Analysis: Tax strategy may be key to Verizon Wireless deal
(Reuters) - Verizon Communications Inc's chances of buying the 45 percent stake in Verizon Wireless owned by Britain's Vodafone Group Plc will hinge, at least in part, on the quality of tax advice it is getting.
Verizon, the No. 2 U.S. telecommunications company, may have found a way to structure a purchase of the stake so that Vodafone can avoid a multibillion-dollar U.S. capital gains tax bill, sources familiar with Verizon's plans said. The possibility of a huge tax bill has previously been regarded by analysts as a big hurdle to any such deal.
Reuters reported last Wednesday that Verizon was preparing a bid worth about $100 billion to take full control of Verizon Wireless - it already owns the other 55 percent - by buying the stake, according to people familiar with the matter. There are no guarantees that Vodafone will want to sell its stake or that Verizon will pursue the plan.
Vodafone declined to comment on the possibility of a Verizon bid for its stake or on the tax question.
One person familiar with the situation said Vodafone cannot consider the size of any tax payout in a possible transaction until the company has received an offer, which it has not.
A Verizon spokesman declined to comment.
Verizon hopes that if it structures a transaction to eliminate much of the tax bill, it can encourage Vodafone to come to the table for talks. Some analysts and investors say Verizon may have to pay as much as $130 billion to clinch the deal.
The tax bill on a $100 billion deal, based on a simple acquisition of the stake, would be about $38 billion, according to UBS Investment Research. It could be much higher if the deal's price tag rises above that figure, UBS noted.
That tax bill is based on the massive growth Verizon Wireless has experienced since it was established 13 years ago. The 45 percent stake that Verizon Communications wants to buy is owned by Vodafone Americas, a U.S. holding company. Given it is a U.S. entity, if Vodafone Americas were to sell that stake outright it would have to pay the full capital gains tax on the stake.
But the sources said Verizon Communications is contemplating a two-part deal that could avoid this. Instead of buying the stake outright, the sources said, Verizon Communications would buy the Delaware-based Vodafone Americas.
The seller of Vodafone Americas would not be a U.S.-based entity, so no U.S. capital gains tax would be due, said Robert Willens, a tax and accounting expert and author of the Willens Report.
Vodafone's international structure is complicated, involving many holding companies, and the precise ownership of some assets is unclear. Vodafone Americas also owns some of Vodafone's non-U.S. assets, the sources said, probably including some in Germany and Spain. These would be sold back to Vodafone by Verizon Communications, which would keep the Verizon Wireless stake, they said.
The two transactions could be done simultaneously or one after the other.
While the sale of the Verizon Wireless stake would not incur capital gains tax, the sale of the international assets back to Vodafone would. This is because it would involve the sale of assets by Verizon Communications, a U.S. entity.
Compared with Verizon Wireless, the smaller international assets are thought to have gained little in value. Analysts estimated their sale could hit Verizon Communications with a U.S. tax bill of about $5 billion or less.
The sources said that Verizon would seek to pass any tax hit on to Vodafone in the two-part transaction.
Verizon has long coveted its partner Vodafone's stake in the Verizon Wireless joint venture, which started operations in 2000.
The last time the two came close to a deal was in 2004, when Vodafone bid for AT&T Wireless. The British company, the world's second-largest mobile operator, however, lost that bid to Cingular and has since held on to the Verizon Wireless stake for its exposure to the U.S. wireless market.
Wall Street analysts had previously seen it as unlikely that Verizon would want to do a deal involving Vodafone Americas' international assets. But those assets have underperformed in recent years when compared with the growth of Verizon Wireless, and are now a smaller part of the holding company, reducing the potential tax hit.
However, the timing of Verizon's interest in doing the deal has more to do with the gains in its stock price and low interest rates, the sources emphasized.
Verizon is considering paying about half of the purchase price in cash and half in stock, Reuters reported on Wednesday. That means it may look to raise around $50 billion in debt.
BRITISH TAX QUESTION
The kind of deal structure envisaged would still leave Vodafone with another tax question, said British academics and analysts: Should it leave the proceeds from any sale offshore or bring them home to Britain?
Leaving the money offshore might invite scrutiny from the U.S. Internal Revenue Service, which sometimes questions transactions if they seem designed solely to avoid tax and are not based on an underlying economic logic, said Prems Sikka, professor of accounting at the University of Essex in Britain.
If the transaction were shaped the way the sources have described, Vodafone would probably repatriate the proceeds into Britain, said Charles Merriman, managing director at Merriman Capital Transactions, a consultancy in London.
Once that was done, he said, the company might be able to reduce its tax bill by taking advantage of Britain's substantial shareholdings exemption. Under certain conditions, this exempts from UK corporation taxation any gains realized when one company disposes of shares in another company.
British tax authorities declined to comment, citing rules on taxpayer confidentiality.
More broadly, though, Vodafone could face a political backlash in Britain from any deal that was clearly structured to avoid taxation, said Robin Bienenstock, a senior analyst at Bernstein Research.
U.S. companies such as Starbucks Corp, Amazon.com Inc and Google Inc have come under fire from British lawmakers for using legal maneuvers to cut their tax bills in Britain.
"The problem with tax is not just the technical ability to avoid it, but the scorched earth that trying to avoid it could leave with the UK government afterwards," said Bienenstock. "Recent tax cases in the UK ... suggest that an attempt to avoid tax on such a large and high-profile deal would be very badly received."
(Reporting by Kevin Drawbaugh in Washington, Nanette Byrnes in Chapel Hill, N.C., and Soyoung Kim in New York; additional reporting by Kate Holton and Tom Bergin in London; editing by Martin Howell and Matthew Lewis)