Here is a post from a few days back. It does a great job explaining taxes and why PALM and COMS can't be purchased after the spin-off.
To: Grislee bear who wrote (38755)
From: Gary Brack Tuesday, Feb 1, 2000 10:10 PM ET
Reply # of 38944
I remember reading a lot of speculation about a 3Com buyout after the IPO and came across an old article that I found interesting. It seems as if it would be unlikely that 3Com would be bought out within the next two years.
- Gary Brack
Wed. 3 Nov. 1999 03:52PM
by Robert Willens
Recently, 3Com Corp. announced plans to spin off its highly touted Palm Computing subsidiary, the corporate parent of the Palm Pilot. The spinoff will be preceded by a public offer of a chunk of Palm Computing stock and, among other reasons, facilitating that stock offering may form the principal business purpose for the spinoff.
To qualify for tax-free treatment, there must be a corporate business purpose for the separation. An acceptable business purpose, memorialized by the Internal Revenue Service in Rev. Proc. 96-30, is to facilitate a stock offering.
In this regard, it is well-settled that an "equity carve-out," of the type planned by Palm Computing, will be more successful (from a pricing viewpoint) if, at the time of the offering, the market is informed that the subsidiary will, via an ensuing spinoff, become an independent entity. This is so because the market, over the recent past, has expressed a clear preference for "pure play" companies that do not have controlling corporate shareholders.
In addition, tax-free treatment depends on satisfaction of the so-called "active business" requirement. Immediately after the spinoff, both the parent and the distributed subsidiary must be engaged in the active conduct of one or more trades or businesses. Further, these businesses must each have been actively conducted throughout the five-year period ending on the date of the spinoff and must not have been acquired, within that period, in a wholly or even partially taxable transaction.
Control of the corporation conducting such businesses must not have been acquired during the five-year interval in such a wholly or partially taxable transaction. These so-called "longevity" rules are designed to prevent a corporation from accumulating liquid assets and using them to purchase or create a business that its shareholders would like to own in their individual capacities and, to foster this goal, the corporation would promptly spin off, in lieu of paying ordinary dividends.
3Com acquired Palm Computing in 1997 with its acquisition of U.S. Robotics. There was, apparently, some pressure exerted on 3Com by the founders of Palm Computing to implement the spinoff of Palm as early as 1998. From a tax viewpoint, however, this appeared to be a non-starter. Almost certainly, Palm Computing did not commence operations until sometime in 1995 so that a spinoff attempted before 2000 would not satisfy the five-year "duration" requirement of the active business test.
The rules also prohibit the spinoff of a corporation where control of that corporation was acquired during the five-year predistribution period. In this case, 3Com acquired control of Palm Computing in 1997. Still, a 2000 spinoff of Palm should pass muster because 3Com's acquisition of U.S. Robotics was fully tax-free. This means that 3Com acquired Palm Computing in a manner permitted by the statute and so not constrained by the five-year waiting period.
The timing of the spinoff is also heavily influenced by the constraints imposed by the pooling-of-interests accounting rules. The acquisition of U.S. Robotics was structured to qualify for such pooling treatment.
However, to qualify for pooling, there can be no "intention or plan" to dispose of a significant portion of the assets of either combining company within two years after the combination, other than disposals in the ordinary course of business or to eliminate duplicate facilities or excess capacity. Although, at least theoretically, a disposal occurring within the two-year, post-transaction period might not be fatal-since the combined corporation could always argue that the disposal was prompted by an unanticipated change -most corporations that have structured a pooling will decline to shoulder this daunting evidentiary burden.
Instead, the company would simply delay significant asset divestitures, until more than two years have elapsed from the closing date of the pooling. Thus, the spinoff here is timed to occur well beyond the second anniversary of the U.S. Robotics acquisition.
Finally, given the speculation that 3Com is, itself, a takeover candidate, it is appropriate to inquire whether the spinoff can function as something of a "poison pill," in the sense that an acquisition of 3Com would entail, for the acquirer, unattractive tax and/or accounting consequences. The pooling rules provide that such treatment is unavailable in cases where either constituent has effected a change in its voting common stock equity interests "in contemplation" of the pooling. For this purpose, moreover, an "unusual" distribution to shareholders (a spinoff is, by definition, an unusual distribution) constitutes a change in the equity interests and a change that takes place during the two-year interval preceding the initiation of the pooling is presumed to be in contemplation thereof.
Therefore, a potential acquirer of 3Com may feel less than secure about its ability to annex the latter in a pooling until at least two years have passed from the time the spinoff is completed. A similar, though not identical, variety of prohibition exists on the tax side of the ledger. A spinoff that otherwise qualifies for tax-free treatment will be rendered taxable at the corporate level if it is found to be part of a plan (or series of related transactions) pursuant to which one or more persons acquire stock representing a 50% or greater interest in either the distributing parent or distributed subsidiary. Sec. 355(e).
This so-called anti-Morris Trust rule contains a presumption that any such acquisition, that occurs during the four-year period beginning two years before the spinoff, occurs pursuant to the requisite plan or series of related transactions. Although the IRS recently proposed regulations describing the circumstances that permit an acquirer to rebut the statutory presumption, those regulations only apply to distributions that take place after the date on which such regulations are issued in final form, perhaps over a year away.
Accordingly, an acquirer may feel queasy about attempting a takeover of 3Com until a full two years have passed from the date of the Palm Computing distribution. Thus, in addition to the well-documented business advantages the spinoff should provide, the transaction may also allow 3Com to preserve its independence, at least until expiration of the two-year takeover embargo arguably imposed by both the pooling rules and Sec. 355(e).
Robert Willens is a tax and accounting specialist at Lehman Brothers Inc. |
