Tax and corporate law on sales and purchases of businesses June 21, 2012

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 2012
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
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under the Internal Revenue Code or (2) promoting, marketing or recommending to any other person any transaction or matter addressed herein.

2. OVERVIEW OF TRANSACTIONS
• Tax Free Reorganizations
• Taxable Transactions
• Foreign Corporations
• Pass-through Entities
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3. TAXABLE VS. TAX FREE
Type of Acquisition Currency
Nature of the Buyers and Seller
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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
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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
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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
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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
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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
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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
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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
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11. TRIANGULAR OR SUBSIDIARY MERGERS
T Shareholders
T P
80%
S
Forward Triangular Merger
Key:
T = Target P = Acquiror S = Merger Sub
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12. TRIANGULAR OR SUBSIDIARY MERGERS
T Shareholders
T P
80%
S
Reverse Triangular Merger
Key:
T = Target P = Acquiror S = Merger Sub
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13. SECTION 382 – LIMITATION ON LOSSES AFTER
CHANGE IN OWNERSHIP
• Section 381 – Survival of Tax Attributes
• Section 382
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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
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15. CONTINGENT STOCK, ESCROWS, AND EARN-OUTS
• Escrows
• Earn-Out Stock
• Rev. Proc. 84-42 Ruling Guidelines – use of escrow or
contingent stock
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16. USE OF WHOLLY OWNED LLC
T Shareholders
Target Acquiror
LLC
Merger of Corporation into LLC
• Reg. 1.368-2(b)(1)
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17. LLC TECHNIQUES
Step 1 Step 2
T Shareholders Former T Shareholders
$
Target Corp. LLC Acquiror
Target
LLC Target
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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
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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
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20. JOINT VENTURE STRUCTURES
Foreign
US Company
Company
LLC
• Section 367 Issues
• Disguised Sale
US & Foreign
Assets
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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)
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22. PURCHASE PRICE ALLOCATION
• Section 1060 classes
• Agreement Allocations – Danielson Rule
• SFAS 141R – Purchase Price Allocations
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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
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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
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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))
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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
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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
sale
Key:
T = Target P = Acquiror S = Merger Sub
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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 Sale
Cash - $1 million / $1 million A/B Reg. 1.338(h)(10) – 1(e)
Assets - $4 million / zero A/B
Example 10
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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 Basis
Key:
T = Target P = Acquiror S = Merger Sub
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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
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31. CORPORATE LAW ISSUES
Net 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
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32. CORPORATE LAW ISSUES
Indemnification
• Consider limitations on:
• Time
• Subject matter
• Amount
• Identifying indemnitors
• Escrowed funds
• Time limit for payment on indemnification
• Arbitration process
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33. CORPORATE LAW ISSUES
Representations 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
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35. PALO ALTO LOS ANGELES SAN FRANCISCO
1717 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
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