Daily Tax Report ®

Lampert’s Sears Bid Targets Tax Offsets Possibly Worth Billions

Dec. 7, 2018, 9:45 AM

Former Sears Holdings Corp. CEO Eddie Lampert’s hedge fund is shaping its bid for Sears to substantially shrink future tax burdens thanks to a quirk in the tax code, according to a source familiar with the fund’s plans.

ESL Investments Inc., Lampert’s hedge fund and a major Sears shareholder and creditor, submitted a Dec. 5 letter indicating its interest in a purchase of the company for $4.6 billion.

Sears’ deferred tax assets were “incorporated” into the acquisition bid price, according to the proposal letter. The company’s federal net operating loss deferred tax assets totaled $1.7 billion as of February, according to its most recent annual filing.

Sears has continued to lose money in 2018—the company reported a $508 million loss in the second quarter alone.

Normally when a company with substantial losses is acquired, the ability to use deferred tax assets to shrink future liabilities is constrained by an annual cap. However, the deal for Sears—and its tax assets—could be more beneficial thanks to a quirk in the tax code for companies that have filed Chapter 11 bankruptcy.

Exceptions Available

While Sears has been able to burn through some of those loss assets by offsetting gains from sales of assets like the Craftsman brand, they’re otherwise generally useless to a company with little profit. They can, however, sweeten a deal if a more profitable company swoops in and buys the loss company.

Section 382 of the tax code sets an annual limit on the net operating loss tax assets the combined company can use. It is based on the market value of the target company right before the change in ownership, multiplied by a long-term, tax-exempt rate set by the Internal Revenue Service.

Consequently, if the target company is practically worthless, that annual cap can be minuscule.

For companies that have filed Chapter 11 bankruptcy, however, there are two exceptions to that restriction.

Under one, the cap on net operating loss use is calculated after the deal, when the market value would likely be higher.

The other option allows the combined company unlimited access to those tax assets. But for the combined company to qualify, half of its stock must have been held by creditors and shareholders who held the target company’s debt for at least 18 months prior to the Chapter 11 filing or whose debt “arose in the ordinary course” of the target company’s “trade or business.”

The bid is intended to fit within the guardrails of the latter exception, the person familiar with ESL’s plans said.

“ESL, we know, is a ‘qualified creditor’ of Sears,” so any stock it receives as part of the deal “would count positively towards satisfaction of the bankruptcy exception,” New York-based tax consultant Robert Willens told Bloomberg Tax in an email.

The proposal not only ensures that ESL will have access to Sears’ NOLs, but that the combined company won’t be “burdened” by the limitation under Section 382, he said.

To contact the reporter on this story: Lydia O'Neal in Washington at loneal@bloombergtax.com

To contact the editors responsible for this story: Meg Shreve at mshreve@bloombergtax.com; Megan Pannone at mpannone@bloombergtax.com

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