GE Perfects the Fine Art of Tax Savings

To most spectators, General Electric's sale of $1.4 billion worth of Genworth Financial stock last week seemed like a typical ho-hum transaction. GE was selling stock in its former insurance subsidiary for the third time since Genworth's initial public offering of stock 19 months ago. Strictly yawn city. But for tax mavens, GE's sale of 41 million Genworth shares was like Michelangelo's final brush strokes on the ceiling of the Sistine Chapel: the conclusion of a masterpiece.

Normally, I criticize convoluted tax deals like this one, but I'm going to depart from form today because even the meanest critic occasionally finds something to like. And I like the artistry of Genworth's saving more than $700 million in taxes, mostly by avoiding what amounts to double taxation on some of the gains in its bond portfolio.

But before we go crunching numbers, some background. GE wanted to unload its insurance businesses, which it considered slow-growth. Anyone with a C or better in Taxes 101 could have shown GE how to distribute Genworth to its holders tax-free -- but GE wanted to sell Genworth and keep the proceeds to invest in businesses it thought had higher growth potential than insurance. And we're talking serious money: GE has raised $11 billion (before taxes) selling Genworth stock, and still owns $3 billion worth that it intends to sell.

Rather than doing a conventional offering of Genworth stock, GE crafted what Lehman Brothers tax expert Robert Willens calls a "supercharged IPO." That's when you sell stock in a new company, endow it with a tax break and split the proceeds. It's like giving your kid a house, then having him kick back his real-estate-tax-deduction savings to you.

GE's supercharger consisted of a new subsidiary that it created to hold the businesses that Genworth was going to own. Genworth bought the businesses from the subsidiary, paying for them by giving the subsidiary a ton of Genworth securities, mostly common stock.

Because Genworth had bought the businesses, it and GE could jointly make what tax types call a 338(h)(10) election -- that's a financial decision, not a political event. They could write up (for tax purposes) the value of the assets that Genworth was acquiring, primarily its bond portfolio. The write-up increased the value of Genworth's assets for tax purposes by $2.04 billion, reducing Genworth's future federal income taxes by $718 million at current rates. But this maneuver won't reduce the income that Genworth reports to shareholders. (Don't ask why things work this way, just accept it.)

As you'll soon see, this was a lot more complicated than simply dropping off your tax-return information at the accountant. For starters, Genworth couldn't do a 338(h)(10) unless GE owned less than 50 percent of it immediately after Genworth's initial public offering -- but GE didn't think it could get a decent price for a giant company like Genworth if it put more than half its stock on the market in the first offering. So GE did something clever: It promised the Internal Revenue Service it would cut its stake in Genworth to less than 50 percent within two years of the IPO, and the IRS issued a private letter ruling blessing the transaction. "Brilliant, just brilliant," says Willens, the Lehman tax expert.

GE told me that it paid $1.1 billion in taxes as the result of this transaction, which became a taxable sale of assets. What's more, a GE spokesman told me, the company may well have to pay more tax on its future Genworth sales.

Has GE suddenly gotten warm and fuzzy toward the IRS? Not really. It probably would have had to pay the $1.1 billion at some point anyway, because its taxable gains from selling its Genworth stock would have been larger than they were by going this route. Meanwhile, Genworth's taxes are lower than they'd otherwise be.

The spokesman says GE wasn't avoiding taxes; it was making sure it and Genworth "were not subject to an inappropriate double tax." GE's argument: The higher value of Genworth's bond portfolio was reflected in the price that GE got for the Genworth shares it was selling, so allowing Genworth to write up the value of the bonds for tax purposes avoids having both companies pay tax on the same gain.

Genworth has agreed to pay GE $552 million of its tax savings, and will also fork over an additional $88 million of "gross up" payments that are based on calculations so complicated they make my teeth hurt.

Bottom line: GE's ahead a lot, Genworth's ahead a little.

As my holiday gift to you, I won't discuss how Genworth saves taxes on its bond portfolio, which had increased in value between the time GE originally acquired the bonds and the time Genworth acquired them from GE.

A final touch: Some $75 million to $100 million of Genworth's tax savings come from being able to deduct "intangible assets" from its taxable income. GE's Genworth stake had to be below 20 percent for Genworth to be able to do that -- and last week's sale reduced GE's stake to 19 percent.

So there you have it: GE's tax department as a Michelangelo with spread sheets. Yet another example of how you can find artistry in the darnedest places.

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