The Internal Revenue Service last month floated a proposal that promises to give buyout firms additional flexibility when trying to buy corporate subsidiaries in the most tax-agreeable manner.
According to Isaac Grossman, partner in the tax department of Morrison Cohen LLP, buyout firms often make sure that the IRS treats their subsidiary stock purchases as asset purchases by making the so-called Section 338(H)(10) tax election.
Assuming the election is made, the buyer has the ability to step up the value of the acquired assets to reflect the purchase price. Doing so gives the acquired business a more valuable asset base with which to depreciate over time–a deduction that can lower its tax bill. Another advantage of the Section 338(H)(10) election: The LBO shop and corporate seller avoid the hassle of an actual asset sale, which would involve assigning contracts, transferring titles, and other headaches.
Both buyer and seller have to make the election in a joint filing. And the transaction must meet a number of requirements. For example, the buyer must be a corporation, and it must acquire at least 80 percent of the stock of the subsidiary.
Last month, under Section 336(e) of the tax code, the Internal Revenue Service proposed a related option that would give buyers and sellers additional flexibility. No longer would the buyer have to acquire at least 80 percent of the company; the only requirement under the proposal would be that the seller disposes of at least 80 percent of the company, through a sale or distribution of stock. In addition, the buyer no longer has to be a corporation. It can be an individual, limited liability company, or other form.
There is a pitfall to avoid. Under the proposal, only the seller would be able to make the Section 336(e) election; by contrast, the Section 338(H)(10) tax election requires a joint filing. In some transactions buyers may find it advantageous, from a tax standpoint, to structure the deal as a straight stock sale. In stock sales, but not asset sales, for example, target subsidiaries can take advantage of prior net operating losses to offset future gains to lower their tax bill. Sellers with a different view on the tax consequences of a deal could quietly make the Section 336(e) election months after closing. And that could turn the deal into an asset sale that delivers a tax nightmare to the unwary buyer.
For more on the Section 336(e) proposal contact Isaac Grossman of Morrison Cohen at 212-735-8735.