Three-way deal skirts the taxman
America Online gets CompuServe's subscriber base at minimal tax expense, according to tax specialists.
Confusing as this deal may be, it seems to have worked out for
the best, at least as far as taxes are concerned. The elimination of the "Morris Trust" tax clause earlier this year is said to have nixed the earlier talks between AOL and CompuServe, because a deal then would have resulted in big tax bills. Morris Trust allowed companies to break up their business into parts and combine them with an acquirer tax-free.
Once the provision was abolished, to limit the tax liability, AOL either had to purchase all of CompuServe in a stock swap from H&R Block or turn to what tax specialists call a "three-corner exchange."
That is where WorldCom (WCOM) stepped in. In this three-corner exchange, AOL wanted CompuServe's subscriber base but didn't want to pay taxes. So WorldCom acted as an intermediary by buying all of CompuServe in a tax-free stock swap. Then it swapped out the subscriber base with AOL.
"There isn't some tax scheme at work here. H&R Block is disposing of CompuServe on a tax-free basis with WorldCom. They could have done that with AOL or anybody," said Brian Wainwright, a lawyer at Pillsbury Madison & Sutro. But that doesn't mean taxes are exempt forever. "When H&R block disposes of WorldCom stock, it will include tax gain, [a capital gains tax]. They are just putting off the taxes...It is a deferral mechanism," added Wainwright.
Executives at CompuServe and AOL couldn't be reached for comment.
H&R Block didn't do a stock swap with AOL, probably because it didn't want the ANS Communications business that WorldCom is acquiring in this deal, according to Mark Silverman, a lawyer at Steptoe & Johnson. WorldCom stepped in to do a tax-free deal with H&R Block and then turned to AOL to get what it was after--ANS, while giving AOL what it wanted.
H&R Block could have done the swap with AOL and then sold ANS to another party, like WorldCom. But that assumes that H&R Block wanted AOL stock and AOL wanted all of CompuServe, which it didn't. In this exchange, everyone ends up with the assets they want, and it is done with the least amount of taxes, said Silverman.
"This deal is as tax-efficient as you can get," he added.