IRS, Treasury Unlikely To Approve Yahoo's Alibaba Spinoff

Yahoo! Inc. YHOO said Wednesday in a press release that its board of directors have unanimously "decided to suspend work" on the proposed spinoff of its $31 billion Alibaba Group Holding Ltd BABA stake.

Change Of Plans

Instead, Yahoo will be spinning off its core assets, including its stake in Yahoo Japan into a new company.

Maynard Webb, chairman of Yahoo's board of directors said the company was previously working under the assumption that the spinoff of Alibaba would result in a tax-free transaction. However, he cited the "market's perception of tax risk" as the tax-free nature of the spinoff was called into question.

Related Link: Yahoo To Suspend Alibaba Spinoff, Explore Other Options

Capstone analyst Max Reale commented that the U.S. Department of the Treasury and the U.S. Internal Revenue Service are unlikely to approve and could take action to block Yahoo's 1.69 percent proposed tax-free spinoff of its stake in Alibaba.

Reale stated the agency is considering changes to rules concerning spinoffs and resulting taxation. "Furthermore, he announced the IRS will temporarily suspend any ruling requests received starting as of the announcement to allow the agency to further study the issue," he wrote.

He continued that based on conversations with tax lawyers and lobbyists, the IRS officials' comments were "carefully choreographed" by both the IRS and Department of the Treasury, and "were designed to send a message to Yahoo concerning the Alibaba spinoff, though neither company was mentioned by name."

Concerns Moving Forward

Capstone's analyst had two main concerns regarding the potential for an adverse ruling. First, Yahoo's approximate stake in Alibaba is valued at $34 billion and a tax-free spinoff is designed to save nearly $11 billion. According to law firm Wachtell, Lipton, Rosen & Katz, there were 201 spinoffs announced in 2013 and 176 in 2012, with aggregate values of $33 billion and $41 billion, respectively.

Secondly, Yahoo "barely reacted" to the IRS comments and was "dismissive of the potential threat," Reale said. Moreover, the company's only public reaction amounted to a two-sentence statement in which the company announced it will continue as planned with the spinoff and does not believe it will be affected by the comments.

He estimated an adverse change in the tax code could result in over $11 in tax expense per Yahoo share. "It appears that Yahoo shares are reflecting little likelihood that the transaction will not go through as planned," Reale said.