It's hard to turn on a TV this time of year without seeing an ad showing smiling people who've supposedly just learned they'll be getting income-tax refunds thanks to a tax service or software program. Of course, your refund is Uncle Sam returning an interest-free loan you graciously made him by overpaying during the year—but it sure feels better to get a check than to write one. So imagine the joy at Great-West Lifeco, which has figured out how to get cash today for tax savings that it won't see for up to 15 years. It will do this by getting $550 million by selling securities backed by tax savings that it expects to get as the result of its $3.9 billion cash purchase of the Putnam Investments mutual-fund business.
Getting tax-savings money upfront? You gotta love it. Here's the deal: Great-West, of Winnipeg, Manitoba, is buying Putnam from Marsh & McLennan of New York. Normally, this would be a plain-vanilla deal, with Great-West's buying the stock of the M&M subsidiary that owns Putnam. This wouldn't give any U.S. tax breaks to Great-West, which has substantial U.S. profits. Instead, M&M and Great-West are adding yummy tax topping to the vanilla by making what tax techies call a 338(h)(10) election. This allows Great-West to treat the deal as if it had bought the assets of Putnam, the nation's 10th largest fund company, rather than buying stock.
The difference? By buying assets for cash, Great-West—perfectly legally and aboveboard—gets to deduct what it paid for Putnam from its U.S. taxable income over the next 15 years by depreciating the assets it purchased. That would reduce Great-West's taxable income by about $260 million a year (1/15th of the $3.9 billion purchase price). This deduction would save Great-West $88 million a year at the current corporate-tax rate of 34 percent. Great-West, which declined to discuss details, is doing a pioneering deal by selling securities tied to those savings. "These guys are breaking new ground," says Lehman Brothers tax expert Robert Willens. "This is absolutely the first time anyone has done this."
Companies can save big on taxes by doing asset-purchase deals if they pay with cash. For instance, Johnson & Johnson stands to save about $5.5 billion over 15 years from its $16.6 billion purchase of Pfizer's consumer-products business last year. The New York Times Co., which spent $410 million for About.com in 2005, and Media General ($600 million for four TV stations in 2006) both announced they'd reap substantial savings by making the deals tax-deductible asset purchases.
However, Wall Street typically doesn't put much value—if any—on these tax savings. J&J never mentioned them, though it did confirm they existed when I asked; and the Times Co. and Media General (in which I have a small stockholding) don't seem to have gotten any Street cred for them. What's more, for reasons I'm not sure I understand, the tax savings from these asset-purchase deals don't show up on a company's profit-and-loss statement. They reduce its tax bill and generate cash, but they don't add to reported profits, and thus generally fly below Wall Street's radar.
Great-West has figured out a way to get those tax savings onto the radar indirectly. Here's how. Raising $550 million upfront from its tax savings means Great-West has to raise only $3.35 billion from stock sales and borrowings to get $3.9 billion to buy Putnam. This will let Great-West sell less stock and borrow less money than it otherwise would, making profits-per-share higher than they'd otherwise be. And that—in theory, at least—would make Great-West's stock price higher than it would otherwise be. Pretty slick.
I often wax moralistic when companies play tax games, which come at the expense of us other taxpayers. But I'm not upset about this one, because capital-gains taxes that Marsh & McLennan will pay on the sale will largely offset Great-West's tax savings (M&M declined to comment). Typically, these deals work by having the buyer and seller split the tax savings. The buyer pays a higher price than it would have paid in a stock deal, but more than offsets that cost by paying lower taxes. The seller's taxes are higher than in a stock sale, but it still comes out ahead because of the higher price it gets.
Now that Wall Street has figured out how to securitize these tax savings and use them to bolster buyers' reported profits, we may see a lot more such deals. They won't be as numerous as those smiling-tax-refundee commercials, of course. But unlike those of us who've given interest-free loans to Uncle Sam, the people doing these tax deals will actually be coming out ahead.