EMC/Dell tax worry overstated, attorneys say
Dell's use of VMware (NYSE:VMW) tracking shares to help fund its purchase of EMC (NYSE:EMC) is not expected to trigger a tax liability, tax attorneys said.
As long as typical tax-sensitive features are used in the tracking stock, the tax liability is unlikely to be a real concern for the transaction, three tax attorneys told this news service.
Earlier this month online technology publication Re/code reported that Dell’s USD 67bn proposed acquisition of storage giant EMC could trigger a tax bill of USD 9bn. The Texas-based technology company has proposed to use cash and a VMware tracking stock to acquire the company.
The report, citing sources familiar with the matter, said the creation of the tracking stock in virtualization technology company VMware, of which EMC owns an 81% stake, could attract scrutiny by the Internal Revenue Service (IRS). The potential concern is the agency may deem the transaction taxable if the tracking stock disguises interest in the assets it will track.
Robert Willens, an independent tax expert, said that during the 35-year history of tracking stocks, the IRS has never attempted to argue that tracking stock is anything other than what it purports to be, stock of the issuing corporation.
A source familiar to the situation agreed, adding that it would be odd for the IRS to come up with new directives now.
“The correlation between tracking stock and the tracked asset in this case is quite tenuous,” Willens said.
Holders of VMware tracking stock, which is called Class V Common Stock, are subordinated to all creditors of Dell parent Denali Holding in claims, yet, no actual shareholders of VMware could be subordinated to the claims of Denali’s creditors, Willens explained, an argument that the tracking shares in VMware are more closely tied to Dell rather than VMware.
The first attorney and Willens said that the IRS is unlikely to rule on the tracking stock in this transaction, but there will be an opinion of the companies’ counsel, which will be forthcoming.
The Re/code story also said that Dell’s plan to create tracking shares in VMware, which it does not yet own, would be an effort to carefully manage tax laws since the transaction would not require a distribution of shares or a spin-off, two types of deals that are sometimes taxable.
Willens and two of the attorneys said they disagreed, noting that EMC and Dell structured the deal in a way where the link between the tracking stock and the tracked asset is more attenuated than normal, and the transaction is not “threading the needle,” as Re/code described it.
An example would be that Denali, the parent company of Dell, is not obligated to distribute to the Class V common stock holders any dividends it receives on the VMware stock, Willens said.
Class V common stock will be issued by Denali to track the performance of a portion of the group’s post-closing economic interest in the VMware business. Denali will issue approximately 223 million shares of the Class V stock at the closing of the transaction, according to SEC filings.
The first and second attorneys said that the companies were trying to structure the deal as a tax-free rollover transaction, which help align the interests with different parties and also bridge valuation and financing gaps.
The Re/code story also mentioned US Internal Revenue Code Section 355, and said that if Section 355 applies, the deal will not happen.
Section 355 regulates the distribution of stock and securities of a controlled corporation and has served as an essential tool for restructurings since it allows the movement of corporate entities to be tax-free.
Willens said Section 355 tolling can be easily dispensed if EMC is merged with and into Denali before spinning off VMware. This eliminates the “purchased” basis in the VMware stock and, in the process, eliminates the Section 355 issue.
The fact that Liberty Media (NASDAQ:LMCA) has been using tracking stock for decades in the face of the supposed risks involved shows the efficacy of tracking stock, added Willens and two attorneys.
Dell and EMC declined to comment. VMware was not immediately available for comment.