The artful dodgers are last week’s big dealmakers, Seagram Co. and DuPont. The transaction, in which DuPont bought back most of Seagrams huge block of DuPont stock, contains a little-noticed provision designed to save Seagram about $1.5 billion of federal income taxes. Because Seagram needed DuPont’s help to Pull off this coup, DuPont got a good price on the shares, paying Seagram almost $800 million less than their stock-market value.
Talk about corporate back scratching. In essence, Seagram and DuPont are splitting the value of the taxes Seagram is saving. DuPont gets a $760 million discount on the stock it’s buying from Seagram. Despite the discounts, Seagram still comes out ahead by keeping $1.5 billion out of Uncle Sa@s hot little hands.
Seagrams perfectly legal dodge is so humongous that you can bet that Congress will close the Seagram loophole like a shot once the screaming starts. Seagram undoubtedly completed the sale last week because it wanted to present Congress with a done deal. It’s betting big bucks that Congress would close the loophole retroactively, the way it trashed Viacom Inc. Viacom, our subject last week, lost a big tax break when Congress retroactively eliminated the tax savings that companies got for selling media properties to minorities. But at Seagram, there’s no anti-affirmative-action hot button for Congress to push.
Given the potential PR problems, you can see why none of the players wanted to talk about this Chivas Regalsize tax dodge on the record. So this article is based on public records, background discussions and my understanding of the tax laws. The game goes like this: Seagram tiptoes through the tax code by treating the $8.74 billion of cash and securities it got from DuPont as a dividend rather than as money from selling stock. What’s the difference? Taxes. Corporations pay federal tax on only 30 percent of the dividends they receive. Seagram, thanks to special legislation that tax mavens call the “Seagram Rule,” pays tax on only 20 percent of its dividends from DuPont. By contrast, corporations pay tax on all their capital gains. Dividend treatment lets Seagram come out ahead even though it’s selling to DuPont at well below market value.
Here’s a simplified version of how this works. Seagram sold DuPont 156 million shares, some 95 percent of its DuPont holding. That stock would have fetched about $9.5 billion on the New York Stock Exchange, but DuPont paid only $8.3 billion of cash and cashlike notes. DuPont also threw in stock-purchase warrants, valued at $440 million, that give Seagram the right but not the obligation to buy 156 million DuPont shares at fixed prices at fixed times. DuPont’s saving: $760 million. Now, for Seagram. Selling the stock for $9.5 billion would have triggered a tax of $2.1 billion by my estimate. The DuPont deal triggers a tax of only $614 million. Seagram’s saving: about $1.5 billion. Selling in the market would have left Seagram with $7.4 billion of cash after taxes. Selling this way gives it $7.7 billion after taxes, plus the $440 million of stock-purchase warrants.
Yes, the warrants are confusing. But they’re the key to the whole game. Because Seagrarn sold 156 million shares and bought 156 million warrants, it can claim for tax purposes that its ownership percentage in DuPont is unchanged. That, in turn, lets Seagram treat the DuPont proceeds as a dividend. This despite the fact that the warrants carry prices so much higher than DuPont’s current price they will probably never be exercised.
And why did Seagram sell DuPont only 95 percent of the DuPont shares it owned? A combination of tax avoidance and cosmetics. Selling all its DuPont stock would have triggered a monumental tax bill for Seagram. Seagram could have kept just one DuPont share and ducked the tax. But keeping only one share would look tacky. It’s much classier for Seagram to keep 8.2 million of them.
You have to love this. Seagram wins, DuPont wins, taxpayers everywhere lose. Something to think about when you ante up to Uncle Sugar.
