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M&A Tax Considerations for Buyers and Sellers

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In these slides, the firm will go over taxes that need to be considered by both buyers and sellers in a merger and acquisition. (06/2016)

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M&A Tax Considerations for Buyers and Sellers

  1. 1. M&A TAX CONSIDERATIONS FOR BUYERS AND SELLERS Royse Law Firm, PC 149 Commonwealth Drive, Suite 1001 Menlo Park, CA 94025 www.rroyselaw.com IRS Circular 230 Disclosure: To ensure compliance with the requirements imposed by the IRS, we inform you that any tax advice contained in this communication, including any attachment to this communication, is not intended or written to be used, and cannot be used, by any taxpayer for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing or recommending to any other person any transaction or matter addressed herein. Roger Royse rroyse@rroyselaw.com www.rogerroyse.com Skype: roger.royse Jonathan Golub jgolub@rroyselaw.com September 12, 2013
  2. 2. OVERVIEW OF TRANSACTIONS • Tax Free Reorganizations: – Type A – Merger – Type B – Stock for Stock – Type C – Stock for Assets – Type D – Spin Off, Split Off, Split Up, and Type D Acquisitive Reorganizations – Type E – Recapitalizations • Compensation Issues • Taxable Transactions: – Stock Sale – Asset Sale • S Corporation Strategies • Foreign Corporations 2
  3. 3. TAXABLE VS. TAX FREE • Type of Acquisition Currency – Stock – Securities/Debt – Deferred payments, earn outs – Compensatory • Nature of the Buyers and Seller – Foreign Parties – Tax Attributes of Parties • Shareholder Level Considerations – Tax Sensitivity of Shareholders – Appetite for Complexity & Risk 3
  4. 4. CONTINUITY OF INTEREST 4 • IRS – 50% Safe Harbor, Rev. Proc. 77-37 • IRS – 40% in Temp. Reg. 1.368-1T(e)(2)(v), example (1) • John A. Nelson – 38% Stock • Miller v. CIR – 25% Stock • Kass v. CIR – 16% Stock is Insufficient • 2011 Regulations address changes in value between the date of signing and close; – if fixed consideration (Consideration is “fixed” if contract states exact number of shares and other cash or property to be exchanged) • Consideration is valued as of last business day before the first day the contract is binding and • If a portion of the fixed consideration is other property identified by value, then the specified value is used for that portion (see Reg. 1.368-1(e)(2)). – 2011 Proposed Regulations (Prop. Reg. 1.368-1(e)(2)(vi)) – consideration that varies as the value of issuing corporation stock changes prior to closing will not fall below (or above) contractual floor (or ceiling) markers for purposes of continuity of interest. If binding contract uses average value of issuing corporation stock that average value can be used for continuity of interest. • Post transaction sales and redemptions
  5. 5. TAX FREE REORGANIZATIONS • Type A – Merger • Type B – Stock for Stock • Type C – Stock for Assets • Type D – Spin Off, Split Off, Split Up, and Type D Acquisitive Reorganizations • Type E - Recapitalizations • Ruling Guidelines – Rev. Rul. 77-37 – Rev. Proc. 86-42 – Rev. Rul. 73-54 (terms) – Rev. Proc. 89-50 – Rev. Proc. 96-30 (Type D Checklist) 5
  6. 6. TYPE A REORGANIZATIONS – SECTION 368(a)(1)(A) STATUTORY MERGER Requirements: • Necessary Continuity of Interest • Business Purpose • Continuity of Business Enterprise • Plan of Reorganization • Net Value Tax Effect: • Shareholders – Gain recognized to the extent of boot • Target – No gain recognition • Acquiror takes Target’s basis in assets plus gain recognized by Shareholders • Busted Merger – taxable asset sale followed by liquidation • Statutory Merger – 2 or more corporations combined and only one survives (Rev. Rul. 2000-5) • Requires strict compliance with statute • Target can be foreign; Reg. 1.368-2(b)(1)(ii) • No “substantially all” requirement • No “solely for voting stock” requirement Target Acquiror Shareholders 6
  7. 7. TYPE B REORGANIZATIONS – SECTION 368(a)(1)(B) STOCK FOR STOCK 7 • Acquisition of stock of Target, by Acquiror in exchange for Acquiror voting stock • Acquiror needs control of Target immediately after the acquisition • Control = 80% by vote and 80% of each class Target Acquiror Shareholders • Acquiror’s basis in Target stock is the same as the Shareholder’s Solely for voting stock • No Boot in a B • Reorganization Expenses – distinguish between Target expenses and Target Shareholder expenses (Rev. Rul. 73-54) • Creeping B – old and cold stock purchased for cash should not be integrated with stock exchange
  8. 8. TYPE C REORGANIZATIONS – SECTION 368(a)(1)(C) STOCK FOR ASSETS 8 • Acquisition of substantially all of the assets of Target, by Acquiror in exchange for Acquiror voting stock • “Substantially All” – at least 90% of FMV of Net Assets and at least 70% of FMV of Gross Assets • Target must liquidate in the reorganization • 20% Boot Exception – Acquiror can pay boot (non-stock) for Target assets, up to 20% of total consideration; liabilities assumed are not considered boot unless other boot exists Target Acquiror Shareholders Target Assets Acquiror Stock Acquiror Stock • Reorganization Expenses – Aquiror may assume expenses (Rev. Rul. 73-54) • Assumption of stock options not boot • Bridge loans by Acquiror are boot • Redemptions and Dividends – who pays and source of funds
  9. 9. TYPE D REORGANIZATIONS – SECTION 368(a)(1)(D) DIVISIVE SPIN OFF, SPLIT OFF, SPLIT UP 9 • Divisive – transfer by a corporation of all or part of its assets to another corporation if, immediately after the transfer, the transferor or its shareholders are in control of the transferee corporation. • Stock or securities of the transferee must be distributed under the plan in a transaction that qualifies under Section 354, 355, or 356. Transferor Transferee Shareholders Transferee Stock Transferee Stock Transferor Assets
  10. 10. TYPE D REORGANIZATIONS – SECTION 368(a)(1)(D) NON-DIVISIVE 10 • If shareholders of Transferor stock receive Acquiror stock and own at least 50% of Acquiror stock, the transaction may be treated as a non-divisive D REORG even if it fails as an A REORG for lack of continuity Transferor Acquiror Shareholders with 20% Acquiror Stock Acquiror Stock Transferor Assets Merger Merger Treated as Acquisitive D Failed Type C Treated as D Shareholders Transferor Acquiror Assets Cash & Stock Liquidation / Reincorporation Shareholders Transferor Acquiror
  11. 11. NET VALUE RULES 11 • 2005 Proposed Regulation 1.368-1(b)(1): Exchange of no net value (liabilities exceed value) does not qualify as a reorganization • Example: – Acquiror owns all of the stock of both Merger Sub and Target. Target has assets with FMV of $100 and liabilities of $160, all of which are owed to B. Target transfers all of its assets to S in exchange for the assumption of Target’s liabilities, and Target dissolves. The obligation to B is outstanding immediately after the transfer. Acquiror receives nothing in exchange for its Target stock. • Explanation: – Under paragraph (f)(2)(i) of the Reg, Target does not surrender net value because the FMV of the property transferred by Target ($100) does not exceed the sum of the amount of liabilities of Target assumed by Merger Sub in connection with the exchange ($160). Therefore, under paragraph (f) of the Reg., there is no exchange of net value. See Prop. Reg. 1.368-1(f)(5) Example 3. • Alabama Asphalt
  12. 12. NON-QUALIFIED PREFERRED STOCK 12 • Preferred Stock – limited and preferred as to dividends; and does not participate in corporate growth if: – (1) shareholder has right to require issuer to redeem – (2) issuer is required to redeem – (3) issuer has right to redeem and is more likely than not to exercise that right; or – (4) dividend rate varies based on interest rate, or commodity price or other index • Redemption right exercisable within 20 years and not subject to contingency that renders likelihood remote • Excludes stock compensation that may be repurchased on separation from service • Conversion feature not enough to participate in growth • Generally treated as boot to shareholders
  13. 13. TRIANGULAR OR SUBSIDIARY MERGERS 13 2. Reverse Subsidiary Merger Target Acquiror Merger Sub AcquirorTarget Merger Sub 1. Forward Subsidiary Merger
  14. 14. TRIANGULAR OR SUBSIDIARY MERGERS 14 Section 368(a)(2)(D) Forward Triangular Merger • A statutory merger of Target into Merger Sub (at least 80% owned by Merger Sub) • Substantially all of Target’s assets acquired by Merger Sub • Would have been a good Type A merger if Target had merged into Merger Sub Target Acquiror Target Shareholders 80% Tax Consequences • Merger Sub takes Target’s basis in assets increased by gain recognized by Target • Acquiror takes “drop down” basis in stock of Merger Sub (same as asset basis) Merger Sub
  15. 15. TRIANGULAR OR SUBSIDIARY MERGERS 15 Section 368(a)(2)(E) Reverse Triangular Merger • Merger of Merger Sub into Target where – (i) Target shareholders surrender control (80% of voting and nonvoting classes of stock) for Acquiror voting stock and – (ii) Target holds substantially all the assets of Target and Merger Sub Target Acquiror Target Shareholders 80% Tax Consequences • Non-taxable to Target and carryover basis • No gain to Acquiror and Merger Sub under Sections 1032 and 361 • No gain to Target shareholders except to the extent of boot • Acquiror’s basis in Target stock generally is the asset basis, but Acquiror can choose to take Target shareholders basis in stock (if it is also a B) • If transaction is also a 351, Acquiror can use Target shareholders’ basis plus gain Merger Sub
  16. 16. DOUBLE MERGER 16 Acquiror Target Shareholders Step 2: A-type Forward MergerStep 1: Reverse Triangular Merger Target Acquiror Merger Sub Target Shareholders 80% Tax Benefit: A taxable reverse merger has just one tax on the shareholders, while a taxable forward merger has two taxes (one on shareholders and one on corporation). Intended that entire transaction be a tax-free A-type merger (where 20% boot limitation does not exist). Pairing the two reduces the risk of incurring the corporate level tax in the event the entire transaction is not treated as an A-type merger. REV. RUL. 2001-46 Merger SubTarget+Sub Merger Sub Survives
  17. 17. DOUBLE MERGER – WHOLLY OWNED LLC 17 Target+Sub Acquiror LLC Merger LLC Survives Step 2: A-type Forward MergerStep 1: Reverse Triangular Merger Target Acquiror Merger Sub Target Shareholders 80% Tax Benefit: A taxable reverse merger has just one tax on the shareholders, while a taxable forward merger has two taxes (one on shareholders and one on corporation). Intended that entire transaction be a tax-free A-type merger (where 20% boot limitation does not exist). Pairing the two reduces the risk of incurring the corporate level tax in the event the entire transaction is not treated as an A-type merger. REV. RUL. 2001-46 Target Shareholders
  18. 18. TYPE E REORGANIZATIONS – SECTION 368(a)(1)(E) RECAPITALIZATIONS • Useful for single company restructuring • Often used to transfer control of a company from one generation to the next • Typical situation = founders of business want to pass on control to children. They engage in a Type E recapitalization to change their voting common stock to non- voting common stock or preferred stock, leaving children with voting control of the company – There may be estate and/or gift tax consequences to such a transaction • An important requirement to qualify for tax free treatment under a Type E recapitalization is that the old stock/securities must have the same value as the new stock/securities for which they are exchanged – A recent IRS Memo (Legal Advice Issued by Field Attorneys 20131601F) stated that where the value of the stock received was in excess of the value of the stock surrendered, there was no Type E recapitalization and therefore the excess amount of stock received was taxable 18
  19. 19. PROPOSED REGULATIONS ON LOSS IMPORTATION • General Rule: The acquirer's basis in assets acquired under Section 368 is usually the transferor’s basis – Section 362(e)(1) provides an exception for assets with built-in losses on the date of the transfer – The IRS has issued Proposed Regulations explaining how these “anti- loss importation” rules apply (also applies to Section 334(b) transactions) • Under the Proposed Regulations, if the aggregate basis of all “Importation Property” is greater than the aggregate value of such property then the basis of all the Importation Property is its value on the date of transfer – Importation Property is property where: • (1) the gain or loss is not subject to US tax in the hands of the transferor on a hypothetical sale immediately before the transfer; and • (2) the gain or loss is subject to US tax in the hands of the transferee on a hypothetical sale immediately after the transfer 19
  20. 20. PROPOSED REGULATIONS ON LOSS IMPORTATION Issues to Consider • Flow-through entities – For flow-through entities such as a partnerships or S Corps, the importation property test is made by reference to the partners or shareholders, not the entity itself – The hypothetical sale will consider allocations of gains and losses as per the organizing instrument – The Proposed Regulations contain an anti-avoidance principal for REITs and RICs which applies the look-through principal above if the REIT/RIC acquired the property as part of a plan to avoid the anti- importation rules • Controlled Foreign Companies (CFCs) and Passive Foreign Investment Companies (PFICs) – Under the Importation Property test, a gain or loss on the sale of an asset by a PFIC or CFC is not considered subject to US tax even though it may result in an inclusion under Section 951(a) – The IRS is aware of the issue and has invited comments 20
  21. 21. TARGET DEBT SECURITIES 21 • Exchange of Target securities for Acquiror securities is tax free under Sections 354 and 356, to the extent that the principal amount of Acquiror debt is less than the principal amount of Target debt • Portion attributable to cash basis accrued interest is taxable • Possible COD income – Example: • Target bonds with an issue price (stated principal amount) of $1,000 exchanged for Acquiror stock or debt worth $900; Target has COD of $100
  22. 22. DIVIDEND EQUIVALENCY 22 • Section 356(a)(2) – Boot as dividend or capital gain; post- reorganization redemption test of Rev. Rul. 93-61 • Clark – hypothetical post-reorganization redemption reduced shareholder’s interest from 1.32% to .92% - substantially disproportionate under Section 302(b)(2) • Section 302(b)(1) – redemption that results in meaningful reduction in voting power is redemption and not essentially equivalent to a dividend • Section 302(b)(2) – greater than 20% reduction is substantially disproportionate • E&P Limitation on Dividend – should be Target’s E&P but unclear if Merger Sub’s E&P counted; PLR 9118025, PLR 9041086, and PLR 9039029
  23. 23. CONTINGENT STOCK, ESCROWS, AND EARN-OUTS 23 • Escrows: – Target shareholders usually treated as owner of escrowed Acquiror shares unless otherwise agreed – Especially true if Target shareholders have right to vote and receive dividends – Not clear who is owner if Target shareholders do not have right to vote or receive dividends • Earn-Out Stock: – Target shareholders not considered owners until Acquiror shares are issued – Not treated as boot – Imputed Interest • Rev. Proc. 84-42 Ruling Guidelines – use of escrow or contingent stock – (1) stock must be distributed within 5 years, subject to escrow or contingency – (2) valid business purpose – (3) maximum number of shares cannot exceed 50% – (4) trigger event not controlled by Target shareholders and not based on tax liability – (5) Formula is objective and readily ascertainable – (6) Restrictions on assignment and substitution – (7) In the case of escrows, Acquiror shares shown as issued to Target shareholders, current voting and dividend rights, and vested
  24. 24. UNVESTED STOCK RECEIVED IN A TAXABLE OR NON-TAXABLE DEAL 24 • Rev. Rul. 2007-49 - The revenue ruling addresses: – (1) the exchange of fully vested stock for unvested stock of an acquiring corporation in a tax-free reorganization, and – (2) the exchange of fully vested stock for unvested stock of an acquiring corporation in a taxable exchange • Under either (1) or (2), the Rev. Rul. provides that the exchange constitutes a transfer of property subject to Section 83. – The service provider would need to file an 83(b) election to avoid the recognition of compensation income in the future as the shares vest. – The Rev. Rul. also provides that the spread will be zero, so there is no downside to the service provider’s 83(b) election.
  25. 25. OPTIONS 25 • Assumption or Substitution – No tax on substitution of NSO – No tax on substitution of ISO, so long as the substitution is not a modification. There is no “modification” so long as: • (1) the aggregate spread in new option does not exceed the spread in the old; and • (2) the new option does not have more favorable terms than the old; see Sections 424(a) and 424(h)(3)
  26. 26. OPTIONS – CASH OUT 26 • Cancel options for cash payment – NSO • Ordinary income – compensation – withholding or 1099 • Deduction to Target or Acquiror? – TAM 9024002 – employer deducts based on method of accounting; not clear if cash out at close is pre-acquisition Target deduction or post-close Acquiror deduction in absence of scripting the timing – Under the cash method, the deduction generally arises when the employer has “paid” the property to the employee. See Regs. §1.461-1(a)(1). Under the accrual method, the deduction arises when the employer's obligation to make the property transfer becomes fixed, the property's value is determinable and economic performance occurs. See Regs. §§1.461-1(a)(2) and -4(d)(2)(iii)(B) – ISO • FICA • Exercise and disqualifying disposition treated differently
  27. 27. 409A 27 • Deferred compensation — A deferral of compensation occurs whenever the service provider (employee) has a legally binding right during a taxable year to compensation that will be paid to such person in a later year. Treasury Regulation Section 1.409A-1(b) • Consequences of violating 409A — Amounts which were to be deferred are subject to immediate taxation — Additional 20% penalty on such amounts — Interest penalty — CA state tax penalty • Bonus or Carve Out Plans • Participation in Earn Outs (Reg. 1.409A-3(i)(5)(iv)) — Payments of compensation in this context may be treated as paid at a designated date or pursuant to a schedule that complies with 409A if the transaction-based compensation is paid on the same schedule and under the same terms and conditions as apply to payments to shareholders generally pursuant to the change in control event
  28. 28. 280G GOLDEN PARACHUTE RULES 28 • 20% excise tax and loss of deduction on Excess Parachute Payment – “Excess Parachute Payment” means the amount by which the Parachute Payment exceeds the Base Amount – “Parachute Payment” means a payment, the present value of which, exceeds three times the Base Amount – “Base Amount” means the average annual compensation for past 5 years – Must be paid to a disqualified individual (meaning employee, officer, shareholder, or highly compensated individual) – As compensation, AND – Contingent on a change in control (50% change ownership or effective control, or ownership change in a substantial portion of the company’s assets) • Reduce Excess for reasonable compensation • Exclude reasonable compensation for future services • Exception for small business corporation and non publicly traded corporation that has 75% uninterested shareholder approval • Withholding requirement
  29. 29. 280G – OTHER ISSUES 29 • Non-Publicly Traded Stock – Approval of 75% of shareholders after adequate disclosure – Vote determines the right of the shareholder to the payment – Ignore shares held by persons receiving the payment • Reduction for Excess (299% of payments) • Reduction for Reasonable Compensation • Reduction for Future Services
  30. 30. TAXABLE STOCK PURCHASES 30 Cash Reverse Triangular Merger • Treated as Stock Sale • Shareholders have gain or loss • Acquiror takes cost basis in Target shares Merger Sub Target Shareholders Target Acquiror
  31. 31. CASH FORWARD MERGER 31 Asset Sale Followed by Liquidation of Target • Target has gain on sale • Target shareholders have gain on liquidation (unless 332 applies) • Acquiror takes cost basis in Target assets Target Shareholders Merger Acquiror Survives Target Shareholders Variation with Merger Sub: Target Target Acquiror Acquiror Merger Sub
  32. 32. SECTION 382 – LIMITATION ON LOSSES AFTER CHANGE IN OWNERSHIP 32 • Section 381 – Survival of Tax Attributes • Section 382 – When there has been an ownership change of a corporation with loss carry forwards, use of Net Operating Losses (NOLs) against future income is limited to the product of the value of the Target and the long term interest rate. – “Ownership Change” occurs if, within a 3 year testing period, the percentage of stock of Target held by 5 Percent Shareholders increases by more than 50% over lowest percentage held by such shareholders during the test period.
  33. 33. BUSTED 351 33 Shareholders Target Shareholder Business Acquiror Target Stock Merger Acquiror Stock Rev. Ruling 70-140 Step 1: Incorporate Target Step 2: Merge Target into Acquiror
  34. 34. USE OF WHOLLY OWNED LLC 34 Target Acquiror LLC T Shareholders Merger of Corporation into LLC • Reg. 1.368-2(b)(1) – by operation of law, all assets and liabilities of Target become those of LLC, and Target ceases legal existence • A Type Reorganization
  35. 35. SECTION 351 / 721 ROLLOVER 35 Target Target Shareholders PEG • 80% vote & value • Taxation of boot • Debt + non-qualified voting stock • Assumption of liabilities Cash out some and rollover Target Target Target Shareholders PEG PEG NewCo NewCo Target Shareholders Target Shares Cash Cash Cash Cash CashAssets Assets
  36. 36. LLC TECHNIQUES 36 Acquiror Step 1 Step 2 LLC Former Target Shareholders Target $ Target Target Corp. LLC T Shareholders
  37. 37. INSTALLMENT METHOD 37 • Gain on each payment = gross profit ratio times payment – Gross profit ratio = ratio of total gain to purchase price – Pre-transaction planning opportunities to utilize basis • Section 453A – interest charge to the extent taxpayer holds more than $5 million face amount of Section 453 obligations • Section 453 Limits – Not available for publicly held stock or securities, or inventory – Not available for sales for demand notes or readily tradable notes – Not available for instruments secured by cash or cash equivalents – Obligor must be purchaser (cannot use parent debt) • Section 453 applies unless taxpayer affirmatively elects out • Section 453(h) – Target shareholders who receive Acquiror debt in liquidation of Target allowed to use installment reporting
  38. 38. CONTINGENT PAYMENTS AND EARN-OUTS 38 • Distinguish Equity vs. Debt • 3 Issues – (1) allocation between interest and sales proceeds; – (2) timing of realization of sales proceeds; and – (3) timing of basis recovery • Interest – 1.1275-4(b) • Contingent payment debt for cash or publicly traded property – use non-contingent bond method; projected non-contingent and contingent payments – 1.1275-4(c) • Contingent debt instrument issued for non-publicly traded property – bifurcate into non-contingent debt instrument and contingent debt instrument; contingent payment treated as principal based on present value, excess is interest • Buyer’s basis is non-contingent portion plus contingent payments treated as principal
  39. 39. CONTINGENT PAYMENTS AND GAIN RECOGNITION 39 Reg. 15A.453-1(c) • If capped by maximum amounts, assume maximum for purposes of gross profit percentage (accelerates gain, backloads basis) – If no cap, but term, basis recovered ratably over term – If neither time nor amount is capped, basis recovered ratably over 15 years • Election out of Section 453 – FMV of contingent obligation is amount realized • Open transaction treatment – rare and extraordinary situations only
  40. 40. SECTION 338 ELECTION 40 • Section 338(g) – Target in stock sale treated as selling all its assets followed by liquidation post close (soaks up NOLs) • Section 338(h)(10) – Sale and liquidation deemed to occur pre-close; joint election; S corporation or sale out of a consolidated group • Adjusted Grossed-Up Basis – New Asset basis is basis in recently purchased stock (last 12 months) grossed up to reflect minority shareholder’s basis + liabilities of Target (including taxes in 338(g)) • Adjusted Deemed Sale Price – grossed up amount realized of recently purchased stock plus liabilities of old T (on day after acquisition date)
  41. 41. 338(g) ELECTIONS 41 • If there is a US Buyer of a foreign owned foreign target, then 338(g) election steps up basis and eliminates E&P and foreign tax credits • Target may be able to offset 338(g) gains with NOLs
  42. 42. PURCHASE PRICE ALLOCATION 42 • Asset Sale or 338 Election – Sections 1060 and 338 classes based on FMV – Class I – cash and equivalents – Class II – actively traded personal property under 1092 – Class III – debt instruments and marked to market – Class IV – inventory – Class V – assets other than those in I-IV or VI – Class VI – goodwill and going concern • Agreement Allocations – Danielson Rule – Parties bound by agreement unless IRS determines that the allocation is NOT appropriate • SFAS 141R – Purchase Price Allocations – Assets booked at FMV as of closing date (not signing date) – Bargain purchase results in accounting gain – Earn Outs – estimated and recorded – Deferred tax assets for excess tax deductible goodwill over book value – Transaction related costs recognized (expensed)
  43. 43. S CORPORATIONS AND 338(h)(10) 43 T (S Corp) Acquiror Merger Sub Target Shareholders • Character difference – ordinary income assets • California 1.5% tax on S corporations • All Target shareholders must consent on Form 8023 • Deemed 338 election for subsidiaries • 1374 – BIG Tax • Minority shareholders in rollover • Hidden tax in liquidation or deemed liquidation in installment sale.
  44. 44. S CORP 338(h)(10) ELECTION AND 453B(h) BASIS ALLOCATION ISSUE 44 • Gain to Shareholders in year of sale: $1 million x 80% = $800,000; A/B of Shareholder = $1.8 million • No 331 liquidation: $1 million cash decreases A/B by $1 million to $800,000; $800,000 A/B in Note = $3.2 million gain • 331 liquidation – apportion basis: $1.8 million basis apportioned $360,000 to cash and $1,440,000 to Note; Gain in cash of $640,000 and gain in note of $2,560,000 for a total of $3.2 million gain (GP % on liquidation is 64%) • Defer cash portion and include in installment obligation: gain on liquidation equal to zero; Shareholder A/B in note of $1 million; profit % is 80% Target Acquiror Shareholders $1 million cash $4 million 453 Note Stock Sale $1 million basis Cash - $1 million / $1 million A/B Assets - $4 million / zero A/B Reg. 1.338(h)(10) – 1(e) Example 10
  45. 45. S CORP NO 338(h)(10) ELECTION – DISAPPEARING BASIS 45 Liquidate Target into Merger Sub or check the box Q-Sub T (S Corp) Acquiror Merger Sub T Shareholders Carryover Basis
  46. 46. S CORP INVESTMENT 46 Holdings, Inc. (S Corp) Target, Inc. (QSSS) T Shareholders Step One: Holdings, Inc. (S Corp) Target, LLC (QSSS) Step Two: T Shareholders Holdings, Inc. (S Corp) Target, LLC (QSSS) T Shareholders Step Three: Investor $$ Membership interest Step One: Shareholders of Target, Inc. transfer all Target, Inc. stock to Holdings, Inc. in exchange for Holdings, Inc. stock. Holdings, Inc. makes an S election and Target, Inc. elects to be treated as a qualified subchapter S subsidiary (QSSS). Step Two: Target, Inc. converts to an LLC for state law purposes (Target, LLC). Step Three: Investor purchases a membership interest in Target, LLC from Holdings, Inc.
  47. 47. Partnership Structure with Profits Interest 47 Target Acquisition Structure: Hold Co, LLC Post Acquisition: Target converts to wholly-owned LLC which should be treated as a tax-free liquidation into Hold Co, LLC Target Shareholders 100% 100%100% Merger $$ Merger Co Acquiror Hold Co, LLC Target Shareholders 100% less profits interest 100% Issuance of unvested profits interest Acquiror Target, LLC
  48. 48. Section 336(e) 48 Acquiror Shareholder $ Target Stock Basic Model (for stock sales): Target is treated as selling all of its assets to an unrelated person while owned by its former shareholders and then reacquiring same upon acquisition by Acquiror. $ $Assets Assets = Actual Component = Deemed Component Acquiror Shareholder Target Target3rd Party Section 336(e) does not apply to sales to a “related person.” The attribution rules could give rise to an unexpected “related person” situation where the seller acquires at least 5% of the acquiring partnership as part of the transaction. For example, where an investment partnership acquires a target and provides a modest partnership interest to the selling shareholders.
  49. 49. FOREIGN CORPORATIONS 49 • Section 367(a) – outbound transactions – Foreign corporation not treated as a corporation except as provided in regulations – Generally, gain recognized unless: • No more than 50% of stock of foreign Acquiror received by US transferors, • No more than 50% of stock of foreign Acquiror owned after the transfer by US persons that are officers or directors or 5% Target shareholders, • Gain Recognition Agreement ("GRA") is entered into by 5% US transferee shareholders • 36 month active trade or business test met, • No intent to substantially dispose of or discontinue such trade or business, • FMV of the assets of transferee must be at least equal to the FMV of the US target, and • Tax reporting • Section 367(b) – inbound and foreign to foreign transfers – US Acquiror and foreign Target • Target can be treated as a corporation • May be income to Target’s US shareholders to extent of Target’s accumulated E&P
  50. 50. FOREIGN CORPORATIONS 50 • Anti-Inversion Rules – tax outbound reorganization and/or tax foreign Acquiror as a U.S. taxpayer; Code Section 7874 – If ownership of former U.S. Target shareholders in foreign Acquiror is 80% or more; foreign Acquiror is treated as a U.S. company – If ownership continuity is between 60-80%; foreign Acquiror is NOT treated as a U.S. company, but U.S. tax attributes cannot be used to offset gains – 20% excise tax on stock-based compensation upon certain corporate inversion transactions – 7874 exception available for companies with “substantial business activities” in the foreign jurisdiction; facts and circumstances test compares activities of company in foreign jurisdiction with activities of company globally • Controlled Foreign Corporations (“CFCs”) – A foreign entity is classified as a CFC if it has “United States Shareholders” who collectively own more than 50% of the voting power or value of the company. For the purposes of the CFC rules, a “United States Shareholder” is defined as US persons holding at least a 10% interest in the foreign corporation.
  51. 51. 1248 AMOUNT ON SALE OF CONTROLLED FOREIGN CORPORATION 51 Section 1248 • Seller of Controlled Foreign Corporation (CFC) must treat as dividend gain to extent of E&P • 1248 inclusion carries foreign tax credits • 1248 amount determined at year end and pro rated based on day count, so post closing events can have an effect on the 1248 amount
  52. 52. JOINT VENTURE STRUCTURES 52 • Section 367 Issues • Disguised Sale US Company Foreign Company LLC US & Foreign Assets
  53. 53. TRANSACTION COSTS 53 • Must capitalize “Facilitative Costs” that relate to a “Categorized Transaction” unless an exception applies • Categorized Transactions – (1) Acquisition of assets constituting a trade or business – (2) Acquisition of an ownership interest in an entity if the acquirer and target are related after the transaction – (3) Acquisition of an ownership interest in the taxpayer – (4) Restructuring, recapitalization, or reorganization of the capital structure of the entity – (5) A Section 351 transfer – (6) Formation of a disregarded entity – (7) Acquisition of capital – (8) Stock issuance – (9) A burrowing; and – (10) Writing an option
  54. 54. TRANSACTION COSTS 54 • “Facilitative Costs” – Costs incurred in the process of investigating or pursuing a Categorized Transaction • Includes valuation costs and registrar and transfer agent fees • Excludes consideration for the transaction (not a Facilitative Cost, but may be capitalized under other principles) and business integration costs – Exceptions • Does not include costs relating to a “Covered Transaction” – Covered Transaction » Taxable acquisition by the taxpayer of assets constituting a trade or business » Taxable acquisition of ownership interest, regardless of whether taxpayer is the target or acquirer, if the two parties are related after the transaction » Type A, B, C, or Acquisitive D reorganizations
  55. 55. TRANSACTION COSTS 55 • “Facilitative Costs” cont. – Exceptions cont. • Bright Line Date – Unless the cost is an “Inherently Facilitative Cost” then costs incurred before the “Bright Line Date” are not Facilitative Costs – The Bright Line Date is the earlier of: (a) the execution of the letter of intent (or similar document); or (b) the authorization of the company’s board of directors – Inherently Facilitative Costs are: (1) valuation; (2) costs to structure the transaction; (3) draft and review of documents; (4) regulatory approval; (5) shareholder approval; and (6) conveyance of property – Success-Based Fees • Costs for which the obligation to pay is contingent upon a successful closing are presumed to be Facilitative Costs, however the taxpayer may overcome this presumption by maintaining sufficient documentation • Rev. Proc. 2011-29 provides a safe harbor permitting taxpayers to treat 70% of the success-based fees as being non-Facilitative Costs and treating the remaining 30% as Facilitative Costs.
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