M&A Tax Considerations for Buyers and Sellers Evaluating Tax - - PowerPoint PPT Presentation

M&A Tax Considerations for Buyers and Sellers

Evaluating Tax Issues Impacting Negotiation, Structure and Price

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THURS DAY, APRIL 19, 2012

Presenting a live 90-minute webinar with interactive Q&A

Brian S . Mast erson, Part ner, Venable, Washingt on, D.C. Michael A. Bloom, At t y, Venable, New Y

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M&A Tax Considerations for Buyers and Sellers

April 19, 2012 1:00 – 2:30 pm EDT Brian S. Masterson, Partner Michael A. Bloom, Associate

5

I. Taxable vs. Tax-Deferred Acquisitions

6

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SELLER OBJECTIVES

• Capital Gain vs. Ordinary Income
• Tax Deferral
• Reduce Tax (e.g., single level of

taxation) BUYER OBJECTIVES

• Deduct, Depreciate or Amortize

the Purchase Price

• Preserve Tax Attributes (e.g., E&P
• r NOLs)
• Avoid Contingent Tax Liabilities
• Integrate Target with Buyer’s Tax

Structure

Party Objectives

8

Taxable

• Use of cash and debt for

acquisition likely to produce a taxable acquisition.

• Primary tax impact is on the target

corporation. Tax-Deferred

• Use of stock and limited cash likely

to produce a nontaxable acquisition.

• Parties involved must be

corporations (C or S).

• Detailed rules apply depending on

the form (e.g., sometimes 80% or 100% of consideration must be stock).

Taxable vs. Tax-Deferred Acquisitions

II. Taxable Acquisitions

9

10

Asset Sale vs. Stock Sale

Stock Sale

• Simplicity of Transferring Title
• Avoid Third-Party Consents
• Avoid Transfer Taxes

Asset Sale

• Liabilities Do Not Transfer (Unless

Assumed)

• Unwanted Assets

11

Asset Sale vs. Stock Sale

Types of Stock Sales

• Sale of Stock
• Sale of Stock w/ Sec. 338

Election

• Taxable Reverse Subsidiary

Merger Types of Asset Sales

• Sale of Assets
• Taxable Merger (i.e., Merger w/ Cash

Consideration)

12

Sale of Assets

Target Sellers Step 1: Exchange Step 2: Target Liquidates Description: Direct purchase of assets. Target recognizes gain or loss (including depreciation recapture) on an asset-by-asset basis. Acquirer takes basis in assets equal to acquisition cost in accordance with Sec. 1060. Buyer Acquirer Target Sellers $$ $$

Target

13

Taxable Merger

Sellers Before Treated as taxable sale of Target’s assets followed by liquidation of Target. Buyer Acquirer

Merger

$$ After Acquirer Buyer Sellers

$$

14

Taxable Asset Acquisition

Tax Consequences to Target:

• 2 Levels of Tax:

1. Corporate Level Tax 2. Shareholder Level Tax

• Assumed Liabilities = Additional Purchase Price.
• Target tax attributes may offset gain.
• Installment reporting may be available for Notes.

Target

15

Taxable Asset Acquisition

Tax Consequences to Acquirer:

• Acquirer receives basis step-up.
• Target’s tax attributes eliminated.
• No liabilities assumed as matter of law (unless Taxable Merger)
• Value of the step-up (PV of 35% over depreciable life) < cost of step-up

(current tax owed).

Acquirer

$$

16

Taxable Stock Acquisition

16

Sellers Before Acq SHs Acquirer Target

$$

After Sellers Acquirer Acq SHs

$$

Target Target

17

Taxable Stock Acquisition

Tax Consequences to Sellers:

• One Level of Tax (Shareholders).
• Generally Capital Gain Treatment.
• Same Result Whether Target is C or S Corp.
• If Seller is a Partnership, gain may be recharacterized to the extent
• f “hot assets”.

Sellers

18

Taxable Stock Acquisition

Tax Consequences to Acquirer:

• No Basis Step-Up.
• Target retains tax attributes.
• NOLs and built-in gains/losses will be subject to annual limitation

triggered by change of ownership.

• For Partnerships, Sec. 754 election can provide Buyer with basis step-up.

Acquirer

$$

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Section 338 Election

Purpose: Allows parties to treat a stock sale as an asset sale for tax purposes. Requirements: Generally available to Acquirer whenever Acquirer purchases (within 12 month period) 80% or more of the stock of an unrelated Target. Tax Consequences: Target shareholders recognized gain (or loss) on the sale

• f their Target stock, and Target recognizes gain (or loss) on the deemed sale
• f its assets.

Rarely Used: Because the PV of the basis step-up received by Acquirer does not exceed the present tax cost of achieving the step-up, regular Sec. 338 elections are rarely used. Exception for Target with NOLs and Foreign Sellers.

20

Section 338(h)(10) Election

Purpose: Same as regular Sec. 338 election but with only single layer of tax. Availability: Same requirements as regular Sec. 338 election except Target must be either (i) member of consolidated group, (ii) member of an affiliated group, or (iii) an S corporation. Tax Consequences: Target is treated as having sold all of its assets to a new Target (owned by Acquirer) and liquidated. No gain or loss is recognized on the deemed liquidation of Target (i.e., only 1 level of tax). Joint Election: Both Sellers and Target must make the election.

III. Tax-Deferred Acquisitions

21

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Tax-Deferred Acquisitions

Special Tax Treatment: A transaction defined as a “reorganization” is subject to special treatment under certain provisions of the Code.

• Secs. 361 and 357. A Corporation transferring assets recognizes

neither gain nor loss if, pursuant to a plan or reorganization, it receives stock or securities of another corporation that is also a party to the reorganization.

• Secs. 354 and 356. Shareholders and creditors of Target who,

pursuant to a plan of reorganization, exchange stock or securities for that of another Corporation that is a party to the reorganization recognize no loss, and generally recognize gain only to the extent that other property is received.

• Sec. 381. In certain reorganizations, Targets tax attributes (e.g.,

NOLs) are inherited by Acquirer.

23

Tax-Deferred Acquisitions

Requirements: For an acquisition to fall within the definition of “reorganization”, it must meet the statutory requirements under Sec. 368, and also certain judicial and administrative tests. Judicial/Administrative Requirements:

• Continuity of Interest.
• Continuity of Business Enterprise.
• Business Purpose.

24

Tax-Deferred Acquisitions

Summary of Tax Consequences:

• No gain (or loss) on stock or securities exchanged solely for stock or

securities in Acquirer as part of plan of reorganization. Gain recognized to the extent of boot received.

• No gain or loss on transfer of assets. Assets retain historical tax basis

and holding period (including depreciation recapture potential).

• Target tax attributes preserved (e.g., NOLs, foreign tax credits,

earnings and profits, etc.)

25

Reorganizations

1. Type A Reorganization (Merger or Consolidation) (Sec. 368(a)(1)(A)). 2. Type B Reorganization (Stock for Stock) (Sec. 368(a)(1)(B)). 3. Type C Reorganization (Asset for Stock) ( Sec. 368(a)(1)(C)). 4. Type D Reorganization (Asset for Stock w/ Control) ( Sec. 368(a)(1)(D)). 5. Type E Reorganization (Recapitalization) (Sec. 368(a)(1)(E)). 6. Type F Reorganization (Change in Form) (Sec. 368(a)(1)(F)). 7. Type G Reorganization (Bankruptcy) (Sec. 368(a)(1)(G)).

Target Acquirer Target SH

• Acq. SH

Before

Description: Target mergers into Acquirer with Acquirer surviving. Target shareholders receive at least 40% Acquirer stock as merger consideration.

26

“A” Reorganization

Merger Consideration (Stock)

Merger

After

Target SH and Acquirer SHs

Acquirer

27

“A” Reorganization

Definition: An “A” Reorganization is simply “a statutory merger or consolidation.” 2006 Regulations: Allow “A” Reorganizations with respect to foreign corporations and disregarded entities for US tax purposes. See Treas. Reg. 1.368-2; T.D. 9242 (Jan. 26, 2006). No “Solely for Voting Stock” Requirement: The only limitations on the type

• f consideration are those imposed by the continuity of interest doctrine

(i.e., 40% equity). Thus, Acquirer may give some non-stock consideration. No “Substantially All” Requirement: No requirement that “substantially all”

• f Target’s assets be transferred, as in the case of a “C” reorganization.

Thus, allowed to spin-off assets before the reorganization.

Acquirer Target SH

• Acq. SH

Before

28

Forward Triangular Merger

Merger Consideration (Stock) Merger

New Sub After New Sub Target SH

• Acq. SH

Acquirer Target

Description: Target merges into New Sub, and the former Target shareholders receive Acquirer stock in exchange for Target stock. [Sec. 368(a)(2)(D)].

29

Forward Triangular Merger

Background: Before enactment of Sec. 368(a)(2)(D), merger of Target into Sub in exchange for Parent stock did not qualify as an “A” Reorganization. Basic Requirements: 1. Parent stock must be issued as merger consideration. 2. Sub must acquire substantially all of Targets assets. 3. Merger of Target into Sub must qualify as an “A” reorganization if performed at Parent level. 4. No stock of Sub may be used. Practical Considerations: Offers several advantages to regular “A” reorganization: (i) avoid exposure to Target liabilities and (ii) need to obtain approval of merger by Parent’s shareholders can be avoided.

Acquirer Target SH

• Acq. SH

Before

30

Reverse Triangular Merger

Merger Consideration (Stock) Merger

New Sub After Target Target SH

• Acq. SH

Acquirer Target

Description: New Sub mergers into Target, and Target shareholders receive Acquirer stock in exchange for Target stock. [Section 368(a)(2)(E)].

31

Reverse Triangular Merger

Description: Target’s shareholder surrender amount of stock representing control of Target in exchange for Parent stock, after which Parent owns substantially all of Target’s assets. Very similar to a triangular “B” Reorganization. Practical Considerations: Preserving corporate existence of the Target (thus avoided difficulty of assigning contracts) and isolate Target liabilities from Parent. Consideration Allowed: Unlike “B” reorganization, “boot” is permissible so long as Parent acquires control solely in exchange for voting stock. (i.e., 80%) There are no restrictions on the issuance of other property for the remaining Target stock. Substantially All Requirement: Target must hold, after the transaction, “substantially all “ of the properties of Target and Sub (the definition of “substantially all” as used for “C” reorganization and forward triangular mergers).

32

Target Acquirer Target SH

• Acq. SH

BEFORE AFTER Acquirer

Acquirer SH (Including Former Target SH)

Target Stock

• Acq. Voting

Stock

Target

“B” Reorganization

33

“B” Reorganization

Description: Acquisition by Parent (or Sub) of stock of Target in exchange solely for voting stock of Parent if, “immediately after” the exchange, Parent (or Sub) controls Target. Structuring: Can be accomplished either by (i) direct exchange of Target stock for Parent stock (Regular “B” Reorganization) or (ii) through merger of Target into newly formed subsidiary of Parent in exchange for Parent stock (Triangular “B” Reorganization). Rev. Rul. 67-448, 1967-2 C.B. 144. Practical Considerations: Requires absolute compliance with the “solely for voting stock requirement”, although no requirement that Target holds substantially all of its historic assets following the acquisition. Degree of Permissible Boot: The IRS’s current litigation position is that the “solely for voting stock” requirement precludes Acquirer from issuing anything other than voting stock in exchange for Target stock.

Target Acquirer Target SH

• Acq. SH

BEFORE AFTER Acquirer

Acquirer SH (Including Former Target SH) Description: Target transfers its assets and liabilities to Acquirer in exchange for Acquirer voting stock. Target then liquidates, distributing Acquirer stock to Target shareholders. In “Triangular C”, Target transfers its assets and liabilities to Acquirer in exchange for voting stock in corporation 80% controlled by Acquirer.

Assets & Liabilities Stock Target Liquidates

34

“C” Reorganization

35

“C” Reorganization

Description: Acquisition of “substantially all” of the properties of Target in exchange “solely for voting stock” of Acquirer (or, if Sub is Acquirer, in exchange solely for Parent stock). Degree of Permissible Boot: Boot given by Acquirer for Target’s assets may not exceed 20% of the fair market value of such assets (including any assets

• f Target that were not transferred to Acquirer). In applying 20% exception,

liabilities assumed are treated as cash boot (but only if other money or property received). Voting Stock: Does not include warrants, options, convertible debt or other similar instruments. To be voting stock, stock must generally have the current right to vote in the election of corporate directors. Substantially All Requirement: Determination of substantially all based upon all relevant facts and circumstances (not simply percentage of assets transferred).

IV. Divisive Reorganizations

36

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Divisive Reorganizations

1. Spin-Offs (In Lieu of Dividend) -- Distributing corporation (“D”) distributes Controlled corporation stock (“C”) pro rata to D shareholders. 2. Spin-Offs (In Lieu of Redemption) -- D distributes C stock to some or all of D shareholders in redemption of all or part of their D stock. 3. Split-Ups -- D distributes stock of two or more controlled companies in liquidation of D.

38

Spin-Offs

Requirements:

• Distribution made with respect to stock.
• Control immediately before.
• Active conduct of trade or business.
• Distribution of all of the stock of the controlled corporation.
• Neither D nor C can be disqualified investment corporation in certain

split-off transactions [IRC 335(g)(1)].

• Rev. Proc. 2003-48 – IRS No Longer Rules On:
• Business Purpose
• Device
• Existence of a Plan under IRC 355(e)

IV. Earn-Outs and Other Deferred Payments

39

40

Earn-Outs

Overview:

• Buyers and Sellers often do not agree on the value of Target.
• Differences resolved by tying a portion of the purchase price to future

performance of the Target.

• There is no “standard” earn-out formula. Key terms:

 Triggers. Milestones must achieve to trigger the earn-out payment (e.g., EBITDA).  Duration. Length of earn-out to minimize volatility in the operations

• r financial results.

 Impact on Indemnity Limits. Consider how contingent compensation affects indemnification provisions.

41

Earn-Outs

Tax Considerations:

• Installment Method.

 Gain taxed at closing equal to all cash received. Gain on contingent payments taxed as received (Section 453A deferred charge on deferred gain > 5MM).

• Closed Transaction Method.

 Gain taxed at closing including the fair market value of all contingent payment rights.

• Open Transaction Method.

 Gain taxed at closing equal to all cash received. Gain on contingent payments taxed as received.

Contact Information

Brian S. Masterson:

• 202-344-4675
• bsmasterson@venable.com

Michael A. Bloom:

• 212-370-6286
• mbloom@venable.com