Structural Tax Advantage Engineering

"After the Tisches’ first year in the Traymore, Gravatt agreed to sell them the hotel for $4,350,000. The deal called for a total down pay- ment of $700,000, including the $500,000 he’d already received. The $200,000 balance was a fraction of the first year’s expected profit. Adding to the transaction’s appeal was the tax benefit of a $420,000 annual depreciation allowance the buyers could take over 12 years. Identifying potential tax benefits in such deals would become a hall- mark of Tisch’s approach to minimizing investment risk. Such bene- fits would become even more useful in later years as he diversified his holdings (the most stunning example of this was CBS, where Tisch essentially recouped his entire initial investment and still held more than 18 percent of the company). A favorable tax treatment often could convert what might seem a gamble—buying a distressed busi- ness—into an investment in which the worst-case scenario was break- ing even."

"Tisch’s bid had an added problem: it was perhaps a little too clever. He had invented a way to reduce takeover cost by building in a sub' stantial tax benefit, thereby turning the tax laws to shareholders’ ben- efit. He weighed a broad range of financial factors when he assessed risks, and he structured a deal with the worst-case scenario in mind."

"His Commercial Credit offer was set up so that the dividend on the shares he bought, combined with the tax benefits, would give Loew’s a profit, no matter what the outcome. Here’s how it worked. If his tender offer succeeded, he would be buying the shares of a company that paid a large dividend—$1.80 a share. He would use the dividends to cover the interest payments on the money he had bor- rowed to buy the shares. The effective tax rate on the dividends, since they would be paid to another corporation, Loew’s, would be just 7.5 percent. That meant the after-tax value of the dividend payments to Loew’s would be $1.66 a share. Meanwhile, the interest on the money to be borrowed for the acquisition would work out to $2.47 a share, all of which would be tax-deductible against Loew’s income, resulting in"

"a tax saving of $1,235, assuming a 50 percent tax rate. That would make the after-tax interest cost $1,235 a share. Subtract that cost from the $1.66 after-tax income from the dividend, and Loews would end up with an after-tax profit from the Commercial Credit dividend of 42.5 cents a share. The effect would be a takeover completed with interest-free debt and a built-in price discount on the share purchase. —"