Octus Estimates a $1.7B Deferred Tax Liability on Liberty Interactive LLC Exchangeable Debentures at Maturity, Expected to Be Cut in Half by Deferred Tax Assets; Likely to Be an Unsecured Claim

Absent a material positive shift in QVC’s underlying business, Octus believes an in- or out-of-court restructuring of the entire QVC capital structure is very likely. In our view, QVC’s immediate concern is the extension of its revolving credit facility, with $1.85 billion outstanding as of March 31 and a maturity date of Oct. 27, 2026. The company also faces a 2029 maturity wall, consisting of $605 million of QVC notes and $637 million of LINTA debentures.

Octus has previously discussed potential maneuvers QVC could use to amend and extend its RCF as QVC Inc.’s liquidity continues to dwindle. As we have reported, the company has hired Evercore and Kirkland & Ellis while an ad hoc group of LINTA unsecured creditors has organized with Centerview Partners and Akin Gump as advisors. We believe creditors should be cognizant of both the QVC/LINTA maturity wall in 2029 and the potential for an estimated $850 million tax liability due at redemption of the LINTA notes.

Nonetheless, given the significant cross-holdings within the RCF, QVC notes and LINTA debentures, the company might attempt to complete a more holistic restructuring of the entire capital structure ahead of its RCF maturity in October 2026.

The dynamics between the operating subsidiary, or OpCo, versus the holding subsidiary, or HoldCo, add a layer of complexity to the QVC Group structure, which is further exacerbated by the looming deferred tax liability at HoldCo entity Liberty Interactive LLC. We believe that the liability currently sits on the books of Liberty Interactive LLC, however OpCo could be liable for the claim under the TSA. Since the QVC-level debt does not have cross-default provisions with the LINTA notes, its possible advisors could try to deal with the tax liability at just the LINTA level.

Octus believes that in a bankruptcy context the RCF and QVC notes would be treated as an unsecured claim at the QVC Inc. level since they are only secured by a parent pledge agreement of the equity of QVC Inc. However, because of that pledge agreement, the RCF and QVC notes are structurally senior to the LINTA notes with regard to the assets at QVC Inc. Liberty Interactive LLC also owns 38% of Cornerstone Brands Inc., in addition to an 80% ownership in Liberty Technology Venture Capital II LLC and varying noncontrolling ownership percentages in LIC Sound LLC portfolio of assets. In a bankruptcy scenario where all credit boxes file, Octus anticipates the recoveries from QVC Inc. assets would be dependant upon on the location of the unsecured tax liability, as illustrated below:

However, if the tax liability is treated as an administrative claim, the recovery waterfall from the value of QVC Inc.’s equity would flow as follows, on the basis of the location of the tax claim:

Tax Claim in a Bankruptcy Context

Given the different pockets of value within the QVC Group structure, deciphering whether the OpCo would be liable for the tax claim is critical to ascertaining recoveries in a restructuring scenario. Also, given the size of the potential tax claim, we expect any restructuring will have to take this liability into consideration.

Octus believes that in a bankruptcy context, the tax liability tied to the LINTA exchangeable debentures would be classified as an unsecured claim with the potential for some part of it to be treated as a priority unsecured claim, ahead of the other unsecured debt at that entity.

Section 507(a)(8) of the Bankruptcy Code provides priority treatment for income or gross receipts taxes “for which a return, if required, is last due, including extensions, after three years before the date of the filing of the petition.” This three-year lookback priority tax claim is junior to administrative expense claims (including professional fee claims and claims for providing postpetition goods or services to a debtor) but senior to general unsecured claims.

Claims for taxes beyond the three-year window are treated as general unsecured claims, unless a tax lien has been filed – for the purposes of this article, we assume no tax liens have been filed to secure either priority or nonpriority tax claims.

Under section 1129(a)(9)(C) of the Bankruptcy Code, a plan of reorganization must provide for payment of section 507(a)(8) priority tax claims in regular cash payments over up to five years after the petition date that equal the value of the allowed amount of the claim as of the effective date.

If a tax is incurred after the petition date, it may qualify for administrative expense priority treatment under section 503(b)(1)(B) of the Bankruptcy Code – meaning it must be paid in full in cash on the effective date of the plan. The debtors would likely argue the tax claim arose prepetition because the agreement giving rise to the deferrals is a prepetition agreement.

Payment of a substantial postpetition or three-year priority tax claim could create a significant cash feasibility issue for confirmation – or drain assets away from general unsecured creditors with claims against the entity owing the tax.

Endo International Serves as a Recent Example of a Tax Claim in Bankruptcy, Albeit Under Special Circumstances

The Endo International case presents a good example of the reorganization dynamics triggered by a large priority tax claim. In Endo, the debtors negotiated a restructuring support agreement with first lien lenders that contemplated a simple section 363 credit bid sale of the debtors’ assets to an entity controlled by the lenders. General unsecured opioid claimants would receive payments directly from the acquisition entity, bypassing the federal government’s priority tax claims – which were initially believed to be relatively small, in the range of hundreds of millions of dollars.

However, in February 2023 the federal government asserted priority tax claims of more than $2.3 billion and objected to the proposed sale’s provision for direct acquisition entity payment of junior general unsecured opioid creditors before the tax claims. In response to objections from the official committee of unsecured creditors, the debtors argued that the section 363 sale had to be approved because they could not pay such large priority tax claims in five years under a plan of reorganization, as required by section 1129(a)(9)(C).

Unusually, the government held out as the sole opposition to a section 363 sale, continuing to press for a plan of reorganization that paid its tax claims before opioid creditors. Generally, the federal government is reluctant to use section 1129(a)(9)(C) to block an otherwise consensual plan of reorganization. The government’s stance in the Endo case may have been prompted by the allegations of criminal misconduct by Endo in its opioid marketing.

After months of negotiations, in December 2023 the debtors agreed to pursue the sale of their assets to lenders via a plan of reorganization rather than a section 363 sale, and the government agreed to accept a one-time payment of $200 million on the effective date in full satisfaction of its priority tax claims. The plan went effective in April 2023 – 616 days after the petition date, a substantial delay caused largely by the tax claims and government resistance.

What does this mean for QVC? Because of section 1129(a)(9)(C), a sizable priority tax claim could give the government considerable leverage to influence the debtors’ plan of reorganization. Although the government rarely attempts to block a consensual reorganization using its tax claims and often settles for a relatively small percentage of its claim (as in Endo), any novel or problematic structural features of the proposed plan could cause the government to use that leverage to force changes – as in Endo – before settling at a reasonable amount.

One way to limit the government’s leverage would be to allocate the tax claim to a debtor entity with relatively few assets or creditors, isolating the claim in an “empty box” while other debtors’ creditors receive payment from entities with substantial assets. However, the government generally has the ability to assert tax claims against the entire structure, as in Endo.

Thus, the issue becomes an intercreditor dispute – which entity (and its creditors) would bear the burden of the priority tax claims under a plan? That dispute would generally be resolved by an intercompany TSA – a common vehicle that allows one entity to act as the taxpayer or recipient of refunds facing the Internal Revenue Service, which then allocates tax benefits and losses to other entities on the basis of their tax attributes and the terms of the TSA.

In a bankruptcy, the TSA gives rise to intercompany claims among the entities, with the entities having positive tax attributes (losses) claiming the right to refunds and the entities with negative tax attributes (profits – or deferred tax obligations) defending against those claims. Unfortunately, TSAs are generally not public, and Octus has not been provided with the TSA for the very complex QVC corporate structure.

In practice, we would expect the creditors of each QVC entity to negotiate any disputes regarding these claims and allocate value under a plan based on a settlement. If the priority tax claim can be reduced, then this negotiation would be less troublesome; if the government insists on a substantial portion of the claim being paid, then the fight could result in substantial shifts in value allocation.

LINTA Debentures Generate Current Tax Benefits in Exchange for Deferred Tax Liabilities

Liberty Interactive LLC has $1.6 billion of unsecured funded debt as of March 31, a byproduct of the Liberty Interactive Corp. and GCI Liberty Inc. split-off, including $778 million of debentures exchangeable into T-Mobile and Lumen stock. The principal amount of $350 million of 4% LINTA exchangeable debentures mature on Nov. 15, 2029, and $428 million of 3.75% LINTA exchangeable debentures mature on Feb. 15, 2030. Along with principal repayment at maturity, these debentures accumulate associated deferred tax liabilities that we estimate at approximately $1.7 billion in aggregate at the debentures’ maturity. This is the consequence of an interest expense tax shield that has been accruing since the debentures’ inceptions in 1999 and 2000, respectively.

The exchangeable debentures allow for tax deductions in excess of their cash coupon payments, a component of their underlying security exchange features. This creates a current period cash benefit for tax deductions in excess of the stated interest rates of 4% and 3.75%, simultaneously creating a contra deferred tax liability, which compounds until the maturity of each bond, at which point the company will have to make a payment to settle the taxes owed. Management’s rationale behind these debentures was that Liberty could earn a higher return on their cash tax savings through certain investments, enough to more than offset the future deferred tax liability.

Octus forecasts that the deferred tax liability associated with the exchangeable debentures due 2029 and 2030 would total approximately $1.7 billion at maturity, assuming a 23.5% tax rate which is in line with the company’s assumptions. The deferred tax liability for the 4% LINTA exchangeable debentures due 2029 would total approximately $695 million at maturity. The deferred tax liability calculation for the 4% LINTA exchangeable debentures due 2029 is shown below:

Octus estimates that the deferred tax liability for the 3.75% LINTA exchangeable debentures due 2030 would total approximately $1 billion at maturity. The deferred tax liability calculation for the 3.75% LINTA exchangeable debentures due 2030 is shown below:

The mechanics behind the exchangeable debenture’s tax liability can be illustrated by way of an example. If we assume a $1 billion debenture with a 4% annual cash coupon and 9% annual tax coupon, on its first interest payment date, the debtor would pay a semiannual cash coupon of $20 million, while the semiannual tax deductible interest is $45 million. The difference between the cash coupon and tax benefit of $25 million is referred to as contingent interest. The contingent interest is multiplied by the prevailing tax rate at the time, for example 21%, to calculate the tax benefit and associated deferred tax liability created during the period, which in this case is equal to $5.3 million.

On the second interest payment date, the semiannual cash coupon is, similar to the first payment, calculated based on the debentures face value of $1,000 per debenture, totaling $20 million. The semiannual tax deductible interest is calculated based on an adjusted face value of $1,025 per debenture (face value plus previously accumulated contingent interest), increasing to $46.1 million this period with contingent interest compounding to $26.1 million on the second interest payment. The tax benefit from contingent interest increases to $5.5 million, 21% of the $26.1 million benefit and the deferred tax liability totals $10.7 million as of the second interest payment date. Going forward, the cash coupon amount remains fixed, while the tax deductible interest amount compounds as the adjusted face value accrues, resulting in a deferred tax liability, which must be paid at the earliest of the maturity or redemption of the underlying bonds.

The company notes that in certain years, the contingent interest exceeds QVC’s limitation on annual interest expense deductibility (currently 30% of tax EBIT, which excludes adjusted EBIT from foreign subsidiaries and is affected by certain book to tax adjustments, plus interest income), resulting in a disallowed interest deferred tax asset. According to company disclosures, these carryforwards do not expire and are expected to be fully utilized upon the debentures maturities in 2029 and 2030. QVC expects the deferred tax assets generated from disallowed interest in current and future years to offset approximately half of the gross deferred tax liability at the debentures maturities.

LINTA Deferred Tax Liability Does Not Appear on OpCo QVC Inc.’s Balance Sheet

According to QVC Inc.’s 10-K, OpCo QVC Inc. is party to a TSA with ParentCo QVC Group Inc. The TSA establishes the methodology for the calculation and payment of income taxes in connection with the consolidation of QVC Inc. with QVC Group Inc. for income tax purposes. Generally, the TSA provides that QVC Inc. will pay QVC Group Inc. an amount equal to the tax liability, if any, that it would have if it were to file as a consolidated group separate and apart from QVC Group Inc., “with exceptions for the treatment and timing of certain items, including but not limited to deferred intercompany transactions, credits and net operating and capital losses.”

To the extent that the separate company’s tax expense is different from the payment terms of the TSA, the difference is recorded as either a dividend or capital contribution. These differences are related primarily to foreign tax credits recognized by QVC Inc. that are creditable under the TSA when and if utilized in QVC Group Inc.’s consolidated tax return.

For example, the difference recorded in 2024 was a capital contribution of $1 million, primarily related to foreign tax credit carryovers being utilized in QVC Group Inc.’s consolidated tax return in excess of those recognized by QVC Inc. The differences recorded in 2023 and 2022 were dividends of $3 million and $1 million respectively, primarily related to foreign tax credits recognized by QVC Inc. and not utilized in QVC Group Inc.’s consolidated tax return.

On the basis of the general summary of the intercompany TSA above, it seems that QVC Inc. would historically pay QVC Group Inc. its income tax liabilities, ahead of the benefit of the interest tax shield from the exchangeable debentures. If this holds, it appears possible that the ParentCos or TopCos might be directly liable for the deferred tax liability, however absent the TSA, this is conjecture.