A Dishy Deal For General Motors

Zero is a big number at General Motors these days. No, I'm not talking about GM's zero-interest car loans, the marketing breakthrough that the rest of the industry followed, sending October auto sales to record levels. Rather, I'm talking about the amount of taxes--zero--that GM and its shareholders will pay on their multibillion-dollar gains from selling GM's direct-broadcasting business.

This is the kind of deal that shows why the finance and tax staffs are GM's biggest moneymakers, hot October auto sales notwithstanding. The case in point is the $22 billion deal announced last week, in which EchoStar will in effect buy Hughes Electronics, the GM subsidiary that owns DirecTV. If the transaction goes through as planned, it will be the grand finale, capping several brilliant tax-avoiding deals that GM has done with Hughes's stock and assets. If you value this deal using EchoStar's closing price on Friday, GM and its common shareholders will have realized about $30 billion, tax-free, from GM's $5 billion purchase of Hughes in 1985. Holders of GM's H stock, which has an economic interest in Hughes but no ownership stake, will have realized an additional $18 billion. The total gain: about $40 billion after taxes. More than GM has earned by making cars and trucks since it bought Hughes. (I'm using slightly massaged GM numbers for this math. You can find details of those deals, as well as a breakdown of how GM extracts cash in the EchoStar sale, on NEWSWEEK's Web site, NEWSWEEK.MSNBC.com.)

Had GM just sold DirecTV for $22 billion and distributed the after-tax proceeds to its shareholders, the company and its holders would have forked over more than $5 billion to the Internal Revenue Service. But by shuffling lots of papers and creating a bizarre corporate structure with three separate classes of common stock with different voting powers, GM gives the IRS nothing. "This is the first time someone has used three classes of stock to avoid the ire of the IRS," says an impressed Robert Willens, Lehman Brothers' tax expert. "The tax books were stacked as high as the corned beef in the Carnegie Deli," quips EchoStar general counsel David Moskowitz. It's all perfectly legal, part of the eternal struggle between tax collectors and corporate-tax mavens.

This deal is what's known in the tax trade as a reverse Morris Trust. To give you the simple version: GM is splitting itself into two fully separate companies--GM and Hughes--and selling Hughes to EchoStar in return for EchoStar stock. Since GM, which has a one-third economic stake in Hughes, is hungry for cash, it has set up a complicated structure to let it emerge with about $6 billion of cash and retired debt. Holders of GM's class-H stock will have an ownership stake in a bigger company, as opposed to the somewhat vague "letter stock" they currently hold. And EchoStar founder Charles Ergen will retain voting control of the new, bigger EchoStar, even though his ownership stake will drop to about 18 percent from its current 50 percent. Pretty slick.

Here's the deal. EchoStar's public shareholders will get A stock, with one vote per share; CEO Ergen will get B stock, with 10 votes per share; Hughes shareholders will get C stock, with between three and four votes a share, the number depending on things so complicated they make my teeth hurt.

The point of all this stuff? To get the Morris Trust tax break. To qualify, Hughes holders must have both a majority of the shares in the new, bigger EchoStar and a majority of the voting power as well. With this three-tier structure, Ergen will have about 38 percent of the voting power. That's more than enough to control the company, because the other shares will be held by thousands and thousands of shareholders.

In one of those wonderful ironies, GM is leaping through all these hoops to meet the requirements of legislation that Congress passed in 1997 to close the Morris Trust loophole. The reason for the legislation? In 1997, GM had found a way around the previous requirements and managed to sell Hughes's defense business to Raytheon for $9.5 billion of cash and stock, tax-free. Staying a step ahead of the tax man is complicated work.

This is the third sizable Morris Trust deal to emerge since August, when the IRS finally published guidelines about what it takes to meet the standards of the 1997 legislation. (The others are Plum Creek's buying Georgia Pacific's timberlands and--giggle--the J.M. Smucker jelly company's buying Jif peanut butter.) Watch for more Morrises, and for Congress to try to close the loophole again. And for GM to find more ways to get to its favorite number: zero.

Follow-Up: In 1998, I criticized Times Mirror Co.'s tax dodging $2 billion "nonsale sales" of two subsidiaries. Turns out the deals failed the IRS smell test. Last month the IRS chief counsel's office issued a directive instructing its auditors to challenge these deals, disallow them and penalize the companies and promoters who did them. Score one for the taxpayers' forces of good.

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