General Electric Co.’s plan to split itself into three companies will likely win the tax-free treatment for shareholders that it is seeking, once it clears a few obstacles, tax attorneys and practitioners said.
The company will separate via spinoffs in 2023 and 2024 that are intended to be free of U.S. federal income taxes, it announced Tuesday. Those plans appear to meet the basic requirements for tax-free treatment from the IRS, like having a legitimate reason for the spinoffs, said Gregory Kidder, a Steptoe & Johnson LLP tax attorney.
“This looks like a fairly vanilla spinoff to create three separate companies,” he said.
“I don’t believe they should face any insurmountable obstacles for either spinoff,” said Linda Swartz, chair of the tax group at Cadwalader Wickersham & Taft LLP.
But there could be a catch, said Robert Willens, a New York-based tax attorney and corporate tax practitioner. Further into the weeds, he said, the IRS might question GE’s retention of a significant stake in one of the companies to be spun off.
“They don’t seem to be meeting all the conditions that you have to meet in order to prove to the IRS that your retention is not motivated by tax avoidance,” Willens said.
GE expressed confidence in its approach, saying in an emailed statement that the plan was “aligned with precedent spin-offs” comparable to its own.
Tax Code Requirements
The plan calls for a tax-free spinoff of its healthcare business in early 2023. That will be followed by the spinoff of its renewable-energy, power, and GE Digital businesses as one company tax-free in early 2024, leaving the remaining GE as an aviation-focused company.
GE said in its announcement Tuesday that it expected to incur tax costs of less than $500 million as a result. According to the company, the spinoffs themselves will be tax-free for the company; the $500 million figure will be non-U.S. tax costs related to the restructuring needed to separate its global operations.
Corporate spinoffs are taxable, but they can win tax-free treatment if they meet a variety of requirements under tax code Section 355. They have to demonstrate that the parent company is relinquishing control over its spun-off unit, for instance, and that the spinoff has a real business purpose—that it isn’t simply aimed at avoiding taxes, or acting as a device for distributing a unit’s profits to shareholders.
GE has been trying to slim down in recent years, amid business problems and accounting irregularities. In announcing the split, GE said its spinoffs would better position the three independent companies “to deliver long-term growth and create value for customers, investors and employees,” with deeper operational focus, more-tailored decisions about allocating capital, and strategic and financial flexibility.
“It seems like there’s a good business strategy for why you want to do the separation,” Kidder said.
But Willens and Swartz said GE’s plan to retain a 19.9% stake in the healthcare spinoff could draw greater IRS scrutiny. GE said it would hold on to the stake to provide flexibility in allocating capital, but parent companies ordinarily don’t hold any stakes in their spinoffs, and the company will have to prove to the IRS that the move isn’t aimed at avoiding taxes, Willens said.
“There has to be a good business reason for retaining any stake in a spinoff,” Swartz said.
In addition, GE says its chairman and CEO, Larry Culp, will be non-executive chairman of the healthcare company after its spinoff, even as he continues to lead GE, and then remain as leader of the GE aviation company after both spinoffs are completed. The IRS frowns on overlaps between the boards or senior leadership of parents and spinoffs, and GE will have to explain to the IRS why Culp’s involvement is necessary, Willens said.
GE’s plan to have its healthcare spinoff issue debt might pose another roadblock. Congressional Democrats’ tax and spending plans would impose greater restrictions on leveraged spinoffs, Willens said, and if such a plan is enacted, GE is “not going to be able to extract that money from GE Healthcare on a fully tax-free basis.”
But “you have to think they have drafted their debt plans with those proposals in mind,” Swartz said. “I would not expect it to block their spinoffs.” In its announcement Tuesday, GE said the proceeds from the healthcare company’s debt issuance will be used to pay off other outstanding GE debt, and all three companies should have investment-grade credit ratings.
The GE split is happening as many other companies are seeking certainty from the IRS about the tax treatment of their spinoffs. Companies have sought and obtained private letter rulings, or PLRs, from the IRS to ensure that they won’t be taxed when they spin off a subsidiary. GE says the tax-free treatment of its spinoffs would be subject to PLRs and tax opinions from its legal counsel.
The IRS has been working for the past few years to prepare what it has called a “one-stop-shop” for guidance under Section 355, working to combine multiple pieces of guidance for the tax treatment of spinoffs in an effort to make things simpler for taxpayers.
“It’s an active project, and we want to get it out as soon as possible,” Brian Loss, an IRS senior technician reviewer, said in May.
If the IRS guidance were to be issued before GE formally requests tax-free treatment for its spinoffs, its requests would fall under the new regulations, Kidder said.