1. Tax Executives Institute – St. Louis Chapter
November 21st 2013
Daniel C. White
Philip B. Wright
Bryan Cave LLP
Tax Aspects of the Acquisition Agreement
and Related Due Diligence
2. 2
I. Overview
A. Acquisition Structure and Scope of Taxes in Acquisition
B. Acquisition Agreement and Taxes
C. Tax diligence and the Acquisition: Pricing, Structuring, & Contracts
II. Tax Related Contract Provisions
B. Purchase Price
C. Representations & Warranties
D. Covenants
E. Indemnity: Control, Collateral, & Enforcement
F. Closing Conditions
G. Miscellaneous
III. Examples
Tax Aspects of the Acquisition Agreement
and Related Due Diligence
3. Acquisition Structure and Scope of Taxes in
the Acquisition
Closing
Date
Pre-Closing Period Post-Closing Period
• Legacy liability
• Attributes/basis
• Tax Status of Target (e.g.,
disregarded, consolidated)
• Income tax
• Transfer/Recordation tax
• Withholding
• Employment tax
• Basis step-up
• Attribute carryover
• Misc. (e.g., OFL, Audits)
3
4. Acquisition Agreement & Taxes
I. Purchase Price
A. Structure
1. Tax
a. Taxable vs. tax-free (e.g.
Reorganization, Section 351)
b. Single level vs. double tax. (See
also, no tax and triple tax)
c. Other taxes (e.g., transfer,
withholding, employment, VAT
2. Non-Tax
a. Legacy Liabilities
b. Contract
c. Change of control issues
(consents, licenses, title)
B. Pricing – Effect of Taxes
(Income taxes vs. non-income
taxes and EBITDA pricing)
C. Purchase Price Adjustments and
taxes
1. Net working capital, Owners
Equity, and Other Adjustments
2. “Cash” taxes vs. Deferred taxes
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5. Acquisition Agreement & Taxes
II. Representations and Warranties
A. Overview (What is a ‘representation’)
B. Purposes of Representations
1. Diligence
2. Closing Condition
3. Indemnity
C. Majors/Big 3 (taxes paid; returns filed;
returns correct)
D. Issues not covered by the Big 3 (e.g.,
no income deferral)
E. Due Diligence Items
F. Tax Representations not in the “Tax”
Section (e.g., interim actions, financial
statements)
III. Tax Covenants
A. Acquisition Structure and Covenant
Scope
B. Transfer taxes
C. Preparation and Review of Tax Returns
filed after Closing
D. Straddle Period Taxes
E. Amendment of Tax Returns, Refunds
of Pre-Closing/Straddle Taxes, and
Carryback of Attributes
F. Tax audits and Cooperation
G. Other (e.g., structure specific
covenants, intercompany accounts)
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6. Acquisition Agreement & Taxes
IV.Indemnity
A. Pre-Closing Taxes and Straddle
Period Taxes
B. Taxes Arising from the
Transaction
C. Post-Closing Taxes
1. Arising from adjustments to
pre-closing periods
2. Other
D. Limitations
1. Minimum claims
2. Baskets/Deductibles
3. Caps
4. Survival
5. Buyer Tax Acts
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7. Acquisition Agreements & Taxes
V. Closing Conditions
A. Representations true in all
material respects/ failure to have
a “material adverse effect”
B. Withholding (backup, FIRPTA,
wages, tax clearance)
C. Elections
D. Tax opinions
VI. Miscellaneous Tax Items
A. Definitions
1. Taxes
2. Tax Returns
3. Governmental Entity
4. Current Assets/Current Liabilities
5. Liens/Permitted Liens
B. Other
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8. 8
Tax Diligence & Its Role in the
Acquisition
Tax
Diligence
Contract
Schedules
Collateral/
Structure
Purchase
Price
9. Tax Diligence & Role in Acquisition Agreement
I. Purpose
A. Identify Pre-Existing Tax Liabilities / Exposure
B. Identify and Allocate Transactional Tax Liabilities / Attributes
Example: Target has outstanding employee stock options the payment of which
will give rise to a deduction. The parties should take the tax benefit of the
deduction into consideration in structuring and in pricing the transaction.
C. Identify opportunities and Post-Closing Integration
Example: Purchaser should consider the effect on its federal, state and foreign
taxes as a result of the acquisition, e.g. allocation and apportionment or nexus
considerations.
II. Effect of Acquisition Structure on Due Diligence
A. Target Tax Classification (Entity Level versus Pass Through Taxes)
B. Actual vs. Deemed Asset Acquisition
Example: Legacy tax liabilities generally will remain with acquired entity
regardless of structure treatment as an “asset acquisition” for federal income tax
purposes
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10. Tax Diligence & Role in Acquisition Agreement
Due Diligence Process
• Industry / Business
• Corporate Documents and Capital
Structure
• Debt / Equity, including Second Class of
Stock (S Corporation)
• Interest Deduction Limitations (AHYDO
& Section 163(i))
• Significant Contracts
• Acquisition Agreement (Potential
Successor Liability)
• Loan Agreements
• Lease Agreements (Nexus / Tax
Indemnification)
• Supply and Distribution Agreements
(Nexus)
• Customer Contracts (Prepaid Income)
• Employment Agreements / Plan Document
Review
• Joint Venture Agreements
• Tax Strategies
• Financial Derivatives
• License Agreements (Nexus / Withholding)
• Law Suits / Settlements
• Deduction versus Capitalization
• Withholding and Information Reporting
• Financial Statement Review
• Tax Items
• Tax Returns and Workpapers
• Tax Jurisdictions
• Return and Workpaper review
• Tax Attributes
• Information Reporting, FBAR and
FATCA Compliance
• Examinations
• Tax Elections and Accounting Methods
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11. Tax Diligence & Role in Acquisition Agreement
• Acquisition Structure &
Diligence Effect
• Asset versus Entity
• Pure Asset Purchase
• Entity Purchase
• General
• Entity Classification (Corporate,
Partnership, or Disregarded Entity)
• S Corporation or Affiliated
Corporation
• Stock Acquisition
• General
• Legacy Tax Liabilities /
Attributes
• Consolidated Group Member
• Deemed Asset Transactions
• Section 338 Election
• Forward Cash Merger
• Section 336(e) Election
• Partnership Interest / Disregarded
Entity Purchase
• Successor Liability
• General
• Consolidated Return – Joint &
Several Liability Treas. Reg.
Section 1.1502-6
• Transferee Liability (Sections
6901-6905)
• State Law
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13. Contract Provision: Purchase Price
Adjustment
Example – Working Capital Adjustment
Net Working Capital means, as of [12:01 a.m.], Central Standard Time on the
Closing Date, the excess of the Current Assets of the Company (excluding any
Cash, Tax receivables and deferred Tax assets of the Company) over the
current liabilities of the Company and its Subsidiaries (excluding any deferred
Tax liabilities, Indebtedness and Company Transaction Expenses and including
any current and long-term deferred revenues), in each case as reflected on the
balance sheet of the Company as of such date.
See also Treas. Reg. 1.1502-76(b)(1)(ii)(A).
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14. Contract Provision: Purchase Price
Example - Purchase Price Covenants
Withholding: Notwithstanding any provision in the Agreement to the contrary, Buyer shall be entitled
to deduct and withhold from any consideration otherwise payable under the terms of this Agreement such
amounts as it is required to deduct and withhold pursuant to any provision of Law related to or regarding
Taxes. To the extent that amounts are so withheld by Buyer under any provision of this Agreement, such
withheld amounts (i) shall be remitted by Buyer to the applicable Governmental Authority in
accordance with applicable Law and (ii) shall be treated for all purpose of this Agreement as having been
paid to the recipients in respect of which such deduction and withholding were made by Buyer.
Allocation of Purchase Price: Seller shall prepare a schedule allocating the Purchase Price in
accordance with section 1060 of the Code and the Regulations thereunder. Seller shall deliver such
schedule to Buyer within ___ days after the Closing Date and shall permit Buyer ___ to review and
comment. Seller shall make such revisions to the schedule as are reasonably requested by Buyer
within ___ days of receiving Buyer’s comments, and the parties shall use reasonable efforts to resolve
any disagreement with the schedule. In the event the parties agree to a schedule, Seller and Buyer shall
file all Tax Returns consistent with such allocations and neither Seller nor Buyer shall take any tax
position that is inconsistent with such allocation unless required by applicable law. [Notwithstanding
the foregoing, in the event that Buyer and Seller are not able to arrive at a mutually agreeable
allocation, each of Seller and Buyer may adopt a separate allocation of the purchase price as such
party shall determine, and each party may use its own separate allocation in filing its own Tax
Returns.]
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15. Contract Provision: Tax Representations
Tax Representations
•General
• Representations speak to the
condition of the asset or
business at the relevant time
(e.g., Closing Date or the
date of the most recent
financial statements)
•Purposes
• Closing Condition
• Due Diligence
•Indemnification
•Considerations
• Multiple Entities (Coverage)
• Depth and Breadth of
Representations - Scope
• Relationship to
Indemnification
• Disclosure Schedules and
Effect on Indemnification
• Possible Taxing Authority
Review of Contract
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16. Contract Provision: Tax Representations
Example – Tax Representations (Majors / Big Three)
Filed Returns: All Tax Returns required to be filed by the Company or
any of its Subsidiaries on or before the Closing Date have been timely
filed
Returns Accurate: All such Tax Returns are complete and accurate [in
all material respect]
Tax Paid: All Taxes (whether or not shown on any such Tax Return) for
which the Company or any of its Subsidiaries are liable have been
timely paid [or accrued]
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17. Contract Provision: Tax Representations
Example – Other Representations
Unrecognized Income: Neither the Company nor any of its Subsidiaries will be
required to include or accelerate the recognition of any item in income, or
exclude or defer any deduction or other tax benefit, in each case in any taxable
period ending after the Closing Date, as a result of any change in method of
accounting, closing agreement, intercompany transaction, installment sale, or
the receipt of any prepaid amount, in each case prior to Closing.
Successor Liability: Neither the Company nor any of its Subsidiaries has any
liability for Taxes of another Person under Treasury Regulation Section 1.1502-6
(or similar provision of other Tax Law), under any agreement the principal subject
matter of which is Taxes [(and excluding any commercial agreements entered
into in the ordinary course of business)] or as a transferee or successor.
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18. Example – Other Representations
Disregarded Entity: At all times since its organization, the Company and each Non-
Corporate Subsidiary has been properly disregarded as an entity separate from its owner for
federal Income Tax purposes pursuant to Treasury Regulations Section 301.7701-3 and no
election has been made, no Tax Return has been filed, and no other action has been taken, in
each case inconsistent with such treatment.
Affiliation: Each Corporate Subsidiary of the Company is properly treated for federal
Income Tax purposes as a corporation that is wholly owned by Seller and a member of the
same federal Income Tax consolidated group as Seller.
Disregarded Entity: With respect to all periods on and after [Date], Seller has filed state
Income Tax Returns consistent with each Non-Corporate Subsidiary being disregarded as an
entity separate from its owner.
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Contract Provision: Tax Representations
19. Example – Other Representations
Interim Tax Events: Since the Balance Sheet Date, the Company and its Subsidiaries have
not:
made any new Tax election or changed any Tax election, amended any Tax Return relating
to the Company, made any closing agreement with respect to any Tax, taken any action or
failed to take any action if such action or omission would have the effect of materially
increasing the Tax liability or reducing any Tax asset of the Company, changed any
accounting period, settled any Tax claim or assessment relating to the Company or its
Subsidiaries, surrendered any right to claim for a Tax refund or other reduction in Tax
liability of the Company, consented to any extension or waiver of the limitation period
applicable to any Tax claim or assessment relating to any of the Company or its Subsidiaries,
or any other similar action relating to the filing of any Tax Return or payment of any Tax,
except to the extent, in each case, required by a change in Applicable Law.
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Contract Provision: Tax Representations
20. Covenants
• General
• Obligations imposed on
contracting parties
• Pre-Closing Covenants
• Business Operations e.g. Elections,
amended returns
• Closing (Post-Closing) Covenants
• Transfer Taxes
• Pre-Closing and Straddle Tax
Periods
• Filing and Preparation of Returns
• Payment of Taxes
• Amended Returns and Tax
Refunds
• Post-Closing
• Tax Audits
• Record Retention / Cooperation
• Termination of Intercompany
Agreements
• Other
• Elections
• Tax Free Transactions
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Contract Provision: Tax Covenants
21. Contract Provisions: Tax Covenants
Example – Tax Covenants
Pre-Closing Return Preparation: Seller shall prepare and file, or cause to be
prepared and filed, in a timely manner all [Income] Tax Returns required to be filed
by or with respect to the Company or any of its Subsidiaries for Pre-Closing Periods
regardless of whether such Tax Returns are due before, on or after the Closing Date
and Seller shall remit or cause to be remitted any Taxes due in respect of such Tax
Returns except to the extent paid prior to Closing, paid by Seller after Closing, or
accrued as a liability in determining Closing Working Capital.
All Tax Returns that Seller files or causes to be filed in accordance with this Section
shall be prepared and filed in a manner consistent with past practices employed by
Seller, the Company or its Subsidiaries, except as otherwise provided by this
Agreement or required by Law. Buyer shall not amend any Pre-Closing Period Tax
Return of the Company or any of its Subsidiaries without Seller’s prior written
consent, which shall not be unreasonably withheld.
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22. Contract Provisions: Tax Covenants
Example – Tax Covenants
Intercompany Accounts: As of the Effective Time, all Inter-company
Accounts will be cancelled without any liability to Seller, its Affiliates,
the Company, or any of its Subsidiaries. The Seller shall cause its
Affiliates to release any and all claims against the Company and its
Subsidiaries with respect to such Inter-company Accounts and shall
cause the Company and its Subsidiaries to release any and all claims
against the Seller and its Affiliates with respect to such Inter-company
Accounts.
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23. Contract Provisions: Indemnity
I. General
A. Representations and
Warranties
B. Pre-Closing and Closing Taxes
1. Post-Closing periods from a pre-
closing event
C. Buyer Acts
D. Survival Period
E. Baskets and Caps
II. Claims Procedures
A. Separate Tax versus General
Claims
B. Commencement of Audit
III.Character of Payments
A. Purchase Price Adjustment
IV.Tax Benefit / Tax Detriment
A. Actual versus Hypothetical
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24. Contract Provisions: Tax Indemnity
Tax Indemnification – Example
Seller shall indemnify the Buyer for Target’s Taxes or its liability, if any
(for example, by reason of transferee liability or application of Treasury
Regulation Section 1.1502-6) for Taxes of others (i) for any Tax period
(or portion thereof) ending on or before the Closing Date, and (ii) as a
result of the transactions contemplated by this Agreement (except to the
extent and in such amount as such Taxes are reflected as an accrued
liability and taken into account in the determination of the Purchase Price).
Such Tax indemnification obligation shall be in addition to, but not
duplicative of, Seller’s indemnification obligation with respect to a breach
of a Tax Representation or Tax Covenant contained in the general
indemnification section of this Agreement.
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25. Contract Provisions: Closing Conditions &
Miscellaneous
Closing Conditions / Deliverables
• General
• Representations and Warranties
• Tax Specific
• FIRPTA Certificates
• Tax Clearance Letters
• Tax Opinion / Tax Representation
Letters
• IRS Forms W-9 or W-8 BEN
• Definitions
• Taxes
• Tax Returns
• Effective Time
• Closing Date
• Straddle Periods
• Transfer Taxes
• Assumed Liabilities
• Indebtedness
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26. Contract Provisions: Misc. Definitions
Definitions:
“Tax” or “Taxes” means (i) all taxes, assessments, levies, customs, duties, governmental
charges or other like amounts imposed by any Governmental Authority, including…net
income, gross income, profits, employment, franchise… customs duties, environmental,
escheatment, unclaimed property, together with all penalties, additions to tax and interest
relating thereto, and (ii) any liability for the payment of amounts determined by reference to
amounts described in clause (i) as a result of being or having been a member of any group of
entities that files, will file, or has filed Tax Returns on a combined, consolidated or unitary
basis, as a result of being a transferee or successor or by operation of Law.
“Tax Return” means any return, declaration, report claim for refund or information return or
statement relating to Taxes, required by Law to be filed, including any schedule or attachment
thereto, and including any amendment thereof.
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27. Indemnification Limitations - Example
Buyer Tax Acts: For the avoidance of doubt, Seller shall not indemnify
and shall hold harmless the Buyer from and against any Taxes that result
from any Buyer Tax Act.
“Buyer Tax Act” means any action taken after the Closing by the Buyer
or any of its Affiliates (including the Company or any Subsidiary) with
respect to the Company or any Subsidiary outside the ordinary course of
business of the Company or any Subsidiary, except as otherwise
contemplated by this Agreement.
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Contract Provisions: Tax Indemnity
28. Examples
Question 1:
Company is purchasing all of the interests in an LLC. Does the
contract and due diligence need to address legacy (Successor)
liability for the entity’s income taxes.
TRUE or FALSE?
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29. 29
Successor Liability – Example
T
Seller
OldCo Merge
Purchaser
T
Example: Target is a disregarded entity, wholly owned by seller, and has never been subject to federal
income tax at the entity level. Target acquired business assets two years earlier when another entity (OldCo)
merged with and into Target with Target surviving. Target is the successor entity with respect to OldCo under
state law as a result of the merger and is liable for any taxes of that predecessor entity.
Two Years Prior
Question 1: Example A
30. 30
P
Shareholder
T
Purchaser
Example: T corporation is a member of an affiliated group of corporation filing a consolidated return. T converts
under applicable state law into a limited liability company that is “disregarded” for federal income tax purpose. The
conversion likely constitutes the distribution of assets to its member in liquidation of the entity for federal income tax
purposes. A purchaser of T will be treated for federal income tax purposes as acquiring the assets (and assuming the
liabilities) of the T entity, thus permitting it to treat the transaction as an asset acquisition, however, T remains potentially
liable for the taxes of the consolidated group for any periods it was a member of that group as well as any federal, state
or other taxes imposed on the entity.
Deemed Asset Purchaser – Successor Liability
T
Question 1: Example B
31. 31
Question 2:
Company is purchasing a subsidiary of a consolidated group and
the agreement provides for a Section 338(h)(10) election.
Does the contract and related due diligence need to address any
any taxes other than those of the Target.
TRUE or FALSE?
Examples
32. 32
Successor Liability – Example (Liquidation versus Merger)
T
OldCo OldCo
T
Merger Liquidation
Example: Target had previously acquired all of the stock of another corporation (Old Co) from the common parent of an affiliated
group that filed consolidated returns and of which OldCo was a member. OldCo was merged upstream into Target following Target’s
purchase of OldCo. Target is potentially liable for the consolidated tax liability of the group of which OldCo was a member for the
period it was a member. A purchaser of Target will purchase Target subject to the potential liability for the entire tax liability of the
OldCo group for the period OldCo was a member.
NOTE: If instead OldCo adopted a plan of liquidation under applicable law, Target would be the successor with respect to OldCo’s prior
tax liabilities to the extent it were considered a transferee and likely only to the extent of the fair market value of any assets received in
the liquidation.
Questions 2: Example
33. 33
Question 3:
Company is purchasing an S corporation and the agreement provides for
a Section 338(h)(10) election. The due diligence indicates that the
company has been a valid S corporation since formation.
Does the contract and related due diligence need to address possible
corporate level taxes (section 1374).
TRUE or FALSE?
Examples
34. 34
T
Shareholder
X
Purchaser
Example: T corporation is a valid S corporation that has always been an S corporation. T purchased X (a C
corporation) five years ago and merged it into T.
Deemed Asset Purchaser – Successor Liability
Question 3:
P
35. Question 4
35
Seller
Target
PurchaserOptionees
Example: Target corporation is bought by Purchaser for $100X, of which 90% is payable to Seller and
10% is payable to the holders of employee stock options in Target. $80X is payable at Closing and $20X
is placed in escrow to secure the obligations of Seller and Optionees.
Questions:
• When is Seller taxed on $72X (90% of $80X) payable at Closing?
• When are optionees taxed on $8X (10% of $80X) payable at Closing? Who pays the employer share
of employment taxes? How is wage withholding effected? Who gets the tax benefit of the
compensation deduction, if any?
• When is Seller taxed on the $18X in escrow?
• When are optionees taxed on the $2X in escrow? Employment taxes? Withholding? Who gets the
benefit of any deductions?
36. 36
Asset versus Stock Treatment – Corporate Level Gain
T
S
P
Merger
Example:
T is a C corporation. P is acquiring T solely for cash via a merger with S. Does the direction of the
Merger (forward versus reverse matter).
Questions 5: Direction of the Merger
