Are NOLs Worth The Trouble?

Acquirers that expected some tax benefits as a bonus in picking up distressed companies face more than a simple use-it-or-lose-it dilemma. If they don’t exhaust all of the benefits, which have a 20-year life, they face a rather stiff financial penalty. Given the odds, says Lehman Brothers managing director and tax expert Robert Willens, the buyers may sidestep a potentially painful sting by simply waiving all credits from a target’s net operating losses (NOLs) when the deal is completed, as allowed by U.S. tax law. Over the last two decades, NOLs have not been high on the radar screen for acquirers. The Internal Revenue Service (IRS) historically has frowned on deals pegged to buying tax credits by requiring that an m&a transaction have a valid business purpose. Congress went even further during the 1980s to discourage NOL-centered transactions by allowing the buyer only a paltry annual amount to shelter some of its own earnings with acquired credits. Under the law, the buyer’s annual allowable credit is the value of the target’s premerger stock multiplied by a tax-exempt debt rate selected monthly by the IRS and recently hanging well below 5%. The penalty for not exhausting all NOLs, added by IRS regulation a few years ago, is a reduction of the parent’s basis in the target’s shares. If the target is divested later, that can artificially inflate a gain or reduce a loss on the sale and impose an unfavorable tax consequence on the parent in either case, Willens says. NOLs regained some prominence recently because of the large number of badly scarred technology, retailing, and other companies that was made available in the m&a market. But many of the NOLs are so massive, on their own or relative to the purchase price or the value of the assets, that they can never be used up, Willens advises. Waiving the credits up front may avoid a lot of hassle down the road, he says.