Ch. 8 - Taxable Corporate
Acquisitions/Dispositions
Disposition options:
1) Sale of stock – easy to accomplish; LT capital
gain treatment to the individual seller; risk
about unknown corporate liabilities.
2) Sale of assets – more complicated transfer
mechanics; concerns about non-assignable
assets; various tax characterizations, dependent
upon allocation of the consideration received.
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Four Alternatives:
Taxable Dispositions p.364
Possible mechanical alternatives for the taxable
disposition of a corporate business:
1. Sale byy the corporation
p
of its assets and the
distribution of the proceeds in liquidation.
2. Distribution by the corporation of its assets “in
kind” to the shareholders who then sell the assets.
3. Sale of the stock by the shareholders.
4. Sale of the assets at the corporate level and no
liquidation of the corporation.
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Taxable Asset Acquisitions
Consideration Paid
p.365
Sale of its assets by the target corporation to a
purchaser for cash, notes, etc. (but not for stock which exchange could be eligible for tax
tax-free
free
corporate reorganization treatment).
Various types of consideration might be paid for
these assets: cash, promissory notes, bonds & other
property (e.g., stock of other than the purchaser
corporate entity).
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1
Possible structures for the
asset acquisition
p.365
1) Forward cash merger of Target into Acquirer
for cash (or merger into subsidiary of Acquirer).
Equivalent to a sale of assets and liquidation by the
acquired corporation. Rev. Rul. 69-6.
2) Liquidation of the Target followed by the
shareholder sale of the assets to Acquirer.
3) Sale of the assets by Target with subsequent
distribution of the proceeds to shareholders.
4) Sale of assets, with the proceeds retained
(avoiding
shareholder
level gain).
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Issues Upon Retention of
Proceeds & Corporate Status
“Lock-in” effect because of retention of stock until
death to enable §1014 basis step-up.
Possible personal holding company status risk –
requiring current distributions of income to the
shareholders to avoid the PHC penalty tax.
Possible conversion of the corporation to S
corporation status (but note S Corporation
provision limitations, e.g., too much investment
income after being a C corp).
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Allocation of the Purchase
Price for Tax Purposes
§1060 requires an allocation of the purchase price
paid for the assets acquired for cash.
Cf.,, William v. McGowan case re sale of separate
p
assets and not the sale of the "business" enterprise
as one unit.
Cf., the sale of shares of a corporation.
This fragmentation approach requires a purchase
price/tax basis allocation among the various assets
acquired by purchaser.
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Tax Basis Allocation
Planning Objectives p.367
Seller: If a tax rate differential exists, a tax planning
objective will be to allocate proceeds to those capital
assets producing LTCG; but, no income tax rate
differential exists for the selling corporation (all
35%; but consider possible NOL & capital loss
carryover utilization).
Buyer: Wants to allocate the purchase price to
inventory and other short lived assets - to enable a
prompt income tax deduction of these costs.
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Approaches to Allocation
of the Purchase Price
1. Proportionate methods, based on the relative fair
market values of all assets.
2. Residual method - allocation (in order) to: (1)
liquid assets, (2) tangible assets, (3) intangible
assets and, (4) goodwill (i.e., based on the increasing
difficulty of valuation).
§1060 implements the residual method.
Also, an allocation is made to a "covenant not to
compete,” treated as an acquired asset.
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Amortization of Intangibles
p.368
§197 - Intangible assets are amortizable over a 15
year period without regard to their actual "useful
life ”
life.
§197 assets defined: customer lists, patents, knowhow, licenses, franchises, etc., including goodwill and
going concern value; also, “covenants not to
compete” (even though the period of the noncompete covenant is actually much shorter than 15
years).
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Allocation of Price - §1060
Asset Classes
p.370
Class 1 assets:
Class 2 assets:
Class 3 assets:
Class 4 assets:
Class 5 assets:
Class 6 assets:
Class 7 assets:
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Cash & cash equivalents.
Marketable securities.
Accounts receivable.
Inventory.
Tangible property.
Intangibles (§197).
Goodwill & going concern
value (also §197 assets).
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Agreement for Allocation of
the Purchase Price? p.370
1) Should the buyer and seller agree on a purchase
price allocation?
2) What is the binding nature of such a price
allocation
ll ti agreementt on the
th IRS?
3) Can the taxpayer reject the agreement and
report another allocation? See the Danielson
case (p. 367 & 370).
§1060 specifies the binding nature of this agreement
for the taxpayers.
See IRS Form 8594, “Asset Acquisition Statement.”
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Stock Acquisitions
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p.371
Purchaser buys stock of a corporation from the
shareholders. Structuring options are:
1 Direct purchase from the shareholders.
1.
shareholders
Similar to a “B” tax-free reorganization.
What about non-consenting shareholders?
Answer: No deal unless super majority is obtained,
followed by a “squeeze-out” merger to eliminate the
remaining shareholders.
continued
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4
Stock Acquisitions
cont.
p.371
Reverse  cash merger:
1) Purchaser forms a transitory subsidiary which
merges into Target; and
2) Target shareholders receive cash (and notes) of
purchaser. Similar to tax-free “Reverse
Triangular Merger.” Shareholders treated as
selling stock to P.
3) Purchaser receives Target stock. Target
thereby becomes a subsidiary of P.
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Stock Acquisitions Income Tax Results
Results of a direct stock purchase or a reverse
subsidiary cash merger:
1 Selling shareholders - capital gain treatment
1.
upon sale of shares (& §453?).
2. The purchaser takes a cost basis for the acquired
shares in acquired corporation.
Impact to the Target Corp.? Unaffected, except
should this transaction actually be treated as a
deemed asset acquisition?
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Kimbell-Diamond case
Asset Purchase?
p.372
Corporation acquired stock of another corporation
with involuntary conversion proceeds. Objective
was to acquire
q
assets.
Issue re tax basis of the assets acquired by the
corporate transferee in the liquidation.
Tax basis for assets was higher than asset FMV.
Was this a tax-free liquidation of wholly owned
subsidiary into parent corporation, under §332?
No, held: cash asset acquisition.
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Code §338 - Elective Asset
Purchase Tax Treatment
Can a corporate shareholder get a tax basis step-up
for indirectly acquired assets without the
liquidation of the acquired corporation?
If treated as a liquidation - therefore, gain
recognition results as if the appreciated assets had
been (i) distributed in kind, and
(ii) re-infused into a new corporation (§351).
But, the stock basis to the purchasing shareholder
disappears.
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Code §338 Objectives
in Stock Purchase
16
p.374
1. Same federal income tax effects as if:
(i) a sale by Target corporation of its assets,
followed by
(ii) a corporate liquidation into parent corp.
2. The buyer gets a cost basis in the assets
acquired from Target.
3. Tax attributes of the Target disappear (e.g., the
e&p account and the holding periods for the
various assets).
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Share Purchase and Tax
Planning Structural Options
1. No §338 election and the asset tax bases inside
the corporation are unaffected.
2. Not elect §338, but liquidate under §332 - historic
asset tax bases move upstream.
3. Elect §338 and treat the stock transaction as a
taxable asset acquisition (keeping corp).
4. Elect §338, treat the acquisition as an asset
acquisition, and then liquidate the acquired
corporation upstream (under §332).
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Qualification Requirements
for §338 Election
p.376
1. Acquisition by the purchasing corporation of an
80% interest in another corporation during a 12
month acquisition period, i.e., a "qualified stock
purchase” has occurred.
2. Buyer must make an irrevocable election.
3. Treated as a hypothetical sale for asset fair
market values as of the acquisition date. Note: The
purchasing corporation has the tax payment
obligation for recognized gain.
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Defining the Sale Price Deemed Fair Market Value
“Aggregate deemed sale price” (ADSP) - the price
allocable to the assets deemed sold.
Target treated as selling assets for the ADSP.
This deemed sale price includes:
1) price of acquired stock (as grossed-up, to
approximate the real price if not all stock was held
by the purchaser); and,
2) the acquired liabilities (Crane case), including
income tax liability incurred in the sale.
Consider the similarity to an asset sale/purchase.
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Adjusted Grossed-up Basis
of Acquired Assets (AGUB)
Tax basis to new Target for the assets deemed
acquired by Purchaser consists of:
1 Grossed-up
1.
Grossed up price of P's
P s recently purchased stock
(need to gross-up where not all shares have been
acquired).
2. P’s actual basis in non-recently purchased stock
(more than 12 months holding period).
3. Target liabilities, including tax liabilities
resulting from the deemed asset sale.
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Allocation of the Adjusted
Grossed-up Basis
p.379
The objective of determining this basis is to
determine the amount to be allocated to the
Target’s various assets after the deemed purchase.
Thi tax
This
t basis
b i is
i allocated
ll t d to
t the
th various
i
assets,
t as
specified in the §338(b)(5) income tax regulations,
similar to the §1060 approach to allocating
purchase price.
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Subsidiary Sale - Possible
§338(h)(10) Election p.381
Acquisition of the stock of a corp. subsidiary.
Parent corporation is the seller of the target
subsidiary corp.
corp stock (keeping the sub alive).
alive)
Possible §338(h)(10) election - Treat the transaction
as (1) if it were a sale of T's assets while a member
of the seller's consolidated group, and, (2) S then
liquidated tax-free into Acquiring Parent under
§332. Objective: To avoid two corporate level gain
tax events.
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When Use §338(h)(10)
Election?
p.383
1) Large potential gain on the stock, but limited
gain on the assets (as if (a) an actual §332
li id ti into
liquidation
i t parentt and
d then
th (b) a sale
l off the
th
subsidiary’s assets).
2) Consolidated group has losses from other
operations which can be used to offset the gain
realized on the deemed asset sale.
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Comparison of Acquisition
Methods
p.384
Probable alternatives:
1) Sell stock with no Section 338 election
2) Make Section 338 election if Target corp. has
net operating losses to offset recognized gains.
Special treatment where Target corp. is a
subsidiary of another corporation –
Code §338(h)(10) election possibility with gain
reported on Seller’s consolidated tax return.
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Problem (a)
p.386
Asset Sale and Liquidation
T: (1) adopts a plan of complete liquidation,
(2) sells (at the corporate level) its 1.1 mil. non-cash
assets
t ((subject
bj t to
t 300x
300 liabilities)
li biliti ) to
t P for
f 800x
800 cash
h
(corporate level tax on gain),
(3) distributes the after-tax proceeds (how much?)
to the shareholders in proportion to their
stockholdings (A&B have LTCG).
Next question: Basis to P for acquired assets?
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Problem (b)
p.386
Asset Liquidating Distribution
T (i) adopts plan of liquidation; (ii) transfers all
assets (& liabilities) to shareholders; and
(iii) shareholders sell the assets to P.
Tax effects of the distribution to (i) corporation treatment under §336(a); and
(ii) Shareholders – treatment under §331.
Also, income tax basis effects to P? Tax basis of
assets is $1.1 million (allocated per §1060).
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Problem (c)
p.386
Installment Note Distribution
P paid T $200,000 in cash and $600,000 in notes
with market rate of interest payable annually and
the entire principal payable in five years. Issues re
the availability of installment sale treatment upon:
(i) T’s asset sale, and (ii) T’s immediate
distribution of notes.
Further, may A and B (C having a loss) report
their §331(a) gain on the installment method upon
the liquidation of Target? See §453(h).
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Problem (d)
p.386
Asset Sale & No Liquidation
Target sells all its assets to P.
T does not liquidate but invests the after-tax
proceeds in publicly traded securities.
T recognizes $150,000 of ordinary income and
$350,000 net LTCG.
Increase to T’s E&P by $325,000 ($500,000 gain
less 175,000 tax liability on sale).
No distribution of proceeds and §331 tax is avoided
at the shareholder level. What tax risks?
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Problem (e)
p.386
Stock Purchase- §338 Election
P purchases all the stock of T for $800 per share
and makes a Code §338 election.
g
capital
p
ggain ((or loss)) on
Shareholders recognize
their share sales.
P is eligible to make a §338 election since a
“qualified stock purchase” has occurred.
New T treated as a new corporation which
purchased all the old T assets on the day after the
acquisition date.
continued
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Problem (e), continued
p. 386
New T’s basis in its acquired assets:
1) $800,000 grossed up basis
2) $300
$300,000
000 bank loan
3) $175,000 tax paid
Total “adjusted grossed-up basis” is $1,275,000.
This $1,275,000 is allocable among T’s assets under
Code §338(b)(5).
Stock sale & §338 election same as asset sale.
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Problem (f)
p.386
Stock Purchase & No §338
P purchases all the stock of T for cash but does not
make the Code §338 election.
T is not deemed to have sold the assets and,
therefore, recognizes no current gain or loss.
T's same asset bases and other T tax attributes
remain as prior to the sale.
A knowledgeable buyer would not pay $1 million
for the stock because of the future income tax
liability upon T’s asset sales.
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Problem (g)
p.386
Choice of Sales Method?
Method of choice is a purchase of stock without a
§338 election.
If (1) Target sells assets and is liquidated,
or (2) Target shareholders sell stock and a Code
§338 election is made,
the transaction generates tax at both the
shareholder and the corporation level.
Do not make §338 election and do not pay current
tax merely to get a tax basis step-up!
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Problem (h)
p.386
Target With NOL Carryover
If T had a NOL carryover of $600,000:
T could shelter the $500,000 of gain on the deemed
sale
l by
b using
i the
th NOL tto offset
ff t th
the sales
l gain.
i
A §338 election enables new T to take a stepped up
basis to fair market value for assets without any
income tax cost resulting from the election.
Could P otherwise use the NOL? Possible §382
limit?
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Problem (i)
Target as Subsidiary
34
p.386
Assume T is a wholly owned subsidiary of S, Inc.
and S has 200x adjusted basis in T stock.
1) T distributes all of its assets (subject to the
liability) to S in complete liquidation. Liquidation
of T is tax-free to S (under §332) and to T (under
§337).
2) S then sells the assets to P. On the sale of assets
S recognizes $150,000 ordinary income and
$350,000 net LTCG. P has cost basis for the
various acquired assets.
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Problem (j)
p.386
Acquisition of Target Stock
P insists that the transaction must be structured as
an acquisition of T stock.
T is the subsidiary of corporate Seller (S) and a
member of a consolidated group.
§338(h)(10) permits S and P to jointly elect to treat
the transaction as a deemed sale of T's assets in a
single transaction, rather than as a sale by S of the T
stock. A lesser gain amount realized then.
S recognizes no gain or loss on the stock sale.
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Tax Policy Issues – Stock
vs. Asset Purchases p.387
Should the repeal of the General Utilities doctrine
be reversed in the corporate
liquidation/takeover context?
D
Does
ad
double
bl ttax ((corporate
t and
d shareholder)
h h ld )
encourage a “lock-in effect”?
Detriment only to closely held businesses?
How provide any relief? At shareholder or
corporate level? Integrated treatment?
15% tax rate on shareholders’ capital gain?
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Tax Treatment of
Acquisition Expenses
Choices for the buyer:
1) Immediate deduction (ordinarily preferred)
2) Amortization (e
(e.g.,
g debt financing)
3) Frozen in the buyer’s tax basis until the
disposition of the asset (e.g., stock cost).
Tax treatment depends on the acquired assets &
financing arrangements.
Cf.: Target’s expenses (hostile or friendly?).
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Possible Application of
INDOPCO Decision
p.388
Holding that takeover costs in friendly takeover
were nondeductible capital expenses – since
cost produced a “future
future benefit.
benefit ”
Cost need not be related to a specific asset.
Different treatment for fees to prevent a hostile
tender offer – only seeking to preserve the
entity - until changing (?) to a friendly
transaction. Staley (7th Cir) case, p. 389.
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Acquisitions & Cost Recovery
p.390
Failed acquisitions: Costs incurred in investigating
an acquisition and transaction fails or is
abandoned – §165 enables a loss deduction.
Th §263 (Indopco)
The
(I d
) regulations
l ti
- Costs
C t iincurred
d tto
complete a transaction must be capitalized and
amortized. But, current deduction for White
Knight costs and hostile takeover defense costs.
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LBOs – Types of
Transactions
40
p.391
Objectives: Reduce equity and increase debt which
facilitates (1) deductible interest and (2) greater
income per share (and greater value based on
the “earnings
g p
per share” p
probable multiple).
p )
- To facilitate a “going private” transaction.
- To facilitate a “bootstrap acquisition” of
another enterprise.
- To facilitate a stock tender offer.
Recall: Chap. 3 re debt-equity considerations.
Further benefit available: dividends taxed at low
15% rate (to individuals) & DRD; cf., interest.
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LBOs & Tax Limitations on
Excessive Debt
p.409
1) “Junk bond” - Applicable high yield discount (AHYDO)
obligations - §163(e)(5).
See §163(e)(5)(F)(iii) –temporary suspension, through
0 0 because oof financial
a c a market
a et ccrash.
as . Not
Notice
ce 2010-11.
0 0 .
2010
& payment in kind (PIK) bonds
2) Limit use of an NOL attributable to debt leveraging
interest expense. §172(h).
3) Earnings stripping limitation - deductible interest paid
to foreign lender. Code §163(j). But, carryover of
excess deduction for future.
4) Other remedies? Limit on PIK bonds
5) Classification issues – debt for tax & equity for GAAP?
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