Buying or selling a member of a consolidated group.

A Catalogue of the Unique Consolidated Return Rules, the Related Contractual Protections/ and a Model of the Tax Provisions for the Acquisition Agreement

Introduction

Too often the tax adviser is given an unduly limited role in the drafting of the acquisition contract. For example, the corporate lawyer will begin with his or her standard agreement and with less than 24 hours before the signing of the contract, will rhetorically ask, "You don't have any problems with the tax reps, do you? I took it from the ABC deal and prestigious firms X and Y were involved."

Exacerbating the timing problem is that many corporations are sold through an auction process, whereby the seller drafts the contract and prospective buyers are told to fill in the purchase price blank and note any changes on the contract. Shortly before the bid contract is to be returned, the corporate lawyer is likely to ask: "You don't have any significant problems with the tax provisions, do you?" He or she may also add, "You realize that the fewer the changes, the better our shot at winning the bid."

Given the complexity of the Internal Revenue Code and the Treasury Regulations dealing with consolidated returns (the customary election of the selling group), and the rapid pace at which deals are closed, it behooves the tax adviser to be ready to react on a moment's notice. A prior article published in 1989 made an attempt to do just that.(1) Since then the consolidated return regulations have undergone a major overhaul with over a dozen newly minted Treasury Decisions, the latest being the significant changes in the SRLY and section 382 rules (effective June 25, 1999) and the treatment of overall foreign losses (effective August 11, 1999). Single or dual member LLCs can be found in many consolidated groups, adding further complexity. Finally, more sophisticated tax representations and warranties have developed, in part because of prior language failures. Hence, this sequel is obligatory.

I. The Economic Significance of Representations, Covenants, and Indemnities

To place the suggested contractual provisions in perspective, keep in mind that the basic purpose of the various provisions is to identify and possibly reduce the risks in the transaction, primarily from the buyer's standpoint. Broken down, the risk identification and reduction is achieved as follows:

A. Representations have three principal purposes:

1. Discovery: By requiring disclosure of, for example, all material tax elections or tax attributes, representations smoke out the hidden problems.

2. Right to Walk: If the representations are not materially true as of the time made or as of the closing date, the buyer has acquired the right to walk (and consequently the right to renegotiate the purchase price).

3. Economic Protection: If the buyer is damaged by a misrepresentation discovered after the closing, the buyer may have a cause of action against the seller. That assumes the representations survive the closing, something surprisingly easy to obtain from the seller with respect to taxes.

B. Covenants: These are promises to do something positive (e.g., terminate all existing tax-sharing agreements) or refrain from taking certain actions. Again, the buyer can walk if the seller has not complied with any pre-closing covenant.

C. Indemnity: The payment of damages for breach of representations or covenants is required in the indemnity provisions. They spell out the obligations, the conditions, and the procedures for enforcing such indemnities.

II. Introduction To Model Agreement

We have attached a Model Agreement to demonstrate the tax-related representations, covenants, and indemnity provisions that might appear in a negotiated acquisition agreement. The suggested Model Agreement is designed to resolve the competing interests of the Selling and Acquiring Groups in a balanced and fair manner. In close cases, we have proposed alternative solutions in the footnotes. Of course, the agreement reached in each transaction will depend on all of the facts and circumstances, including, most importantly, the relative bargaining power of the Selling and Acquiring Groups.

III. Introduction To The Catalogue

The following Catalogue of consolidated return rules is essentially a primer designed to get the practitioner comfortable with the special consolidated return rules he or she will encounter in connection with an acquisition. Consider it a prelude to the Model Agreement.

The consolidated return regulations are very complex and volumes can and have been written. We have attached Exhibit A as an addendum to the Catalogue; it describes issues that do not arise very often. To avoid undue complexity, such items are not covered in the Model Agreement or the Catalogue. However, such items are worth considering--especially for the consolidated return aficionados -- during the due diligence process.

IV. Basic Facts Assumed

For purposes of the accompanying Catalogue and Model Agreement, the following basic set of facts is assumed:

Target company ("Target" or "Company") is a 100-percent owned subsidiary in a selling group ("Selling Group"). Target has a wholly owned subsidiary ("Subsidiary") that is deemed to be included within the term "Target," unless otherwise specified. Target is being acquired in a taxable purchase by a purchaser (the "Purchaser"), a member of an acquiring group ("Acquiring Group") and no section 338 election is being made. Both Selling Group and Acquiring Group file consolidated returns.

It is also assumed that (i) Selling Group and Acquiring Group enter into an agreement for the purchase and sale of Target's stock (the "Acquisition Agreement"), and (ii) the closing of such purchase and sale (the "Closing") will occur on a subsequent date (the "Closing Date"). While this base-line case is being used to simplify the analysis, note that most of the consolidated return rules would apply if Target were the common parent of Selling Group, or if the acquisition were in the form of a tax-free reorganization, although the contractual protections may be different.

The Catalogue

Summary of Consolidated          Summary of Protective
Return Rules That May            Provisions That May Be
Affect the Acquisition           Included in Acquisition
                                 Agreement

I. Taxable Periods and Due Dates of Related Tax Returns

A. General Rule: Premature       A. Obtain representation
   Closing of Taxable Period.       that all returns for Selling
   The taxable year of Target       Group that include Target
   closes at the end of the         that are due on or prior to
   day in which it ceases to        the Closing Date have been
   be a member of Selling           timely filed and all taxes
   Group (Treas. Reg.                due for such periods have
   [sections] 1.1502-76(b)(1)       been paid or provided for.
   (ii)(A)).(2) The resulting       If the taxable year of
   short period (assuming that      Target does not close on
   the disposition does not         the Closing Date (e.g., for
   occur on the natural year        state tax purposes), the
   ends of both the Selling         Acquisition Agreement should
   and Acquiring Groups)            prescribe rules on how to
   counts as a taxable year         allocate the taxes due for
   for carryover and other          the pre- and post-closing
   purposes ([sections]-76(b)       partial periods. Establish
   (2)(i)).If Selling Group's       responsibility for filing
   taxable year differs from        returns (and paying tax)
   Acquiring Group's taxable        for the period including the
   year, then Target must           Closing Date. Include
   adopt Acquiring Group's          provision for contesting
   taxable year ([sections]         issues arising thereunder.
   -76(a)(1)).                      Acquiring Group in
                                    particular needs contractual
B. Exception: Reverse               protections. See Craigie
   Acquisition. In the case         v. Commissioner, 84 T.C. 466
   of a reverse acquisition         (1985) (by operation of
   (i.e., shareholders of           [sections]-77, common
   Target obtain more than          parent of Selling Group
   50 percent of the fair           controls issues arising
   market value of the stock        in pre-closing consolidated
   of the common parent of          return years). Important
   Acquiring Group), Target's       contest issues include: (a)
   taxable year will not            who controls the contest
   close; Acquiring Group's         with the IRS, particularly
   taxable year, however,           if its resolution would
   will close ([sections]           have a continuing effect;
   -75(d)(3)(v)).                   (b) who bears the costs; and
                                    (c) notice requirements.
C. Due Dates of Related             The parties should focus on
   Tax Returns. [sections]          whether to require a payment
   -76(c) sets out rules            with respect to tax benefits
   to determine when                arising from an item giving
   Target's short period            rise to an indemnity
   return must be filed.(3)         payment, and the extent
   If the Acquiring Group's         such item produces
   consolidated return must         indemnifiable tax benefits.
   be filed before the due          Also need provisions
   date (determined without         dealing with access to
   regard to the acquisition        books and records.
   and including extensions
   of time) for the Target's
   separate return, then
   the Target's short period
   return must be filed no
   later than the due date
   (including extensions of
   time) of the Acquiring
   Group's consolidated
   return ([sections]-76
   (c)(1)). If the Acquiring
   Group's consolidated
   return is not due
   (including extensions
   of time) until after
   the due date of the
   Target's short period
   return (determined
   without regard to
   the acquisition and
   including extensions
   of time), then on the
   due date for the Target's
   short period return, the
   Target must file a
   separate return for its
   short period, or for its
   entire taxable year
   ([sections]-76(c)(2)).
   Appropriate amended returns
   must be filed if Target
   files what turns out to
   be an inappropriate
   return. For example, if
   the Target files a separate
   return for its
   entire taxable year and
   the Acquiring Group
   subsequently files a
   consolidated return,
   the Target must file an
   amended return for the
   portion of the Target's
   taxable year that is not
   included in the
   consolidated return.

II. Taxable Income For Last Period Target Included in Selling Group

A. Allocation of Income for      A. Acquisition Agreement
   Short Period. Unless             should reflect the
   acquired as of the close         method of allocation
   of Target's taxable year,        agreed to by the
   the income for Target's          parties.
   last year must be
   allocated between Selling
   and Acquiring Groups'
   consolidated returns
   ([sections]-76(b)(1)(i)).
   The regulations provide
   alternative methods of
   allocation:

1. Default method - closing      1. Require Target to close
   of books. Target's short         books and records as of the
   period included in               Closing Date (including a
   Selling Group's return           taking of inventory). See
   is subject to the general        [sections]-76(b)(4) Example
   rules applicable to short        (3).
   periods as if Target's
   taxable year ended upon
   disposition ([sections]
   -76(b)(2)(i)).

2. Ratable allocation of         2. Require ratable allocation
   year's items. Selling            of Target's items for the
   and Acquiring Groups may         full taxable year and
   elect to allocate                address the making of the
   Target's items for its           election by both Selling
   full taxable year                and Acquiring Groups.
   (disregarding for this           Identify extraordinary
   purpose the required             items that are not eligible
   short periods under              for ratable allocation and
   ([sections]-76(b)(1)(ii)         specify the period in which
   (A)) ratably based upon          they will be reported.
   the number of days in
   each group, provided that
   Target is not required to
   change either its method
   of accounting or its
   taxable year end
   ([sections]-76(b)(2)(ii)).
   However, a large number of
   "extraordinary items" (13,
   plus any others identified
   by the Commissioner) are
   not eligible for ratable
   allocation ([subsections]
   -76(b)(2)(ii)(B) and (C)).
   For some items it may not
   be clear in which period
   the extraordinary item
   properly should be
   reported although it
   should not be reflected in
   a manner that distorts
   income.

3. Ratable allocation of         3. Require ratable allocation
   month's items. Selling and       of Target's items for the
   Acquiring Groups may elect       month that includes Closing
   to apply the ratable             Date and address the use of
   allocation rules for the         this method by both Selling
   month Target is acquired,        and Acquiring Groups.
   provided the allocation is       Require Target to close
   consistently applied by all      books at the end of the
   parties and the general          month that includes Closing
   ratable allocation rules         Date and at the end of the
   are applied in a                 immediately preceding
   reasonable manner. For           month. Identify
   example, the Target could        extraordinary items
   close its books at the end       occurring during the month
   of the month in which the        of closing that are not
   transaction occurs as well       eligible for ratable
   as the end of the                allocation and specify the
   preceding month, and             period in which they will
   ratably allocate Target's        be reported.
   items for the month in
   which the transaction
   occurs([sections]-76(b)(2)
   (iii)). However, as under
   the general ratable
   allocation rules, certain
   "extraordinary items" are
   ineligible for ratable
   allocation.

4. Allocation of taxes.
   Regardless of the general
   allocation method chosen,
   taxes are to be allocated
   by reference to the items
   to which the taxes relate.
   For example, property
   taxes are allocated over
   the period the property is
   owned ([sections]-76(b)
   (2)(iv)).

5. Passthrough entities. If      5. Obtain representations from
   Target has an ownership          Target and Selling Group
   interest in a partnership        concerning the extent of the
   or other passthrough             ownership (including through
   entity, Target is treated        attribution) of passthrough
   as having sold all of its        entities. If the ownership
   interest in the                  interest is 50% or greater, the
   passthrough entity               Acquiring Group runs the risk
   immediately prior to             of violating the consistency
   Target's acquisition by          rule when filing its
   Acquiring Group.                 consolidated return ([sections]
   ([sections]-76(b)(2)(v)          -76(b)(2)(v)(B)). Also, due to
   (A)). This could have the        the attribution rule,
   effect of constructively         representations should be
   closing the partnership's        obtained regarding related
   year, requiring an               party interests in passthrough
   inclusion of Target's            entities.
   distributive share of
   partnership items for the
   partnership year ending
   within Target's short
   period. In addition, if
   Target would be considered
   to own (under section 318
   (a)(2)) 50% or more of any
   stock held by the
   partnership, then the
   method used to allocate
   items of the partnership
   must be the same as the
   method used to allocate
   the Target's items between
   the short period returns
   of the Selling and
   Acquiring Groups
   ([sections]-76(b)(2)
   (v)(B)).

B. Income for the Closing
   Date

1. General rule: End-of-day      1. Prohibit extraordinary
   rule. Target is considered       transactions on the
   a member of Selling Group        Closing Date by the
   through the end of the           Acquiring Group other
   Closing Date and is deemed       than those identified
   to join Acquiring Group at       in the Acquisition
   the beginning of the             Agreement.
   following day. Target's
   taxable year closes for
   all federal income tax
   purposes at the end of the
   Closing Date ([sections]
   -76(b)(1)(ii)(A)).

2. Exception: Next-day rule.     2. Agree on the time of closing
   Target's Closing Date            and whether post-closing
   transactions that are            transactions occurring on the
   properly allocable to the        Closing Date are allocable
   portion of the day after         to the Closing Date or the
   the closing must be              following day (e.g.,
   treated as occurring on          severance payments to
   the following day                employees terminated as a
   ([sections]-76(b)(1)(ii)         result of the change in
   (B)). An allocation to the       control).
   next day under this rule
   will be respected if it is
   reasonable and consistently
   applied by both Selling and
   Acquiring Groups. The rules
   to determine whether an
   allocation is reasonable
   are described (in rather
   obscure terms) in
   [subsections]-76(b)(1)(ii)
   (B)(1)-(4).

3. Special rules under
   section 338. If a section
   338(h)(10) election is made
   for Target, all of Target's
   income for the Closing
   Date, including gain or loss
   from the deemed sale of
   Target's assets, will be
   included in Selling Group's
   consolidated return. See
   Treas. Reg. [sections]
   1.338(h)(10)-1(e)(1).

   If a section 338(g)
   election is made for
   Target, all of Target's
   income for the Closing Date
   is reported by Target, on
   Selling Group's
   consolidated return, except
   for gain or loss from the
   deemed sale of Target's
   assets. Target's gain or
   loss from the deemed sale
   of its assets is reported
   on a separate "deemed sale
   return." See Treas. Reg.
   [sections] 1.338-1(e)(2).

C. "Restoration" of "Deferred"
   Gains and Losses and Excess
   Loss Accounts.

1. General rule. Intercompany    1. Selling Group's indemnity
   items "deferred" under           obligation generally will
   consolidated return              protect Acquiring Group from
   single-entity principles         taxes relating to the
   generally are "restored"         acceleration of matching
   into Target's income             items if it covers taxes of
   immediately prior to             Selling Group for periods
   Target's departure from          ending on or prior to the
   Selling Group. These items       Closing Date.
   include gains and losses
   from intercompany
   transactions and excess
   loss accounts (ELAs). The
   applicable rules have
   dropped the "deferred" and
   "restoration" labels, are
   very complex, and are found
   in [sections]-13(c) (the
   "matching" rules);
   [sections]-13(d) (the
   "acceleration" rules); and
   [sections]-19(c) (ELA
   recapture rules).

2. Exception for related-party
   transactions. Regulations
   under section 267(f) may
   override the restoration of
   intercompany losses if the
   subject property remains
   within the same group of
   "controlled" corporations
   or is transferred to
   certain other related
   parties. See Treas. Reg.
   [sections] 1.267(f)-1,
   former Temp. Reg.
   [subsections] 1.267(f)-1T
   and 2T, and section 267(a).

3. Exception for acquisition     3. Obtain representation
   of entire group. If Target       regarding the amount of
   is the common parent of a        intercompany gains and
   group prior to its               losses and excess loss
   acquisition by Acquiring         accounts the Acquiring
   Group, then any deferred         Group may be inheriting
   gains and losses and ELAs        (particularly any
   with respect to Target and       deferred gains arising from
   its subsidiaries will not        the distribution or sale of
   be included in income as a       a subsidiary within the
   result of an acquisition of      Selling Group). Consider
   Target's stock or a              obtaining an indemnity for
   tax-free acquisition of          the tax liability inherited
   Target's assets, except          by Acquiring Group.
   with respect to any members
   of Target's group that do
   not become members of
   Acquiring Group(4)
   ([subsections]-13(j)(5)
   and -19(c)(3)).(5)

   A similar exception exists
   with respect to the
   intercompany gains and
   losses and ELAs of an
   Acquiring Group that
   acquires Target in a
   reverse acquisition as
   defined in [sections]-75
   (d)(3).

4. Exception if section
   338(h)(10) is elected. If
   Selling and Acquiring
   Groups jointly elect
   section 338(h)(10) with
   respect to Target, then
   Target's intercompany gains
   and losses will remain
   deferred within the Selling
   Group (assuming the
   property does not leave the
   group). In addition, an
   excess loss account with
   respect to Target stock
   will be eliminated provided
   the deemed liquidation of
   Target qualifies under
   section 332.

   However, any deferred
   intercompany gains with
   respect to Target stock (or
   stock of its subsidiaries
   with respect to which
   section 338(h)(10) also is
   elected) will be triggered
   into Selling Group's
   income.(6)

5. Intercompany stock
   transactions. The rules
   dealing with recognizing
   gain or loss with respect
   to intercompany stock
   transactions rely heavily
   on separate entity
   concepts. For example, gain
   is immediately recognized
   if a member acquires its own
   stock in an intercompany
   transaction, including in
   a section 332 liquidation,
   and there exists a deferred
   intercompany item with
   respect to such member's
   stock. See [sections]-13(f)
   (4). Virtually no relief is
   provided for a section 311
   distribution of a
   subsidiary (or intragroup
   sale) followed by a section
   332 liquidation of such
   subsidiary. Prospective
   relief is provided for a
   section 311 distribution of
   stock of a subsidiary (or
   intragroup sale) followed
   by a sale of stock pursuant
   to section 338(h)(10). In
   such case, taxpayer may
   elect to have section 331
   (not section 332) apply to
   the deemed liquidation,
   thereby creating a loss to
   offset the deferred
   intercompany gain on the
   stock. An anti-zero basis
   rule, however, does embrace
   the single entity theory.
   Thus, a member can use
   stock of its parent in an
   acquisition without fear of
   triggering a gain in most
   cases. See [sections]-13(f)
   (6) (ii).

6. Special rules for             6. Obtain a representation
   intercompany obligations.        Target owns any debt of
   In contrast to the rules         members of Acquiring
   for stock, the rules for         Group.
   intercompany debt normally
   follow a single-entity
   approach. For example,
   intercompany debt between
   Target and other members of
   Selling Group that remains
   outstanding following the
   acquisition will be deemed
   satisfied and reissued
   immediately before the debt
   becomes a "nonintercompany
   obligation" ([sections]-13
   (g)(3)). This may create
   offsetting amounts of
   income and loss to the
   debtor or creditor members
   of the Selling Group.
   Similarly, any pre-existing
   indebtedness between Target
   and members of Acquiring
   Group will be deemed
   satisfied and reissued
   immediately after it
   becomes an intercompany
   obligation. If Target
   holds depreciated debt of a
   member of Acquiring Group,
   such group would be
   required to report items
   with mismatching
   characterizations
   (ordinary COD income to
   the Acquiring Group member
   and a capital loss to the
   Target). See [sections]-13
   (g)(4).

III. Basis, Basis Adjustments, and Calculation of Gain or Loss

A. Adjustments to Avoid Double   A. Acquiring Group should obtain
   Tax or Double Benefits.          stock basis and ELA amounts
   Elaborate rules in               for Target's subsidiaries. In
   [sections]-32 attempt to         addition to being relevant in
   carry out the single entity      determining the optimum tax
   concept of consolidation by      structure for the
   adjusting a member's basis       acquisition, these amounts
   in stock of a lower-tier         will be critical in the event
   member to reflect the            of subsequent dispositions of
   income or loss of the            any such subsidiaries. Obtain
   lower-tier member. The           representation that stock
   basic purposes of this           basis determinations were
   "investment adjustment           made in compliance with
   system" are: (i) to              [sections]-32, including the
   prevent a member from            treatment of losses that
   recognizing taxable gain         previously expired unused.
   on the disposition of            Obtain representations that
   subsidiary stock to the          each subsidiary has only one
   extent the increased             class of stock outstanding
   value of the subsidiary          or, alternatively, obtain
   already has been                 lists of each class. If
   accounted for by the             stock basis is not readily
   group as the subsidiary          available, obtain a
   generated income (whether        description of books
   taxable or tax-exempt) and       and records available to
   (ii) to prevent a member         calculate basis adjustments,
   from recognizing a loss on       including books and records
   the disposition of               with respect to consolidated
   subsidiary stock to the          return years of prior
   extent the group already         consolidated groups.
   has reflected the decreased
   value of the subsidiary
   through the absorption of
   losses generated by the
   subsidiary or by incurring
   subsidiary expenditures
   that never will give rise
   to a deduction.

   Specific investment
   adjustments include: (i) an
   upward adjustment for a
   subsidiary's taxable
   income, as well as income
   that is permanently
   excluded from gross income
   (such as tax-exempt income)
   or is offset by a deduction
   (such as the dividends
   received deduction); and
   (ii) a downward adjustment
   for a subsidiary's tax loss
   that is absorbed by the
   group or expires,(7) a
   subsidiary's expenditures
   that are permanently
   disallowed or eliminated in
   determining its taxable
   income or loss (such as its
   allocable share of federal
   income taxes), and any
   distributions (as of the
   date the member owning the
   stock becomes entitled to
   the distribution). See
   [sections]-32(b).

   Basis adjustments with
   respect to a chain of
   subsidiaries are made
   beginning with the
   lowest-tier member; basis
   adjustments made at higher
   tiers therefore reflect
   those made with respect to
   lower-tier members. In
   addition, special rules
   govern the allocation of
   basis adjustments among
   multiple classes
   of stock, and cumulative
   redeterminations of basis
   adjustments sometimes are
   necessary ([sections]-32(c)).

   Basis may, in effect, be
   reduced below zero under
   the investment adjustment
   system. This "negative
   basis" is referred to as an
   "excess loss account" (ELA)
   and may be included in
   income upon the occurrence
   of certain subsequent
   events, including a sale or
   spin-off of the subsidiary
   outside the group. See
   [subsections]-19(b) and
   (c).

B. Loss Disallowance Rule.       B. Obtain representation with
   Under the controversial          respect to the portion of
   "loss disallowance               Target's basis in its
   regulations" (LDR), all or       subsidiaries that is
   a portion of any loss on         attributable to extraordinary
   the disposition (including       gain dispositions, positive
   a worthless stock                investment adjustments, net
   deduction) of a                  operating and capital loss
   consolidated subsidiary may      carryovers, and deferred
   be disallowed. The               deductions (e.g. interest
   disallowed loss cannot           under section 163(j)). This
   exceed the sum of the            information will be relevant
   following loss disallowance      to the LDR computation upon a
   factors: (i) income from         future disposition
   "extraordinary gain              or deconsolidation of such
   dispositions" reflected          subsidiary.
   in stock basis under
   [sections]-32; (ii) prior
   positive investment
   adjustments with respect to
   the stock, with no netting
   for distributions or
   negative earnings (except
   for a transition period
   ending in 1991);
   and (iii) the subsidiary's
   "duplicated loss"
   (generally the excess of
   the asset basis and the
   loss carryovers of the
   subsidiary over the value
   of the subsidiary's stock
   and the liabilities of the
   subsidiary, plus any
   "relevant items"). See
   [subsections]-20(a) and
   (c).

   LDR also provides that if a
   subsidiary is
   deconsolidated at a time
   when its stock basis
   exceeds its fair market
   value, stock basis must be
   reduced, with such
   reduction not to exceed the
   sum of the loss
   disallowance factors
   described above. See
   [subsections]-20(b) and
   (c).

IV. Carryover of Tax Attributes and Certain Tax
    "Taints" or Detriments of Target

A. Earnings and Profits (E&P).   A. Obtain representation
   The consolidated return          regarding the E&P of Target
   regulations contain              that will not be eliminated
   specific rules governing         immediately prior to
   the calculation of E&P.          deconsolidation from the
   Under the single-entity          Selling Group.
   principle underlying these
   rules, the common parent's
   E&P generally includes a
   ratable portion of the
   separately calculated E&P
   (or deficit) of its direct
   and indirect subsidiaries
   generated while members of
   the group ([sections]-33
   (a)). Target's E&P
   generated while a member of
   Selling Group will in
   effect be replicated in the
   E&P of the common parent of
   Selling Group; however,
   such E&P of Target
   generally will be
   eliminated from Target's
   separate E&P immediately
   before Target ceases to be
   a member of Selling Group.
   Thus, Acquiring Group
   generally will not succeed
   to Target's E&P generated
   while it was a member of
   Selling Group. However,
   Target's E&P that has not
   "tiered-up" within Selling
   Group (such as E&P
   generated prior to joining
   Selling Group(8)) will not
   be eliminated and therefore
   will remain with Target
   within Acquiring Group.
   See [sections]-33(e). Other
   exceptions to the
   elimination rule: (i) if
   the Selling Group is
   acquired; (ii) if a
   subsidiary is distributed
   under section 355; (iii) to
   test distributions from
   thrift institutions; (iv)
   to test amounts received by
   insurance companies; and
   (v) other cases to be
   identified in an Internal
   Revenue Bulletin.

B. Allocation of Tax             B. Obtain representations
   Attributes to Target:            regarding the amount of
   General. Subject to the          losses and credits of
   limitations and elections        Target from years prior to
   described below, Target's        the affiliation with the
   unused losses and credits        Selling group, if any, and
   from years prior to joining      the amount of consolidated
   the Selling Group are            net operating losses, net
   carried with it into the         capital losses, foreign tax
   Acquiring Group ([sections]      credits, investment credits
   -21(b)(1)). In addition,         and other tax credits of the
   the Target also may carry        Selling Group allocable to
   with it an allocable             Target.
   portion of consolidated tax
   attributes of the Selling
   Group to which it has
   contributed. ([subsections]
   -21(b)(2) and -79(c)-(e)).
   Income for the entire
   taxable year of Selling
   Group in which the
   disposition of Target
   occurs reduces the amount
   of the losses and credits
   that will be apportioned to
   Target ([sections]-21(b)(2)
   (ii)(A)). Gain or loss on
   the sale of Target, however,
   is not taken into account
   in determining the amount
   of any unused consolidated
   net operating loss or
   consolidated net capital
   loss attributable to Target
   under the anti-"circular
   basis" rules
   ([sections]-11(b)).

   If Selling Group (or a           Obtain representations
   subgroup thereof that            regarding the existence and
   includes Target) previously      amount of any NUBIL that will
   experienced an ownership         be apportioned to Target.
   change under section 382
   and has remaining net
   unrealized built-in losses
   (NUBILs), corporations that
   cease to be members of a
   group on or after June 25,
   1999, also may be allocated
   a portion of Selling
   Group's NUBIL. The
   apportionment generally is
   based upon the portion of
   the group's (or subgroup's)
   NUBIL remaining at the close
   of the year in which Target
   ceases to be a member of
   Selling Group that is
   attributable to assets held
   by Target immediately after
   it ceases to be a member
   ([sections]-95(e)).

C. The SRLY Limitation, as       C. Obtain representation
   Modified by the Section 382      regarding the amount of
   Overlap Rule.(9) In              existing SRLY losses and
   addition to statutory            credits, as well as built-in
   limitations imposed by           losses with respect to
   sections 269, 382,               Target.
   383, and 384, the
   absorption of most of
   Target's loss and credit
   carryforwards and
   carrybacks may be subject
   to special restrictions
   under the separate return
   limitation year (SRLY)
   rule. Under this rule, the
   utilization of Target's
   attributes generally is
   limited to Target's
   cumulative contribution to
   the consolidated taxable
   income (or consolidated
   capital gain net income or
   consolidated tax liability,
   as the case may be) of the
   group to which the
   attribute is to be carried
   ([subsections] 21(c),
   -22(c), -3T(c), -55T(h)
   (4)). The limitation on the
   use of a Target's
   attributes (and the
   attributes subject to such
   limitation) is determined
   on the basis of the
   combined contribution of
   Target and its affiliates
   that are included in a
   SRLY subgroup as defined in
   [sections]-21(c)(2). The
   benefits of the subgroup
   rules could be challenged
   if (i) a member of the
   subgroup is formed,
   acquired, or availed of
   with a principal purpose of
   avoiding or increasing the
   limitation, or (ii) a member
   is excluded with a
   principal purpose of
   avoiding or increasing the
   limitation. See [sections]
   -21(c)(2)(iv).

   For taxable years for which
   the unextended consolidated
   return due date is after
   June 25, 1999, the SRLY
   limitation will not apply
   in certain circumstances.
   In general, the SRLY rule
   may not limit the
   absorption of losses that
   also become subject to
   limitation under section
   382 within a six-month
   period of becoming subject
   to the SRLY rules ("the
   overlap rule"). If, for
   example, Acquiring Group
   acquires 80 percent or more
   of Target's stock in a
   single transaction, section
   382 will apply to Target's
   preacquisition losses and
   the SRLY limitation
   generally will not apply.
   The overlap rule will apply
   only if the section 382
   loss subgroup and the SRLY
   subgroup have identical
   membership.

   In certain circumstances,
   when built-in losses of
   Target are recognized,
   they become subject to the
   SRLY rules. A built-in loss
   is, in general, determined
   under section 382(h)(3),
   and thus must be
   significant and can include
   certain built-in
   deductions. See [sections]
   -15. The overlap rule also
   may render the [sections]
   -15 limitation on the
   utilization of recognized
   built-in losses inapplicable
   in certain situations.

   The overlap rule discussed
   above with respect to loss
   carryovers does not apply
   with respect to credits.
   For example, minimum tax
   credits generally may be
   subject to limitations
   under both section 383 and
   SRLY. However, foreign tax
   credits carried to
   consolidated return years
   for which the unextended
   return due date is after
   March 13, 1998, are not
   subject to the SRLY
   limitation.(10)

D. Exceptions to General Allocation Rule for Losses.

1. Selling Group's election to   1. Agree regarding the amount of
   retain Targets loss              Target's losses that will be
   carry-forwards. If the           reattributed to Selling
   Selling Group recognizes a       Group, even though Target and
   loss on the sale of Target       its former Parent technically
   and all or a portion of          make the election. If the
   such loss is disallowed          election is to be made,
   under LDR ([sections]-20),       Selling Group should obtain
   then the Selling Group           representation that Acquiring
   may make an irrevocable          Group will attach the
   election to retain some or       necessary statement to
   all of the operating or          Acquiring Group's first
   capital loss carryovers          return that includes Target
   (including any SRLY              in order to perfect Selling
   losses) of Target up to the      Group's election.
   amount of the disallowed
   loss, except to the extent
   Target and its subsidiaries
   are insolvent ([sections]
   -20(g)). If Target's losses
   that are retained by
   Selling Group under this
   election are subject to a
   pre-existing section 382
   limitation, the parent also
   may elect to apportion all
   or a part of the applicable
   section 382 limitation to
   itself ([sections]-96(d)
   (4)).

2. Acquiring Group's election    2. Obtain list of loss
   to "waive" Target's loss         carryovers of Target, the
   carryforwards. If Target         date such losses will expire,
   carries operating or             and any section 382
   capital losses into the          limitations impeding the
   Acquiring Group and such         absorption of such losses
   losses are expected to           (taking into account the
   expire unused, Acquiring         apportionment or
   Group may make an                non-apportionment of the
   irrevocable election (for        section 382 limitation under
   the first year Target            8-95 (see IV.G.)).
   is included in the
   Acquiring Group's return)
   to "waive" any or all of
   such loss carryforwards in
   order to prevent the
   negative stock basis
   adjustment that will occur
   if such losses are
   permitted to expire in
   Acquiring Group ([sections]
   -32(b)(4)). Depending upon
   the tax character of the
   acquisition of Target
   (i.e., taxable purchase vs.
   tax-free reorganization),
   negative stock basis
   adjustments may result even
   with this election.
   Although this election is
   made unilaterally by
   Acquiring Group, it may
   reduce Selling Group's
   disallowed loss on its
   disposition of Target and,
   correspondingly, reduce the
   amount of Target's loss
   carryforwards that it could
   elect to retain under
   [sections]-20(g).

E. Allocation and Recapture of   E. Obtain representation
   Overall Foreign Loss.            regarding the share of OFLs
   Consolidated overall             and SLLs allocable to Target.
   foreign losses (OFL) (and,
   presumably, separate
   limitation foreign losses
   (SLL)) must be apportioned
   to departing members in an
   amount equal to the
   "notional overall foreign
   loss account" of Target
   (for departures before
   January 28, 1999)
   ([sections]-9A(c)(3)) or an
   asset-based apportionment
   method (for departures
   after January 27, 1999)
   ([sections]-9(c)(2)), and
   are subject to recapture
   under section 904(f) if the
   Acquiring Group has
   foreign-source income. For
   consolidated returns for
   which the unextended due
   date is after March 13,
   1998,(11) the recapture of
   OFLs and SLLs is not
   subject to SRLY
   restrictions (i.e.,
   recapture is based upon
   foreign source income of
   the entire Acquiring Group,
   which may impede the
   ability to absorb
   consolidated foreign tax
   credits of Acquiring Group
   even if Target has no
   foreign source income).

F. Allocation of Minimum Tax     F. Obtain representation
   Credits. Consolidated            regarding the portion of MTCs
   minimum tax credits (MTCs)       allocable to Target, or agree
   must be apportioned to           with respect to the general
   Target when it leaves the        methodology for apportioning
   Selling Group. Proposed          consolidated MTCs to Target.
   regulations prescribing an
   apportionment method have
   not been finalized; pending
   finalization, consolidated
   groups may use any
   reasonable method.

G. Pre-Existing Section 382      G. Agree to the apportionment
   Limitations. If Selling          of existing section 382
   Group (or a subgroup             limitations and net
   thereof including Target         unrealized built-in gains and
   and the Subsidiaries) has        specifically address the
   undergone                        making of the requisite
   a section 382 ownership          election.
   change, a portion of the
   section 382 limitation
   resulting from such
   ownership change may be
   apportioned to Target and
   the Subsidiaries when they
   cease being members of
   Selling Group. An
   affirmative election
   is required or else the
   entire section 382
   limitation will remain with
   Selling Group and Target's
   section 382 limitations
   will be zero (even if
   Target carries the covered
   tax attributes with it as
   described in IV.B.)
   ([sections]-95(b)(2)
   and (c)). All or a part of
   Selling Group's (or
   subgroup's) net unrealized
   built-in gain also may be
   apportioned to Target upon
   its departure from Selling
   Group, thereby increasing
   Target's apportioned
   section 382 limitation if
   it subsequently recognizes
   built-in gains during the
   five-year recognition
   period ([sections]-95(c)).

H. Tax Refunds for Carrybacks.   H. Much bargaining over
   Subject to SRLY                  this issue. Acquiring
   limitations, unused losses       Group will bargain for
   and credits of Target            right to carry back the
   created after it becomes         the losses and credits
   a member of Acquiring Group      Target to Selling Group's
   must be carried back to          returns and to obtain a
   Selling Group unless a           refund relating to the
   section 338 election is          absorption of such losses
   made by Acquiring Group(12)      and credits of within a
   or the Acquiring 172(b)(3)       short period after Selling
   to forgo the carryback           Group receives such refund.
   period for net operating         refund. Selling Group will
   losses.(13) The refund           not want Acquiring Group
   check attributable to            meddling in its
   carrybacks generally will        its consolidated return,
   be sent to Target's former       nor will it want Acquiring
   common parent.                   Group utilizing Target's
                                    losses and credits to
   For acquisitions after           obtain a refund of taxes
   August 24, 1999, Acquiring       paid by Target while a
   Group may make an                member of Selling Group.
   irrevocable election to          Therefore, Selling Group
   relinquish, for all              will bargain for a
   consolidated net operating       provision requiring
   losses attributable to           Acquiring Group to elect
   Target (and its affiliates       to waive net operating
   which also were members of       loss carryback privilege
   Selling Group), the portion      under section 172(b)(3),
   of the carryback period          which will be easier to
   during which Target was          negotiate since the new
   a member of Selling Group.       rules only require a
   This election must be made       waiver for losses of
   with the first tax return        Target. The fate of
   of the Acquiring Group that      foreign tax credit and
   includes Target and is not       capital loss carrybacks
   available if Target was not      also should be resolved
   a member of another              because neither Acquiring
   consolidated group during        Group nor Target can waive
   the otherwise applicable         such carryback rights.
   carryback period
   ([sections] 21(b)(3)(ii)
   (B)). Any other election to
   forgo the carryback period
   will apply to the entire
   Acquiring Group
   ([sections]-21(a)(3)(i)).

   In addition, Treas. Reg.
   [sections] 301.6402-7
   provides rules pursuant to
   which the IRS may pay the
   refund attributable to a
   former member that is an
   insolvent financial
   institution directly to the
   fiduciary of that former
   member.

V. Administrative and Other Miscellaneous Provisions

A. Several Liability. Target     A. Obtain representation with
   and each of its                  respect to which consolidated
   Subsidiaries are                 groups and for which years
   "severally" liable for           Target was a member. Obtain
   the entire tax liability of      indemnification for taxes for
   the consolidated group for       which Target may be liable.
   any year in which they were      If Target has potentially
   a member for one or more         significant 8-6 liabilities,
   days ([sections]-6(a)).          obtain letters of credit or
   This is the case even if         other collateral or covenant
   section 338(h)(10) is            that Selling Group will
   elected to treat the             cooperate with Acquiring
   transaction as a deemed          Group in getting District
   purchase of Target's             Director to exercise its
   assets. See Treas. Reg.          authority to limit Target's
   [sections] 1.338(h)              several liability.
   (10)-1(e)(5). The
   District Director may, if
   he believes the balance of
   any group deficiency will
   not be jeopardized, assess
   and collect from Target
   only the portion of the
   Selling Group's deficiency
   which the District Director
   "may determine to be
   allocable" to Target
   ([sections]-6(b)).
   If so, the normal agency
   rules under [sections]-77
   will  not
   apply.

B. Notice of Deficiency.         B. Obtain covenant that
   Selling Group will receive       Acquiring Group will be
   all notices of deficiency        notified (within specified
   from the IRS pursuant to         time period) of any
   its agency power prescribed      post-closing deficiency
   by [sections]-77(a).             notices received by Selling
                                    Group.

C. Common Parent's Right to      C. Obtain representation
   Make Tax Elections. The          regarding all current
   common parent of the             federal, state, or local
   Selling Group has the            tax elections
   authority under                  in effect and a covenant that
   [sections]-77 to make all        Selling Group will not change
   tax elections for Target         any current elections or make
   (with four exceptions)           new elections after the
   while Target is a member         signing of the Acquisition
   of its group.                    Agreement that would affect
                                    Target without obtaining
                                    Acquiring Group's consent.
D. Estimated Tax. General rule
   is that Target's prior
   history is ignored in
   computing Acquiring Group's
   estimated tax liability
   (which is required to be
   computed on a consolidated
   basis beginning with its
   third consolidated year).
   See [sections]-5(b).
   Moreover, the exception
   from penalties based on
   taxes shown in a preceding
   year is not very useful
   because this
   exception (section
   6655(d)(1)(B)(ii)) applies
   only to small groups
   (generally, taxable income
   of $1 million or less).
   Therefore, Acquiring Group
   generally will have to
   amend its estimated tax to
   reflect Target's earnings
   for the post-closing
   partial period of Acquiring
   Group's taxable year.

E. Tax-Sharing Agreements.       E. Require termination of
   Most affiliated groups           existing tax-sharing
   agree in advance what            agreements with respect to
   portion of the consolidated      Target as of the Closing Date
   tax liability will be            and the release of all
   payable by each member           liabilities of Target
   and the timing of such           thereunder for amounts due in
   payments.                        respect of any period prior
                                    to the Closing Date. If, as
                                    of the time Target is
                                    acquired by the Acquiring
                                    Group, Target retains
                                    pre-Closing earnings with
                                    respect to which income tax
                                    has not been paid, parties
                                    may allow Target to
                                    distribute, prior to Closing,
                                    an amount that represents an
                                    allocable portion of the
                                    income tax of Selling Group,
                                    determined in accordance with
                                    the existing tax-sharing
                                    agreement.

F. Outstanding Options,          F. Obtain representation that
   Warrants, Etc. In certain        there is no outstanding
   circumstances, stock             preferred stock, option,
   options, warrants,               warrant, or other contractual
   convertible debt, stock          obligation that would be
   appreciation rights,             treated as outstanding stock
   phantom stock, and similar       under sections 1504(a)(4) and
   rights to acquire stock          (5) and the applicable
   will be deemed exercised         regulations.
   for purposes of determining
   whether a corporation is a
   member of an affiliated
   group. In addition,
   depending upon its terms,
   preferred stock may be
   taken into account as well.
   See sections 1504(a)(4)
   and (5); Treas. Reg.
   [sections] 1.1504-4.

Exhibit A

Other Potential Consolidated Return Issues That May Require Contractual Protection

Our readers should be aware of the following consolidated return items that are unlikely to arise in most acquisitions. To avoid unduly burdening the acquisition agreement, it is recommended that contractual protections be added to the agreement only if the buyer has reason to believe (e.g., through due diligence) that it may be a material item.

I. Dual Consolidated Loss Issues.

A. Recapture of previously absorbed losses. If Target and subsidiaries have previously absorbed dual consolidated losses (DCLs) attributable to dual resident corporations or separate units (e.g., a foreign branch or an interest in a partnership) with respect to which the elective relief provision in Treas. Reg. [sections] 1.1503-2(g)(2) is applicable, the sale of Target to Acquiring Group may be a triggering event that requires Selling Group to "recapture" the DCLs plus an accrued interest charge. See Treas. Reg. [subsections] 1.15032(g)(2)(iii)(A)(2) and (vii).

The recapture may be avoided if the Selling and Acquiring Groups enter into a closing agreement with the IRS whereby Acquiring Group becomes bound to the elective relief conditions (including potential recapture) previously agreed to by Selling Group.

B. Conflicting dual consolidated loss elections. Either Selling or Acquiring Group may have elected, under Treas. Reg. [sections] 1.1503-2(h)(2)(ii), to replace agreements and certifications made in conformity with more stringent former temporary regulations (Temp. Reg. [sections] 1.1503-2A) with new agreements and certifications under the final regulations (Treas. Reg. [sections] 1.1503-2). Such an election must have been made on a group-wide basis. The regulations are silent, however, regarding the consequences where an electing group acquires a member from a non-electing group (or vice versa).

C. Election under section 953(d). A qualifying foreign insurance company can elect to be taxed as a domestic corporation under section 953(d). An additional tax is required under section 953(d)(6). Further, any loss of such corporation (if subject to an income tax under foreign law) is treated as a dual consolidated loss for purposes of section 1503(d) without regard to any possible regulatory relief under section 1503(d)(2)(B). The election may be terminated by the consent of the Commissioner or by a failure to meet all the qualifications. A termination will result in a deemed transfer of all of the property of the electing taxpayer to a foreign corporation under sections 367 and 354. The Acquiring Group should obtain a representation regarding any existing section 953(d) election, the amount of unused dual consolidated losses, and Target's qualification under section 953(d).

II. Reversal of Election to Treat Foreign Subsidiary as a Domestic Corporation under Section 1504(d).

If Acquiring Group does not elect to continue any section 1504(d) election of Target or subsidiaries, this may cause the termination of the section 1504(d) status of such corporation(s), with the result that a deemed transfer of property by a domestic corporation to a foreign corporation occurs under Treas. Reg. [sections] 1.367(a)1T(c)(5) on the last day Target is a member of Selling Group. If applicable, Selling Group may require appropriate indemnity for section 367 toll charges that may occur if Acquiring Group causes the section 1504(d) election to terminate in a time and manner that would affect the Selling Group's return.

III. Eligibility for Consolidation.

A. Five-year prohibition on reconsolidation. Target or any subsidiaries (or predecessors of Target or subsidiaries) that previously were affiliated with Acquiring Group within the past sixty months may not be included in Acquiring Group's consolidated return unless a waiver is obtained. Section 1504(a)(3).(14)

B. Five-year waiting period for life insurance companies. If Target or any subsidiary of Target is a life insurance company subject to tax under section 801, such life insurance company may not be included in Acquiring Group's consolidated return for the five full taxable years of the parent of the Acquiring Group following the date of the acquisition. Sections 1504(b)(2) and (c)(2).(15)

C. Prior election to deconsolidate. If an election to deconsolidate under Rev. Proc. 95-11 or Rev. Proc. 95-39 was made by Selling Group, or was made by a group that formerly included Target or any subsidiaries of Target, notice must be provided to the IRS as required by those revenue procedures if the acquisition occurs within sixty months following the effective date of the deconsolidation.(16) Such subsidiaries may not be included in Acquiring Group's consolidated return for sixty months following the deconsolidation unless the IRS either requires such corporations to join Acquiring Group's consolidated return or grants a waiver requested by Acquiring Group.

IV. Stock Basis Issues.

A. Reduction in basis of nonconsolidated subsidiaries.

1. LDR. The loss disallowance rule may require a basis reduction for any Target subsidiaries that are not immediately includible in Acquiring Group's consolidated return. See [subsections]-20(b) and (c).

2. BRA. If Target owns stock in any nonconsolidated subsidiaries with which it previously filed a consolidated return, a "basis reduction account" may exist with respect to such subsidiaries. In that case, any distributions from such subsidiary will reduce stock basis notwithstanding that it is not a member of a consolidated group. See [sections]-32(h)(5)(ii); former [sections]-32T.(17)

B. Reduced basis in stock of parent of Selling Group upon disaffiliation. If a built-in loss exists with respect to any stock of parent of Selling Group held by Target on the Closing Date, such stock basis must be reduced immediately before the acquisition. [sections]-13(f)(6)(i)(B).

C. Elective basis reduction in stock of parent of the Acquiring Group. If a built-in loss exists with respect to any stock of the parent of Acquiring Group held by Target on the Closing Date, the Acquiring Group may elect (under [sections]-13(f)(6)(i)(C)) to reduce such stock basis immediately before Target becomes a member (to avoid a future basis reduction for a disallowed loss with respect to the stock of parent).

V. A Member Leaving the Selling Group with Attributes That May Be Relevant to Determine the Character of Any Gain to Be Reported by the Buyer Remaining in the Acquiring Group.

The activities of former selling members of the Selling Group may affect the attributes of the remaining buying members of Target with respect to "corresponding items" from intercompany transactions within Selling Group that subsequently are taken into account by Acquiring Group. See [sections]-13(d)(2)(i)(B).

VI. Retroactive Application of Intercompany Transaction Regulations Governing Certain Stock Elimination Transactions.

An election by Selling Group to treat intercompany gains or losses with respect to stock of Target or its subsidiaries that arose in taxable years beginning before July 12, 1995, in accordance with the more lenient regulations generally applicable to intercompany transactions that occur in taxable years beginning after July 11, 1995, may not carry over into the Acquiring Group. See [sections]-13(1)(3).

VII. Recapture Issues.

A. Amount of recapture of net ordinary losses under section 1231(c). There are no regulations dealing with "non-recaptured net section 1231 losses." Acquiring Group may obtain representation regarding the amount of any potential "recapture" liability related to ordinary loss on section 1231 property previously reported by Target or its subsidiaries. Query whether a SRLY-type rule should apply to this negative attribute.

B. Amount of recapture of ITC and other business credits. Unless a section 338(h)(10) election is made, the sale of Target stock is not treated as a sale of the underlying assets and therefore investment tax credit (ITC) recapture generally will not occur. Target's subsequent disposition of investment credit property would require recapture of ITC. Acquiring Group may seek representations regarding the "non-vested" portion of ITC with respect to any properties owned by Target and its subsidiaries.

VIII. Section 1503(f) Limitation on Absorption of Losses and Credits.

If Target or any Subsidiaries have outstanding preferred stock described in section 1504(a)(4),(18) then to the extent dividends are distributed to nonmembers with respect to such stock, the separately computed taxable income of the issuing corporation cannot be offset by losses or credits of other members of Acquiring Group (including losses and credits of other corporations acquired in the same transaction). Section 1503(f).

IX. Irrevocable Hedging Election.

Rules clarifying the treatment of hedging transactions for consolidated groups operating through a hedging desk of a member of the group provide an irrevocable election for a consolidated group to elect separate entity treatment of its hedging transactions. See Treas. Reg. [sections] 1.12212(d)(2)(iv). The regulations are silent regarding the consequences where an electing group acquires members from a nonelecting group (or vice versa).

X. Prior Deconsolidation Tactics to Avoid Foreign Tax Credit Limitations.

Target should disclose whether its subsidiaries are all affiliated for foreign tax credit (FTC) purposes under section 904(i). The applicable regulations (Treas. Reg. [sections] 1.904(i)-1) are extremely broad and add members to the affiliated group for FTC purposes that would be includible corporations assuming that: (i) a consolidated return election applied; (ii) the exceptions in section 1504(b) to the list of includible corporations (such as foreign corporations and life insurance companies) do not apply; and (iii) the broad constructive ownership rules of section 1563(e) apply. For example, regardless of intent to evade, interposing a newly acquired life insurance company within the affiliated group will be disregarded in computing the FTC.

XI. Notification of Resurrection of Losses Following a "Bumping" under [sections]-47.

Under the life/nonlife consolidated return subgroup rules, a nonlife corporation may have had its loss for the current year absorbed by current income of a life company, only to have such absorbed loss resurrected by a carryback of a subsequent life loss to the life income which previously offset nonlife losses. See [sections]-47(a)(2). Selling group should be required to advise the Acquiring Group of any such changes in loss carryovers.

Model Agreement: Tax Representations and Warranties, Covenants, and Indemnity Provisions

The following are representations and warranties, covenants, and indemnity provisions that might appear in an acquisition agreement. In addition, Exhibit B sets forth additional provisions that are relevant if the parties contemplate making an election under section 338(h)(10).

[The following section is part of the Definitions section of the Acquisition Agreement.]

SECTION X. DEFINITIONS. For purposes of this Agreement:(19)

X.01. "Code" shall mean the Internal Revenue Code of 1986. All citations to the Code, or the Treasury Regulations promulgated thereunder, shall include all amendments thereto and any substitute and successor provisions. All section references to the Code (or Treasury Regulations) shall include all similar provisions under the applicable state, local, or foreign tax law.

X.02. "Tax" or "Taxes" shall mean all federal, state, local, foreign, and other taxes, assessments or other governmental charges, including, without limitation, (i) income, estimated income, business, occupation, franchise, property, sales, use, excise, employment, unemployment, payroll, social security, ad valorem, transfer, gains, profits, capital stock, license, gross receipts, stamp, real estate, severance, and withholding taxes, and (ii) interest, penalties, and additions in connection therewith, in each case, for which the Company and each of the Subsidiaries is or may be liable (including as a result of the application of Treas. Reg. [sections] 1.1502-6).

[The following section is part of "Representations and Warranties of the Seller."]

SECTION XX. TAX MATTERS.(20)

XX.01. Filing of Tax Returns.(21) Each of the Seller, the Company, the Subsidiaries, and the Parent has timely filed with the appropriate taxing authorities all returns (including, without limitation, information returns and other material information) in respect of Taxes required to be filed through the date hereof. All such returns are, and the information contained therein is, complete and accurate in all material respects. Except as specified in the Tax Disclosure Schedule, none of the Seller, the Company, the Subsidiaries, or the Parent has requested any extension of time within which to file returns (including, without limitation, information returns) in respect of any Taxes. The Parent and the Seller have made available to the Purchaser copies of such portions of the federal, state, foreign and local income tax returns of the Selling Group for the last four years ([1995, 1996, 1997 and 1998]) that relate to the Company and each of the Subsidiaries. Except as set forth in the Tax Disclosure Schedule, neither the Company nor any of the Subsidiaries has derived income or operated a trade or business in any foreign country, state, or locality.

XX.02. Payment of Taxes.(22) All Taxes in respect of periods beginning before the date hereof (i) if due and payable, have been timely paid, (ii) if not yet due and payable, have an adequate reserve established therefor in accordance with GAAP, as set forth in the Tax Disclosure Schedule, or (iii) are being contested in good faith by the Parent, the Seller, the Company or a Subsidiary pursuant to appropriate proceedings which are being diligently pursued and an adequate reserve therefor has been established in accordance with GAAP, as set forth in the Tax Disclosure Schedule. The Company and the Subsidiaries do not have any material liability for Taxes in excess of the amounts so paid or reserves so established. The Company and each of the Subsidiaries have, within the time and manner prescribed by applicable law, rules and regulations, withheld and paid over to the proper taxing or other governmental authorities all Taxes required to be withheld and paid over.(23)

XX.03. Audit History.(24) Except as set forth in the Tax Disclosure Schedule, there are no deficiencies for Taxes claimed, proposed, or assessed by any taxing or other governmental authority that have not yet been fully and finally resolved and, if such resolution required payment of any Taxes, such payment has been made. Except as set forth in the Tax Disclosure Schedule, there are no pending or, to the best of the Parent's, the Seller's, the Company's, or the Subsidiaries' knowledge, threatened audits, investigations or claims for or relating to Taxes, and there are no matters under discussion with any taxing or other governmental authority with respect to Taxes, in each case, that, in the reasonable judgment of the Parent, the Seller, the Company, the Subsidiaries, or their respective tax advisors, are likely to result in a material additional amount of Taxes. Audits of federal, state, foreign, and local returns for Taxes of the Company and the Subsidiaries by the relevant taxing authorities have been completed for each period set forth in the Tax Disclosure Schedule. Except as set forth in the Tax Disclosure Schedule, no extension of a statute of limitations relating to Taxes is in effect with respect to the Parent, the Seller, the Company, or the Subsidiaries.

XX.04. Tax Elections.

(a) All material elections with respect to Taxes affecting the Company and the Subsidiaries that are effective as of the date hereof are set forth in the Tax Disclosure Schedule.

(b) None of the Parent, the Seller, the Company, or any of the Subsidiaries: (i) has made a consent dividend election under section 565 of the Code; (ii) has consented at any time under section 341(0(1) of the Code to have the provisions of section 341(f)(2) of the Code apply to any disposition of the Company's or any Subsidiaries' assets; (iii) has agreed, or is required, to make any adjustment under section 481(a) of the Code by reason of a change in accounting method or otherwise; or (iv) has made an election, or is required, to treat any asset of the Company or any Subsidiary as owned by another person pursuant to the provisions of section 168(f)(8) of the Internal Revenue Code of 1954, as amended and in effect immediately prior to the enactment of the Tax Reform Act of 1986, or as tax-exempt bond financed property within the meaning of section 168(g) of the Code or as tax-exempt use property within the meaning of section 168(h)(1) of the Code.

XX.05. Asset Liens. There are no liens for Taxes (other than for current Taxes not yet due and payable) on any assets of the Company or any of the Subsidiaries.

XX.06. Tax Rulings/Binding Agreement. Neither the Company nor any of the Subsidiaries has requested or received any ruling from any taxing authority, or signed any binding agreement with any taxing authority (including, without limitation, any advance pricing agreement), that would impact the amount of Tax after the Closing Date.

XX.07. Power of Attorney. There is no power of attorney granted by the Company or any of the Subsidiaries relating to Tax that is currently in force.

XX.08. Prior Affiliated Groups. Tax Disclosure Schedule lists all combined, consolidated, or unitary groups of which the Company or any of the Subsidiaries has been a member and which has filed a combined, consolidated, or unitary return for federal, state, local, or foreign tax purposes, other than the Selling Group.

XX.09. Tax-Sharing Agreements. Except for the tax-sharing agreement of the Selling Group of which the Company and the Subsidiaries are members (a complete and accurate copy of which was delivered to the Purchaser prior to the date hereof), neither the Company nor any of the Subsidiaries is a party to a tax-sharing agreement or any similar arrangement.

XX.10. Existing Partnerships and Single Member LLCs. Except as set forth in the Tax Disclosure Schedule, neither the Company nor any of the Subsidiaries (i) is subject to any joint venture, partnership or other agreement or arrangement which is treated as a partnership for federal income tax purposes or (ii) owns a single member limited liability company which is treated as a disregarded entity.

XX.11. Parachute Payments. Except as set forth in the Tax Disclosure Schedule, neither the Company nor the Subsidiaries has made or become obligated to make, or will, as a result of any event connected with the acquisition of the Company and the Subsidiaries by the Purchaser or any other transaction contemplated herein, make or become obligated to make, any "excess parachute payment" as defined in section 280G of the Code (without regard to subsection (b)(4) thereof).

XX.12. Earnings and Profits. Immediately after the Closing Date, the Company and the Subsidiaries expect to have approximately $-- in current and accumulated earnings and profits that will remain with the Company and the Subsidiaries.

XX. 13. Balance of Intercompany Items. Except as set forth on the Tax Disclosure Schedule, all items of income, gain, deduction, or loss from an intercompany transaction will be taken into account as of the Closing under the matching and acceleration rules of Treas. Reg. [sections] 1.1502-13.

XX.14. Amount of Certain Recapture Items. The amount of investment tax credit of the Company and the Subsidiaries subject to recapture is $--. The amount of overall foreign losses of the Selling Group allocable to the Company and the Subsidiaries under Treas. Reg. [sections] 1.1502-9 and subject to recapture is $--.

XX.15. Debt or Stock of Acquiring Group. Neither the Company nor any of the Subsidiaries owns any debt obligation or any shares issued by any member of the Acquiring Group.

XX.16. Allocable Loss and Credit Carryovers. The Tax Disclosure Schedule sets forth (i) the amount of consolidated net operating losses, net capital losses, net unrealized built-in losses, foreign tax credits, minimum tax credits, investment tax credits, and other tax credits of the Selling Group allocable to the Company and the Subsidiaries under Treas. Reg. [subsections] 1.1502-21, 1.1502-22, 1.1502-79, and 1.1502-95 (separately stating any such amounts arising in years prior to the affiliation with the Selling Group); (ii) the date such losses or credits will expire; and (iii) all applicable limitations under sections 382 and 383 (taking into account the apportionment or non-apportionment of section 382 limitation under Treas. Reg. [sections] 1.1502-95).

XX.17. Basis and Excess Loss Accounts in Subsidiaries. The Tax Disclosure Schedule sets forth (i) the Company's basis and excess loss account (if any) in each Subsidiary (and each Subsidiary's basis and excess loss account (if any) in any other Subsidiary), (ii) the portion of the Company's basis in each Subsidiary (or each Subsidiary's basis in any other Subsidiary) that is attributable to extraordinary gain dispositions and positive investment adjustments as defined in Treas. Reg. [sections] 1.1502-20 and (iii) if any Subsidiary is a non-consolidated Subsidiary, the amount of any "basis reduction account" with respect to such Subsidiary as defined in Treas. Reg. [sections] 1.1502-32(h)(5).(25) The Company has computed such stock basis and excess loss account, if any, in each Subsidiary in compliance with Treas. Reg. [sections] 1.1502-32.

XX.18. Classes of Stock. Except as set forth in the Tax Disclosure Schedule, each Subsidiary has only one class of stock outstanding.

XX.19. Compliance with Section 6038A. The Parent, the Seller, the Company, and the Subsidiaries have complied with all reporting and record keeping requirements under section 6038A of the Code with respect to certain foreign-owned companies and transactions with certain related parties.

XX.20. FIRPTA. The Seller is not a "foreign person" as defined in section 1445(f)(3) of the Code.

XX.21. Permanent Establishment. Neither the Company nor any Subsidiary has or has had a permanent establishment in any foreign country, as defined in any applicable Tax treaty or convention between the United States of America and such foreign country.

[The following section is part of "Actions Prior to Closing."]

SECTION XXX. ACTIONS PRIOR TO CLOSING.

XXX.01. Termination of Existing Tax-Sharing Agreements. All tax-sharing agreements or similar arrangements involving the Company or any of the Subsidiaries or to which the Company or any of the Subsidiaries is a party shall be terminated with respect to the Company and the Subsidiaries prior to the Closing Date, and, after the Closing Date, the Company and the Subsidiaries shall not be bound thereby or have any liability thereunder.

XXX.02. Tax Elections. No new elections, and no changes in current elections, with respect to Taxes affecting the Company and the Subsidiaries shall be made after the date of this Agreement without the prior written consent of the Purchaser, which consent shall not be unreasonably withheld.

XXX.03. Tax Certificates. The Seller and the Company shall provide the Purchaser, on or prior to the Closing Date, with (i) all forms, certificates and/or other instruments required in connection with the transfer and recording taxes and charges arising from the transactions contemplated by this Agreement, together with evidence satisfactory to the Purchaser that such transfer taxes and charges have been paid in full by the Seller, (ii) an affidavit stating, under penalties of perjury, the Seller's United States taxpayer identification number and that the Seller is not a foreign person pursuant to section 1445 (b)(2) of the Code, and (iii) a clearance certificate or similar document(s) which may be required by any state taxing authority to relieve the Purchaser of any obligation to withhold any portion of payments to the Seller pursuant to this Agreement.

XXX.04. Access to Books and Records. Between the date of the Agreement and the Closing Date, the Seller, the Parent, and the Company shall give the Purchaser and its authorized representatives reasonable access to all books, records, and returns of the Company, the Subsidiaries, and the Seller and have their personnel and accountants available to respond to reasonable requests of the Purchaser and its authorized representatives.

XXX. 05. Settlement of Tax Reserves. To the extent there are reserves for Taxes shown on the books of the Selling Group with respect to consolidated, combined, or unitary Taxes for which the Parent files a return on behalf of the Selling Group, including the Company and the Subsidiaries (excluding reserves established for deferred Taxes), the Company or the Subsidiaries shall be permitted to distribute an amount equal to such reserves attributable to earnings of the Company and the Subsidiaries to the Parent or the Seller (or any other affiliate designated by the Parent or the Seller) prior to the Closing Date. The computation of such amount shall be based on the existing tax-sharing agreement of the Selling Group, subject to the Purchaser's review and consent, which shall not be unreasonably withheld.

[The following section is part of "Indemnification."]

SECTION XL. TAX INDEMNITIES, FILING REQUIREMENTS, AND OTHER POST-CLOSING MATTERS

XL.01. Survival of Representations and Warranties. The representations and warranties of the Seller contained in Section XX of this Acquisition Agreement shall survive the Closing until the expiration of the applicable statute of limitations (giving effect to any waiver or extension thereof).(26)

XL.02. Filing of Tax Returns.

(a) The Parent and the Seller shall prepare and timely file all consolidated, combined, or unitary income tax return for the Selling Group for all periods ending on or prior to the Closing Date (including, with respect to the Company and the Subsidiaries, a short taxable year ending on the Closing Date) and shall include the Company and the Subsidiaries in such returns. All such returns shall be prepared in accordance with past practice (unless a contrary position is required by law), to the extent any position taken in such returns may affect the tax liability of the Company or any Subsidiary after the Closing. The Parent and the Seller shall discharge all tax liabilities shown on such returns. In connection with preparation of such returns, the Parent and the Seller shall prepare books and working papers (including a closing of the books as of the Closing Date) which shall clearly demonstrate the income and activities of the Company and the Subsidiaries for the period ending on the Closing Date.(27) The Parent and the Seller shall provide a copy of portions of such returns relating to the Company and the Subsidiaries to the Purchaser for its review at least 20 days prior to the filing of such returns. The Parent and the Seller shall not file any amended return for a period ending on or before the Closing without the Purchaser's consent (which consent shall not be unreasonably withheld) if the filing of any such amended return may affect the tax liability of the Company or any Subsidiary for which the Purchaser is liable.

(b) The Purchaser shall prepare and timely file all tax returns with respect to the Company and the Subsidiaries, other than the income tax returns referred to in XL.02(a), that are required to be filed after the Closing, and shall duly and timely pay Taxes due on such tax returns. To the extent such tax returns relate to any period beginning before the Closing Date and ending after the Closing Date (a "Straddle Period"), the Purchaser's preparation of such tax returns shall be subject to the Seller's review and approval, which approval shall not be unreasonably withheld. The Purchaser shall make such tax returns for a Straddle Period available for the Seller's review and approval no later than 20 business days prior to the due date for filing such tax returns. Within 10 days prior to the due date for the filing of such tax return, whether or not the Seller and the Parent agree with the contents of such tax return, the Seller or the Parent shall pay the Company or the Purchaser an amount equal to the amount of Taxes shown as due on such tax returns allocable to the Seller and the Parent under Section XL.07 for the portion of the Straddle Period up to and including the Closing Date (such portion, being referred to as a "Pre-Closing Partial Period") less any estimated Taxes paid for such Taxes prior to the Closing Date.(28)

XL.03. The Parent and the Seller Indemnity. The Parent and the Seller shall jointly and severally indemnify, defend, and hold the Purchaser, the Company, the Subsidiaries, and each of their respective affiliates, successors, and assigns harmless from and against any and all Taxes for which the Company or any of the Subsidiaries shall be liable (including Taxes payable as a result of the application of Treas. Reg. [sections] 1.1502-6) (i) with respect to all periods ending on or prior to the Closing Date, (ii) with respect to each Straddle Period, but only with respect to the portion of each such period up to and including the Closing Date (such portion, being referred to as a "Pre-Closing Partial Period"), (iii) without duplication, resulting from the untruth or inaccuracy of any representation or warranty set forth in Section XX of this Acquisition Agreement, and (iv) without duplication, resulting from any breach of any covenant or agreement set forth in this Acquisition Agreement.(29) Notwithstanding the foregoing, neither the Parent and nor the Seller shall be required to indemnify the Purchaser, the Company, or the Subsidiaries for Taxes payable as a result of an election made (or deemed made) under section 338 of the Code.(30) The Parent and the Seller shall be entitled to any net refunds of Taxes (including interest thereon) with respect to the periods described in clauses (i) and (ii) above, except to the extent such refund arises as the result of a carryback of a loss or other tax benefit as provided in Section XL.05(a).

XL.04. The Purchaser Indemnity. The Purchaser shall indemnify and hold the Parent, the Seller, and each of their respective affiliates, successors, and assigns harmless from and against any and all Taxes for which the Company and the Subsidiaries shall be liable (i) with respect to all periods beginning after the Closing Date, (ii) with respect to each Straddle Period, but only with respect to the portion of each such period beginning the day after the Closing Date (such portion, a Post-Closing Partial Period), (iii) resulting from an election made (or deemed made) under section 338 of the Code, and (iv) resulting from any events occurring on the Closing Date, but after the Closing, which are outside of the ordinary course of business. The Purchaser shah be entitled to all refunds of Taxes with respect to the periods described in clauses (i) and (ii) above.

XL.05. Carryovers and Carrybacks.

(a) For purposes of this Section XL, Tax or Taxes shall include the amount of Taxes which would have been paid but for the application of any credit or net operating or capital loss deduction attributable to periods beginning after the Closing Date or to any Post-Closing Partial Period.(31) If the Company earns any credit or loss that is carried back to offset income for a period ending on or prior to the Closing Date and if the Seller or the Parent realized a reduction in Tax for such a period as a result of such carryback (either in the form of a refund or an offset), the Seller shall pay to the Purchaser the amount of such reduction within 30 days after the receipt of the refund or an offset; provided, however, that the Seller shall not make such payment to the Purchaser to the extent the Seller could otherwise offset such income (to which such carryback was applied) with the Selling Group's own credit or net operating or capital loss pursuant to normal consolidated return and other applicable rules. The Seller and the Parent shall, at the request of the Purchaser, cooperate in connection with the filing of necessary returns and other documents and the related procedure, and provide a basis for the computation of the amount paid to the Purchaser pursuant to this Section XL.05 .in reasonable detail.(32)

(b) The Parent, the Seller, and the Purchaser agree that (i) pursuant to Treas. Reg. [sections] 1.1502-20(g), out of $-- of net operating loss carryovers and $-- of net capital loss carryovers, $-- and $--, respectively, shall be reattributed to the Seller and (ii) $-- of consolidated minimum tax credits of the Selling Group shall be allocated to the Company and the Subsidiaries upon the Closing? Schedule XL.05 provides for the amount of the net operating loss carryovers, the capital loss carryovers, and consolidated minimum tax credits, the respective subsidiaries and the relevant years. The Parent and the Seller shall make an appropriate election to effectuate such reattribution in accordance with Treas. Reg. [sections] 1.1502-20(g).

XL.06. Payment for Tax Benefits Realized In Connection With Indemnity by the Parent and the Seller. If the Parent or the Seller is required to make an additional payment of Taxes in respect of any period ending on or prior to the Closing Date or a Pre-Closing Partial Period (either directly to a governmental agency or to the Purchaser as an indemnity payment under Section XL.02 of this Agreement) and, due to such payment (or an item giving rise to such payment), the Purchaser, the Company, or any Subsidiary obtains a deduction or credit, the Purchaser shall pay to the Seller an amount equal to the actual tax savings produced by such deduction or credit.(34) The amount of any such tax savings for any period shall be the amount of the actual reduction in Taxes reflected on any consolidated federal income tax return or any foreign, state, or local income tax return (net of any resulting increases in Taxes reflected on any other such return) for such period as compared to the Taxes that would have been reflected on such return in the absence of such deduction or credit. Any deduction or credit not resulting in an actual tax savings for the taxable period to which it relates or for any earlier period shall be carried forward to succeeding taxable years until used to the extent permitted by law. All payments pursuant to this Section XL.06 (together with supporting calculations) shall be made within 30 days after the filing of the applicable tax return for the period in which such deduction or credit results in a reduction in the Taxes paid by the entity receiving such deduction or credit. If the Purchaser makes a payment pursuant to this Section XL.06 and the actual tax savings (or portion thereof) relating to such payment is eventually not realized, the Purchase shall promptly notify the Seller (with documents illustrating the loss of any tax savings) and, upon the receipt of such notice, the Seller shall promptly refund such payment (or such allocable portion thereof) with interest (at the prevailing prime rate) to the Purchaser.(35)

XL.07. Allocation Between Partial Periods. Any Taxes for a Straddle Period shall be apportioned between the Pre-Closing Partial Period and the Post-Closing Partial Period, based, in the case of real and personal property Taxes, on a per diem basis and, in the case of other Taxes (including, without limitation, income taxes and taxes in lieu of income taxes), on the actual activities, taxable income or taxable loss of the Company and the Subsidiaries during such Pre-Closing Partial Period and such Post-Closing Partial Period, based on a closing of the books (including taking of inventories) as of the close of business on the Closing Date.(36) Neither the Company nor any Subsidiary shall be permitted to carry out any transaction outside the ordinary course of its trade or business on the Closing Date after the Closing (other than the transactions contemplated by the Acquisition Agreement).(37)

XL.08. Control of Post-Closing Audits and Other Proceedings.

(a) The Parent and the Seller, on the one hand, and the Purchaser, on the other hand, agree to give prompt notice to each other of any proposed adjustment to Taxes for periods ending on or prior to the Closing Date or any Pre-Closing Partial Period, within 10 days after receipt of such proposed adjustment. If the indemnified party fails to provide prompt notice, the indemnifying party's indemnity obligation shall be reduced, but only to the extent of any damages (or an increase thereof) incurred as a result of the delay.

(b) The Parent, the Seller, and the Purchaser shall cooperate with each other in the conduct of any audit or other proceedings involving the Company or the Subsidiaries for periods ending on or prior to the Closing Date and Pre-Closing Partial Periods and each may participate at its own expense,(38) provided that the Parent and the Seller shall have the right to control the conduct of any such audit or proceeding for which the Parent and the Seller agree that any resulting Tax is covered by the indemnity provided in Section XL.03. The Purchaser shall execute or cause to be executed powers of attorney or other necessary documents in order for the Parent or the Seller to exercise its control over such audit or proceeding. Neither the Parent nor the Seller may settle or otherwise resolve any such claim, suit, or proceeding without the consent of the Purchaser, which consent shall not be unreasonably withheld. Notwithstanding anything to the contrary, the Parent and the Seller, on one hand, and the Purchaser, on the other hand, shall jointly control all proposed adjustments to Taxes relating to a Straddle Period.(39)

Exhibit B

Section 338(h)(10). Additional Representations and Covenants

The following provisions should be included in the acquisition agreement where the parties contemplate making an election under section 338(h)(10). Because the several liability imposed by Treas. Reg. [sections] 1.1502-6 applies to the Company and its Subsidiaries even where a section 338(h)(10) election is made, the Purchaser should obtain the same representations regarding, and indemnification for, Taxes of the Company and any Subsidiaries as in a stock purchase without a section 338(h)(10) election.

Additional Representations:

1. The Parent and the Seller represent and warrant that the Company and the Subsidiaries are "selling affiliates" as such term is defined in Treas. Reg. [sections] 1.338(h)(10)1(c)(4) and that the Parent is eligible to make an election under section 338(h)(10) of the Code and to make a comparable election under each applicable state and local tax law with respect to the Company and the Subsidiaries.(40)

Additional Covenants:

1. The Parent and the Purchaser agree to join in making an election under section 338(h)(10) of the Code (the "Election") with respect to the acquisition of the Company and the Subsidiaries. As soon as practicable after the Closing, the Parent and the Purchaser shall mutually prepare an Internal Revenue Service Form 8023, including, without limitation, all additional data and materials required to be attached to such Form 8023 pursuant to Treas. Reg. [sections] 1.338(h)(10)-1. The Purchaser and the Parent shall also cooperate with each other to take all actions necessary and appropriate (including, without limitation, filing such additional forms, returns, elections, schedules and other documents as may be required) to effect and preserve such Election in accordance with the provisions of Treas. Reg. [sections] 1.338(h)(10)-1 (and comparable provisions of each applicable state and local tax law) or any successor provisions.

2. With respect to the Election, the Modified Aggregate Deemed Sales Price as defined in Treas. Reg. [sections] 1.338(h)(10)-1 (the "Modified ADSP') shall be allocated among the assets of the Company and the Subsidiaries pursuant to Treas. Reg. [sections] 1.338(h)(10)-1. The Purchaser and the Parent shall use their good faith best efforts to agree upon such allocation. The Seller or the Parent, on one hand, and the Purchaser, on the other hand, shall use their respective best efforts to resolve any disagreement that arises in the allocation and if no resolution is achieved within three months after the Closing, the Seller or the Parent, on one hand, and the Purchaser, on the other hand, shall mutually select an independent accounting firm, whose determination of the issue for which there is disagreement shall be final and binding on the Seller or the Parent, on one hand, and the Purchaser, on the other hand and shall be enforceable in any court of competent jurisdiction. The Parent (or the Seller) shall provide to the Purchaser a schedule and supporting material reflecting such allocation for the Purchaser's review and consent, which consent shall not be unreasonably withheld. The parties shall take no action inconsistent with, or fail to take any action necessary for the validity of, the Election, and shall adopt and utilize the asset values determined from such allocation for the purpose of all tax returns filed by them, and shall not voluntarily take any action inconsistent therewith upon examination of any tax return, in any refund claim, in any litigation, or otherwise with respect to such tax returns.

(1) This article is an updated version of the article that appeared in the Spring 1989 issue of THE TAX EXECUTIVE, "Buying or Selling a Member of a Consolidated Group?" by Irving Salem and Karen L. Halby (41 THE TAX EXECUTIVE 263). The authors wish to express their appreciation for the valuable comments and suggestions provided by Steve Della Rocca and David Blue of Latham & Watkins and Larry Axelrod of Deloitte & Touche.

(2) Hereafter, all citations to the consolidated return regulations will omit "Treas. Reg. [sections] 1.1502" and instead refer only to the section number (e.g., [sections]-76(b)(1)(ii)(A)).

(3) These rules assume that Target's short period will not be reported on the return of another group. If Target is included in Selling Group's return through the Closing Date, this rule will not alter the due date of the Selling Group's consolidated return, which will include Target's income and deductions through the Closing Date.

(4.) For instance, because of the five-year affiliation prerequisite under section 1504(c), Target Subsidiaries that are life insurance companies are not immediately includible in Acquiring Group.

(5.) For deferred intercompany gains and losses that arose in taxable years beginning prior to July 12, 1995, a similar exception is contained in former [sections]-13(f)(2)(i)); however, under the former regulation the non-includibility of a single corporation would render the exception inapplicable.

(6) See [sections]-13(f)(5)(ii)(C) for an elective provision that may mitigate the effect of this rule provided that the intercompany gain arose in a taxable year beginning after July 11, 1995, or, if prior to that date, an election under [sections]-13(1)(3) was made in the Selling Group's return that included July 12, 1995.

(7) [sections]-32(h)(4) contains an exception to this general rule, providing that the expiration of loss carryovers from SRLYs of members acquired by the group in a taxable year beginning prior to January 1, 1995, will not cause a reduction in stock basis.

(8) This will always be the case if Target was a stand alone corporation or the common parent of a group prior to its acquisition by the Acquiring Group. In addition, the elimination of Target's E&P immediately prior to its deconsolidation from a group first became effective for deconsolidations in taxable years beginning after December 31, 1994. Thus, if Selling Group acquired Target from another consolidated group in a year beginning before January 1, 1995, Target's E&P would not have been eliminated.

(9) Restrictions on the use of attributes in the case of a consolidated return change of ownership (CRCO) have been removed. The removal is generally effective for CRCOs occurring during 1997 and subsequent years ([sections]-21T(d)(1).

(10) Groups have the option of applying these rules along with certain other rules for taxable years beginning after December 31, 1996, even if the return is due before March 14, 1998 ([sections]-3T(c)(4)). Additionally, groups may elect to delay the effective date of the removal of the SRLY limitation with respect to the recapture of overall foreign losses until years beginning after January 1, 1998 ([sections] -9A(b)(1)(vi)).

(11) See note 10 for an optional alternative effective date.

(12) Target's carrybacks arising after the acquisition for which section 338 is elected would be carried to prior years of the Acquiring Group under the principles of the "offspring rule" in [sections]-21(b)(2)(ii)(B). The SRLY rules effective June 25, 1999 clarified the offspring rules to make them applicable to a Target acquired in a section 368(a)(2)(D)

(13) In this case, Target's unused net operating losses will be available for carryforward only.

(14) Rev. Proc. 91-71 provides an automatic waiver procedure under certain circumstances. Groups not within the scope of the automatic waiver procedure may seek a private letter ruling from the IRS National Office.

(15) Two or more such excluded life insurance companies that are affiliated with each other may be permitted to file consolidated returns that include only life insurance companies. Section 1504(c)(1).

(16) A deconsolidation under Rev. Proc. 95-11 or 95-39 was effective beginning with the first taxable year beginning on or after January 1, 1995, or the first taxable year beginning on or after July 12, 1995, respectively.

(17) [sections]-32T created a basis reduction account for corporations ceasing to be members of a group in taxable years beginning prior to January 1, 1995.

(18) "Section 1504(a)(4) preferred stock" is nonvoting, nonparticipating, nonconvertible, and does not possess unreasonable liquidation or redemption rights. Such stock is excluded in determining whether the issuer is a member of an affiliated group.

(19) Brief definitions of other defined terms that are used in the Agreement are as follows:

"Closing Balance Sheet" shall mean a balance sheet prepared as of the Closing.

"GAAP" shall mean generally acceptable accounting principles in the United States, as in effect from time to time.

"Parent" shall mean the common parent of the Selling Group.

"Seller" shall mean the member of the Selling Group that directly owns 100% of the Target stock.

(20) An Agreement typically requires representations to be "brought down" as of the Closing Date while the Tax Disclosure Schedules are finalized as of the signing date. If the parties expect that events with respect to Taxes (such as a new tax audit) would occur between the signing and the closing -- especially when the closing is significantly delayed -- the representations have to be drafted to prevent the occurrence of such events from causing a failure to provide accurate representations.

(21) If the parties desire to limit this representation, any of the following modifications could be utilized: (i) Instead of referring to "all returns," limit the returns to either "material" returns or returns relating to "material Taxes" (or certain specific Taxes (such as income tax)); (ii) qualify the representation by adding a qualifier based on certain knowledge (such as "to the best knowledge of Parent, Seller, Company, and the Subsidiaries"); (iii) limit the period covered by the representation to the past 3 to 5 years; or (iv) any combination of the above.

(22) If the parties desire to limit this representation, in addition to the modifications referred to in note 21, the parties may limit the Taxes covered in such representation to "Taxes shown on the returns filed by Seller, Company, and the Subsidiaries."

(23) This representation could be broadened by adding the following language at the end thereof:

"Except (i) for acts, events or omissions that are ordinary business activities, (ii) to the extent relating to income Purchaser receives after the Closing, or (iii) as set forth in the Tax Disclosure Schedule, no acts, events or omissions have occurred on or before the Closing Date that would result in material Taxes for which the Company or any of the Subsidiaries is or may become liable that will apply in a period or a portion thereof beginning on or after the Closing Date."

(24) If the parties desire to limit this representation, they may do so by limiting it to (i) a "written" claim, proposal or assessment, (ii) "material" Taxes, or (iii) a combination of both.

(25) Alternatively, if the basis or excess loss account information is not readily available, the representation may provide the following:

"The Parent, the Seller, and the Company have made available or will make available, at the request of the Purchaser, books and records that are relevant in calculating the Company's basis and excess loss accounts, if any, in each Subsidiary (and each Subsidiary's basis and excess loss accounts, if any, in any other Subsidiary) and any adjustments thereto, including, without limitation, a list of losses that previously expired unused."

(26) Alternatively, the Acquisition Agreement could provide that the Tax representations terminate as of the Closing Date and provide for no indemnity for a breach of a Tax representation. In that case, Purchaser would rely solely on the tax allocation and indemnity provisions to protect itself from any Tax liabilities of Company or the Subsidiaries relating to pre-Closing periods.

(27) See note 36 for an alternative method of allocating the income tax liability for the taxable year that includes the Closing Date.

(28) If the purchase price is subject to an adjustment based on the Closing Balance Sheet, the payment to be made by Seller for the pre-Closing periods may be further reduced by the amount of any undistributed reserve for Taxes shown on the Closing Balance Sheet.

(29) This item (iii) may be deleted if Tax representations terminate as of the Closing Date. See note 26.

(30) If the parties decide to make a section 338(h)(10) election, the carve-out should be clarified by limiting it to Taxes payable as a result of an election made (or deemed made) under section 338(g) (but not section 338(h)(10)). The same carve-out should also be made on Section XL.04 (iii). In addition, if there is a purchase price adjustment based on the Closing Balance Sheet, parties should consider excluding Taxes for which a reserve is established on the Closing Balance Sheet. See note 28.

(31) For example, if on audit Company's taxable income is increased by $100 (at a 34-percent tax rate) for a taxable year ending prior to the Closing Date and Company has a $50 net operating loss in a taxable year beginning after the Closing Date that it carries back, Seller must indemnify Purchaser for $34, even though the additional Taxes paid by Company is only $17.

(32) If the Selling Group insists on a no-meddling-in-my-return rule, the Acquisition Agreement could require the Acquiring Group to waive a carryback of losses. For acquisitions before August 25, 1999, such waiver could place an unnecessarily harsh restriction on the Acquiring Group, since such waiver would apply to all loss carrybacks arising in years for which the return is due after August 25, 1996 (and not just loss carrybacks from an Acquiring Group's taxable year to a Selling Group's taxable year).

(33) If Purchaser does not desire Company or the Subsidiaries to carry with them any of their previous losses, a provision can be added in this section to the effect that the Acquiring Group will make an irrevocable election to waive loss carryovers. Such waiver would prevent a negative stock basis adjustment that would occur if the losses expire in the Acquiring Group.

If the Selling Group has undergone a section 382 ownership change, an affirmative election can be made in order to have a portion of the applicable section 382 limitation allocated to Company and Subsidiaries, as follows: "Parent, Seller, and Company agree that out of $--, which is the aggregate limitation on the use of certain losses of the Selling Group as a result of an ownership change within the meaning of section 382 of the Code in --, $-- is allocated to Company and Subsidiaries in the transaction contemplated by this Acquisition Agreement, and that the parties will cooperate in order to comply with the required election to effectuate such allocation."

(34) Alternatively, a payment for tax benefits could be required not only when there is an indemnity payment but whenever the Purchaser receives a credit or deduction as a result of an audit adjustment with respect to Taxes of the Company or a Subsidiary for a pre-Closing period. For example, if a deduction claimed by the Company prior to the Closing Date is required to be depreciated or amortized (a frequent occurrence as a result of the INDOPCO case), the resulting deficiency would be paid by the Seller or the Parent (due to the consolidated return filing) and thus there would be no indemnity payment, except to the extent a separate return was filed by the Company or the Subsidiary for state tax purposes. However, the Purchaser might enjoy unanticipated tax benefits from amortization of expenses to the extent deductible after the Closing Date.

(35) The benefit of a deduction or amortization can be realized by way of a loss carryover, and, if so, the computation of the actual benefits could take a number of years and can become an administrative nightmare. In order to simplify the process, parties may agree to (i) limit the computations to take into account only the actual benefits realized in the taxable year in which the deduction is claimed, (ii) limit such computations to a defined period, e.g., 3 to 5 years, or (iii) make a binding estimate of the present value of the expected benefit. It is also noted that adjusting the amount of indemnity for any tax benefits realized from the payment giving rise to an indemnity (because of any deduction resulting from such payment) is often utilized in the general indemnity sections as well.

(36) Alternatively, income taxes can be apportioned, except for extraordinary items, based on (i) a ratable allocation with respect to the taxable year that includes the Closing Date, in which case an irrevocable election has to be made in accordance with Treas. Reg. [sections] 1.1502-76(b)(2)(ii)(D), or (ii) a ratable allocation only with respect to the month which includes the Closing Date in accordance with Treas. Reg. [sections] 1.1502-76(b)(2)(iii).

(37) If Purchaser carries out any extraordinary transaction on the Closing Date, a special allocation will be made under which Taxes resulting from any such extraordinary transaction taking place on the Closing Date after the Closing is allocated to Purchaser. See Section XL.04(iv).

(38) Parties may want to clarify the meaning of participation, including whether or not it includes participation in meetings with governmental authorities or in the receipt or preparation of correspondence with the governmental authorities.

(39) Parties may also want to have a joint control agreement with respect to Tax issues relating to a period ending on or before the Closing Date but which could have a significant impact on Taxes for a period after the Closing Date (such as the tax treatment of recurring items).

(40) Treatment for state and local tax purposes varies and should be carefully reviewed by the parties.

IRVING SALEM and JIYEON LEE are partners at Latham & Watkins. PATRICIA PELLERVO is a principal at PricewaterhousesCoopers LLP and did not participate in drafting the Model Agreement.3