M&A Shop Talk IX

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This blog is a continuation of a three part series, the first blog can be found here. As previously discussed, when negotiating the best selling price for your business, tax attributes like NOLs and R&D credits play an important factor during negotiations. Such attributes allow the seller to economically accommodate the buyer with an asset acquisition transaction, which if properly structured would prevent the transaction proceeds from being doubly taxed.

The general rule of thumb in a negotiation process works so that the inherit tax benefits the buyer party receives will at minimum approximate the present value of the 15 years amortization deduction attributable to purchased intangibles. Therefore, it is imperative as the seller that before the letter of intent and/or exclusivity letter is executed, you reach an agreed to percentage of the described minimum tax benefit with the buyer. Moreover, at minimum you want the buyer party to make you whole in case there are not enough tax attributes carried over at the target entity level to offset the anticipated asset sale gain, and thus prevent the double taxation ramifications.

In the context of a typical exiting scenario involving a stand-alone “Target entity”, that is C corporation structured with large NOLs and R&D credits carried over, there are two basic tax structuring approaches to evaluate that could conceivably yield similar tax results that would appear more favorable toward the seller.

The first approach if there are no contract novation constraints, is to consummate a straight asset sale transaction followed by a liquidation of the target entity. Accordingly, an analysis calculation must be conducted beforehand to make a determination of whether the estimated calculated gain from the asset sale structured transaction will be entirely offset with the target entity’s carried over tax attributes. If following this route, make sure to take into consideration transaction bonuses, etc. Now, the net liquidation proceeds from the asset sale would be accordingly taxable to the investor’s selling group and taxed at the preferential federal long-term capital gain rate of 20% and state domiciliary rate, if applicable. From a pure liability assumption protection perspective, this approach would be the most beneficial to the buyer party.

The second approach to consider would entail completing a qualified stock sale to make an IRC Section 338 election under IRC Section 338(g) tax regime hereafter referred to as “regular Section 338 election”, to treat such qualified stock sale as a deemed asset sale at the target entity level for tax reporting purposes. Accordingly, from a pure contract novation perspective, it would be the most attractive legal structure to the buyer party. However, from a liability assumption risk management perspective, the buyer party assumes all inherit liabilities of the target entity including unknown contingencies that would require seller party indemnification (i.e., generally 10% to 15% of the base price will be held back in escrow and subject to indemnification terms and conditions). Please note to effect a regular Section 338 election, at least 80% of the underlying stock ownership must be sold within a certain 12-month period and certain legal and administrative requirements must be agreed and complied thereto by the seller and buyer parties.

Now, under a IRC Section 338(g) tax election, tax regime, the selling shareholders irrespective of the asset gain recognition transaction as described above are required to report the stock sale. Lastly, all the tax attributes of the target entity can only be utilized by the selling target entity with the filing of its final return.

Next time on M&A Shop Talk we’ll work through an example illustrating the utilization of tax attributes under IRC Sections 382 through 384 limitation provisions as discussed in the initial blog. We’ll incorporate a summary analysis of both described structuring alternatives, including the pros and cons for selecting each. In the meantime, if you have any questions or need additional information, please feel free to call me at 301-222-8220 or email me at jrodriguez@aronsonllc.com.



About Jorge Rodriguez

Jorge Rodriguez has written 26 post in this blog.

Jorge L. Rodriguez, CPA, serves as a partner in Aronson's Tax Services Group. He is a seasoned professional with more than 25 years of public accounting experience. He is known for delivering a broad, in-depth tax perspective, informed by his deep, wide-ranging industry knowledge, to every engagement for the benefit of his diverse clientele. Jorge specializes in federal tax consulting and compliance with a special focus on M&A transaction structuring, planning, and modeling. He routinely helps his clients resolve highly complex tax matters including: entity formation, classification, and conversion planning issues; accounting method and period elections and changes; consolidated tax return filling elections and tax accounting concerns; Sec 382 analysis and study; and all aspects of ASC 740 compliance involving purchase accounting and foreign operation reporting areas. Jorge works with a broad cross section of companies. His clients include emerging businesses, middle-market firms, and public business enterprises engaged in a wide variety of industries including government contracting, software development, light manufacturing, IT technology services and products sales, and specialty construction contracting. Jorge is passionate about helping his clients formulate tax strategies that make business sense. He shares his expert insights freely as a regular contributor to Aronson’s Tax Matters blog with series such as “M&A Shop Talk.” Prior to joining Aronson in 2009, Jorge was a practicing tax partner with several regional public accounting firms. He is licensed to practice in Maryland and Virginia. Professional & Community Involvement: Maryland Association of Certified Public Accountants: Member American Institute of Certified Public Accountants: Member Education: University of Maryland: Bachelor of Science in Accounting -Ongoing education in tax matters

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