A rare, arcane tax rule could force News Corp. to plunk down an extra billion dollars to buy Chris-Craft’s 10 television stations.
Why? Just look at the $5.35 billion deal’s structure.
The FCC is already questioning whether the structure violates the agency’s 1995 rule that restricts foreign ownership of U.S.-based media properties. Australia-based News Corp., which is controlled by media mogul Rupert Murdoch, is limited to acquiring stations only through its Fox Television Stations subsidiary.
News Corp. believes it is complying with the FCC law by merging Chris-Craft’s 10 television stations into a newly created subsidiary called NewCo. and then transferring those assets to Fox Entertainment Group, an affiliate of News Corp.
But in choosing that asset transfer path, News Corp.’s structure conflicts with an IRS rule on tax-free transactions. “It’s a real arcane issue,” says Robert Willens, an accounting analyst at Lehman Brothers. “It’s never really come up before.”
The IRS rule offers tax-free eligibility on a corporate and shareholder level only to “vertical” asset transfers. But Chris- Craft’s assets are actually being transferred in a more “horizontal” manner, from NewCo. to its sister company Fox–which the IRS currently doesn’t allow.
To illustrate, if News Corp.’s structure complied with the IRS’s “vertical” structure, it would instead be transferring Chris-Craft’s assets to a subsidiary directly under NewCo. But News Corp. likely did not go that route because that would visibly conflict with the FCC’s rules that require the acquisition through Fox.
Now, the FCC could step in and require News Corp. to change the structure of the deal if it thinks the company is not complying with the foreign ownership rules. However, Willens says that new FCC-mandate could still result in a big potential tax bill for News Corp. because the asset transfer even then may not comply with IRS guidelines.
Talk about being stuck between a rock and a hard place. “Any tax problems will be precipitated by these FCC directives,” Willens says.
And this is no small issue. He believes that if News Corp. faces corporate taxes, it will have to pay as much as $1 billion.
To avoid the hefty corporate level taxes, News Corp. has a back-up merger structure ready to go. Under this alternative plan, the Chris- Craft assets would wind up retaining their identity rather than dissolving under the Fox name. This move would enable News Corp. to avoid paying corporate taxes on the transaction.
But, Chris-Craft’s shareholders would still be stuck with a tax bill.
However, should this happen News Corp. is said to be prepared to pay an extra $5 per share for Chris-Craft to compensate Chris-Craft shareholders.
“If they change the structure, the reason they change is they feel there is a possibility or likelihood of corporate taxes being assessed by the IRS,” Willens says. “Once the FCC tells them what’s acceptable, they will test that against the tax laws.”