Tribune in Tax Dispute Over Times Mirror Deals

When Tribune Co. acquired Times Mirror Co. nearly two years ago, it picked up seven daily newspapers--and maybe a giant tax headache as well.

The Chicago-based media holding company is locked in a high-stakes dispute with the Internal Revenue Service over the tax accounting on a couple of transactions that Times Mirror pulled off in 1998. If the IRS gets its way, Tribune will have to pay the government $880 million in back taxes, penalties and interest. That’s more money than the company has earned over the last two years.

Times Mirror originally set aside about $180 million as a tax reserve to cover the disputed deals. But the IRS is demanding the higher figure. Wall Street, however, appears to have only minor qualms about the potential exposure for Tribune, which publishes the Los Angeles Times, Chicago Tribune, nine other daily newspapers and owns 23 TV stations nationwide.

The prospect of Tribune losing its tax fight “isn’t built into my projections” for Tribune, said Brian Shipman, an analyst with Robertson Stephens. Shipman figures “the chances are slim” that Tribune will lose. He added, “If they were ever to have to pay any or all of that amount, it would be viewed as a one-time occurrence.”

It was Times Mirror that aggressively pushed the accounting envelope. But Tribune inherited the potential tax burden when it acquired the Los Angeles-based publisher for about $8 billion in stock and cash in June 2000.

Since the acquisition, the IRS has continued to scrutinize Times Mirror’s deals. A year ago, in its first 10-K report to the Securities and Exchange Commission since the acquisition, Tribune disclosed that the two 1998 Times Mirror transactions were “under review” by the IRS, and that Tribune could face back taxes of up to $600 million.

In the 2001 10-K report filed last month, however, Tribune disclosed that the IRS is pressing ahead. After completing its audit, the IRS last year issued a “notice of proposed adjustment,” Tribune said.

“If the IRS prevails,” Tribune reported, the company would owe not only the $600 million in state and federal taxes due for 1998, but also $160 million in accrued interest and a penalty of about $120 million.

An IRS spokeswoman, citing agency policy, declined to comment on the dispute.

A Tribune spokesman, asked when the company thinks the issue will be resolved and whether the dispute is likely to damage earnings, said: “Because this is a matter under IRS review, I’m not in a position to comment beyond what the [10-K] document says.”

Tribune’s filing says that the company intends to “vigorously defend” against the IRS case and that the outcome of the dispute is “unpredictable.”

The case hinges on some controversial and dauntingly complex asset-shifting that Times Mirror carried out in 1998. That year, Times Mirror transferred its Matthew Bender & Co. legal-publishing business to European publisher Reed Elsevier.

Times Mirror indirectly received $1.38 billion in cash from Reed Elsevier. But in its dealings with the IRS, the company insisted that the deal was a “corporate reorganization,” and thus tax-free.

The deal looked like a sale to a number of observers. The transaction was structured so that Times Mirror was made the “manager” of a specially created company whose only asset was the cash paid in by Reed Elsevier. Times Mirror controlled the funds, spending some of the money to buy back its own shares. Times Mirror, which was known for aggressive tax policies, liked the structure so much that it reorganized another subsidiary later in 1998 using the same procedure.

Now, the tab for the aggressive accounting may be coming due. When Tribune said the IRS was reviewing the case, the news earned a shrug from the investing community. But when the latest filing disclosed that the IRS has made a formal determination against Tribune, interest in the transaction rose.

While Tribune’s potential financial exposure is big, “we recognize that there is likely to be significant and potentially long-term litigation” before the case is resolved, said analyst Al Turner of Fitch Ratings.

Last week, Turner marked down by one notch Fitch’s rating on Tribune’s senior unsecured debt, subordinated debt and commercial paper. The tax case “was a factor we noted, but was by no means a determinative factor,” Turner said. The debt markdown “primarily reflected the lower level of earnings the company expects over 2002” as a result of industry conditions, he said.

The downgrade also anticipates a possibility that Tribune, known as a substantial consolidator in the broadcast and publishing sectors, may opt to stress its balance sheet more by undertaking further acquisitions during 2002 or 2003.