Kroger to Acquire Albertsons in Giant Grocery Deal Featuring Taxable Spin and $6.85 Special Cash Dividend

By Stuart E. Leblang, Michael J. Kliegman and Amy S. Elliott

Kroger to Acquire Albertsons in Giant Grocery Deal Featuring Taxable Spin and $6.85 Special Cash Dividend

On October 14, supermarket giant The Kroger Co. (NYSE:  KR) (Kroger), which operates about 2,700 stores in 35 states under various names including Fred Meyer, announced^[1] plans to acquire rival chain Albertsons Companies, Inc. (NYSE:  ACI) (Albertsons), which operates about 2,300 stores in 34 states under various names including Safeway.  In connection with the $25 billion deal and due largely to antitrust considerations, Albertsons expects to separate off between 100 and 375 stores into a newly formed subsidiary (SpinCo) that it will spin off to Albertsons shareholders immediately prior to the merger closing (SpinCo will then be operated as a standalone public company).  In addition, and as part of the transaction, Albertsons will pay a special cash dividend of up to $4 billion on November 7 to shareholders of record as of the close of business on October 24.^[2]

The acquisition will be effected by way of a merger of a Kroger Merger Sub with and into Albertsons, with Albertsons surviving as a direct wholly owned subsidiary of Kroger.  Merger consideration of $34.10 for each Albertsons share will be reduced by the special cash dividend (expected to be about $6.85 per share) and by the value of the SpinCo stock (pursuant to a formula in the merger agreement).

Note that even though the combination is not expected to close until sometime in early 2024 (the outside date is January 13, 2024, although it may be extended by written notice), the special cash dividend will be paid out two weeks from now.  While the merger is contingent on, among other conditions, obtaining Albertsons stockholder and regulatory approvals, the payment of the special cash dividend will presumably occur before Albertsons has obtained shareholder approval for the merger.  Although the amount paid in the merger will be reduced by the amount of this special dividend, the special dividend will be treated as a dividend for tax purposes, including withholding tax to foreign investors of 30 percent, subject to potential reduction under an applicable tax treaty.

On an October 14 call discussing the Kroger and Albertsons merger agreement,^[3] Kroger Chief Financial Officer Gary Millerchip explained that the stores to be separated off in SpinCo should facilitate Federal Trade Commission approval of the combination.  “We believe we have a clear path to achieve regulatory approval with divestitures.  We really see SpinCo as one option to be able to address those divestitures.  We think it’s a really clean option in the sense that it could potentially be a faster way to package up a strategy around divestitures.  And from a Kroger perspective, it gives us confidence in the level of price that we achieve for those stores.  But we would intend to fully market [the stores that we intend to divest], and we would look at SpinCo as one option within that plan.  And depending on what the level of divestiture is would obviously frame and shape what the size and shape of SpinCo would look like,” Millerchip said.

The spin-off will be taxable to Albertsons, because of application of Internal Revenue Code Section 355(e), which restricts the ability of the distributing corporation or the controlled corporation to be acquired post-spin (in this case, Albertsons is the distributing corporation).  Specifically, Section 355(e) provides that if “1 or more persons acquire directly or indirectly stock representing a 50-percent or greater interest in the distributing corporation or any controlled corporation” as part of a plan with the spin-off, then the spin-off becomes taxable to the distributing corporation.  Here, Kroger is acquiring 100 percent of the stock of Albertsons, so Albertsons will recognize taxable gain on the SpinCo distribution as if it had sold the divested stores at their fair market value.

The spin-off will also be taxable to the Albertsons shareholders, as it flunks the Section 355 “device” and “continuity of interest” requirements, each of which is very likely fatal in a situation where the spin-off is linked to a prearranged cash sale of the distributing corporation.^[4]

Note that the merger agreement leaves open how the spin-off will be effected, which impacts the shareholder-level tax treatment.  The agreement explicitly contemplates that the SpinCo shares could either be distributed as an in-kind dividend, or as additional consideration in the merger.^[5]In the former case, the taxable spin-off will be taxable to shareholders as a dividend (subject to withholding tax to foreign investors).  If the spin-off is effected via the merger, then shareholders should be treated as receiving the Spinco shares in a pre-sale redemption of a portion of their Albertsons stock,^[6]with the result being capital gain treatment and no withholding tax to foreign investors.  In that case, however, absent changes to the statute or other guidance to the contrary, this redemption distribution of Spinco stock would likely be subject to the new 1 percent stock buyback excise tax.^[7]

Finally, we confirmed with the corporate actions group at the New York Stock Exchange that due-bill procedures will not apply in connection with the special cash dividend to be paid out next month.  The general rule is that if the amount of a special dividend is greater than 25 percent of the stock price, then it will trade with due bills for a period of time between the record date and the ex-date.^[8]But at the time the deal was announced (after market close October 13), a share of ACI was trading at $28.63, such that the $6.85 special dividend was only 24 percent of the trading price (just under the 25-percent threshold), so it will trade regular way.  That means the last day you could have purchased a share of ACI and have been entitled to the dividend was October 20 (assuming regular settlement).

^{[1] Press Release, Kroger, Kroger and Albertsons Companies Announce Definitive Merger Agreement (Oct. 14, 2022) (https://ir.kroger.com/CorporateProfile/press-releases/press-release/2022/Kroger-and-Albertsons-Companies-Announce-Definitive-Merger-Agreement/default.aspx).}

^{[2] Press Release, Albertsons, Albertsons Companies Announces Special Dividend in Connection with Signing of Merger Agreement (Oct. 14, 2022) (https://www.sec.gov/Archives/edgar/data/1646972/000119312522263421/d405268dex991.htm).}

^{[3] Agreement and Plan of Merger, dated as of October 13, 2022, by and among Albertsons, Kroger and Kroger Merger Sub (https://www.sec.gov/Archives/edgar/data/56873/000110465922108671/tm2227942d1_ex2-1.htm).}

^{[4] See Treas. Reg. §1.355-2(c) and (d). An argument could be made that it wouldn’t violate the device test based on the strength of the business purpose to spin off the stores to meet antitrust concerns, though we find many tax advisors erroneously believe a prearranged plan to sell is an insurmountable obstacle. In any case, the sale would violate the separate continuity of interest test.}

^{[5] See Section 2.1 of the Merger Agreement.}

^{[6] See Rev. Rul. 78-250.}

^{[7] See IRC §4501 excise tax on repurchase of corporate stock.}

^{[8] While it is trading with due bills, the purchaser will be entitled to receive the dividend amount from the seller but for tax purposes is not treated as receiving it as a taxable dividend. (See Rev. Rul. 82-11, 1982-1 C.B. 51; Technical Advice Memorandum 200048011 (Aug. 17, 2000).)}