Big Corporate Mergers Get Fresh Tax Scrutiny in Washington
Summary
Two senators—a Democrat and a Republican—want to end tax-free corporate mergers like the pending Capital One-Discover all-stock combination, a move that would reshape dealmaking.
WASHINGTON—A progressive Democrat and a populist Republican are teaming up to attack big mergers, offering a new proposal that would remove a cornerstone of the corporate tax code and potentially reshape dealmaking.
Sens. Sheldon Whitehouse (D., R.I.) and J.D. Vance (R., Ohio) want to eliminate companies’ ability to do tax-free mergers like the pending Capital One-Discover deal. Under their bill, shareholders who receive stock through such deals would owe capital-gains taxes immediately, instead of deferring those taxes until they sell their shares. The senators plan to introduce the legislation on Thursday; it has exceptions for companies with annual revenue below $500 million.
The Whitehouse-Vance legislation stands little chance of becoming law soon, given that Congress is struggling to pass a tax bill that a majority of lawmakers support. But the bill is a sign of political sentiment against corporate power that unites some Republicans and Democrats who are otherwise far apart on tax policy. And it is a rare attempt to address competition policy through the tax code.
“Our bipartisan bill will end a massive tax giveaway for giant corporate mergers and get our government out of the business of subsidizing corporate consolidation," Whitehouse said, arguing that mergers drive up consumers’ costs.
Tax-free reorganizations have been part of U.S. law for a century, and there have been few, if any, serious proposals to eliminate them. They are a common structure for mergers, though not the only one that companies use.
Tax-free reorganizations let companies merge in stock or asset transactions without forcing the companies or their shareholders to pay taxes. In addition to the Capital One deal, the senators list AT&T’s Time Warner deal and Canadian Pacific’s purchase of Kansas City Southern as examples of mergers that could have been affected had their bill been law.
Under the proposal, shareholders in all-stock mergers would pay taxes on the difference between their shares’ value when they bought them and what they receive in the deal, rather than delaying taxes until they sell the new shares.
Whitehouse and Vance describe their bill as removing a tax break, and it would make stock-for-stock deals similar to all-cash deals, which already trigger shareholder taxes.
“Massive corporate mergers rarely produce their promised benefits but often leave American workers and families behind," Vance said. “It’s past time to close the unfair loopholes that allow these deals to escape tax liability."
Alternatively, the current tax law could be viewed as a way to prevent taxes from being imposed on shareholders who don’t get cash and as a way of keeping the tax system neutral so companies can make business decisions. In that view, the Whitehouse-Vance proposal would be a new tax on top of that, one that most Republicans’ antitax philosophies wouldn’t countenance.
“This would really sort of impact a core area of the tax law," said Lisa Zarlenga, a tax lawyer and partner at Steptoe. “This kind of pushes tax to the forefront" in dealmaking decisions.
Executives considering mergers would have to think more about their shareholders’ tax bills. In many cases, they might move ahead anyway, even if a planned share swap generates large taxable gains for some investors, because many of their biggest shareholders don’t actually care about their taxes.
That may sound implausible, but endowments, many foreigners, pension funds and 401(k) plans don’t pay U.S. capital-gains taxes. Individual shareholders with nonretirement accounts do.
However, except in unusual cases—where executives or founders own a significant chunk of a company—shareholders’ taxes may not be particularly important to executives.
“Shareholder-level tax considerations are often second-order considerations to all of the other rationales, synergies and the like, for doing a corporate transaction," said Michael Mollerus, a partner at law firm Davis Polk who advises companies on mergers.If the Whitehouse-Vance bill became law, Mollerus said, he would expect many mergers to proceed as taxable stock transactions rather than stop altogether.
“I don’t think that this is an earthquake in what’s going to happen in the M&A market. I think it’s a tremor at best, because a lot of deals are taxable as it is," said Victor Fleischer, a former Senate Democratic tax aide who is now a law professor at the University of California, Irvine. “Bigger deals could be affected."
Write to Richard Rubin at richard.rubin@wsj.com
