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Summary

  • Viewtran appears to have generated a large U.S. federal income tax liability of which it is unaware, based on my analysis of VIEW’s SEC filings.
  • I estimate this liability to be very approximately 17% of market capitalization, and 3% of total stockholders’ equity as reported by VIEW.
  • I have informed the IRS about this possible liability, though it is unclear if or when the IRS will act on this information.

About the Author

I am a tax attorney specializing in IRS whistleblower claims. Further information on my background is available from my LinkedIn profile.

Disclaimers

I do not have any interest in the stock of Viewtran Group, Inc. (NASDAQ:VIEW). I have submitted a claim to the IRS whistleblower program regarding VIEW, and so stand to benefit from taxes collected from VIEW by the IRS as a result of that information.

The possible tax liability described in this article is based on incomplete information. The actual liability may be more or less than I describe, or altogether non-existent. I have not tried to discuss these issues with VIEW's management.

For a more detailed discussion, and for citations to sources, please see my article appearing in the July 28, 2014 edition of Tax Notes, "The Tax Whistleblower's Guide to Chinese Reverse Mergers," which is available on SSRN. All of the information about VIEW contained in this article is derived from the company's SEC filings and website, and my analysis of those sources.

Background on VIEW

VIEW and its related companies (which I collectively refer to as the VIEW Group) have historically sold electronic components to manufacturers. However, over 2012 and 2013 the VIEW Group disposed of most of its operating subsidiaries, and is now restructuring itself as a service provider to the technology sector. The VIEW Group's principal operations are based in the People's Republic of China. The VIEW Group has no U.S. operations.

VIEW is a Cayman Islands corporation that is treated as a U.S. corporation for U.S. federal income tax purposes, as a result of a corporate inversion that occurred in August 2011. VIEW directly owns Cogo Inc., another Cayman Islands corporation, which in turn owns the VIEW Group's other subsidiaries.

The below structure chart is a simplified representation of the VIEW Group's legal structure after the 2011 inversion and prior to the sales of subsidiaries in 2012 and 2013. Readers may find it useful to refer to this diagram in relation to the discussion of those sales, further below.

Assets, Liabilities and Equity

As of year-end 2013, the VIEW Group reports $251 million of total assets, $8 million of total liabilities, and $244 million of total stockholders' equity. As of August 10, 2014 VIEW had market capitalization of $52 million.

Reverse Merger

The VIEW Group entered the U.S. in 2004 through a transaction known as a reverse merger. China-based companies that have entered the U.S. through reverse mergers have been scrutinized for their accounting practices, though their U.S. tax compliance has been largely ignored by commentators.

Possible Tax Liability

Because it is treated as a U.S. corporation for U.S. federal income tax purposes, VIEW is subject to U.S. federal income tax on its worldwide income at rates up to 35%. Taxable income includes dividends received from subsidiaries, if those dividends are made out of the subsidiaries' profits.

VIEW never reports having paid any U.S. corporate income tax.

2012 Sale of Subsidiaries

In October 2012 VIEW entered into an agreement to sell certain subsidiaries to a related party for $78 million. A copy of that agreement is available here. Those subsidiaries were only indirectly owned by VIEW, and were directly owned by Cogo, Inc. However, Cogo, Inc. is not a party to the sale agreement and VIEW is entitled to receive the entire $78 million sale consideration.

It is not clear how much gain the $78 million sale price represents. The VIEW Group formed each of the sold subsidiaries (as opposed to having acquired them). As far as I am aware no information is available regarding how much money the VIEW Group may have used to capitalize the sold subsidiaries. Because the VIEW Group was generally profitable during a period of several years when it owned these subsidiaries, I think it is logical to assume the $78 million sale price represents substantial gain.

The proceeds of the sale were to be used in part to fund a share buyback program for VIEW. Between the completion of the sale in November 2012 and the end of the third quarter of 2013 (roughly the date of the 2013 sale), the VIEW Group used approximately $13.1 million to repurchase VIEW stock. This strongly suggests that VIEW in fact received at least $13.1 million of the proceeds from the 2012 sale.

2013 Sale of Subsidiaries

In September 2013 VIEW entered a similarly structured agreement to sell other subsidiaries to a different related party, this time for consideration of $80 million. A copy of that agreement is available here. Again, those subsidiaries were only indirectly owned by VIEW, and were directly owned by Cogo, Inc. As in the 2012 sale, Cogo, Inc. is not a party to the 2013 sale agreement and VIEW is entitled to receive the entire $80 million sale consideration.

It is not clear how much gain the $80 million sale price represents. On the basis of VIEW's SEC disclosure, which only provides incomplete information, I calculate that the VIEW Group paid at least an aggregate of $35 million for its acquisitions of the subsidiaries disposed of in the 2013 sale. There appears to be no indication of how much capital the VIEW Group may have contributed to those subsidiaries after it acquired them. Because the disclosed aggregate original purchase prices ($35 million) for these subsidiaries is substantially less than the 2013 sale price ($80 million), and because the VIEW Group was generally profitable during a period of several years when it owned these subsidiaries, I think it is logical to assume the $80 million sale price represents substantial gain.

As with the 2012 sale, the proceeds of the 2013 sale were to be used in part to fund a share buyback program for VIEW. Between September 30, 2013 (roughly the date of the 2013 sale) and May 21, 2014, the VIEW Group used approximately $14.8 million to repurchase VIEW stock. This strongly suggests that VIEW in fact received at least $14.8 million of the proceeds from the 2013 sale.

U.S. Tax Characterization of 2012 and 2013 Sales

Because of the confusing nature of the 2012 and 2013 sale agreements, under which VIEW was to receive payment for the sale of property belonging to Cogo, Inc., the proper U.S. federal income tax treatment of these transactions is not entirely clear.

However, in situations like this, U.S. tax treatment generally follows the substance of a transaction rather than the transaction's mere legal form. I think that the 2012 sale and the 2013 sale are most naturally understood as sales by Cogo, Inc. followed immediately by dividend distributions to VIEW. Alternate characterizations are possible, however there appears to be support for my characterization in IRS published guidance regarding a comparable fact pattern.

The amount of the resulting deemed dividend distributions from Cogo, Inc. should be the amounts actually received by VIEW and available for its use. In this case, that amount would most likely be the amounts used for VIEW's share repurchases, and any other amounts VIEW received.

Such deemed distributions would be taxable to VIEW to the extent that they come from the profits of Cogo, Inc. As such, if Cogo, Inc. realized a gain on the sales, VIEW would be taxable on an amount equal to the smaller of: (1) Cogo, Inc.'s gain, or (2) the amount of distributions deemed received by VIEW from Cogo, Inc.

Tax Credits and Losses

As reported in VIEW's annual report on Form 20-F for 2013, it either had a relatively small amount of U.S. tax losses available to offset against income, or none at all (due to their likely use to offset an unspecified uncertain tax position). As such, I do not expect any substantial amount of VIEW's income to be offset by accumulated tax losses.

Generally, foreign taxes paid by a U.S. company or its subsidiaries may reduce the parent company's U.S. tax liability. The amount of the reduction for VIEW should generally be proportional to the VIEW Group's foreign effective tax rate (herein called ETR), calculated as the total amount of foreign taxes paid, divided by the total amount of foreign earnings. I calculate the VIEW Group's foreign ETR to be 7.2% for the period 2004-2013.

Estimated Total Tax Liability

The following is a back-of-the-envelope calculation of VIEW's approximate U.S. federal income tax liability. This calculation is very imprecise, and is intended only to give a sense of the order of magnitude of the possible liability.

This calculation rests on two key assumptions: (1) the 2012 and 2013 sales resulted in at least a total of $27.9 million of gain to Cogo, Inc., thereby creating profit available to distribute to VIEW, and (2) VIEW is only taxable on the $27.9 million of sale proceeds used for share repurchases, not on any other portion of the consideration received.

  • $13.1 million receipt of 2012 sale proceeds + $14.8 million receipt of 2013 sale proceeds = $27.9 million total taxable income
  • $27.9 million income * 35% tax rate = $9.8 million tax liability before foreign tax credits
  • $27.9 million dividends * 7.2% foreign ETR = $2 million estimated foreign tax credits
  • $9.8 million preliminary liability - $2 million foreign tax credits = $7.8 million tax liability
  • $7.8 million tax liability + 20% tax understatement penalty = $9.3 million estimated total liability

Mitigating Considerations

IRS Enforcement

It is possible that the IRS will disagree with my analysis, or will otherwise decide not to act on this information. The IRS has to prioritize use of its limited resources in enforcement actions, and does not follow up on all possible liabilities.

Incomplete Information

My analysis is based on incomplete information; facts unknown to me could reduce or eliminate the possible liabilities I have described. Or, my analysis could be mistaken.

In particular, whether VIEW is taxable on the deemed receipt of distributions from Cogo, Inc. depends on whether, and to what extent, Cogo, Inc. realized gains on the 2012 and 2013 sales. I think that the available information indicates that Cogo, Inc. likely would have realized gain in excess of the total $27.9 million used for VIEW share repurchases following the sales, though I could be wrong.

Market Response to Prior Publication of this Information

A version of this analysis of VIEW's U.S. tax position was first published in my article, "The Tax Whistleblower's Guide to Chinese Reverse Mergers," in the July 28, 2014 edition of Tax Notes. It is unclear to me if markets have assimilated that information. As far as I am aware, this information has not appeared in any mainstream media outlets. VIEW's stock opened on July 28, 2014 at $2.01 per share, and closed on August 8, 2014 at $1.95 per share.

Conclusion

VIEW appears to have generated a large U.S. federal income tax liability of which it is unaware.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

Source: Viewtran: About To View Large Tax Bill?