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The views, opinions, statements, analysis and information contained in these materials are those of the individual presenters and do not necessarily reflect the views of the panelists’ organizations or any oftheir past, present and future clients. These materials (1) do not constitute legal advice; (2) do not form the basis for the creation of the attorney/client relationship; and (3) should not be relied upon withoutseeking specific legal advice with respect to the particular facts and current state of the law applicable to any situation requiring legal advice. No attorney-client relationship is created by these materials, andno party may rely on these materials to support any tax position.
A Rose by Any Other Name Might Cost You More: Form, Substance, and Business Transactions Under Subchapter K
November 8, 2019
University of Chicago72nd Annual Federal Tax Conference
Lead Presenter: Sara B. Zablotney | Kirkland & Ellis LLPModerator: Bahar Schippel | Snell & Wilmer LLPPanelists: Kimberly Blanchard | Weil, Gotshal & Manges LLP
John Rooney | KPMG
Agenda• Part 1: Legal Entity Form• Part 2: Transactional Form• Part 3: Subchapter C/Subchapter K Interaction
2
3
“The source of the problem is that tax laws necessarily have a limited number of terms, but must be applied to a nearly unlimited range of transactions.”
“In addition to reflecting the world, [tax] statutes are also creatures of art that impose their own form on the world.”
“When we are dealing with statutory terms of art, the form-substance dichotomy is a false one. ‘Substance’ can only be derived from forms created by the statute itself.”
Joseph Isenbergh, “Musings on Form and Substance in Taxation,” 49 U. CHI. L. REV. 859, 879 (1982).
Part 1: Legal Entity Form
4
Relevance of Legal Form?
Definitions
Electivity
5
► Treas. Reg. § 301.7701-1(a) purports to define the existence of an “entity” solely by reference to federal tax law.– Certain corporations organized under state law can be a non-entity (though usually
Moline Properties Inc., 319 U.S. 436 (1943) doctrine trumps). Can a contractual arrangement taxed as a partnership also be an “entity”?
► As a result of Treas. Reg. § 301.7701-3, taxpayers have tremendous flexibility to determine the substance of their tax results with respect to non per se corporations through the filing of a piece of paper, regardless of the substance of the owners’ legal rights under state law.
► Once a partnership exists as a tax “entity,” it is hard to kill. – E.g., Harbor Cove Marina Partners P’ship v. Comm’r, 123 T.C. 64 (2004) (mere retention of cash is
sufficient for continuation); Foxman v. Comm’r, 41 TC 535 (1964), aff’d 352 F.2d 466 (3d Cir. 1965) (partnership continues even though its only assets are cash and a note); Rev. Rul. 66-264 (partnership continues when 3 of 5 partners purchase partnership assets at a judicial sale).
– Entity status is probably independent of trade or business continuity, ownership, or state law status, provided the partnership has more than one owner. Continuation authorities to be discussed in greater detail later.
Endurance
Does the Form That a Tax Partnership Takes Matter?• Tax law historically has afforded significant analytical effect to
state law legal entity structure for purposes of Subchapter K.• Examples: Section 752 liability allocation; self-employment tax. • Best understood as equating state law entity rights as mere contractual
rights?• i.e., FACTS!
• State law differences can and do drive tax substance in business transactions notwithstanding Treas. Reg. § 301.7701-1’s claim that entity existence for tax purposes is a creature of federal tax law.
• In the case where a state law legal entity exists, there is a relatively low bar to find the existence of a tax partnership.
6
Here We Digress on Entity Theory
Entity Theory is Very Crucial and
Important to Understanding
Tax Substance in Subchapter K
► Subchapter K is built around an entity-theory framework, and aggregate rules supplement the entity framework in order to preserve flow-through taxation and prevent abuse.
– For this reason, e.g., Sections 707, 721, 731, 741 focus on the partner’s relationship to the entity (the partnership) in order to determine tax consequences (that is, focus on the fact that the partners are not the same as the partnership and provide rules to deal with that reality).
7
► Entity theory exists because Congress and people in general see businesses conducted by partners in a partnership as a thing separate and apart from the partners. It is thus a necessary evil that exists only to the extent it is absolutely necessary in order to support the concept of a “partnership” at all (e.g., calculation of taxable income, choice of accounting methods). Partnerships (though sometimes persons in the Section 7701 sense) are not taxpayers, and that’s important.
Entity Theory is At Best a
Distraction to Understanding
Anything
A Partnership Changes Everything
• The very existence of a partnership can change the tax outcome of transactions to partners, including in non-abusive situations (e.g., the application of new Section 163(j); consolidation, etc).
• Because the partnership exists, rules for movement of property in and out of the partnership (e.g., Section 731; Section 721), and transfers of partnership interests (e.g., Section 741) are necessary.
• Rev. Rul. 2007-40 (transfer of partnership property to a partner in satisfaction of a guaranteed payment is a Section 1001 transaction).
8
How should we analyze state law legal entity form for purposes of Subchapter K?
9
Are these the same or different?
ABC GP
A
B
C
1/3
1/31/3
Bank Loan ABC LLC
A
B
C
1/31/3
Bank Loan ABC LP
A
B
C
Bank Loan
1/3
1/3GP
1/3LP 1/3
LP
10
What about these?
ABC GP
A
B
C
1/3
1/31/3
Bank Loan
ABC GP
A
B
C
1/3
1/3
Bank Loan ABC LP
A
B
C
Bank Loan
1/3
1/3GP
1/3LP
1/3LP
11
A LLC
LLC Opco
B LLC
A LLC
Of Course!
• Same sharing of economic results of the business.
• Same liability burdens the operations of the business.
(Not)
• Different local law legal consequences with respect to limited liability (and maybe fiduciary duties).
12
Is this really just a Section 752 liability allocation issue? Is there any other reason why the tax law should care about the form that a tax partnership takes?
Conversion of Partnership Legal Form:Do we need a rule for that?
• Service appears to take the view that (i) a rule is needed and (ii) the conversion constitutes a realization event:• Rev. Rul. 84-52 (general partnership to limited partnership);• Rev. Rul. 95-37 (conversion to LLC);• Rev. Rul. 95-55 (general partnership to LLP).
• Service also appears to take the view that movement among legal equity forms is a realization event:• Rev. Rul. 86-101 (general partnership interest to limited partnership
interest);• Treas. Reg. § 1.721-2(g)(3) (conversion of convertible “preferred”
partnership interest to “common” partnership interest). 13
• General realization principles (e.g., Section 1001 as interpreted by Cottage Savings, 499 U.S. 554 (1991)) suggest that changes in non-tax legal characteristics require realization.
• Non-tax-lawyer humans see real substantive differences among state law legal entity types.
• Partnerships are entities (at least sometimes), and for that reason, changes in entity type should be given substance.
• Subchapter K is flexible and sophisticated enough to handle changes in partner rights as a result of entity-level changes without reference to a realization event (e.g., Section 752).
• Partnerships are also aggregates and the state law legal entity form that the aggregate takes is irrelevant for purposes of Subchapter K taxation.
• Rev. Rul. 84-52 is not only unnecessary, but also broken, as its fictions are unclear and perhaps flatly inconsistent with analogous parts of Subchapter K.
Of Course! (Not)
14
Subchapter C has a rule for this – Section 368(a)(1)(F).
Conversion of a Partnership Legal Entity: Case Study of Rev. Rul. 95-37
AB LP
A
B
LPGP
1 2
AB LP
A
LPGP
B
GP interests
LP interests
AB LLC
AB LLC
B
A
AB LP
3
15
A holds a GP interest in AB LP, through A LLC, a disregarded entity. B holds an LP interest in AB LP. A and B wish to convert AB into a limited liability company through a formless conversion under state law.
It appears that the fiction adopted by Rev. Rul. 95-37 is a contribution by the partners of interests in AB LP to a newly formed AB LLC…
…followed by a liquidation of old AB LP.
A LLC
A LLC
A LLC
AB LP
A
B
LPGP
1 2
AB LP
A
LPGP
B
A LLC interests
LP interests
AB LLC
AB LLC
BA
3
GP
LP
Does it/should it matter if A LLC and AB LP liquidate?
16
Conversion of Partnership Legal Entity; Alternative Steps
A holds a GP interest in AB LP, through A LLC, a disregarded entity. B holds an LP interest in AB LP. A and B wish to convert AB into a limited liability company through the following state law steps.
A contributes 100% of A LLC, and B contributes 100% of the LP interests it holds, to newly formed AB LLC
A LLC A LLC
A LLC
AB LP
• Fiction is not fully explained in rulings; some find non-recognition theory hard to support.
• Fiction inconsistent with fictions elsewhere (e.g. Treas. Reg. §1.708-1(c)).
• Unclear enough that taxpayers still seek rulings in complex entity conversion situations.
• As a practical matter would there be any difference in tax result if there was no realization event at all? Should the Cottage Savingsdoctrine extend this far?
Does the rule on entity conversions work? Is it necessary?
17
Case Study: PLR 201745005*
*simplified
Facts: X LLC has two managing members, Y Corp. and Z DRE LLC. Z DRE LLC is wholly owned by W Corp., unrelated to Y Corp. Members wish to convert X to a limited partnership under State A Law.• Step 1: Y contributes a portion of its X
units to DRE 1 LLC; Z DRE LLC contributes a portion of its X units to DRE 2 LLC.
• Step 2: X converts under State A law in a formless conversion to a limited partnership; interests held by DRE 1 and DRE 2 converted by state law into GP interests.
• Representations: No changes in debt allocation; no changes in ownership allocation among partners.
• Ruling: No gain or loss recognized; Rev. Rul. 84-52.
Y CorpOthers
W Corp
X LLC
Pre-Transaction Structure
Y CorpOthers
W Corp
X LLC
Some X interests
Some X interests
DRE Contributions
Y Corp
Others
W Corp
X LP
Post-Transaction
GPGP
LPLPLP
18
Z
21
Z
1
2
Z
Part 2: Transactional Form
19
Are these the same?
• Rev. Rul. 99-5 situation 1. Treated as if B purchased a 20% undivided interest in each of A’s assets, then A and B contribute their interests in the assets to A LLC in exchange for an 80% and 20%, respectively, partnership interest in A LLC.
• Rev. Rul. 99-5 doesn’t really address. More like a disguised sale of assets by A? Tax consequences to A could be different than a situation 1 transaction. Situation 1.5?
• What if there is more than one contributor? Any difference in result?
A BCash
20% of A LLC
A LLC
BA
80% 20%
A BCash
20% of A LLC
Cash
A LLC
BA
80% 20%
1 2
20
A LLC
A LLC
What about these?
• ABC LLC redeems 100% of C’s interest in ABC for cash.
• Does Section 736 apply to C? Does it matter?
• Is this transaction different?
• What if A and B pay with notes that are guaranteed as to payment by ABC LLC?
ABC LLC
BA
31.25% 68.75%
ABC LLC
BA
31.25% 68.75%
1 2
ABC LLC
B
C
25%
50%
25%
A
ABC LLC
B
C
25%
50%
A Cash
6.25% ABC
21
Are these the same?*
AB LP
A BLP
GP
1 2
AB LP
A
LPGP
B
3
*Loosely based on Jupiter Corp. v. U.S., 2 Ct. Cl. 58 (1983).
CCash
Pfd LP Interest
Cash
• A and B hold respectively, old and cold GP and LP partnership interests in a limited partnership.
• New partner C contributes cash for a newly issued preferred LP interest.
• Cash contributed by C (i) repays AB debt and (ii) the excess is distributed to A and B pro rata.
AB LP
A GP+ Pfd LP
BGP+ Pfd LP
AB LP
A BGP+ Pfd LP
GP+ Pfd LP C
Cash
Pfd LP Interest
Cash
• As a first step, A and B recapitalize a portion of their interests into the type of preferred LP interest C wants to buy.
• New partner C contributes cash to AB for a newly issued preferred LP interest, AB pays down debt.
• A and B sell the portion of their partnership interests represented by the new preferred LP interests received in Step 1 to C for cash.
AB LP
ALP
GP
GP Interest
CBCash
LP Interest
AB LP
A
LPGP
BC
GP+LP
AB LP
A
GP
BC
PfdLP
LP
• A and B sell a portion of their interests to C for cash; C contributes cash to AB for a preferred LP interest in AB.
• C converts its interests purchased from A and B into the same preferred interests it purchased directly from AB.
22
• The legislative history to Section 707(a)(2)(B) instructed Treasury to write regulations to treat situation 1 as a sale (presumably of partnership interests).
• In each case A and B receive cash, and their unitary interest in AB is reduced as part of a plan.
• The qualification of the AB interests as LP or GP interests (or preferred and common interests) has marginal meaning outside of Section 752.
• Rev. Rul. 84-52 and its progeny are (or should be) irrelevant to determination of whether a transaction is, in substance, a sale of a partnership interest.
• Despite legislative history, there is a real difference between a new type of equity purchased in a primary offering, a portion of the proceeds which may be used to make a distribution to existing partners, and a true sale.
• Although non-recognition under Section 731 may be unavailable to A and B in situation 1, that does not mean that each transaction is taxed the same. The state law formal difference still matters. Note the absence of certainty due to the lack of regulations describing the effect of disguised sales of partnership interest.
Of Course! (Not)
23
Can We Be Confident These Transactions are a Sale of Interests?
• A and B each own 50% of AB LLC in the form of common units. C invests $1,000 in exchange for 1/3 of the common units in AB
• As part of a plan, AB distributes $800 of the invested cash to each of A and B, using the remainder to finance Capex.
• Does C receive a step up under Section 743? Can C be sure of this result?
• A, B, and C each own 1/3 of the common equity of AB LLC. A also owns a preferred unit that entitles it to a priority return of capital and 8% IRR, which is currently worth $800.
• C invests $1,000 into AB in exchange for a new preferred instrument that entitles C to a priority return of capital but no preferred yield. AB uses $800 of such contribution to redeem A’s preferred, and the remainder for capex.
• Note effect of Rev. Rul. 84-53 (basis allocation) on A’s tax result.
1 2
24
AB LLC
AB LLC
AB LLC AB
A
AA
A
BB
BB
CC C
50% Common
$400 Cash
50% Common
$400 Cash
1/3 Common
1/3 Common
1/3 Common
Preferred; 1/3 Common
New Preferred; 1/3 Common
1/3 Common
1/3 Common
1/3 Common
1/3 Common
Are these the same?
• AB LLC is a holding company; all operations are in DRE. Each of A and B sell 100% of their interests in AB to C and D.
• Each of A and B treated as selling partnership interests in AB to C and D under Section 741. C and D should receive a step-up in DRE assets. Is a Section 754 election at AB LLC required for this result?
• AB LLC continues under Section 708? Does it matter whether the transactions occur at the same time/pursuant to a plan or happen over time/independently? Note tension with Rev. Rul. 99-6, situation 2.
• Same as 1, except AB sells 100% of DRE to CD LLC for cash and then liquidates. Is this a sale by AB LLC of all of its assets to CD LLC, followed by a liquidation of AB LLC?
• Does it matter if CD LLC is old and cold or a Newco? Does it matter how long it takes AB LLC to liquidate?
• Compare: Barran v. Comm’r, 334 F.2d 58 (5th Cir. 1964); LaRue v. Comm’r, 90 T.C. 465, (1988); Hatch’s Estate, 198 F. 2d 26 (9th Cir. 1952) with Foxman v. Comm’r, 352 F. 2d 466 (3d. Cir. 1965); Baker Commodities v. Comm’r, 415 F.2d 519 (9th Cir. 1969); Harbor Cove Marina Partners P’ship v. Comm’r, 123 T.C. 64 (2004).
AB LLC
A B
AB LLC
DC
50% 50%
1 2
C
D50%
50%Cash
AB LLC
CD LLC
A B C D50% 50% 50% 50%
CD LLC
C D50% 50%
AB LLC
A B
50% 50%
Cash
Cash
Cash100% DRE
25
DRE DRE DRE DRE
What about these?
• Same as 1, except immediately after the purchase C and D contribute 100% of AB LLC to CD LLC.
• Does AB LLC continue under Section 708? Does it matter if CD is an old and cold partnership?
• Is this a Rev. Rul. 99-6 transaction or a continuation of AB LLC?
• Does it matter if CD LLC is old and cold or a Newco?
• Does it matter if (and when) AB LLC is liquidated by CD LLC post-purchase?
AB LLC
A B
DC50% 50%
3 4
C
D50%
50%Cash
AB LLC
CD LLC
A B C D
50% 50%50% 50%
CD LLC
C D50% 50%
50% AB
Cash
Cash
50% AB
CD LLC
CD LLC
26
DRE
50% AB
AB LLC AB LLC
DRE DRE DRE
• In each of these cases A and B sell all of their interests in AB LLC to C and D.
• No matter the number of entities used, the result to A and B is the same, assuming in each case CD LLC entities are newly formed.
• The scenarios are fundamentally different legal arrangements and these are important facts that should be taken into account.
• Also, why should AB continue without its historic partners? The aggregate has completely changed.
• Where CD LLC exists and is old and cold, transaction should be analyzed differently.
Of Course! (Not)
27
Are these the same?
• AB LLC is a holding company; all operations are in DRE. Pursuant to a purchase and sale agreement, A agrees to transfer all of its interests in AB to BC for cash, and B agrees to transfer all of its interest in AB for cash and an additional 2.5% interest in BC.
• Is this an “assets over” merger of AB and BC under Treas. Reg.§1.708-1(c), with the purchase of interests governed by Treas. Reg.§1.708-1(c)(4) assuming the conditions are met? (See Treas. Reg. §1.708-1(c)(5) Example 2).
• Does it matter if BC LLC is an old and cold or a Newco?
• Same as 1, but the acquisition by BC of AB LLC is accomplished by a state law merger.
• Is this an “assets over” merger of AB and BC under Treas. Reg.§1.708-1(c), with the purchase of interests governed by Treas. Reg.§1.708-1(c)(4), assuming the conditions are met?
• Does it matter if BC LLC is an old and cold or a Newco?
• Does the direction of the merger or the legal entity form of any of the entities matter?
A B
50%
47.5%
1 2
C
AB LLC
BC LLC
A B C
70% 30%50%
BC LLC
B C52.5% 50%
AB LLC
BC LLC
70%
30%
50% BC LLC
B C
52.5%
Cash + BC Equity
Cash Cash + BC Equity
28
DRE DRE DRE DRE
AB LLCAB LLC
MS
• MS’s momentary existence to accomplish a corporate mechanic is irrelevant to the tax result under Subchapter K.
• Particularly where both AB and BC are old and cold entities, Treas. Reg. §1.708-1(c) respects only two forms: assets over, and if all corporate law requirements are met, “assets up.” All other forms treated as “assets over” transactions. The continuing partnership for tax law purposes may or may not be the same as the surviving entity for state law purposes.
• If BC LLC is a Newco, does the form suggest a “purchase” rather than a “disguised sale” in situation 2?
• See Goudas v. Comm’r, 137 F. 3d 368 (6th Cir. 1998)
• (But honestly, where both entities are old and cold, the provisions of Treas. Reg. §1.708-7(c) lead to same result regardless of form).
Of Course! (Not)
29
Does the Corporate Law Form of a Partnership Merger Ever Matter?
• Each of AB LLC and CD LLC are old and cold partnerships. AB LLC merges with and into CD LLC with CD LLC surviving. Each of A and B receive cash and interests in CD LLC in the merger.
• “Assets over” merger of AB and CD, with CD continuing.
AB LLC
A B
CD LLC
DA
10% 40%
1 2
C D50%50%
CD LLC
50%50%
B C
10% 40%
AB LLC
DA
10% 40%
B C
40%10%
• Each of AB LLC and CD LLC are old and cold partnerships. CD merges with and into AB LLC, with AB LLC surviving. A and B receive cash in the merger. C and D receive AB LLC equity.
• Same - “assets over” merger of AB and CD, with CD continuing.
Merger
AB LLC
A B50%
Merger
50%
C D
CD LLC
50% 50%
30
Does the Corporate Law Form of a Partnership Merger Ever Matter?
• Each of AB LLC and CD LLC are old and cold partnerships. CD forms a merger subsidiary, MS LLC, which merges with and into AB LLC with AB LLC surviving. Each of A and B receive cash and interests in CD LLC in the merger.
• “Assets over” merger of AB and CD, with CD continuing.
AB LLC
A B
CD LLC
DA
10% 40%
3 4
C D50%
AB LLC
CD LLC
A B C D
50% 50%
50% 50%50%
CD LLC
50%50%
B C
10% 40%
AB LLC
DA
10% 40%
B C
40%10%
• Each of AB LLC and CD LLC are old and cold partnerships. AB distributes cash pro rata to A and B. Immediately thereafter, AB forms a merger subsidiary, MS LLC, which merges with and into CD LLC with CD LLC surviving. Each of C and D receive interests in AB LLC in the merger.
• Same - “assets over” merger of AB and CD, with CD continuing.
31
MS LLC AB LLC MS LLCCD LLC
Does the Corporate Law Form of a Partnership Merger Ever Matter?
• AB LLC is an old and cold partnership. C and D form and capitalize CD LLC as a Newco to acquire AB. CD forms a merger subsidiary, MS LLC, which merges with and into AB LLC with AB LLC surviving. Each of A and B receive cash and interests in CD LLC in the merger.
• CD treated as continuation of AB. Merger regulations not applicable?
AB LLC
A B
CD LLC
DA
10% 40%
5 6
C D50%
AB LLC
CD LLC
A B C D
50% 50%
50% 50%50%
CD LLC
50%50%
B C
10% 40%
AB LLC
DA
10% 40%
B C
40%10%
• Exactly the same, except AB LLC merges with and into MS, with MS surviving.
• Same? Would debt financing change any of these answers?• What if in each case A and B each only receive a de minimis interest in
AB LLC?
Cash Cash Cash Cash
32
MS LLC MS LLCMS LLC AB LLC
• Where the partnership merger regulations of Treas. Reg. §1.708-7(c) apply, there is little scope for difference. However, the treatment of the cash that A and B receive may vary from example to example dependent on whether the transaction specifically complies with Treas. Reg. §1.708-1(c)(4).
• E.g. In example 4 is the cash distribution a disguised sale of partnership interests, part of a disguised sale of assets or something else?
• Where one of the partnerships is newly formed, doubtful if Treas. Reg. §1.708-1(c)(4) applies. In that case does corporate form drive the answer?
• Is there learning from Subchapter C that can be helpful? (E.g .Rev. Rul. 73-427; Rev. Rul. 79-273; Rev. Rul. 90-95).
• The results of each of these transactions are dictated by Treas. Reg. §1.708-1(c).
• True even if one partnership is newly formed?• Does “continuation” or merger “rule” control?
• Also, Subchapter C analogues (i) do not exist, (ii) are unhelpful and muddy the analysis or (iii) are irrelevant.
Of Course! (Not)
33
Part 3: Sub-C/Sub-K Interaction
34
Where Sub-C and Sub-K Meet, Form Matters
• Crossover between the regimes requires a certain amount of formal deference.
• Because Subchapter C authorities are better developed, Subchapter C principles perhaps play an outsize role in determining effect of transaction form.
• Many Subchapter C/ Subchapter K authorities have more to do with Subchapter C than Subchapter K (e.g., Rev. Rul. 95-69 is fundamentally about continuity, a singularly Subchapter C concept.)
• Rev. Rul. 84-111 provides 3 methods of incorporating a partnership: (1) assets over, (2) assets up, (3) interests over. If form followed, tax consequences of each respected.
• Formless conversions under state law a 4th method. Because there is no state law form, Rev. Rul. 2004-59 imposes a form (assets over).
35
Are these the same? (1 of 4)
• AB LLC is a holding company and conducts all of its business through Opco LLC. Pursuant to a plan, A agrees to transfer all of its interests in AB to Newco 2 for cash. B agrees to transfer 25% of AB LLC to Newco 2 for cash and 10% of AB LLC to New LLC for a 5% interest in New LLC.
• Is New LLC a continuation of AB? What if Newco 1 does not further contribute AB LLC interests to Newco 2 so that AB LLC remains a partnership?
• What if B contributed its AB LLC interests to Newco 1 in exchange for Newco 1 stock in a Section 351 transaction and then further contributed such stock to New LLC for New LLC equity (see next slide)?
A B95%
C
AB LLC New
LLC
70% 30%
New LLC
B C5%
Newco 1
Newco 2
10% AB LLC
10% AB LLC
Newco 1
36
Newco 2
Opco
AB LLC
Opco
Are these the same? (2 of 4)
• AB LLC is a holding company and conducts all of its business through Opco LLC. Pursuant to a plan, A agrees to transfer all of its interests in AB to Newco 2 for cash. B agrees to transfer 20% of AB LLC to Newco 2 for cash and 10% of AB LLC to Newco 1 for a 5% interest in Newco 1. Immediately thereafter, and as part of a plan, B contributes the Newco 1 interests to New LLC in exchange for a 5% interest in New LLC.
• Any difference from scenario 1, particularly given Moline Properties respect for Newco 2?
A B95%
C
AB LLC
70% 30%
New LLC
B C5%
Newco 1
Newco 2
10% AB LLC
Newco 1
37
Newco 2
NewLLC
Newco 2
Newco 1
B
C
5% Newco 1
10%90%
100%5% New LLC
Opco
AB LLC
Opco
New LLC
Are these the same? (3 of 4)
• Pursuant to a plan, AB redeems B’s interest in AB LLC for interests in Opco. Immediately thereafter, AB sells its 70% interest in Opco for cash to Newco 2. B contributes 10% of its interests in Opco to New LLC in exchange for 5% of New LLC’s equity. Newco 2 purchases the remainder of B’s interest in Opco for cash.
• Is Opco a continuation of AB LLC immediately after the distribution? Is New LLC a continuation of AB LLC? What if Newco 1 does not further contribute Opco LLC interests to Newco 2 so that Opco LLC remains a partnership?
• What if there was a third partner in AB LLC so that AB LLC remained a partnership after B’s redemption? Does it matter if AB LLC immediately liquidates?
A B95%
C
AB LLC
NewLLC
70% 30% New LLC
B C
5%
10% Opco
10% Opco
Newco 1
Newco 2
Cash
30% Opco
Newco 1
Newco 2
A
Opco
B70%
30%
100%
10% Opco
Cash
Cash
Cash
20% Opco
5% New LLC
Cash
A100%
38
AB LLCAB LLC
OpcoOpco
Are these the same? (4 of 4)
• Pursuant to a plan, AB redeems 10% of B’s interest in AB LLC for 10% of the interests in Opco. Immediately thereafter, AB sells its 90% interest in Opco for cash to Newco 2. B contributes its 10% interest in Opco to New LLC in exchange for 5% of New LLC’s equity.
• Is OpCo a separate partnership for a day? Is New LLC a continuation of any partnership?
• Does it matter if AB LLC liquidates?
A B5%
C
AB LLC
NewLLC
70% 30% New LLC
C B
95%
10% Opco
10% Opco
Newco 1
Newco 2
Cash
10% Opco
Newco 1
Newco 2
AB LLC
A
Opco
B
90%
10%
80%
Cash
Cash
Cash
AB LLC
10%20%A
90%
39
OpcoOpco
• From a substance perspective, each of these transactions begins and ends at the same point.
• The ordering of steps matters, including, from a gain recognition standpoint and a sales characterization point.
• Moline Properties doctrine respects the entities and the different tax consequences that flow therefrom.
• Even though steps are predetermined, taxpayers can choose whether to sell equity or assets and that choice should be respected.
• Rev. Rul. 84-111 supports proposition that form matters.
• (But, Rev. Rul. 99-6 does seem to provide that form does not need to lead to consistent results).
Of Course! (Not)
40
Are these the same?
• AB LLC owned by A and B Corp., which is a holding company with no operations. C wishes to acquire AB. B is unwilling to transact unless C purchases B Corp. C forms C Corp. and C Sub to effect transaction.
• Pursuant to a single plan, A agrees to transfer all of its interests in AB to C Sub for cash, and B agrees to transfer all of its interest in B corp for cash; C corp contributes newly borrowed proceeds to AB to pay off AB debt.
• As part of a plan with the acquisition C Sub contributes all of the AB equity to B Corp. What if it did not make the contribution – any difference?
• Same as 1, but the acquisition by C of B Corp. and AB LLC is accomplished by simultaneous state law mergers, with the merger subsidiaries borrowing a portion of the merger consideration as co-borrowers.
• Does the order of the mergers matter? What if the order isn’t specified?
• Does the direction of the AB LLC merger matter?
• Note that this alternative results in one entity fewer and different borrowing entities. Does it/should it matter?
A B
1 2
C
B Corp.
AB LLC
C Corp.
C Sub.
C Corp.
C Sub
C
B Corp.
AB LLC
Debt
New Debt
Cash
Debt
A B
B Corp.
AB LLC
Debt
C
C Corp.
Merger Sub 1
Merger
New Debt
New Debt
C
C Corp.
B Corp.New Debt
New Debt
41
MS 2 AB LLC
• Both transactions accomplish the purchase of all of AB LLC and B Corp.
• The use of the corporate merger mechanic and placement of debt is irrelevant, particularly given the terms of modern guarantee and security purchase.
• These are fundamentally different transactions, with different entities, different borrowers and potentially different results.
Of Course! (Not)
42
Are these transactions the same?
• A holds a GP interest in AB LP through A LLC. B holds 100% of the LP interests in AB LP. A sells A LLC to C Corp. for cash. B sells its LP interest in AB LP to C Sub. for cash.
• Treated as a purchase of partnership interests by C Corp. and C Sub. AB LP continues as a partnership in C’s ownership.
• Form is a Rev. Rul. 99-6 transaction, followed by a creation of a new partnership through the contribution of B’s AB LP interest to C Sub.
• Should C’s transitory ownership of B’s AB LP interest be respected? Does it matter (particularly given the Rev. Rul. 99-6 fiction) if A and B are aware of C’s plan to contribute AB to C Sub.?
• Are now largely-irrelevant corporate authorities such as Groman v. Comm’r, 302 U.S. 82 (1937), and Helvering v. Bashford, 302 U.S. 454 (1938), instructive in this context?
1 2
43
AB LP
A
B
LP
GP
C Corp.
C Sub.
C Corp.
C Sub.
AB LP
GPLP
C Corp.
C Sub.
AB LP
A
B
LP
GP
C Corp.
C Sub.
B’s AB LP Interest
C Corp.
C Sub.
AB LP
GPLP
A LLC
A LLC
A LLC
A LLC
