Exploiting and Sharing Tax Benefits: Seagram and Du Pont

Abstract:     
On April 6, 1995 Seagram sold 156 million of its 164.2 million Du Pont shares back to Du Pont for $8.776 billion to finance its acquisition of MCA. We estimate that the tax savings generated in this transaction were approximately $1.8 billion, which is more than 1 percent of total 1996 U.S. corporate income tax revenues. The substantial tax savings were achieved through clever tax planning on the part of both Seagram and Du Pont, which resulted in the redemption of over 95 percent of Seagram's Du Pont holdings being taxed as a dividend instead of a sale. Dividend treatment and the corporate dividends received deduction allowed 80% of the redemption proceeds to escape taxation. Seagram received dividend treatment because the Du Pont redemption was not "substantially disproportionate" as defined under I.R.C. ? 302(b)(2). The redemption was not substantially disproportionate because Seagram received warrants to purchase 156 million Du Pont shares as part of the total $8.776 billion of consideration received from Du Pont. For tax purposes, these warrants counted as ownership and hence Seagram's percentage ownership of Du Pont did not change and was therefore not "substantially disproportionate."

Du Pont's reward for its role in the deal was the acquisition of a large block of its outstanding shares at a discount from market price of approximately $800 million. Although Seagram realized a sizable share of the total tax benefits (about $1 billion) in the transaction, we estimate that Seagram's market value of equity declined by more than $2.5 billion in response to the sale of its Du Pont holdings and subsequent purchase of MCA. Seagram accounted for its 25% ownership in Du Pont under the equity method of accounting, and during the period 1982-1995, the Du Pont investment accounted for about 65% of Seagram's reported earnings. Our analyses provide some evidence that a portion of Seagram's shareholder wealth losses were attributable to investor concerns about lower accounting earnings, so-called financial reporting costs, caused by the loss of Du Pont's accounting profits.

Although the transaction was taxed as a dividend, Seagram accounted for it as a sale. As part of the financial accounting for the transaction, Seagram recorded a $1.5 billion deferred tax liability. This deferred tax liability is unlikely to give rise to a cash obligation in the near future unless: (i) Seagram generates a capital loss of nearly $4 billion or, (ii) Du Pont's share price appreciates to a price at which a sale would not generate negative cash flow. Neither event is likely, particularly in the near term, which indicates that the $1.5 billion financial accounting liability is significantly overstated in economic terms.

JEL Classifications: H25, H26, M41

Accepted Paper Series