Grab Coveted Losses, Buy a Car Company

The auto-industry bailout is stalled, but here's an opportunity to secure highly sought-after net operating losses in an acquisition.
Marie LeoneDecember 12, 2008

The Senate crushed hopes of an automotive-industry rescue on Thursday when it failed to pass a bailout bill. Then on Friday, the White House vowed to save America’s car industry from “a precipitous collapse.” Whatever happens over the next few days or weeks, it is worth taking a look at the potential tax implications of an auto-industry bailout because it could make a big difference to any company pondering a takeover of one of the beleaguered Big Three, says tax expert Robert Willens, who heads an eponymous consultancy.

Based on the “auto bill” that passed in the House of Representatives on Wednesday — with backing of the Bush Administration — any company that acquires one of the failing auto manufacturers would get a sweetheart deal in terms of tax breaks. In fact, acquiring companies would receive a benefit that would dwarf the potential tax break Congress handed to companies that purchased ailing banks or the mortgage lenders Fannie Mae and Freddie Mac, asserts Willens.

The tax break relates to net operating losses (NOLs) and the limitation imposed on corporations that buy money-losing businesses. Profitable companies that acquire distressed companies covet NOLs because the losses can be used to offset taxable income for up to 20 years. So to squelch the blatant trafficking of NOLs picked up in mergers, the Internal Revenue Service put restrictions on the amount of losses a parent company can use against its income.

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Specifically, Section 382 of the U.S. Tax Code provides a formula to calculate how much of the target company’s losses the new parent can claim as its own NOLs. The limit is established by multiplying the target company’s market capitalization on the day of the acquisition by the IRS’s long-term tax-exempt rate — which is currently 4.6 percent.

In its current form, the auto bill exempts carmakers from the Section 382 limitation, says Willens. Indeed, the bill plainly states that “Section 382 shall not apply in the case of an ownership change resulting from this Act or pursuant to a restructuring plan approved under this Act….”

Further, the legislation stipulates that before March 31, 2009, each eligible auto manufacturer must submit a restructuring plan to the “auto czar” (more formally known as the President’s designee) that “achieves and sustains” three criteria: long-term viability, international competitiveness, and energy efficiency. The bill also provides that the auto czar should approve the restructuring scheme if he or she determines that it will result in — among other things — the achievement of a “positive net present value.”

In short, if the auto czar approves the restructuring plan, any company that acquires a carmaker covered by the plan will be able to use the NOLs without limitation, says Willens. General Motors has lost nearly $73 billion since 2004, and lost $4.2 billion in the third quarter of this year, according to Bloomberg. Ford has reported $24 billion in losses since 2005, and U.S. sales at privately held Chrysler tumbled 28 percent this year.