The document summarizes various tax planning techniques for U.S. and international transactions, including:
1) Inversions following recent IRS notices that limit benefits;
2) Acquisitions of foreign targets through alternative structures like a non-inversion, inversion, or acquisition by a foreign subsidiary;
3) Considerations for cross-border transactions like tax deferral, foreign tax credits, and tax-efficient repatriation.
4) Potential tax consequences of inversion transactions for shareholders.
35. Benefits of Step-Up in Basis
• A step-up in basis provides for larger depreciation and amortization
deductions for the acquirer
• These larger deductions provide tax savings
• The value of the potential tax savings is often significant
• If a $1 billion Target with tax basis of $100 million in its assets is purchased
by Buyer, the tax savings (at a 40% corporate tax rate) due to a step-up in
basis are $24 million every year for 15 years, or $260 million over the 15
year period
• Discounted to present value (8% discount rate), these tax savings are worth
$205 million (or approximately 20% of the deal price of $1 billion)
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36. Scenario 1: Stock Deal
Buyer Target
$1B
Target Stock (Basis = $100M)
• In Scenario 1, there is no step-up in basis.
• Target continues to have original basis in assets ($100 million).
Shareholders
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37. Scenario 2: Asset Deal
Buyer Target
$1B
Assets (Basis = $100M)
• In Scenario 2, there is a step-up in basis.
• Target steps-up the basis of the assets to $1 billion ($900 million greater
than Scenario 1).
• The additional $900 million in basis can be depreciated/amortized over
time.
• Assuming that (i) all of the basis step-up attributable to goodwill is
depreciable over 15 years, (ii) Buyer pays tax at a 40% corporate tax rate,
and (iii) an 8% discount rate applies, the present value of this benefit is
$205 million.
Shareholders
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38. Scenario 3: Asset Deal with Benefit
For Both Parties
Buyer Target
$1.116B
Assets (Basis = $100M)
• In Scenario 3, Buyer compensates Stockholders for some of the benefit realized
due to a step-up in basis by increasing the purchase price by $116 million.
• Buyer acquires assets with basis of $1.116 billion ($1.016 billion greater than in
Scenario 1).
• The $1.116 billion in basis can be depreciated and amortized over time.
• Assuming that (i) all of the basis step-up attributable to goodwill is depreciable
over 15 years, (ii) Buyer pays tax at a 40% corporate tax rate, and (iii) an 8%
discount rate applies, the present value of this benefit is $232 million.
• Taking into account the increase in purchase price by $116 million, the present
value of Buyer’s tax benefit is $116 million more than the benefit of the stock deal
in Scenario 1.
• Because of the tax benefit of the step-up in basis, both parties are better off
by $116 million.
Shareholders
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39. Opportunities for Basis Step-Up
• Common Opportunities:
• S Corporations
• Partnerships and “Disregarded Entities”
• Other Opportunities:
• C Corporations with Significant Net Operating Losses
• Subsidiaries within Consolidated Groups
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40. S Corporations – 338(h)(10) Election
• S Corporations can obtain a basis step-up through an election under
Section 338(h)(10).
• Section 338(h)(10) allows an S corporation and the shareholders of
that S corporation to elect to have the disposition of their S corporation
shares treated as an asset sale rather than a stock sale for U.S.
federal income tax purposes.
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338(h)(10) Election
Buyer Target
Purchase Price
Target Stock
Shareholders
41. S Corporations – 338(h)(10) Election
• Some potential issues arise when making a Section 338(h)(10) election:
• Tax-Deferred Rollover
• Sellers cannot defer tax on any rollover portion (if one exists) when an election under Section
338(h)(10) is made
• Anti-Churning
• Anti-churning rules may disallow amortization on certain intangibles and property (negating
some of the benefits of the election)
• Section 1374 Tax
• Section 1374 imposes tax on some corporate level built-in gains when a C corporation has
converted into an S corporation
• Invalid S corporation election by Target disallows the Section 338(h)(10) Election
• If the Target’s S corporation election is invalid, the section 338(h)(10) election will be invalid and
there will be no step-up in basis
• Buyer must be a corporation and not an individual or partnership
• All S corporation shareholders must make the election for the election to be valid
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42. S Corporations – 336 Election
• Alternatively, S Corporations can obtain a basis step-up through an
election under Section 336.
• Section 336 allows shareholders of an S corporation who dispose of 80% or
more of their interests to elect to have the disposition treated as an asset
sale rather than a stock sale for U.S. federal income tax purposes.
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336 Election
Buyer Target
Purchase Price
Target Stock
Shareholders
43. S Corporations – 336 Election
• Some potential issues arise when making a Section 336 Election:
• Tax-Deferred Rollover
• Sellers cannot defer tax on any rollover portion (if one exists) when an election under Section
336 is made
• Anti-Churning
• Anti-churning rules may disallow amortization on certain intangibles and property (negating
some of the benefits of the election)
• Section 1374 Tax
• Section 1374 imposes tax on some corporate level built-in gains when a C corporation has
converted into an S corporation
• Invalid S corporation election by Target disallows the Section 336 Election
• If the Target’s S corporation election is invalid, the Section 336 election will be invalid and there
will be no step-up in basis
• All S corporation shareholders must make the election for the election to be valid
• Some potential benefits arise in connection with a Section 336 Election
(compared with a Section 338(h)(10) Election):
• Buyer can be a partnership or an individual
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44. S Corporations – F Reorganization
• S Corporations can utilize a reorganization under Section 368(a)(1)(F)
of the Code to deliver a step-up in basis to the buyer while avoiding
some of the issues associated with elections under 338(h)(10) and 336
• Benefits of an F reorganization:
• Allows for tax-deferred rollover
• Eliminates issues related to an invalid S corporation election
• Buyer does not have to be a corporation
• All of the shareholders are not required to make an election
• Issues an F reorganization does not solve:
• Historic tax liabilities
• Section 1374 taxes still exist (but are left behind)
• Anti-churning rules are still implicated
• Disproportionate rollover may be tax inefficient
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45. F Reorganization Steps
Target Corp
(S Corp)
Shareholders
100%
Original
Structure
Step 1
Target Corp
(S Corp)
Shareholders
100%
New Corp
(S Corp)
Contribute
shares of
S Corp.
Step 2
New Corp
(S Corp)
Shareholders
100%
Target Corp
(Q Sub)
100%
Final
Structure
New Corp
(S Corp)
Shareholders
100%
100%
New Corp makes
Q Sub Election for Old
Corp and New Corp
converts Old Corp to
an LLC
Sale
BuyerNew Corp
(S Corp)
NewCo sells
interests in
LLC to
Buyer
Target LLC
(Disregarded)
Target LLC
(Disregarded)
Shareholders
100%
100%
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46. Partnerships
• Buyer automatically obtains a basis step-up in an acquisition of 100%
of a partnership.
• Benefits of partnership acquisitions:
• Allows for tax-deferred rollover and basis step-up
• No Section 1374 taxes
• Buyer does not have to be a corporation
• No election is necessary for the step-up in basis
• Fewer issues related to ensuring Target is a partnership than to ensuring
Target is a valid S corporation
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Buyer
Purchase Price
100% of Partnership Interests
Partners
Partnership
47. Partnerships – Mitigating Anti-Churning Problems
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• Anti-Churning
• Partnership can have rollover and avoid anti-churning on basis step-up on
portion acquired
• See Treas. Reg. § 1.197-2
• Partnership must make an election under Section 754 to provide for basis
step-up
Buyer
Purchase Price
60% of Partnership Interests
Partners
Partnership
48. Initial Public Offering of a Partnership
• Basic Structure:
• An entity taxed as a partnership wishes to go public.
• Public companies generally need to be C corporations.
• A C corporation can acquire 100% of a partnership for cash and stock and
obtain a basis step-up just like any other deal.
• Issues:
• Issue 1: Investing public does not place value on basis step-up when valuing
an IPO.
• Issue 2: Historic partners become shareholders in a C corporation and lose
the benefit of partnership investing.
• Issue 3: No further basis step-up on sale of stock.
• Opportunity: Up-C structure combined with Tax Receivable Agreements
(“TRAs”)
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49. IPOs – Up-C Structure
• Basic Structure:
• In an Up-C structure a public corporation is formed to raise cash to purchase the
majority of interests in a partnership.
• Pre-IPO partners retain interests in the partnership.
• This purchase results in a step-up in basis for the public company (assuming
the partnership makes an election under Section 754).
• Pre-IPO owners of the partnership retain interests in the partnership, which
can be exchanged for stock in the new public company.
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Public Company
Partners
Partnership
Shareholders
IPO
[TBD]% of Partnership Interests
Cash
Cash
50. IPOs – Up-C Structure Continued
• Benefits of the Up-C structure from the perspective of pre-IPO owners:
• Allows pre-IPO owners to obtain the benefits of the IPO (including liquidity
by converting partnership interests to public company stock)
• Maintains flow-thru treatment
• Captures material tax benefits through the use of TRAs
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51. IPOs – Tax Receivable Agreements
• TRAs allow for tax benefits to be allocated to a certain party
• In this instance those tax benefits derive from the depreciation and
amortization deductions due to the step-up in basis
• TRAs are used to allocate to the pre-IPO owners a percentage of the
tax benefits from the step-up in basis
• Generally, transactions using this structure have allocated 85% of the
increased tax deductions to the pre-IPO owners
• TRAs generally trigger payments on a change in control
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52. Examples of Up-C Transactions and TRAs in IPOs
• GoDaddy:
• Value: ~ $800 million of tax benefits
• Blackstone Group:
• Value: ~ $870 million of tax benefits
• Graham Packaging Company:
• Value: ~ $200 million of tax benefits
• National CineMedia:
• Value: ~ $200 million of tax benefits
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53. Partnerships Revisited – Bipartisan Budget Act of 2015
• The Bipartisan Budget Act of 2015 (“Act”), signed into law on November 2,
enhances the IRS’s ability to audit partnerships.
• The Act provides that tax adjustments resulting from an audit will generally be
determined and collected at the partnership level (as opposed to at the partner
level).
• If the percentage interests in the partnership have changed between the tax year audited
and the current year, the cost of the adjustment will not be borne in the same proportions as
it would have been had the tax been paid in the taxable year.
• The Act provides for a procedure to mitigate this consequence through elective
Form K-1 adjustmens.
• The partnership may elect to send amended Form K-1s to individuals and entities who were
partners in the earlier year.
• Under this procedure, the partners are required to pay a higher rate of interest on the
underpayments (5% instead of 3%).
• The new procedures under the Act should be taken into account when
contemplating an acquisition of a partnership, because an audit of a previous year
may create tax liability that is borne by the acquirer if no procedures are put in
place to reassign such a loss.
• These changes apply to partnership taxable years beginning after December 31,
2015.
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