April 21, 1997

Elimination of Merger Tax Loophole Will Impact Defense Industry Restructuring

Critics of the controversial "Payoffs for Layoffs" proposed legislation, which would repeal current defense contractor reimbursements of restructuring costs by the DoD, picked up considerable momentum recently when two powerful chairman of the Republican Congress (Bill Archer of Texas/House Ways and Means Committee and William V. Roth, Jr. of Delaware/Senate Finance Committee) introduced bills to close the Morris Trust tax loophole that allows companies to sell off defense assets for billions without paying federal tax.
We anticipated that the volatile issue of avoiding federal corporate tax would focus attention on the ongoing intense merger activity in the defense sector, already questioned in the pending General Motors Corporation sale of Hughes Electronics to Raytheon Corporation for $9.5 billion without GM's payment of federal taxes. Now the other shoe has dropped. We warned our clients back in February, that the reimbursement of post-merger restructuring costs by the DoD would likely be linked to tax free sales, and perceived by the public as a double government subsidy. Given that at least $500 billion in additional cuts will be required to balance the budget by FY '02, opponents are likely to seize on the broad "grandfathering" of announced mergers as the equivalent of closing the barn door after the horses have escaped. Since opponents will assert that billions of taxable revenue could be grabbed this year alone, the real battle will focus on congressional negotiations to determine whether ongoing mergers will be considered and remain, "grandfathered." Now is the time for targeted contractors to decisively document the scope and value of tax free "inducements" in valuing the transactional price or financing terms under the Supreme Court's Winstar doctrine. Changing policy "after the fact" may become the ultimate insurance policy against the public mandate to balance the budget and purge all appearances of corporate welfare.