Buying or selling a member of a consolidated group?
Too often the tax adviser is given an unduly limited role in the development of the language for the acquisition contract. Indeed, it is not unusual for us to be the last to know a contract is about to be signed. The corporate lawyer will begin with his standard agreement (no doubt a prehistoric version) and with less than 24 hours before the signing of the contract, will say, "You don't have any problems with the tax reps, do you?"
And things are getting worse! Many corporations are being 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." The day before the bid contract is to be returned, the corporate lawyer will once more say: "You don't have any problems with the tax reps, do you?" He will also add, "You realize that the fewer the changes, the better our shot at winning the bid."
In any event, with the added complexity of the Code and the rapid pace at which deals are cut, it behooves us to try to be ready to react on a moments notice. With that in mind, this article provides an overview of what you are up against if you are the tax adviser on the base case which, for purposes of the accompanying catalogue and model agreement is, as follows:
The basic facts assumed are that Target is a 100-percent subsidiary in Selling Group, that Target and its wholly owned Subsidiaries are being acquired in a taxable purchase by Acquiring Group, no section 338 election is being made and 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) that the closing of such purchase and sale will occur on a subsequent date, the "Closing Date." While this base-line case is being used to simplify the analysis, it should be noted that most of the consolidated return rules would apply if Target were the common parent of Selling Group, or if the acquisition is in the form of a tax-free reorganization, although the contractual protections may be different.
THE ECONOMIC SIGNIFICANCE
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, 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 bought the right to walk (and consequently the right to renegotiate the purchase price).
3. Economic Protection: If the buyer is damaged by a misinterpretation discovered after the closing, the buyer may sue the seller. That assumes the representations survive the closing, something surprisingly easy to obtain from seller with respect to taxes.
B. Covenants are promises to do something positive (e.g., pay all taxes for pre-closing date returns) or refrain from taking certain action. Again, buyer can walk if seller has not complied with any pre-closing obligation or can sue if the seller fails to comply with any post-closing covenant.
C. Indemnity provisions provide for the payment of damages for breach of representations or covenants. The indemnity provisions will spell out the obligations, the conditions, and the procedures for enforcing such indemnities.
MODEL AGREEMENT: TAX
The following are representations and indemnity provisions that might appear in an Acquisition Agreement to resolve the competing interests of the Selling and Acquiring Groups. This is not intended to be a definitive or model agreement because the agreement reached in each transaction will depend on all of the facts and circumstances, as well as the relative bargaining power of the Selling and Acquiring groups. (*1)
[The following sectins is part of
SECTION X. Definitions. For purposes of this Agreement:
X.01. "Tax" or "Taxes" shall mean all federal, state, local, foreign, and other taxes, assessments or other governmental charges, including without limitation, income, estimated income, business, occupation, franchise, property, sales, employment, or withholding taxes, including interest, penalties and additions in connection therewith for which the Company and each of the Subsidiaries is or may be liable.
X.02. "Code" shall mean the Internal Revenue Code of 1986. All citations to the Code, or the Treasury Regulations promulgated thereunder, shall include any amendments or any substitute or successor provisions thereto.
[The following section is part of
"Representations and Warranties of
Section XX. Tax Matters.
XX.01. Filing of Tax Returns. Each of Seller, Company, the Subsidiaries, Parent (and any affiliated group of which Company and the Subsidiaries are now or have been members), 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. The information filed is complete and accurate in all material respects. Except as specified in the Disclosure Schedule, none of Seller, Company, the Subsidiaries, Parent nor any group of which Company and the Subsidiaries are now or were members, have requested any extension of time within which to file returns (including without limitation, information returns) in respect of any Taxes.
XX.02. Payment of Taxes. All TAxes, in respect of periods beginning before the date hereof, have been paid, or an adequate reserve has been established therefor, as set forth in the Disclosure Schedule, and Company and the Subsidiaries do not have material liability for Taxes in excess of the amounts so paid or reserves so established.
XX.03. Audit History. Except as set forth in the Disclosure Schedule, no material deficiencies for Taxes have been claimed, proposed or assessed by any taxing or other governmental authority. Except as set forth in the Disclosure Schedule, there are no pending or, to the best of Parent's, Seller's, Comany's, or the Subsidiaries' knowledge, threatened audits, investigations or claims for or relating to any material liability in respect of Taxes, and there are no matters under discussion with any governmental authorities with respect to Taxes that in the reasonable judgment of Parent, Seller, Company, the Subsidiaries, or their counsel is likely to result in a material additional amount of Taxes. Audits of federal, state, and local returns for Taxes by the relevant taxing authorities have been completed for each period set forth in the Disclosure Schedule and, except as set forth in the Disclosure Schedule, none of Parent, Seller, Company, or the Subsidiaries has been notified that any taxing authority intends to audit a return for any other period. Except as set forth in the Disclosure Schedule, no extension of a statute of limitations relating to Taxes is in effect with respect to Parent, Seller, Company, or the Subsidiaries.
XX.04. Tax Elections.
(a) All material elections with respect to Taxes affecting Company and the Subsidiaries as of the date thereof are set forth in the Disclosure Schedule.
(b) None of Parent, Seller, Company, or the Subsidiaries: (i) has made or will make a deemed dividend election under Treas. Reg. $S 1.1502-32 (f)(2) or a consent dividend election under section 565 of the Code; (ii) has consented at any time under section 341(f)(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 the 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; (iv) has made an election, or is required, to treat any asset of Company or the Subsidiaries as owned by another person pursuant to the provisions of section 168(f) of the Code or as tax-exempt bond financed property or tax-exempt use property within the meaning of section 168 of the Code; or (v) has made any of the foregoing elections or is required to apply any of the foregoing rules under any comparable state or local income tax provision.
XX.05. Prior Affiliated Groups. Except as set forth in the Disclosure Schedule, Company and the Subsidiaries are not and have never been includable corporations in an affiliated group of corporations, within the meaning of section 1504 of the Code, other than in the affiliated group of which Parent is the common parent corporation.
XX.06. Tax-Sharing Agreements. All tax-sharing agreements or similar arrangements with respect to or involving Company and the Subsidiaries are set forth on the Disclosure Schedule.
XX.07. FIRPTA. Seller is not a "foreign person" as defined in section 1445 (f)(3) of the Code.
XX.08. Existing Partnerships. Except as set forth in the Disclosure Schedule, neither Company nor the Subsidiaries is subject to any joint venture, partnership, or other arrangement or contract which is treated as a partnership for federal income tax purposes.
XX.09. Parachute Payments. Neither Company nor the Subsidiaries has made or become obligated to make, or will, as a result of any event connected with the acquisition of Company and the Subsidiaries by 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.10. Earnings and Profits. As of the date hereof, Company has $ in current and accumulated earnings and profits. As of the Closing Date, Company expects to have at least $ in current and accumulated earnings and profits. The adjustment to be made by Seller for earnings and profits required by section 1503 (e) of the Code upon the disposition of the Company is $ .
XX.11. Balance of Deferred Inter-company Items. Except as set forth on the Disclosure Schedule, there are no outstanding balances of deferred gain or loss accounts related to deferred intercompany transactions between Company and the Subsidiaries.
XX.12. Allocable Loss and Credit Carryovers. The amount of consolidated net operating losses, net capital losses, foreign tax credits, investment, and other tax credits of the consolidated group of which Parent is the common parent allocable to Company and the Subsidiaries under Treas. Reg. [sec.] 1.1502-79 is set forth in the Disclosure Schedule.
XX.13. Basis and Excess Loss Accounts in Subsidiaries. Company's basis, and excess loss account, if any, in each Subsidiary is set forth on the Disclosure Schedule. The earnings and profits (and any adjustment required by section 1503(e) of the Code) for each Subsidiary is set forth on the Disclosure Schedule.
XX.14. Recapture Items. The amount of investment tax credit of Company and the Subsidiaries subject to recapture is $ . The amount of overall foreign losses of the consolidated group of which Parent is the common parent allocable to Company and the Subsidiaries under Treas. Reg. [sec.] 1.1502-9 and subject to recapture is $ . The aggregate amount of ordinary losses on section 1231(b) property that has been deducted by Company and the Subsidiaries is $ .
[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 with respect to or involving Company and the Subsidiaries shall be terminated prior to the Closing Date, and, after the Closing Date, Company and the Subsidiaries shall not be bound thereby or have any liability thereunder for amounts due in respect of periods prior to the Closing Date.
XXX.02. Tax Elections. No new elections with respect to Taxes, or any changes in current elections with respect to Taxes, affecting Company and the Subsidiaries shall be made after the date of this Agreement without the prior written consent of Purchaser.
[The following section is part of
SECTION XXXX. Tax Indemnities, Filing Requirements and Other Post-Closing Matters.
XXXX.01. Survival of Representations and Warranties. The representations and warranties of Seller contained in Section XX of this Agreement shall survive the Closing until the expiration of the applicable statute of limitations (giving effect to any waiver or extension thereof).
XXXX.02. Parent and Seller Indemnity. Parent and Seller shall indemnify and hold harmless. Purchaser, Company, the Subsidiaries, and each of their respective affiliates, successors, and assigns, from and against all Taxes (i) with respect to all periods ending on or prior to the Closing Date, (ii) with respect to any period beginning before the Closing Date and ending after the Closing Date, but only with respect to the portion of such period up to and including the Closing Date (such portion, a "Pre-Closing Partial Period"), or (iii) payable as a result of a material breach of any representation or warranty set forth in Section XX of this Agreement. Notwithstanding the foregoing, Parent and Seller shall not be required to indemnify Purchaser, Company, or the Subsidiaries for Taxes (x) to the extent of the reserves set forth on the Closing Balance Sheet, (y) payable as a result of an election made (or deemed made) under section 338 of the Code, or (z) payable as a result of any events occurring on the Closing Date, but after the Closing, which are outside of the ordinary course of business. Parent and 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 from a period beginning after the Closing Date.
XXXX.03. Purchaser Indemnity. Purchaser shall indemnify and hold harmless Parent, Seller, and each of their respective affiliates, successors, and assigns, from and against all Taxes (i) with respect to all periods beginning after the Closing Date, (ii) with respect to any period beginning before the Closing Date and ending after the Closing Date, but only with respect to the portion of such period beginning the day after the Closing Date (such portion, a "Post-Closing Partial Period"), (iii) payable as a result of an election made (or deemed made) under section 338 of the Code or any comparable provision of state or local law, or (iv) payable as a result of any events occurring on the Closing Date, but after the Closing, which are outside of the ordinary course of business. Purchaser shall be entitled to all refunds of Taxes with respect to the periods described in clauses (i) and (ii) above.
XXXX.04. Effect of Carryovers and Carrybacks. For purposes of this Section XXXX, 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, but shall not include amounts which would have been paid but for the application of any credit or net operating or capital loss deductions attributable to periods ending on or prior to the Closing Date or to any Pre-Closing Partial Period.
XXXX.05. Payment for Tax Benefits Realized In Connection With Indemnity by Parent and Seller. If Parent or Seller is required to make an additional payment of Taxes (either directly to a governmenal agency or to the Purchaser as an indemnity payment under Section XXXX.02 of this Agreement) and, in connection with such payment, the Purchaser, Company, or any Subsidiary obtains a deduction or credit, Purchaser shall pay to Seller an amount equal to the actual tax savings produced by such deduction or credit. * The amount of any such tax savings for any period shall be the amount of the reduction in Taxes reflected on any consolidated federal income tax return or any foreign, state, or local 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 XXXX.05 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 Purchaser makes a payment pursuant to this Section XXXX.05 and it is later determined that Purchaser did not receive the actual tax savings (or portion thereof) relating to such payment (including non-receipt of such tax benefit as the result of the absorption of other losses or tax benefits incurred by the Purchaser, Company, the Subsidiaries, or the affiliated group of which any of them are members), Seller shall promptly refund such payment (or such allocable portion thereof) with interest (at the prevailing prime rate) to Purchaser.
XXXX.06. Allocation Between Partial Periods. Any Taxes for a period including a Pre-Closing Partial Period and a Post-Closing Partial Period shall be apportioned between such Pre-closing Partial Period, and such Pre-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, on the actual activities, taxable income taxable loss of Company and the Subsidiaries during such Pre-Closing Partial period and such Post-Closing Partial Period.
XXXX.07. Filing of Tax Returns. Parent and Seller shall include Company and the Subsidiaries in the consolidated federal income tax return filed by Parent and Seller for the period ending on or prior to the Closing Date. Parent and Seller shall prepare books and working papers (including a closing of the books) which will clearly demonstrate the income and activities of Company and the Subsidiaries for the period ending on the Closing Date and any Pre-closing Partial Period. Purchaser shall include Company and the Subsidiaries in the consolidated federal income tax return filed by Purchaser for periods beginning after the Closing Date. An election under Treas. Reg. [sub.] 1.1502-76 (b)(5) (relating to the 30-day election rules) shall not be made by Company and the Subsidiaries.
XXXX.08. Post-Closing Audits and Other Proceedings. Parent and Seller, on the one hand, and 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. Parent, Seller, and Purchaser shall cooperate with each other in the conduct of any audit or other proceedings involving Company or the Subsidiaries for such periods and each may participate at its own expense, provided that Parent and Seller shall have the right to control the conduct of any such audit or proceeding for which Parent and Seller (i) agree that any resulting Tax is covered by the indemnity provided in Section XXXX.02 of this Agreement, and (ii) demonstrate to Purchaser their ability to make such indemnity payment. Notwithstanding the foregoing, neither Parent nor Seller may settle or otherwise resolve any such claim, suit or proceeding without the consent of Purchaser, such consent not to be unreasonably withheld.
XXXX.09. Cooperation. Parent and Seller, and the one hand, and Purchaser, on the other hand, agree to furnish or cause to be furnished to each other, upon request, as promptly as practicable, such information and assistance (including access to books and records) relating to Company and the Subsidiaries as is reasonably necessary for the preparation of any return for Taxes, claim for refund or audit, and the prosecution or defense of any claim, suit or proceeding relating to any proposed adjustment. Furthermore, Parent and Seller will cooperate with Purchaser in getting the District Director of the Internal Revenue Service to exercise its authority to limit the liability of Company and the Subsidiaries under Treas. Reg. [sub.] 1.1502-6 for Taxes of the affiliated group of which Parent is the common parent.
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). The parties could take the position that a section 338(h)(10) transaction should be treated like an asset sale for federal income tax purposes and therefore provide for fewer representations and indemnity provisions. Note, however, one significant area now being disputed is whether the several liability imposed by Treas. Reg. [sub.] 1.1502-6 applies to Company and its Subsidiaries where a section 338(h)(10) election is made. If treated as a mere purchase of assets, no such liability would attach. Until clarified, purchasers should obtain representations regarding, and indemnification for, this liability.
(1) Parent and Seller represent that a consolidated federal income tax return with Company and the Subsidiaries was filed for the taxable year immediately preceding the current taxable year and that Parent is eligible to make an election under section 338(h)(10) of the Code with respect to Company and the Subsidiaries.
(2) Parent, Seller, and Purchaser hereto acknowledge that for United States federal income tax purposes the acquisition of the stock of Company will be treated by the parties as a sale of the assets (other than Subsidiary stock) of Company, and a sale of the assets of each of the Subsidiaries, to new corporations owned by Purchaser, followed by a complete liquidation of Company and the Subsidiaries into Seller. The parties agree to report the transaction in a manner consistent with this treatment. (*4)
(1) Parent and Purchaser agree to join in making an election under section 338(h)(10) of the Code with respect to the acquisition of Company and the Subsidiaries. As a condition to Closing, Parent and Seller shall deliver to Purchaser at Closing, a fully completed and executed Internal Revenue Service Form 8023, including all additional data and materials required to be attached to such Form 8023 pursuant to Treas. Reg. [subsec.] 1.338-1T and 1.338(h)(10)-1T. Paren shall attach a copy of such Form 8023 to the consolidated federal income tax return of the Selling Group for its taxable period which includes the Closing Date and otherwise cooperate fully with Purchaser in making the election under section 338(h)(10) of the Code.
(*1) Exhibit A sets forth additional provisions whioch are relevant if the parties contemplate making an election under section 338(h)(10).
(*2) 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 which it carries back, Seller must indemnify Purchaser for $34, even though the additional Taxes paid by Company is only $17. On the other hand, if Company had a $50 net operating loss from a period prior to the Closing Date which is used to offset the additional $100 of income, Seller is required to indemnify Purchaser only to the extent of $17.
(*3) For example, if a deduction for expenses claimed by the Company prior to the Closing Date is required to be depreciated or amortized, Seller must indemnify Purchaser under the agreement for the additional Taxes due by Company for the year the expense is disallowed. Company, and therefore Purchaser will enjoy the benefit of the amortization or depreciation deductions associated with that item in taxable years after the Closing Date. This provision provides for a "give back" of those tax benefits to the Seller as they are realized by the Purchaser.
(*4) Treatment for state tax purposes varies and should be carefully reviewed by the parties.
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|Author:||Halby, Karen L.|
|Date:||Mar 22, 1989|
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