Abandoned Yahoo Spinoff a Sign That Tax Is Fading as a Deal Driver
Yahoo’s proposed spinoff had been driven by tax concerns. In a world without taxes, Yahoo could have simply sold its Alibaba shares and distributed the proceeds to shareholders. Yahoo will now concentrate on other strategic options, including possibly selling off the core business.
Tax considerations have been responsible for a lot of deal flow of late, including real estate investment trust spinoffs (Darden, Sears, Windstream), new energy master limited partnerships, and, of course, corporate inversions (Coca-Cola Enterprises, CF Industries, Burger King/Tim Hortons). But deal flow tends to be cyclical, and the tax phase is waning.
What these deals all have in common is a reshuffling of ownership structure in order to shield a portion of business profits from the United States corporate tax.
■ In the case of Yahoo, the company wanted to avoid paying tax on the appreciation in the value of its stake in Alibaba.
Marissa Mayer, Yahoo’s chief, had planned to spin off Yahoo’s 15 percent stake in Alibaba and focus her attention on the company’s core business.Yahoo Is Said to End Plan to Spin Off Alibaba Stake
■ In the case of corporate inversions, United States-based multinationals give up American citizenship in order to avoid tax on offshore profits and make it easier to shift United States income offshore.
■ In the case of R.E.I.T.s and energy M.L.P.s, businesses that have traditionally operated as taxable corporations split into parts, shifting as much income as possible into real estate or oil and gas entities that are not subject to corporate tax.
In tax policy terms, the problem is known as the erosion of the corporate tax base.
The government has responded slowly and incrementally, but the sandbags are starting to pile up. Over the last two years, the Treasury Department and I.R.S. have released new guidance on corporate inversions, spinoffs and energy M.L.P.s.
Even Congress is showing signs of life. Representative Kevin Brady, the Republican chairman of the House Ways and Means Committee, has introduced a bill that would take away the tax benefit of spinning off real estate holdings into a newly formed R.E.I.T.
The legislation, part of the year-end package of renewing expired tax breaks known as tax extenders, is likely to pass. Activist shareholders have been pushing for R.E.I.T. spinoffs, also known as OpCo/PropCo structures, at dozens of public companies, including McDonald’s and Macy’s.
We should not be too surprised that the R.E.I.T. legislation comes from the Republican side of the aisle. Executives at McDonald’s and Macy’s might prefer not to find themselves in a situation like that of Yahoo’s chief executive, Marissa Mayer, who has been distracted from her efforts to turn around the business by Byzantine tax rules. While the proposed legislation would not completely halt the expansion of R.E.I.Ts, it would reduce the pressure from activist investors to engage in tax-driven restructurings.
The government’s response to inversions, R.E.I.T.s and energy M.L.P.s is more Band-Aid than cure. Democrats like Hillary Clinton and Senator Elizabeth Warren are right to call for legislation that would make these deals less attractive. But Republicans are also right that the deals are symptoms of a diseased tax code.
At some point, Congress will have to address the structural distortions of the corporate tax. Similar economic activity is taxed differently depending on changes in legal form.
■ An American corporation pays tax at a 35 percent rate, and shareholders pay additional tax on dividends or capital gains. A United States partnership pays no tax, but instead passes through income to partners.
■ A United States corporation must pay tax at a 35 percent rate on its worldwide income, but foreign corporations pay tax only on United States source income.
■ Corporations pay tax at 35 percent, but corporations with extensive real estate holdings may qualify as R.E.I.T.s and pay no tax on qualifying real estate income.
■ Corporations pay tax at 35 percent, but publicly traded partnerships with qualifying oil and gas income may qualify to pay no tax.
These arbitrary legal distinctions provide a great playground for tax lawyers, investment bankers and hedge funds. No tax system can eliminate all distortions, but there is room for bipartisan consensus around a corporate tax system with a lower rate, broader base and fewer distortions.
We are all better off when deals are driven by business considerations, not tax considerations. Financial capital should be allocated to its highest and best use, not to companies that have a comparative advantage in avoiding taxes.
Stopgap measures have slowed the pace of tax-driven deals. But unless Congress acts to rationalize the corporate and international tax system, water will eventually find its own level, and tax-driven deals will return to the stage before long.