Alice G. Abreu Professor of Law Temple University Beasley School of Law October 31, 2012

Transcription

1 Alice G. Abreu Professor of Law Temple University Beasley School of Law October 31, 2012

2 CC , 2012 TNT Notice states that enactment of Section 7701(o) does not change the Service s view of the application of the economic substance doctrine. Four directives: Exam: Follow LB&I Directives and examine PLRs Notice of Deficiency or FPAA: Levels of Coordination Litigation: No new assertion of ESD without National Office review Administrative Pronouncements: Coordination with LB&I Directives

3 Reasonable Compensation Proposed Regs on stock options and SARs: maximum number to be granted per employee required. Rev. Rul : even if the restricted stock and RSUs were performance based, the related dividend and dividend equivalents must be payable upon the attainment of pre-established performance goals. Mulcahy, Pauritsch, Salvador & Co. v. Comm r, 101 T.C.M. (CCH) 1340 (2011), aff d, 680 F.3d 867 (7th Cir. 2012). Posner persists on the hypothetical independent investor test.

4 Reasonable Compensation (cont d) Watson v. United States, 668 F. 3d 1008 (8 th Cir. 2012). Accountant contributed his interest in an accounting partnership to an S corporation, which then paid him $24,000 per year in salary with the amounts distributed to the corporation from the partnership ($203,651 in one year and $175,470 in the other) characterized as dividends. Taxpayer lost $91,000 of the distribution treated as salary subject to employment taxes. Years were DKD Enterprises, Inc. v. Comm r, 685 F.3d 730 (8th Cir. 2012). Attempt to avoid section 183 by having corporation run hobby (cattery) failed. Dividend resulted- no deduction to corporation and income to shareholder. Total deficiency $$135,000 and $26,000 in penalties.

5 Debt vs. Equity Pepsico Puerto Rico, Inc. v. Comm r, T.C.M. (RIA) , 2012 TNT Instruments ( Advance Agreements ) were treated as equity for U.S. purposes, resulting in no subpart F income because no foreign E&P, but debt for foreign purposes, resulting in favorable foreign taxation under the Dutch treaty. Tax Court applied 13 factor test of Dixie Dairies Corp. v. Comm r, 74 T.C. 476, 493 (1980).

6 Debt vs. Equity Hewlett-Packard v. Comm r, 103 T.C.M. (CCH) 1736 (2012): Foreign tax credit generator Tax Court used the 11 factor test of A.R. Lantz Co., 424 F.2d 1330, 1333 (9 th Cir. 1970) because case appealable there. Government won. Economic Substance doctrine not invoked. NA General Partnership v. Comm r, 103 T.C.M. (CCH) 1916 (2012). Partnership checked the box to elect corporate status, and parent made advance to be used in acquisition of Target. Non-FTC generator where Tax Court again invoked the 11 factor test, this time citing Hardman v. United States, 827 F. 2d 1409 (9 th Cir. 1987). Taxpayer won and advance was treated as debt, so interest deductible only relatedness of parties suggested equity treatment.

7 NA General Partnership v. Comm r, 103 T.C.M. (CCH) 1916 (2012). S/H SP TARGET PacificCorp (PC) NAGP MERGER Simplified structure/transaction NEWCO

8 NA General Partnership v. Comm r, 103 T.C.M. (CCH) 1916 (2012). S/H SP Former PC shareholders received SP American Depositary Shares or regular SP shares in exchange for their PC stock NAGP Simplified structure/transaction TARGET PacificCorp (PC)

9 NA General Partnership v. Comm r, 103 T.C.M. (CCH) 1916 (2012). $896 million floating rate note Maturity 2014 SP Stock $4 billion fixed rate note Maturity Nov Simplified structure/transaction NAGP TARGET PacificCorp (PC) Notes issued in consideration of SP s issuance of its stock for the stock of PC, which NAGP ends up with, in effect treating SP as if it transferred its stock to NAGP for use in the merger, in consideration of NAGPs issuance of the notes.

10 NA General Partnership v. Comm r, 103 T.C.M. (CCH) 1916 (2012). $896 million floating rate note Maturity 2014 SP $4 billion fixed rate note Maturity Nov NAGP TARGET PacificCorp (PC) NAGP failed to make interest payments during the first year, and missed the first payment in the second, but eventually paid most of the interest with dividends received from PC. Simplified structure/transaction

11 NA General Partnership v. Comm r, 103 T.C.M. (CCH) 1916 (2012). $896 million floating rate note Maturity 2014 SP $4 billion fixed rate note Maturity Nov Simplified structure/transaction NAGP TARGET PacificCorp (PC) In a subsequent year NAGP borrowed funds from SP to make the interest payments on the notes but it repaid that by borrowing from an outside lender, to which SP was subordinated. It repaid that loan with dividends received from PC.

12 NA General Partnership v. Comm r, 103 T.C.M. (CCH) 1916 (2012). $896 million floating rate note Maturity 2014 SP $4 billion fixed rate note Maturity Nov The floating rate notes were capitalized with cash two years later upon advice of PWC NAGP TARGET PacificCorp (PC) The fixed rate notes were partially repaid and partially capitalized after the floating rate notes were capitalized in response to a change in US tax law Simplified structure/transaction

13 MIDCO Transactions MIDCO as illustrated in Notice : Shareholders X T Sale of Stock (Corporation with Built-in Gain low basis, high FMV) Cash MIDCO Y (Buyer) T (Corporation with Built-in Gain) Cash Sale of Assets

14 MIDCO Transactions Feldman v. Comm r: Shareholders Stock $300,000 Redemption Dude Ranch Cash Net sale proceeds plus 33% of tax liability Sale of Stock MIDCO Asset sale = $2.6 M $2.3 M cash $750,000 total tax liability Cash Y (Buyer) Dude Ranch Cash No Assets Sale of Assets

15 MIDCO Transactions Slone v. Comm r: Shareholders Cash $35,753,000 plus assumption of tax liability Sale of Stock MIDCO Family Corporation Y Asset sale = $38 M gain $15 M tax liability Cash (Buyer) Family Corporation Cash No Assets Sale of Assets

16 DYI Section 336(e) Lineage: Section 338(h)(10) via section 332 Sale of Target assets can be accomplished with one level of tax on seller side. P Basis: $100 FMV: $1,000 Buyer Target Asset Basis: $500 Asset FMV: $1,000

17 DYI Section 336(e) Lineage: Section 338(h)(10) via section 332 Sale of Target assets can be accomplished with one level of tax on seller side: Sell T assets, then liquidate T. No G/L P Buyer $1,000 Cash Liquidation Stock Basis: $100 FMV: $1,000 Target Sell Assets Gain Recognized to Target: $300 Buyer gets assets with FMV basis Asset Basis: $700 Asset FMV: $1,000

18 DYI Section 336(e) Lineage: Section 338(h)(10) via section 332 Sale of Target assets can be accomplished with one level of tax on seller side: Liquidate T, the sell T assets. Buyer No G/L Asset Basis = $ $1,000 Cash Sale of assets Liquidation No G/L Gain Recognized to P =$300 Buyer gets assets with FMV basis P Stock Basis: $100 FMV: $1,000 Target Asset Basis: $700 Asset FMV: $1,000

19 DYI Section 336(e) Because the 1 level of tax result is attributable to the availability of sections 332/337 on the seller side, that possibility exists regardless of whether the buyer is a corporation or not. Section 336(e) ensures a 338(h)(10)-like result even if 338 is not available because the buyer is not a corporation. P Basis: $100 FMV: $1,000 Buyer Target Asset Basis: $700 Asset FMV: $1,000

20 DYI Section 336(e) Ltr Failed 338(h)(10), because buyers were not corporations. Buyer Buyer S Corp

21 DYI Section 336(e) Ltr Rescission of failed 338(h)(10), (Rev. Rul , C.B. 181), fixed by having buyers establish a Holdco. Buyer S Corp

22 DYI Section 336(e) Ltr Distributing Pre-existing binding agreement to sell preferred Preferred Investors Common S Business A T Business B Newco T Business B

23 DYI Section 336(e) Ltr Pre-existing binding agreement to sell preferred = no 351 exchange Distributing Preferred Investors Common S Business A Newco T Business B Newco treated as purchasing stock of T. Purchase = QSP Newco and D make 338(h)(10) election

24 DYI Section 336(e) Ltr Distributing Preferred Investors Common S Business A Newco T Business B 338(h)(10) election allows purchase of T stock by Newco to be treated as purchase of assets, allowing recognition of loss by T

25 DYI Section 336(e) Ltr Distributing Preferred Investors Newco Stock Common S Business A Controlled Newco T Business B

26 DYI Section 336(e) Ltr Spin-off distribution of stock of Controlled Distributing Preferred Investors S Business A Controlled Newco T Business B D reorg contribution of Newco stock to Controlled Loss on deemed sale of T assets recognized immediately before distribution of Controlled stock

27 Horizontal Double Dummy Suppose X wants to acquire Y for consideration consisting of 30% X stock and 70% cash. No reorganization provision would apply, because the transaction would lack continuity of proprietary interest, which is a requirement even for a simple A reorganization, and couldn t be an A(2)(E) because the amount of cash precludes satisfaction of the section 368(a)(2)(E) requirement that control of Target (Y) must be acquired for stock. Any cash precludes a B.

28 X shareholders Y shareholders Newco X Acquiring Y Target Newco Dummy 1 Newco Dummy 2

29 X shareholders Newco Stock Y shareholders Newco X Acquiring Y Target Merger Newco Dummy 1 Newco Dummy 2 Merger

30 X shareholders Newco Stock Y shareholders Newco Y Target X Acquiring Newco Dummy 2 Merger

31 X shareholders Newco Stock Newco 70% cash Y shareholders 30% stock Y Target X Acquiring Newco Dummy 2 Merger

32 X stock exchanged for 100% Newco Stock X shareholders Y shareholders Y stock exchanged for 30% stock and 70% cash Newco X Acquiring Y Target Merger

33 X shareholders Y shareholders Newco X Y Newco Dummy 1 Newco Dummy 2 Reverse Triangular Merger in Form

34 X shareholders Y shareholders Newco X Y Newco Dummy 1 Newco Dummy 2 Section 351 Transaction in Substance?

35 X stock exchanged for 100% Newco Stock X shareholders Y shareholders Y stock exchanged for 30% stock and 70% cash Newco X Acquiring Y Target Merger Section 351 = shareholders of X and Y contributed property, their stock in X and Y to Newco and after the contribution those shareholders, are in control (indeed they own 100%) of Newco stock.

36 X stock exchanged for 100% Newco Stock X shareholders Y shareholders Y stock exchanged for 30% stock and 70% cash Newco X Acquiring Y Target Merger If it s a 351 transaction, boot is fine, there is no requirement for continuity of interest or business enterprise. Rev. Rul , C.B. 106.

37 Other Dummy Transactions Ltr Sibling Group 55% Asset Transfer all food assets, 67% of total assets 38% Transferor Transferee Target 6.6% 22.5% of stock Newco Asset drop down

38 Other Dummy Transactions Ltr S/H Sibling Group Target Transferor Stock of Target is exchanged for 77.5% of the stock of Transferee 77.5% of stock Merger Merger Sub Transferee Newco

39 Dummy Transactions Ltr Sibling Group Stock of Target is exchanged for 77.5% of the stock of Transferee Transferee is treated as if it had simultaneously received the assets of Transferor and the stock of Target in exchange for 22.5% % = 100% of its stock, resulting in a good 351 transaction rather than a failed 351 and a reverse triangular merger. Transferor 22.5% of stock Transferee Newco Target

40 Ltr (June 1, 2012) A B C Corp LLC

41 Ltr (June 1, 2012) A B C Corp LLC Company

42 Ltr (June 1, 2012) A B C Newco Stock LLC interest Newco Corp LLC Company Merger Sub

43 Ltr (June 1, 2012) A B C LLC interest Newco Stock Newco Company Stock Corp LLC Company Merger Merger Sub

44 Ltr (June 1, 2012) A B C Newco LLC Newco Stock Company Corp Company Stock IRS ruled that the transfers by A, B, and C to Company in exchange for Company Stock, and the merger of Merger Sub into Corp in exchange for the public receiving Company Stock would be treated as a good 351 transaction.

45 North-South Transactions North Leg distribution of Controlled Stock by Distributing S/H South Leg contribution by S/H Distributing Controlled Question: Are these two separate transactions (North Leg=good spin-off) or related transactions in which the South Leg contribution is in exchange for the North Leg distribution and hence a taxable exchange?

46 Ltr. Rul (Jan. 13, 2012) D2 Internal realignments to put foreign holdings under D1 Controlled 2 D1 (Foreign) Foreign Subs Controlled 1 (Foreign)

47 Ltr. Rul (Jan. 13, 2012) D2 Controlled 2 D1 (Foreign) Foreign holdings South leg placed all of the foreign holdings under D1 in exchange for D1 stock not for stock of publicly held foreign company Controlled 1 (Foreign)

48 Ltr. Rul (Jan. 13, 2012) D2 Distribution of Controlled 1 by D1 to D2 Controlled 2 D1 (Foreign) Controlled 1 (Foreign)

49 Ltr. Rul (Jan. 13, 2012) Distribution of Controlled 1 by D1 to D2 (Internal Distribution) Good 355(c) transaction D2 Controlled 2 D1 (Foreign) Controlled 1 (Foreign)

50 Ltr. Rul (Jan. 13, 2012) $ IPO Stock Controlled 2 Debt D1 (Foreign) D2 301 Distribution Controlled 1 (Foreign) Distribution of Controlled 1 by D1 to D2 (Internal Distribution) Good 355(c) transaction

51 Ltr. Rul (Jan. 13, 2012) Distribution of Controlled 1 by D1 to D2 (Internal Distribution) IPO Controlled 2 Debt C2 stock +cash D1 (Foreign) D2 Contribution of D1 stock to Controlled 2 +Distribution of Controlled 2 to D2 s shareholders (External Distribution) =D reorg +355 distribution Controlled 1 (Foreign)

52 Ltr. Rul (Jan. 13, 2012) Controlled 2 D2 Controlled 1 (Foreign) D1 (Foreign)

53 Leveraged Spin-offs Distributing Debt Distributing Assets Controlled Debt Stock Controlled

54 Leveraged Spin-offs Distributing Debt Controlled Debt Distributing Assets Controlled Debt Stock Controlled

55 Leveraged Spin-offs Controlled Debt Distributing Controlled Distributing substituted Controlled Debt for its own, thus using Controlled assets, in effect, to retire its debt, at no tax cost. Problem: Holders of Distributing Debt might not think that Controlled debt is the same

56 Leveraged Spin-offs Distributing Debt Bank Distributing Assets Stock Debt Controlled Bank acquires the Distributing Debt before the Spin, and the exchange of Controlled debt for Distributing Debt then takes place with the bank, which subsequently sells the Controlled debt.

57 Leveraged Spin-offs Distributing Debt Bank Distributing Assets Stock Controlled Standard rep: Purchase by Bank is at least 14 days before the spinoff distribution and there is no agreement between Bank and Distributing to exchange the debt for at least 5 days after Bank has acquired it. Bank therefore has credit and event risk.

58 Leveraged Spin-offs Distributing Assets Distributing Debt Bank More recent twist: Distributing Debt is newly issued to the Bank, not Old and Cold. Stock Controlled

59 Leveraged Spin-offs Distributing Assets Stock Distributing Debt Bank Required reps: 5 and 14 plus a rep that the amount of Controlled debt exchanged will not exceed the average third party indebtedness immediately before the spinoff. Controlled

60 Ltr (Feb. 16, 2012) Distributing Steps: LLC checks the box to become a Corp. and changes name to Controlled LLC

61 Ltr (Feb. 16, 2012) Distributing Steps: LLC checks the box to become a Corp. and changes name to Controlled Controlled

62 Ltr (Feb. 16, 2012) Distributing Controlled distributed unwanted (non-coffee business) assets to Distributing U.W. Assets Controlled

63 Ltr (Feb. 16, 2012) NDS Distributing issues New Distributing Securities (NDS) to the. Distributing Controlled This happens at least 5 days before the declaration of the distribution of Controlled and the exchange of Controlled Securities for Distribution Securities must wait for 14 days after the issuance of the NDS.

64 Ltr (Feb. 16, 2012) NDS Distributing Controlled Distributing contributes more coffee assets to Controlled in exchange for Controlled stock, assumption of liabilities and cash, as well as Controlled Securities

65 Ltr (Feb. 16, 2012) Distribution of Controlled Stock Distributing NDS Distribution of Controlled Securities in satisfaction of the NDS Controlled

66 Ltr (Feb. 16, 2012) Controlled Securities Controlled Distributing Distributing debt extinguished by issuance of Controlled debt directly to the public.

67 Ltr (Feb. 16, 2012) Controlled Securities Controlled Distributing Distributing debt extinguished by issuance of Controlled debt directly to the public. Controlled engaged in a special borrowing so that it could pay a special dividend to its shareholders shortly after the distribution of its stock Following the distribution, Controlled inverted and Distributing did a reverse (1 for 5) stock split and changed its name to Hillshire Brands.

68

69