Mergers, Acquisitions, and Buyouts NEW February 2013 Edition of

NEW February 2013 Edition of
Mergers, Acquisitions,
and Buyouts
by Martin D. Ginsburg, Jack S. Levin, and
Donald E. Rocap
We are proud to enclose the February 2013 edition of Ginsburg, Levin, and
Rocap’s Mergers, Acquisitions, and Buyouts.
Here is a summary of major developments reflected in the new edition, written
by co-authors Jack S. Levin and Donald E. Rocap, senior partners in the
international law firm of Kirkland & Ellis LLP.
Highlights of the New Edition
l
Tax rates for 2013 and thereafter.
n
Corporate tax rates. The top federal corporate tax rate for 2013 and thereafter (on
both OI and LTCG) continues at 35% (subject to an approximately 3 percentage
point reduction on qualified U.S. production activities net income). See discussion
at ¶106.3.4.
n
Individual tax rates. After enactment of 1/13 tax legislation, the top federal
individual tax rates for 2013 and thereafter are:
5
For OI and STCG, the top rate has increased from 35% in 2012 to 39.6%
(subject to an approximately 3 percentage point reduction on qualified U.S.
production activities net income).
5
5
For normal LTCG, the top rate has increased from 15% in 2012 to 20%.
5
For Code §1202 LTCG (on ‘‘qualified small business stock’’ held more than 5
years):
For QDI, the top rate has increased from 15% in 2012 to 20% (i.e., the same as
LTCG).
1
Copyright © 2013 CCH Incorporated. All Rights Reserved.
MORE
0% for such stock acquired between 9/28/10 and 12/31/13 (rather than
12/31/11 as was the deadline before the 1/13 legislation).
¡
7% for stock acquired between 2/18/09 and 9/27/10, and
¡
14% for stock acquired before 2/18/09 (but after 8/10/93) or after 12/31/13.
Individual Medicare taxes.
5
For compensation and self-employment income, the Medicare tax (which is in
addition to regular income tax described above) has increased from the prior
2.9% (imposed 1 2 on employer and 1 2 on employee or 100% on a self-employed
person) by an additional 0.9% (i.e., to 3.8% aggregate) on the portion of such
income in excess of a threshold amount (generally [e.g.] $250,000 for a joint
return and $200,000 for an unmarried individual’s return, with no inflation
adjustment for these thresholds), with the entire 0.9% increase imposed on the
employee/self-employed person.
5
For passive income—generally meaning (a) dividends, interest, royalties, rents,
and annuities, (b) income from a business (including operating income), and
(c) net gain (including CG) from disposition of property, unless such income
described in (a) through (c) is derived from the individual’s conduct of a
business as to which he is active (i.e., not Code §469 passive)—there is a new
3.8% Medicare tax (which is in addition to regular income tax described above)
based on (1) the amount of the taxpayer’s passive income or (2) if less, the
amount of the taxpayer’s AGI in excess of a threshold amount (generally [e.g.]
$250,000 for a joint return, $200,000 for an unmarried individual’s return, and a
lower threshold for an estate or trust, with no inflation adjustment for these
thresholds).
=
n
¡
=
For purposes of this passive Medicare tax, the sale of an ownership interest in
a partnership, LLC, or S corp is viewed as if the entity had sold its assets, so that
the individual’s gain/loss on his actual sale of the entity ownership interest is
taken into account for purposes of the passive Medicare tax only to the extent a
hypothetical sale of the entity’s assets would generate income/loss to the
taxpayer (1) from a business as to which the taxpayer is Code §469 passive or (2)
from a non-business activity (e.g., investing). However, gain on sale of C corp
stock is subject to this tax whether or not the taxpayer is §469 active with
respect to the C corp’s business or activity.
n
Individual deduction and exemption phase-outs. Individual federal income taxes for
2013 and thereafter are also affected by:
5
An itemized deduction phase-out, in general by 3% of the taxpayer’s AGI in
excess of a threshold amount (generally [e.g.] $300,000 for a joint return and
2
$250,000 for an unmarried individual’s return, adjusted for post-2012 inflation),
with a maximum phase-out equal to 80% of itemized deductions.
5
A personal exemptions phase-out, based on a taxpayer’s AGI, with personal
exemptions (e.g.) on a joint return phasing out as AGI increases from $300,000
to $450,000, adjusted for post-2012 inflation.
While discussed at length in ¶106.3 (and also in ¶215 with respect to Code
§1202 rates), these changes in top individual tax rates—from 35% to 39.6% for OI,
from 15% to 20% for LTCG and QDI, from 14% to 0% for LTCG on Code
§1202 small business stock purchased during 2012 and 2013 and held more than
5 years, from 2.9% to 3.8% for the Medicare tax on wages and self-employment
income in excess of a threshold, and from 0% to 3.8% for the Medicare tax on
passive income in excess of a threshold—have been reflected throughout the treatise.
l
Timing of T’s entry into P’s consolidated return.
n
T is C corp. When P which is filing a consolidated return (or will file a consolidated
return following P’s acquisition of T) acquires sufficient T stock so that T
becomes a member of P’s affiliated group, T’s tax year then in progress (T’s
‘‘pre-acquisition year’’) ends and T begins a new taxable year (T’s ‘‘post-acquisition
year’’) which is included in P’s consolidated return.
Whether items of income or deduction incurred on the day on which P acquires
sufficient T stock so that T enters P’s consolidated return (the ‘‘acquisition date’’)
are included in T’s pre-acquisition return or in the P-T post-acquisition return can
be important, e.g., when T has a large deduction arising from a payment on the
acquisition date in cancellation of T’s outstanding stock options. If such a payment
is deductible in T’s pre-acquisition return, T may be entitled to immediate tax
savings (by offsetting the deduction against T’s pre-acquisition taxable income) or
an immediate tax refund (by carrying the deduction back against T’s previous two
years of taxable income), but if the payment is deductible in the P-T postacquisition return, any tax benefit is delayed until at least the filing of P’s tax return
for the tax year in progress when the P-T acquisition was consummated.
Where T is a C corp, the consolidated return regulations state that T ‘‘becomes . . . a
member [of the P group] at the end of the day on which its status as a member changes,
and its tax year ends for all federal income tax purposes at the end of that day’’
(emphasis added). Thus, T’s income and expenses for the acquisition date are
ordinarily reported on T’s final pre-acquisition return (on Bigco’s consolidated return
if Bigco was T’s prior owner), not on the P-T post-acquisition consolidated return.
This general rule is subject to several regulatory exceptions. First, ‘‘appropriate
adjustments’’ must be made if another provision of the Code or regulations
3
MORE
‘‘contemplates the event occurring before or after [T’s] change of status,’’ e.g., for
deferred intercompany gains or losses triggered by T’s ceasing to be a member of
the Bigco group.
Second, under the next-day rule, a transaction ‘‘properly allocable’’ to the portion
of T’s day after P’s purchase of T’s stock must generally be treated as occurring at
the beginning of the following day, so that the transaction is included in the P-T
post-acquisition consolidated return. Under this exception, a determination by the
parties as to whether a qualifying transaction is properly allocable to the portion of
T’s day after the acquisition is respected so long as reasonable and consistently
applied by the parties. It appears clear that this next-day rule is intended to apply if
(a) after P acquires T’s stock, but before the end of the acquisition date, (b) P causes
T to engage in a significant transaction, such as a distribution of assets to P or a
sale of assets to P or another party, and (c) such transaction was not pursuant to a
plan prearranged with T (or with T’s former shareholder Bigco).
A 2012 IRS Chief Counsel Memorandum addressed the applicability of the nextday rule to three categories of expenses T incurred on the P-T acquisition date:
(a)
payments in cancellation of outstanding T employee stock options and stock
appreciation rights,
(b) compensation to T’s financial advisers in connection with the acquisition,
and
(c)
payments to retire at a premium outstanding T bonds tendered in connection
with the P-T acquisition.
The IRS memorandum takes the position that the employee and adviser
compensation in categories (a) and (b) were from ‘‘transactions that precede’’ T’s
acquisition, and hence ‘‘the corresponding deductions are not attributable to any
‘transaction’ on the Acquisition date other than the Acquisition itself,’’ so that the
next-day rule is ‘‘inapplicable on its terms,’’ and T and P are not permitted to report
the deductions on the P group return.
On the other hand, the IRS memorandum viewed the bond repurchase
payments—category (c)—as ‘‘based on a decision made by [T] after the closing’’
and hence as deductions that T and P could reasonably agree to allocate to the
post-closing portion of the acquisition date and report on the P group return. See
discussion at ¶211.3, ¶1503.1.3.1, and ¶1503.1.3.2.
n
T is S corp. If T is an S corp that, as a result of P’s purchase of T’s stock, becomes a
member of P’s consolidated group, T’s final S corp year ends on the day before the
stock purchase and the regulations treat T as joining P’s consolidated group on the
day of the P-T stock purchase (rather than the day after). This special rule for an S
4
corp joining a consolidated group prevents the acquisition from creating three
separate taxable years for T: (1) a short SCo year ending on the day before the
acquisition date, (2) a one-day separate C corporation year for the acquisition date,
and (3) a short period of inclusion in the P-T consolidated group starting on the day
after the acquisition date.
As a result of this special S corp rule, deductions for stock option cancellation
payments that become fixed on the day P acquires T-SCo’s stock should be
includible in P-T’s post-acquisition year. See discussion at ¶211.3 and ¶1503.1.3.3.
l
Leveraged dividend or recapitalization. Since 2003 when the tax rate on QDI was
reduced from the OI rate to the LTCG rate, it has been advantageous for T (a C corp
owned primarily by individuals) to (a) pay out excess earnings (to the extent of E&P) as
dividends and indeed to borrow in order to pay leveraged dividends or (b) to use
surplus funds from earnings and borrowings (to the extent of E&P) to redeem T shares
substantially pro rata to stock ownership so that the proceeds constitute QDI.
The Code provision taxing QDI at LTCG (rather than OI) rates was scheduled to
expire on 12/31/12, in which event QDI would have been taxed at full OI rates and it
would no longer have been desirable (from a tax standpoint) for T to pay out dividends
and/or make stock redemptions taxable as a dividend. However, 1/13 legislation
permanently extended the post-2002 rule that QDI is taxed at the LTCG rate. See
discussion at ¶216.
l
Collapsible corporations repealed. Designed to discourage excessive or ‘‘abusive’’
reliance on the General Utilities doctrine, inordinately long and nearly incomprehensible Code §341 (the collapsible corporation provision) entered the tax law in 1950 and
was thereafter repeatedly amended and lengthened. Indeed, the collapsible corporation
rules contained a single sentence (section 341(e)(1)) that was significantly longer than
the entire Gettysburg Address.
In logic, Code §341 should have died as a part of the 1986 legislation overturning the
General Utilities doctrine. Logic having played no large role in the birth and evolution
of Code §341, the provision nevertheless persisted a further 17 years.
At long last the 2003 Act did indeed repeal Code §341, effective for taxable years
beginning after 12/31/02. However, the 2003 Act’s sunset provision stated that, ‘‘All
provisions of, and amendments made by, this title shall not apply to taxable years
beginning after December 31, 2008, and the Internal Revenue Code of 1986 shall be
applied and administered to such [post-2008] years as if such [2003 Act] provisions and
amendments had never been enacted.’’ Mercifully, 12/31/08 became 12/31/12 by virtue
of two legislative postponements of the 2003 Act’s sunset, each of 2 years duration.
5
MORE
And thus, like a phoenix, Code §341’s collapsible corporation provision did indeed
return to life on 1/1/13, but even more mercifully Code §341 departed the very next day
(on 1/2/13) upon enactment of the 2013 Act, which retroactively made the 2003 Act’s
repeal of §341 permanent. Shakespeare recalled that of a departed liege it was said,
‘‘Nothing in his life became him like the leaving it.’’ See discussion at ¶305.
l
Deductibility of milestone fees paid, e.g., to investment banker, arising out of
acquisition. §263 regulations issued in 12/03 take a hostile position with respect to the
deductibility of a success-based fee paid in connection with an acquisition or other
transaction, i.e., a fee contingent on the successful closing of the transaction, such as an
investment banker’s fee. The regulations decree that such a fee facilitates the acquisition
or other transaction (and thus must be capitalized) unless the taxpayer can satisfy very
onerous IRS documentation requirements necessary to ‘‘establish’’ the portion of the
success-based fee allocable to non-facilitative activities (e.g., general due diligence).
A 4/11 revenue procedure—which recognized that there have been numerous disputes
between IRS and taxpayers because of the difficulties in satisfying the above-described
stringent IRS regulations—promulgated a safe harbor for a taxpayer who elects to
deduct 70% of a success-based fee paid in connection with a ‘‘covered transaction’’
(generally the acquisition of a business’s assets or ownership interests) but not such a
fee paid in connection with a ‘‘non-covered transaction’’ (e.g., a debt or stock issuance,
an acquisition of less than 50% of an entity’s equity interests, a tax-free Code §351 or
§721 transaction, or a Code §355 spin-off/split-off).
However, not infrequently a success-based fee calls for non-refundable milestone
payments after certain prescribed events occur—such as an affirmative shareholder
vote in favor of the transaction—with such milestone payments creditable against the
ultimate success-based fee but retained by the bankers, even if the transaction does not
ultimately close.
In effect, these milestone payments are ‘‘mini success-based fees,’’ except that they are
paid upon the achievement of specified interim steps in the transaction as opposed to
final consummation of the overall transaction. All of the policy concerns underlying
the 4/11 revenue procedure—reducing controversies between IRS and taxpayers as well
as simplifying the administrative burdens of these capitalization rules—are fully
applicable to milestone payments.
However, IRS concluded in a 7/12 Chief Counsel Advice that milestone fees do not
qualify as success-based fees because the ‘‘[n]onrefundable milestone payments are not
contingent upon the successful closing of the transaction.’’ Thus, IRS held that milestone
payments are deductible only to the extent P establishes, based on all the facts and
circumstances, that the bankers’ activities were not facilitative of the transaction.
6
We believe this IRS position is mistaken because it leads to the same type of
administrative complexities and controversies that the 4/11 70% safe-harbor election
was meant to alleviate.
However, since IRS takes the position that milestone payments are not success-based
fees, such payments are not subject to the harsh presumption of capitalization
applicable to success-based fees and similarly are not subject to the strict
documentation requirements necessary for taxpayers to avoid that presumption.
Rather, milestone payments are like any other normal transaction expense—analyzed
on their facts and circumstances—and not subject to the special rules applicable to
success-based fees. See discussion at ¶402.3 (capitalization of success-based fee).
l
Code §197 amortization of customer-based intangibles. Code §197 allows 15-year
straight-line amortization for certain purchased intangible assets, including
customer-based intangibles.
Where P acquires tangible assets along with customer relationships and future
profits are expected to be derived from the provision of goods or services to such
customers, a factual issue often arises as to the extent to which purchase price
attributable to those anticipated future profits should be allocated to the tangible
assets acquired to produce such goods or services or to the simultaneously acquired
intangible asset consisting of the customer relationship. IRS addressed this issue in two
2012 letter rulings (both dealing with the same transaction) discussed immediately
below, reaching different conclusions in each, but eventually holding that the portion
of the purchase price attributable to the intangible asset is governed by Code §197.
In the letter rulings P, a power company, purchased from T a number of wind energy
facilities consisting of tangible assets. Each facility had entered into one or more
long-term power purchase agreements (‘‘PPAs’’) under which the facility committed to
sell some or all of its energy output at fixed prices to a customer. Each of the PPAs was
facility-specific, with the only source of the energy output that could be delivered to
the customer being output from the particular wind energy facility. Because of energy
price declines, the prices that P was entitled to charge exceeded the market price of
power on the date of the transaction and, for financial accounting purposes, P
allocated a portion of its purchase price to the above-market PPAs.
Despite this financial accounting treatment, IRS first ruled that ‘‘where [P]
acquired wind energy facilities subject to facility-specific PPAs, no portion of the
purchase price shall be allocated to the PPAs and the purchase price of such wind
energy facilities that is attributed to such PPAs shall be taken into account in
determining the adjusted basis of the wind energy facilities.’’
Eight months later, however, IRS reversed position on this issue, revoking the earlier
letter ruling and stating that the ruling ‘‘is not in accord with the current views of the
7
MORE
Service. After reconsideration, we have concluded that the portion of the purchase
price paid by [P] that is attributable to the PPAs is to be allocated to the PPAs and not
to the wind energy facilities.’’ See discussion at ¶403.4.1.3.
l
Expedited IRS letter rulings on Code §368 or §355 transactions terminated. In
2005 IRS adopted a procedure for (1) expedited treatment for letter rulings on
transactions intended to meet the requirements of either Code §368 or Code §355, so
long as (2) the taxpayer requested expedition pursuant to Rev. Proc. 2005-68, and
(3) the transaction is ‘‘rulable’’ (i.e., presents a ‘‘significant issue’’), formerly covered in
¶601.2.1. Expedited handling translated as IRS ‘‘will endeavor to complete and
issue . . . within ten weeks after receiving the ruling request.’’
In 2012 IRS terminated this salutary procedure by deleting all reference to expedited
letter rulings in Rev. Proc. 2013-1.
l
Non-qualified preferred stock. If a T shareholder receives NQ Pfd (i.e., preferred
stock which is too debt-like) in a Code §368 reorganization or a Code §351 transaction,
the NQ Pfd is treated as ‘‘not stock,’’ i.e., is treated as taxable boot for certain purposes.
NQ Pfd is defined by Code §351(g)(3)(A) as ‘‘stock which is limited and preferred as to
dividends and does not participate in corporate growth to any significant extent’’ (unless
such stock fits within a specific exception to the NQ Pfd definition).
Long-standing regulations under Code §305 (which deals not with NQ Pfd but with
other preferred stock tax issues) state that:
The term ‘‘preferred stock’’ generally refers to stock which, in relation to other classes
of stock outstanding enjoys certain limited rights and privileges (generally associated
with specified dividend and liquidation priorities) but does not participate in
corporate growth to any significant extent. . . . However, a right to participate which
lacks substance will not prevent a class of stock from being treated as preferred
stock. Thus, stock which enjoys a priority as to dividends and on liquidation but
which is entitled to participate, over and above such priority, with another less
privileged class of stock in earnings and profits upon liquidation, may nevertheless,
be treated as preferred stock for purposes of section 305 if, taking into account all the
facts and circumstances, it is reasonable to anticipate at the time a distribution is
made . . . with respect to such stock that there is little or no likelihood of such stock
actually participating in current and anticipated earnings and upon liquidation
beyond its preferred interest.
A 2012 Tax Court decision dealing with §351’s NQ Pfd definition relied on this
§305 regulation to conclude that preferred stock did not ‘‘participate in corporate
growth to a significant extent’’ for purposes of the Code §351(g)(3)(A) NQ Pfd
8
definition where, upon redemption or liquidation, the preferred stock was entitled to
receive the greater of (a) a fixed amount and (b) a formula price which turned in
part on the issuer’s net equity value, because, in the court’s view, the formula
participation lacked ‘‘any meaningful substance’’ since no meaningful increase in the
preferred stock issuer’s net equity value was ‘‘reasonably foreseen as of the time the
. . . stock was issued.’’ Thus, the court found that the shareholder’s equity participation
right was not a ‘‘meaningful interest,’’ was ‘‘illusory,’’ and ‘‘granted no meaningful
rights.’’ See discussion at ¶604.3.1.1.
l
Code §355 (spin-off/split-off) letter rulings. IRS has long imposed restrictions on a
taxpayer’s ability to obtain a letter ruling on several aspects of a Code §355
distribution. In particular, IRS will not rule on whether the distribution of a controlled
corporation’s stock is being carried out for one or more corporate business purposes,
whether the transaction is being used principally as a device, or (as a general matter)
whether the distribution and an acquisition are part of a plan for purposes of Code
§355(e), and IRS ordinarily will not rule on whether Code §355(b)’s active business
requirement is met or on any other Code §355(e) issue.
In Rev. Proc. 2013-3, IRS announced further restrictions: it will not issue rulings with
respect to so-called North/South Transactions (discussed in ¶1002.1.1.8), certain
leveraged spin-off transactions (discussed in ¶1012.2), or the issuance of high-vote/lowvote stock in anticipation of a spin-off (discussed in ¶1003.1.1) until future guidance is
issued with respect to such transactions.
l
l
Treatment of non-compensatory warrants in a §355 spin-off/split-off. A 2012
IRS letter ruling holds that, in a §355 spin-off/split-off, D’s outstanding noncompensatory warrants (apparently issued to lenders along with notes) that have a
nominal exercise price and share in distributions as if exercised constitute stock for
purposes of a §355 distribution, so that C stock distributed to the D warrant holders
is tax free under Code §355, citing prior Revenue Rulings in which IRS recharacterized
deep-in-the-money options as stock based upon an anti-abuse rationale. While in the
letter ruling D sought to disavow its chosen transaction form, recharacterizing the
warrants as stock was clearly consistent with their economic substance given the
warrants’ full right to participate in dividends on an as-if exercised basis. See discussion
at ¶1002.1.2.1.
Code §1374 S corp-level penalty tax. Code §1374 has long imposed a corporatelevel penalty tax on an S corp (or REIT) selling assets within 10 years after (1)
switching from C to S status (or electing REIT status, as the case may be) or (2)
acquiring COB assets from a C corp. In 2/09 Congress temporarily reduced the time
period to 7 years for such gain recognized in 2009–10, and in 9/10 Congress further
temporarily reduced the time period to 5 years for such gain recognized in 2011.
9
MORE
1/13 tax legislation further extended the 5-year time period to cover gain recognized
in 2012 and 2013. See discussion at ¶1103.7.4, ¶1108.1.
l
Effect of third-party loans to S corp on S corp shareholder’s basis in S corp for
purposes of deducting S corp losses. In general, each S corp shareholder may
deduct his share of S corp’s losses to the extent of his tax basis in his S corp stock plus
his tax basis in loans he has made to S corp (subject to the at-risk and passive activity
loss limitations of Code §465 and §469). Loans by other persons to S corp do not give S
corp’s shareholders any tax basis against which they may deduct S corp’s losses.
An S corp shareholder should, however, be able to obtain tax basis in S corp debt by
structuring a back-to-back loan, in which the shareholder borrows funds from a lender
and then loans the funds to S corp. This taxpayer-favorable result is reasonably clear
where the S corp shareholder borrows the funds from an unrelated lender.
The result is not clear where the S corp shareholder borrows the funds from a
related lender or seeks to restructure an existing third-party loan to S corp as a
back-to-back loan. In these situations, a number of cases have denied the shareholder
basis credit on the theory that the shareholder’s loan did not constitute an ‘‘actual
economic outlay.’’ 6/12 proposed regulations would abandon this ‘‘actual economic
outlay’’ theory, and require only that there be ‘‘bona fide indebtedness of the S
corporation that runs directly to the shareholder.’’ Whether such debt exists would be
determined under general federal income tax principles based on all relevant facts
and circumstances.
If a third-party loan to S corp is guaranteed by S corp’s shareholders, the
shareholders generally do not obtain tax basis in S corp’s stock or debt unless, and then
only to the extent, they make payments on the guarantee. Consistent with this position,
the 6/12 proposed regulations state that ‘‘a shareholder does not obtain basis of
indebtedness in the S corporation merely by guaranteeing a loan.’’
Under the Plantation Patterns line of cases, where a loan by a third party to a
thinly capitalized corporation is guaranteed by a shareholder and the lender is relying
principally on the shareholder guarantee for assurance of repayment, the loan may be
recharacterized for federal income tax purposes as, in substance, a loan by the lender
to the shareholder, followed by an equity contribution by the shareholder to the
corporation. In Plantation Patterns, IRS asserted this recharacterization to prevent
the putative corporate borrower from deducting interest on the guaranteed debt and to
require the shareholder-guarantor to recognize dividend income on debt service
payments made by the corporation. Unsurprisingly, S corp shareholders seeking to use
S corp losses have argued for a similar recharacterization to obtain tax basis with
respect to S corp debt guaranteed by the shareholder.
10
In a 1985 opinion, the 11th Circuit acknowledged the potential validity of such a
recharacterization, stating ‘‘we conclude that under the principles of Plantation
Patterns, a shareholder who has guaranteed a loan to a Subchapter S corporation may
increase her basis where the facts demonstrate that, in substance, the shareholder
has borrowed funds and subsequently advanced them to her corporation,’’ and
remanded the case to the lower court for appropriate factual findings.
Other courts addressing this fact pattern have consistently rejected taxpayer attempts
to use a Plantation Patterns recharacterization to obtain additional S corp tax basis.
However, these cases relied, in significant part, on the view that an ‘‘actual economic
outlay’’ is required to obtain S corp tax basis. IRS’s decision in its 6/12 proposed
regulations to abandon the ‘‘actual economic outlay’’ theory and instead rely on
general federal tax principles to determine S corporation shareholder tax basis—which
general tax principles surely include the Plantation Patterns line of cases—may breathe
new life into this argument. Nonetheless, taxpayers will still face an uphill battle in
arguing for a recharacterization of their own transaction form, particularly if their
initial reporting of the transaction was not consistent with such a recharacterization.
See discussion at ¶1104.2.4 and ¶1302.3.
l
LossCo recognizes CODI in a debt restructuring where LossCo new debt is
issued (or deemed issued) for “market traded” LossCo old debt. Where LossCo
(in a debt restructuring) issues new debt in exchange for its old debt (or is deemed to
issue new debt in such an exchange as a result of the old debt’s significant
modification), the new debt’s ‘‘issue price’’ (and thus LossCo’s debt cancellation
(‘‘DC’’)) depends on whether either the new debt or the old debt is traded on an
‘‘established securities market’’ (very broadly defined, as discussed below and referred
to herein as ‘‘market traded’’).
If the new debt is market traded, the new debt’s issue price is its FV on the first
date a substantial amount of the new debt is issued. If the new debt is not market
traded but is issued in exchange for old debt that is market traded, the new debt’s issue
price is the old debt’s FV on the first date a substantial amount of the new debt is
issued in exchange for the old debt. If neither the new nor the old debt is market traded,
the new debt’s issue price is generally the new debt’s stated principal amount so long
as the new debt bears interest of at least the AFR.
The debt of a troubled obligor (like LossCo) typically trades at a substantial
discount to face because of the high credit risk, so that if either the old debt or the
new debt is market traded, there is likely to be greater DC income on the exchange (or
deemed exchange) than where neither the old nor the new debt is market traded.
Continuing repercussions from the 2007–10 financial crisis have also caused substantial
fluctuations in the trading price of many debt instruments, even where the debtor is
11
MORE
reasonably healthy, so that even a reasonably healthy company may face significant
DC if it modifies or restructures existing debt and either the old or the new debt is
market traded.
Long-standing regulations dealing with whether debt is market traded were replaced
by new final regulations issued in 9/12, applicable to debt instruments issued on or
after 11/13/12.
The new regulations are broader than the old regulations and treat as market-traded
debt instruments that are not publicly traded in a colloquial sense, but as to which
pricing information is available.
Under the new 9/12 regulations a debt instrument is market traded if all of the
instruments that are part of the same issue have an outstanding principal amount
greater than $100 million and at any time during a 31-day testing period ending 15 days
after the debt’s issue date (including the date of a deemed issuance as a result of a
signification modification):
(1) an ‘‘executed’’ sales price for the debt (or information sufficient to calculate the
sales price) is ‘‘reasonably available’’ to issuers, regular buyers and sellers, or
brokers of debt instruments (including a price provided only to certain
customers or subscribers), or
(2) one or more ‘‘firm quotes’’ from a broker, dealer, or pricing service are
available for the debt (including such a quote provided only to certain
customers or subscribers), the identity of the person providing the quote is
reasonably ascertainable, and the quoted price is substantially the same as the
price for which the person receiving the quote could purchase or sell the
property (and a quote is viewed as ‘‘firm’’ for this purpose if the person
providing the quote designates it as a ‘‘firm’’ quote or if market participants
typically purchase or sell at the quoted price, even if the quote is not legally
binding), or
(3) one or more ‘‘indicative quotes’’ from a broker, dealer, or pricing service (i.e., a
quote that is not a ‘‘firm quote’’) are available for the debt (including such a
quote that is provided only to certain customers or subscribers).
Even where debt is not market traded before its issue date or deemed issue date,
LossCo still cannot make a final determination at time of issuance (or deemed issuance)
whether such debt is market traded for tax purposes, since trading or quotations
may occur during the 15-day post-issuance portion of the 31-day testing period.
If a principal purpose for the existence of any sale or price quotation is to cause
property to be treated as market traded or to materially misrepresent the value of
property, such sale or price quotation is disregarded.
12
The regulations treat as market traded any debt for which there is, during the 31-day
testing period, a temporary restriction on trading, a purpose of which is to avoid
characterization of the debt as market traded—even if not imposed by LossCo, but
rather imposed by LossCo’s creditors or by a bankruptcy court.
The 9/12 regulations provide that if an available sale price or quote (firm or
indicative) causes a debt instrument to be treated as market traded, the FV of the debt
instrument is presumed to be equal to the sale or quoted price. If there is more than one
sale or quoted price, ‘‘a taxpayer may use any reasonable method, consistently applied
to the same or substantially similar facts, to determine’’ FV. For this purpose, the
taxpayer may weigh factors such as the time of the sales or quotes in relation to the
debt issuance date, whether the price is from a sale, a firm quote, or an indicative
quote, the size of the relevant sale or quote, and whether the sale or quoted price
corresponds to other available market pricing information. If only indicative quotes are
available and the taxpayer determines that the quote(s) ‘‘materially misrepresent’’ the
debt instrument’s FV, the regulations allow use of any method that provides a
reasonable basis to determine the FV of the property (so long as the taxpayer
establishes that such method more accurately reflects FV than the indicative quote(s)).
This ability to determine FV based on information other than that provided by
available sale prices or quotes is, by its terms, limited to situations where only
indicative quotes (and not sales prices or firm quotes) exist. For example, if, in
connection with a material modification in the terms of a debt instrument, a broker or
dealer makes a firm offer to holders of the debt to purchase the debt at a low-ball price
so that the persons receiving the quote could sell the debt at this price to the broker or
dealer, the low-ball offer appears to qualify as a ‘‘firm quote’’ (notwithstanding that
holders could not purchase the debt from the broker or dealer at this price), thus
causing the debt to be market traded, even though the low-ball purchase offer
materially misrepresents the debt’s FV. The 9/12 regulations state that the debt’s FV is
‘‘presumed’’ to equal the price of the firm quote. Thus, it appears that a taxpayer
seeking to avoid being bound by such an off-market firm quote may be forced to obtain
another, more reasonable, firm or indicative quote from a broker, dealer, or pricing
service before the end of the relevant 31-day testing period so that competing quotes
exist and the more reasonable one can be used to determine FV.
The 9/12 regulations require the debt instrument’s issuer to determine whether the
debt instrument (or the property for which it is exchanged) is market traded and, if so,
its FV. If a market-traded determination is made, the issuer must make this
determination and FV information available to holders in a commercially reasonable
fashion (including by electronic publication) within 90 days of the debt instrument’s
issuance. A holder of the debt instrument is bound by the issuer’s determination unless
the holder discloses that it has made a different determination (either of market trading
13
MORE
or FV) and describes the reasons for such different determination. See discussion at
¶1202.2.4(2) and ¶203.6.5(2).
l
Corporate equity reduction transaction (“CERT”) limitation on NOL carrybacks.
CERT rules enacted in 1989 limit the ability of a C corp involved in a CERT to carry
back to a taxable year prior to the taxable year in which the CERT occurs any NOL
incurred in the taxable year in which the CERT occurs or in either of the 2 succeeding
taxable years. A CERT generally occurs when (1) P acquires 50% or more (by vote or
value) of T’s stock without a Code §338 or §338(h)(10) election (a ‘‘major-stockacquisition CERT’’) or (2) D makes dividend or redemption distributions in a taxable
year in an amount exceeding the greater of 10% of D’s stock FV and 150% of D’s
average distributions in the prior 3 years (an ‘‘excess-distribution CERT’’).
In 9/12, twenty-three years after the CERT rules’ enactment, IRS issued detailed
proposed regulations interpreting the CERT rules, applicable to transactions occurring
on or after the regulations are finalized, which include the following significant
provisions:
n
Prior editions of the treatise expressed hope that IRS would exempt from the CERT
rules certain acquisition and distribution transactions that did not have the effect of
reducing overall corporate equity. The 9/12 proposed regulations fail to do so, and
indeed specify that P’s tax-free acquisition of T stock and P’s acquisition of 50% or
more of T’s stock directly from T are major-stock-acquisition CERTs and that D’s
tax-free distribution of C stock under Code §355 may be an excess-distribution CERT.
n
The proposed regulations test all steps of an integrated plan by P to acquire
T stock (including redemptions of T stock and other distributions by T) as a single
potential major stock acquisition. If the integrated plan constitutes a major
stock acquisition and includes one or more T distributions, the distributions are
treated as part of the major stock acquisition and disregarded for purposes of
determining whether an excess distribution has occurred.
n
The proposed regulations provide detailed rules for applying the ‘‘avoided cost’’
method to determine the amount of interest expense allocable to a CERT. Under
these rules, all CERT costs (including the FV of T stock acquired in exchange for P
stock in a major-stock-acquisition CERT and the FV of C stock distributed by D in
an excess-distribution CERT and related capitalized costs) are treated as cash
expenditures that could have been used to pay down debt.
n
All members of a consolidated group are treated as a single taxpayer in applying
the CERT rules. The proposed regulations provide detailed guidance regarding
such single-entity treatment, including the treatment of corporations that join or
leave a consolidated group. See discussion at ¶1208.1.
14
l
Fiduciary duty for a Delaware partnership or LLC. Most Delaware Chancery Court
opinions have concluded that fiduciary duties are implicit in a Delaware partnership
or LLC agreement absent a clear waiver of fiduciary duties. However, an 11/12
Delaware Supreme Court opinion—dealing with an LLC agreement that contained
explicit (contractual) fiduciary duty language—chastised the Chancery Court for
invoking not only explicit fiduciary duty but also implicit fiduciary duty arising out of
the LLC agreement’s failure to deny fiduciary duty and pointedly ‘‘decline[d] to express
any view regarding whether default fiduciary duties apply as a matter of statutory
construction’’ where an LLC agreement is silent on fiduciary duty.
If (after further litigation) it turns out that there is no implied fiduciary duty for a
Delaware LLC, perhaps there would also be none for a partnership, since the Delaware
partnership fiduciary duty statute is identical to the Delaware LLC fiduciary duty
statute. However, within a few days after the 11/12 Delaware Supreme Court’s opinion
discussed above, the Delaware Chancery Court stated: ‘‘There has never been any
serious doubt that the general partner of a Delaware limited partnership owes fiduciary
duties.’’ See discussion at ¶1602.1.3.
l
Upstream migration of bankrupt T’s ERISA group liability to 80% or greater
parent entity (including PE/VC fund) and sideways migration to parent’s other
80% affiliates. Where Bigco or PE/VC fund owns 80% or more of bankrupt T, T’s
parent entity (and the parent entity’s other 80% or greater affiliates) generally becomes
liable for T’s ERISA liabilities. For this purpose 80% or greater is defined in a
surprisingly broad manner, often including ownership well below 80%.
This upstream ERISA liability migration rule clearly applies where the parent entity
is a corporation. However, where the parent entity is a partnership or an LLC (rather
than a corporation) and is not engaged in a ‘‘trade or business,’’ (1) the regulatory
language does not make the partnership or LLC parent (e.g., PE/VC fund) liable for its
bankrupt T subsidiary’s unpaid ERISA liabilities and (b) there is also an argument
under the regulatory language that the partnership/LLC parent’s other 80%-or-greater
subsidiaries are not contingently liable for T’s ERISA liabilities.
If income tax precedents (particularly the Supreme Court’s Higgins decision stating
that ‘‘[n]o matter how large [an investor’s portfolio] . . . or how continuous or
extended the work required may be,’’ including hired help and rented office space,
investment activities do not constitute a trade or business) are applied in determining
whether a non-corporate entity (e.g., PE/VC fund formed as a partnership or LLC)
is engaged in a ‘‘trade or business,’’ then a non-corporate PE/VC fund engaged only in
long-term investment activities—even though actively conducted by a staff of
professionals—is not engaged in a trade or business.
15
MORE
However, several cases dealing with the ERISA-group-liability issue have (1) declined
to apply income tax trade-or-business precedents, (2) held instead that ERISA should
be construed liberally to provide maximum protection to workers covered by pension
plans, and (3) seized selectively on language in the Supreme Court’s Groetzinger income
tax decision, holding that a full-time gambler is engaged in a ‘‘trade or business’’
because his activities have ‘‘continuity and regularity and [a] . . . primary purpose . . .
[of] income or profit.’’
The vast majority of the ERISA cases declining to follow income tax precedents in
interpreting the phrase ‘‘trade or business’’ arose in the context of an individual who
leased real estate or equipment to a corporate business of which the individual was
sole or principal shareholder and not in the context of investment activities. Moreover,
the Supreme Court in Groetzinger (full-time gambler is engaged in business) explicitly
stated that the Groetzinger decision did ‘‘not overrule or cut back on the Court’s
[earlier] holding in Higgins’’ (active investor not engaged in business ‘‘[n]o matter how
large [the portfolio] . . . or how continuous or extended the work’’).
Nevertheless, a 2007 PBGC Appeals Board ruling rejected this conclusion for several
reasons:
n
First, PBGC stated that PE/VC fund’s general partner controlled PE/VC fund and
was PE/VC fund’s agent under Delaware law, so the general partner’s activities
were attributed to PE/VC fund itself, and stated that this would be true even if a
separate management company conducted PE/VC fund’s day-to-day management.
n
Second, PBGC cited the Groetzinger case as holding that activities undertaken with
the ‘‘primary purpose of income or profit,’’ and with ‘‘continuity and regularity’’
do constitute a trade or business, although that Supreme Court case dealt with a
professional gambler and not investment activities. PBGC determined that PE/VC
fund was engaged in a trade or business on account of the size of PE/VC fund’s
portfolio, the profits generated from its investments, and the fees paid to the
management company and the general partner for ‘‘investment advisory’’ services,
characterizing the general partner’s carried interest as compensation for services,
rather than investment income.
n
Third, PBGC sought to distinguish the Supreme Court’s prior cases (e.g., Higgins
and Whipple which held that investment activities do not constitute a trade or
business) by asserting that those cases applied only to individuals managing their
personal investments, not to a PE/VC fund partnership whose purpose is to ‘‘select,
acquire, dispose of, and manage investments (trades or businesses) on behalf
of its partners.’’
n
Fourth, and contrary to the Supreme Court’s Whipple language, PBGC concluded
that PE/VC fund was not a passive investment vehicle because PE/VC fund
16
controlled the management of the insolvent portfolio company (which sponsored
the underfunded pension plan) by reason of PE/VC fund’s 96% stock ownership.
The district court’s 2010 Palladium decision, although agreeing that Higgins sets
the legal standard—i.e., ‘‘no matter how large an investor’s portfolio or how much
managerial attention an investor pays to his investments, investing alone does not
constitute a ‘trade or business’ ’’—found that the PBGC 2007 ruling ‘‘coins an
‘investment plus’ standard’’ which is satisfied where the PE/VC fund and the GP/
manager ‘‘had a business purpose other than mere investment’’ pursuant to which
they ‘‘exert[ed] power over [T’s] financial and managerial activities,’’ e.g., by selecting
a majority of T’s board members . . . and thus had ‘‘consistent involvement . . . in
[T’s] management,’’ and hence the court found ‘‘the PBGC’s [2007] reasoning
persuasive.’’
Finally, in the very well-reasoned 10/12 Sun Capital Partners district court decision,
the court:
(a)
flatly rejected the 2007 PBGC Appeals Board ruling,
(b) held that PE/VC fund (which had no employees or office space, was simply a
pool of investment capital holding passive investments, and had only investment
income, i.e., dividends and CGs) was not engaged in a ‘‘trade or business,’’
because PE/VC fund is respected as a separate entity from its related
management and general partner entities (which did have employees who made
PE/VC fund’s investment decisions, did have office space, was involved in the
operations of PE/VC fund’s portfolio companies, and received management
fees), and
(c)
disagreed with the pension plan’s argument that PE/VC fund should be viewed
as a single entity along with its related management and general partner entities.
Thus the court refused to attribute the activities of the management and general partner
entities to PE/VC fund, commenting that the 2007 PBGC decision had ‘‘incorrectly
attributed the activity of [PE/VC fund’s] general partner to the investment fund.’’
A second issue in the 10/12 Sun Capital Partners decision dealt with application of the
80% test. Two Sun funds (formed several years apart) had co-invested in T (which
ultimately went bankrupt), one such fund owning 30% of T’s stock and the other fund
owning 70% of T’s stock, thus raising the question whether either fund should be
viewed as owning 80% of T, perhaps on a substance-over-form approach.1 In the end
1
The ERISA statutory attribution rules (which cover, e.g., attribution among family members, attribution
from an optionor to an optionee, and attribution from an entity to its owners) did not apply because the two
PE/VC funds (although having the same management company/sponsor) were principally owned by
different investors.
17
MORE
the court concluded (as described above) that because the two funds were both
partnerships or LLCs not engaged in a ‘‘trade or business,’’ neither is liable for
T’s unfunded pension obligations even if one fund is viewed as owning 80% or
more of T.
However, the court did discuss application of a specialized ERISA statutory
provision which disregards a transaction (here splitting the T investment between two
PE/VC funds operated by the same management company/sponsor so that neither
PE/VC fund owned 80% of T) if the transaction’s ‘‘primary purpose’’ was to avoid
ERISA group liability. The two commonly controlled PE/VC funds conceded that—
when deciding to split the T investment between the two related PE/VC funds with
neither acquiring 80% of T—they did consider the potential to lessen their exposure
to ERISA group liability, but asserted that they also considered the risk-spreading
inherent in splitting their investment between two PE/VC funds with significantly
different owners. Hence although the Sun decision is not definitive on this point, it
can be read as lending support for respecting multiple investments by related parties
as separate for purposes of applying the 80% ERISA group liability test. See
discussion at ¶1702.3.5(3) and (4).
l
1934 Act reporting company. A 1934 Act reporting company must file extensive
reports with SEC (e.g., annual 10-Ks, quarterly 10-Qs, periodic 8-Ks, annual proxy
statements) and must also comply with many complex SEC rules. In addition to a
company with securities traded on a national securities exchange and a company
which has made a 1933 Act registered public offering, the definition of a 1934 Act
reporting company long included (under §12(g)) a company with at least 500 record
holders of a class of equity securities and at least $10 million of GAAP assets.
A 4/12 statutory amendment changed the number of shareholders (from 500) to at
least 2,000 record holders of a class of equity securities or at least 500 non-accreditedinvestor record holders (except that for a bank or BHC, the test is at least 2,000 record
holders with no additional test based on the number of non-accredited-investor
holders).
In counting record holders under the 4/12 statutory amendment, the company can
ignore (1) securities the equity holder received under an employee compensation plan in
a transaction exempt from 1933 Act registration (such as pursuant to the SEC Rule 701
exemption) and (2) securities acquired pursuant to an offering made under the 1933
Act’s new §4(a)(6) ‘‘crowdfunding’’ exemption from 1933 Act registration.
However, if a company had already completed a 1934 Act registration before the 4/12
statutory amendment was enacted (because the company had the requisite 500
shareholders to require registration under the pre-4/12 version of §12(g)), the
company’s 1934 Act registration continues indefinitely after 4/12 even though the
18
company has fewer shareholders than would require registration after §12(g)’s 4/12
amendment, unless the number of shareholders declines to the level that would allow
deregistration (less than 300, except less than 1,200 for a bank or BHC), but in
counting shareholders after 4/12 the company can use the post-4/12 shareholder-count
rules that allow certain shareholders to be ignored (e.g., a shareholder whose only
shares were received as executive compensation without SEC 1933 Act registration).
See discussion at ¶1702.8.6 and ¶1702.9.2.1(4).
l
1933 Act Reg. D—general solicitation or advertising permitted for Rule 506 sale
solely to accredited investors. In the past no general solicitation or advertising for
potential purchasers has been permitted for a Reg. D offering (with a narrow exception
dependent on state blue sky laws for certain Rule 504 offerings not exceeding $1
million). Hence Newco (or its sponsor or financial adviser/placement agent) has been
permitted to contact only potential investors with whom one of them had a pre-existing
substantive relationship. This rule has long precluded:
n
a publication, broadcast, or other use of mass media methods mentioning the
offering,
n
a seminar or meeting with potential purchasers invited by general solicitation or
advertising,
n
a face-to-face discussion, phone call, letter, or other communication about the
offering to anyone with whom the issuer or its sponsor or financial adviser/
placement agent did not have a pre-existing substantive relationship.
Under a 4/12 statutory amendment (effective when SEC issues regulations), general
solicitation and advertising are permitted for a Rule 506 offering (but not for a Rule
505 offering nor for a Rule 504 offering except for the long-standing Rule 504 narrow
exception dependent on state blue sky laws mentioned above), but only if all purchasers
in the offering are accredited investors.
Although the 4/12 legislation required SEC to promulgate final regulations
within 90 days (i.e., by 7/12)—so that the legislative changes would then be effective—
SEC did not even issue proposed regulations until 8/12 and as of this writing, SEC has
still not finalized those regulations.
SEC’s 8/12 proposed regulations would bifurcate Rule 506 into (i) Rule 506(b) for an
offering where there is no general solicitation or advertising and (ii) Rule 506(c) for an
offering where all buyers are accredited investors and there is general solicitation or
advertising, with Rule 506(c) applicable only if ‘‘the issuer . . . take[s] reasonable steps
to verify that the purchasers . . . are accredited investors’’ and ‘‘reasonably believes that
they [are].’’
19
MORE
While refusing to itemize the ‘‘reasonable steps’’ the issuer must take, the
promulgating release provides this guidance:
n
‘‘The more information an issuer has indicating that a prospective purchaser is an
accredited investor, the fewer steps it would have to take, and vice versa.’’
n
An issuer could rely upon (a) ‘‘publicly available information in filings with a
federal, state, or local regulatory body,’’ including a 1934 Act registered company’s
proxy statement or a tax-exempt organization’s IRS Form 990, (b) IRS Forms
W-2, (c) industry or trade publications, and (d) verification of accredited investor
status from a third party, such as a broker-dealer, attorney, or accountant, where
the issuer has a reasonable basis to rely thereon.
n
‘‘An issuer that solicits new investors through a website accessible to the general
public or through widely disseminated email or social media solicitation would
likely be obligated to take greater measures to verify accredited investor status than
an issuer that solicits new investors from a database of pre-screened accredited
investors created and maintained by a reasonably reliable third party. . . . In the
case of the former, [SEC does] not believe that an issuer would have taken
reasonable steps to verify accredited investor status if it required only that a person
check a box in a questionnaire or sign a form, absent other information about the
purchaser indicating accredited investor status,’’ but in ‘‘the latter [case SEC]
believe[s] an issuer would be entitled to rely on a third party that has verified the
person’s status as an accredited investor, provided that the issuer has a reasonable
basis to rely on such third party verification.’’
n
‘‘The ability of a purchaser to satisfy a minimum investment amount requirement
that is sufficiently high such that only an accredited investor could reasonably
be expected to meet it, with a direct cash investment that is not financed by the
issuer or by any third party, could be taken into account in verifying accredited
investor status.’’
n
It is ‘‘important for issuers to retain adequate records that document the steps
taken to verify that a purchaser was an accredited investor.’’
The release makes clear that an issuer who takes ‘‘reasonable steps to verify’’ a
purchaser’s accredited investor status does not lose the Reg. D exemption (even
where such purchaser is not in fact an accredited investor) as long as the issuer
reasonably believes at the time of the purchase that such purchaser is an accredited
investor.
Where an issuer makes two related securities offerings, one offering with all
accredited purchasers, and one offering which includes a non-accredited purchaser,
the issuer likely forfeits the right to use Rule 506(c) for the all-accredited offering,
20
because there was a non-accredited purchaser somewhere in the integrated offering,
unless the offering in which the non-accredited purchaser participated was a
Reg. S offshore issuance or a Rule 701 issuance, neither of which is integrated with a
Reg. D offering. See discussion at ¶1702.9.2.2(6), ¶1702.9.2.3(5), and ¶1702.9.2.8.
l
Purchase and recap GAAP accounting for the acquisition. When P acquires T,
the accounting carrying value of T’s assets is, under the purchase accounting rules of
FASB 141R (now known as FASB Codification Topic 805), written up (or down) to
the amount P paid (in cash or stock) to acquire T, regardless of the transaction form
(e.g., stock purchase, asset purchase, or merger). A purchase accounting book value
write-up for T’s assets often increases P-T’s post-acquisition (a) GAAP depreciation/
amortization for the old T assets and (b) GAAP impairment write-downs for the
purchased T goodwill and other intangibles. See discussion at ¶1703.1 and ¶1703.2.
However, after FASB 141R’s adoption an unwritten exception to the purchase
accounting rules developed: where the acquisition satisfies the informal requirements
for recapitalization accounting, T’s assets retain their old accounting carrying value on
T’s (post-acquisition) separate financial statements. Two of the requisites for recap
accounting are that (1) T must survive and (2) T’s old non-collaborative shareholders
(i.e., T’s old shareholders who are not part of a collaborative group with P) must
continue to own a ‘‘significant’’ stake in recapitalized T’s common equity, with 20% or
more continuing ownership generally sufficient, in some circumstances more than 5%
sufficient, and in no instance 5% or less sufficient.
When recap accounting applies to T’s carrying value for its pre-acquisition assets on
its separate financial statements, the accountants generally say that P’s new purchase
carrying value for T’s stock is not being ‘‘pushed down’’ to T’s assets on T’s separate
financial statements. See discussion at ¶1703.3.
In 5/12 FASB announced a new push-down accounting project intended to determine
when ‘‘an acquired entity [here T] should establish a new accounting basis in [i.e., apply
push-down accounting to] its standalone financial statements due to a change in its
[here T’s] ownership as a result of a purchase transaction accounted for as a business
combination by the acquiring entity [here P]’’ and if so, ‘‘the level of change in [T’s]
ownership at which the new accounting basis should be required.’’ FASB outlined three
possible viewpoints for the application of push-down accounting:
(1) Substantially all threshold. Push-down accounting should apply to T’s separate
financial statements if (i) P obtains ‘‘substantially all’’ of the controlling
financial interests in T and (ii) such controlling financial interests give P
control over the form of T. In some other contexts, FASB defines
‘‘substantially all’’ as 90%.
21
MORE
(2) Control threshold. Push-down accounting should apply to T’s separate
financial statements if P (i) obtains ‘‘control’’ of T (defined as ‘‘the possession,
direct or indirect, of the power to direct or cause the direction of the
management and policies of an entity [T] through ownership, by contract, or
otherwise’’) and (ii) consolidates T’s financial statements, thus generally
requiring ‘‘ownership of a majority voting interest.’’
(3) No push-down accounting. Push-down accounting should not apply to T’s
separate financial statements because of P’s acquisition of T’s stock. We
understand informally that FASB is unlikely to adopt this viewpoint (3).
In 10/12, FASB expanded the scope of the push-down project to examine whether
new accounting basis (i.e. push-down accounting) should also apply to an entity (T) if a
single party or group obtains control of the entity as a result of an event other than a
purchase and, if so, what level of control would be required to trigger push-down
accounting. The project is also expected to include guidance on when multiple investors
should be considered a collaborative group for purposes of determining the level of
control obtained in a transaction or other event.
By analogy to FASB’s 7/01 decision abolishing pooling-of-interests accounting
prospectively, we believe that any change to push-down purchase accounting should
apply only to a transaction occurring after final FASB rules are published. See
discussion at ¶1703.2.3 (FASB Update).
l
HSR filing for acquisition. A Hart-Scott-Rodino (‘‘HSR’’) filing with FTC/DOJ is
required if the size of an acquisition or investment (and, in certain cases, the size of the
parties to the transaction) exceeds specified numerical tests.
n
Annual inflation adjustment. The authors have updated the HSR discussion to
reflect the 2/13 annual inflation adjustment of all the HSR tests, thresholds, and
filing fees. See discussion at ¶1707.
n
HSR reportable transaction. Amendments to the HSR Rules, proposed 8/13/12, if
adopted, would add a new potentially reportable transaction, treated as an asset
acquisition: a transfer of ‘‘all commercially significant rights’’ to a patent covering
products whose manufacture and sale would generate revenues in the pharmaceutical and medicine manufacturing industry. The proposed amendments define
‘‘all commercially significant rights’’ as ‘‘the exclusive rights to a patent that allow
only the recipient of the exclusive patent rights to use the patent in a particular
therapeutic area (or specific indication within a therapeutic area).’’ Under the
proposed amendments, a transaction in which a pharmaceutical patent owner
grants exclusive marketing and sales rights to a third party, but retains the right to
22
manufacture a product under the patent exclusively for such third party, would be
treated as an HSR asset transfer. See discussion at ¶1707(2).
l
Sample acquisition agreements. Certain of Volume 5’s pro-buyer and neutral (but
not pro-seller) sample acquisition agreements have been revised to reflect IRS’s
assertion that it can require T (the company being acquired by buyer) to include an
amount in T’s income (as a Code §481(a) adjustment) in any taxable year for which the
statute of limitations has not expired to the extent necessary to reverse a deduction that
was claimed by T in a prior taxable year under an impermissible method of
accounting—even if the statute of limitations for the prior taxable year has expired.
l
and much, much more . . .
This publication is designed to provide accurate and authoritative information in regard to the subject matter
covered. It is sold with the understanding that the publisher and the author(s) are not engaged in rendering
legal, accounting, or other professional services. If legal advice or other professional assistance is required, the
services of a competent professional should be sought.
—From a Declaration of Principles jointly adopted by a Committee of the American Bar Association
and a Committee of Publishers and Associations
23
`