Tax Diligence, Representations, Covenants and Indemnifications in Business Acquisitions

Transcription

1 Tax Diligence, Representations, Covenants and Indemnifications in Business Acquisitions Steven D. Bortnick and Timothy J. Leska Lorman Education Services Teleconference February 29, 2012

2 Part I Overview of Tax Due Diligence 2

3 Parties to the Process Seller Buyer Seller s accountants Buyer s accountants Seller s lawyers Buyer s lawyers 3

4 Documents to Request Corporate structure chart Entity classification elections (8832) Past income tax returns (all jurisdictions) Accountants workpapers Tax reserves FIN 48 workpapers Information/materials regarding prior reorganizations State income tax allocation calculations Foreign tax credit calculations Review general accounting methods / elections Sales tax returns Payroll tax returns 4

5 Things to Consider Return Positions Aggressive tax positions Unreasonable compensation Undervaluation of ending inventory Listed/reportable transactions Disproportionate allocation to depreciable property/consulting agreements in prior acquisitions Adequate reserves 5

6 Things to Consider Inheriting Liabilities Asset sale v. stock sale Ability to leave behind liabilities Transferee liability Bulk sale issues Consolidated return liability election impact on liability 6

7 Things to Consider - Audits Revenue agent reports and requests for information Consider hot points if known Likelihood of success Quantify down side risk 7

8 Things to Consider - Structure Integration issues Inefficiencies Classification of foreign entities 8

9 Things to Consider 338 Election Availability Federal tax cost State tax cost International concerns Purchase price allocation 9

10 Part II Tax Representations and Warranties 10

11 Purpose Further diligence process Ability to terminate agreement Buyer protection 11

12 Representing the Seller Speak to the accountants or tax director Make sure even reasonable representations are true Ability to schedule out exceptions Debate over materiality qualifier Debate over knowledge qualifier 12

13 Key Definitions Tax Any federal, state, local or foreign income gross receipts, license, payroll, employment, excise, severance, stamp, occupation, premium, windfall profits, environmental, customs duties, capital stock, franchise, profits, withholding, social security (or similar), unemployment, disability, real property, personal property, sales, use, transfer, registration, value added, minimum, estimated or similar tax, including any interest, penalty or addition thereto Taxes of others, including under

14 Key Definitions Tax Return Any return, declaration, report, claim for refund, information return or statement relating to Taxes, including any schedule or attachment thereto or any amendment thereto 14

15 Tax Returns All tax returns timely filed and are true, correct and complete Material tax returns or all? Materially, true, correct and complete What if just purchasing one division or subsidiary? No position that would be subject to penalties under 6662 (or state, local or foreign) Redundant 15

16 All Taxes Paid Paid all taxes required to have been paid Materiality Whether or not shown on a tax return Reserves for tax liability adequate up to date of agreement and through closing 16

17 All Taxes Paid No indication from jurisdiction in which don t file that may be subject to tax there Duplicative Materiality Written notice Complied with obligations to withhold and remit taxes Employee, contractor, foreign person, other No liens for taxes Permitted liens 17

18 Audit History Nothing Pending Audit, investigation, proceeding No notice of intent to audit or request for information No expectation of additional assessment Who s expectations count Duplicative Schedule of tax returns for x years and which subject of audit No waiver/extension of statute of limitations to assess or collect 18

19 No Lost Deductions 280G Parachute payments 162(m) Excessive compensation 168(h) Tax exempt use property 103(a) Security for tax-exempt bonds 168(f)(8) Old safe-harbor lease 19

20 Post Closing Tax Detriments No income inclusions after closing or loss of deduction after closing as a result of Pre-closing change of accounting Change of accounting required as a result of closing Closing agreement Consolidated rules ELA, deferred gains Prepayments Installment sales Deferral of CODI 20

21 FIRPTA Concerns Buyer must withhold 10% on purchase of USRPI Buyer concerns about purchase of USRPI Seller not foreign Get affidavit Target not a USRPHC Need affidavit if multiple sellers or foreign seller If don t need affidavit, still want rep 21

22 Tax Attributes, Etc. Identify Basis in assets ELAs Deferred intercompany gains NOLs Unused tax credits 22

23 No Agreements Tax sharing, indemnification, allocation or similar agreements No closing agreements No outstanding rulings or requests that would impact taxation of the target post closing 23

24 Representations if Foreign Ops Entity classification - no change (by election, merger, reorganization) in classification of entity for tax purposes Not subject to tax except in country of formation No permanent establishment outside country of formation No CFCs No 952(c)(2) if CFC No PFICs 482 Correctness/reasonableness of transfer pricing methods 24

25 Representations for S Corp Target Always (uninterrupted) an S corporation from date of formation through date prior to (or of in the case of a 338 election) closing Specific rep on state/local Consider states/cities that don t respect e.g., NYC 25

26 Part III Tax Covenants 26

27 Tax Return Preparation Who prepares returns filed post closing Consolidated, stand alone, S corporation, Straddle period Review rights Consistency with prior returns Handling disagreements 27

28 Payment of Taxes with Returns Seller to pay all taxes paid with final returns (and straddle period to extent allocated to preclosing period) Integrate with working capital adjustment Seller prefers to run through indemnification section Straddle period pre/post closing allocation Allocate based on deemed closing of the books method for taxes based on income, receipts, expenditures, wages Who pays transfer taxes 28

29 Cooperation Filings tax returns, audits, litigations, proceedings Who controls audits Document retention and provision of records though end of statute of limitations Notification before destruction Dealing with costs Obtain certificates (e.g., bulk sale) to reduce tax 29

30 338(h)(10) Election Preclude 338(g) election Buyer and seller agree to elect 338(h)(10) Representations regarding availability Dealing with basis allocation Agree to file in accordance with agreed allocation Who pays the extra tax (state, local, additional federal, conversion of capital gain to ordinary income) 30

31 Prohibited Actions Seller will not (and will cause Target not to) Make, revoke, change any tax election Waive/extend any time/restriction for assessment or collection Agree/modify agreement with respect to taxes /settle any tax matter 31

32 Part IV Tax Indemnification 32

33 Sellers Liability Sellers pay: All taxes to the extent related to pre-closing periods Include pre-closing portion of straddle period Loss resulting from the breach of a representation Taxes of any person other than the target and subsidiaries under applicable law (including ), as transferee, successor, by contract or otherwise 33

34 Limitations Coordinate with working capital or other adjustments to avoid double counting Baskets / caps Public target usually no indemnity Failure to notify indemnifying party of potential liability Survival periods 34

35 Securing the Indemnification Obligation Right only as good as ability to collect Holdbacks Escrows Who taxed on earnings if cross tax years 35

36 Steven D. Bortnick Steven D. Bortnick is a partner in the Tax Practice Group of Pepper Hamilton LLP, resident in the Princeton and New York offices. Mr. Bortnick focuses his practice on domestic and international tax and private equity matters. He also is a member of the firm s Sustainability and Climate Change Team. (609) bortnicks@pepperlaw.com Mr. Bortnick handles a broad range of cross-disciplinary transactions, including asset, stock, cross-border and domestic acquisitions, tax-free spinoffs, recapitalizations and reorganizations. He is experienced in the structuring of domestic and international private equity transactions from tax and venture capital operating company standpoints. He also has worked with pooled investment vehicles, and he counsels corporate entities on tax issues. In addition, Mr. Bortnick advises U.S. citizens and corporations in overseas investment, and he has been involved in the formation of private equity and hedge funds. An active speaker and author, Mr. Bortnick has written materials and spoken for several major private equity tax conferences. Topics of his presentations include private equity, venture capital, cross-border investing, venture capital operating company issues, and merger and acquisition tax issues. Mr. Bortnick is on the advisory board of Practical US/International Tax Strategies. Mr. Bortnick is a graduate of Glassboro State College (B.S., cum laude, 1985), Rutgers University School of Law - Camden (J.D., with honors, 1988), where he received his Tax Honors Certificate with distinction, and New York University School of Law (LL.M. in taxation, 1992). He is a member of the bars of New Jersey, New York and Pennsylvania, and he is admitted to practice before the U.S. Tax Court and the U.S. Court of Federal Claims. He is a member of the tax sections of the New York and American Bar Associations. 36

37 Timothy J. Leska Timothy J. Leska is an associate in the Tax Practice Group of the law firm of Pepper Hamilton LLP, resident in the Philadelphia office. Mr. Leska focuses his practice on general tax matters, including mergers and acquisitions, venture capital, and private equity. (215) Prior joining Pepper, Mr. Leska was an attorney in the Office of Chief Counsel for the Internal Revenue Service in Washington, DC. While at the IRS, Mr. Leska participated in the issuance of IRS pronouncements, including final regulations regarding partnership allocations of creditable foreign tax expenditures. Mr. Leska is a graduate of Lycoming College (B.A., magne cum laude, 2001), Temple University School of Law (J.D., cum laude, 2004), and Georgetown University Law Center (LL.M. in taxation, with distinction, 2007). He is a member of the bar of Pennsylvania. 37

38 Our Locations BERWYN 400 Berwyn Park 899 Cassatt Road Berwyn, PA FAX BOSTON 15 th Floor, Oliver Street Tower 125 High Street Boston, MA FAX DETROIT Suite Renaissance Center Detroit, MI FAX HARRISBURG Suite Market Street P.O. Box 1181 Harrisburg, PA FAX NEW YORK The New York Times Building 37th Floor, 620 Eighth Avenue New York, NY FAX ORANGE COUNTY Suite Park Plaza Irvine, CA FAX PHILADELPHIA 3000 Two Logan Square Eighteenth and Arch Streets Philadelphia, PA FAX PITTSBURGH 50th Floor 500 Grant Street Pittsburgh, PA FAX PRINCETON Suite Carnegie Center Princeton, NJ FAX WASHINGTON Hamilton Square 600 Fourteenth Street, N.W. Washington, DC FAX WILMINGTON Hercules Plaza, Suite Market Street P.O. Box 1709 Wilmington, DE FAX

39 Pepper Locations Pepper has expanded from its Philadelphia origins to 11 locations. Detroit, MI Pittsburgh, PA Philadelphia, PA Boston, MA New York, NY Princeton, NJ Berwyn, PA Wilmington, DE Harrisburg, PA Orange County, CA Washington, DC 39

40 40 For more information, visit