Sanofi to Acquire Inhibrx in Taxable Spin-Off Plus Merger

By Stuart E. Leblang, Michael J. Kliegman and Amy S. Elliott

On January 23, biopharma company Inhibrx, Inc. (Nasdaq:  INBX) (Inhibrx) and Sanofi (Nasdaq:  SNY) (Sanofi) announced an agreement whereby Aventis Inc. (Aventis), a wholly owned U.S. subsidiary of Sanofi, will acquire Inhibrx via merger (the Merger) after Inhibrx spins off to its shareholders the stock of a newly formed corporation, Inhibrx Biosciences, Inc. (Inhibrx SpinCo) containing all assets not part of the business combination (the Spin-Off). ¹  Specifically, the retained assets will be those associated with INBRX-101, and the spun assets will be all others, including INBRX-105, INBRX-106, INBRX-109, other biopharmaceuticals in its pipeline and the corporate infrastructure.  The Spin-Off and Merger will be fully taxable to the Inhibrx shareholders.

Following the Spin-Off, Aventis will acquire all the stock of Inhibrx in a statutory merger of an Aventis merger subsidiary (Merger Sub) into Inhibrx, with Inhibrx as the survivor.  In the Merger, for each share of Inhibrx stock, shareholders will receive $30 in cash and one contingent value right (CVR) representing the right to receive a contingent payment of $5 in cash upon the achievement of a regulatory milestone prior to June 30, 2027.  The CVRs will not be transferable.  In the Spin-Off, shareholders will receive one share of Inhibrx SpinCo for every four shares of Inhibrx stock held.  In connection with the transaction, Sanofi will assume and retire Inhibrx’s third-party debt and will cause Inhibrx SpinCo to be funded with $200 million in cash.  Only 92 percent of Inhibrx SpinCo will be distributed, with Sanofi retaining an 8 percent interest.²

Tax Treatment of the Spin-Off and Merger

With the merger consideration being solely cash and CVR, the reverse subsidiary merger will be treated as a sale by the shareholders of their Inhibrx stock to Aventis.  We will address taxation of the CVR separately below.  The pre-merger Spin-Off is intended to be treated as a taxable distribution, rather than a tax-free spin-off under Section 355 of the Internal Revenue Code.  For the corporation, taxable gain will be recognized to the extent that the fair market value of the distributed stock exceeds its tax basis.  There is no definitively prescribed method for valuation of the distributed stock for purposes of both corporate and shareholder tax, but it certainly will be based upon the post-spin trading price of the stock.  We note that, for the corporation, the base trading price may be modified upwards by a control premium and modified downwards by a blockage discount generally applicable to valuing large blocks of public stock.

Inhibrx will make a Section 336(e) election with respect to the Spin-Off.  Under that provision and applicable regulations, where there is a taxable distribution of the stock of an 80-percent-or-more owned subsidiary, the election results in a step-up in tax basis of the assets of the distributed subsidiary to fair market value, as if there had been a taxable asset disposition. ³ 

For shareholders, the Spin-Off will be taxed as a dividend to the extent of the current and accumulated earnings and profits (E&P) of Inhibrx.  To the extent the amount distributed exceeds E&P, it will be a return of the shareholder’s basis in its Inhibrx stock, and any excess will be taxable as capital gain.  E&P is a tax concept, somewhere between taxable income and financial statement income.  While the Company’s significant deficit in retained earnings ⁴ implies a deficit in E&P as of 12/31/2023, current income in 2024 (including any gain in the stock of Inhibrx SpinCo) will give rise to dividend treatment, not netting against the accumulated deficit.

Dividend treatment should generally not be a problem for domestic individual investors.  The rate of tax on the dividend portion should ordinarily be the same as for long-term capital gains, under the qualified dividend income rules. ⁵  The drawback to dividend treatment is that the gross amount of the distribution is taxable, with no basis offset.  Here, because the distribution will be followed by a sale of the Inhibrx stock in the merger, the full basis will be utilized in that transaction.  Dividend treatment will, however, be a problem for offshore investors, who face withholding tax of 30 percent (subject to reduction under an applicable treaty) on the distribution.  The withholding tax would likely be “collected” through a reduction in the number of Inhibrx SpinCo shares received.

Could this detriment to offshore investors be avoided?  Under certain circumstances, it may be possible to avoid these consequences, but we do not know if the interests of this constituency were factored into the details of the transaction structure.  If the Inhibrx SpinCo shares were distributed in redemption of a portion of the Company stock held by the shareholders, that would move the tax analysis of the distribution into the Section 302 redemption rules.  Although the distribution is pro rata, under the Zenz doctrine, ⁶ the comparison between the post-redemption and pre-redemption percentages is made taking into account the planned sale of the Company in the subsequent merger.  As such, the redemption would ordinarily qualify as a complete termination of interest under Section 302(b)(3), and as such, be treated as a sale of stock and not subject to dividend withholding tax.

How to arrange for the Spin-Off to be viewed as a redemption of stock?  In order to have a redemption, there must be an actual reduction in the number of Company shares each shareholder will own immediately after the distribution.  There are a few approaches to working this out mechanically for a public company, but it seems the most direct approach in this case would be to add the Inhibrx SpinCo shares to the merger consideration.  Under well-established authority and practice, where a reverse subsidiary merger is used to effect a taxable transaction stock sale, consideration received by the Target shareholders that is held by the Target corporation (rather than coming from the purchaser) is treated as received in a redemption distribution. ⁷ 

One countervailing consideration is the stock buyback excise tax under Section 4501 of the Code.  As confirmed by the recently published proposed regulations that supplement and replace prior guidance, distributing Inhibrx SpinCo stock in a taxable redemption transaction would attract a tax of one percent of the fair market value of the redeemed shares, presumably approximately equivalent to the value of the Inhibrx SpinCo stock.⁸ 

Finally, we have to ask:  Do we know for sure that the Spin-Off will not qualify for tax-free treatment under Section 355?  That provision is not technically elective, so that the Spin-Off cannot be definitively ruled taxable absent one or more technical disqualifications.  First, even if the Spin-Off met the requirements under Section 355, it would in any case be taxable at the corporate level under the Section 355(e) anti-Morris Trust rules.  Essentially, those rules provide that an otherwise tax-free spin-off will be taxable to the distributing corporation if the spin-off is part of a plan resulting in the shareholders of the distributing corporation not retaining a majority of the stock of both the RemainCo and the SpinCo.  Because of the prearranged sale of the Company to Sanofi, the rule would be triggered.

As to the Spin-Off’s qualifying under Section 355, we see three problematic areas.  One is whether the transaction would satisfy the active trade or business (ATB) test, which requires that immediately after the spin-off, RemainCo and SpinCo each be engaged in an ATB that has been continuously carried on for at least five years.  At a fairly cursory level, it appears that, by the time of the Spin-Off, the Company will have been actively engaged in the research and development of therapies for more than five years.  We note that the IRS has in recent years liberalized its view of the need for both in-house employee activity and revenue, mainly from the standpoint of not insisting that biotech companies have reached the stage of realizing revenue from the therapies that they spent many years working on.  In these circumstances, it seems likely that the IRS could find that the ATB requirement was satisfied.

We think it more likely the Company’s tax advisers are relying more on the planned sale to Sanofi to fully disqualify the Spin-off under Section 355.  In this regard, there are two separate requirements that come into play.  The more familiar one is the “device” test, and the other is continuity of interest, which is more familiar in acquisitive reorganization.  Section 355 requires that the distribution “was not used principally as a device for the distribution of . . . earnings and profits”  ⁹  This is commonly understood to mean that the transaction is being used to enable the shareholders to avoid dividend taxation, mainly by receiving a tax-free distribution and selling the shares of RemainCo or SpinCo.  The regulations indicate that a prearranged post-spin sale of stock of either company is substantial evidence of device. ¹⁰  On that basis alone, most tax advisers would conclude that the Spin-Off most likely fails to qualify under Section 355.

If the steps of the transaction were altered as we suggest above to enable the shareholders to obtain redemption treatment rather than dividend treatment, it would be less clear that the transaction ran afoul of the device test.  This is because the regulations establish something approaching a safe harbor, stating that a “distribution is ordinarily considered not to have been used principally as a device if, in the absence of section 355, with respect to each shareholder distributee, the distribution would be a redemption to which section 302(a) applied.” ¹¹   This would be the case if the Spin-Off were done in the form of a redemption.

Even if this were the case, and device were less of a concern, the continuity of interest requirement could rule the day.  This requirement is not well developed in the Section 355 regulations but does require that the pre-spin shareholders continue to own a significant amount of stock in each of the post-spin companies.  A post-spin stock-for-stock merger will not run afoul of this requirement, but it seems likely that a post-spin prearranged sale of the entire Remainco (as here) would.

Taxation of the CVR

CVRs have become fairly common in pharmaceutical industry acquisitions, but this does not mean that their tax treatment is well understood.  There will eventually be a public disclosure document issued to the Inhibrx shareholders that will include an explanation of how it views the tax treatment of the transaction, including the CVRs.  We expect that the fact that the CVRs are generally not transferable makes it more likely that these will be treated essentially the same as an earnout in a private transaction, i.e., contingent additional consideration that might be received in a future year.  With the exception of an interest component that is imputed in connection with deferred consideration, the $5 to be received in the future will be additional capital gain.  Having initially not taken the CVR into consideration in reporting the tax treatment of the merger, no loss would be realized if the CVR expires with no payment.

There is a technical question regarding whether the deferred realization of the CVR is under the installment method or as an open transaction.  If it is under the installment method, regulations prescribe an approach to basis recovery that defers a portion of the basis until it is determined whether the CVR will result in payment.  If there is none, then there would be a resulting capital loss in a later year.  Open transaction treatment—which is generally purportedly frowned upon by the IRS—may be more common in relation to CVRs and may have the added advantage of allowing for full basis recover in the year of the merger.

^{[1] Press Release, Inhibrx Announces Sale of INBRX-101 to Sanofi for an aggregate value of up to $2.2B, Inhibrx, Jan. 23, 2024 (https://inhibrx.investorroom.com/2024-01-23-Inhibrx-Announces-Sale-of-INBRX-101-to-Sanofi-for-an-aggregate-value-of-up-to-2-2B).}

^{[2] Inhibrx Form 8-K filed March 12, 2024 (https://www.sec.gov/ix?doc= /Archives/edgar/data/1739614/000110465924033457/tm248501d1_8k.htm).}

^{[3] Treas. Reg. §1.336(e)-2(h). See Section 5.8 of the Separation Agreement.}

^{[4] Inhibrx Form 10-K filed Feb. 28, 2024, see accumulated deficit line relative to total stockholders’ equity (https://www.sec.gov/ix?doc=/Archives/edgar/data/1739614/000173961424000006/inbx-20231231.htm).}

^{[5] See IRC §1(h)(11).}

^{[6] Zenz v. Quinlivan, 213 F.2d 914 (6thCir. 1954).}

^{[7] See Rev. Rul. 78-250; Rev. Rul. 73-427.}

^{[8] See Prop. Treas. Reg. §58.4501-2; Notice 2023-2.}

^{[9] IRC §355(a)(1)(B).}

^{[10] Treas. Reg. §1.355-2(d)(2)(iii).}

^{[11] Treas. Reg. §1.355-2(d)(5)(iv).}