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Sprint Corp. is bringing more to the table than just a fatter telecom market share in its merger deal with T-Mobile US Inc. It’s bringing what is essentially an annual tax deduction of a half-billion dollars or more, according to tax professionals.
“Everyone is focusing on the business benefits and antitrust concerns, but I would imagine this would be a factor in the attractiveness of Sprint,” said Robert Willens, an independent tax consultant based in New York. Sprint’s massive tax assets “could reduce the real acquisition cost by hundreds of millions of dollars,” he told Bloomberg Tax.
Overland Park, Kan.-based Sprint, which jointly announced its merger agreement with T-Mobile on April 29, held $16.4 billion in federal tax loss carryforwards—capital losses from previous years that can be used to offset future taxable income—as of March 31, 2017, according to its most recent annual filing with the Securities and Exchange Commission. (It additionally held $17.5 billion in state tax loss carryforwards, but the state tax losses are less valuable because state rates are far lower than the federal 21 percent.)
It’s unclear whether the hundreds of millions of dollars in future tax offsets were factored into Sprint’s price, but “it ought to affect the acquisition price,” and “it would be very odd if it didn’t,” said Lawrence Zelenak, a corporate tax professor at the Duke University School of Law.
While the all-stock merger itself is a “pretty straightforward” tax-free reorganization, Willens said, “their cash tax rate is probably going to be zero,” thanks to Sprint’s having “one of the largest batches of net operating losses we have in America.”
T-Mobile Chief Financial Officer J. Braxton Carter called the combination “a very good tax deal” during an April 29 conference call with executives from both corporations.
Carter said the new company “will not be a significant taxpayer until 2025”—a benefit he said would “drive value for shareholders” and “allow us to supercharge our competitive position here in the U.S. with lower prices.”
T-Mobile declined to respond to questions from Bloomberg Tax.
Sizable deductions tend to matter more for companies with large incomes, and the marriage of two of the telecommunications sector’s four biggest players in North America is widely expected to be profitable, if it passes regulatory scrutiny.
“In telecom, scale matters the most. If you’re going from four to three, it’s very good for Sprint and T-Mobile,” said John Butler, a senior Bloomberg Intelligence telecommunications analyst. Sprint and T-Mobile, which have respective market shares of 11 percent and 15.8 percent, have been “sub-scale” compared with their rivals, Verizon Communications Inc. at 31.2 percent, and AT&T Inc. at 25 percent, forcing them to compete through lower prices, he added.
The combination awaits a green light from regulators including the Federal Communications Commission, but Willens said the new corporation has no reason to fear Internal Revenue Service scrutiny of its hefty tax assets.
“There’s nothing underhanded or worthy of criticism,” he said. “It’s perfectly permissible.”
Sprint, which isn’t expected to release its annual report until later this month, told Bloomberg Tax that it ate into the tax assets somewhat in 2017. But tax professionals estimated that because of certain tax code limitations, the combined corporation, to be named T-Mobile, would be able to use roughly $10 billion to $12 billion of its NOLs over a span of close to 20 years at most, depending on Sprint’s value just before the change of ownership and when the assets expire.
Rules in tax code Section 382, which outlines restrictions on the use of net operating losses, will cap the use of those NOLs at Sprint’s market capitalization multiplied by a long-term, tax-exempt rate periodically set by the IRS, currently 2.3 percent.
Sprint’s equity value plummeted in the wake of the merger news, and has hovered around $21 billion in the days since. But depending on where its share price lands right before the change in ownership, assuming the deal passes government muster, the combined company could shelter between $500 million and $610 million of its income from taxes each year over nearly two decades, tax professionals said.
Even so, during the first five years after the merger, the limit may be higher, Willens said, because of rules in Section 382 related to recognized built-in gains from certain depreciation and amortization deductions. Using Sprint’s market value around the time of the announcement, $26.5 billion, he estimated the usable loss assets for those first five years would approach $700 million.
Still, NOLs that arose before 2018 can only be carried forward for 20 years, so the combined company won’t be able to use $16.4 billion in NOLs under the limit. Though fortunately for Sprint and T-Mobile, just $620 million of those federal carryforwards were set to expire between 2017 and 2021, according to Sprint’s annual filing; the remaining $15.8 billion in NOLs expire between 2022 and 2034, the company said.
Although Section 382 places a ceiling on how much of those NOLs Sprint can use, it also provides for smoother sailing when the new T-Mobile would seek to use them, thanks to an old regulation.
Normally, when a corporation that’s part of a group of companies filing a single tax return—known as a consolidated group—acquires a loss corporation, separate return limitation year (SRLY) rules only allow the corporation with losses to use those NOL assets to offset its own income, not that of the overall company. (Practitioners pronounce the acronym “surly.")
But Treasury Regulations Section 1502-21(g) renders those rules a non-issue for the two telecom companies, Larry Axelrod, a partner at Ivins, Phillips & Barker Chartered, in Washington, told Bloomberg Tax. The regulation, he pointed out, allows corporations and their loss-holding acquisition targets to bypass SRLY rules as long as the transaction is subject to the Section 382 limits.
“If we got 382, that’s enough—SRLY can be avoided,” Axelrod said. “1502-21(g) turns off SRLY.”
Some have characterized the merger as a “ bailout” for loss-ridden Sprint, and tax professionals have suggested that without the deal with T-Mobile, Sprint would have little use for its NOLs because such losses tend to shield companies from tax liability.
While Sprint, in a May 2 earnings release for its 2017 results, reported annual net income for the first time in 11 years, Bellevue, Wash.-based T-Mobile generated more than $4.5 billion in profits last year, according to its most recent annual filing with the SEC.
But despite its status as a loss corporation, Sprint says it has been using the loss assets, and it shows: The total federal loss carryforwards stood at $19.6 billion for Sprint’s fiscal year 2015, according to that year’s annual filing, meaning the company used or let expire $3.2 billion worth to reach the $16.4 billion figure by the end of its 2016 fiscal year.
Companies that report little or no pre-tax income on their financial statements can still use tax assets like NOLs before they expire—or become subject to limitations—using certain tax accounting methods that permissibly defer deductions or accelerate income relative to normal methods of accounting for tax purposes, tax and accounting professionals said.
For instance, companies like Sprint can change their methods of accounting for depreciation to recover the cost of capital expenditures more slowly, allowing them to maximize the use of their NOLs by delaying the more immediate benefits of depreciation. The practice can widen the difference between tax liabilities that appear in accounting for tax purposes and those in financial accounting, especially for capital-heavy sectors such as telecommunications.
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