The French luxury-goods company LVMH, Louis Vuitton-Moët Hennesy, issued a series of perpetual floating-rate notes on the international capital market in the 1990s. These bonds have the advantage of being quasi-equity, while benefiting from favorable tax treatment. Pioneered by state-owned French firms that cannot sell stock to the public, and subsequently used by a number of private European companies that were reluctant to dilute their stocks, the subordinated perpetual floating-rate note is an instrument that remains outstanding in name only. These securities are called instantly repackaged perpetuals, or IRPs.
After a 5-billion franc issue in 1990, LVMH sold, in March 1992, 1.5 billion francs of IRPs. The company received 1.1 billion francs, the remaining 400 million being transferred to an offshore trust. The trust used the proceeds to buy fifteen-year zero-coupon bonds issued by banks underwriting the LVMH issue or by sovereign borrowers such as Denmark and Austria. The 400-million investment in zero-coupon bonds will be redeemed for 1.5 billion in fifteen years. The IRPs have the peculiarity that they pay interest only for the first fifteen years; the interest becomes nil thereafter. After these fifteen years, the trust is committed to repurchase the perpetuals at their face value of 1.5 billion francs. The trust, especially set up for this purpose, will then hold the IRPs forever, but their market value has become zero as they are perpetuals, which pay no interest. The semiannual coupon was set at six-month PIBOR (Paris InterBank Offer Rate) plus ½%.
From an accounting viewpoint, these IRPs are treated as new equity of LVMH, because they are perpetual. From a tax viewpoint, the interest paid on the IRPs during fifteen years can be deducted as interest expense (while dividend payments are not tax deductible).
a. Assume that you are an investment banker proposing such an IRP to a potential client. Explain in detail the advantage of such a package relative to a plain-vanilla fifteen-year FRN, or relative to a new stock issue.
b. In 1990, the French tax authorities decided to allow a write-off of interest expense for only the net amount of capital that the issuer actually takes on its books (1.1 billion for LVMH). Why does this decision reduce the attraction of issuing IRPs?
c. Following the 1992 LVMH issue, the tax authorities decide to introduce a new regulation for trusts, whereby capital gains would be taxed at the normal income tax rate. In effect, the trust would make a capital gains equal to the difference between the face value of the zero-coupon bonds and their issue price. This basically shut the market for IRPs. Why?

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The Answer of The French luxury-goods company LVMH, Louis Vuitton-Moët Hennesy, issued a series of perpetual floating-rate notes on the international capital market in the 1990s. These bonds have the advantage of being quasi-equity, while benefiting from favorable tax treatment. Pioneered by state-owned French firms that cannot sell stock to the public, and subsequently used by a number of private European companies that were reluctant to dilute their stocks, the subordinated perpetual floating-rate note is an instrument that remains outstanding in name only. These securities are called instantly repackaged perpetuals, or IRPs.
After a 5-billion franc issue in 1990, LVMH sold, in March 1992, 1.5 billion francs of IRPs. The company received 1.1 billion francs, the remaining 400 million being transferred to an offshore trust. The trust used the proceeds to buy fifteen-year zero-coupon bonds issued by banks underwriting the LVMH issue or by sovereign borrowers such as Denmark and Austria. The 400-million investment in zero-coupon bonds will be redeemed for 1.5 billion in fifteen years. The IRPs have the peculiarity that they pay interest only for the first fifteen years; the interest becomes nil thereafter. After these fifteen years, the trust is committed to repurchase the perpetuals at their face value of 1.5 billion francs. The trust, especially set up for this purpose, will then hold the IRPs forever, but their market value has become zero as they are perpetuals, which pay no interest. The semiannual coupon was set at six-month PIBOR (Paris InterBank Offer Rate) plus ½%.
From an accounting viewpoint, these IRPs are treated as new equity of LVMH, because they are perpetual. From a tax viewpoint, the interest paid on the IRPs during fifteen years can be deducted as interest expense (while dividend payments are not tax deductible).
a. Assume that you are an investment banker proposing such an IRP to a potential client. Explain in detail the advantage of such a package relative to a plain-vanilla fifteen-year FRN, or relative to a new stock issue.
b. In 1990, the French tax authorities decided to allow a write-off of interest expense for only the net amount of capital that the issuer actually takes on its books (1.1 billion for LVMH). Why does this decision reduce the attraction of issuing IRPs?
c. Following the 1992 LVMH issue, the tax authorities decide to introduce a new regulation for trusts, whereby capital gains would be taxed at the normal income tax rate. In effect, the trust would make a capital gains equal to the difference between the face value of the zero-coupon bonds and their issue price. This basically shut the market for IRPs. Why?

The French Luxury-Goods Company LVMH, Louis Vuitton-Moët Hennesy, Issued a Series