NEW YORK — After years of searching in vain for a way to break the corporate merger wave, Congress may have found a way to do so, nestled deep within the House Ways and Means Committee's tax-reform proposal.
Among the more obscure provisions of the panel's bill, which reached a completed form last weekend, is one that could alter the economics of billions of dollars in takeover deals by lifting a key corporate tax exemption. The industries most broadly affected would include oil and gas, insurance and broadcasting--those in which some of the most celebrated and condemned multibillion-dollar deals have taken place.
Had the provision been in effect earlier, say tax professionals, it might have rendered impossible or, at the least, caused material restructuring of such recently proposed transactions as the planned conversion into a master limited partnership of Mesa Petroleum, the corporate vehicle for T. Boone Pickens' takeover raids in the oil industry.
Macy Deal Could Be Affected
And prospective deals that might yet fall under the impact of any such tax-code change include the proposed management buy-out of R. H. Macy & Co., a retailer with extensive real estate interests that might become subject to stiff corporate taxes in the course of the transaction. Macy's executives, who have remained silent on the fate of their bid, declined to comment on the tax bill's potential impact on their deal.
The provision at issue repeals the so-called General Utilities doctrine, a tax rule based on a 1935 Supreme Court ruling and one so misleadingly labeled that some members of the Ways and Means Committee reportedly thought that they were voting on a tax provision for utility companies.
The doctrine allows corporations that are liquidating in a sale such capital assets as oil, insurance policies, real estate and patents to do so without paying a corporate tax on the resulting capital gain. (But, if capital gains from asset sales are distributed to shareholders, they would be taxed directly.)
Such liquidations have been key elements of many recent takeovers, particularly those known as "bust-up" transactions: those financed with such heavy debt that an acquiring company must sell off assets of the target company to pay off much of the debt. Under the House committee's proposal, capital gains earned on such sell-offs, now exempt from corporate tax, would become taxable. House staff members contend that the change would raise about $4.8 billion in revenue over five years, but many tax professionals say revenue gains would be a fraction of that figure because the size and number of taxable corporate transactions would dwindle.
"This won't kill merger activity, but it will make corporations, particularly capital-asset-rich companies, less valuable in the marketplace," says Arthur Feder, a New York tax attorney.
The change received considerable support during House hearings last spring from executives in industries such as oil and timber, where capital assets have appreciated sharply but stock prices have remained disproportionately low.
The market discrepancy allows a corporate "raider" to buy up his target's stock, generally with borrowed money that in turn generates tax-deductible interest, and to pay off the debt by selling the appreciated assets at their higher market price. The maneuver is financially rewarding because the acquiring firm pays no capital gains tax on the sale of the assets.
Among the executives who howled for some form of tax relief to discourage the stratagem was George James, executive vice president of Crown Zellerbach, a San Francisco-based timber company then engaged in an ultimately fruitless defense against a takeover bid from Anglo-French financier Sir James Goldsmith.
"We feel that the increase in the . . . target's assets should give rise to a taxable gain," James said during the House hearings.
Although current law gives a corporation the choice of booking these liquidated assets at their old historical value or accounting for them at the "stepped-up" acquisition value, the Ways and Means panel's proposal requires the step-up and imposes the resulting capital gains tax.
Most businessmen and investment bankers who testified at the House hearing disputed the notion that tax considerations are the main motivation behind the takeover vogue. But some congressional staff members believe that repealing the General Utilities rule would drastically alter takeover economics.
Says one Senate staff member: "This would be a small step, some would say in the right direction, toward taking away some of the rationale for acquisition activity."