Question

What are the disadvantages of effecting a change in the basis of all the target's assets either by their sale or by a stock purchase along with Section 338(h)(10) election to treat the stock purchase as a purchase of all firm's assets?

Answer 1

Answer : When purchasing a business owned by a corporation, there are two basic choices. The buyer can buy the stock (and thus the target corporation) from the shareholders or buy the business and other assets from the target corporation.

It is often preferable and less cumbersome to structure the sale of a business as a stock sale rather than as a sale of assets. Stock sales, however, do not allow purchasers to benefit from a “step up” in the basis of the acquired company’s assets. In such circumstances, parties to a transaction can utilize one of the few, genuine diathroses of the tax code — an election under Section 338(h)(10), which permits taxpayers to achieve the tax benefits of an asset sale while structuring the transaction as a stock sale.

Disadvantages:

1. The disadvantages of an asset purchase is that it often requires assignment of each asset and assignment and assumption of each contract, lease or license to which the target corporation is a party. A purchase of stock of the target corporation will avoid the need for assignments of each asset and may avoid the need to obtain consent to the sale from at least some other parties such as certain licensing agencies and certain parties to the target corporation’s contracts.

2. In situations where the Inside Basis is lower than the seller’s basis in its target corporation stock (the “Outside Basis”), a 338(h)(10) election will tend to disadvantage the seller, who may incur additional taxes due to the disparity between Inside and Outside Bases. In such situations, it is often advantageous for the purchaser to pay some or all of any additional tax incurred by the seller. Because any additional payment by the purchaser for the increased taxes is itself taxable, the entire indemnification amount must be “grossed up” by the highest applicable tax rate.