IRC Section 338(h)(10) Election

Transcription

1 Presenting a live 110 minute teleconference with interactive Q&A IRC Section 338(h)(10) Election Strategies for Tax Counsel Leveraging the Election in Structuring Acquisitions, Dispositions and Asset and Stock Transfers TUESDAY, DECEMBER 18, pm Eastern 12pm Central 11am Mountain 10am Pacific Today s faculty features: Monty W. Walker, Principal, Walker Business Advisory Services, Wichita Falls, Texas Shane Kiggen, Manager, Transaction Advisory Services - M&A, Ernst & Young, Washington, D.C. Attendees seeking CPE credit must listen to the audio over the telephone. Please refer to the instructions ed to registrants for dial-in information. Attendees can still view the presentation slides online. If you have any questions, please contact Customer Service at ext. 10.

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5 Strafford Section 338(h)(10) Webinar Tuesday December 18, 2012 Shane Kiggen Ernst & Young Monty Walker Walker Business Advisory Services

6 Circular 230 disclaimer Any US tax advice contained herein was not intended or written to be used, and cannot be used, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions. ii These slides are for educational purposes only and are not intended, d and should not be relied upon, as accounting advice. 6

7 Elections under Section 338 generally Section 338 provides two elective procedures Section 338(g) and Section 338(h)(10) to treat a qualifying purchase and sale of stock of an eligible target as a purchase and sale of the assets of the target (and, in some cases the target s subsidiaries) for Federal income (and, in some cases, state) tax purposes The Federal income tax consequences of, and prerequisites to, making a Section 338(g) election differ markedly from the Federal income tax consequences of, and prerequisites to, making a Section 338(h)(10) election: A Section 338(g) election can be made with respect to a qualifying acquisition of any C corporation; a Section 338(h)(10) ) election can be made only with respect to a qualifying acquisition of an 80% corporate subsidiary or an S corporation A Section 338(g) election results in both corporate and shareholder level tax; a Section 338(h)(10) election results only in corporate level tax The two levels of tax that attend a Section 338(g) election render it uneconomic in all but a limited set of circumstances (e.g., g where the seller is foreign or the target has net operating or built in losses sufficient to offset corporate level gain on the deemed asset sale) A Section 338(g) election is made unilaterally by the purchasing corporation, and the purchasing corporation bears the incremental tax burden from the gain on the deemed sale of the target's assets; a Section 338(h)(10) election is made jointly by the purchasing corporation and seller, and the seller bears the incremental tax burden from thegain on the deemed sale of the target's assets 7

8 Section 338(g) Transaction Actual: Purchaser Purchaser Receives Stock Seller Seller Receives Cash moves to Purchaser Deemed Additional Transaction: New New receives all of Old Assets Old receives Cash PLUS New assumes liabilities Old 8

9 Impact of Section 338(g) Election New New receives all of Old Assets Old receives Cash PLUS New assumes liabilities Old is treated as having sold its assets for Fair Market Value s unused and remaining tax attributes disappear s Shareholders h treated as selling Stock s Shareholders liable for tax on gain from stock sale Purchaser is liable for tax on gain from deemed asset sale 9

10 Section 338(h)(10) Transaction Actual: Purchaser Purchaser Receives Stock Seller Seller Receives Cash moves to Purchaser Deemed: Purchaser Sll Seller New New receives all of Old Assets Old receives Cash PLUS New assumes liabilities Old Old target liquidates into Seller 10

11 Impact of Section 338(h)(10) ) Election Purchaser Seller New New receives all of Old Assets Old receives Cash PLUS New assumes liabilities Old Old target liquidates into Seller s shareholder s stock sale is disregarded is treated as selling assets and ceasing to exist for federal tax purposes s shareholders are liable for tax on gain from deemed asset sale Purchaser generally receives step up in basis on s assets s unused tax attributes carry over to selling shareholder if member of consolidated filing group 11

12 Mechanics of the Section 338(h)(10) ) election The Section 338(h)(10) election is a joint election by the purchasing corporation (P) and the selling consolidated group (or selling affiliate or S corporation shareholders) (S) to treat a qualifying purchase and sale of stock of an eligible target (T) as a purchase and sale of the assets of T (and, in some cases T s subsidiaries) bidi i )for Federal li income (and, in some cases, state) tax purposes If P and S join in making a Section 338(h)(10) election for T: T (Old T) is treated as transferring all of its assets to an unrelated person in a taxable transaction for an amount generally equal to the consideration received for the stock plus liabilities assumed Old T recognizes gain or loss on the deemed sale of its assets while a member of the S consolidated group Following the deemed asset sale, but while Old T is still a member of the S consolidated group, Old T is treated as transferring all of its assets (i.e., the deemed sales proceeds) to S and as ceasing to exist This transfer is characterized for Federal income tax purposes as if the parties had actually engaged in the transactions deemed to occur, taking into account other transactions that actually or were deemed to occur. The principal consequences of this characterization are that, usually, the shareholders will have the tax result attendant to a liquidation of the company The regulations lti are unclear, but tfrom P s perspective, the transaction ti may be viewed as if it created td a new (tl (at least 80% owned) subsidiary (New T), which purchased the assets of Old T in a taxable transaction for an amount generally equal to the consideration paid for the stock plus the assumption of T s liabilities The principal consequence of this characterization is that, as in any other taxable purchase, New T will take basis in its assets equal to the purchase price, and will generally not succeed to the tax attributes of Old T 12

13 Requirements of a Section 338(g) and 338(h)(10) Elections Purchaser must be a corporation Purchaser makes a Qualified Stock Purchase QSP Purchase An actual taxable purchase must occur Test Must acquire at least 80 % of the voting stock and at least 80% ofthe total shares ofall other classes ofstock except nonvoting preferred stock. 12 Month Period All applicable shares must be acquired within a 12 month period Purchaser must make Election by 15 day of the 9 th month following the QSP Purchase Election is made by filing IRS Form 8023 Both Purchaser and Seller must jointly file Election for a Section 338(h)(10) In a Section 338(h)(10) Election, must be an eligible Section 338(h)(10) 13

14 Code Section 338(h)(10) ) target eligibility is a member of a Consolidated Group (This is a group that does a consolidated tax filing.); or is a member of an Affiliated Group (This is a group that has the ability to file a consolidated return.); or is an S Corporation Treasury Reg. Section 1.338(h)(10) 1(c) 14

15 Examples of when a Section 338(g) may be useful The target corporation has unused net operating losses, capital losses or tax credit carryovers that will offset the tax liability created as a result of the election. The target corporation has depreciable assets and has had a tax liability within the last two or three years prior to the sale of the business. The deemed sale of the depreciable assets may create a net operating loss that can be carried back to obtain a tax refund from a prior year. The target corporation has non depreciable built in loss property and has depreciable built in gain property. Subsequent to the sale, these gains and losses have the effect of canceling each other out. Additionally, the depreciable property will have a stepped up basis, which will provide a larger depreciation deduction going forward. The selling stockholders recognize minimal gains or a loss on the sale of the target corporation s stock. 15

16 Examples of when a Section 338(g) may be useful Because the Section 338(g) election results in the imposition of corporate and shareholder level h l ltax, a Section 338(g) ()is generally useful only in two instances: Where the target net operating losses (NOLs) or credits that can shelter the Federal tax caused by this election Where the target is a foreign corporation 16

17 Examples of when a 338(h)(10) may be useful The target corporation is a member of a consolidated return group that has tax attributes to offset the gain and any resulting tax liability from the deemed sale of assets. The target corporation is a member of a consolidated return group and hastax attributes beyond what is needed to absorb any gains resulting from the deemed sale of assets. The target corporation is an S Corporation. has large base of assets requiring title transfer has Contracts which hare dff difficult to transfer has Authorizations which are difficult to transfer has Government preference status such as HUB Purchaser desires maximum consistency for ongoing operations Purchase desires maximum transparency for ownership change has long history which Purchaser would benefit by preserving has excellent insurance rates, Workers Comp Rates, State Unemployment Rates, etc Purchaser is a key employee or group of employees Etc 17

18 Qualified Stock Purchase Defined A QSP is any transaction, or series of transactions, in which P "purchases," within the "12 month acquisition period," stock constituting at least 80% of the vote and 80% of the value of T. Only a narrow class of non voting, nonparticipating preferred stock is excluded from consideration (Section 1504(a)(4)) The 12 month acquisition period is generally the 12 month period beginning with the date of the first purchase of the T stock counted in determining whether a QSP has occurred The acquisition date is the date on which the QSP occurs. In other words, it is the first day that P achieves the required 80% ownership of T by purchase within the 12 month period All stock purchases made by members of the P group are aggregated in determining whether a QSP has occurred Note that in order for a transaction to constitute a QSP, a corporation must purchase the stock of T 18

19 Purchase Defined To count as part of a QSP, T stock must be acquired by purchase. A purchase is any acquisition of stock with the following exceptions: Carryover basis acquisition: an acquisition where the basis to P is determined, in whole or in part, by reference to its basis in the hands of the transferor (carryover basis) is not a purchase (e.g., T stock acquired in a transaction subject to Section 304) Non recognition transaction: an exchange to which Sections 351, 354, 355, or 356 apply, or any other acquisition described in regulations in which the transferor does not recognize the full amount of realized gain or loss (e.g., T stock acquired in a Section 351 exchangeor a B reorganization) Related party acquisition: an acquisition from a person whose stock ownership would be attributed to P under the attribution rules of Section 318(a) (other than the option attribution rule of Section 318(a)(4)) However, a purchase, otherwise qualifying, will not be disqualified by the related party rules if the acquisition is from a corporation, at least 50% of whose stock was purchased by P 19

20 The Related Party Acquisition Rule Reg (b)(3)(ii) generally provides that for purposes of the related party acquisition rule, P is treated as related to another person if the relationship exists In the case of a single transaction, immediately after the purchase of T stock In the case of a series of acquisitionsotherwiseotherwise constituting a qualified stock purchase within the meaning of Section 338(d)(3), immediately after the last acquisition in such series In the case of a series of transactions effected pursuant to an integrated plan to dispose of T stock, immediately after the last transaction in such series 20

21 Going Public Section 338(h)(10) Public Public Parent NewCo stock + $ Parent NewCo NewCo $ stock $ stock IPO investors Underwriter Subsidiary stock 49% 51% Subsidiary NewCo NewCo Subsidiary Subsidiary Transaction steps: Parent forms NewCo with nominal capital Parent enters into a binding contractual agreement with Underwriter whereby Parent agrees to sell 51% of the NewCo stock to Underwriter, for resale to the public, immediately after step (3) below Parent transfers all of the Subsidiary stock to NewCo in exchange for shares of NewCo stock and cash pursuant to the agreement executed in step 2 above, Parent sells 51% of the NewCo stock to Underwriter, which, in turn, sells the NewCo stock to the public Parent and NewCo join in making a Section 338(h)(10) election for Subsidiary Parent and NewCo enter into a TRA whereby NewCo agrees to annually pay to Parent 85% of the tax benefits attributable to the depreciation and amortization deductions that would have been unavailable in the conventionalipo (i.e., a sale of 51% of the Subsidiary stock to Underwriter, for resale to the public) See Reg. Section (b)(3)(iv), example 1 21

22 Staged Going Public Section 338(h)(10) Public Public Parent NewCo stock + $ Parent NewCo NewCo $ stock $ stock IPO investors Underwriter Subsidiary stock 79% 21% Subsidiary NewCo NewCo Subsidiary Subsidiary Transaction steps: Parent forms NewCo enters into a binding contractual agreement with Underwriter whereby Parent agrees to sell 21% of the NewCo stock to Underwriter for resale to the public, immediately after step (3) below Parent transfers all of the Subsidiary stock to NewCo in exchange for shares of NewCo stock and cash Pursuant to the agreement executed in step 2 above, Parent sells 21% of the NewCo stock to Underwriter, which, in turn, sells the NewCo stock to the public Parent and NewCo join in making a Section 338(h)(10) election for Subsidiary within 24 months of step (4), Parent undertakes one or more additional public offerings of NewCo stock to reduce its ownership below 50%. If the offerings do not occur as planned, Parent, in accordance with a plan of disposition, reduces its ownership of NewCo to less than 50% through one or more alternative transactions Parent and NewCo enter into a TRA whereby NewCo agrees to annually pay to Parent 85% of the tax benefits attributable to the depreciation and amortization deductions that would have been unavailable in the conventional IPO (i.e., a sale of 51% of the Subsidiary stock to Underwriter, for resale to the public) NewCo with nominal capital See PLRs ,

23 Section 197 Anti churning Rules In general, the Section 197 anti churning rules preclude amortization of intangibles if: Acquired from a related party or from an unrelated party when the user of the intangible asset does not substantially change The intangible was held by the taxpayer or the seller at any time from July 25, 1991 to August 10, 1993 The intangible was not the type of asset that would have been depreciable or amortizable under pre Section 197 law Section 197(f)(9) defines relatedness by reference to Sections 267(b) and 707(b), but lowers the ownership threshold from 50% to 20%. The persons are related if the relationship exists either immediately before or immediately after the acquisition of the intangible In the case of a series of related transactions ti (or a series of transactions ti that t comprise a QSP), the time for testing the relationship between the buyer and the seller is immediately before the earliest such transaction or immediately after the last such transaction. Reg (h)(6)(ii)(B) If buyer is a newly formed corporation, the momentary relationship does not cause the antichurning rules to apply However, if the buyer is an existing corporation, the anti churning rules apply since immediately before the transaction, the seller is related to the buyer 23

24 QSP: Sell the Seller to satisfy related party acquisition rule Public (4) $ Public Parent stock (3) NewCo stock FMV=100 =30 Parent FMV=700 = 200 NewCo Wanted Subsidiary stock Acquiring Parent Wanted Unwanted Wanted Subsidiary Subsidiary Subsidiary Unwanted Subsidiary NewCo Wanted Subsidiary Transaction steps: Parent forms a new corporation, NewCo, with nominal capital Parent transfers all of the Wanted subsidiary stock to NewCo in a transaction that does not qualify for non recognition treatment Parent distributes its entire interest in the NewCo stock to Public Public sells Parent to Acquiring for cash Parent and NewCo join in making a Section 338(h)(10) election for Wanted subsidiary See PLRs , ,

25 Bifurcated acquisition of standalone with NOL $70 A (2) $30 FMV=100 =70 $30 A (3) Acquiring FMV=70 =70 =0 Ls=0 NOL=30 (1) Acquiring Stock PP&E Transaction steps: sells Property, Plant and Equipment to Acquiring for its value of $30. Acquiring will use the PP&E in its business and thus has no plan or intention to transfer the PP&E to distributes the $30 proceeds to A in redemption of 30% of A s stock A sells its remaining stock to Acquiring for its value of $70, recognizing no gain 25

26 The Consistency Rules of Section 338 When Congress enacted Section 338 in 1982, it included consistency rules designed to curb selectivity in the treatment of corporate acquisitions that is, the acquisition iii of certain T assets and the acquisition iii of T stock (a bifurcated d acquisition ) Currently, the regulations implementing the consistency rules prevent P from obtaining i a stepped up basis for assets purchased dfrom T where P subsequently acquires T in a QSP without a Section 338 election The gain from the sale of T s assets is essentially not taxed at the corporate level Where T is a domestic corporation, the consistency rules generally apply if T is a subsidiary member of a consolidated group, and during the 12 month period preceding the QSP, P acquires assets from T (or a lower tier affiliate of T) at a gain, and the gain is reflected in S s basis in the T stock under Reg , thereby reducing the S group s gain from the sale of the T stock 26

27 Structuring Around the Consistency Rules A stock purchase with a Section 338(h)(10) election is treated as an asset purchase. So, the consistency rules may apply if the P group acquires the stock of a higher tier corporation and does not make a Section 338 election This is because the gain from the Section 338(h)(10) election will tier up and generally will reduce the gain on the sale of the stock of the higher tier member The consistency rules apply only in the case of a QSP, which requires a stock purchase by a corporation. Where P wishes to structure a bifurcated acquisition, the consistency rules can be avoided in certain circumstances by having a partnership first purchase selected T s assets andthen purchase T s Ts stock 27

28 Bifurcated acquisition: Avoiding the consistency rules Fund MGMT Buyer stock Fund MGMT (1) (3) Seller Buyer (1) LLC $30 FMV=100 =70 $30 (2) LLC Buyer =0 Ls=0 Business A assets Buyer Transaction steps: Fund and Buyer management form LLC, a limited liability company that is classified as a partnership for Federal income tax purposes, and transfer to LLC all of the stock of Buyer LLC purchases from the assets of Business A for their value of $30 distributes the proceeds from the sale of the Business A assets to Seller See PLR

29 Bifurcated acquisition: Avoiding the consistency rules (continued) Fund MGMT Fund MGMT FMV=70 =70 $70 LLC (5) Buyer Stock LLC Seller (4) Buyer Stock Buyer Buyer Transaction steps: The following day, LLC purchases all of the stock of for its value of $70 LLCtransfers all of the stock of Buyer to in a transactionqualifying as a reverse acquisition within the meaning of Reg (d)(3). Thus, the Buyer group continues with as the common parent of the Buyer group 29