A Valuable Tool to Unlock Shareholder Value
In our last post, we outlined some of the reasons why corporate spin-offs are used. In this post, we address some of the most common methods used to implement the corporate spin-off.
How do I implement it?
In some cases, a Canadian public corporation seeking to distribute shares of Spinco to its shareholders will be able to do so by a reorganization known as a “butterfly transaction”. The advantage of a butterfly transaction is the deferral of Canadian income tax both at the corporate and shareholder level. The tax rules governing butterflies are highly complex and various restrictions, including prohibitions on certain pre and post-butterfly transactions, may preclude the Parent from using this method.
Depending on the circumstances, other options for a Canadian public corporation to effect a spin-off of Spinco shares are (a) as a dividend-in-kind, (b) a distribution of property as part of a share-for-share exchange, and (c) a distribution of property on a corresponding reduction of stated capital as part of the reorganization of the distributing corporation’s business. Engaging tax counsel is a must.
Spin-Off Dividend. Spin-offs are sometimes achieved by distributing shares of Spinco to the shareholders of the Parent by way of a dividend. This was the method used by Time Warner in its spin-off of AOL. Boards of directors must exercise their business judgment and conclude that the distribution is in the best interests of the Parent. Directors, too, will need to comply with corporate laws designed to ensure that the Parent is, after the payments are made, still able to satisfy its liabilities as they become due.
In the context of a Canadian corporation, the dividend-in-kind (i.e. satisfied by the distribution of Spinco shares) would be taxed in the hands of the shareholders as a regular dividend (i.e. non-eligible dividend or eligible dividend if so designated for Canadian tax purposes by the payor corporation).
Reduction of Stated Capital. The Parent may be able to distribute shares in Spinco to its shareholders by way of a reduction of stated capital. In certain circumstances, this will be treated as a tax-free return of paid-up capital rather than a taxable dividend. The corporate statutes in Canada, however, generally provide that a corporation must obtain the approval of its shareholders (by a special resolution) in order to reduce its stated capital.
Plan of Arrangement. The advantage of a plan of arrangement is that it enables the Parent to effect a custom, multi-faceted transaction in a flexible and efficient manner. For example, a plan of arrangement is commonly used to effect a spin-off by way of a butterfly transaction or share-for-share exchange. Through a plan of arrangement, the distribution of Spinco shares by the Parent to its shareholders can also benefit from prospectus and registration exemptions under National Instrument 45-106 – Prospectus and Registration Exemptions. In addition to seeking court approval for the plan of arrangement, the Parent will need to take appropriate steps to obtain shareholder approval (possibly including approval from other securityholders, such as bondholders).