Exploiting and Sharing Tax Benefits: Seagram and DuPont

Abstract

In April 1995, Seagram sold 156 million DuPont shares back to DuPont for $8.8 billion to finance its acquisition of MCA. Clever structuring of DuPont's redemption generated tax savings of approximately $1.8 billion for Seagram and DuPont. DuPont captured about $800 million of the total tax benefits in return for facilitating the tax-saving structure. In spite of tax benefits of approximately $1 billion, Seagram's equity value declined by more than $2.5 billion in response to the DuPont redemption/MCA acquisition. Our analyses provide some evidence that a portion of these wealth effects are attributable to the loss of DuPont's earnings, which accounted for approximately 65 percent of Seagram's reported profits. As part of the financial accounting for the DuPont sale, Seagram recorded a $1.5 billion deferred tax liability and this financial accounting liability appears to be significantly overstated in economic terms.

Empirical Tax Research in Accounting

“…More recently, Erickson and Wang (1999) document that by redeeming Seagram's shares at a below-market rate in 1995, DuPont retained 40 percent of Seagram's tax savings. On the other hand, Engel et al (1999) show that taxes had little effect on asset prices in their TRUPS study.…”

How Prevalent is Tax Arbitrage? Evidence from the Market for Municipal Bonds

“…10 For interest disallowance to occur under these rules, there must be "a determination, based on all the facts and circumstances, as to the taxpayer's purpose in incurring or continuing each item of indebtedness. Such purpose may, however, be established by either direct or circumstantial evidence....Direct evidence of a purpose to purchase tax-exempt obligations exists where the proceeds of indebtedness are used for, and are directly traceable to, the purchase of tax-exempt obligations...Direct evidence of a purpose to carry tax-exempt obligations exists where tax-exempt obligations are used as collateral 9 In contrast, developing bright-line tests can sometimes backfire on the tax authorities, as illustrated in Erickson and Wang's (1999) analysis of the DuPont/Seagram transaction. 10 As mentioned before, prior to the mid 1980s, banks enjoyed special provisions allowing them to deduct the interest on debt issued to purchase or carry tax-exempt securities, causing banks to own large amounts of municipal bonds during this period.…”

Income misattribution under formula apportionment

“…3 See, for example,Mintz and Weiner (2003) andRiedel and Runkel (2007).4 Scholes et al (2005) offers a nontechnical review of some of the tax considerations in mergers and divestitures. 5 See, for example, the evidence presented byAuerbach and Reishus (1988),Dhaliwal et al (2004),Erickson (1998),Erickson and Wang (1999a, 2000,Hayn (1989),Kaplan (1989),Maydew et al (1999),Schipper and Smith (1991), andWeaver (2000).…”