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Allan Sloan

Leading the Way in Loophole Efficiency

By Allan Sloan
Tuesday, October 26, 2004; Page E03

When it comes to creating the most-efficient manufacturing plants or fuel-efficient cars, we in the United States still lag behind other countries. But when it comes to creating tax-efficient corporate transactions, we continue to lead the world. No matter how many tax loopholes get closed, corporate America and its tax technologists always seem to find new ones to squeeze through. The latest piece of corporate-tax tech is something called a "cash-rich split-off." Don't try this at home. It's designed for companies that have ownership relationships with each other but have decided the time has come to split up. In a mutually profitable way, of course.

Here's the deal. We've got a corporate couple in which one company owns a big piece of a second company -- but the relationship is so over. Instead of breaking up by selling the stock and paying tax on the profit, the first company trades the stock to the second company for a big pile of cash and a smallish business. (A business has to change custody to make the tax game work. Don't ask why.) Both companies come out ahead financially and report substantial gains to shareholders -- but neither one shows a profit to the taxman. Despite congressional boasts that the corporate-tax bill enacted earlier this month eliminated corporate-tax loopholes, this one wasn't touched. "The cash-rich split-off is still intact," says Robert Willens, Lehman Brothers' tax expert.

_____Deals Archive_____
Small Business, Ill-Defined (The Washington Post, Oct 19, 2004)
Google's New Approach Followed the Same Old Path (The Washington Post, Oct 5, 2004)
Don't Let October Scare You (The Washington Post, Sep 28, 2004)
More Columns by Sloan
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Not only intact, but growing. Companies including a staid utility (Keyspan) and the go-go empire run by tax-phobic media mogul John Malone (Liberty Media) have played this particular game, which made its debut a year ago. That's when Janus, the mutual fund company, swapped a 28 percent stake in DST Systems for $999 million of cash and a small DST business. Keyspan (disclosure: I own about $5,000 of its stock) later swapped a big stake in Houston Exploration for cash and a Houston Exploration property; Liberty swapped cash and some properties to Comcast in return for about $1 billion of Liberty stock that Comcast owned.

The most recent cash-rich split-off to emerge, involving Clorox and a German company named Henkel, is bigger than the three previous deals combined -- a sign that this tax-avoidance strategy is going both mainstream and big-time.

Clorox plans to trade about $2.1 billion of cash plus some businesses for Henkel's 29 percent stake in Clorox. By my estimate, Clorox and Henkel will avoid a combined total of more than $1 billion in federal income tax. (The companies declined to comment on my math.) This would bring total taxes avoided in all four deals to more than $2 billion, by my count. You can be sure there will be more -- and larger -- cash-rich split-offs coming until Congress or the Internal Revenue Service closes this loophole.

Clorox and Henkel are scratching a mutual corporate itch, as it were. Henkel has had business dealings with Clorox since the 1970s, and the German company bought Clorox stock to cement the relationship. But Henkel's got a new squeeze -- it's buying Dial, a Clorox competitor -- and could use a few billion extra bucks. Clorox, which has been gradually buying back stock in the open market, wants Henkel gone, and it leaped at the chance to buy the Henkel stock at a discount. Even better, this deal would increase Clorox's earnings per share. What's not to like?

So Clorox is borrowing $2.1 billion and setting up a subsidiary to hold the cash, its Soft Scrub cleanser and Combat pest-control businesses, and other odds and ends. By the end of November, if all goes as planned, Clorox will swap the subsidiary to Henkel in return for Henkel's 61.4 million Clorox shares. That means that this transaction won't be a sale, which would be taxable; rather, it will be a tax-free exchange.

Had Henkel sold its stock to Clorox for $2.85 billion of cash, it would have to pay tax -- my estimate, $900 million -- on the profit. And had Clorox sold its businesses for $745 million, it would have had to pay about $200 million in taxes. So the companies cooperated and, in effect, split Henkel's tax saving by letting Clorox pay a below-market price for its stock. Henkel says the discount is 12.6 percent -- by my count, that's about 40 percent of its tax saving.

So at the end of the day, Henkel and its shareholders come out ahead, thanks to this tax game. Clorox and its shareholders come out ahead. Uncle Sam and us regular old taxpayers come out behind. 'Twas ever thus.

Sloan is Newsweek's Wall Street editor. His e-mail address is sloan@panix.com.


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