The opportunity for tax planning on Burmah hinged on the way the balance sheet was structured in the new company to optimize the purchase price. When RJR acquired Burmah, it bought two separate corporations – Burmah Oil and Gas. (BOAG), and Burmah Offshore Drilling Inc. (BODI).
BOAG owned long-held properties. Their purchase price was already depleted away, and BOAG had a low-cost basis. In contrast, BODI held new offshore leases, recently purchased and with a relatively high-cost basis.
If the $522 million purchase price had been allocated directly across all properties, RJR would have carried this amount on its books and would have depleted these assets as the oil was pumped from the wells. Depletion is a non-cash expense that shelters the company’s earnings from income tax and generates cash.
The RJR tax department was aware of the Burmah balance sheet but believed that it offered no useable advantage. I learned after the acquisition that the tax attorney at our outside counsel, Davis Polk, had captured this opportunity. BOAG was treated for tax purposes as a purchase of stock, preserving the high-cost basis in its properties. In contrast, BODI was treated as an asset purchase with a high proportion of the $522 million price allocated to its properties. This allowed a step-up in asset basis in total, to $622 million. Each of those extra dollars would shelter Burmah’s earnings from income tax of about 40%, resulting in $40 million of cash over the life of the wells, or about $30 million of present value to RJR.
The attorney’s expertise added real value to RJR. At the time, she was one of only two women partners at top New York law firms. With service to her clients like this, her status was not a surprise. The tax rules have changed; this favorable treatment is no longer available.