Tax Planning in Initial Public Offerings : The Case of Equity Carve-Outs

We explore the importance of book and tax factors in initial public offerings using equity carve-outs undertaken by publicly traded parents. The advantage of such carve-outs over typical IPOs is that the book and tax positions of pre-IPO shareholders can be accurately estimated due to financial reporting requirements faced by publicly traded parents. We particularly examine why any of the shares offered in the subsidiary IPO would be sold by the parent instead of being newly issued by the subsidiary. Sales of secondary shares occur in 37% of carve-outs, and appear to be tax-disadvantaged in that they trigger sizeable capital gains for parents that could be avoided if primary shares were issued instead. This suggests that either the apparent tax cost borne by parents is overstated, or parents earn offsetting non-tax benefits. We find evidence consistent with both alternatives, particularly the former. Parent corporate capital gains tax rates that are measured on a marginal basis and that take into account the extent to which the carve-out gain would have otherwise been deferred are on average only one-fifth of the statutory capital gains tax rate. Some parents can also increase their net income at no tax cost by selling secondary shares