Sohu 20-F Reveals $144mm Tax Benefit

Sohu’s 20-F revealed that the company no longer believes it will owe any special one-time tax in connection with the 2017 US Tax Reform.  If correct then this will free up $144mm of cash (about $3.69/ADS) for general corporate purposes.

SOHU Sotp 040319

Investors in Changyou and Sohu are frustrated by the lack of information about the status of the Changyou privatization offer, but the tax benefit and change in company structure provide increased flexibility for corporate actions that will benefit shareholders.  Group chairman Charles Zhang acquired 1.5mm Sohu ADS last year at prices up to $37.11.

BACKGROUND

Sohu recorded a $219m provision in 4Q17 for tax payable on deemed repatriation of foreign earnings. (source: Sohu 2017 10-K)

Sohu.com Inc. is a Delaware corporation and is subject to income taxes in the United States. New U.S. federal tax legislation, commonly referred to as the Tax Cuts and Jobs Act (the “U.S. Tax Reform”), was signed into law on December 22, 2017. The U.S. Tax Reform significantly modified the U.S. Internal Revenue Code by, among other things, reducing the statutory U.S. federal corporate income tax rate from 35% to 21% for taxable years beginning after December 31, 2017; limiting and/or eliminating many business deductions; migrating the U.S. to a territorial tax system with a one-time transition tax on a mandatory deemed repatriation of previously deferred foreign earnings of certain foreign subsidiaries; subject to certain limitations, generally eliminating U.S. corporate income tax on dividends from foreign subsidiaries; and providing for new taxes on certain foreign earnings.

“Income tax expense was $273.1 million for 2017, compared to $21.1 million and $76.9 million, respectively, for 2016 and 2015. The increase in 2017 resulted primarily from a one-time transition tax of $219 million recognized in the fourth quarter of 2017 that represented management’s estimate of the amount of U.S. corporate income tax based on the deemed repatriation to the United States of Sohu’s share of previously deferred earnings of certain non-U.S. subsidiaries of Sohu mandated by the U.S. Tax Reform”

In order to pay the $219mm liability Sohu ‘s Changyou subsidiary declared a special dividend of $500mm of which $337mm was received by Sohu.

In 4Q18 Sohu revised its estimate of the tax payable to $0 (zero).  A $77mm benefit was recognized in the 4Q18 financial statement, but an additional $144mm is still shown as an accrued liability that could be recaptured if management’s tax estimate is correct. (Source: Sohu 2018 20-F)

“For the fourth quarter of 2018, the Sohu Group’s management re-evaluated the impact on the Sohu Group of the Toll Charge under the U.S. TCJA. Management determined that it was more likely than not, based on the technical merits, that the tax position that the Sohu Group had no Toll Charge liability would be sustained. The Group recognized a tax benefit in the amount of $77 million, which was the largest amount that management determined to be greater than 50% likely to be realized upon settlement with the U.S. IRS. As a result, as of December 31, 2018 the Sohu Group had an unrecognized tax benefit in the amount of $142 million, which represented the difference between the tax benefit recognized in the fourth quarter of 2018 and management’s previous estimate of the Toll Charge. In addition, the Sohu Group accrued $2 million in interest on the unrecognized tax benefit.

The tax benefit recognized and the unrecognized tax benefit in relation to the Toll Charge may be subject to further adjustment in subsequent periods based on facts and circumstances that arose after December 31, 2018, such as final IRS Toll Charge regulations published in February 2019, and any future circumstances such as any guidance issued by the U.S. Department of the Treasury, any IRS assessments upon audit on the Toll Charge, if any, and management’s further judgment and estimates.”

Sohu’s year-end financials show US$180mm of cash held at the parent company level (Source: Sohu 2018 20-F).  These funds are likely to be retained for three years until the audit period for Sohu’s transition tax has passed.  After that time the money would be available for any corporate purpose.

Sohu Parent Cash 123118

In response to the US Tax Reform Sohu sought and received shareholder approval for a corporate reorganization that shifted its holding company to the Cayman Islands where it has increased flexibility to pursue corporate transactions without giving rise to US tax liability (details in F-4 statement).  In particular Sohu’s 10-K had noted that tax would apply to sale of shares of Changyou (as contemplated by the privatization offer from group Chairman Charles Zhang).

“Sohu.com Inc. would also be subject to U.S. corporate income tax under Subpart F to the extent that Sohu.com Inc.’s non-U.S. subsidiaries sell Changyou ADSs or Sogou ADSs at a price higher than the adjusted tax basis of such ADSs for U.S. federal income tax purposes.”

DISCLOSURES:

The author is a shareholder of Sohu and Changyou.  The author does not make any recommendation regarding investment in either company.  Investors should verify any facts in the article they deem relevant to their own decision about investment in either company.

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