Question

"Corporate Liquidations, Taxable Acquisition Transactions, and Nontaxable Reorganizations"

• IRC Section 338 allows a deemed sale election generating immediate taxation to the target corporation and a stepped-up or stepped-down basis to the price paid by the acquiring corporation for the target corporation stock plus liabilities on the deemed sale. Examine at least one (1) benefit of a Section IRC 338 liquidation election for a target corporation. Create a scenario that would demonstrate a favorable IRC Section 338 liquidation election for a target corporation.

Answer 1

Answer: IRC 338 is often favourable for buyers in corporate acquisitions. Sec. 338 permits a corporation that makes a “qualified stock purchase” of another corporation to elect to treat such acquisition as an asset rather than a share acquisition for federal tax purposes. In general, the impact of a Sec. 338 election is that a stock acquisition is treated as an asset acquisition and, therefore, the tax basis of the assets held by the target company is stepped up to the purchase price.

Sec. 338 elections generally take one of two forms: the Sec. 338 (g) election, which is most useful in the case of foreign acquisitions, and the Sec. 338(h)(10) election, which is commonly used in the case of domestic acquisitions. Both types of Sec. 338 elections require that a purchaser acquire 80% of the vote and value of the target company’s stock.

In the case of a Sec. 338(g) election, the target recognizes gain on the deemed sale of its assets. The tax impact of this gain is borne by the acquirer. The target is then considered a new corporation with a stepped-up basis in the assets. In addition, the seller recognizes gain or loss on the sale of the target company shares. Accordingly, the Sec. 338(g) election results in two levels of tax and thus is generally not beneficial in the case of a domestic acquisition since the acquirer pays tax on the gain immediately and realizes the benefit of the stepped-up basis over time. In the case of an acquisition of a foreign target, a Sec. 338(g) election may be beneficial. The deemed sale of assets by a foreign corporation without U.S. operations has no impact as the foreign corporation is not subject to U.S. tax. The election results in the elimination of any accumulated earnings and profits of the foreign corporation. Also, the assets of the foreign target would be stepped up for U.S. tax purposes which would result in lower future earnings and profits due to higher depreciation and amortization.

The Sec. 338(h)(10) election, in contrast to the Sec. 338(g) election, results generally in a single level of tax. The target is deemed to have sold all its assets to the new target and to have distributed the proceeds to the old target shareholders. The sale of the shares is in essence ignored. The acquirer receives a stepped-up basis in the assets and thus obtains the benefit of future increased depreciation and amortization deductions. Thus, the buyer can have the benefit of the step-up without being required to pay a tax on the full amount of the gain at the time of the election. The buyer also receives the benefit of the increased cash flow.

The requirements for a Sec. 338(h)(10) election are as follows:

• The acquisition must be at least 80% of the target stock
• The target must be a corporation that is either a) a subsidiary that filed with a consolidated group; b) a corporation that is 80% controlled without filing consolidated; or c) an S corporation
• Both parties (buyer and seller) need to agree to the election

Joint tax reporting, i.e. both the buyer and seller need to complete Form 8594