Recent developments in corporate and partnership planning. May 1, 2013

Transcription

1 Recent developments in corporate and partnership p planning Domestic Tax Conference May 1, 2013

2 Disclaimer Ernst & Young refers to the global organization of member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young LLP is a client-serving member firm of Ernst & Young Global Limited located in the US. 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 and its member firms expressly disclaim any liability in connection with use of this presentation or its contents by any third party. The views expressed by panelists in this webcast are not necessarily those of Ernst & Young LLP. 2

3 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. These slides are for educational purposes only and are not intended, and should not be relied upon, as accounting advice. 3

4 Today's presenters Phillip Gall Michael Kaibni Brian Peabody Franny Wang 4

5 Topics Section 355 Monetization Strategies & New No-rule Policy Section 355 & REIT Election Partnership IPO Structures Virtual Incorporations Gone & Back Strategy Key Divestiture Tax Concepts and Complexities Chairman Camp s Small Business Tax Reform Draft Proposal 5

6 Section 355 Monetization Strategies & New IRS No-rule Positions 6

7 Background A frequent objective in Section 355 transactions is to optimize the capital structures of the businesses of the distributing corporation ( D ) and the controlled corporation ( C ), providing each business with a capital structure tailored to how it operates. Another frequent objective is for a corporate group to divest itself of one or more lines of business in order to focus on a core business (or business). However, D may want or need to receive compensation for the divestiture but, for a variety of reasons, a sale of the unwanted business may not be possible or practical. 7

8 General Methods Generally, there are six methods by which the value can be extracted from a non-core business in connection with the tax-free separation of core and non-core operations. Controlled Assumption of Liabilities: assumption of liabilities of the distributing corporation (D) by the controlled corporation (C); Controlled Cash Distribution: distribution of C s cash in exchange for assets transferred by D; Controlled Cash Purchase: C s Cs purchase of D s Ds assets for cash; Controlled Securities Exchange: exchange of C securities (long-term debt) for D debt; Controlled Stock Exchange: exchange of a portion of C stock for D debt; and Reverse Direction Spin-off: leverage the non-core business and spin the core business (together with the proceeds of leveraging) 8

9 Controlled Assumption of Liabilities and Distribution of Cash: Mechanics & Limitations D S/Hs D C C stock, cash, & assumption of D liabilities Business 2 Mechanics D transfers Business 2 to newly formed C in exchange for C stock, cash (debt funded), and C s assumption of some of D s outstanding liabilities and D distributes the stock of C to its shareholders. Limitations Basis Limitation: Assumed liabilities and distributed cash are cumulatively limited to the basis of the assets transferred by D to C. To the extent that the liabilities assumed by C and cash distributed to D exceed the basis in the transferred assets, D will recognize gain. Contingent liabilities generally excluded. Use of Cash: Cash must be used by D (i) to repay its debt* OR ii) for distribution to its shareholders (i.e., dividends or redemptions). 9

10 Controlled Securities & Stock Exchange Prior to No-Rule: Mechanics D S/Hs Mechanics FI $600M D issues $600M principal amount short-term term debt (ST debt) to ST debt $600M cash D Bus 2 a financial institution (FI), which holds the debt for its own account, in exchange for cash. D transfers Business 2 to a newly formed C in exchange for $300M of C securities (long term debt), and Two classes of C common stock Class A high vote (80% vote & 60% value) and Class B low vote (20% vote & 40% value). FI $300M C securities & C Class B shares D S/Hs D C stock $600M D Bus 2 Debt C D transfers the C securities (300M), and Class B low vote shares to FI in exchange for the $600M ST debt and distributes the C Class A stock to D s shareholders in a distribution intended to qualify under Sections 355 and 368(a)(1)(D). FI sells the C securities & Class B shares for cash in a public offering. Bus 2 10

11 Controlled Securities & Stock Exchange Prior to No-Rule: Mechanics (continued) D S/Hs New S/Hs FI 80% Vote/ 60% Value 20% Vote/ 40% Value $ Fees D $600M Cash C Bus 2 Security Holders D now has $600M of cash with no restrictions on what the cash can be used for. Receipt of Controlled Stock and Controlled Securities is currently NOT basis limited it (compare distribution ib ti of cash or assumption of a liability). Key to tax free treatment of Securities Exchange & Stock Exchange is that the Securities & Stock were used to retire D Debt. 11

12 Revenue Procedure , Section 5, No- Rule, Areas Under Study New Debt Issuance: Whether either sections 355 or 361 applies to a distributing corporation's distribution of stock or securities of a controlled corporation in exchange for, and in retirement of, debt issued in anticipation of the distribution. Control: Whether a corporation is a "controlled corporation" within the meaning of section 355(a)(1)(A) if, in anticipation of a distribution, control was acquired as the result of a recapitalization, or if, in anticipation of a distribution such corporation issues stock to another person having different voting power per share than the stock held by the distributing corporation. North-South: Whether transfers of property by a person to a corporation and transfers of property by that t corporation to that t person in what are ostensibly two separate transactions (so-called "north-south" transactions), at least one of which is a distribution with respect to the corporation's stock, a contribution to capital, or an acquisition of stock, are respected as separate transactions for Federal income tax purposes. 12

13 North-South Example Cash Parent D C Controlled Stock For business reasons, D would like to distribute the stock of C to Parent. However, Distributing is subject to certain debt covenants and Parent needs to contribute cash or other assets to D in order to compensate for the loss of C. Alternatively, in a recent but unrelated transaction, Parent contributed business assets to D. Under the current no-rule position, the Service will not rule on this transaction. Potential 20% exception Note: the North-South no-rule applies to Section 355 distributions as well as to other movements of property outside of the Section 355 context. 13

14 Section 355 & REIT Election 14

15 Spin-off and related Propco REIT conversion Step 1: The dropdown Step 2: The spin-off Shareholders Shareholders Propco shares Parent Parent (Opco) Propco shares Property assets and entities Propco Propco 15

16 Summary illustration of Opco/Propco spinoff (cont.) Step 3: Post-spin-off Shareholders 100% 100% Opco (former Parent) Lease Agreement* Propco * Alternatively, Opco could enter into a management agreement with Propco or a subsidiary of Propco. 16

17 Partnership IPO Structures 17

18 Partnership IPO Structures Overview Publicly Traded Partnership (PTP) / Master Limited Partnership (MLP) Limited availability Limited investor base Complex reporting Up-C Structure Possible application where: PTP is not available or desirable Issuer cannot consolidate with Sponsor Tax Receivable Agreement Full-on Incorporation / Traditional IPO 18

19 Partnership IPO Structures PTP/MLP vs. Up-C vs. Traditional PTP/MLP Up-C Traditional IPO Sponsor Public Sponsor High-Vote Shares Public Sponsor Public PubCo PTP/MLP OpCo IPO Co. Nonqualifying Income Qualifying Income Qualifying & Nonqualifying Income Qualifying & Nonqualifying Income 19

20 Partnership IPO Structures Comparison of IPO Structures PTP / MLP Double tax only on nonqualifying (blocked) income Asset basis step up on sales of equity, except for blocked assets UP-C Double tax on Public s share Asset basis step up on sales of Sponsor equity Traditional IPO Double tax on everything unless Sponsor can consolidate No asset basis step up on sales of equity 20

21 Partnership IPO Structures Up-C Structure Benefits and Considerations Benefits Tax receivable agreements Cash benefit to Founders PubCo agrees to pay the Founders a percentage (commonly 85%) of the cash tax benefit it receives from a positive Section 743(b) adjustment (and other attributes) in OpCo s assets Founders are still subject to a single level of tax Provides multiple currencies (OpCo interests and PubCo stock) for future acquisitions and/or executive compensation arrangements Considerations Anti-churning rules (if PubCo is related to Founders) Introduces greater complexity from several perspectives (e.g., governance, operating, capital markets, accounting, tax) 21

22 Checkable Arrangements (a.k.a. Virtual Incorporations) 22

23 Virtual incorporations Beginning g structure USP Division X Oldco USP operates division X ( Division X ). USP also owns 100% of the stock of Oldco. USP wants to incorporate Division X for tax reasons, but, due to non-tax reasons (e.g., non-transferrable assets, transfer taxes, regulatory, etc.), USP cannot transfer the assets of Division X to another legal entity. Reg (a) provides that a business entity that is not classified as a corporation (i.e., an eligible entity ) can elect to its classification for US federal tax purposes. Division X is not an entity for purposes of the check-the-box regulations. 23

24 Virtual incorporations (cont d) Contract execution USP Division X Check-the-box election USP Division X profits interest profits interest in Branch Oldco Oldco In order to obtain the benefits of incorporating Division X, the following steps are taken: 1. USP and Oldco enter into a contractual arrangement, under which Oldco will share in the economics of Division X. See Reg (a)(2) ( A joint venture or other contractual arrangement may create a separate entity for federal tax purposes if the participants carry on a trade, business, financial operation, or venture and divide id the profits therefrom. ) 2. Division X elects to be treated as a corporation for US federal tax purposes. Same result if Division X is a branch. See, e.g., PLR Entity status considerations how significant? ifi 24

25 Gone and back in 120 seconds Taxable Distributions and Upstream Reorganizations 25

26 Gone and back in 120 seconds Parent Parent is a holding company. Sub 1 has two lines of business (X and Y). Sub 1 X&Y Sub 2 X Sub 2 has one line of business (X only). For valid non-tax business reasons, Parent wants only Sub 2 to operate business line X. 26

27 Gone and back in 120 seconds (cont d) Sub 1 X & Y Parent Sub 2 X Step 1: At 11:57 p.m. on Day 1, Sub 1 converts to an SMLLC pursuant to applicable state elective conversion statutes. 27

28 Gone and back in 120 seconds (cont d) Parent Step 2: At 11:58 p.m. on Day 1, Sub 1 LLC transfers business line X directly to Sub 2 in exchange for no consideration. Sub 1 LLC S1 X & Y Sub 2 X X 28

29 Gone and back in 120 seconds (cont d) Sub 1 LLC S1 Y Parent Sub 2 X Step 3: At 11:59 p.m. on Day 1, Sub 1 LLC converts back to a corporation pursuant to applicable state elective conversion statutes. 29

30 Gone and back in 120 seconds (cont d) Section 311(b) distribution? 11:56 p.m. Parent Section 332 liquidation followed by Section 351 transfer? Sub 1 X & Y Sub 2 X Sideways reorganization with boot? Upstream reorganization? 11:59 p.m. Parent See, e.g., PLR ; PLR New technology? Sub 1 Y Sub 2 X PLR vs. opinion letter. State tax consequences. Impact of minority shareholder ownership of Sub 1? 30

31 Key Divestiture Tax Concepts and Complexities 31

32 Results of Global Corporate Divestment Study Show Significant Planned Divestiture Activity Survey of 567 corporate executives representing more than 14 industries across Americas, Asia Pacific, Europe, the Middle East and Africa) Significant findings 46% of respondents are in the process of a divestiture or are planning to divest within the next 2 years Sectors most likely to divest include power and utilities, and consumer products 50% of respondents indicated that the level of preparation required for a successful divestiture has increased over the past 2-3 years 27% of respondents found that "Determining and implementing tax planning" to be one of the 3 top challenges of their most recent divestiture The other two are: (i) negotiating TSAs, and (ii) dealing with the complexity of closing One of 5 key leading practices of successful divestitures is separation planning, including tax planning The other four are: (i) portfolio management, (ii) consider ing the full range of potential buyers, (iii) articulating compelling value/growth story for each buyer, and (iv) preparing rigorously for the divestment process 32

33 Tax Complexities Must be Addressed Up Front to Successfully Divest Tax-Free Spinoffs Significant lead time for IRS, SEC and/or local country approvals Carve-out financial statements are usually needed and are complex, especially for large businesses and/or those operating in multiple countries Primary identification of tax costs and complications to creating SpinCo often must be quantified and considered before a public announcement can be made IRS policy for issuing i private letter rulings has recently contracted, t adding potential ti complexity and risk Divestitures, in General If financial statements are needed, begin tax planning very early in process Do not underestimate the complexity of unwinding previously integration tax operations and/or the complexity of creating an efficient multinational Spinco Tax basis and valuation information needs to be sufficiently detailed to allow for calculation of direct and indirect tax costs of creating Spinco legal lstructure t Consideration must be given to trapped cash within Spinco structure and cash that may become trapped as a result of sale of Spinco stock or assets A multi-faceted divestiture strategy that considers sale, joint-venture, spinoff, and/or IPO is very complex but likely to produce the most successful outcome 33

34 Chairman Camp s Small Business Tax Reform Draft Proposal 34

35 Camp Draft Proposal Overview On March 12, 2013, House Ways and Means Committee Chairman Dave Camp (R-MI) released a discussion draft for reforming the tax rules affecting small businesses. The draft is intended to solicit feedback from a broad range of stakeholders, practitioners, economists, and members of the general public on how to improve on the proposal. The draft presents two options for the reform of pass-through entities Option 1 Retains Subchapter K and Subchapter S as separate. Option 2 Unified rules for partnerships and S corporations. 35

36 Camp Draft Proposal Option 1 Revisions to Subchapters K and S Subchapter K revisions: Repeal guaranteed payment rules. Require basis adjustments upon partnership distributions of property or transfers of interests in a partnership. Adjust the limitation on a partner s share of losses to take into account the partner s share of the partnership s charitable contributions and foreign taxes. Apply Section 751(b) to all inventory items, not just substantially appreciated inventory items. Eliminate the current seven-year limitation on the recognition of pre-contribution gains or losses on distributions of property. 36

37 Camp Draft Proposal Option 1 Revisions to Subchapters K and S Subchapter S revisions: A permanent reduction in the recognition period for the built-in in gains tax under Section 1374 from 10 years to 5 years. Correspondingly, the draft would make permanent the rule that installment sales are governed by the provision that was applicable when the sale occurred. Increase to 60 percent (from 25 percent) the amount of gross receipts that an S corporation with Subchapter C earnings and profits may have before being subject to the tax on excess passive investment income. Permit nonresident aliens to be potential current beneficiaries of electing small business trusts (ESBTs). 37

38 Camp Draft Proposal Option 2 Unified Rules for Passthroughs This option repeals Subchapter K and Subchapter S and replaces them with a uniform set of rules that apply to non-publicly traded businesses for Federal tax purposes regardless of how the business is organized for state law purposes. Would the rules apply to any non-public entity? Would publicly traded partnerships be eligible for flow-through treatment? Transition rules? The new rules would: Allow contributions of property and money on a tax-free basis. Maintain the passthrough nature of an entity s items (and preserve the character of those items). Permit special allocations of only net ordinary income or loss, net capital gain or loss, and tax credits (and prohibit special allocations of individual items within each of those three categories). 38

39 Camp Draft Proposal Option 2 Unified Rules for Passthroughs The new rules would (continued): Require basis adjustments upon a distribution of property by the passthrough entity or a transfer of an interest in a passthrough entity. Require entity-level withholding on the passthrough entity s income and gain with a corresponding credit for the owner s tax reporting. Limit deductions for losses to an owner s basis in his passthrough interest, but allow excess losses to be carried forward indefinitely. Limit tax-free distributions (of money and property) to an owner s basis in his passthrough interest. Require passthrough entities to recognize gain on all distributions of appreciated property and require owners to take a carryover basis in the distributed property (to preserve losses in distributed property). Allow owners to include entity-level debt (both recourse and non-recourse) in their basis in their passthrough interest. Allow owners to be treated as employees of the business. 39

40 Questions and answers 40

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