November 13 - Tax-Free Holiday for Delta, American and United


INDUSTRY ANALYSIS

A White Paper that Delta Air Lines, American Airlines and United Airlines (Big Three) presented to the Obama Administration in January 2015 was the centerpiece of the failed $50 million lobbying campaign against Open Skies and the much-needed competitive choice offered to passengers by Emirates Airline, Etihad Airways and Qatar Airways (Gulf Carriers).

That White Paper was the most expensive piece of aviation fiction ever written. Truth was the casualty of political sound bites and anti-competitive fabrications. However, the paper was highly noteworthy for its assertion that not being required to pay corporate income taxes constitutes state-enabled unfair competition. Specifically, it alleged, “this exemption from taxation provides another significant competitive advantage to Emirates, Etihad and Qatar relative to U.S. carriers, which are subject to taxation in the United States.”

When it comes to gaining a competitive advantage from not being cash taxpayers, the Big Three speak with firsthand experience and authority. They don’t pay cash income taxes on their mega multi-billion profits and have not for some time. Accordingly, holding the Big Three to their own competitive litmus test, and given the billions of dollars they continue to save as a result of their tax-free holiday, they are among the most unfair competitors in global aviation.

In the past three years, the Big Three have racked-up the staggering sum of nearly $40 billion in net profits. Yet, the Big Three have paid no cash federal income tax and will continue to be exempt from paying cash federal taxes for the foreseeable future.

In 2015, the Big Three collectively earned $12.5 billion in profits.  They paid zero in cash income tax. They were also on cash tax-free holidays in 2016 and 2017 when they collectively earned $11.7 and $12.2 billion in net profits, respectively.

How is this possible?

The answer is that the US tax code allows the Big Three to carry forward past net operating losses. These so-called Net Operating Losses (NOLs) are used to offset taxable profits. If an eligible business has sufficient NOLs to fully offset its otherwise taxable income – and the Big Three have had a Fort Knox full of them – the company pays zero cash taxes.

In the world of NOLs, bust years can produce a tax-free bonanza in the future. The Big Three’s huge losses in the early 2000s drove each of them to file for Chapter 11 bankruptcy. Those bankruptcies seemingly wiped the slate clean as corporate equity and debt as well many hard-earned employee benefits totally disappeared. A virtual tsunami of write-offs and value destruction. There was a significant human toll for loyal employees and many financial casualties. In return, the Big Three got a fresh start. A tabula rasa.

However, ironically, the one thing that survived Chapter 11 was the impetus for it - the tens of billions of dollars in operating losses that drove the Big Three into bankruptcy in the first place. Not only were these losses not expunged for tax purposes, but these ugly ducklings became beautiful golden geese – tens of billions of dollars in NOLs that have enabled the Big Three to avoid being cash federal taxpayers for more than a decade and counting.

How’s that for the confluence of the US bankruptcy law, US tax code and accounting alchemy. The tens of billions of dollars in operating losses - that enabled the Big Three to massively benefit from competition-distorting Chapter 11 bankruptcy - survived the reorganization massacre. Those dollars were transformed by the US tax code into a multi-billion tax-saving asset for the Big Three who exited Chapter 11 with otherwise clean balance sheets?    

Surely the Big Three’s eye-watering collective profits must have fully exhausted their NOL carry-forwards by now, right? No, it will be at least several more years before the Big Three are cash taxpayers. As of the end of 2016, American still had $10.5 billion in NOL credits and United had some $4.3 billion. At the end of 2015, Delta had $9.5 billion in NOL carry-forwards.

Given this history of not paying cash taxes on historic profits, the Big Three hardly needed another tax windfall but they recently received one - the Tax Cuts and Jobs Act of 2017. They are benefitting enormously from that 2017 corporate tax reform package.

In addition to reducing the Big Three’s corporate tax rate from 35 to 21 percent, they will be able to “expense” – immediately write-off rather than depreciate over the useful life of the asset – their capital expenditures. For a capital-intensive industry such as commercial aviation, this is a very valuable reform further reducing cash tax liability.

However, do not look for these substantial tax savings to reduce the amount of cash taxes the Big Three pay in 2018. This year will be another tax-free holiday year despite multi-billion profits. Glen Hauenstein, Delta’s President, succinctly summed it up this way in its Q4 2017 earnings call: “Obviously you're not going to see any cash savings in 2018 from tax reform since we weren't anticipating paying any taxes and we still don't anticipate paying taxes in 2018.”

Billions in profits with an added boost from the corporate tax reform law but no cash taxes.         

Instead, the 2017 tax reform law will lower the Big Three’s tax liability thereby slowing the burn rate for their NOLs and extending their tax-free holiday. For instance, an October 3, 2016 Atlanta Journal-Constitution article describing how Delta pays no federal income taxes due to NOLs included a Delta company statement that “we expect to become a cash taxpayer in 2018 for the long term.”

However, that was before the 2017 corporate tax reform law and the windfall it provides to the Big Three. At Delta’s December 2017 Investors Day, its Chief Financial Officer, Paul Jacobson, speculated on the potential impact of the new tax law that had not yet passed Congress. Jacobson indicated that if the new law both lowered the corporate tax rate and permitted immediate expensing of capital investments, together that would enable Delta’s cache of NOL carry-forwards to keep it cash tax-free “into 2020.” In other words, because those two reforms were included in the new law, Delta’s cash tax-free holiday will be extended at least two more years. So, again in 2018 and 2019, Delta will continue to not pay cash taxes to the US Treasury despite expected multi-billion profits in each year.   

Nothing lasts forever. At some point, the Big Three’s tax-free holiday will end and they will join the ranks of cash-paying taxpayers. That reality has spurred at least one of them to plot how to avoid the harsh reality of writing a tax payment check to the US Treasury.  Bloomberg reported on one such scheme in its troubling December 15, 2014 article entitled “To Avoid Taxes, Delta’s Assets Could Book a One-Way Flight to Europe.” (https://btcnews.co/2OHp502)

Then Delta CEO Richard Anderson pulled back the curtain a bit on the scheme it then was incubating. Anderson reportedly said “[w]e got it figured out. At least we have a good piece of it figured out. But we're not ready to talk about it. But we're working on it. When you have those big joint ventures that are euro-dominated and you own 49 percent of an airline in London and you already have a big commercial office in Amsterdam for joint-venture pricing and yield management. Amsterdam is a good place.” In other words, Delta was plotting how to off-shore its profits either to the United Kingdom or the Netherlands because, at that time, both countries had significantly lower corporate tax rates. 

That tax dodge plan likely now is in the waste bin. Given that the 2017 law lowered US corporate tax rates to 21 percent, there would be little advantage for Delta to off-shore its profits to the UK, and there would be a tax disadvantage were it to shelter them in the Netherlands. However, it is a safe bet each of the Big Three is hatching tax avoidance schemes in anticipation of their NOL cash tax-free holiday ending in several years.

The Big Three’s anti-competitive campaign against Open Skies and competitive choice was a hypocritical house of cards. They claimed job losses were imminent. In fact, the Big Three are on hiring sprees bolstering employee ranks by thousands. They wrapped themselves in the stars and stripes claiming they are great champions of US workers. In fact, the Big Three are world-class outsourcers of US jobs. As such, it should come as no surprise that when the Big Three whine and complain about competitive distortions resulting from government-granted tax advantages they are in fact looking in the mirror.

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