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How to improve focus on capital and operations in a tax-free spin-off

The tax-free spin-off road map outlines the most critical steps to completing a successful transaction.

In brief

  • Spin-offs can create value through more focused capital allocation, including M&A, because SpinCo can control free cash flow and investment decisions.
  • When successfully executed, spin-offs allow for improved operations and management focus on the core business, removing redundant systems and infrastructure.

Tax-free spin-offs are extremely complex and must satisfy many legal and regulatory requirements. Failing any of those requirements can result in shareholder and/or corporate-level tax. Understanding potential spin-off capital structure and associated costs is also critical in making a transaction decision. Below are key questions to ask, and the analyses to determine if a transaction is feasible from a tax and capital structure perspective.

Will a tax-free spin-off achieve your business objectives?

  • A spin-off must effectuate a complete operational separation of RemainCo and SpinCo, and RemainCo generally must distribute all of its stock of SpinCo.
  • Both RemainCo and SpinCo must have at least one qualifying active trade or business (ATB) that has been conducted continuously for five years immediately prior to the spin-off.
  • A tax-free spin-off cannot be part of a shareholder plan to dispose of a controlling interest in either RemainCo or SpinCo, which can significantly restrict post-spinoff M&A activity.
  • Spin-offs present only a limited ability to monetize SpinCo value.

Do you have a valid corporate business purpose for the spin-off?

  • The spin-off must be motivated in whole or substantial part by a real and substantial non-federal tax purpose germane to the business of RemainCo, SpinCo, or their respective affiliates (i.e., a shareholder purpose alone does not qualify as a “corporate business purpose”).
  • The corporate business purpose needs to clearly demonstrate the need for the spin-off.

Do RemainCo and SpinCo each have an ATB?

  • Both companies must have at least one qualifying ATB, which means more than simply “conducting a business.”
  • The ATB’s key business functions must be performed by employees of RemainCo, SpinCo or their affiliates; independent contractors are excluded from the analysis.

Can you restructure your outstanding debt in a tax-efficient way?

A spin-off can require a company to restructure its debt, potentially at a large or prohibitive cost.

Below are critical steps for each of the workstreams during a spin-off transaction:

  1. Transaction governance
  2. Capital markets and structure
  3. Tax
  4. Financial reporting
  5. Operation separation

Chapter 1

Transaction governance

Four critical steps in a spin-off transaction for transaction governance.

1. Establish governance with clearly defined roles. Define spin-off game plan, form transaction team and communicate objectives to kick off the new transaction efficiently and avoid a slow start.

2. Develop timeline and key milestones to manage successful separation execution.

  • Define the separation timeline and align workstreams to key deadlines and milestones to maintain momentum, track progress and target the desired close date
  • Set targets, delegate and monitor progress through reporting in order to manage the complexity of a spin-off and maintain accountability

3. Develop communication strategy and plan. Decide which internal and external stakeholders should know about the transaction and strategic plans before they are public, and develop messaging accordingly.

4. Engage SpinCo leadership and establish SpinCo Board.

  • Consider the appropriate role of SpinCo management; SpinCo management is typically involved in SpinCo organizational design and setting the strategic vision because it will be responsible for execution
  • Establish board of directors’ oversight and knowledge of key events through the entire process; there should be routine dialogue between the board and management

Chapter 2

Capital markets and structure

Five critical steps in a spin-off transaction for capital markets and structure.

1. Propose capital structure for each company based on its cash flow and growth profile.

  • Review terms of outstanding debt; consider debt to target for exchanges and restructuring in order to minimize transaction costs. Consider currency and cash flows by currency, jurisdiction with tax and treasury team
  • Determine how historical liabilities will be split (e.g., pension, environmental obligations)
  • Assess Day 1 cash requirements to ensure sufficient working capital needs are considered

2. Forecast cash flow and develop a view of stand-alone costs.

  • Will be an input into the pro forma Form 10 disclosures and debt and equity roadshows
  • Helps determine interest and dividend payments available to the market
  • Determine one-time costs and who will pay in order to assess funding needs

3. Determine which business will be retained (i.e., RemainCo) and which business will be distributed (i.e., SpinCo).

  • Legal and/or regulatory restrictions may limit asset or stock transfers
  • Distributing business with lower inherent tax gain may be preferred

4. Determine profile of the stock to be distributed (e.g., voting rights, distribution ratio, dividend policy).

  • Consider the distribution ratio and a reverse stock split if the anticipated share price is suboptimal
  • A split-off may benefit from a subsidiary IPO to set the market price, allowing for an exchange offer

5. Develop the equity story for roadshows to garner sufficient market interest and avoid post-close sell-off.


Chapter 3


Seven critical steps in a spin-off transaction for tax.

1. Develop a legal entity step plan.

  • Mitigates potential business, operational, financial and tax impediments and costs
  • Legal entities with commingled operations, multiple non-US jurisdictions, and legal or regulatory restrictions on transferability of assets drive transaction complexity
  • Legal and/or regulatory restrictions may limit asset/stock transfers

2. Determine tax basis, earnings and profits (E&P) and fair market value (FMV).

  • Appreciation (i.e., excess FMV over tax basis) of the existing businesses may drive the decision regarding the identity of RemainCo and SpinCo
  • RemainCo can generally “monetize” its investment in SpinCo to the extent of the tax basis in SpinCo stock
  • The FMVs govern allocation of tax basis and E&P (required for a dividend distribution)

3. Refine the proposed capital structure to optimize tax efficiencies.

  • Allocating existing debt may result in an inefficient capital structure
  • Companies may need to issue new debt to avoid tax costs of assuming existing debt

4. Resolve intercompany agreements and settle accounts to prepare for legal separation.

  • Necessary in order to achieve a complete separation
  • Impacts tax basis, value and debt capacity, and may influence the legal step plan

5. Develop scope and duration of Transitional Services Agreements (TSAs), a tax-sharing agreement and other arrangements.

  • Companies may not be able to operate completely independently immediately following the spin-off
  • Continuing relationships between RemainCo and SpinCo must be of limited scope and duration and generally must be priced at arm’s length

6. Prepare supporting documentation for a tax-free treatment.

  • Contemporaneous support is generally required for tax-free treatment and future audits
  • A tax opinion is necessary in nearly all circumstances – the IRS does not generally issue private letter rulings (PLRs) pertaining to spin-off matters  
  • If a company requests a PLR, the tax opinion may address only those matters not covered by the PLR

7. Prepare public documentation and related disclosures (e.g., tax return disclosures, IRS Form 8937).

  • Required to ensure the company is compliant with IRS and other governmental disclosure requirements

Chapter 4

Financial reporting

Six critical steps for financial reporting in a spin-off transaction.

1. Invest time upfront to properly plan for preparing SEC-compliant historical carve-out financial statements.

  • Timely completion of the audited carve-out financial statements (generally a four- to six-month process) is critical to achieve transaction timelines and being able to complete other financial reporting work streams (e.g., MD&A, pro forma financial information, credit rating agency/investor information, etc.)
  • Empower a project manager that understands SEC reporting requirements, sets interim milestones and globally aligns interdependent functions (e.g., management, tax, attorneys, bankers and auditors) in order to prepare carve-out financial statements and complete audits on time
  • Longer lead time items include basis of presentation, corporate cost allocations, push-down of certain assets and liabilities, historical SpinCo acquisitions, goodwill and intangible impairment testing and carve-out tax provisions

2. Develop an IT solution that aggregates data, posts adjustments and supports statement preparation.

  • Having one place to store all data for multiple outputs (e.g., audited and pro forma financial statements, rating agency financials, discontinued operations) can minimize version control issues, data problems and re-work
  • Align with tax to track and compile adjusted information at a granular enough level to enable carve-out tax provisions by jurisdiction

3. Complete external audits of historical carve-out financial statements.

  • Address basis of presentation matters as audited financial statements may not necessarily equal SpinCo deal basis
  • Involve auditors early and often to align on management conclusions and approaches to audit testing and support
  • Lower levels of materiality lead to unaccustomed depth of audit testing 

4. Compile pro forma financial information.

  • Adjustments can include impact of new capital structure, impacts of various transaction agreements, asset/liability transfers, employee liabilities triggered upon sale and distribution, and ratio on earnings-per-share calculations
  • Do not underestimate effort required and potential stakeholder scrutiny of standalone and one-time cost disclosures

5. Plan for SEC registration and review.

  • Put forward your best effort into completing the initial Form 10 filing and initial comment letter response to avoid a prolonged review process
  • Understand anticipated timing for initial filing, SEC review process and amendments, reporting deadlines, holidays and “stale” dates
  • It can take four to five months (and four to five amendments) from initial Form 10 filing to SEC declaring your filing effective — important to adhere to publicly communicated timelines
  • Anticipate SEC hot-topic matters (e.g., revenue recognition, segments, executive compensation, MD&A)

6. Anticipate post-spin reporting matters.

  • Plan early as preparation for post-spin filings has to run concurrent to SpinCo’s SEC registration process
  • RemainCo may have numerous reporting requirements, including reporting SpinCo within discontinued operations and filing Form 8-K within four business days from spin date
  • SpinCo must file its first Form 10-Q for the quarter following the most recent period included in the Form 10 (later of 45 days after the effective date or the date the Form 10-Q would otherwise be due)

Chapter 5

Operational separation

Five critical steps in operational separation, and in functional separation across IT, HR, finance and supply chain and manufacturing.

1. Define the operating model of both companies.

  • Understanding current state operations in detail is key to minimizing delays and cost overruns
  • Define the Day 1 and future state operating model, including employee allocation, and align it to post-spin strategic objectives
  • Right-size the organizations — an optimized future operating model can enhance deal value

2. Determine level of separation on Day 1.

  • Different transaction rationales call for different degrees of separation on Day 1 (e.g., short timeline, complexity to separate systems)
  • Regulatory bodies generally look for complete separation within two years (IT can be the exception)
  • A high degree of separation will accelerate the need to manage RemainCo’s stranded costs

3. Define TSA requirements and governance model. Understand requirements and cost to deliver services on Day 1, as well as exit strategy.

4. Assess time required to establish new legal entities.

  • Requirements to establish new legal entities vary by jurisdiction and industry and can take over a year to complete
  • Failure to act expediently can delay establishing bank accounts, contracting with vendors, configuring systems, establishing processes, selling product and other activities, and can delay closing

5. Develop public-company governance and corporate infrastructure.

  • Management and the board must be prepared for public-company responsibilities — e.g., they must be ready to file financial statements with the SEC post-close
  • SpinCo can set new corporate governance structure to eliminate legacy challenges

Functional separation considerations


IT is often the most entangled functional area; it requires the most lead time and it’s one of the most expensive to separate. Key activities include assessing the current system landscape; allocating systems, capabilities and infrastructure; segregating access and data; defining the Day 1 IT operating model; and, at times, creating separate IT system architectures for SpinCo and RemainCo.


A spin-off puts strain on the finance organization. Form 10 preparation, separation accounting, as well as SpinCo standup and SEC reporting, create double duties for an organization that still has ongoing business responsibilities.


SpinCo generally needs to create a new HR and benefits infrastructure:

  • Transferring employees may require union consultations, new country-specific payroll and benefits setups
  • An employee communications strategy should address transition arrangements, time off, compensation, year-end processes and changes to health or pension benefits
Supply chain and manufacturing

Interdependencies can significantly affect SpinCo’s Day 1 operating model and separation efforts. Key impacted areas include:

  • Order-to-cash and purchase-to-pay processes
  • Corporate organization and principal company/tax effective supply chain management (TESCM) model
  • Long-term supply agreements with RemainCo and facilities and logistics networks


In its operational, regulatory and strategic complexity, a tax-free spin-off is something of a three-part challenge: as demanding as any business carve-out, with added requirements akin to those of an IPO, plus the close involvement of tax authorities and the SEC. In assessing the most critical steps of a tax-free spin-off, companies can better understand whether a spin is feasible and how to complete a successful deal.

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