teiFall2013acquisitionagreementFinal Edits-v1

Tax Executives Institute – St. Louis ChapterNovember 21st 2013

Daniel C. WhitePhilip B. WrightBryan Cave LLP

Tax Aspects of the Acquisition Agreementand Related Due Diligence

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I. OverviewA. Acquisition Structure and Scope of Taxes in Acquisition

B. Acquisition Agreement and TaxesC. Tax diligence and the Acquisition: Pricing, Structuring, & Contracts

II. Tax Related Contract ProvisionsB. Purchase PriceC. Representations & WarrantiesD. CovenantsE. Indemnity: Control, Collateral, & EnforcementF. Closing ConditionsG. Miscellaneous

III. Examples

Tax Aspects of the Acquisition Agreementand Related Due Diligence

Acquisition Structure and Scope of Taxes in the Acquisition

ClosingDate

Pre-Closing Period Post-Closing Period

• Legacy liability• Attributes/basis• Tax Status of Target (e.g.,

disregarded, consolidated)

• Income tax• Transfer/Recordation tax• Withholding • Employment tax

• Basis step-up• Attribute carryover• Misc. (e.g., OFL, Audits)

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Acquisition Agreement & TaxesI. Purchase Price

A. Structure 1. Tax

a. Taxable vs. tax-free (e.g. Reorganization, Section 351)

b. Single level vs. double tax. (See also, no tax and triple tax)

c. Other taxes (e.g., transfer, withholding, employment, VAT

2. Non-Taxa. Legacy Liabilities b. Contractc. Change of control issues

(consents, licenses, title)

B. Pricing – Effect of Taxes

(Income taxes vs. non-income taxes and EBITDA pricing)

C. Purchase Price Adjustments and taxes1. Net working capital, Owners

Equity, and Other Adjustments2. “Cash” taxes vs. Deferred taxes

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Acquisition Agreement & Taxes

II. Representations and WarrantiesA. Overview (What is a ‘representation’) B. Purposes of Representations

1. Diligence 2. Closing Condition3. Indemnity

C. Majors/Big 3 (taxes paid; returns filed; returns correct)

D. Issues not covered by the Big 3 (e.g., no income deferral)

E. Due Diligence ItemsF. Tax Representations not in the “Tax”

Section (e.g., interim actions, financial statements)

III. Tax CovenantsA. Acquisition Structure and Covenant

ScopeB. Transfer taxesC. Preparation and Review of Tax Returns

filed after ClosingD. Straddle Period TaxesE. Amendment of Tax Returns, Refunds of

Pre-Closing/Straddle Taxes, and Carryback of Attributes

F. Tax audits and CooperationG. Other (e.g., structure specific covenants,

intercompany accounts)

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Acquisition Agreement & Taxes

IV. Indemnity

A. Pre-Closing Taxes and Straddle Period Taxes

B. Taxes Arising from the Transaction

C. Post-Closing Taxes

1. Arising from adjustments to pre-closing periods

2. Other

D. Limitations

1. Minimum claims

2. Baskets/Deductibles

3. Caps

4. Survival

5. Buyer Tax Acts

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Acquisition Agreements & Taxes

V. Closing ConditionsA. Representations true in all

material respects/ failure to have a “material adverse effect”

B. Withholding (backup, FIRPTA, wages, tax clearance)

C. ElectionsD. Tax opinions

VI. Miscellaneous Tax ItemsA. Definitions

1. Taxes2. Tax Returns3. Governmental Entity4. Current Assets/Current Liabilities5. Liens/Permitted Liens

B. Other

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Tax Diligence & Its Role in the Acquisition

TaxDiligence

Contract

Schedules

Collateral/Structure

PurchasePrice

Tax Diligence & Role in Acquisition Agreement

I.PurposeA. Identify Pre-Existing Tax Liabilities / ExposureB. Identify and Allocate Transactional Tax Liabilities / Attributes

Example: Target has outstanding employee stock options the payment of which will give rise to a deduction. The parties should take the tax benefit of the deduction into consideration in structuring and in pricing the transaction.

C. Identify opportunities and Post-Closing IntegrationExample: Purchaser should consider the effect on its federal, state and foreign taxes as a result of the acquisition, e.g. allocation and apportionment or nexus considerations.

II. Effect of Acquisition Structure on Due DiligenceA. Target Tax Classification (Entity Level versus Pass Through Taxes)B. Actual vs. Deemed Asset Acquisition

Example: Legacy tax liabilities generally will remain with acquired entity regardless of structure treatment as an “asset acquisition” for federal income tax purposes

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Due Diligence Process• Industry / Business• Corporate Documents and Capital Structure

• Debt / Equity, including Second Class of Stock (S Corporation)

• Interest Deduction Limitations (AHYDO & Section 163(i))

• Significant Contracts• Acquisition Agreement (Potential Successor

Liability)• Loan Agreements• Lease Agreements (Nexus / Tax

Indemnification)• Supply and Distribution Agreements (Nexus)• Customer Contracts (Prepaid Income)• Employment Agreements / Plan Document

Review

• Joint Venture Agreements

• Tax Strategies• Financial Derivatives• License Agreements (Nexus / Withholding)

• Law Suits / Settlements• Deduction versus Capitalization

• Withholding and Information Reporting

• Financial Statement Review• Tax Items

• Tax Returns and Workpapers• Tax Jurisdictions• Return and Workpaper review• Tax Attributes

• Information Reporting, FBAR and FATCA Compliance

• Examinations• Tax Elections and Accounting Methods

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• Acquisition Structure & Diligence Effect• Asset versus Entity

• Pure Asset Purchase

• Entity Purchase• General

• Entity Classification (Corporate, Partnership, or Disregarded Entity)

• S Corporation or Affiliated Corporation

• Stock Acquisition• General

• Legacy Tax Liabilities / Attributes

• Consolidated Group Member

• Deemed Asset Transactions

• Section 338 Election

• Forward Cash Merger

• Section 336(e) Election

• Partnership Interest / Disregarded Entity Purchase

• Successor Liability• General

• Consolidated Return – Joint & Several Liability Treas. Reg. Section 1.1502-6

• Transferee Liability (Sections 6901-6905)

• State Law

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Tax Related Contract Provisions

• Purchase Price / Acquisition Structure• Consideration

• Recipients • Equity Holders• Option Holders• Creditors• Others (Transaction Expenses)

• Withholding• Purchase Price Adjustments

• Closing Adjustments• Working Capital• Net Equity• Hybrid

• Post-closing Adjustments• Earn Out• Escrow

• Section 1060 Allocation• Liabilities• Covenant Not to Compete• Reporting

• Tax Characterization• Installment Reporting• Tax Free Reorganization• Deemed Asset Purchase – Rev.

Rul. 99-6

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Contract Provision: Purchase PriceAdjustment

Example – Working Capital AdjustmentNet Working Capital means, as of [12:01 a.m.], Central Standard Time on the Closing Date, the excess of the Current Assets of the Company (excluding any Cash, Tax receivables and deferred Tax assets of the Company) over the current liabilities of the Company and its Subsidiaries (excluding any deferred Tax liabilities, Indebtedness and Company Transaction Expenses and including any current and long-term deferred revenues), in each case as reflected on the balance sheet of the Company as of such date.

See also Treas. Reg. 1.1502-76(b)(1)(ii)(A).

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Contract Provision: Purchase PriceExample - Purchase Price Covenants

Withholding: Notwithstanding any provision in the Agreement to the contrary, Buyer shall be entitled to deduct and withhold from any consideration otherwise payable under the terms of this Agreement such amounts as it is required to deduct and withhold pursuant to any provision of Law related to or regarding Taxes. To the extent that amounts are so withheld by Buyer under any provision of this Agreement, such withheld amounts (i) shall be remitted by Buyer to the applicable Governmental Authority in accordance with applicable Law and (ii) shall be treated for all purpose of this Agreement as having been paid to the recipients in respect of which such deduction and withholding were made by Buyer.

Allocation of Purchase Price: Seller shall prepare a schedule allocating the Purchase Price in accordance with section 1060 of the Code and the Regulations thereunder. Seller shall deliver such schedule to Buyer within ___ days after the Closing Date and shall permit Buyer ___ to review and comment. Seller shall make such revisions to the schedule as are reasonably requested by Buyer within ___ days of receiving Buyer’s comments, and the parties shall use reasonable efforts to resolve any disagreement with the schedule. In the event the parties agree to a schedule, Seller and Buyer shall file all Tax Returns consistent with such allocations and neither Seller nor Buyer shall take any tax position that is inconsistent with such allocation unless required by applicable law. [Notwithstanding the foregoing, in the event that Buyer and Seller are not able to arrive at a mutually agreeable allocation, each of Seller and Buyer may adopt a separate allocation of the purchase price as such party shall determine, and each party may use its own separate allocation in filing its own Tax Returns.]

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Contract Provision: Tax Representations

Tax Representations•General

• Representations speak to the condition of the asset or business at the relevant time (e.g., Closing Date or the date of the most recent financial statements)

•Purposes • Closing Condition• Due Diligence

• Indemnification•Considerations

• Multiple Entities (Coverage) • Depth and Breadth of

Representations - Scope• Relationship to

Indemnification• Disclosure Schedules and

Effect on Indemnification• Possible Taxing Authority

Review of Contract

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Example – Tax Representations (Majors / Big Three)

Filed Returns: All Tax Returns required to be filed by the Company or any of its Subsidiaries on or before the Closing Date have been timely filed Returns Accurate: All such Tax Returns are complete and accurate [in all material respect]Tax Paid: All Taxes (whether or not shown on any such Tax Return) for which the Company or any of its Subsidiaries are liable have been timely paid [or accrued]

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Example – Other Representations

Unrecognized Income: Neither the Company nor any of its Subsidiaries will be required to include or accelerate the recognition of any item in income, or exclude or defer any deduction or other tax benefit, in each case in any taxable period ending after the Closing Date, as a result of any change in method of accounting, closing agreement, intercompany transaction, installment sale, or the receipt of any prepaid amount, in each case prior to Closing.

Successor Liability: Neither the Company nor any of its Subsidiaries has any liability for Taxes of another Person under Treasury Regulation Section 1.1502-6 (or similar provision of other Tax Law), under any agreement the principal subject matter of which is Taxes [(and excluding any commercial agreements entered into in the ordinary course of business)] or as a transferee or successor.

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Disregarded Entity: At all times since its organization, the Company and each Non-Corporate Subsidiary has been properly disregarded as an entity separate from its owner for federal Income Tax purposes pursuant to Treasury Regulations Section 301.7701-3 and no election has been made, no Tax Return has been filed, and no other action has been taken, in each case inconsistent with such treatment. Affiliation: Each Corporate Subsidiary of the Company is properly treated for federal Income Tax purposes as a corporation that is wholly owned by Seller and a member of the same federal Income Tax consolidated group as Seller. Disregarded Entity: With respect to all periods on and after [Date], Seller has filed state Income Tax Returns consistent with each Non-Corporate Subsidiary being disregarded as an entity separate from its owner.

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Interim Tax Events: Since the Balance Sheet Date, the Company and its Subsidiaries have not:made any new Tax election or changed any Tax election, amended any Tax Return relating to the Company, made any closing agreement with respect to any Tax, taken any action or failed to take any action if such action or omission would have the effect of materially increasing the Tax liability or reducing any Tax asset of the Company, changed any accounting period, settled any Tax claim or assessment relating to the Company or its Subsidiaries, surrendered any right to claim for a Tax refund or other reduction in Tax liability of the Company, consented to any extension or waiver of the limitation period applicable to any Tax claim or assessment relating to any of the Company or its Subsidiaries, or any other similar action relating to the filing of any Tax Return or payment of any Tax, except to the extent, in each case, required by a change in Applicable Law.

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Covenants• General

• Obligations imposed on contracting parties

• Pre-Closing Covenants• Business Operations e.g. Elections,

amended returns

• Closing (Post-Closing) Covenants• Transfer Taxes

• Pre-Closing and Straddle Tax Periods• Filing and Preparation of Returns

• Payment of Taxes

• Amended Returns and Tax Refunds

• Post-Closing• Tax Audits

• Record Retention / Cooperation

• Termination of Intercompany Agreements

• Other• Elections

• Tax Free Transactions

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Contract Provision: Tax Covenants

Contract Provisions: Tax Covenants

Example – Tax Covenants

Pre-Closing Return Preparation: Seller shall prepare and file, or cause to be prepared and filed, in a timely manner all [Income] Tax Returns required to be filed by or with respect to the Company or any of its Subsidiaries for Pre-Closing Periods regardless of whether such Tax Returns are due before, on or after the Closing Date and Seller shall remit or cause to be remitted any Taxes due in respect of such Tax Returns except to the extent paid prior to Closing, paid by Seller after Closing, or accrued as a liability in determining Closing Working Capital. All Tax Returns that Seller files or causes to be filed in accordance with this Section shall be prepared and filed in a manner consistent with past practices employed by Seller, the Company or its Subsidiaries, except as otherwise provided by this Agreement or required by Law. Buyer shall not amend any Pre-Closing Period Tax Return of the Company or any of its Subsidiaries without Seller’s prior written consent, which shall not be unreasonably withheld.

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Contract Provisions: Tax Covenants

Example – Tax Covenants

Intercompany Accounts: As of the Effective Time, all Inter-company Accounts will be cancelled without any liability to Seller, its Affiliates, the Company, or any of its Subsidiaries. The Seller shall cause its Affiliates to release any and all claims against the Company and its Subsidiaries with respect to such Inter-company Accounts and shall cause the Company and its Subsidiaries to release any and all claims against the Seller and its Affiliates with respect to such Inter-company Accounts.

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Contract Provisions: Indemnity

I. GeneralA. Representations and

WarrantiesB. Pre-Closing and Closing Taxes

1. Post-Closing periods from a pre-closing event

C. Buyer ActsD. Survival PeriodE. Baskets and Caps

II. Claims ProceduresA. Separate Tax versus General

ClaimsB. Commencement of Audit

III.Character of PaymentsA. Purchase Price Adjustment

IV.Tax Benefit / Tax DetrimentA. Actual versus Hypothetical

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Contract Provisions: Tax Indemnity

Tax Indemnification – Example

Seller shall indemnify the Buyer for Target’s Taxes or its liability, if any (for example, by reason of transferee liability or application of Treasury Regulation Section 1.1502‑6) for Taxes of others (i) for any Tax period (or portion thereof) ending on or before the Closing Date, and (ii) as a result of the transactions contemplated by this Agreement (except to the extent and in such amount as such Taxes are reflected as an accrued liability and taken into account in the determination of the Purchase Price). Such Tax indemnification obligation shall be in addition to, but not duplicative of, Seller’s indemnification obligation with respect to a breach of a Tax Representation or Tax Covenant contained in the general indemnification section of this Agreement.

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Contract Provisions: Closing Conditions & MiscellaneousClosing Conditions / Deliverables

• General

• Representations and Warranties

• Tax Specific• FIRPTA Certificates

• Tax Clearance Letters

• Tax Opinion / Tax Representation Letters

• IRS Forms W-9 or W-8 BEN

• Definitions• Taxes

• Tax Returns

• Effective Time

• Closing Date

• Straddle Periods

• Transfer Taxes

• Assumed Liabilities

• Indebtedness

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Contract Provisions: Misc. Definitions

Definitions:

“Tax” or “Taxes” means (i) all taxes, assessments, levies, customs, duties, governmental charges or other like amounts imposed by any Governmental Authority, including…net income, gross income, profits, employment, franchise… customs duties, environmental, escheatment, unclaimed property, together with all penalties, additions to tax and interest relating thereto, and (ii) any liability for the payment of amounts determined by reference to amounts described in clause (i) as a result of being or having been a member of any group of entities that files, will file, or has filed Tax Returns on a combined, consolidated or unitary basis, as a result of being a transferee or successor or by operation of Law. “Tax Return” means any return, declaration, report claim for refund or information return or statement relating to Taxes, required by Law to be filed, including any schedule or attachment thereto, and including any amendment thereof.

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Indemnification Limitations - Example

Buyer Tax Acts: For the avoidance of doubt, Seller shall not indemnify and shall hold harmless the Buyer from and against any Taxes that result from any Buyer Tax Act.“Buyer Tax Act” means any action taken after the Closing by the Buyer or any of its Affiliates (including the Company or any Subsidiary) with respect to the Company or any Subsidiary outside the ordinary course of business of the Company or any Subsidiary, except as otherwise contemplated by this Agreement.

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Contract Provisions: Tax Indemnity

Examples

Question 1:

Company is purchasing all of the interests in an LLC. Does the contract and due diligence need to address legacy (Successor) liability for the entity’s income taxes.

TRUE or FALSE?

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Successor Liability – Example

T

Seller

OldCo Merge

Purchaser

T

Example: Target is a disregarded entity, wholly owned by seller, and has never been subject to federal income tax at the entity level. Target acquired business assets two years earlier when another entity (OldCo) merged with and into Target with Target surviving. Target is the successor entity with respect to OldCo under state law as a result of the merger and is liable for any taxes of that predecessor entity.

Two Years Prior

Question 1: Example A

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P

Shareholder

T

Purchaser

Example: T corporation is a member of an affiliated group of corporation filing a consolidated return. T converts under applicable state law into a limited liability company that is “disregarded” for federal income tax purpose. The conversion likely constitutes the distribution of assets to its member in liquidation of the entity for federal income tax purposes. A purchaser of T will be treated for federal income tax purposes as acquiring the assets (and assuming the liabilities) of the T entity, thus permitting it to treat the transaction as an asset acquisition, however, T remains potentially liable for the taxes of the consolidated group for any periods it was a member of that group as well as any federal, state or other taxes imposed on the entity.

Deemed Asset Purchaser – Successor Liability

T

Question 1: Example B

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Question 2:Company is purchasing a subsidiary of a consolidated group and the agreement provides for a Section 338(h)(10) election.

Does the contract and related due diligence need to address any any taxes other than those of the Target.

TRUE or FALSE?

Examples

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Successor Liability – Example (Liquidation versus Merger)

T

OldCo OldCo

T

Merger Liquidation

Example: Target had previously acquired all of the stock of another corporation (Old Co) from the common parent of an affiliated group that filed consolidated returns and of which OldCo was a member. OldCo was merged upstream into Target following Target’s purchase of OldCo. Target is potentially liable for the consolidated tax liability of the group of which OldCo was a member for the period it was a member. A purchaser of Target will purchase Target subject to the potential liability for the entire tax liability of the OldCo group for the period OldCo was a member.

NOTE: If instead OldCo adopted a plan of liquidation under applicable law, Target would be the successor with respect to OldCo’s prior tax liabilities to the extent it were considered a transferee and likely only to the extent of the fair market value of any assets received in the liquidation.

Questions 2: Example

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Question 3:Company is purchasing an S corporation and the agreement provides for a Section 338(h)(10) election. The due diligence indicates that the company has been a valid S corporation since formation.

Does the contract and related due diligence need to address possible corporate level taxes (section 1374).

TRUE or FALSE?

Examples

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T

Shareholder

X

Purchaser

Example: T corporation is a valid S corporation that has always been an S corporation. T purchased X (a C corporation) five years ago and merged it into T.

Deemed Asset Purchaser – Successor Liability

Question 3:

P

Question 4

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Seller

Target

PurchaserOptionees

Example: Target corporation is bought by Purchaser for $100X, of which 90% is payable to Seller and 10% is payable to the holders of employee stock options in Target. $80X is payable at Closing and $20X is placed in escrow to secure the obligations of Seller and Optionees.

Questions: • When is Seller taxed on $72X (90% of $80X) payable at Closing?• When are optionees taxed on $8X (10% of $80X) payable at Closing? Who pays the employer share

of employment taxes? How is wage withholding effected? Who gets the tax benefit of the compensation deduction, if any?

• When is Seller taxed on the $18X in escrow?• When are optionees taxed on the $2X in escrow? Employment taxes? Withholding? Who gets the

benefit of any deductions?

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Asset versus Stock Treatment – Corporate Level Gain

T

S

P

Merger

Example:

T is a C corporation. P is acquiring T solely for cash via a merger with S. Does the direction of the Merger (forward versus reverse matter).

Questions 5: Direction of the Merger

teiFall2013acquisitionagreementFinal Edits-v1

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