Dell Considered Novel Tax Strategy in Buyout

In the proposed buyout of Dell Inc. by its founder, the company considered but ultimately rejected as too risky a novel strategy that tweaks the now-curbed practice of corporations moving overseas to take advantage of lower taxes.

The strategy, drafted by JPMorgan Chase and disclosed in Dell’s regulatory filings in recent months, proposed a fresh twist on that practice, which has largely been banned by the Internal Revenue Service. In slides of a presentation dated last October, JPMorgan cited a “lack of precedent” for the strategy, calling it a “new structure â€" has not been executed publicly.”

Dell and its advisers decided not to use the strategy in part because of potential image problems with United States and European regulators and investors, people briefed on the matter said. But the new strategy could serve as a template for future buyout participants because it circumvents anti-abuse regulations, said Robert Willens, a tax and accounting expert.

While maneuvering continues over the price that Michael S. Dell and the investment firm Silver Lake will offer to buy out the company he founded, the scrapped tax strategy sheds light on Dell’s quest for tax benefits to the buyout.

The slides appeared in a Dell filing as recently as May 20. No other tax structure regarding the buyout has emerged in filings, and it is unclear how large shareholders, including Carl C. Icahn and his ally, Southeastern Asset Management, viewed it. Mr. Icahn was not available for comment on Tuesday. Calls to a Southeastern spokeswoman were not returned.

David Frink, a Dell spokesman, declined to comment on Tuesday on the rejected strategy or its successor. So did Brian Marchiony, a JPMorgan spokesman.

What is clear is that Dell was presented with a maneuver some tax lawyers said appeared legal but aggressive.

Under a section labeled “political,” the slides ask whether use of the strategy could “raise issues” or “impact” government contracts, indication of concern that it could have faced a backlash.

The apparent reason is the strategy resembles a corporate inversion, a stamp in recent decades for tax-dodging corporations like Tyco International and Nabors Industries. Those companies prompted Congressional investigations and tougher I.R.S. rules after they moved their headquarters to the offshore haven of Bermuda, with a post-office box holding company as the parent to the main United States subsidiary that housed operations and management.

Mr. Willens said the strategy would most likely have passed technical muster under I.R.S. rules but would also have brought “political and popular heat to Dell, and reputational risk.”

The proposed strategy involved conducting the buyout through a newly created foreign entity that would have effectively owned Dell. Under United States tax laws, that foreign entity would have legally escaped United States corporate taxes because it would have been a partnership for United States tax purposes.

At the same time, the foreign entity, whose jurisdiction was not specified, would have been treated under tax laws in that unspecified jurisdiction as a corporation and would have been subject to foreign taxes. Those two contrasting tax outcomes, embodied in one structure, would have created a “foreign hybrid,” able to navigate different national tax regimes and access offshore cash while paying little or no United States taxes.

The “unprecedented” piece in the JPMorgan strategy was the proposal that Dell designate the foreign hybrid as a partnership, securities filings show. The foreign hybrid would have held a new entity called Denali, which would have held Dell share, and Denali would have owned Dell’s foreign subsidiaries. (Mr. Dell was known in secret negotiations on the buyout as “Mr. Denali.”)

Dell’s physical headquarters would have remained in Round Rock, Tex., while the company would have been able to tap into the cash and tax benefits of being legally based in a lower-tax country. And it would have been able to borrow money from cash-rich offshore subsidiaries to finance Dell’s operations, all without having to pay United States corporate income taxes. “Can likely access existing offshore cash without U.S. tax,” one slide of the novel structure said.

Global tax officials have increasingly criticized foreign hybrids as leaching corporate profits out of higher tax jurisdictions. The Organization for Economic Cooperation and Development has railed against what it calls “hybrid mismatches” for several years.

Edward Kleinbard, a tax law professor at the University of Southern California and a former chief of staff of the Congressional Joint Committee on Taxation, called the strategy “a twist on the old corporation inversion that relies on the fact that U.S. companies can dress up their foreign entities in different costumes for different tax purposes.”

Whatever maneuverings are used, tax analysts are wondering precisely how the deal might take advantage of Dell’s considerable overseas cash hoard without generating large tax bills. (The United States corporate rate for bringing overseas cash home is 35 percent.) Dell has said it wants to tap nearly half of its estimated $10.4 billion in overseas cash and cash equivalents to help finance the buyout. The rejected strategy would have done just that. Reuven Avi-Yonah, a professor of taxation at the University of Michigan, said that other ways of structuring tax to access cash tax-free could present problems.

“There are a couple of other options, but those have come under I.R.S. attack,” he said, so the rejected option “would have been safer.”

Mr. Willens wonders whether shareholders might be interested in the value of that offshore cash.

“You’d think a shareholder would say, ‘Wow, they can afford to pay me more â€" they’re accessing cash tax free,’” he said.