Yahoo's tax-free plans for Alibaba stake clouded by IRS

[NEW YORK] Yahoo! Inc. investors have reason to worry about the company's plan to exit its stake in Alibaba Group Holding Ltd in the wake of new scrutiny by the Internal Revenue Service of such tax-free spinoffs, tax lawyers said.

In January, Yahoo announced a plan to shed its shares in Alibaba, a stake then valued at almost US$40 billion. A US company would typically face a federal tax bill of about 35 per cent when it sells stock in another company for cash.

Yahoo is structuring its deal as a complex spinoff, putting its Alibaba stake into a new company that will also own an online service for setting up and running small enterprises. Shares in the new company would then be distributed to existing Yahoo shareholders, which the company hopes will ensure tax-free treatment for the deal. The transaction could save as much as US$16 billion, according to a report from Bloomberg Intelligence.

On Tuesday, however, an IRS official said the agency is "thinking about" changes in how it treats spinoffs involving businesses that are small compared with a company's other assets.

The potential change in IRS policy "absolutely could affect the Yahoo deal," said Jason Factor, a tax attorney at Cleary Gottlieb Steen & Hamilton LLP in New York.

"It is very unclear - I expect deliberately so -- whether any sort of grandfathering rule might apply, and whether ruling requests currently in the pipeline will ultimately continue or get held up." He added: "I cannot imagine that this is not fully deliberate, and with an eye to the Yahoo deal."

SEEKING ADVICE

Companies such as Yahoo typically ask the IRS for advance rulings on those kinds of transactions to get comfort they will pass tax muster. The IRS official, Isaac Zimbalist, on Tuesday said the agency will hold off on such requests for new rulings going forward as the issue is studied. Requests for rulings that are already in the pipeline will move forward, though that is subject to change, too, he said.

The IRS is prohibited from discussing specific taxpayers. Yahoo filed its ruling request with the agency in the first quarter of this year and continues to work toward completing the planned spinoff in the fourth quarter, the company said in a statement.

Even as the agency considers a change, Yahoo is being advised in its effort by William Alexander of Skadden, Arps, Slate, Meagher & Flom LLP. Alexander joined the firm after working as associate chief counsel, corporate in the IRS's Office of Chief Counsel and was a central figure in previous IRS decisions on the spinoff issue.

LITTLE NOTICE

For years, the IRS paid little if any attention to the size of an active business inside a company that was spun off, said Scott Levine, a partner at Jones Day LLP who was on a panel with Zimbalist at Tuesday's event in Washington.

The IRS "seemed to be OK with that," Mr Levine said.

Mr Levine described the IRS announcement as a "very deliberate statement" that included a reference to public attention to spinoffs. He said it wasn't clear how the IRS would apply any new thinking to requests already in the agency's pipeline.

Yahoo shares gained 4.4 per cent to US$42.79 at the close Wednesday in New York, after falling 7.6 per cent on Tuesday.

BLOOMBERG