The NOL Poison Pill & Corporate Self-Determination

Abstract:     
Corporations generally have the ability to structure their transactions and activities to dictate the legal consequences. One glaring exception to this premise is corporations’ inability to protect their net operating losses (NOLs). In this area, corporations lack self-determination and are often times reduced to utilizing poison pills with dramatically low triggers.

The tax code allows corporations to use a form of income averaging. Corporations can use operating losses to offset recent past or future income, which can result in substantial tax savings. Because of their ability to reduce tax, NOLs are assets in corporate hands. To prevent the potential abuse of and trafficking in these assets, however, the code substantially limits the use of NOLs for corporations with aggregate ownership changes above a certain level. Accordingly, a corporation could lose the use of its NOLs if there is too much shareholder turnover.

To protect their NOL assets, corporations have turned to NOL poison pills. Corporations use these poison pills, not as a takeover defense, but as a remedy for a problematic code section that creates a specific tax treatment for technical ownership changes, not necessarily real ones. The tax treatment, in many circumstances, can be triggered without the permission or knowledge of the corporation. This article presents the view of NOL poison pills as efforts to regain corporate self-determination in tax planning.

Tax policy typically evaluates tax law on its equity, efficiency, and simplicity. Corporate self-determination, which is the corporation’s power to determine by its actions and planning when and to what extent tax treatment is triggered, is not explicitly present in traditional tax policy analysis. The article suggests and considers the place for self-determination in tax policy analysis.

Part one of the article discusses how a corporation acquires and uses NOLs as well as how a corporation’s NOL use can be limited. Part two discusses poison pills and the variation that NOL poison pills require. Part three discusses the policy implications of the NOL rules and suggests that tax policy should consider the importance of self-determination in establishing corporate tax rules.

Keywords: NOL, net operating loss, poison pill, corporate law, tax, corporate tax, tax policy

working papers series