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Last December the Treasury Department issued a directive to make sure General Motors's future initial public offering would not trigger a technical ownership change – and limit the car company's ability to use its NOLs.
Robert Willens, CFO.com | US
September 27, 2010
After months of discussion about an initial public offering, General Motors, which is partly owned by the U.S. Treasury Department, finally made it official in August by filing paperwork indicating it would pursue an IPO. In the transaction, which likely will take place in November, Treasury will be selling an undisclosed portion of its approximately 61% stake in the carmaker. Eventually, if market conditions are favorable, Treasury will dispose of its entire holding of GM stock.
But under current tax rules, GM is at risk of losing some of its coveted deferred tax assets — assets that help to lower corporate tax bills. Here's the situation:
GM has reported that "most of the tax attributes generated by old GM...survived the Chapter 11 proceedings and we expect to use the tax attributes to reduce future tax liabilities." This suggests that the so-called 363 sale,1 in which the assets of old GM were conveyed to GM, constituted a "G" reorganization, so named because it follows
Section 368(a)(1)(G) of the Internal Revenue Code.
In the case of a G reorganization, the "acquiring corporation" (GM) takes into account the items described in Section 381(c), most notably the transferor's net operating loss (NOL) carryovers and various credit carryovers. In fact, GM is reporting a deferred tax asset balance of $9.2 billion with respect to U.S. federal and state NOLs, and a deferred tax asset amount with respect to general business credits and foreign tax credits of more than $4.2 billion.
The company has established a valuation allowance "against" such deferred tax assets to reflect the fact that, at this point, it is not more likely than not that the company will be able to "realize" such deferred tax assets. If GM continues to report profits, and makes selective acquisitions of companies with prospective profits, its outlook will quickly change, with the result that the valuation allowance would be reduced or eliminated and an equivalent amount of earnings would be recorded.
The company warns that its ability to use certain of its U.S. tax attributes in future periods "could be limited" by the tax code, specifically Section 382. That is, if the company undergoes an "ownership change" (within the meaning of Section 382(g)), annual limits will be placed on the amount of taxable income and tax liability that its prechange NOLs and tax credits can offset. An ownership change occurs, with respect to a loss corporation, when one or more of the loss corporation's "five percent shareholders" increase their percentage ownership by more than 50 percentage points relative to their lowest percentage ownership of such stock at any time during the specified "test period."
The sale by Treasury of its stock to the public would contribute toward the occurrence of an ownership change for GM. As a result, the regulations state that if a loss corporation is owned, in whole or in part, by a public group (or groups), the dreaded "segregation" rules shall apply. These rules apply when a first-tier entity (presumably Treasury is such an entity) owns a 5% or more direct ownership interest in a loss corporation and transfers that ownership interest to "public shareholders."
In that event, each direct public group that exists immediately after the transfer shall be segregated so that the ownership interests of each public group that existed before the transfer are treated separately from the public group that acquires stock of the loss corporation (as a result of the disposition by the first-tier entity).2
Accordingly, each time Treasury sold stock, a new 5% shareholder would come into existence — with the 5% shareholder's increase in ownership contributing toward the occurrence of an ownership change.
Fortunately, the segregation rules will not operate in this case, which means that Treasury's current and prospective dispositions of GM stock will not contribute toward an ownership change. In an Internal Revenue Service notice issued in December, Treasury anticipated the situation.3 The government decreed that if it sells stock that was issued as part of the Emergency Economic Stabilization Act of 2008 (including the Automotive Industry Financing Program), and, as here, the sale creates a public group, the new public group's ownership in the issuing corporation shall not be considered to have increased solely as a result of such a sale.
Therefore, it appears that the Treasury Department's activities with respect to GM stock cannot, by themselves, create an ownership change that compromises the car company's ability to employ its tax attributes when Treasury terminates its status as a majority shareholder.
Contributor Robert Willens, founder and principal of Robert Willens LLC, writes a weekly tax column for CFO.com.
1 Refers to a sale of a debtor's assets under Section 363 of the Bankruptcy Code.
2 See Regulation Section 1.382-2T(j)(3)(i).
3 Notice 2010-2, I.R.B. 2010-2, December 14, 2009.