TAX AND CORPORATE LAW CONSIDERATIONS IN              PURCHASES AND SALES OF BUSINESSES                                    ...
OVERVIEW OF TRANSACTIONS• Tax Free Reorganizations• Taxable Transactions• Foreign Corporations• Pass-through Entities     ...
TAXABLE VS. TAX FREEType of Acquisition CurrencyNature of the Buyers and Seller                                       3
TAX FREE REORGANIZATIONS•   General Requirements – Continuity of Interest•   Type A – Merger•   Type B – Stock for Stock• ...
CONTINUITY OF INTEREST• IRS – 50% Safe Harbor, Rev. Proc. 77-37   – 40% per IRS Reg. 1.368-1T(e)(1)• John A. Nelson – 38% ...
TYPE A REORGANIZATIONS – SECTION 368(a)(1)(A)            STATUTORY MERGER         Shareholders            Target          ...
TYPE B REORGANIZATIONS – SECTION 368(a)(1)(B)             STOCK FOR STOCK          Shareholders            Target         ...
TYPE C REORGANIZATIONS – SECTION 368(a)(1)(C)             STOCK FOR ASSETS         Shareholders                 Acquiror  ...
TYPE D REORGANIZATIONS – SECTION 368(a)(1)(D)     DIVISIVE SPIN OFF, SPLIT OFF, SPLIT UP          Shareholders            ...
TYPE D REORGANIZATIONS – SECTION 368(a)(1)(D)               NON-DIVISIVE  Merger Treated as Acquisitive D      Shareholder...
TRIANGULAR OR SUBSIDIARY MERGERS    T Shareholders             T                    P                                     ...
TRIANGULAR OR SUBSIDIARY MERGERS    T Shareholders             T                     P                                    ...
SECTION 382 – LIMITATION ON LOSSES AFTER          CHANGE IN OWNERSHIP• Section 381 – Survival of Tax Attributes• Section 3...
DIVIDEND EQUIVALENCY•   Section 356(a)(2) – Boot as dividend or capital gain•   Clark•   Section 302(b)(1) –meaningful red...
CONTINGENT STOCK, ESCROWS, AND EARN-OUTS• Escrows• Earn-Out Stock• Rev. Proc. 84-42 Ruling Guidelines – use of escrow or  ...
USE OF WHOLLY OWNED LLC            T Shareholders               Target            Acquiror                                ...
LLC TECHNIQUESStep 1                      Step 2T Shareholders              Former T Shareholders                         ...
FOREIGN CORPORATIONS• Section 367(a) – outbound transactions   • Foreign corporation not treated as a corporation except a...
FOREIGN CORPORATIONS• Anti-Inversion Rules – tax outbound reorganization and/or tax  foreign Acquiror as a U.S. taxpayer; ...
JOINT VENTURE STRUCTURES                             ForeignUS Company                            Company                 ...
SECTION 338 ELECTION• Section 338(g)   • US Buyer of a foreign owned foreign target   • Offset 338(g) gains with NOLs• Sec...
PURCHASE PRICE ALLOCATION• Section 1060 classes• Agreement Allocations – Danielson Rule• SFAS 141R – Purchase Price Alloca...
UNVESTED STOCK RECEIVED IN A TAXABLE OR NON-               TAXABLE DEAL • Rev. Rul. 2007-49:    • (1) the exchange of full...
OPTIONS• Assumption or Substitution   • No tax on substitution of NSO   • No tax on substitution of ISO, so long as the su...
409A• Deferred compensation   • A deferral of compensation occurs whenever the service provider     (employee) has a legal...
280G GOLDEN PARACHUTE RULES• 20% excise tax and loss of deduction on Excess Parachute  Payment• Reduce Excess for reasonab...
S CORPORATIONS AND 338(h)(10)                                   •   Character difference – ordinary  T Shareholders       ...
S CORP 338(h)(10) ELECTION AND  453B(h) BASIS ALLOCATION ISSUE   Shareholders $1 million   basis                         $...
S CORP NO 338(h)(10) ELECTION – DISAPPEARING                    BASIS  T Shareholders    T (S Corp)            P       • L...
OTHER TAX CONSIDERATIONS• State and Local Taxes   •   Stock sales taxed in seller’s state of residence   •   Asset sales m...
CORPORATE LAW ISSUESNet working capital adjustments • Define working capital and valuation   •   Not just GAAP definition ...
CORPORATE LAW ISSUESIndemnification • Consider limitations on:     • Time     • Subject matter     • Amount•   Identifying...
CORPORATE LAW ISSUESRepresentations and warranties • Representations = statements of present or past facts • Warranties = ...
34
PALO ALTO              LOS ANGELES              SAN FRANCISCO1717 Embarcadero Road   1150 Santa Monica Blvd.       135 Mai...
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Tax and Corporate Law on Sales and Purchases of Businesses

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Tax and corporate law on sales and purchases of businesses

June 21, 2012

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Tax and Corporate Law on Sales and Purchases of Businesses

  1. 1. TAX AND CORPORATE LAW CONSIDERATIONS IN PURCHASES AND SALES OF BUSINESSES Roger Royse Royse Law Firm, PC 1717 Embarcadero Road Palo Alto, CA 94303 rroyse@rroyselaw.com www.rroyselaw.com BASF Conference Center, June 21, Skype: roger.royse 2012IRS 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 1under the Internal Revenue Code or (2) promoting, marketing or recommending to any other person any transaction or matter addressed herein.
  2. 2. OVERVIEW OF TRANSACTIONS• Tax Free Reorganizations• Taxable Transactions• Foreign Corporations• Pass-through Entities 2
  3. 3. TAXABLE VS. TAX FREEType of Acquisition CurrencyNature of the Buyers and Seller 3
  4. 4. TAX FREE REORGANIZATIONS• General Requirements – Continuity of Interest• 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 4 4
  5. 5. CONTINUITY OF INTEREST• IRS – 50% Safe Harbor, Rev. Proc. 77-37 – 40% per IRS Reg. 1.368-1T(e)(1)• John A. Nelson – 38% Stock• Miller v. CIR – 25% Stock• Kass v. CIR – 16% Stock is Insufficient 5
  6. 6. TYPE A REORGANIZATIONS – SECTION 368(a)(1)(A) STATUTORY MERGER Shareholders Target Acquiror • Statutory Merger – 2 or more corporations combined and only one survives (Rev. Rul. 2000-5) • Asset transfer 6
  7. 7. TYPE B REORGANIZATIONS – SECTION 368(a)(1)(B) STOCK FOR STOCK Shareholders Target Target Acquiror Acquiror • Acquisition of Target stock by Acquiror in exchange for Acquiror voting stock • Control 7
  8. 8. TYPE C REORGANIZATIONS – SECTION 368(a)(1)(C) STOCK FOR ASSETS Shareholders Acquiror Stock Acquiror Stock Target Acquiror Target Assets• Acquisition of substantially all of Target’s assets by Acquiror in exchange for Acquiror voting stock• “Substantially All”• Reorganization Expenses 8
  9. 9. TYPE D REORGANIZATIONS – SECTION 368(a)(1)(D) DIVISIVE SPIN OFF, SPLIT OFF, SPLIT UP Shareholders Transferee Stock Transferee Stock Transferor Transferee Transferor Assets • 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 9
  10. 10. TYPE D REORGANIZATIONS – SECTION 368(a)(1)(D) NON-DIVISIVE Merger Treated as Acquisitive D Shareholders with 20% Acquiror Stock Acquiror Stock Transferor Acquiror Transferor Assets Merger Failed Type C Treated as D Liquidation / Reincorporation Shareholders Shareholders Assets Transferor Acquiror Transferor Acquiror Cash & Stock 10
  11. 11. TRIANGULAR OR SUBSIDIARY MERGERS T Shareholders T P 80% S Forward Triangular MergerKey:T = Target P = Acquiror S = Merger Sub 11
  12. 12. TRIANGULAR OR SUBSIDIARY MERGERS T Shareholders T P 80% S Reverse Triangular MergerKey:T = Target P = Acquiror S = Merger Sub 12
  13. 13. SECTION 382 – LIMITATION ON LOSSES AFTER CHANGE IN OWNERSHIP• Section 381 – Survival of Tax Attributes• Section 382 13
  14. 14. DIVIDEND EQUIVALENCY• Section 356(a)(2) – Boot as dividend or capital gain• Clark• Section 302(b)(1) –meaningful reduction• Section 302(b)(2) –substantially disproportionate• E&P Limitation 14
  15. 15. CONTINGENT STOCK, ESCROWS, AND EARN-OUTS• Escrows• Earn-Out Stock• Rev. Proc. 84-42 Ruling Guidelines – use of escrow or contingent stock 15
  16. 16. USE OF WHOLLY OWNED LLC T Shareholders Target Acquiror LLCMerger of Corporation into LLC• Reg. 1.368-2(b)(1) 16
  17. 17. LLC TECHNIQUESStep 1 Step 2T Shareholders Former T Shareholders $ Target Corp. LLC Acquiror Target LLC Target 17 17
  18. 18. FOREIGN CORPORATIONS• Section 367(a) – outbound transactions • Foreign corporation not treated as a corporation except as provided in regulations• Section 367(b) – inbound and foreign to foreign transfers • US Acquiror and foreign Target 18
  19. 19. FOREIGN CORPORATIONS• Anti-Inversion Rules – tax outbound reorganization and/or tax foreign Acquiror as a U.S. taxpayer; Code Section 7874• Controlled Foreign Corporations (“CFCs”) • CFC gain on sale recharacterized as a dividend 19
  20. 20. JOINT VENTURE STRUCTURES ForeignUS Company Company LLC • Section 367 Issues • Disguised Sale US & Foreign Assets 20
  21. 21. SECTION 338 ELECTION• Section 338(g) • US Buyer of a foreign owned foreign target • Offset 338(g) gains with NOLs• Section 338(h)(10) 21
  22. 22. PURCHASE PRICE ALLOCATION• Section 1060 classes• Agreement Allocations – Danielson Rule• SFAS 141R – Purchase Price Allocations 22
  23. 23. UNVESTED STOCK RECEIVED IN A TAXABLE OR NON- TAXABLE DEAL • Rev. Rul. 2007-49: • (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 23
  24. 24. OPTIONS• Assumption or Substitution • No tax on substitution of NSO • No tax on substitution of ISO, so long as the substitution is not a modification• Cancel options for cash payment • NSO • ISO 24
  25. 25. 409A• 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. Reg. 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)) 25
  26. 26. 280G GOLDEN PARACHUTE RULES• 20% excise tax and loss of deduction on Excess Parachute Payment• Reduce Excess for reasonable compensation• Exclude reasonable compensation for future services• Exception for small business corporation• Exception for Non-Publicly Traded Stock • Approval of 75% of shareholders after adequate disclosure • Vote determines the right of the shareholder to the payment• Withholding requirement 26
  27. 27. S CORPORATIONS AND 338(h)(10) • Character difference – ordinary T Shareholders income assets • California 1.5% tax on S corporations T (S Corp) P • All Target shareholders must consent on Form 8023 • Deemed 338 election for subsidiaries S • 1374 – BIG Tax • Minority shareholders in rollover • Hidden tax in liquidation or deemed liquidation in installment saleKey:T = Target P = Acquiror S = Merger Sub 27
  28. 28. S CORP 338(h)(10) ELECTION AND 453B(h) BASIS ALLOCATION ISSUE Shareholders $1 million basis $1 million cash $4 million 453 Note Target Acquiror Stock SaleCash - $1 million / $1 million A/B Reg. 1.338(h)(10) – 1(e)Assets - $4 million / zero A/B Example 10 28
  29. 29. S CORP NO 338(h)(10) ELECTION – DISAPPEARING BASIS T Shareholders T (S Corp) P • Liquidate Target into Merger Sub or check the box Q-Sub S Carryover BasisKey:T = Target P = Acquiror S = Merger Sub 29
  30. 30. OTHER TAX CONSIDERATIONS• State and Local Taxes • Stock sales taxed in seller’s state of residence • Asset sales may be taxed in more than one state • Sales tax • Real estate taxes/property taxes• Pre-Sale Estate Planning • Grantor Retained Annuity Trusts 30
  31. 31. CORPORATE LAW ISSUESNet working capital adjustments • Define working capital and valuation • Not just GAAP definition • Cash • Inventory • Bad debts • Accounts payable• Deferred revenue clauses • Important in high gross margin businesses• Dispute resolution procedure • Consider valuation from a mutually agreed upon accounting firm 31
  32. 32. CORPORATE LAW ISSUESIndemnification • Consider limitations on: • Time • Subject matter • Amount• Identifying indemnitors• Escrowed funds• Time limit for payment on indemnification• Arbitration process 32
  33. 33. CORPORATE LAW ISSUESRepresentations and warranties • Representations = statements of present or past facts • Warranties = promise of indemnity if a statement of fact is false • Extensive set of promises representing all parts of the business • Sellers can consider representation and warranty insurance 33
  34. 34. 34
  35. 35. PALO ALTO LOS ANGELES SAN FRANCISCO1717 Embarcadero Road 1150 Santa Monica Blvd. 135 Main Street Palo Alto, CA 94306 Suite 1200 12th Floor Los Angeles, CA 90025 San Francisco, CA 94105 www.rroyselaw.com 35

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