https://www.hightable.com/corporate-finance/insight/will-aethers-tax-loss-assets-ever-be-realized-4151A common financial “urban legend” is the idea that tax net operating losses generated by one company can be “purchased” and used by another entity to reduce future tax liabilities. Unfortunately, in most cases, this simply is not the case. This commentary debunks this legend and provides insight into Aether Holdings’ tax loss position. This article documents Aether Holdings Inc.’s recent acquisition of UCC Capital in a reverse merger. The transaction was designed to preserve approximately $1 billion in tax net operating and capital losses generated by Aether since 2001, so these “tax assets” could be used to offset future taxable income generated by UCC Capital Corp.’s future operations. While the article does note that Bob D’Loren’s planned use for the tax losses has some risk, it falls woefully short of outlining the full extent of the potential hazards.
Aether’s 10-K tax note indicates that almost $300 million of its loss carryovers relate to capital losses. Such losses can only be used to offset future capital gains. One must wonder how Aether’s intends to generate such gains during the next few years, as the losses expire between 2006 and 2010. Moreover, Section 384 of the Internal Revenue Code does not allow an acquiring corporation’s loss carryovers to be deducted against a target company’s built-in gains that are recognized during a five-year post-acquisition period. Built-in gains occur when the fair market value of all the corporation’s assets exceed their tax basis at the time of the ownership change. This restriction virtually eliminates any possibility of Aether using its gain capital losses to offset UCC capital gains given the capital loss expiration period.
As for the almost $780 million in net operating loss carryovers which expire between 2011 and 2025, the prospects for extracting $320 million in value associated with these “assets” also are questionable. The article does not address a very significant limitation on tax losses referred to as the Separate Return Limitation Year (SRLY) restriction. SRLY considerations arise when the stock of a loss corporation is acquired by another corporation. SRLY refers to the tax year in which a member of an affiliated group either filed its own separate tax return or filed as part of another group. SRLY losses generated in the past by the loss corporation cannot offset income generated by other group members in a consolidated return year. Consequently, Aether’s operating loss carryforwards can only be used to offset taxable income which it generates, not that generated by other subsidiary companies (i.e., UCC Capital Corp.).
Additionally, the article is silent on the potential impact that Section 382 of the Internal Revenue might have on Aether’s tax loss usage. Section 382 imposes severe annual limits on the use of net operating loss carry-forwards when there has been a significant ownership change of a loss corporation. So, future equity issuances to raise additional capital to meet strategic objectives could jeopardize Aether’s ability to use its loss carryforwards.
Confirmation of the above concerns also can be found in the most recent 10-K filing’s tax note. Despite D’Loren’s assertions to the press, Aether’s management has created a 100 percent valuation reserve for all of its deferred tax assets (including the tax loss carryovers) suggesting that will not be realized in the future. So, while UCC Capital may have “acquired” Aether’s tax losses, it has significant hurdles to clear before it will be able to extract any value from them.
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