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Going for Break: Our Third Annual Tax Efficiency Scorecard

New rules and a down economy have companies revising their tax strategies. Who's best at paying the least?

Earlier this year, Procter & Gamble announced that it would buy the Clairol hair-care business of Bristol-Myers Squibb for $4.95 billion in cash, a significant premium over Bristol-Myers’s cost basis for the assets. In response, Standard & Poor’s and Dominion Bond Rating Service soon downgraded P&G’s credit ratings.

But these credit agencies ignored the tax benefits that P&G gained from the deal. In fact, because P&G paid a premium for Clairol, the value of the goodwill amortization deduction will improve P&G’s cash flow for the next 15 years. The tax consequences reduced the cost of the deal to P&G by $1 billion — or 20 percent. Yet Bristol-Myers presumably got more for Clairol than it would have if P&G received no such benefits. Neither P&G nor Bristol-Myers would comment.

This transaction was accomplished courtesy of Section 338(h)10 of the U.S. tax code, and it is one that other firms besides P&G and Bristol-Myers are eyeing. Under Section 338(h)10, a company that makes an acquisition is entitled to write off goodwill against its taxable income for the next 15 years. That, to be sure, would also reduce reported earnings. But buyers are always interested in goodwill amortization for tax purposes, and they may be able to convince investors to ignore the resulting hit to earnings.

What’s more, the end of pooling-of-interest accounting will encourage more asset disposition of all kinds. While pooling made it easy for even the most aggressive acquirers to avoid earnings hits from goodwill, that applied only to acquisitions of entire companies. The rules also required companies to wait at least two years to sell assets. Starting last July 1, buyers are free to dispose of assets at any time.

Indeed, the accounting change may greatly reduce effective tax rates simply because in most cases goodwill will no longer be written off against earnings unless it is impaired. The average firm paid nearly 37 percent of its revenue in federal, state, and local taxes last year, up more than two percentage points from 1997, according to CFO’s Third Annual Tax Efficiency Scorecard.

Under the new rules, more companies will have less amortization inflating their effective tax rates. But with new freedom to do deals anytime as the economy weakens, companies will find themselves both freer and under increasing pressure to pursue synergies through asset disposals.

“The situation is changing,” says a tax expert who asks not to be identified, “because of new rules and the impact of a down economy.” The downturn helps explain why other moves may also gain currency these days. For example, companies that have losses abroad may want to designate their foreign subsidiaries as branches so that the parent can use the losses for tax purposes.

“We’re looking at everything,” says Sandy Peiser, vice president and tax manager of Raymond James Financial, an investment and brokerage firm based in St. Petersburg, Florida. Currently in Peiser’s sights are tax credits for training and business development at the local and state levels, which are often connected with so-called enterprise zones. Such credits require a considerable amount of Peiser’s attention, in part because of the significant differences in each jurisdiction’s terms for qualifying. “They don’t all play by the same rules,” he notes. But Raymond James, for one, finds the rules worth mastering, since the company has offices in all 50 states.

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