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Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Wednesday, December 18, 2013

Sysco Forgoes 'Horizontal Double Dummy' and $200 Million Tax Savings in Acquisition of US Foods

NY Times Dealbook (2013)New York Times:  Sysco Deal Leaves Money on the Food Table, by Lynnley Browning:

The Sysco Corporation’s deal to acquire its chief rival, US Foods, would put food on the table at a wide swath of restaurants, schools and hospitals. But it may have left money on the table as well. The concern is the less-than-creative tax structure of the $3.5 billion deal. ...

Under the merger, Sysco would use $3 billion of its stock to acquire the bulk of US Foods’ shares and would pay $500 million in cash for the rest. Some tax experts say that the cash part of the deal is the Wall Street equivalent of throwing away perfectly good food — in this case, perhaps $200 million. That is because the steps that Sysco is taking in the merger do not allow it to use a lucrative tax benefit involving extra value, in the form of lower future tax bills, embedded in that cash. 

The upshot of the steps, known in the tax world as a reverse triangular merger followed by a forward merger, is that for the cash portion of the deal, Sysco inherits the relatively low value, for tax purposes, of the assets of US Foods, which include machinery, equipment, vehicles and the like. That value, known as cost basis, reflects the fact that US Foods had to depreciate and amortize those assets over time. A lower cost basis typically translates into higher tax bills.

Had Sysco structured its deal differently, it could have increased its cost basis and created perhaps $200 million in future tax savings, said Robert Willens, a tax and accounting expert in New York. If Sysco had instead set up a structure known as a horizontal double dummy, it would have been able to include that $500 million in cash in its cost-basis calculations, in turn lowering the combined company’s tax bills.

Mr. Willens said that “$500 million in basis is worth 35 percent in tax savings somewhere along the line, so that’s nearly $200 million in value that’s being forfeited by the combined new company.” ...

Michael L. Schler, a tax lawyer at Cravath, Swaine & Moore in New York, said that one deterrent to using double dummies was the complexity of the structure and the need to reregister and list the merged entity as a public company. But “if it is done correctly, the tax rules are clear cut and there is no reason for the Internal Revenue Service to challenge it,” he said.

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Given the caliber of the financial and legal advisers on this deal, I believe something is missing from this story.

Posted by: HTA | Dec 18, 2013 1:02:59 PM

Perhaps what is missing is an actual business reason to employ such a transactional contrivance. Oh wait, you can just make that up after the fact and pretend it was the reason all along.

Posted by: Stanley Wonstock | Dec 19, 2013 8:59:42 AM