23 rd Annual Health Sciences Tax Conference

Transcription

1 23 rd Annual Health Sciences Tax Conference December 11, 2013

2 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. Page 2

3 Disclaimer EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. Ernst & Young LLP is a clientserving member firm of Ernst & Young Global Limited operating in the US. For more information about our organization, please visit ey.com. This presentation is 2013 Ernst & Young LLP. All rights reserved. No part of this document may be reproduced, transmitted or otherwise distributed in any form or by any means, electronic or mechanical, including by photocopying, facsimile transmission, recording, rekeying, or using any information storage and retrieval system, without written permission from Ernst & Young LLP. Any reproduction, transmission or distribution of this form or any of the material herein is prohibited and is in violation of US and international law. Ernst & Young LLP expressly disclaims any liability in connection with use of this presentation or its contents by any third party. Views expressed in this presentation are not necessarily those of Ernst & Young LLP. Page 3

4 Presenters Carole Belmar Vice President, Taxation Team Health, Inc. Knoxville, TN Laura MacDonough 1101 New York Avenue N.W. Ernst & Young LLP Washington, DC David Miller Ernst & Young LLP 1 Victory Park Suite Victory Avenue Dallas, TX david.miller@ey.com Torsdon Poon Ernst & Young LLP 1101 New York Avenue N.W. Washington, DC torsdon.poon@ey.com Page 4

5 Agenda Mergers & acquisitions with: C corporations Section 336(e) regulations Acquisitions and personal goodwill S corporations Qualification as an S corporation S corporation due diligence Post-acquisition restructuring Other planning considerations Partnerships Acquisition of a business owned in partnership solution Acquisition of an interest in an existing partnership Acquisition of a partial interest in a business: dealing with the antichurning rules Page 5

6 Mergers & acquisitions with C corporations Page 6

7 Section 336(e) regulations Page 7

8 Background and benefits Section 336(e) What is it? Provides that certain stock sales and dispositions may be treated as asset transfers for US federal income tax purposes To whom does it apply? S corporations Private equity Corporations Benefits Operational benefits Flexibility in structure Section 336(e) versus Section 338(h)(10) Sell-side deal optimization Page 8

9 Example 1: effect of forward cash merger Taxable forward merger Stock purchase with 336(e) election Seller Seller P shp Target P shp Target The tax effect of a forward cash merger and that of a 336(e) transaction are similar. Although Partnership owns the assets of Target directly in a forward cash merger, an even more similar result occurs if Partnership subsequently drops Target assets into a new corporation under Section 351. Taxable forward merger results in a new entity owning Target s assets. Licenses to Target may not be transferrable. Stock purchase with 336(e) election offers same basis step-up in Target s assets as that of the taxable forward merger, but Target continues to own all assets. 336(e) election thereby offers same result but is less operationally invasive than a taxable forward merger. Page 9

10 Example 2: private equity (PE) club deal Unwanted Corp. stock PE Fund 1 PE Fund 2 Parent Holdco PE Fund % 33.33% 33.33% Unwanted Corp. stock Unwanted Corp. Holdco Wanted Corp. Unwanted Corp. stock Purchaser 336(e) election offers an opportunity to separate wanted and unwanted businesses in typical private equity fund structure. Distribution of unwanted business and sale of wanted business are available, provided each fund is unrelated (owns less than 50% of Parent Holdco). 336(e) election is available for both the distribution of unwanted and the sale of wanted. Page 10

11 Comparison of Section 336(e) to 338(h)(10) Section 338(h)(10) Section 336(e) Election maker Joint seller and purchaser election Seller and target election by agreement Timing Election within 8.5 months Election on tax return(s) Type of purchaser Corporate purchaser Corporate or noncorporate purchasers Type of Seller and Target US corporation seller and consolidated affiliate corporation target or nonconsolidated affiliate target; or S corporation target US corporation seller and affiliated (but not necessarily consolidated) target; or S corporation target Time frame 12-month acquisition period, limited creeping 12-month disposition period Amount of stock disposed of Related parties Foreign Seller or Target Qualitative nature Sale of 80% vote and value (excluding Section 1504(a)(4) stock) Related-person restriction (Section 318(a) attribution) Note: 50% threshold for corporation attribution Not available if seller or target is foreign No carryover basis in whole or in part/no transfer of stock in a transaction to which Section 351, 354, 355 or 356 applies Sale and/or taxable distribution of 80% vote and value (excluding Section 1504(a)(4) stock) Related-person restriction (Section 318(a) attribution but not between partnerships with < 5% partners) Note: 50% threshold for corporation attribution Not available if seller or target is foreign No carryover basis in whole or in part/no transfer of stock in a transaction to which Section 351, 354, 355 or 356 applies Page 11

12 Flexibility of Section 336(e) vs Section 338(h)(10) Corporate purchaser required for 338(h)(10) Stock purchase/distribution with 336(e) election Public P shp Seller Acquirer Seller P shp Individuals Target Target Section 336(e) offers flexibility regarding the type of business entity that can acquire a Target. Page 12

13 Summary of seller and purchaser considerations Seller Benefits Can market-basis step-up to purchaser if willing to make 336(e) election Ability to sell with step-up and without requiring intellectual property relicensing Opportunity to carve out unwanted subsidiaries Purchaser Basis step-up Don t need corporate purchaser Can liquidate target promptly Traps Loss limitation on distribution No notice provisions Creeping transactions Consistency rules Loss of net operating losses Contractual provisions/ considerations Breach of contract for failure to make 336(e) election Reporting File election jointly with target Enter into binding agreement with target to make election Require or prohibit 336(e) election in stock purchase agreement No participation in election Reporting with respect to target during creeping acquisition for consolidated and S corporation returns Page 13

14 Section 338(h)(10) with S corporation considerations For 338(h)(10) election to be valid, target must have valid S election in effect. All shareholders (including non-selling) must consent. Incremental cost: Potential ordinary income (cash-basis receivables, depreciation recapture, etc.) Built-in gains tax State and local income taxes Page 14

15 Section 338(h)(10) with S corporation considerations Installment sale considerations: Corporate gain deferral, except for corporate level taxes Shareholder gain acceleration (basis allocation issue) Defer all payments to maximize gain deferral? Contingent installment sale rules Basis allocation ruling for fixed-period contingent installment note State tax planning Involves deferral of all payments to avoid gain recognition at corporate level Questionable viability of planning Page 15

16 Reporting considerations Election is joint between Seller and Target (or between S corporation target and its shareholders). Target essentially represents the Purchaser(s) in the election because there may be many. Seller(s) and Target must enter into binding agreement to make election. Election is made on the consolidated return of the Seller and Target or, otherwise, on both returns if they are not filing consolidated returns by filing a Section 336(e) election statement (contents described in Treas. Reg (h)). For allocation of aggregate deemed asset disposition price and adjusted gross-up basis, Form 8883 should be used with appropriate adjustments made. Creeping acquisitions raise reporting issues Consolidated groups: timing for inclusion on Seller s consolidated return vs Purchaser s consolidated return prior to completion of qualified disposition date S corporations: K-1 obligation prior to qualified disposition date after selling shareholders have disposed of stock Page 16

17 Acquisitions and personal goodwill Page 17

18 Personal goodwill vs corporate goodwill Personal goodwill (PG): individual s personality, business acquaintances, character, reputation, skill and knowledge Corporate goodwill: intangible assets of a business, including client lists and records, trained personnel and favorable leases Existence of PG Personal service corporations (e.g., doctors, dentists, etc.) Closely held corporations for which shareholder provides personal services Corporations for which a shareholder s personality, business acquaintances, character, reputation, skill and knowledge have increased the value of the business enterprise Page 18

19 Taxable stock acquisitions and PG Individual A Public $ Target Acquirer Acquirer to acquire Target stock and Individual A s PG from Individual A in exchange for cash in a taxable stock acquisition Treatment of US federal income tax consequences to Individual A and Acquirer? Purchaser vs seller considerations Other tax considerations: Impact of covenant not to compete or long-term employment contract Valuation issues Impact of multiple shareholders Character of PG Applicability of anti-churning rules Page 19

20 Taxable asset acquisitions and PG A $ Public $ Target $ Target assets Acquirer Acquirer to acquire assets from Target and PG from Individual A in exchange for cash in taxable asset acquisitions Treatment of US federal income tax consequences to Individual A and Acquirer? Purchaser vs seller considerations Other tax considerations: Impact of covenant not to compete or long-term employment contract Valuation issues Impact of multiple shareholders Character of PG Applicability of anti-churning rules Page 20

21 Mergers & acquisitions with S corporations Page 21

22 Qualification as an S corporation Page 22

23 S corporation definition An S corporation is a small business corporation that has filed a valid election to be treated as an S corporation. The election is made on Form The election must be signed by a duly authorized officer of the corporation. In addition, each shareholder owning stock on the date the election is filed must consent to the election. If the election is to be effective retroactive to the beginning of the tax year, any person owning stock during the pre-election must also consent. If an S election is missing an officer or shareholder s consent, then the election is invalid. Page 23

24 Small business corporation A small business corporation is a corporation that: Is a domestic corporation Is not an ineligible corporation Has only individuals (other than nonresident aliens), certain trusts and certain tax-exempt organizations as shareholders Has no more than 100 shareholders Has only one class of stock Page 24

25 Qualified Subchapter S subsidiary (QSub) A parent S corporation may elect to treat a qualifying subsidiary as a Qsub. A qualifying subsidiary is a domestic corporation (other than an ineligible corporation) that is wholly owned by a parent S corporation for US federal income tax purposes. When a valid QSub election is made for a subsidiary, the subsidiary is disregarded for US federal income tax purposes. Accordingly, its assets, liabilities and items of income, gain, loss, deduction and credit are treated as those of its parent S corporation. Page 25

26 Failing to qualify as a small business corporation If corporation is not a small business corporation at the time its S election is filed, the election is invalid. If a corporation ceases to be a small business corporation subsequent to the filing of a valid S election, its S election terminates. A corporation s S election will also terminate if it has excessive passive investment income for three consecutive tax years and Subchapter C earnings and profits at the close of each of these tax years. Page 26

27 Failing to qualify as a small business corporation If a corporation s S election is invalid or subsequently terminated, it is a C corporation. The QSub elections made for subsidiaries would be invalid or terminated; thus, the QSubs would also be C corporations. The corporation would be liable for corporate-level taxes. A Section 338(h)(10) election would be unavailable. Note that the IRS may grant relief for an inadvertently invalid or terminated S election or QSub election (see Section 1362(f)). Page 27

28 S corporation due diligence Page 28

29 S corporation due diligence Confirm S corporation status of target Confirm QSub status of relevant subsidiary corporations Evaluate exposure for corporate-level taxes applicable to S corporations Last-in, first-out recapture tax Built-in gains tax Passive investment income tax State, local and foreign taxes Payroll taxes Page 29

30 Common S corporation due diligence issues Unable to locate copy of S election and/or QSub elections Missing spousal consent Impermissible trust shareholder (or unable to locate election to treat as permissible shareholder) More than one class of stock Disproportionate distributions Personal expenses paid by corporation Unreasonably high shareholder compensation Non-arm s-length related-party transactions Unreasonably low compensation Built-in gains tax (note differing recognition periods) Page 30

31 Use of limited liability company (LLC) to address diligence issues Facts Buyer wants to acquire Oldco, a purported S corporation, in a transaction that results in basis step-up. For legal and other business reasons, the transaction cannot be structured as actual asset acquisition. Buyer has concerns about validity of Oldco s S election. Current structure Shareholders Oldco Page 31

32 Use of LLC to address diligence issues Possible restructuring: Oldco shareholders form Newco; an S election is made for Newco. Oldco shareholders contribute stock of Oldco to Newco in exchange for Newco stock. Immediately following the contribution, Oldco is converted to an LLC under state law conversion statute. A check-the-box election is NOT made. Buyer acquires LLC. Revised structure Shareholders Newco Oldco LLC Page 32

33 Use of LLC to address diligence issues Results: Buyer is treated as having acquired assets of Oldco in a taxable asset acquisition. Treatment provides buyer with certainty regarding basis step-up. Newco should be liable for any built-in gains (or other corporate level) tax resulting from sale transaction. Oldco LLC should have successor liability for any corporate-level taxes incurred pre-restructuring. Page 33

34 Post-acquisition restructuring Page 34

35 Use of LLC to avoid termination of S election (1) S Corporation transfers operating assets (and related liabilities) to LLC in exchange for LLC interests. (2) S Corporation sells LLC interests to buyer. (1) Assets and liabilities S Corporation New LLC (2) LLC interests (2) Cash (1) LLC interests Buyer Flow-through status is maintained because ineligible investor is a partner, not a shareholder. Anti-churning rules should be considered. If money is to be used in business, funds could be contributed to LLC. Disguised-sale rules should be considered. Page 35

36 Structuring alternatives for unwanted assets Contribute unwanted assets to LLC and distribute to shareholders (or distribute outright) Taxable gain Form new S corporation; contribute stock of existing S corporation and make QSub election (or convert to LLC); distribute unwanted assets to S corporation; sell QSub stock (or LLC interests) Contribute desired assets to new QSub (or LLC) and sell QSub stock (or LLC interests) Page 36

37 Built-in gains tax planning: bifurcated asset/stock sale (2) Cash Shareholders (3) Stock (3) Cash (1) S Corporation sells non-big assets to Buyer for cash; Buyer gets step-up in basis. (2) S Corporation distributes proceeds from sale to shareholders (or Buyer increases purchase price for stock). (3) Shareholders sell S Corporation stock to Buyer; no 338(h)(10) election is made. S Corporation (1) Non-big assets Buyer (1) Cash Page 37

38 Other planning considerations Page 38

39 Taxable income planning Eliminate indebtedness of QSub to parent prior to termination of S election Planning for income and expense recognition Pre- or post-acquisition Timing of compensatory deductions Page 39

40 Contract considerations Gross-up for incremental cost associated with Section 338 (h)(10) Should be addressed in letter of intent Section 1362(f) relief Responsibility for filing final S corporation return Signing of final S corporation return Refund of Section 7519 deposit (and making of deposit if necessary) Elections Indemnifications Working-capital considerations Page 40

41 Mergers & acquisitions with partnerships Page 41

42 Partnership transactions Acquisition of a business owned in partnership solution: Taxpayer does not own an interest in the existing partnership. Taxpayer does own an interest in the existing partnership. Acquisition of a partial interest in a business: Acquisition is of an interest in an existing partnership. Acquisition is of a partial interest in a business (forming a new partnership and dealing with the anti-churning rules). Page 42

43 Acquisition of a business owned in partnership solution Page 43

44 Acquisition of a partnership (no pre-existing ownership) Buyer Partner A Partner B Target Assets Page 44

45 Acquisition of a partnership (pre-existing ownership) Partner A Buyer Target Assets Page 45

46 Acquisition of a partnership (pre-existing ownership) Partner A Buyer Partial liquidation Target From whom does Buyer acquire the purchased assets? Does it matter? Page 46

47 Acquisition of an interest in an existing partnership Page 47

48 Basic considerations and traps for the unwary Amendment to partnership agreement Inheriting your predecessor s economic and tax attributes Capital account, operating and liquidating distribution waterfall Tax allocations: catch-up allocations, minimum gain, Section 704(c) built-in gain (and method) Section 754 election Mechanics of Section 743 adjustment/interaction with Section 704(c) Built-in loss and mandatory adjustments Partnership terminations Restart depreciation Short-period returns and new elections Consequences to lower-tier partnerships Page 48

49 Basic considerations and traps for the unwary Section 706 Intra-year allocations and permissible methods Partnership year end change? Section 706 rules governing partnership year end based on year end of partners Majority interest/principal partners/lease aggregate deferral Special rules for certain foreign and tax-exempt partners Required change from cash to accrual method? Partnership generally prevented by Section 448 from using cash method of accounting if a C corporation is a partner Exception for certain small partnerships meeting $5M gross receipts test Entity-level taxes (withholding, employment, state, etc.) Tax protection agreements Cash contributions and related distributions If newly admitted partner contributing cash and if related cash distribution to one or more existing partners, consider application of disguised-sale rules Page 49

50 Acquisition of a partial interest in a business: dealing with the anti-churning rules Page 50

51 Step 1: partnership formation Buyer Seller 5% interest in Target Seller Sub LLC $600m assets Page 51

52 Step 2: interest purchase Buyer 70% interest in Target* $420m cash Seller Seller Sub LLC * Seller and Seller Sub own 30% combined going forward. $600m assets Page 52

53 Step 2a: partnership borrowing Buyer Seller 95% Seller Sub 5% LLC $400m Note Bank $600m assets Page 53

54 Step 3a: debt-financed distribution Buyer Seller $380m cash 95% Seller Sub 5% $20m cash LLC $400m note Bank $600m assets Page 54

55 Step 4a: interest purchase Buyer 70% interest in Target* $140m cash Seller $380m cash* Seller Sub $20m cash* LLC $400m note Bank * Seller and Seller Sub own 30% combined going forward. $600m assets Page 55

56 Resulting structure Seller Buyer $520m cash* Seller Sub 70% 30%* $20m cash* LLC $400m note Bank * Seller and Seller Sub own 30% combined going forward. $600m assets Page 56

57 Questions? Page 57