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Asset acquisition for contingent convertible debt.

An acquiring corporation purchased assets for a base purchase price plus a contract to issue a promissory note to the seller, contingent on the purchased business's performance over a defined term. The note would be convertible into stock of the selling company, if the acquiring corporation goes public within the performance period for a primary stock offering exceeding a defined amount.

The purchased assets included both tangible and intangible property, such as valuable patents, trade names, processes and goodwill. The parties allocated the base purchase price to the assets acquired based on the mix of assets on the date of purchase, pursuant to Sec. 1060. Both the acquiring company and the selling company filed consistent reports on Form 8594, Asset Acquisition Statement Under Section 1060.

Under existing authorities, the face amount of a debt instrument issued for property is used to measure the property's purchase price, provided adequate interest is stated (see Sec. 1274(a)(1) and (c)). in similar fashion, APBO 21 (8-71), [paragraph]12, provides that a note's face amount is used to measure assets' purchase price for financial reporting, unless the stated interest rate is unreasonable or the face amount price is materially different from a cash purchase price.

The contingent note convertible into stock of the purchasing corporation is not an investment unit as defined in Sec. 1273(c). Furthermore, it is not clear that the investment unit rules of Sec. 1273 apply to a note issued to purchase property, which is governed by Sec. 1274. Consequently, the entire face amount of the contingent note should be usable in determining the additional purchase price for the assets at the time the note is issued. In similar fashion, APBO 14 (3-69), [paragraph]12, prevents an allocation of a debt issue price to a conversion feature, while [paragraph]17 does allocate the issue price to the value of a detachable warrant.

Accordingly, it appears that if the contingency is met and the acquiring company issues the note to the seller, the note's face amount will be used to measure the assets' additional purchase price. The seller and the buyer should agree on whether the asset mix at the date of the original purchase or at the date the contingent note is issued should control the allocation under Sec. 1060, reported on supplemental Form 8594 filings. Presumably, the asset mix at the time of initial purchase should be used.

Subsequent conversion by the selling corporation of the acquiring corporation's contingent note, into acquiring corporation stock, should be nontaxable to the seller under Rev. Rul. 72-265, since the conversion is into stock of the same corporation that issued the debt. Had the conversion been into stock of a different corporation, it would be taxable under Rev. Rul. 69-135.
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Author:Hampton, Randall C.
Publication:The Tax Adviser
Date:Jan 1, 1994
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