In a move to safeguard billions of dollars in tax assets, the board of Ford Motor Co. has adopted a poison-pill plan to preserve the carmaker’s net operating losses (NOLs). The tax benefit preservation plan, announced on Friday, allows Ford to thwart a technical change of ownership, which under federal law would cause the company to forfeit $19 billion in deferred tax benefits.
Indeed, the tax assets Ford is protecting can be used to offset $19 billion in future taxable income up to two decades into the future — thereby reducing its potential federal income-tax bill for the years it puts the NOLs to use.
In July Ford reported pretax income of $2.3 billion for the second quarter and $751 million for the first half of the year. Its pretax operating losses were $424 million for the second quarter and $2.4 billion for the first half of 2009.
In general, Ford’s poison pill protects the company’s NOLs by dissuading a technical change of ownership as defined by Section 382 of the tax code. Under that rule, an ownership change occurs when a public company’s “5% shareholders” collectively increase their ownership by more than 50 percentage points over a rolling three-year period. Once an ownership change is triggered, the Internal Revenue Service limits the amount of income NOLs can offset in any year after the change — regardless of how much income a company earns.
The income ceiling is calculated by multiplying the company’s market capitalization by the long-term tax-exempt rate. For September 2009, the rate is set at 4.33%, which means a company with a $1 billion market cap on the day of an ownership change would be able to use NOL offsets against only $43 million of income for any subsequent years. Based on Tuesday morning trading, Ford’s market cap was about $23.8 billion.
The adoption of the preservation plan is likely tied to Ford’s recent agreement with the United Auto Workers union that allows the company to fund its retiree health-care trust — known as a Voluntary Employee Beneficiary Association or VEBA — with either cash or stock. If the company issues too much stock in an attempt to fund the VEBA, Ford could trigger an ownership change under the law and eviscerate a substantial chunk of its tax assets.
“Clearly the VEBA was the principal motivator” in adopting the asset-preservation plan, says tax expert Robert Willens, who runs an eponymous consultancy in New York. Ford’s “market cap is so low [a change of ownership] would render the NOLs useless,” he told CFO.com. “In fact, the UAW agreement may have hastened the adoption of the poison-pill plan.”
The Ford plan states that if any nonexempt person or group acquires 4.99% or more of the company’s outstanding shares of common stock, the stock purchase would trigger a significant dilution in the ownership interest of the group or person that increased its holdings in Ford. The dilution comes in the form of a dividend; that is, the Ford board declared a dividend of one preferred-share purchase right for each outstanding share of its common stock and Class B stock purchased. However, the purchase rights would only be activated if the poison-pill threshold of 4.99% is exceeded.