This ingenious–and perfectly legal–piece of financial engineering is designed to let GM dispose of its defense business for $9.5 billion without the company’s or its stockholders’ having to pay a penny in capital-gains taxes. GM won’t tell me the price at which it carries its defense business for tax purposes. However, it seems to be less than $1.5 billion. Thus, a normal, straightforward sale for $9.5 billion would produce a profit of more than $8 billion. That, in turn, would generate a tax bill of more than $3 billion, given GM’s combined federal, state and local tax rate of about 40 percent.

Enter the Loophole. Because of the way the Loophole works, GM argues that words like ““sale’’ and ““profit’’ don’t apply to this deal, in which GM’s defense business is being conveyed to Raytheon Co. The Loophole is designed to let GM dispose of its defense business without selling it. No sale, no gain for tax purposes. No gain, no tax. See? Isn’t life wonderful? Wouldn’t you love to be paid a nonsalary salary or make nonprofit profits from your business? Wouldn’t everyone?

You can see why GM loves the Loophole. If this snazzy vehicle performs, GM and its shareholders end up with a collective $9.5 billion in their pockets. Without the Loophole, they end up with maybe $6.5 billion. Since GM’s managers are paid to make money for shareholders, you can see why they prefer the $9.5 billion to $6.5 billion. GM’s managers, accountants and lawyers are, of course, doing exactly what they’re paid to do.

But what’s good for General Motors isn’t good for the country. Especially because there seems to be nothing to stop dozens of other companies from adapting the Loophole to unload assets without paying capital-gains taxes. To understand why this can happen, you’ve got to understand how the Loophole works. There’s a simplified operating manual in the box adjacent to this column. The key step is the third one, in which Raytheon, which is taking over GM’s defense business, combines with the GM subsidiary that owns the business now and will briefly become an independent company.

The combined company will be named Raytheon and will be run by Raytheon’s managers. So how can GM claim with a straight face that it’s not selling to Raytheon? Read the fine print. Technically, Hughes Aircraft, the GM subsidiary that owns the defense business, will buy Raytheon by issuing Hughes Aircraft stock to Raytheon holders. The instant the deal is completed, Hughes Aircraft will change its name to Raytheon.

Now, watch. Holders of GM’s common stock and its GMH stock, which is tied to GM’s Hughes Electronics subsidiary, will own 30 percent of the ““new’’ Raytheon’s shares, while existing Raytheon holders will own the other 70 percent. Doesn’t sound like Raytheon is being taken over, does it? So, to fend off the tax man, GM has added a brilliant twist: the Raytheon shares owned by GM and GMH holders will have 80.1 percent of Raytheon’s voting power when it comes to electing members of the board, even though this stock represents only 30 percent of Raytheon’s shares outstanding. That voting power lets GM claim that Hughes Aircraft is buying control of Raytheon rather than selling out to Raytheon. (There are so many GM and GMH holders that none will own enough stock to control Raytheon. And you can bet that Raytheon, plenty savvy, has erected defenses to make sure no one can buy enough new shares to take control of its board; however, that’s a story for another day.)

What’s especially ironic is that while GM intends to pay no tax on its nonsale sale, the Pentagon will probably shell out megabucks to Raytheon to help pay for its nonpurchase purchase. The Pentagon typically pays some of the buyer’s costs when big defense contractors combine, on the theory that these restructurings result in lower prices and should be encouraged. Raytheon wouldn’t say whether it will ask the Pentagon to pay for part of this deal.

Unlike other billion-dollar tax dodges–such as Seagram’s 1995 sale of most of its 25 percent stake in Du Pont and Viacom’s 1996 sale of its cable-TV systems to Tele-Communications Inc.–this one is already drawing heavy fire from tax techies before it’s completed. ““At the beginning of the day, GM owns the defense business, and at the end of the day, GM and its stockholders have $9.5 billion and Raytheon has the defense business . . . That sounds like a sale to me,’’ said Kenneth Kies, chief of staff of Congress’s Joint Committee on Taxation. GM, of course, disagrees. ““We’re obeying not only the letter of the tax law, but also the spirit of the law,’’ GM spokeswoman Toni Simonetti said.

It’s not clear whether the Internal Revenue Service will give GM the favorable tax ruling that it’s seeking, or whether GM will proceed with the deal and risk a trip to tax court if the IRS balks. What is clear is that the stakes go far beyond the $3 billion at risk here. If the Loophole passes its road test, any company could use it to dispose of businesses tax-free. All the seller would need is a buyer like Raytheon that’s willing to jump through hoops to let the acquired business claim to be the acquirer.

You have to admire GM’s financial engineering–my bet is that this deal, ridiculous as it is, goes through. But we taxpayers had better hope that congressional lawmakers or the IRS tweaks the tax code enough to make sure that the Loophole’s production run ends after only one model.

Here’s how GM plans to unload its defense business without paying any taxes. The exact amounts of cash and Raytheon stock will be set just before the deal closes.

the GM subsidiary that owns GM’s defense business, borrows about $4.5 billion, gives the money to GM.

briefly makes Hughes independent. It’s owned by GM and GMH stockholders.

merges with Raytheon, which takes over responsibility for the $4.5 billion debt. GM and GMH holders get about $5 billion in Raytheon stock.

wind up with $9.5 billion in cash and stock. Taxes due: zero.

SOURCES: GM, Newsweek estimates.