Tax

How Cablevision Spin-off Shifted Debt Without Tax Effect

The cable giant was able to shift a big chunk of indebtedness – almost surely an amount greater than the debt of the properties it transferred to A...
Robert WillensSeptember 6, 2011

On June 30, 2011, Cablevision Systems Corp. completed a leveraged spin-off of AMC Networks. Although CSC had compelling reasons for spinning off AMC that had nothing to do with tax, the deal ended up having no tax consequences at all for the cable giant. Because they enable the parent company to pay off debt in the process of separating from a subsidiary without having any tax effects on the deal, deals like CSC’s shedding of its AMC unit have become a popular method for accomplishing a spin-off.

As part of the CSC deal, each of the cable company’s Class A and Class B shareholders got a quarter of a comparable share of AMC. Some cash was also paid instead of distributing fractional shares of AMC to the shareholders.

CSC undertook the spin-off to achieve two compelling nontax business purposes. The first and foremost was “to enhance the credit profile of CSC by accessing its RMH [Rainbow Media Holdings] subsidiary’s available borrowing capacity” to reduce CSC’s indebtedness.

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Cutting its debt in that way would thus provide CSC with greater financial and strategic flexibility to pursue acquisitions. Here the goal was to shift indebtedness from CSC to AMC (whose principal asset will be CSC’s RMH subsidiary) with a view toward enabling CSC to make strategic acquisitions in the future using borrowed funds.

The second nontax purpose was to boost the aggregate stock prices of CSC and AMC relative to the predistribution value of CSC’s stock. That would enable each corporation to issue stock in connection with acquisitions on more favorable terms. It was also aimed at increasing the long-term attractiveness of equity-compensation programs. Under the arrangement, both cases could be achieved with less relative dilution to existing equity holders.

Thus, as part of the distribution, CSC caused AMC to incur an aggregate of $2.425 billion in new debt, consisting of $1.725 billion principal amount of senior secured term loans and $0.7 billion principal amount of senior unsecured notes.

About $1.275 billion of the new debt will be issued to CSC Holdings, a wholly-owned subsidiary of CSC, which will apparently be part of the parent company for tax purposes. CSC Holdings will use the new debt to satisfy and discharge outstanding CSC or CSC Holdings indebtedness.

To make those debt payments, CSC Holdings will enter into a deal with one or more investment banks. In the deal, CSC Holdings will exchange a part of the new debt for outstanding CSC or CSC Holdings’s debt, a substantial portion of which will have been acquired from CSC’s or CSC Holdings’s lenders by the investment banks for this purpose.

Thus, CSC will have transferred its RMH business to AMC in exchange for the latter’s stock, AMC’s assumption of a part of CSC’s liabilities, and new debt. The AMC stock will be distributed to CSC’s shareholders and the new debt conveyed to the investments in exchange for CSC or CSC Holdings debt acquired by the exchanging entities shortly before the exchange.

As a result of the way the deal was structured, CSC recognized neither a gain nor a loss on the receipt from AMC of its stock and “securities” (it seems likely that the new debt was properly treated by CSC as securities). Section 361(a) of the Tax Code provides that no gain or loss will be recognized to a corporation (in this case, CSC) if the company is a “party to a reorganization” and exchanges property solely for stock or securities in another corporation (AMC) party to the reorganization. Thus, both the stock and new debt was received by CSC on a tax-free basis.

Further, no gain or loss will be recognized by CSC with respect to the distribution of the AMC stock and securities to its shareholders and creditors. In that regard, Section 361(c)(1) provides that no gain or loss will be recognized to a corporation that’s party to a reorganization on the distribution to its shareholders of property as part of the plan of reorganization.

Here, however, CSC distributed property to both its shareholders and creditors. Fortunately, for purposes of this rule, any transfer of “qualified property by the corporation to its creditors “in connection with the reorganization” shall be treated as a distribution to its shareholders pursuant to the plan of reorganization.

Qualified property includes any stock in another corporation — in this case, AMC — that is a party to the reorganization or obligation of another corporation in which stock is received by the distributing corporation “in the exchange.” Thus, the new debt received in the exchange constitutes qualified property. And a distribution of qualified property to a party’s creditors in connection with the reorganization is treated as a distribution by such party to its shareholders. Further, both the distribution of AMC’s stock to CSC’s shareholders and the conveyance of the latter’s new debt to CSC’s creditors were also unrecognized as taxable income. Thus, CSC was able to shift a substantial amount of indebtedness, almost certainly an amount greater than its basis in the properties transferred to AMC, without tax consequences.

Robert Willens, founder and principal of Robert Willens LLC, writes a tax column for CFO.com.