues to perform well following the consummation of the tax-free partial spin-off. The business case for pursuing tax-free partial spin-offs is perhaps best captured by the acronym "LEVELING UP," as explained below.
Liability Management and Liquidity
Partially spinning off high performing Subsidiaries can help distressed and/or highly levered public companies manage their debt burdens. There was a surge in corporate borrowing during the height of the COVID-19 pandemic as companies opportunistically borrowed due to historic low interest rates. Additionally, companies in certain industries adversely impacted by the COVID-19 pandemic, such as travel/leisure, incurred significant debt to shore up their liquidity levels.
Many of these COVID-19 era debt issuances are coming due between 2025-2028—a phenomenon known as the "maturity cliff." Due to challenging conditions such as the prevailing high-interest rate environment and continued market volatility, conventional debt and equity capital financings may be inopportune. Accordingly, tax-free partial spin-offs represent a timely, compelling alternative for companies seeking to manage significant upcoming liabilities and enhance liquidity, while still allowing them to benefit from the strong future performance of the Subsidiary. Any gains realized from equity ownership stakes in the spun-out Subsidiary can be used to reduce leverage and shore up liquidity.
Efficient Management
Partially spinning off high growth Subsidiaries can also result in more efficient management at the Parent Entity level because Parent Entity management can focus on overseeing a streamlined, smaller business as opposed to managing a more expansive business enterprise.
Value Creation
Partially spinning off strong performing Subsidiaries can also maximize shareholder value by allowing such Subsidiaries the opportunity to disentangle from slower-growth business lines within the Parent Entity, thereby allowing such high performing Subsidiaries to realize higher valuations. Through their ownership stake in the spun-out Subsidiary, Parent Entities will stand to benefit from such higher valuations.
Establish Defense against Takeovers
Partially spinning off high growth Subsidiaries can also help Parent Entities thwart takeovers as Parent Entities may become less compelling acquisition targets after a high growth Subsidiary is spun out.
Lower Costs and Regulatory Burden
Partially spinning off high performing Subsidiaries may result in lower costs for both the Subsidiary and the Parent Entity. For example, the partial spin-off of a high growth Subsidiary in a capital-intensive industry may help lower costs for the Parent Entity, while still allowing the Parent Entity to benefit from the strong performance of the Subsidiary following the consummation of the tax-free partial spin-off. Similarly, lower costs can be achieved by reducing regulatory burden for both the Parent Entity and high performing Subsidiary alike.
Incentivize Management
Partially spinning off high growth Subsidiaries may help incentivize officers and employees to establish more appropriate compensation packages that reflect compensation metrics more narrowly tailored and germane to the Subsidiary.
Nimble Financing
Partially spinning off strong performing Subsidiaries enables more nimble financing by the Subsidiary. For example, by disentangling from a relatively poor performing Parent Entity, Subsidiaries with strong prospects can approach future capital raising activities with more agility and alacrity, thereby delivering benefits to not only the Subsidiary, but also the Parent Entity which retains an ownership stake in the spun-out Subsidiary.
Good Governance
Partially spinning off high growth Subsidiaries can promote good governance by eliminating conflicts and tensions between business lines, thereby minimizing distractions at the management levels of both the Parent Entity and the Subsidiary. An environment marked by less conflicts will allow both the Subsidiary and Parent Entity to solely focus on executing on business imperatives.
Utilize Equity as Acquisition Currency
Struggling and/or financially distressed Parent Entities seeking to partially spin off a high growth Subsidiary can leverage equity stakes in the spun-out Subsidiary as future acquisition currency.
Public Reputation
A partial spin-off can enhance the public reputation of a Parent Entity. A Parent Entity with a lackluster marketplace reputation or stale branding can refurbish its image in the marketplace by partially spinning out a high performing Subsidiary. Investor buzz surrounding the announcement can boost the fortunes of both the Parent Entity and Subsidiary alike and any gains achieved by the spun-out Subsidiary will improve not only the bottom line of the Parent Entity, but will also augment Parent Entity's reputation among investors.
Similarly, by becoming a standalone, independent public company, a promising Subsidiary can enhance its stature in the marketplace in a more immediate and dramatic fashion than it would have had it remained entangled with an underperforming Parent Entity.
Key Threshold Considerations
Set forth below is a non-exhaustive list of significant, preliminary considerations that should be heeded by Parent Entity personnel and advisors when structuring tax-free partial spin-offs.
1. Engage Skilled Advisors Early
Engaging skilled advisors early is crucial for effective transaction structuring. At least 12-18 months in advance of commencing work on a tax-free partial spin-off, boards and management should retain legal counsel, auditors and other advisors, including, but not limited to, experienced investment bank and tax advisors who have demonstrated experience advising on tax-free spin-offs and in particular, tax-free partial spin-offs. Additionally, such advisors should have a strong understanding of the industry or industries, as applicable, in which the Parent Entity and Subsidiary operate.
2. Assess Tax-Free Distribution Eligibility
One of the primary advantages of a partial spinoff is that it can be classified as a tax-free distribution under Section 355 of the IRC. In order for a partial spin-off to qualify as a tax-free distribution, it must be structured properly. Great care should be taken by advisors to ensure that the proposed transaction adheres to the requirements promulgated by the Internal Revenue Service. Set forth herein is a non-exhaustive list of requirements advisors should heed when structuring tax-free partial spin-offs.
The requirements below assume that the Subsidiary is a US entity. First and foremost, the transaction must be driven by proper business purpose which may include, but is not limited to, the following: (i) achieving cost savings, (ii) enabling borrowing, (iii) enabling a stock offering, (iv) providing employees with equity interests, (v) enabling acquisitions, or (vi) addressing competitive concerns. Notably, a desire to reduce federal income taxes is not considered a valid business purpose.6
Second, advisors should verify and confirm that the Parent Entity and Subsidiary have engaged in an active trade or business for the immediately preceding five-year period before the contemplated tax-free distribution. Relatedly, Parent Entity and Subsidiary must continue to participate in such active trade or business following the consummation of the tax-free distribution.7
Third, the proposed transaction cannot be used as a device to facilitate the distribution of earnings and profits.8
Fourth, Subsidiary must be controlled by the stockholders of the Parent Entity which can be achieved by ensuring that Parent Entity stockholders own: (i) 80 percent of the total combined voting power of all classes of stock entitled to vote; and (ii) 80 percent of the total number of shares of each other class of stock of the spun-out Subsidiary.9
Fifth, there must be demonstrated continuity of interest. The historic stockholders of Parent Entity must have a continuing interest in both the Parent Entity and the Subsidiary following the consummation of the transaction.10
ould result in the transaction losing tax-free status, thereby eliminating a key advantage. Accordingly, advisors should conduct a comprehensive review of a proposed transaction's eligibility for tax-free distribution status. Additionally, advisors should verify and confirm that (i) there was no purchase of 50 percent or more of the stock distributed in the transaction within the immediately preceding five-year period,11 and (ii) there has been no acquisition of 50 percent or more of an equity interest in either the Parent Entity or Subsidiary in a plan involving the distribution.12 There are strict timing requirements at play in connection with the foregoing requirements.13
Accordingly, advisors should exercise caution in ensuring compliance and/or evaluating the applicability of safe harbors available under IRC Section 355(e).14 Advisors should also be mindful of these requirements when determining the percentage of the Parent Entity's ownership stake in the spun-out Subsidiary.
3. Evaluate if Registration under the US Federal Securities Laws Is Necessary
In addition to assessing whether a proposed transaction meets the tax-free distribution eligibility requirements discussed above, Parent Entity personnel and advisors should evaluate the applicability of the US federal securities laws when structuring a tax-free partial spin-off. In general, per the Staff of the Securities and Exchange Commission (SEC), a spinoff transaction not preceded by an initial public offering that satisfies the criteria discussed herein typically will not require registration under Section 5 of the Securities Act of 1933, as amended (Securities Act).
The spun out Subsidiary's stock must be registered pursuant to Section 5 of the Securities Act unless the following threshold criteria are met: (i) there must be no consideration paid by Parent Entity stockholders for shares of the spun out Subsidiary's stock; (ii) the distribution must be made on a pro rata basis; (iii) Parent Entity must provide sufficient information about the proposed transaction to its stockholders via the filing of an information statement and Form 10 with the SEC; and (iv) the proposed transaction must have a proper business purpose.15
The foregoing criteria represent threshold criteria; additional requirements may apply if Parent Entity required the Subsidiary from a third party. It is critical that Parent Entity personnel and advisors carefully ensure adherence to the foregoing criteria— if the conditions described above are not met, the proposed transaction will implicate Section 5 of the Securities Act and the transaction must be registered with the SEC.
Conclusion
Tax-free partial spin-offs offer compelling benefits to ailing and financially sound Parent Entities alike as they allow Parent Entities to effectively "level up," as discussed herein. Nevertheless, there is little guidance available on how to properly structure these transactions. Parent Entity personnel and advisors should heed the threshold considerations discussed herein when structuring these complex transactions.
Footnotes
2. https://www.wsj.com/articles/trucking-experts-projectspinoff-of-fedexs-freight-business-7129e046.
3. Id.
5. https://www.wsj.com/articles/trucking-experts-projectspinoff-of-fedexs-freight-business-7129e046.
6. IRS Rev. Proc. 96-30; Treas. Reg. § 1.355-2(b).
7. Treas. Reg. § 1.355-3.
8. Treas. Reg. § 1355-2(d).
9. IRC §§ 355(a)(1)(A), 368(c).
10. Treas. Reg. § 1.355-2(c).
11. Internal Revenue Code, § 355(d).
12. Internal Revenue Code, § 355(e).
13. Internal Revenue Code, § 355(e).
14. Internal Revenue Code, § 355(e).
15. SEC Staff Legal Bulletin No. 4 (September 16, 1997).
Originally published by The Corporate & Securities Law Advisor
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
