What does Neiman Marcus, the fancy department store chain, have in common with the Gartner Group consulting outfit? No, the answer isn't that they both get to charge high prices because they have such upscale images. Rather, it's that both companies are using fancy financial footwork to declare independence from their parent companies -- and from the tax collector. Which seems especially appropriate for the Fourth of July season.
Let me explain. The games involving Neiman and Gartner are part of one of America's more interesting indoor sports: the eternal battle between corporate loophole users and loophole closers. It's not as much fun as the pro-basketball playoffs or the Fourth of July, but it has its moments. In this case, Neiman, Gartner and their controlling stockholders -- Harcourt General and IMS Health, respectively -- are squeezing through a loophole that seems likely to shut on July 16, when the tax-writing House Ways and Means Committee is scheduled to introduce this year's tax bill. Loophole-closing provisions generally take effect when the bill is introduced rather than when it passes.
The loophole we're talking about involves ways of controlling 80 percent of a company while owning less than 80 percent of its stock. Eighty percent is a crucial number, because under current tax law a company that controls at least 80 percent of another company can distribute those shares to its own stockholders tax-free. Not meeting the 80 percent requirement means big taxes on both the parent company and its shareholders.
While no one knows whether the control-ownership loophole will get closed -- a Ways and Means spokesman declined to comment -- tax techies are already kissing it goodbye. Meanwhile, Harcourt and IMS aren't taking any chances. They control Neiman and Gartner, but own far less than 80 percent of them. How to get to 80 percent control? Trade regular Neiman and Gartner shares back to those companies in return for "super-voting" shares that will elect 80 percent of the companies' board members. Then distribute these super-voting shares to Harcourt and IMS holders. Harcourt and IMS candidly say they hustled to get the deals underway before the loophole closes. They'd be fools not to.
The managements of Neiman and Gartner are gung-ho for this because it will let their companies become independent by breaking controlling blocks of stock into smaller pieces held by lots of stockholders. It might also make their stock more attractive to big investors by increasing the number of shares available for trading. Big investors typically shun companies that don't have enough publicly available shares to let players buy or sell large blocks of stock with minimal hassle. Harcourt and IMS figure that giving their shareholders two separate stocks will produce a greater return. Wall Street, as we all know, loves "pure plays" these days more than conglomerates.
The loophole allowing 80 percent control without 80 percent ownership has been around for years, but it was used for only a handful of small deals, and was generally ignored. The loophole just sort of evolved about 15 years ago, when the New York Stock Exchange first allowed companies with differing classes of common stock to have NYSE listings. But last fall the loophole came up on the Treasury's radar screen big time. That's because DuPont sold 30 percent of its Conoco energy subsidiary for $4.4 billion and announced plans to distribute the other 70 percent tax-free to DuPont holders in return for some of their DuPont stock. This swap -- worth $12 billion at current prices -- is tax-free because DuPont's 70 percent Conoco stake has 92 percent voting power. It's one thing for obscure companies to play this game with equally obscure subsidiaries. But DuPont-Conoco is a whole other thing because it's so big and so visible. So in February the Treasury proposed to close this loophole by requiring tax-free spinoffs to include at least 80 percent of the market value of the spun-off company's stock, in addition to 80 percent control. The Treasury estimates that this will raise $111 million in extra taxes over the next five years. It seems more likely, though, that closing the loophole won't raise a penny, because companies will either find a new loophole or stop doing these deals.
"It was a wonderful loophole. I just wish we had gotten to exploit it more often," says Robert Willens, a Lehman Brothers tax expert.
But never fear. New loopholes will appear, because corporate tax-dodging is as American as Mom, apple pie and the Fourth of July. And, for corporations, it's so much more rewarding.
Sloan is Newsweek's Wall Street editor. His e-mail address is firstname.lastname@example.org.