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Why a Reverse Morris Trust Is Path for AT&T-Discovery: QuickTake

May 17, 2021, 8:12 PM

To carry out the planned merger of their media operations, AT&T Inc. and Discovery Inc. proposed a tax-advantaged transaction known as a Reverse Morris Trust. This route can be attractive to highly leveraged corporations such as AT&T, the world’s most heavily indebted nonfinancial company. The goal is for AT&T and its shareholders to see no tax on gains from the deal.

1. What is a Reverse Morris Trust?

It’s essentially a tax-free spinoff with a twist: The spunoff entity joins a third party in a prearranged merger. In this case, AT&T proposes to 1) spin off (or split off) WarnerMedia, which includes brands like HBO, CNN, and TBS; 2) merge it with Discovery; and 3) have its shareholders retain more than 50% ownership of the newly merged company, a crucial test to keep the arrangement tax-free. Spinning off or splitting off a subsidiary are two paths to the same goal, with the difference being who receives the shares of the new company.

2. How did the Reverse Morris Trust come about?

The name stems from a transaction that withstood a challenge by the U.S. Internal Revenue Service in a 1966 ruling by the U.S. Court of Appeals for the Fourth Circuit. The Mary Archer W. Morris Trust resisted a tax bill from the IRS over its stake in a bank that had merged with a rival. In ruling against the IRS, the appeals court found that the Morris Trust and other stockholders had “realized no recognizable taxable gain” in becoming shareholders of the spunoff corporation. That gave rise to so-called regular Morris Trust corporate reorganizations, in which the parent company -- rather than the spunoff entity -- merges with a third party. After Congress moved to crack down on the tax-free nature of such deals, the Reverse Morris Trust, with the spunoff entity merging with the third party, came into vogue.

3. How common are Reverse Morris Trust deals?

In a typical year, just a handful are announced. Prominent examples include a complex deal between Hewlett Packard Enterprise and Computer Sciences Corp., announced in 2016. Another one announced that year was Lockheed Martin Corp. splitting off a chunk of its business that combined with Leidos Holdings Inc. But since the Republican-led overhaul of the tax code in 2017, tax professionals have expected reverse Morris Trust transactions and other spinoff deals would gain traction.

4. Why is that?

As part of the overhaul -- and to raise some revenue to offset lower rates -- Congress placed a cap on the amount of debt interest expenses that companies can write off. That effectively increased the cost of debt financing for some highly leveraged companies, especially those with low earnings, and heightened the attractiveness of moving cash and debt around.

5. Why would AT&T and Discovery choose this route?

Reverse Morris Trusts can come with opportunities to reduce debt and generate cash without a tax bill. In this case, AT&T would get $43 billion in cash, debt securities and retention of existing debt by WarnerMedia, according to a news release. Newly separate WarnerMedia, meantime, would “utilize the significant cash flow of the combined company to rapidly de-lever,” or pay off its debts.

6. Are there any catches?

Parties to a Reverse Morris Trust must adhere to certain requirements to keep the IRS from treating the deal as taxable to the parent company. AT&T shareholders will have to retain more than half the shares in the newly combined company, for instance. (AT&T shareholders are set to retain well above that, with 71% of the new company.) Sometimes companies request private letter rulings -- which are anonymized, case-specific statements of certain tax treatment -- from the IRS, though that can be expensive and take months. Additional restrictions apply to what kinds of companies can engage in tax-free spinoffs: They must have earned income in the five years beforehand, for example. The IRS said several years ago that it was studying this requirement and could eventually change it.

The Reference Shelf

  • Bloomberg’s story about the proposed deal.
  • The news release from AT&T and Discovery.
  • A 2018 KPMG paper on use of the Reverse Morris Trust.
  • Read the 1966 appeals court ruling in the case of the Morris Trust.
  • Members of Congress expressed alarm in 2010 at use of the Reverse Morris Trust to avoid paying taxes.
  • Bloomberg Opinion columnist Tara Lachapelle has thoughts on AT&T’s retreat from Hollywood.

To contact the reporter on this story:
Lydia O’Neal in Arlington at loneal5@bloomberg.net

To contact the editors responsible for this story:
Colleen Murphy at cmurphy194@bloomberg.net

Laurence Arnold, Kevin Miller

© 2021 Bloomberg L.P. All rights reserved. Used with permission.

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