Exempt from the universe of 5% shareholders are some institutional holders, such as funds of funds that hold Ford stock on behalf of several individual mutual funds, where no single fund owns 5% or more of the auto company’s stock.
Poison-pill plans are not unusual, especially when companies — especially bankrupt ones — use the deterrent to ward off hostile-takeover attempts. But recently, more solvent companies have been using these preservation plans to capture tax benefits related to big losses sustained during the current recession and credit crisis. Witness last year’s poison-pill plan adopted by homebuilder Hovnanian. At the end of 2007, the company had $392 million of deferred tax assets and NOLs carryforwards slated to expire between October 2008 and October 2027. Its plan protected the NOLs by souring any attempt by 5% shareholders to acquire more stock and trigger an ownership change under Section 382.
Similarly, Ford’s plan shields the NOLs for at least the next three years. Under its agreement with the UAW, Ford is expected to make three separate payments of $610 million in cash or stock due in December 2009, June 2010, and June 2011. In May Ford issued 300 million shares of common stock to raise $1.4 billion. The net proceeds from the sale will be used for general purposes, including funding the VEBA. It’s expected that Ford will use cash to fund the December obligation, according to a statement made by company president and CEO Alan Mulally at the time of the stock issue. Nevertheless, Willens says the adoption of the poison pill may be an indication that stock will be used to satisfy the VEBA obligations.
The modern version of the 5% stockholder rule was issued in 1986 to prevent “the trafficking of losses,” says Willens. To be sure, the IRS didn’t want the prospect of grabbing NOLs through an acquisition to be the primary reason for purchasing a company. “The rule makes NOLs neutral in an acquisition,” he opines.
The “surprising” part of the law, Willens says, is that the 50 percentage point change by 5% owners is an aggregate number, meaning the stock purchases that drive up holdings past the threshold, and trigger an ownership change, can be unrelated. So an increase in the VEBA’s holdings, combined with other unrelated stock purchases, could trigger the NOL limits.
The 5% ownership issue is widely considered one of the most complex parts of the tax code, asserts Willens, who says it is often not clear who is a 5% shareholder and when an ownership change has occurred. In addition, the fact that the unrelated stock purchase transactions can trigger an ownership change adds another level of complexity to applying the proper tax treatment. The rule comes to “a surprising conclusion [regarding unrelated transactions] but there is little doubt about the way it works regarding limiting access to NOL offsets,” asserts Willens.