The following article is adapted and reprinted from the M&A Tax Report, Vol. 11, No. 8, March 2003, Panel Publishers, New York, NY.
TRACKING STOCK TRIBULATIONS
By Robert W. Wood
Not too many years ago, investment professionals and corporate dealmakers alike were touting the benefits of tracking stock. We at The M&A Tax Report were not exempt from this seeming industry trend. Indeed, we've tried to look not only at the nontax motivations for tracking stock that seem to be in the news a lot a few years ago (see Natusch, "Non-Tax Motivations for Tracking Stock?" Vol. 8, No. 6, The M&A Tax Report (January 2000), p. 1), but also, as befitting our name, at the tax aspects of these deals. See Wood, "Tracking Stock Not Dead Yet," Vol. 9, No. 1, The M&A Tax Report (August 2000), p. 7.
What I found most interesting about tracking stock (at least back in its heyday) is the lack of discussion about how tracking stock fits in with established tax rules. Way back (it now seems way back) in President Clinton's 2001 tax proposals, there was a proposal to tax tracking stock (basically as a dividend). Plus, the Treasury Department proposed amendments to the Section 355 regulations that would require gain recognition on distributions of tracking stock, at least under certain conditions. I suppose the latter should be no surprise, given that commentators (and obviously the Service) have sometimes dubbed tracking stock the "poor man's spinoff." See Wood, "Tracking Tracking Stock," Vol. 9, No. 5, The M&A Tax Report (December 2000), p. 7.
So, should tracking stock really be treated as a dividend? I think no, but the answer may turn out to be moot. Indeed, with its characteristic play on words and witticisms, The Wall Street Journal recently quipped: "Ask a roomful of investors these days to applaud if they like "tracking" stock, and you probably could hear a pin drop." See Drucker, "Sprint Shows Pitfalls of Investing in Tracking Stocks," Wall Street Journal, March 7, 2003, p. C1. The pin drop, it turns out, alludes to Sprint and its two less than stellar tracking stocks.
Indeed, in a curious reversal, it is precisely because of the failure of such issues (like the two tracking stock issuances turned out by Sprint) that tracking stock just can't hold a candle to a real spinoff. In Sprint's case, one stock tracks the performance of Sprint's traditional business (not so cleverly called the "FON Group"), and the other tracks Sprint's wireless business (the "PCS Group").
But, unlike standalone companies following a spinoff, the results of one group clearly can affect the other. Sprint, for example, has to deal with the more than $16 billion of debt it racked up on its wireless operations. The debt actually boosts FON's results, since the company allocates an interest rate to its PCS unit based on the interest rate that PCS would obtain (according to Sprint) without the guarantee of Sprint. Id. This is a kind of "what would we be like if we were independent" analysis that is nearly always doomed to failure.
In any event, this kind of intergroup interest charge (even if you can't prove its accuracy or its arbitrariness) is a creature of fiction. After all, it doesn't really exist for Sprint Corp. Why? Because the income is cancelled out on a consolidated basis, counting as an expense on PCS' income statement. If FON were a standalone company, on the other hand, what adds up to $336 million in interest income just would not be there.
To Expense or Capitalize: That is the Question, Vol. 11, No. 8, The M&A Tax Report (March 2003), p. 8.