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State and Local Tax Challenges in Mergers,
Acquisitions and Asset Sales Anticipating and Responding to Successor Liability, Bulk Sales,
Incentives, Records Retention and Other Issues
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WEDNESDAY, JUNE 26, 2013
Presenting a live 110-minute teleconference with interactive Q&A
Kim Krueger, Director, PricewaterhouseCoopers, New York
Benjamin Bacon, Director, PricewaterhouseCoopers, New York
Darren McCarthy, Principal, State and Local Tax – M&A Tax, KPMG, New York
Bob Buckley, Senior Manager, KPMG, New York
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State and Local Tax Challenges in Mergers, Acquisitions and Asset Sales Seminar
Bob Buckley, KPMG
Kim Krueger, PricewaterhouseCoopers
June 26, 2013
Darren McCarthy, KPMG
Benjamin Bacon, PricewaterhouseCoopers
Today’s Program
Due Diligence-Related Topics
[Darren McCarthy and Bob Buckley]
Structuring The Acquisition
[Benjamin Bacon and Kim Krueger]
Slide 8 – Slide 53
Slide 54 – Slide 81
Notice
ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY
THE SPEAKERS’ FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY
OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT
MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR
RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.
You (and your employees, representatives, or agents) may disclose to any and all persons,
without limitation, the tax treatment or tax structure, or both, of any transaction
described in the associated materials we provide to you, including, but not limited to,
any tax opinions, memoranda, or other tax analyses contained in those materials.
The information contained herein is of a general nature and based on authorities that are
subject to change. Applicability of the information to specific situations should be
determined through consultation with your tax adviser.
DUE DILIGENCE-RELATED TOPICS
Darren McCarthy, KPMG
Bob Buckley, KPMG
© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated
with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Agenda For This Section
Introduction
Target
Transaction
– Retained liability
– Successor liability
Tax risk identification
– Including transfer taxes
Tax risk mitigation
9
Introduction
© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated
with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Introduction
Always understand what you are
buying before taking the leap.
What state and local tax liabilities
remain with the business entity or
entities to be acquired?
What state and local tax liabilities
attach to acquired business assets?
What state and local tax liabilities do
not attach to assets?
Consider ways to mitigate
state & local tax risks.
How can you protect yourself
from acquiring identified and
unforeseen state & local tax
liabilities?
© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated
with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Tax Risk Mitigation Process
Know the target
Legal entity
Separate
company or
consolidated
group
Elections
affecting target
State tax
treatment
History of entity
structure
Know the deal
Stock v. assets
Multi-member
LLC treated as a
corporation or
partnership
Single-member
LLC treated as a
corporation or
disregarded entity
Applicable taxes
Income tax
Franchise tax
Gross receipts tax
Sales/use tax
Real property tax
Personal property tax
Employment taxes
Miscellaneous
industry taxes
Unclaimed property
Due diligence
Management
Income and non-
income tax filings
Income tax
provision
Financial
statements
Legal documents
Offering memo
Quantify
exposure
Protect your
company
Change the
structure
Purchase price
adjustments
Escrows
Indemnities
Transaction Target Types of tax
risk
Tax risk
identification
Tax risk
mitigation
12
© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated
with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
What Creates Tax Risk In A Target?
Reasons for
historical risk
Target’s materiality threshold
Lack of knowledge of
law
Prior Transactions
Errors in filings
Aggressive planning
Limitations of accounting
systems
13
Target
© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated
with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
What Are You Buying?
Stock of corporation
• Public v. private
• Elections under IRC Sect. 338(h)(10)
Stock of S corporation
• C corporation history
• Quality of election and status
• Elections under IRC Sect. 338(h)(10)
Interests in partnership
• Check entity status
• Check-the-box or not
Stock or interests in a disregarded entity
• Single-member LLC
• QSUB fiction
• Potential carryover of corporate liability when sub is checked or merged into DRE
Real, tangible and intangible assets
•Generally limited carryover of historical income tax liabilities
•Sales/use taxes, property taxes and, in some cases, employment taxes remain with acquired business assets.
•Some states impose successor liability for all taxes, including income taxes, when assets of trade or business are acquired,
Corporation
P'Ship
DRE
S corporation
15
Transaction
- Retained Liability
- Successor Liability
© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated
with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Retained Liability
Stock acquisitions
All SALT exposures remain with the target and are assumed by the buyer upon
acquisition.
Unclaimed property exposures remain with the target and are assumed by the
buyer upon acquisition.
17
© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated
with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Retained Liability (Cont.)
Stock acquisitions
Is it really a “stock” acquisition?
Acquisition of an interest in a flow-through entity is not an asset deal, for all
tax purposes.
State tax treatment of LLCs, partnerships and S corps
– Some states impose an entity-level income tax.
– Liable for income tax of non-resident partners
– Most states adopt non-resident income tax withholding requirements on
LLCs, partnerships and S corps.
Treated as a sale of an intangible for sales/use tax purposes
18
© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated
with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Retained Liability (Cont.)
Stock acquisitions
IRC
338(h)(10) election
Treated as a fictional sale of assets for federal, and most state, income tax
purposes
– Successor liability applies to a transaction for all taxes on which both
parties agree to make an IRC
338(h)(10) election.
Treated as a sale of an intangible for sales/use tax purposes
19
© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated
with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 20
Successor Liability
Asset acquisitions
Exposures generally not transferred:
Income/franchise taxes (net worth and capital-based tax)
Exposures generally transferred:
Sales and use taxes
Gross receipts taxes
State unemployment tax - successor employer
Property tax - lien date-driven
Unclaimed property (legal counsel should be consulted)
© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated
with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Successor Liability (Cont.)
Asset acquisitions (Cont.)
Successor liability statutes is typically embedded in the sales/use tax chapter
of the state tax code.
Certain states provide for successor liability for income tax and possibly other
taxes; for example:
Illinois (income tax)
Florida, Michigan, Pennsylvania and South Carolina (all taxes)
Texas (including the old and new franchise taxes)
Wisconsin (income and franchise, if the seller dissolves)
Missouri (personal income withholding tax)
21
© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated
with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Successor Liability (Cont.)
Asset acquisitions (Cont.)
Confirm whether a state adopts successor liability upon acquisition of “all” or
“substantially all” of the assets of the business or if it applies to partial
transfers of assets.
If the transaction involves the purchase of only certain assets (division),
ascertain whether successor liability applies to the buyer if the seller
continues business operations in the state.
Is there successor liability, for practical purposes?
Likely, if the seller is out of the business and terminates its tax presence in
the state in which the assets were located
Unlikely, if only some assets sold and seller will continue in business and
file tax returns in the state
22
© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated
with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Successor Liability (Cont.)
Asset acquisitions (Cont.)
Bulk sale notification requirements
Many states require a seller to advise the state of a proposed bulk sale of
business assets.
Some states require filing a final sales/use tax return by the seller.
Some states provide for a buyer to obtain a tax clearance with respect to
the seller’s tax liabilities.
23
Common SALT Exposures
© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated
with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Nexus
Nexus
In order for a state to impose tax on a company, the company must have sufficient contact to create nexus with the state. Generally, if a company has physical presence (property or employees) in the state, that will constitute nexus and create a filing requirement.
Public Law 86-272
Companies that merely solicit sales of tangible personal property from customers in a state, when the approval for the order of such property occurs outside the state, and the shipment of such property originates from a location outside the state, are generally not required to file an income tax return in the destination state.
Economic nexus
Approximately 30 states adopt economic nexus.
25
Slide Intentionally Left Blank
© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated
with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Nexus (Cont.)
Agency nexus (generally related to creating sales/use tax nexus)
In Scripto v. Carson, the U.S. Supreme Court held that the distinction between employees and independent contractors was without constitutional significance, and IC activities can create nexus in a state. See also, MTC Bulletin 95-1
Affiliate nexus (generally related to creating sales/use tax nexus)
Some states take the position that the existence of common ownership between a corporation with physical presence in a state and an out-of-state corporation that has no physical presence in the state but sells into the state is sufficient to create nexus for the out-of state affiliate.
Click-through nexus (generally related to creating sales/use tax nexus)
Some states take the position that an out-of-state, online retailer has nexus with the state if it enters into an agreement with an in-state resident to refer customers to the online retailer for a commission.
27
© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated
with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Nexus (Cont.)
Various localities impose income/franchise or other taxes at the local level:
New York City
District of Columbia
California cities, e.g., Los Angeles, San Francisco, others
Kentucky cities, e.g., Louisville, Lexington, others
Michigan cities, e.g., Detroit, others
Missouri cities, e.g., St. Louis
Ohio cities, e.g., Cleveland, Cincinnati, others
Pennsylvania cities, e.g., Philadelphia, Pittsburgh, others
Virginia cities, e.g., Alexandria, others
Various localities impose sales/use tax at the local level (i.e., home rule states).
28
© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated
with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Intercompany Transactions
State law addback requirements
Intercompany payments between related entities
Interest expense
Royalty expense
Management fee expense
Historical state tax planning opportunity to create deductions in separate
company states for operating companies
If the target group comprises several entities, consider whether
adjustments to inter-company income or expenses will result in increased
income in an entity, which could result in income tax exposure in a state
that requires income/franchise tax returns be filed on a separate-company
basis.
29
© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated
with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Intercompany Transactions (Cont.)
Disallowance of related member transactions; e.g., intercompany
interest or royalties
Exceptions to intercompany expense disallowance rules
Certain states provide exceptions to the intercompany expense
disallowance rules. For example, interest expense paid between related
members that is ultimately paid to a third party lender may qualify for a
conduit exception to the disallowance rule. Or, interest expense paid
between related members that is subject to income tax in another
jurisdiction may also qualify for an exception to the disallowance rule.
Management fees or allocated administrative expenses
General ability for state to reallocate intercompany expenses
30
© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated
with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Sales Factor Receipts Sourcing
Receipts from sales of tangible personal property
Destination test: Sales of TPP, other than sales to the U.S. government, are generally sourced to the numerator of the sales factor of the destination, or “shipped to” state.
Throwback rule
– Sales to U.S. government are sourced to the “shipped from” state.
– Sales to a state where the seller is not taxable (e.g., does not have nexus) are sourced based on the numerator of the sales factor of the “shipped from” state.
Combined reporting states: Joyce or Finnigan
– Joyce: Throwback is avoided if the selling member has nexus with the state.
– Finnigan: Throwback is avoided if any member has nexus with the state.
Throw-out sales
– Sales to a state where the seller is not taxable (e.g., does not have nexus) are excluded from the numerator and denominator of the state sales factor,
– New Jersey (ended in 2011), Maine, West Virginia
31
© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated
with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Sales Factor Receipts Sourcing (Cont.)
Receipts other than sales of tangible personal property
Cost of performance rule
Receipts generated from sales other than sales of TPP are considered in-state sales if the income-producing activity is performed in the state. If the income-producing activity is performed in two or more states, then the sale is assigned to the state where the greater proportion of the income-producing activity is performed, based on cost of performance.
All-or-nothing cost of performance approach
Pro-rata cost of performance approach
Inclusion/exclusion of costs incurred by independent contractors
Market-based approach
Receipts generated from performing services are sourced to the state where the customer receives the benefit of the service.
Where cost of performing services are incurred is not considered.
32
© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated
with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Sales Factor Receipts Sourcing (Cont.)
Receipts other than sales of tangible personal property
Royalties derived from patents, copyrights, trade names and other
intangibles are generally sourced to the state where the intangible is used
(i.e., apply a market-based approach).
Interest generally is sourced to the state where the assets securing the
loan are located. However, certain states look to where the solicitation,
investigation, negotiation, approval and administration (SINAA) activities
take place.
Industry specific apportionment rules
Financial services (e.g., bank, credit union, insurance)
Transportation (e.g., airlines, trucking, railroad)
Construction (e.g., engineering, architectural)
33
© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated
with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Non-Income Taxes
Various types of non-income taxes are also frequent exposure areas.
Sales/use tax
– Aggressive nexus determinations and complex taxability rules by state
Gross receipts taxes
– Both state and local
Property taxes
– Generally, personal property
Employment taxes
– Federal and state employment/payroll taxes
Miscellaneous industry specific taxes
– Fuel taxes, spill taxes, severance taxes, excise taxes (both federal and state)
34
Tax Risk Identification
© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated
with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Tax Risk Identification
Learn about target’s operations
Read the confidential information memorandum
Read public documents, e.g., Form 10-K
If available, read corporate organizational chart
Visit the target’s Web site
Gather information about the target’s geographic footprint in the U.S. and
overseas, including office locations, customer locations, consider job
postings and marketing materials
36
© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated
with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Tax Risk Identification (Cont.)
Interview the target’s management
Management discussions should take place following a review of the
documents provided and the information available in the public domain.
Management interview is essential to understanding nexus, revenue
streams, sales factor sourcing methodologies, etc.
Access to tax advisors is usually not sufficient.
Tax advisors rarely have answers to any non-income tax questions.
37
© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated
with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Tax Risk Identification (Cont.)
Read the financial statements
Income statement
Effective tax rate
Discontinued operations
Balance sheet
Deferred tax balances
ASC 740 (FIN 48 reserves)
Footnotes
Details of tax items
Acquisitions
Subsequent events
38
© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated
with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Tax Risk Identification (Cont.)
Read the federal income tax returns
What will we receive?
Stand-alone entity or an entire consolidated group: Signed federal income
tax returns will likely be provided,
Member of a federal consolidated group: Pro forma returns and separate
company state returns may be provided.
Asset purchase: Unlikely to receive any returns
39
© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated
with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Tax Risk Identification (Cont.)
Read the federal income tax returns
What do we look at?
Consolidation or stand-alone
Net operating loss or income
Other attributes
Identify tax items relevant to state taxes
– Consolidating schedules included?
– Any amended federal returns? Were state amended returns also filed?
40
© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated
with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Tax Risk Identification (Cont.)
Read the federal income tax returns
What do we look at?
Identify flows of funds - intercompany transactions
– Intercompany interest expenses
– Intercompany royalty payments
– Intercompany management fees
“Other deductions”
Do not limit your thoughts to income tax (e.g., travel expenses may indicate contact with other states, payments to consultants may indicate payroll tax issues)
“Taxes and licenses”
Real estate tax expense indicative of owned real estate
Gross receipts tax expense indicative of tax costs post-acquisition
41
© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated
with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Tax Risk Identification (Cont.)
Read significant agreements
Agreements related to acquisitions and dispositions
Debt agreements
Transfer pricing agreements
42
© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated
with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Tax Risk Identification (Cont.)
Create target’s state tax profile
Create a state tax calendar on which returns are filed
– Include income and non-income tax returns
Create apportionment worksheet for each relevant entity
– Create an Excel file incorporating apportionment formulas each year
– If apportionment work papers are not available, extract from the returns
– Include line items for total gross receipts and federal taxable income
– This information can be used for more than income taxes.
Identify potential property tax filing obligations
Identify state employment tax obligations
Identify gross receipts tax obligations
43
© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated
with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Tax Risk Identification (Cont.)
State and local income/franchise tax
Read the state income/franchise tax returns
Identify material states, in terms of apportionment
Intercompany expense addback requirements
– Consider safe harbors
Business income and non-business income positions
Business expense and non-business expense positions
Consider state modifications (depreciation, etc.)
Calculate the effective state tax rate – reasonable?
Consider material franchise taxes not subject to a cap
44
© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated
with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Tax Risk Identification (Cont.)
Gross receipts tax
Various states and localities adopt gross receipts taxes
Michigan Business Tax (GRT component)
– Repealed effective Jan. 1, 2011
– Remains relevant, from a due diligence perspective
Ohio commercial activity tax
Washington business and occupation tax
California localities
Ohio localities
Virginia localities
Washington localities
Others
45
© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated
with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Tax Risk Identification (Cont.)
Sales tax
Sales tax typically is imposed on retail sales of tangible personal property
and certain enumerated services.
Identify states where target has nexus and filing obligation
Request a taxability matrix identifying revenue streams by state as taxable
or not taxable
Depending on the target (number of states/number of entities), request all
sales/use tax returns or a sampling of sales/use tax returns
Question exempt status of sales and availability of documentation to
support the exempt nature of sales
Localities that adopt “home rule” reporting requirements
46
© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated
with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Tax Risk Identification (Cont.)
Use tax
Inquire about use tax policies and procedures
Taxable purchases of supplies and equipment
Identify promotional items and other products given away subject to use
tax (removed from inventory)
– Demonstration products or samples removed from inventory
– Promotional items distributed at trade fairs or as advertising
– Items distributed to customers free of charge
– Printed adverting materials
47
© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated
with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Tax Risk Identification (Cont.)
Property tax
Read personal property tax returns, bills and related proof of payment;
confirm/identify property reported on the returns
Read real estate tax bills and related proof of payment
Inquire about historical challenges to assessed values
Employment tax (federal and state)
Worker classification
– Employee vs. independent contractor
Multi-state personal income tax withholding
– States adopt de minimis thresholds before withholding is required.
48
Slide Intentionally Left Blank
© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated
with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Tax Risk Identification (Cont.)
Unclaimed property
Unclaimed property is not a tax.
– Legal counsel must determine what is unclaimed property.
The target likely has unclaimed property in the form of uncashed payroll or vendor checks.
Other types of unclaimed property:
– Unused advertising credits relating to advance payments
– Unused gift cards or gift certificates at retail establishments
Dormancy periods vary based on the type of property.
Issue occurs when the target has history of taking unclaimed property into income.
– Distortion of EBITDA
50
© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated
with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Tax Risk Identification (Cont.)
Transfer taxes
Stock acquisition (including LLC interests, partnership interests, etc.)
– Sales/use tax does not apply.
– Real estate transfer tax may apply.
Transfers of a controlling interest in an entity that holds an interest in real property
Asset acquisition (actual transfers of real and tangible business assets)
– Sales/use tax may apply.
Consider available exemptions by state
– Occasional sales, sales for resale, M&E used in manufacturing, etc.
– Exemptions from sales/use tax generally do not apply to transfers of motor
vehicles.
– Real estate transfer tax may apply.
Recording taxes
51
Tax Risk Mitigation
© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated
with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Purchase price
adjustment Restructure the deal Escrow Indemnities
Tax Risk Mitigation
Consider changing the
terms of the deal to
asset or DRE
transaction
Depending on the
structure, may
provide some
downside protection
May be cost -
prohibitive to seller
Collateral legal and
business issues
Bulk sale notification
Tax clearance
certificate
By adjusting purchase
price for quantifiable
tax risks, buyer is
protected from any
future cash tax
exposure.
Consider interest
and penalties in the
purchase price
adjustment
Be prepared to
negotiate based on
contingent nature of
risk and timing of
recognition
Business decision
An escrow can provide downside protection for quantifiable risks for a certain period of time.
Escrows normally won’t extend as long as the statute of limitations.
Cherry pick the risks to be included in escrow
Tax-only vs. general escrows
Be prepared to negotiate based on contingent nature of risk and timing of recognition
Business decision
Indemnities provide
protection but require a
recognition event and
subsequent legal action
to enforce contractual
provisions.
Work best for risks that cannot be quantified or are highly contingent in nature
Be aware of “seller” and the ability to enforce indemnity provisions (e.g., public targets)
Ensure indemnities survive through the closing of the statute of limitations
53
STRUCTURING THE ACQUISITION
Benjamin Bacon, PricewaterhouseCoopers
Kim Krueger, PricewaterhouseCoopers
PwC
Optimal State Tax Structuring Considerations
Stock v. asset overview
State tax treatment of IRC
338(h)(10)
• IRC
338(h)(10) - New York example
Characterization of gain – business vs. non-business
Combined reporting and instant unity
Intercompany debt considerations
Pushdown of acquisition debt
June 26, 2013 55
PwC
State Tax Considerations In Stock v. Asset Deals
• Overview
- Stock deals
◦ Carryover of tax liabilities, tax attributes, E&P, etc.
◦ Short-period filings, but retention of Tax ID numbers
◦ QSPs => state-only 338 elections
- Asset deals
◦ Generally, do not inherit tax liabilities except for sales taxes under successor liability rules
◦ Existing NOL/credit shields may be gone.
◦ Immediate impact to nexus profile
◦ Step-up in tax basis
› Capital tax implications
› 197 amortization can often be significant.
June 26, 2013 56
PwC
Deemed sale by Old T
Deemed sale of assets at FMV to New T at close of acquisition date → Old T (owned by P) recognizes gain/loss; tax attributes disappear/
IRC
338(h)(10) –
338
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Deemed purchase by New T
Deemed purchase of assets at beginning of day after acquisition date → adjusted basis either stepped up or down in T’s assets.
Stock
Cash
Old T
S P
New T
Generally, 338 election is made when the present value of future tax savings resulting from the “step-up” in basis of T’s assets (e.g., increased depreciation deductions) exceeds the current tax cost of such a step-up.
Deemed sale of assets
Deemed purchase of assets
PwC
IRC
338(h)(10)
June 26, 2013 58
Stock
Cash
Old T
S P
New T
• Election jointly made by P & S
• Consequences of
338(h)(10) to S:
• Old T will recognize gain or loss on deemed sale of its assets while included as a member of the selling group.
• No gain or loss will be recognized by members of the selling group on their sale of T stock.
• S inherits T’s tax attributes
• Consequences of
338(h)(10) to P:
• New T gets stepped-up basis.
Deemed sale of assets
Deemed liquidation
Deemed purchase of assets
PwC
State Treatment Of IRC § 338(h)(10)
• The majority of states generally conform to IRC §338(h)(10).
• Some states conform to IRC §338(h)(10) by using federal taxable income, before NOL and special deductions, as the starting point for computing state taxable income.
• In other states, a corporation that makes a IRC §338(h)(10) election for federal income tax purposes does not have to make a separate election for state purposes.
• However, several states impose special rules permitting the parties to make (or not make) an IRC §338(h)(10) election for state purposes.
• For instance, in California and Wisconsin, a corporation that has not made an IRC §338(h)(10) election for federal purposes can still make one for state purposes, by making an affirmative election within the designated time period.
June 26, 2013 59
PwC
IRC §338(h)(10): New York Example
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60
• P purchased the stock of T for cash. Seller (S) and P made
338(a) and
338(h)(10) elections.
•
338(a) resulted in T recognizing ordinary income on the deemed sale of its assets (other than its stock of Tsub).
• The subsequent transfer of assets pursuant to
338(h)(10) qualified as a
332 liquidation.
• T sold the stock of Tsub to P. No 338 elections were made. T recognized a capital loss from the sale of Tsub stock.
NYS/C Group #1
S
T
Tsub
NYS/C Group #2
P
PwC
IRC §338(h)(10): New York Example (Cont.)
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Issues:
1. Does NY conform to IRC
338(h)(10)?
• TSB-M-87(4)C: New York declined to recognize unless NYS group is identical to federal consolidated group
• Thus, if the groups are different, the transaction would be treated as if only a
338(a) election were made. Seller
would recognize gain from the sale of the target’s stock; however, it may constitute income from subsidiary capital.
• TSB-M-91(4)C: In all cases, 338(h)(10) election should be ignored.
• TSB-A-99(22)C: 338(h)(10) election is available as long as the selling parent corporation qualifies as a “selling affiliate.”
• Thus, the ordinary income recognized by T on the deemed sale of its assets to P pursuant to 338(a)(1) would be included in T’s ENI.
PwC
New York IRC §338(h)(10): Example (Cont.)
June 26, 2013 62
Issues (Cont.):
2. Whether the capital loss recognized by T on the sale of Tsub stock constitutes income from business capital, and whether such loss is allowed in determining the ENI of Combined Group #2’s ENI.
• Bausch & Lomb/TSB-M-08(3)C
• Gain/loss from a parent corporation’s sale of stock in a subsidiary included in the combined report → business income (not subsidiary income – which is a subtraction modification)
• Gain/loss not included in the receipts factor
• Tsub is included in T’s combined group in the year of sale. Thus, the capital loss recognized by T on the sale of Tsub constitutes income from business capital.
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PwC
New York IRC §338(h)(10): Example (Cont.)
June 26, 2013 64
Issues (Cont.)
3. To the extent the Combined Group #2 is unable to use the capital loss (i.e., due to insufficient capital gains) or a portion thereof, whether S would succeed to the remaining capital loss following the deemed liquidation of T under IRC
338(h)(10), and whether such
loss constitutes income from business capital
• Deemed liquidation = complete liquidation under IRC
332
• IRC
381(c): Acquiring corporation (S) succeeds to any capital loss carryover of the transferor corporation (i.e., T).
• Classification of loss
PwC
Taxation And Characterization Of Gain
• Business vs. non-business
• UDITPA definition of business income: “Income arising from transactions and activity in the regular course of the taxpayer’s trade or business and includes income from tangible and intangible property if the acquisition, management, and disposition of the property constitute integral parts of the taxpayer’s regular trade or business operations.”
• Business income → apportioned by formula (property, payroll, sales)
• Non-business → allocated based on the location of the underlying property. Non-business income from intangible assets is generally allocated to the state of commercial domicile.
• Transactional test: Whether the transaction or activity that gave rise to the income arose in the regular course of the taxpayer’s trade or business
• Functional test: If the acquisition, management and disposition of the property are “integral parts” of the taxpayer’s regular trade or business, regardless of whether the income was derived from an occasional or extraordinary transaction
• Certain states do not conform to business/non-business distinction.
June 26, 2013 65
PwC
Combined Reporting And “Instant” Unity Issues
• When the stock of a subsidiary is purchased, an important tax return filing issue is whether the purchased subsidiary is included with the taxpayer’s unitary group in combined reporting states.
• California has taken the position that, in general, a newly acquired affiliate is not unitary with the purchasing group in the initial year of acquisition.
• When an entire business is purchased, it is often difficult to demonstrate that the new basis is “instantly” unitary with the acquiring group.
• Accordingly, although many taxpayers claim to be instantly unitary with a newly acquired business unit, such a filing position may be challenged by the state.
• Assuming the target and the new parent are able to demonstrate that they are working towards integrating their operations and there are sufficient indicia of unity as of the beginning of the first full tax year following the year of acquisition, the new member will be allowed to join the combined report of the purchasing group.
• A growing number of states (including Oregon, Massachusetts, Texas, Vermont and Wisconsin) have addressed instant unity in their statutes or regulations.
June 26, 2013 66
PwC
Intercompany Debt Planning: Transfer Of Affiliate Receivables
P
S
• P files in New Jersey
• P receives $100 million dividend from S
• P breaks even in current year before dividend
Contribution of a note
June 26, 2013 67
P
S
Distribution of a note
PwC
Intercompany Debt Considerations
• For contributions, monitor impact of an franchise tax posture
• For distributions, consider effects that dividend income may have on Pennsylvania capital stock tax base
• Separate company earnings and profits and stock basis studies can be critical to determining state tax cost of distributions.
• A distribution in excess of E&P and basis will not result in deferral treatment in a stand-alone state.
• Dividend-received deductions are not always 100% in a separate state, despite federal treatment of wholly owned distributors.
June 26, 2013 68
PwC
Pushdown Of Acquisition Debt
Optimal placement of push-down debt
• Identify best candidates to receive debt – profitable, expansive separate company footprint
• Intercompany notes - 482, floating rates, principal payments
• Ability to borrow, E&P/basis of distributor, solvency
• Push down via restructuring – consideration of basis
• I/C interest expense addback – confirm safe harbor exception
• Economic nexus considerations for lender
• Debt v. equity
June 26, 2013 69
PwC
State M&A Considerations
Post-Transaction Integration Considerations
PwC
Post-Acquisition Considerations
• Overview
• Application of consolidated return regulations
• Legal entity simplification
• State tax attributes and financial statement impact
• California IRC 355 conformity and DISA updates
June 26, 2013 71
PwC
State Income Tax Restructuring
• After a corporate restructuring takes place, companies will need to determine the impact of the planning on their state tax footprint.
• Opportunities may arise to realign a taxpayer’s state filing methodology upon the acquisition or disposition of an entity or group of entities.
• Combined reporting may be advantageous to a taxpayer if it:
- Allows losses to shield operating income from tax
- Brings less-profitable entities into the group
- Brings entities with lower in-state apportionment into the group
- Keeps administrative and recordkeeping burdens low
- Allows operating companies to benefit from interest expense at holding company level
• Consideration should be given to separate company footprint, in addition to unitary concerns.
June 26, 2013 72
PwC
Application Of Consolidated Return Regulations
• Certain combined reporting states have incorporated the federal consolidated return regulations (e.g., Treas Reg. 1.1502 et al) into their own rules, in part or in their entirety.
• For multi-state corporate taxpayers, it is important to know which states have partially adopted the consolidated regulations and the provisions that were not included.
• For example, some states that are considered “1502 states” do not follow the consolidated loss rules in 1.1502-21 (e.g., loss allocation based on pooling of losses), but instead provide that the net operating loss is tracked on a combined basis or based on each group member’s apportionment factor in the state (e.g., intrastating method).
• Some incongruities exist for unitary states that follow or adopt consolidated return regulations, but do not respect separate federal consolidated groups when the two groups are unitary.
June 26, 2013 73
PwC
Legal Entity Simplification LLC Conversion
P
S
• P files in New Jersey
• P receives $100 million dividend from S
• P breaks even in current year before dividend
Deemed distribution of assets
P
S SMLLC
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PwC
Legal Entity Simplification Conversions And Mergers
• State income tax issues
• Determine post-transaction filing footprint
• Receipt sourcing study
• Deferral/elimination of intercompany transactions
• Availability of attributes
• 382 studies for state
• Stand-alone state NOL limitations
• Existing intercompany balances
• Alternative or special apportionment
• Deferred tax impact based on new balances and separate effective tax rate shifts
June 26, 2013 75
PwC
Check-The-Box Conformity And Entity Level Taxes On Flow-Throughs
• Most states recognize federal check-the-box treatment, but some states do not respect these rules and tax flow-throughs on a stand-alone basis.
• Some states impose franchise taxes or fees on all types of entities, regardless of federal classification.
• Certain states require partnerships to file and remit income and/or gross receipt taxes (e.g., Tennessee, Illinois).
• Texas subjects single-member limited liability companies to tax despite its federal treatment.
• New Hampshire imposes BPT on single-member LLCs, and these entities should be filing as members of a combined group.
June 26, 2013 76
PwC
Net Operating Losses
• Once acquired, a company should revisit its available tax attributes.
• Combined reporting states differ in their treatment of net operating losses by employing the following methodologies for tracking:
• The combined level, resulting in one loss for the entire group
• Apportioning total group losses pursuant to each member’s apportionment numerators over group denominators (commonly known as the “intrastated approach” that is employed in California and Minnesota)
• Adopting federal consolidated return rules and attributing group losses pursuant to pro forma losses (e.g., a member receives its portion of the combined NOL based on its pro forma loss over all pro forma losses)
• Many states will require taxpayers to impose IRC §381 and §382 limitations on net operating losses of newly acquired corporations.
• Some states that require net operating losses to be tracked on a post-apportioned basis state that taxpayers must apportion any §382 limitations, while others do not.
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PwC
Tax Accounting Considerations
• State ETR – current provision impact
• State ETR – measurement of deferred tax items
• Valuation allowances – potential state attribute realization and re-measurement
• Restatement of target’s pre-acquisition financial statements
• Determine financial statement impact of any items discovered during diligence and whether reserve is necessary
• FIN 48 review
June 26, 2013 78
Slide Intentionally Left Blank
PwC
Treatment Of 355: Differing State Approaches
• California
- In 2oo9, California passed IRC conformity legislation that adopted the Internal Revenue Code as of 2009 for tax years beginning on or after 1/1/2010 (S.B. 401).
- California had last adopted the IRC as of 1/1/2005.
- In 2006, the IRS issued relaxed 355 requirements with respect to its active trade or business definition.
- In 2010, California issued Proposition 26, which provided that any legislation that resulted in any taxpayer paying a higher tax not passed by a 2/3 supermajority vote by Nov. 3, 2011 may be void. S.B. 401 was passed 4/12/2010 by a simple majority vote.
- Accordingly, there is some uncertainty surrounding spin transactions that do not meet the more stringent pre-2006 355 requirements.
• Mississippi
- In 2012, Mississippi passed legislation to conform with IRC 355, no longer subjecting distributions of subsidiary stock to gain in the state.
- Note that most states conform to new IRS spin treatment
June 26, 2013 80
PwC
California has proposed several recent changes to its intercompany regulation, including several DISA fixes. Interested party hearing in July 2013 and likely late-year passage
• Capital contributions:
- A subsequent capital contribution from the parent can reduce an existing DISA created by a subsidiary’s distribution to that parent.
- The contribution will first offset the DISA until full elimination, before increasing the parent’s basis in its subsidiary stock.
• Mergers:
- A merger between members of a combined reporting group will no longer require a DISA to be taken into account as income or gain, provided the majority of the stock of merging entities is owned by other group members.
• Tiered corporate distributions:
- Any DISA created when a subsidiary distributes property to its parent which, in turn, distributes the same amount to its parent will be treated as earnings and profits to the first (lower-tier) parent, for purposes of determining the DISA to the second parent that could result from the second distribution.
Proposed Changes To California DISA Rules
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