Loral Used Offshore Partnership for Tax Haven
Loral Corp., which is being acquired by Lockheed Martin in a $9.1-billion deal scheduled to close Monday, has used a limited partnership in the Cayman Islands tax haven to avoid U.S. corporate income taxes, according to financial disclosures made in connection with the merger.
The partnership is legal and is something widely used by others in the satellite communications industry, but it highlights the increasing use of often sophisticated and controversial tax strategies in the defense industry, according to tax experts and securities analysts.
Congress is increasingly concerned about the effects of these tax strategies as their use expands and as the massive consolidation of the defense industry continues, costing thousands of workers their jobs.
“I suspect substantial amounts of taxpayer funds are being spent to benefit defense contractors at a time when they are throwing American workers out on the street,” said Rep. Bernard Sanders (I-Vt.). “I suspect tax breaks are being provided for people who do not need the help.”
Rep. Peter DeFazio (D-Ore.) said he is outraged by the tax strategies, adding, “Congress already guarantees their profits and now we find out that they are dodging what few taxes they might be liable for.”
But defense contractors believe it is entirely legitimate to use U.S. laws to shield income or capital gains from taxation. Before the merger, Loral used a limited partnership in the Cayman Islands to shield income from its investment in the Globalstar communication system, according to the firm’s securities filings.
Lockheed is paying cash for most Loral’s defense business, making that part taxable, and spinning off Globalstar into a separate company. But a significant number of other defense industry mergers, acquisitions and spinoffs have been organized under Internal Revenue Service rules that have allowed both the corporations and shareholders to avoid any tax liability.
When General Electric, for example, sold its defense operations to Martin Marietta in 1993, the deal was made under a so-called Section 351 reorganization that allowed GE to avoid capital gains taxes on the deal, a GE spokesman said.
Rockwell International is currently attempting to sell its defense operations under another arcane Tax Code provision, known as a Morris Trust, a two-step process in which it would spin off the operations to a new entity and then merge that new entity with an acquiring corporation, according to Wall Street investment sources. (The company has declined comment on the merger speculation.)
Litton Industries effectively split itself in half in a tax-free deal two years ago, utilizing provisions of IRS Code Section 355(a), according to a company spokesman.
“The defense industry is right up there in the vanguard of using the most sophisticated tax techniques,” said Robert Willens, a tax expert on the Columbia University business faculty.
Indeed, had many of these deals been subject to regular capital gains taxes, the revenues flowing to the federal government could have reached into the billions of dollars, according to securities analysts familiar with the tax strategies.
In a straight cash acquisition, a corporation or its shareholders are subject to capital gains taxes--computed as the difference between the sales price of the unit being sold and its basis price. The basis price is seldom, if ever, reported publicly to shareholders or the Securities and Exchange Commission. In general, defense firms have very a low basis, in part because their physical plants are so old and are fully depreciated.
Because defense contractors are essentially supported by taxpayers, their profit margins, executive salaries, tax payments and political contributions are often held to a higher standard of business conduct than the rest of American industry, according to Danielle Brian, executive director for the Project on Government Oversight.
“These defense contractors are the worst welfare queens, especially when we discover they are not paying their fair share of taxes,” Brian said.
