IRS Hasn’t Got Time for Pain Of Forced Divestiture: Say goodbye to favorable tax treatment of sell-offs executed to address regulatory objections to a deal

The IRS has ruled emphatically that a company divesting businesses to win approval of a merger from antitrust regulators is not entitled to any tax relief on the proceeds of the sale. In a sharply worded opinion, the agency derided the novel contention of an unidentified divestor that the sell-off was a hardship and a tax break would help ease the sting. The ruling was so dismissive, says Robert Willens, managing director and corporate tax expert at Lehman Brothers, that it suggested that the IRS was drawing a hard line against any future bids for favorable tax treatment of sell-offs executed to cure regulatory objections to mergers and acquisitions. “You rarely see them [the IRS] inject attitude into an opinion,” Willens says. “Basically, they said you are not even close on this one. If this was an effort to ease the pain, let me assure you there’s no way.” The ruling could have wide ramifications because divestitures are commonly used by combining companies to counter objections by the FTC and the Antitrust Division of the Justice Department that a merger may harm competition or create concentration in specific product lines, markets, or geographical regions. Moreover, the regulators in recent years have encouraged merger partners to propose their own divestiture cures so the approval process can be sped up. The gains from the sell-offs often are large. In a move that may have been the first of its type, the petitioning company asked to have a sell-off declared an “involuntary conversion,” which would have allowed it to defer taxes on the gain from the sale of a product line. The firm struck out on all counts. The sale, the IRS said, was not involuntary, was not a conversion because nothing was destroyed, and was not a hardship because it was connected to benefits reaped by an “economic family.” If a taxpayer wins an involuntary conversion classification, it can defer taxes on the gain from a sale that it recognizes for two years, provided it reinvests the money in a property that is “similar or related in use.” The company that was rejected is the American subsidiary of a foreign company that merged with another overseas concern. After reviewing the deal, the FTC ordered the divestiture of a product line that was a mainstay of the U.S. sub and the merging partners agreed, assigning part of the sales price to the American unit. The U.S. unit alleged the sale was an involuntary conversion and wanted to have the gain on its assigned portion deferred. Although the IRS chastised the effort as an overly expansive reading of a previous ruling in an unrelated case, Willens says the company’s proposal “wasn’t that far-fetched” on its face. The petitioner, he explains, was contending it was separate from its foreign-based parent, was being forced to “dispose of its best asset,” and was being “deprived through no fault of its own.” However, the IRS wasn’t buying any of it. “The IRS said you and the parent are in the same economic family,” Willens notes. “There was no compulsion to do the deal. It was a voluntary act by the economic family.” n Kimberly-Clark to Drop Non-Consumer Lines Continuing a restructuring trend in the paper industry, Kimberly-Clark Corp. is planning to sharpen its emphasis on consumer and health care products by shedding its tiny interests in business paper and pulp production. Directors of the Dallas-based firm gave management the go-ahead to weigh a spin-off a Canadian pulp mill and timberlands and two producers of writing and coated papers with annual sales of $650 million, or less than 3% of corporate-wide volume. Given the units’ microscopic position inside Kimberly-Clark, some observers think a spin-off is overkill but point out that the company could be advertising them for sale. “Once you’ve announced a disposition, you’ve put them in play,” one expert commented. Although the company said the businesses are slower growing and lower margined than core operations and that removal of the pulp mill would enhanced operational flexibility, the move is part of a broader strategic repositioning in the paper field. Gib Carey, a consumer products expert at Bain & Co., says that studies have found that companies in all industries perform best when they concentrate on a single core business and are not distracted by periphery units. Kimberly-Clark’s primary challenge, he notes, is to “build value” for consumers, while the pulp and non-consumer businesses depend on cost cutting and efficiencies from scale. “It is very difficult for a corporation to be excellent in different things,” he says. “The company has to decide on what its true core is and where it wants to participate.” Among other restructuring-minded paper companies are Georgia-Pacific Corp., which tried an IPO for its consumer products, while both GP and International Paper Co. turned their timberlands into trusts. Copyright 2004 Thomson Media Inc. All Rights Reserved. http://www.thomsonmedia.com http://www.majournal.com