Recently, legislation was proposed by the ranking members of the Senate Finance Committee, Sen. Baucus (D-Mont.) and Sen. Grassley (R-Iowa) which would have the effect of preventing publicly-traded entities from qualifying as partnerships for tax purposes in cases where the partnership was engaged in providing investment advisory and/or asset management services. As a result of this proposal, stocks of affected companies declined precipitously. However, the market was in error. It assumed that AllianceBernstein Holding, LP was, along with Blackstone and Fortress, affected by this proposal. In fact, it is not--AB's partnership status is premised on a different exception (to the rule which provides that a "publicly-traded partnership" shall be taxable as a corporation) which the proposal does not address. Accordingly, once we circulated our findings, regarding AB's continued ability to function as a partnership, the stock price quickly recovered and, in fact, traded above the levels that it had reached before the proposal was announced. We were aware, from the outset, that AB was exempt from the impact of the proposals and our clients, armed with this knowledge, could have made the proverbial "killing" by trading in and out of AB's stock.
Liberty's ability to "monetize", tax-efficiently, its appreciated portfolio positions, by means of a transaction known as a "cash rich" split-off, was always apparent. In fact, changes in the tax law, enacted in May, 2006, which were designed to "discourage" these transactions, have actually had the opposite effect. Because of these changes, Liberty was able to count its minority stake in DirecTV as a "qualifying asset" and thus facilitate its disengagement from News Corp. We have long been advocates of this technique and have advised you of its efficacy since it was first undertaken by Janus in connection with the monetization of its stake in DST Systems, Inc.
Prices paid for REITs can always be higher than the conventional wisdom would lead you to believe. This is so because the purchaser of a REIT can secure a "cost basis" in the acquired assets at a "manageable" cost; at the cost of only a single level of tax. This is so because, unlike the case with a "normal" C corporation, a REIT will not pay tax on the gain from the sale of its assets so long as it distributes the sales proceeds "in liquidation" within the 24 month period beginning on the date it adopts its plan of liquidation. Similarly, as most recently demonstrated in the sale of Putnam Investments, a selling parent can always exact a higher price for the stock of its subsidiary if it is willing to join the buyer of the stock in executing an election under Sec. 338(h)(10). Once again, in these cases, the buyer obtains a "basis step-up" in the target's assets-for which it will be willing to "pay up"-at the cost of only a single level of tax imposed, in this case, on the selling group. For a buyer, the making of such an "(h)(10)" election can make the "effective price" of a deal (taking into account tax savings) as much as 25 percent below the "headline price".
We have long advocated a separation of WY's timber operations from its non-timber businesses and we feel that this "divorce" can be done tax-efficiently, through a tax-free "reverse" spin-off. Our view is that WY should (i) "lever up" the timber business and use the proceeds of the leverage to remit a "special dividend" to its shareholders and concurrently distribute, in a tax-free spin-off, the stock of a Newco which would conduct WY's non-timber activities. Immediately after the spin-off, WY, now conducting only the timber activities, would elect to convert itself into a REIT. We firmly believe that this spin-off would be eligible for tax-free treatment because the transaction would, in fact, satisfy the "business purpose" requirement. We are not convinced that electing REIT status is the type of "tax avoidance" that adversely affects a transaction's claim that it is undertaken for one or more corporate business purposes and, even if it is, it is still clear that such a spin-off would be carried out, "in substantial part" (which is all that the regulations demand) for one or more corporate business purposes.
Can a corporation spin-off a subsidiary and, in the process, extract funds from the subsidiary in amounts well in excess of the corporation's basis in the subsidiary's stock and do so without tax consequences? The answer is yes, so long as the spin-off is part of a so-called ‘D' reorganization and the corporation distributes the funds so extracted to its shareholders and creditors "in pursuance of the plan of reorganization". This strategy is now employed in most spin-offs, including the spin-off of Idearc by Verizon and the "split-off" of Domtar Corp. by WY, with the result that the "monetizing" spin-off, which was supposed to have been "laid to rest" by the "anti-Morris Trust" rules, is alive and well.
Net Operating Losses
We have assisted you in assessing the value of a corporation's Net Operating Losses (NOLs) for many years-You have, with our assistance, accurately analyzed the situations existing at Eddie Bauer, Mirant, Delta Airlines, Armstrong and countless other corporations possessing this valuable attribute. The rules in this area are complex. What is an "ownership change"; what happens when one occurs? Are the NOLs summarily forfeited or are the "penalties" imposed for "trafficking" in such NOLs more subtle than that? How do these rules differ for corporations that experience ownership changes in the course of a Title 11 or similar case? What rules apply when a loss corporation experiences multiple ownership changes? What new rule, instituted by the I.R.S. in 2003, but still not widely-understood, has the effect of nearly doubling the value of a loss corporation's NOLs?
What are the "anti-Morris Trust" rules? When can a corporation, either the distributing parent or the spun-off subsidiary, which has participated, recently, in a tax-free spin-off, be acquired? Is there really a two-year embargo on such acquisitions? If so, how can we explain the fact that Realogy, spun-off by Cendant, announced an agreement to be acquired by Apollo, some five months after the spin-off was completed or that First Data, which spun-off Western Union announced, within six months of the separation an agreement to be acquired by KKR? The I.R.S. has issued final regulations setting forth the rules that apply to post-spin-off acquisitions. These rules are quite liberal and belie the notion, widely and erroneously held, that such an embargo exists. In fact, in the case of an acquisition following a spin-off, the events are part of a prohibited "plan" (with the result that the spin-off would become taxable at the distributing corporation's level) only if there was an agreement, understanding, arrangement or "substantial negotiations", regarding the acquisition or a "similar acquisition", at some time during the two year period ending on the date of the spin-off.
What is a ‘C' reorganization? We maintained, throughout this arduous process, that Price would undertake a complete liquidation in which it would distribute its Verizon stock (and other assets) to its shareholders in exchange for their Price stock. If such a distribution was not made, the transfer of Price's assets to Verizon (in exchange for voting stock of Verizon) would have been taxable and some $500 million in taxes would have become due and payable. In fact, last summer, Price announced its firm intention to completely liquidate and distribute, by next summer, all of its assets to its shareholders. Thus, patient investors who were seeking to "create" Verizon (through a purchase of Price stock) economically will have been rewarded.
Qualified Dividend Income
We have assisted you in navigating the rules that pertain to "qualified dividend income". When is such income eligible to be taxed at preferential rates? What are the "holding period" requirements imposed in order to enjoy such preferential tax rates? Can an investor engage in hedging activities and still earn credit towards the statutory holding period requirements? When can dividends be "stripped" such that an investor can successfully transform short-term capital gain income (taxed at top marginal rates) into qualified dividend income taxed at rates that are less than half of the rates imposed on short-term capital gain income? Which party to a transaction reports dividend income in cases where the ex-dividend date follows, rather than precedes, the record date and the stock is sold during this interim period between the record date and the (delayed) ex-dividend date?
Was there a way for Seagate to, effectively, "distribute" its highly appreciated Veritas stake to its shareholders yet avoid triggering the gain inherent in this asset? There was, via a "downstream merger", the structure that Seagate actually adopted and, in the process, some $7 billion of corporate taxes were avoided. This technique is presently available to Cypress Semiconductors with respect to its highly appreciated stake in SPWR. In addition, even though CY acquired control of SPWR in a taxable transaction within the past five years, so that a direct distribution of the stock of SPWR would not attain tax-free status until sometime in 2009, there are strategies available which would permit a distribution of the SPWR stock to proceed before 2009 in a tax-efficient manner. We enumerated these strategies in a report and Chapman Capital, the "activist" hedge fund which is seeking to coax CY's management into entertaining a re-structuring, has adopted our strategies as the centerpiece of his proposals.
Many corporations, including Raytheon, Waddell & Reed, Neiman-Marcus, Florida East Coast Industries, Gartner, Inc., Chipotle Mexican Grill, GameStop and Blockbuster, in order to facilitate spin-offs, were required to adopt two class of stock capital structures, high vote and low vote stock. The lower vote stock, due to its greater liquidity, almost always trades at a substantial premium vis a vis the higher vote stock. When can such a corporation propose a re-capitalization in which it seeks to re-combine the classes? If it can happen with alacrity, following the spin-off, a profitable arbitrage trade can be "set up" and quickly cashed in.