Yahoo's spinoff of Alibaba stake in 'uncharted territory' after IRS waffles on tax-free status

A crucial deal for Yahoo has hit a snag after the IRS refused to bless the Internet company's proposed spinoff of its $23 billion stake in Alibaba Group as a tax-free transaction.

Despite the rebuff, Yahoo emphasized Tuesday that the IRS didn't rule out the possibility that the spinoff could still be completed without triggering taxes on the profits that the company has accumulated from its initial $1 billion investment in Alibaba, which runs some of China's most popular online services.

Even so, Yahoo withdrew its request for an IRS ruling on the matter, according to a Tuesday regulatory filing.

The IRS's indecision raises uncertainty about the value of Yahoo's most prized asset and could intensify pressure on CEO Marissa Mayer to boost the company's slumping stock. The proposed spinoff is now in "uncharted territory," Evercore analyst Ken Sena wrote in a Tuesday research note.

Yahoo is still proceeding with its plans to place the Alibaba stake and a small-business service into separate company called Aabaco Holdings, while its board members "carefully consider" other options, according to the regulatory filing.

Investors interpreted the IRS development as a setback, causing Yahoo's stock to fall $1.22 to $29.68 in Tuesday's extended falling. The shares have already dropped nearly 40 percent so far this year amid mounting frustration with Mayer's inability to revive Yahoo's revenue growth more than three years into her tenure.

Yahoo's stock still has nearly doubled since Mayer became CEO, largely because Alibaba has been thriving, although it has been hurt by a slowdown in China's economy. Yahoo's stake is currently worth about $23 billion, down from $40 billion at the start of the year.

The Alibaba holdings will be worth even less if Yahoo has to pay taxes on its gains. If the Alibaba stake is taxed, it will be worth about $22 per share to Yahoo stockholders instead of $31 per share in a tax-free spinoff, Sena estimated.

Yahoo "is likely to face a higher bar to satisfy tax authorities, and this news will at least lengthen the process for the proposed spin," Sena wrote.

Mayer has been hoping to complete the spinoff by the end of this year. Yahoo, based in Sunnyvale, California, declined further comment beyond its filing.

The spinoff may now hinge on the opinion of Skadden, Arps, Slate, Meagher & Flom, the law firm assessing the tax implications of the deal. The firm told Yahoo that the IRS's ruling didn't reflect any change to U.S. laws, nor would it prevent its attorneys from making their own determination about whether the deal can be done tax free.

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AP Technology Writer Brandon Bailey contributed to this story.