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Taxable Acquisitions

Taxable Acquisitions. Asset Sale. Purchase of Marriott Assets. Sodexho Shareholders. Marriott Shareholder. Sodexho (Aquiring Co). Host Marriott (Target) Food Services. $400,000 Cash. Food Services Assets : Basis $40,000 ; FMV $400,000. Sale of Host Marriott Assets.

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Taxable Acquisitions

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  1. Taxable Acquisitions

  2. Asset Sale

  3. Purchase of Marriott Assets Sodexho Shareholders Marriott Shareholder Sodexho (Aquiring Co) • Host Marriott • (Target) • Food Services $400,000 Cash Food Services Assets: Basis $40,000 ; FMV $400,000

  4. Sale of Host Marriott Assets • Assume Sodexho pays cash, $400,000, for all of the assets of Host Marriott. • Sodexho obtains a cost basis in the assets purchased. • Host Marriott recognizes gain on the asset sale. • If liquidated thereafter, Host Marriott shareholder recognizes gain or loss on his stock (FMV of property received minus stock basis).

  5. Sale of Host Marriott Assets • Same outcome if the assets are sold by the Host Marriott shareholder following a liquidating distribution of those assets. • Host Marriott recognizes gain on the deemed sale under Code Sec. 336 • Host Marriott shareholder recognizes gain or loss under Code Sec. 331 • Host Marriott shareholder takes an FMV basis in distributed asset so no further gain when the assets are sold to Sodexho.

  6. Allocation of Purchase Price • With respect to the allocation of purchase price to goodwill or going-concern value, §1060, enacted by the 1986 TRA, generally mandates the use of the residual method to allocate purchase price in actual asset sales, in addition to deemed sales under §338.

  7. Code Sec. 1060 Residual Method • The residual method's system of priorities is based on seven asset classes: • Class I assets are cash and cash equivalents, including general deposit accounts other than certificates of deposit held in banks, savings and loan associations, and other depository institutions. • Class II assets are actively traded personal property within the meaning of §1092(d)(1) and Regs. §1.1092(d)-1.505 • Class III assets are certain debt instruments and those assets that the taxpayer marks to market at least annually for federal income tax purposes and debt instruments.

  8. Code Sec. 1060 Residual Method • Class IV assets are stock in trade of the taxpayer or other property of a kind that would properly be included in the taxpayer's inventory if on hand at the close of the taxable year. • Class V assets are all assets other than those included in the other six asset classes. • Class VI assets are all §197 intangibles except goodwill and going-concern value. • Class VII assets are goodwill and going-concern value, regardless of whether they otherwise qualify as a §197 intangible.

  9. IRS Form 8594 • Form 8594, Asset Acquisition Statement Under Section 1060, must be filed by the buyer and seller of assets used in a trade or business to which goodwill or going concern value could attach (Reg. §1.1060-1(e)(1) ). Information that must be reported includes: • the amount of the purchase price; • the allocation of the purchase price to goodwill or going concern value; and • any information concerning subsequent adjustments to the purchase price. • Form 8594 is filed with the return for the tax year that includes the first date assets are sold pursuant to the applicable asset acquisition.

  10. Stock Sale

  11. Stock Sale by Host Marriott Shareholders • Assume that Host Marriott is an old and cold corporation containing a food services business. • Sodexho wishes to purchase the stock rather than the assets because of: • difficulties of transferring certain assets • non-tax attributes of the target corporation which could not be transferred in an asset purchase. • a desire to avoid inheriting historic target liabilities, preferring to keep the acquired entity outside of its own corporate shell.

  12. Stock Purchase Consequences • Assume Sodexho purchases all of the Host Marriott stock for $400,000 • Assume (for simplicity) that Host Marriott is owned by one shareholder with a stock basis of $10,000.

  13. Taxable Purchase of Marriott Stock Sodexho Shareholders Marriott Shareholder $400,000 Cash Stock basis = $10,000 (FMV $400,000) Sodexho (Aquiring Co) • Host Marriott • (Target) • Food Services Food Services Assets: Basis $40,000 ; FMV $400,000

  14. End Result of Stock Purchase Sodexho Corp Shareholders Sodexho Basis in Host Marriott Stock = $400,000 100% Host Marriott (Sub) Asset Basis $40,000 ; FMV $400,000

  15. Stock Purchase Consequences • Marriott Shareholder recognizes $390,000 ($400,000 - $10,000) of LTCG on the stock sale. • Sodexho’ stock basis (outside basis) is $400,000, • The inside basis (asset basis) for Host Marriott assets, remains at $40,000. • Note, if Host Marriott has NOLs, they will potentially be limited by Code Sec. 382 (post-acquisition)

  16. Subsequent Liquidation of Host Marriott • If Host Marriott liquidates into Sodexho, neither the parent (Sodexho) nor subsidiary (Host Marriott) recognizes gain or loss per Code Sections 332 and 337. • Asset basis and tax attributes carry over to Sodexo per Code Sec. 334 • The purchase and liquidation are not integrated into an asset purchase even if planned from the outset. • Sodexho’s use of Host Marriott NOLs would be subject to limitation under Code Sec. 382 (discussed later).

  17. Liquidation and Dissolution Of Host Marriott Sodexho Corp Shareholders Sodexho Host Marriott Stock Basis of $400,000 100% Host Marriott H.M. Asset Basis $40,000 ; FMV $400,000

  18. Stock Salewith Section 338(g) Election

  19. 338(g) Election • Can Host Marrriott’s assets be stepped up to match the purchase price (and stock basis)? • Yes, with a Section 338(g) election (regular 338 election). • A corporation that purchases 80% of the stock of a target corporation within a 12-month period can irrevocably elect, per 338(g), to treat the stock purchase as an asset acquisition.

  20. Consequence of Sec 338 Election Sodexho Corp Shareholders Sodexho Host Marriott Stock Basis of $400,000 100% Host Marriott H.M. Asset Basis $400,000 ; FMV $400,000

  21. 338 (g) Election Consequences • To Seller (Marriott Shareholder) LTCG of $390,000 ($400,000 - $10,000) is recognized—same as without the 338(g) election. • Sodexho’ stock basis (outside basis) is $400,000 (same as without Sec. 338). • The inside basis (asset basis) for Host Marriott assets is $400,000 (verses 40,000 w/o Sec. 338) • This higher asset basis is THE tax benefit of the Sec. 338(g) election. • At what tax cost? Target recognizes $360,000 of gain.

  22. 338(g) Election Consequences • If the election is made: • the target corporation (Host Marriott) is treated as if it sold all of its assets at the close of the first day that the purchaser has acquired 80% of the target's stock, i.e., the "acquisition date.“ • the target (Host Marriott) is then treated as a new corporation ("new target") that purchases, on the day after the acquisition date, old target's assets at a price that reflects the price paid for target's stock plus target's liabilities and other adjustments.

  23. 338(g) Election Consequences • Old Target is treated as selling its assets for their “aggregate deemed sale price” (“ADSP”). Reg. 1.338-4(b)(1), (d). • New Target’s basis in its assets is the “adjusted grossed-up basis” (“AGUB”). Reg. 1.338-5(a). • Old target's (Host Marriott’s) tax attributes are extinguished and new target starts with a clean slate.

  24. 338(g) Election Consequences • The price for new target's basis step-up is immediate double tax: • One incurred by the seller (Host Marriott shareholder) on the sale of the target stock (same as without Sec. 338 election) • and • another on old target's (Host Marriott’s ) deemed sale of its assets.

  25. 338(g) Election Consequences • The seller is responsible for any tax liability arising out of the stock sale. • The deemed asset sale occurs on the acquisition date, and any tax liability resulting from such sale is old target's liability and, absent contractual provisions to the contrary, is effectively borne by the purchaser (Sodexho) as the owner of new target.

  26. Why elect 338(g)? (regular 338 election) • Normally Not. Normally, with a domestic target, the double tax from the immediate gain recognition (as factored into the negotiated price) far exceeds the present value of the tax benefit to Target Corp from the higher cost basis. A current tax increase in exchange for a smaller deferred tax benefit. • Foreign Targets. • If Target is a foreign corporation not subject to U.S. tax, Purchaser should consider a Section 338 election because Purchaser may be able to avail itself of the basis step-up in the foreign Target's assets without exposing the non-U.S. taxpaying foreign Target to U.S. tax on the corresponding gain recognition.

  27. Why elect 338(g)? (regular 338 election) • NOLs. • Purchaser should consider a Section 338 election when Target has sufficient net operating losses ("NOLs") or net capital losses (or tax credits) to offset gain recognition (or tax due) as a result of the election. • Particularly if Target has NOL carryovers which are likely to expire before they can be utilized or which will be limited by Section 382.

  28. 338(h)(10) Election

  29. 338(h)(10) Election • A 338(h)(10) election is desirable (relative to a Sec. 338 election) because the sale of target stock is ignored for federal income tax purposes. • Consequently, a §338(h)(10) election results in a single level of federal income tax, imposed on the deemed asset sale.

  30. 338(h)(10) Election Availability • A §338(h)(10) election is available for a domestic target that is a member of an affiliated group, as well as for subchapter S corporations. • The election is made jointly by the purchasing corporation, on the one hand, and the selling consolidated group, the selling affiliate, or the S corporation shareholders • The §338(h)(10) election must be made not later than the 15th day of the 9th month beginning after the month that includes the acquisition date.

  31. Taxable Purchase of Marriott Stock Marriott Shareholder Sodexho Shareholders $400,000 Cash For Host Marriott Stock • Marriott International • Hotel Management Sodexho (Aquiring Co) 100% • Host Marriott • (Target) • Food Services Food Services Assets: Basis $40,000 ; FMV $400,000

  32. End Result of Sec 338(h)(10) Election Sodexho Corp Shareholders Sodexho Host Marriott Stock Basis of $400,000 100% Host Marriott H.M. Asset Basis $400,000 ; FMV $400,000

  33. 338(h)(10) Election Logic • Note that with a corporate parent owning 80% or more of a subsidiary, such as Host Marriott on these facts, the assets of the subsidiary could be liquidated (tax free with a transferred basis per Code Secs. 332 and 337). • Therefore, Marriott International could have liquidated Host Marriott and sold the assets to Sodexho (the purchaser) and have only one level of taxable gain –on the asset sale. • Compare if Host Marriott were owned by an individual. Code Secs. 331 (stock sale) and 336 (deemed assets sale on liquidation) would trigger double tax.

  34. 338(h)(10) Election Logic • Same result, one level of tax on a sale of assets, if Host Marriott sells its assets to Sodexo and then liquidates into Marriot International. • Marriott International would be protected from gain on receipt of the cash, in liquidation of Host Marriott, by Code Sec. 332. • Essentially, Sec. 338(h)(10) pretends that the above two steps occurred.

  35. Impact of 338(h)(10) Election • Result: • Gain of $360,000 to Target (Host Marriott) on deemed asset sale. • The basis of the assets of the Host Marriott subsidiary (owned by Sodexho) are reflected at FMV (as if purchased). • No gain to Marriott International (shareholder) on the actual stock sale. • Marriott International inherits the tax attributes of Host Marriott.

  36. 338(h)(10) Election Requirements With 338(h)(10), the C corporation Target must be a subsidiary, but not necessarily file a consolidated return. Unlike 338(g), 338(h)(10) will not work for the purchase of stock of a freestanding C corporation. However, 338(h)(10) does apply to the purchase of a freestanding S Corporation. For both 338 elections, the buyer must be a corporation (not an individual).

  37. 338(h)(10) Regulations • The current §338(h)(10) regulations were finalized in February 2001 and seek to treat all relevant parties as if they had actually engaged in the transactions deemed to occur. • Under the final regulations, if a §338(h)(10) election is made for target, target is deemed to have sold all of its assets while a member of the selling group and to have distributed the proceeds to the selling group before target terminates its existence.

  38. 338(g)/338(h)(10) Election Form Form 8023 Form 8023 Instructions

  39. Why Elect 338(h)(10) Election • Lower Inside Gain—both seller and buyer benefit from election (win-win). • Consider a joint election under Section 338(h)(10) where the gain from a stock sale (outside gain) would exceed the gain from a deemed asset sale (inside gain). • Because the stock sale (outside gain) is ignored in a Section 338(h)(10) transaction, Seller would minimize its gain recognition while Purchaser would receive a basis step-up in the Target assets—win,win.

  40. Why Elect 338(h)(10) Election • Despite Higher Inside Gain—small tax cost to seller may be more then offset by benefit to buyer. Even with higher inside gain the election should be the subject of price negotiations if the tax on the excess of "inside gain" over the "outside gain", the incremental tax cost to Seller of making a Section 338(h)(10) election, is less than the present value of Purchaser's aggregate benefits from a deemed asset sale (e.g., anticipated depreciation and amortization deductions and reduced gain recognition on subsequent asset dispositions).

  41. Why Elect 338(h)(10) Election • NOLs. • If Seller has sufficient NOLs, net capital losses or credits to offset any increased gain that would be recognized by electing into deemed asset sale treatment, Seller may be amenable to "selling" those NOLs.

  42. Why Elect 338(h)(10) Election • “Quick Assets.” If Target has substantial assets that Purchaser anticipates selling soon after the transaction, then the gain reducing benefit of the basis step-up will be enjoyed relatively quickly. • Rapidly Depreciable Assets. If Target's assets can be depreciated on an accelerated schedule, Purchaser's benefit from the basis step-up in these assets will be more likely to outweigh Seller's cost on the gain differential.

  43. Why Elect 338(h)(10) Election • Self-Created Intangibles. Same if the benefit of future deductions gained by converting non-amortizable self-created intangibles to amortizable Section 197 intangibles exceeds the cost of the inside/outside gain differential.

  44. Code Sec. 336(e) • Will apply principles similar to Sec. 338(h)(10) when the 336(e) regulations are promulgated. • 336(e) may, in regulations yet to be issued, extend the benefit of the 338(h)(10) election to individual buyers (as opposed to just corporate buyers).

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