Hewlett Packard CEO Meg Whitman sounded pretty chipper this week about the future of the company. She spoke effusively about how well things were going. And she attempted to skim right over her really, really big news: HP is laying off about 8% of its workforce, or 27,000 people (about half the population of Greenland).
Pretty massive job cuts. So what’s the thinking there? Whitman has pitched the cuts as part of her strategy to turn HP around. Initial estimates are that the job cuts (and other cost-cutting measures) will result in savings of $3 billion to $3.5 billion.
But will it be enough?
Whitman appears to think this is the first best step towards recovery. But unless she is seeing something that we’re not, the news for the company doesn’t look that great. Revenues are not up, they’re down. And expenses are not down, they’re up. And the company received another blow this month when it lost a case against the Internal Revenue Service (IRS) related to an aggressive tax savings scheme. The loss? $190 million.
The scheme is tied to a foreign tax shelter designed by an arm of American International Group (AIG). You remember AIG, right? That was the bank that took $173 billion in bailout money, then threw a blow-out party just months later and then offered their execs $165 million (all while screaming they were losing money). The same AIG that then sued the IRS for a huge tax refund-related to the so-called Lilo (short for lease-in/lease-out) and Silo (short for sale-in/lease-out) tax shelters (Lilo and Silo transactions were eventually banned).
In the scheme related to HP, the plan focused on trading derivatives (basically an agreement or option to buy or sell based on underlying assets). Derivatives are all about speculation and the plan is generally to get the maximum benefit with the minimum risk – that is unless you’re trying to generate losses on purpose. That’s what the IRS claims HP was doing: trying to generate capital losses and foreign tax credits in order to artificially lower their tax bill. The IRS has banned most of these transactions.
In the case of HP, they passed funds along to a company called Foppingadreef, incorporated in the Dutch Antilles, long considered a problem child for tax haven purposes by the OECD (though that’s changing). That company was created by an arm of AIG. The transactions were, of course, “blessed” by tax attorneys (at Sullivan & Cromwell LLP and Skadden, Arps, Slate, Meagher and Flom, LLP, if you’re curious), because that made them marketable. All of these transactions get blessed that way: it’s arguably what brought down Jenkens Gilchrist, made a mess at Sidley Austin, and changed the way many taxpayers viewed the formidable Ernst and Young.
HP bought into this kind of transaction, allegedly approved at the top. The transactions appear to have accelerated under CEO Carly Fiorina, who was forced to retire in 2005.
HP claimed that these were investments and that the result of the investments was a loss. But the court found that the funds were actually paid back, more like a series of loans than investments with Judge Goeke writing that the money was “more appropriately characterized as debt, rather than equity, for Federal income tax purposes.”
The result was the loss of the tax break. You can read the TC Memo here (downloads as a pdf)
But HP isn’t crying over its forms 1118 (Foreign Tax Credit – Corporation). Instead, it’s gearing up for its next battle with IRS: it has supposedly filed for refunds worth nearly a quarter of billion dollars for the years 1994, 1995, and 1998. I’m not sure how the statute of limitations hasn’t run on that request but I’ll keep you posted. According to the docket, the matter has not yet made it to Tax Court.
