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Ford's Poison Pill Prevents Tax Losses

The automaker tries to discourage investors from triggering a technical change of ownership in the company that would cause it to lose $19 billion in net operating loss carryforwards.
Marie Leone, CFO.com | US
September 15, 2009

In a move to safeguard billions of dollars in tax assets, the board of Ford Motor Co. has adopted a poison-pill plan to preserve the carmaker's net operating losses (NOLs). The tax benefit preservation plan, announced on Friday, allows Ford to thwart a technical change of ownership, which under federal law would cause the company to forfeit $19 billion in deferred tax benefits.

Indeed, the tax assets Ford is protecting can be used to offset $19 billion in future taxable income up to two decades into the future — thereby reducing its potential federal income-tax bill for the years it puts the NOLs to use.

In July Ford reported pretax income of $2.3 billion for the second quarter and $751 million for the first half of the year. Its pretax operating losses were $424 million for the second quarter and $2.4 billion for the first half of 2009.

In general, Ford's poison pill protects the company's NOLs by dissuading a technical change of ownership as defined by Section 382 of the tax code. Under that rule, an ownership change occurs when a public company's "5% shareholders" collectively increase their ownership by more than 50 percentage points over a rolling three-year period. Once an ownership change is triggered, the Internal Revenue Service limits the amount of income NOLs can offset in any year after the change — regardless of how much income a company earns.

The income ceiling is calculated by multiplying the company's market capitalization by the long-term tax-exempt rate. For September 2009, the rate is set at 4.33%, which means a company with a $1 billion market cap on the day of an ownership change would be able to use NOL offsets against only $43 million of income for any subsequent years. Based on Tuesday morning trading, Ford's market cap was about $23.8 billion.

The adoption of the preservation plan is likely tied to Ford's recent agreement with the United Auto Workers union that allows the company to fund its retiree health-care trust — known as a Voluntary Employee Beneficiary Association or VEBA — with either cash or stock. If the company issues too much stock in an attempt to fund the VEBA, Ford could trigger an ownership change under the law and eviscerate a substantial chunk of its tax assets.

"Clearly the VEBA was the principal motivator" in adopting the asset-preservation plan, says tax expert Robert Willens, who runs an eponymous consultancy in New York. Ford's "market cap is so low [a change of ownership] would render the NOLs useless," he told CFO.com. "In fact, the UAW agreement may have hastened the adoption of the poison-pill plan."

The Ford plan states that if any nonexempt person or group acquires 4.99% or more of the company's outstanding shares of common stock, the stock purchase would trigger a significant dilution in the ownership interest of the group or person that increased its holdings in Ford. The dilution comes in the form of a dividend; that is, the Ford board declared a dividend of one preferred-share purchase right for each outstanding share of its common stock and Class B stock purchased. However, the purchase rights would only be activated if the poison-pill threshold of 4.99% is exceeded.

Exempt from the universe of 5% shareholders are some institutional holders, such as funds of funds that hold Ford stock on behalf of several individual mutual funds, where no single fund owns 5% or more of the auto company's stock.

Poison-pill plans are not unusual, especially when companies — especially bankrupt ones — use the deterrent to ward off hostile-takeover attempts. But recently, more solvent companies have been using these preservation plans to capture tax benefits related to big losses sustained during the current recession and credit crisis. Witness last year's poison-pill plan adopted by homebuilder Hovnanian. At the end of 2007, the company had $392 million of deferred tax assets and NOLs carryforwards slated to expire between October 2008 and October 2027. Its plan protected the NOLs by souring any attempt by 5% shareholders to acquire more stock and trigger an ownership change under Section 382.

Similarly, Ford's plan shields the NOLs for at least the next three years. Under its agreement with the UAW, Ford is expected to make three separate payments of $610 million in cash or stock due in December 2009, June 2010, and June 2011. In May Ford issued 300 million shares of common stock to raise $1.4 billion. The net proceeds from the sale will be used for general purposes, including funding the VEBA. It's expected that Ford will use cash to fund the December obligation, according to a statement made by company president and CEO Alan Mulally at the time of the stock issue. Nevertheless, Willens says the adoption of the poison pill may be an indication that stock will be used to satisfy the VEBA obligations.

The modern version of the 5% stockholder rule was issued in 1986 to prevent "the trafficking of losses," says Willens. To be sure, the IRS didn't want the prospect of grabbing NOLs through an acquisition to be the primary reason for purchasing a company. "The rule makes NOLs neutral in an acquisition," he opines.

The "surprising" part of the law, Willens says, is that the 50 percentage point change by 5% owners is an aggregate number, meaning the stock purchases that drive up holdings past the threshold, and trigger an ownership change, can be unrelated. So an increase in the VEBA's holdings, combined with other unrelated stock purchases, could trigger the NOL limits.


The 5% ownership issue is widely considered one of the most complex parts of the tax code, asserts Willens, who says it is often not clear who is a 5% shareholder and when an ownership change has occurred. In addition, the fact that the unrelated stock purchase transactions can trigger an ownership change adds another level of complexity to applying the proper tax treatment. The rule comes to "a surprising conclusion [regarding unrelated transactions] but there is little doubt about the way it works regarding limiting access to NOL offsets," asserts Willens.

 




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