WHEN A COMPANY IS CONSIDERING A MERGER OR ACQUISTION
THEN THESE ISSUE ARE IN THE MIND OF COMPANYS DIRECTOR.THESE ARE THE
FOLLOWING ISSUE OF FACTOR.
- Financing Structure — How will the transaction
be financed? With cash, notes and/or the Buyer's stock (common or
preferred)? A higher concentration of the purchaser's common stock
and/or notes may allow for a tax-free reorganization to be
structured. If the Buyer is foreign, debt financing may require the
domestic debtor to withhold taxes on payments. This issue can also
arise in a multi-state context. In addition, the "interest
stripping" rules of IRC Section 163(j) may limit the amount of the
current year interest deduction. "Thinly Capitalized" companies may
also be denied interest deductions to the extent a portion of the
debt financing is re-characterized.
- Legal Status of Target — Is the acquired
entity an S Corp, LLC or Partnership? If so, the tax basis of its
assets may be revalued through the use of an IRC Section 338(g) or
338(h)(10), or an IRC Section 754 election in the case of a
partnership. The stock of a C Corp target company may also be
acquired utilizing a Section 338(g) or (h)(10) election; however,
the overall tax burden will generally be much higher for the
seller. in order to allow the 338 election, at least 80 percent of
the Seller's stock must be sold. Special, and complex 338 rules
apply when asset transfers take place before or after the stock
sale occurs, in order to make sure the Buyer and Seller are not
allowed to obtain added step-up or loss benefits on selected
assets, while obtaining capital gains breaks on all other assets
retained in the Corporation.
- Ordinary vs. Capital Gain — If the assets
being sold include inventory, depreciated assets, or other
"ordinary" income assets, ordinary tax rates will apply to net
gains associated with the prior depreciation allowed or allowable
(versus treating the entire gain as capital gains, which would be
the case with an outright C or S Corp stock sale (without an 338
election). The sale of a partnership assets or partnership
interests can trigger ordinary gain to the extent of "hot assets"
such as cash basis accounts receivable, depreciation recapture,
etc.
- Purchase Price Allocation — The allocation of
purchase price by the buyer and seller is of critical importance in
an asset or 338 transaction. See IRC Section 1060. If the Buyer or
Seller is a public company they may be more focused on GAAP
treatment and the Seller may have more flexibility on structuring
and purchase price allocation. For maximum tax benefits, the Seller
in an asset or 338(h)(10) transaction will want to allocate as much
of the sales price to assets which generate capital gain, such as
goodwill, land, or other assets with fair market values higher than
original tax cost (thereby generating Section 1231 gain). The buyer
on the other hand will generally want to allocate as much as
possible to short-lived assets such as machinery and equipment,
inventory, prepaid expenses, etc. rather than goodwill or covenants
not-to-compete, which are amortized under Section 197 over 15 years
for tax purposes.
- Sales and Other Transfer Taxes — These costs
are often overlooked until the 11th hour or in some cases after the
close. Since these taxes are generally applied to the gross
allocations (versus taxable gain amounts) made to certain asset
types (e.g. machinery & equipment, certain software, vehicles,
and other assets), these taxes and fees can often raise the cost of
asset sale transactions by five percent to 10 percent. It is
important for the parties to carefully define which party will bear
the transfer tax costs of the transaction.
- Post-Transaction Filing Requirement/Elections
— Generally a taxable asset purchase will allow the new owner to
make new tax elections of accounting periods and methods, while a
stock purchase or reorganization will require the new owner to
continue to use the former entity's tax elections. Year-end
conformity with affiliated companies' year-end will often be
required, and "short-period" returns for the pre-acquisition period
may be required. It is important for the parties to include in the
acquisition documents the responsibility for the pre- and
post-acquisition income tax, payroll tax, property tax and other
filings, as well as the allocation of the related liabilities.
- Transaction Costs — Each party's separate
legal, accounting and other transaction costs will generally reduce
the reportable capital gains or ordinary income reportable by the
Seller and the Buyer will generally add the costs to their basis of
assets or entities acquired. Some costs related to pre- and
post-acquisition periods may be deductible as general operating
costs for the period incurred.
- Accrued Liabilities/Contingent Expenses — Care
must be taken to document all pre-acquisition liabilities incurred
by the Seller and assumed by the Buyer. The tax deductibility of
payments made post-acquisition can result in either the Seller or
Buyer or in some cases neither party, getting the tax deduction for
the payments. Generally the tax deductibility is a bit clearer when
stock, LLC or partnership interests are sold versus assets.
Significant efforts are spent by Buyers in evaluating whether
unrecorded liabilities may be present. Time should also be spent
evaluating whether the Seller has unrecorded assets such as
unclaimed tax refunds associated with loss carryback potential,
unclaimed tax credits and other assets that may not be reflected on
the balance sheet.
- S Corp Targets and Related Issues — A
frequently encountered structure involves the acquisition of an S
Corp by a public company or another taxpayer that desires to make a
Section 338(h)(10) election in order to step-up the acquired
assets, thereby allowing the write-off of the re-valued assets over
a one year (inventory), three to 10 year (most machinery and
equipment) to 15-year (intangibles, including goodwill) period or
39 years in the case of real estate. It is critically important for
both parties to make sure that the Target's S Corp election and
operations are valid and the entity is a valid S Corp at the time
the election is made — otherwise a stock acquisition followed by a
338 election can trigger unintended double taxation, since the
Target entity will be treated as a C Corp and will be saddled with
extra taxes.