Asset versus Stock Acquisitions

1. Asset versus Stock Acquisitions • Nontax issues • Known and potential liabilities of target corporation • Rights and benefits associated with target’s legal entity • Negotiation with target management vs. target shareholders

2. Taxable Asset Acquisitions • Two options: • Direct asset purchase without liquidation of target • Direct asset purchase with liquidation of target or merger • Recall tax consequences: • Target recognizes gain/loss on sale of assets • If acquisition is a merger or target liquidates, target shareholders recognize gain/loss on disposition of their target stock • Acquiring corporation takes a tax basis in targets assets equal to their purchase price

3. Taxable Stock Acquisitions • Tax consequences without Sec. 338 election: • Target recognizes no gain/loss • Tax basis of target assets is not affected (no step-up or step-down to FMV) • Target shareholders recognize gain/loss on disposition of their target stock • Acquiring corporation takes a tax basis in target stock equal to purchase price

4. Taxable Stock Acquisitions continued • Tax consequences with Sec. 338 election: • Target recognizes gain/loss as though its assets were sold for ‘aggregate deemed sale price’ • Tax basis of target assets is stepped-up or down to aggregate deemed sale price • Aggregate deemed sale price = price paid for stock + target’s liabilities assumed + tax on basis step-up or step-down • Target shareholders recognize gain/loss on disposition of their stock • Acquiring corporation takes a tax basis in target stock equal to purchase price

5. Example: Taxable Acquisition Alternatives • Acquiring corporation (A) wishes to purchase the assets of target corporation (T) for $500,000 cash or will pay a price for the stock of T that provides equivalent value to T’s shareholders • T’s assets have a tax basis of $100,000 • T’s shareholders have $150,000 of tax basis in their T stock and have owned it longer than 1 year • T has no liabilities and no NOL, capital loss, or tax credit carryforwards

6. Example continued • What are the tax consequences of the acquisition to T, A, and T’s shareholders under the 4 taxable acquisition alternatives? • Suppose that T owns the following assets: • Inventory with a tax basis of $50,000 and a FMV of $120,000 • Personal property with a tax basis of $50,000 and a FMV of $80,000 (MACRS life of 5 years) • What future tax benefits would A receive by stepping up the basis of T’s assets?

7. Example continued • Suppose that the future tax benefits of the step up are worth $95,000 • Which acquisition alternative would A prefer? Why? • Would A’s preferences change if T had expiring capital loss carry forwards of $150,000? What are the tax consequences of each alternative to A, T, and T’s shareholders in this case?

8. Example continued • Refer back to the original scenario, with no capital loss carry forward. At what price for an asset purchase is A indifferent between an asset purchase and a stock purchase without a Sec. 338 election? • At this price, which option do T’s shareholders prefer?

9. Strategic Issues • Determination of final price is the result of negotiations that often ‘split’ tax costs and benefits • Acquirer should consider tax consequences of alternative transaction forms to the seller in determining a competitive offer • Choice is often between taxable and nontaxable forms as well as between asset and stock acquisitions

10. Practical Issues • How would the acquirer estimate the tax basis of a potential target’s assets, and its other tax attributes, to determine whether an asset or stock purchase is desirable and determine a competitive price? • How would the acquirer determine the tax status of the target’s shareholders? • How would the future tax benefits of a basis step up be determined?