Question

338(a)(1) shall be treated as having sold all its assets at the close of the acquisition date at fair market value in a single transaction, and 338(a)(2) shall be treated as a new corporation which purchased all the assets referred to in paragraph one as of the beginning of the day after the acquisition date. 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 the benefits of IRC Section 338 liquidation election for a target corporation and create a scenario that would demonstrate a favorable Section 338 liquidation election for a target corporation.

Answer 1

1) IRC Section 338:

It 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.

An Internal Revenue Code (IRC) Section 338 election is often advantageous 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.

Section 338 provides two elections: the so-called “regular Section 338 election” under Section 338(g), and the other under Section 338(h)(10).

A Section 338(h)(10) election is much more common than a Section 338(g) election because the 338(g) election results in two levels of tax, whereas a 338(h)(10) election results in only one. In a regular Section 338 election, two levels of tax are imposed: one on the shareholders upon their sale of the target stock and the other on the deemed asset sale by the target corporation (“Old Target”).

In a Section 338(h)(10) election, typically only one level of tax is imposed, on the deemed asset sale; the stock sale is ignored for tax purposes and the deemed liquidation is tax-free to the selling shareholders. In effect, the parties are treated (purely for applicable tax purposes) as though (1) the buying corporation established a new corporation (“New Target”), (2) New Target purchased the assets of the target corporation (“Old Target”) and assumed its liabilities and (3) Old Target liquidated in the hands of the seller.

Tax Implications:
Due to the double imposition of tax, a regular Section 338 election often is unattractive and typically is made only when the target has significant tax attributes (e.g., net operating losses) to offset the gain recognition at the target level.

While regular Section 338 elections are rare, elections under 338(h)(10) are quite common. Section 338(h)(10) elections are available only for targets who are S Corporations or members of an affiliated group of corporations (whether or not they file a consolidated federal income tax return).

2) A multinational food and beverage company, made a Sec. 338(g) election on an international acquisition. From the acquirer’s perspective, the Sec. 338(g) election potentially provided significant tax benefits without the upfront gain required from the deemed asset sale since the target was a non-U.S. entity. Making the Sec. 338(g) election afforded the acquirer the opportunity to start fresh with zero earnings and profits, potentially minimizing future taxability of distributions and simplifying the future determination of the tax impact of distributions and simplifying the future determination of the tax impact of higher depreciation and amortization deductions for U.S. tax purposes which result from the stepped-up basis in the assets. Here, the purchase price has been allocated to the different acquired legal entities and then allocated the legal entity value to the various asset categories (i.e. working capital, PP & E, intangible assets and goodwill). The analysis provided the acquirer with a tax basis in the acquired assets by legal entity and also provided the acquirer with value estimates (for the various assets).
In support of a major food processor’s Sec. 338(h)(10) election, the valuation of both tangible and intangible assets has been made. This valuation was used to provide a supportable basis of value for allocation of the purchase price for tax reporting purposes to the tangible and intangible assets acquired and to the respective legal entities. The tangible assets included land, buildings, machinery and equipment, office furniture and equipment, computers, and storage facilities. The intangible assets included patents, trademarks, service marks, and software. The assets were allocated to the seven asset classes as required under Sec. 338(b)