Spin-off by subordination

The term "spin-off by subordination" was used by Professor Ignacio Sanín Bernal in his book A new right societies; the one proposed from the statute tributaries (Temis, 2001, p. 249) to indicate that when the beneficiary of a spin-off is the subsidiary of the spin-off, the use of book value as a method of valuation and exchange of shares would be irrelevant (and even advisable), since the beneficiaries would be exactly the same shareholders, in the same proportions. The purpose of this article is to justify the viability of this spin-off mechanism, in accordance with the doctrinal developments that have taken place in recent years.

Law 222 of 1995 established, in its article 3, that there is a spin-off when a company -whether dissolving or not- transfers en bloc one or more parts of its assets to one or more existing companies or allocates them to the creation of one or more companies. It also states that, unless the highest corporate body unanimously decides otherwise, "the partners of the spun-off company will participate in the capital of the beneficiary companies in the same proportion as they have in the former".

It has been understood by the doctrine that when a company splits a portion of its equity to incorporate it to one of its subsidiaries, and it is the splitting company (and not its shareholders) that receives in exchange shares of the beneficiary company, it will be an improper spin-off or segregation, an operation that is really a contribution in kind. The Superintendence of Finance, through External Circular 05 of 2005 (numeral 2.6), stated that through this operation the segregating company "allocates one or several parts of its equity to the incorporation of one or several companies or to the capital increase of already existing companies, which will be called "beneficiaries", generally in the form of contributions in kind. In return, the segregating company receives shares, quotas, or parts of interest of the beneficiary companies". Because the shareholders of the spin-off company do not participate as shareholders of the beneficiary company, the spin-off has not really been considered, by the doctrine, as a type of spin-off and could not be considered as a tax neutral operation because it does not comply with the requirements of article 319-6 of the Tax Statute. However, the Superintendence of Securities has indicated that if the spin-off generates an equity impairment in the shareholders, they may exercise their right of withdrawal, a procedure that can only be exercised in a spin-off process and not in one of contribution in kind (Concept 20057-1579 of September 14, 2005).

In 2019, by means of Official Letter 220-046656 of May 16, the Superintendence of Corporations recognized the viability of the reverse spin-off indicating that "the spin-off of the subordinate company in favor of its parent company is viable, by means of which it is feasible for the subsidiary company to transfer a patrimonial block in favor of its parent or controlling company".  This operation follows the same logic - but in the opposite direction - as the reverse merger, where the subsidiary absorbs the parent company. The only difference between the dynamics of both operations (merger and reverse spin-off) is that the spin-off does not always have to be total (as in the merger) but can be partial (partial reverse spin-off where the subsidiary subsists after segregating part of its equity to the parent company).

In view of this, consider the case of company A, parent and sole controlling company of company B, whose shareholders are C and D. If A wanted to spin off and transfer a line of business or a place of business to B (spin-off by absorption), it could do so and in such case the shareholders C and D (being the owners of the assets being spun off) would become shareholders of B. If, after the spin-off, A retained control of B (by majority shareholding in the capital or by any other circumstance), the spin-off would be a typical "spin-off by subordination" (organizational spin-off by absorption between parent and subsidiary where the shareholders of the parent would also become shareholders of the subsidiary). If, in addition, in the operation the requirements of participation, consideration and minimum holding were preserved, the spin-off by subordination would not be taxable for the intervening entities and for the shareholders in the light of article 319-6 of the Tax Statute.