What are the tax implications for both the company and investors in a divestiture from a publicly traded company?

In finance, divestiture is defined as a reduction of a company's assets as a result of asset closures or the selling of business units, subsidiaries, divisions or assets to other corporations or individuals. A selling company typically receives consideration for assets such as cash, securities or other assets. Divestitures take the form of spinoffs, equity carve-outs, subsidiary stock sales and subsidiary asset sales. Spinoffs and equity carve-outs are usually not taxable events for the divesting company and its shareholders. Capital gains on subsidiary stock sales and subsidiary asset sales are usually taxable for the divesting corporation. If a parent company distributes proceeds from the sale to its shareholders in the form of dividends, such proceeds are taxable for shareholders.

Spinoffs involve a parent company distributing shares of its subsidiary to shareholders on a pro rata basis. Spinoffs involve a no-cash exchange and are tax-free for the parent company and its shareholders if certain requirements regarding control of the subsidiary and timing of the spinoffs are satisfied. To be tax-free, spinoffs must involve a distributing controlling package of shares to investors, continuing interest and control requirements, and the subsidiary must not have been acquired by the parent company in the previous five years in a taxable transaction. An example of a tax-free spinoff is AOL, which was spun off from Time Warner in 2009.

An equity carve-out, sometimes called a partial initial public offering (IPO), involves a parent company selling a percentage of the equity of a subsidiary on the stock market. Usually, parent companies sell a little less than 50% of the total common shares and retain control over the subsidiary. The carve-out transactions are tax-free for the parent company and its shareholders. An example of a successful equity carve-out is the sale of ThermoLase by Thermo Electron Corporation.

A subsidiary stock sale involves a parent company selling secondary shares of the subsidiary to the public on the stock market. The parent company must recognize taxable gain equal to the difference between the cash proceeds and the tax cost basis in the subsidiary's shares. If the parent company does not distribute sale proceeds to its shareholders in the form of a regular dividend, the subsidiary stock sale is tax-free for the shareholders of the parent company. Otherwise, investors must pay taxes on any proceeds received from the divesting company.

A parent company may sell a portion of the subsidiary's assets, such as equipment, real estate or patents, recorded on the balance sheet of the subsidiary. Such asset sales almost always trigger gains that are taxable for the parent company. If the parent company does not distribute proceeds to its shareholders from the asset sale, there are no tax implications for investors. However, if the company makes a dividend distribution, the divesting company's shareholders must pay taxes on such proceeds.