Thursday, August 6, 2015

Similar Deals, Different Tax Effects: Aetna\Humana and ACE\Chubb

We spend a considerable amount of time in our Acquisition Finance course analyzing form of payment and form of combination.  Deal terms are vital for many reasons, not the least of which is the tax consequence to selling shareholders.  Nearly identical deals can produce substantially different tax consequences.

This point is driven home by an interesting article appearing in the Wall Street Journal recently.  (See Same Deals, Different Taxes, by Laura Saunders.)  Ms. Saunders describes three deals: Cigna's purchase by Anthem, the combination of Aetna Inc. and Humana Inc., and the merger of ACE Ltd. and Chubb.

The form of payment is similar in all three deals - about half cash and half stock but Cigna and Humana shareholders won't owe taxes on the share portion of the deal because of the way the combination is facilitated.

The details are a bit complicated, but are provided  in a report  by Robert Willens who publishes The WillensReport.  (Ms. Saunders drew on Mr. Willens for her article.)  With Mr. Willen's permission I quote from his report:  The basic idea is that "an acquisition of stock ...... followed by an 'upstream merger' .... will be treated as an 'integrated asset acquisition' in a single statutory merger if the transaction, so viewed, qualifies as a reorganization in which the acquiring corporation takes a carryover basis in the target's assets."

To be clear, Cigna and Humana shareholders will  ultimately pay taxes but only when shares are sold - thus deferring payment and hence gaining the time value of money.

As I mentioned, the details are more complicated, but the point is that how you merge matters.  Competent legal and tax advice is essential.

Here are some concluding thoughts:

1) Depending on the parties often conflicting objectives, you can often find a way to make a deal 'tax free'
2) The ultimate deal reflects the following:
                a) bargaining power
                b) buyer objectives
                                1) taxes: a tax free deal means carryover basis(no step up). Thus, lower future depreciation and higher taxes on a subsequent sale.
                                2) price: the above may be reflected in the price
                c) seller objectives
                                1) taxes: deferred taxes are preferred
                                2) price: the price may be lower for tax free deal

3) Bottom line: the parties will focus on net after tax returns which involves comparing NPV of asset write-ups for buyer less increased price needed to compensate seller for taxes paid.

All the best,

Joe and Ralph

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