3a. Why is the Micro Focus deal taxable to
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Summary: Whether this was one of HPE's original intentions or not, HPE's outside tax counsel believes that the transfer of HPE's software business to the UK-based Micro Focus will be penalized by the US Government as a "corporate inversion" -- a process by which companies move their legal home overseas to reduce their US tax bill.
Details on the temporary corporation "Seattle SpinCo"
The original Sept 7, 2016 HPE announcement says "The transaction is expected to be tax-free to HPE." (emphasis added.) By contrast, the HPI/HPE split was originally announced as "tax-free to HP’s shareholders" and the DXC spin/merge as "tax-free to HPE and CSC and their respective shareholders."
The HPE cost basis letter, dated September 26, 2017, says "Dear Shareholder" but was not mailed to shareholders.
It says: "HPE received an opinion of counsel from Skadden, Arps, Slate, Meagher & Flom... ... subject to the application of the gain recognition provisions of section 367(a)(1) of the Code. As a result, you generally do not recognize gain or loss for U.S. federal income tax purposes on receipt of the Seattle Class A common stock in the Distribution, but U.S. shareholders will be required to recognize gain (but not loss) on the exchange of their Seattle Class A common stock for Micro Focus ADSs." [emphasis added] (The document has no letterhead or logo. To authenticate it, go to the HPE investor page and select "Software/Micro Focus Cost Basis.")
The December 15, 2017 FY 2017 Annual Report says on page 27: "We obtained a private letter ruling from the IRS regarding certain matters impacting the U.S. federal income tax treatment of the completed separation of our former Enterprise Services business..." [i.e. the DXC spinoff] and "We have applied for a private letter ruling from the IRS regarding certain U.S. federal income tax matters relating to the Software Separation..." [i.e. the Micro Focus spinoff.]
Whether this was one of HPE's original intentions or not, the Micro Focus spin-merge is apparently being penalized by the U.S. Government as a "corporate inversion."
"Corporate inversion is the process by which companies move overseas to reduce the tax burden on income. One way that a company can re-incorporate abroad is by having a foreign company buy its current operations. The foreign company then owns the assets, the old corporation is dissolved, and the business -- while it remains the same in its daily operations -- is now effectively domiciled in a new country... Corporate inversion is a legal strategy and is not considered tax evasion." Investopedia
The Federal law behind this is 26 US Code 367 -- "Foreign corporations. Transfers of property from the United States." See https://www.law.cornell.edu/uscode/text/26/367 (Cornell Law School's Legal Information Institute -- "a small not-for-profit group that believes everyone should be able to read and understand the laws that govern them, without cost.")
From page 4 of the letter: "The information set forth above and in the attached exhibits is for general information purposes only and does not purport to address all aspects of federal taxation that may be relevant to particular shareholders. This information does not constitute tax advice and may not be applicable to shareholders who are not citizens or residents of the united states. Nor does it address tax consequences which may vary with your individual circumstances. Accordingly, you are urged to consult your tax advisors to determine the application of the information set forth above and in the attached exhibits to your individual circumstances and the particular federal, foreign, state and local tax consequences of the spin–off to you." [Converted from all upper case.]
The only other place we have found where HPE covers the US tax issue is in the Seattle SpinCo SEC filing of 8/3/17 (page 54)
Documents on the Micro Focus website: "Tax Documentation Cover Letter" (The document has no letterhead or logo. To authenticate it, go to the Micro Focus ADR page and select the "Seattle SpinCo, Inc / Micro Focus Merger Tax Documentation Additional Information" link.) There is a link in that document to find Micro Focus Form 8937.
How to treat this on your 2017 US taxes: go back to 3. Micro Focus Tax
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