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Yahoo fails to get IRS blessing for tax-free Alibaba spinoff

[NEW YORK] Yahoo! Inc failed to get the advance approval it sought from US officials for a plan to spin off its stake in Alibaba Group Holding Ltd without incurring taxes. The Web company may proceed with the transaction anyway.

The Internal Revenue Service told Yahoo that the government wouldn't grant its request for a ruling, and Yahoo then withdrew its petition, the company said in a regulatory filing on Tuesday. The IRS "was not ruling adversely on the request," Yahoo added. Yahoo shares fell 3.8 per cent in extended trading.

Yahoo said it sought advice from its legal advisers, and they said the IRS's actions haven't changed their opinion that it can satisfy the requirements for tax-free treatment of the spinoff of the shares in Alibaba. The setback may erode the appeal for shareholders who bought Yahoo betting they essentially would get a tax-free payout when the deal closes.

"Yahoo's board of directors will continue to carefully consider the company's options, including proceeding with the spinoff transaction on the basis of an opinion of counsel," the company said in the filing.

Failure to get a decision by the IRS casts doubt over how and when the company will monetize its US$23 billion stake in Alibaba. Yahoo announced plans in January to conduct a tax-free spinoff of its shares in the Chinese e-commerce giant, seeking to maximize the return of cash to shareholders.

"It's just incremental uncertainty," said Brian Wieser, an analyst at Pivotal Research Group. "It's just that we now have less certainty about it being tax-free - and more to the point, less certainty about the timing."

The Alibaba spinoff is a critical step for Chief Executive Officer Marissa Mayer after coming under pressure from Starboard Value LP and other investors to return cash to shareholders, find ways to cut taxes and avoid major acquisitions.

"Federal law prohibits the IRS from discussing specific taxpayers," said an agency spokesman, Dean Patterson. Rebecca Neufeld, a spokeswoman for Sunnyvale, California-based Yahoo, declined to comment.

Yahoo asked the IRS in February to rule on the spinoff of its 15 per cent stake in Alibaba. Yahoo has said that it will include its small business unit, which has a fraction of the profit of Yahoo as a whole, with the Alibaba shares, in order to fulfill the requirements for a tax-free spinoff.

The process appeared to be on track until May, when an IRS official raised questions about certain spinoff rules. The agency indicated that there were concerns about transactions in which a small operating business folded into a larger company for the purposes of a spinoff, a situation similar to the proposed Yahoo transaction. In July, the IRS formally announced it was studying new guidance on the topic.

"I believe the spinoff will proceed as planned and, in the final analysis, will be found to be tax-free," said Robert Willens, a New York-based tax consultant.

The agency had no update late Tuesday on its broader examinations of its policies on private letter rulings and spinoffs.

Scott Levine, a tax partner at the Jones Day law firm, said he wasn't surprised that the IRS didn't grandfather Yahoo's request, even though it was submitted months before the government signaled that it was rethinking some of its policies. If he were advising Yahoo, Levine said he would urge the company to move sooner rather than later in the event the IRS decides to change its policy. So far, the IRS hasn't provided any detail on whether and how it will alter its approach.

"They're still being very coy about it," he said.

BLOOMBERG