To Avoid Taxes, Delta's Assets Could Book a One-Way Flight to Europe

U.S. airlines have avoided the taxman for many years due to the industry's steep losses. That's going to change

A canal in Amsterdam, where Delta and Air France-KLM have a joint venture for their trans-Atlantic flights.

Photographer: Jasper Juinen/Bloomberg

The long years of financial losses for U.S. airlines came with at least one silver lining: a very easy time with the Internal Revenue Service. No income, no taxes. Now, following a wave of airline consolidation and strong customer demand, the industry is rolling in profitability. The collapse of crude oil prices will deliver another financial boost (although not to every carrier).

All that good fortune has some investors pondering the day in the not-too-distant future when the taxman comes to call on the U.S. carriers and the billions of dollars in past red ink has run dry. Net operating losses from the bad years, called "carryforwards," allow airlines and other companies to offset the cash tax burdens from their current profits. Delta Air Lines, for example, will end 2014 with $12.4 billion in prior losses on the books, offsetting its cash outlay for taxes. American had about $10.6 billion following its departure from bankruptcy and merger with US Airways a year ago, and United's most recent report claimed about $11 billion in leftover tax offsets.

U.S. airlines are poised to earn billions in 2015 and beyond, barring a dramatic shock that reverses the boom times for air travel. The most profitable of the Big Three, Delta, predicts pretax income of more than $5 billion next year, with a forecast of $2 billion pocketed from lower fuel prices. All that profit will come without cash taxes—for now. Given all the money it earns, Delta will very likely become the first large U.S. airline to face a tax bill. (Southwest, which has been consistently profitable, has no past losses on its books.) Delta told investors last week that it expects to face a cash tax bill in 2017 for part of that year's income.

At the same time, however, Delta Chief Executive Richard Anderson praised as "very prescient" an analyst's question about how the airline might reduce its future tax expense, promising that his airline was "all over" a tax strategy. It seems likely that the U.K. and the Netherlands—with corporate tax rates of 21 percent and 25 percent, respectively—could play a role in that effort. Delta, Air France-KLM, and Alitalia have a joint venture for their flights across the Atlantic, which allows the four carriers to coordinate routes and fares. The Amsterdam-based venture, which is not subject to antitrust prosecution, carried 17 million passengers last year and had $13 billion in sales. Delta also owns a 49 percent stake in Virgin Atlantic Airways. Those two carriers have since formed a joint venture for their U.S.-London business.

That gives Delta two helpful European cutouts for the U.S. taxes coming its way. Here's Anderson discussing the arrival of cash taxes, without going into too much detail:

We got it figured out. At least we have a good piece of it figured out. But we're not ready to talk about it. But we're working on it. When you have those big joint ventures that are euro-dominated, and you own 49 percent of an airline in London, and you already have a big commercial office in Amsterdam for joint-venture pricing and yield management, Amsterdam is a good place.

If Delta were seeking to keep some of its profit out of America, the key to any strategy would be finding a cost-efficient method of transferring aircraft across the Atlantic to an entity based in Europe, says Jennifer Blouin, an accounting professor at the University of Pennsylvania's Wharton School. Delta would almost certainly consult with U.S. tax authorities about the structure of any aircraft migration to Europe. "It's an airline," Blouin said, "so these hard assets are more mobile than most."

That's not always the norm. The prospect of large, sustained profits are rare enough—and a virtual unicorn for the volatile airline industry. Corporate transfers to Europe motivated by taxes typically involve intellectual property from U.S. pharmaceutical and technology companies, not airlines. "A lot of these tax-efficiency strategies are about postponing the taxes, not avoiding the taxes," says Mitchell Petersen, a finance professor at Northwestern's Kellogg School of Management. "If you pay the tax in 10 years, the present value of that burden drops." A Delta spokesman, Trebor Banstetter, said the company had no comment.

Any airline not keen on facing the U.S. corporate tax rate of 35 percent and with commercial operations in Europe might decide to keep some profits abroad as Congress debates a lower corporate rate, Petersen said. American & International Airlines Group's British Airways unit has a similar joint venture across the Atlantic. So, too, does United, with Germany's Lufthansa group of airlines and with Air Canada.

Michelle Hanlon, a tax expert and accounting professor at MIT Sloan School of Management, said Delta would likely incur some IRS scrutiny and reorganization expenses if it decided to shift assets to Europe. Still, the tax benefits could outweigh any short-term costs. "They need some viability behind these transactions, but there's certainly some leeway—they have to do something," she said in an interview.

Tax bills or not, investors ought to be pleased. "It's a good problem to have," says Jim Corridore, an analyst with S&P Capital IQ. "The airlines haven't had sustained profitability in their history."