- Posted by jbehrendt on July 26, 2009
Finally, the request for a binding advice from the tax authorities on the treatment of hidden reserves was answered. One week ago, a high-level meeting between representatives from different tax authorities in the German states affected met with the head of taxation at customer side, and with the tax advisors hired especially for this project. I was, fortunately, not present - as far as I heard, the fight went on for a couple of hours. Initially, a lot of ideas about additional real estate assets and participations to be added to the two carve-out objects were expressed by the representatives of the tax authorities, and even questions if specific brands should be transferred to the new joint venture were discussed. Unfortunately, most of these ideas would be show stoppers for our project, since the customer was neither willing to accept brand ownership in operational units, nor to accept high additional real estate purchasing taxes, which would be due in case real estate assets, or participations containing real estate assets, would be transferred. The interest of the tax authorities, at least regarding real estate purchasing taxes, was obviously different.
After hours of discussion, an unexpected compromise was found. No more transfer of brands, or of real estate assets (or related participations) was requested. But instead of this, another participation in one of the two companies would have to be added to the carve-out object in order to become part of the new company. This company was a company we had reviewed before but never thought it could be relevant - you never stop learning. It provides internal leasing services within the group, meaning if a new store is opened, the relevant fixtures and fittings, storage systems, checkouts etc. are not purchased by the company opening the store but by this leasing company, which then establishes a long-term leasing contract with the operating company within the group, and another financing contract with the internal financing company of the group. This construction was established years ago - for tax purposes, and now tax authorities considered it to be an essential part of the carve-out object.
Although it first looked like a nice compromise, it brought significant last-minute load to the project. This participation is a "heavy" one, with a lot of assets and debt, meaning the carve-out balance sheets would have to be changed. Live is not getting easier by the fact that the group reports are set up both according to the German Commercial Code, and to IFRS, with different treatment of leasing contracts in both accounting frameworks. As a result, the capital structure of the new company may have to be reviewed. The more difficult part is to adjust the valuation of the company, since leasing contracts are based on a full-amortization time of six years, whereas depreciation may take longer, causing temporary profits (and free cash flows, and therefore a significant DCF value) for the leasing company. This, in turn, creates an increase of the valuation of one of the two companies - which creates a change in the already communicated share allocation to both shareholders. The worst part is that, being a pure internal company without external market connections, the strategic planning for this unit is a little bit superficial, not providing correct planning results which are in line with the forecasted balance sheets.
Last efforts to mofify the respective planning were made in the night from Friday to Saturday. At 5.00 in the morning on Saturday I received the information that modelling was completed. I don't know the results in detail, and I don't know how to communicate the changes in participations to shareholders, but at least the planning and valuation process seems now completed. This week, the last project meeting of this project phase will take place in order to approve the final versions of valuation reports, carve-out contracts and carve-out balance sheets. If everything goes fine, on Thursday all work will be completed, and communicated to the decisionmakers for preparing their decisions in the second half of August. Slowly we see light at the end of the tunnel - now it looks as if all problems can be overcome, and supervisory boards and general assemblies will approve the carve-outs. Let's hope the best - we spent more than one year on it.