Year after year, General Motors lost money – enormous sums of money. It designed cars. It built cars. But no one wanted to buy the cars it designed and built. Over time, it accumulated huge operating losses (“net operating losses,” or NOLs). The tax code let GM carry forward these NOLs into the future. It let the firm save them for that day in the future when it would once again sell cars that people wanted.
The day never came. Instead, in June 2009 GM (or “Old GM”) declared bankruptcy. It filed under Chapter 11 of the Bankruptcy Code and sold its assets to a new shell (New GM) in a transaction under Sec. 363 of the Code. Old GM’s shareholders were not part of New GM, and the firm’s creditors took stock: the US Treasury, the auto unions, and Canada swapped debt claims against Old GM for equity stakes in New GM. With 61 percent, the Treasury took the largest share among this group. Other Old GM creditors acquired a 10 percent stake in New GM as well. In the fall of 2010, Treasury re-sold a large amount of its New GM shares to the public, and cut its share to 26%.
New GM has the factories, offices, designs and some of the workers that Old GM had. It also acquired some $18 billion worth of its NOLs (the losses themselves were $45 billion). It could not use them to reduce its corporate income tax liability immediately – it earned no income against which to apply them. But in 2010 New GM did finally turn a profit. Presumably, it will now start using its NOL’s to avoid its corporate tax.
Ordinarily, when one company buys another’s assets, it does not acquire its tax losses too. But the sale from Old GM to New GM qualified as a tax-free reorganization under Sec. 368 of the tax code. As a result, neither Old GM nor New GM incurred a tax liability, New GM entered Old GM’s assets on its books with Old GM’s “adjusted basis,” and New GM acquired Old GM’s NOLs.
The problem lay in Treasury’s planned sale of the shares it acquired in New GM. If the combined equity stake of any group of shareholders in a “loss corporation” like New GM climbs by more than 50 percentage points, Sec. 382 of the tax code limits the firm’s ability to use those accumulated NOLs. Given Treasury’s large stake in New GM, if it sold its entire stake to the public, those new owners would raise their combined interest by 50 points. They would buy Treasury’s shares, and New GM would lose its ability to avoid taxes on any future income.
To solve this problem, the Treasury issued a series of “Notices.” The Sec. 382 rules, it declared, simply did not apply to itself. When it sold its shares in New GM, its buyers might increase their ownership stake by 50 percentage points, but they would not trigger the Sec. 382 limits. The tax code offered no exception for government-owned shares, and the Treasury did not purport to find one. Instead, it just declared that the law did not apply. Treasury issued several similar “Notices” for AIG and Citigroup. Through the TARP transactions, both of these firms experienced ownership changes over 50%. By law, they lost their NOLs. By “Notice,” the Treasury announced that it would let them keep the losses.
In an article titled Can the Treasury Exempt its Own Companies from Tax? The $45 Billion GM NOL Carryforward, Eric B. Rasmussen and I consider the Treasury’s actions with respect to these losses. We do not address the wisdom of the bailouts. Neither do we ask whether giving a multi-billion-dollar tax break to an automobile or financial company makes sense. Instead, we focus on the propriety of the Treasury’s manufacturing a tax break. We find two aspects of the transaction especially troubling:
- a. The GM Notice transfers a large amount of money to one of the largest contributors to the administration’s party, the UAW. The UAW was merely an unsecured creditor to GM – yet through the reorganization it emerged with a much larger equity stake than its interest warranted. Through this Notice, the government now transferred vast sums of money to it.
- b. The GM Notice hides the real cost of the TARP bailout. Involving as it does very complex provisions of the corporate tax code, the Notice escapes virtually all public scrutiny. Yet at root it cuts the firm’s future taxable income by $45 billion. The true total cost of the TARP transactions does not involve only the direct outlay; it also includes the $45 billion in future income that the Treasury freed from tax.
Had the administration given such a large amount of cash to the UAW, the public would have complained massively. The administration gave it through a legally unauthorized Sec. 382 exemption, and no one noticed.
We conclude the article by exploring procedural reforms Congress might adopt to prevent a recurrence of what happened with GM. We urge it to give legislators standing to contest in court any tax benefits that the Treasury provides.
The article is available for download here.