In every stock acquisition agreement there are var-ious tax provisions that can have an effect on abuyer and a seller. These provisions, among otherthings, can backstop diligence, shift the risk of loss,result in actual cash outlays by either party, and canrun the gamut from simple, boiler plate languageto complex, highly specific terms. Not only aretaxes brought up in representations and pre- andpost-closing covenants, but they can also be foundin purchase price adjustments, escrow provisions,and indemnification sections. A buyer (the“buyer”) and a seller (the “seller”) that enter into anagreement (the “agreement”), whereby the sellersells all the outstanding stock of a target corpora-tion (the “target”), can encounter many of these taxissues. This article will provide a general overviewof various common tax provisions that may arise inthe agreement1 and the buyer’s and the seller’s po-tential positions with respect to those terms.2

DefinitionsWhen reviewing the definition section of the agree-ment, the first definitions that the parties generally

consider are “Taxes” and “Tax Returns.” The buyerwill try to make each of these definitions as broad aspossible, while the seller generally will try to narrowthe provisions as much as possible.

Taxes. A typical definition for Taxes may readas follows:

“Taxes” shall mean all United States federal, state, local, orforeign taxes, charges, fees, levies or other assessments, in-cluding, without limitation, income, gross receipts, excise,real and personal property, profits, estimated, severance, oc-cupation, production, capital gains, capital stock, goods andservices, environmental, employment, escheat, withhold-ing, stamp, value added, alternative or add-on minimum,sales, transfer, use, license, social security, Medicare, payrolland franchise taxes, or any other tax, customs duty, or gov-ernmental fee, or other like assessment or charge of any kindwhatsoever, imposed by the United States, or any state, coun-ty, local, or foreign government, or subdivision or agencythereof, and such term shall include any interest, penalties,fines, or other additions attributable to such taxes, charges,fees, levies, or other assessments.

The buyer may try to expand on this defini-tion by inserting “related liabilities” or refer-ences to Reg. 1.1502-6 (liability for tax). Theseller may try to resist “related liabilities” sincethe reference is vague, while depending on thescope of the tax representations and indemni-fication, and a reference to Reg. 1.1502-6 maynot be necessary. In addition, the seller mayfind that the term “other additions” is too vagueand want to strike it.

Stockacquisition

agreements cancontain a rangeof tax-related

provisions thatboth the sellerand buyer need

to fullyunderstand in

order to ensureeach is receiving

the economicdeal they expect.

THOMAS GRAY is a partner with Drinker Biddle & Reath LLP, basedin New York, New York. He thanks Stephen D.D. Hamilton for histhoughtful comments. The views expressed in this article are those ofthe author and do not necessarily reflect the views or professional ad-vice of Drinker Biddle & Reath LLP.

REPRESENTATIONS,COVENANTS, ANDOTHER TAXPROVISIONS INTAXABLE STOCKACQUISITIONSTHOMAS GRAY

3 CORPORATE TAXATIONMAY / JUNE 2015

One point of contention that has come up inthe definition of Taxes is the inclusion of “es-cheat.” Since the financial crisis of 2009, stategovernments have taken a greater interest in es-cheat and abandoned property claims as asource of revenue.3 Since a state claim with re-spect to unclaimed property can have a signifi-cant impact on a corporation, the buyer willwant to make sure that the agreement providessome level of protection against such a claim.But is the definition of “Taxes” the appropriateplace for providing such protection? The seller may argue that the requirement to

turn over property to a jurisdiction when noone has claimed that property is not a tax, butrather a general obligation of the corporationand, as a general obligation, any representa-tions or indemnification with respect to suchclaims should have the life and limitations asso-ciated with general claims, not tax claims. Inaddition, a corporation’s tax department maynot have any responsibility with respect to es-cheat issues and therefore the target corpora-tion does not treat escheat as a tax. The buyer,however, may argue that most state laws requirereturns to be filed with respect to escheat prop-erty, just like a general tax return, and such re-turns normally are filed with the state’s depart-ment of revenue or taxation. The failure to filesuch returns or pay over such amounts to theproper jurisdiction can result in penalties andinterest. Unless the agreement provides for spe-cific representations for escheat or unclaimedproperty, the definition of Taxes appears to be alogical place for inclusion.

Tax Returns. The definition of “Tax Returns”generally is not too controversial and a typical def-inition may read as follows:

“Tax Return” means any return, declaration, report, or sim-ilar statement required to be filed with respect to any Tax(including any attached schedules), including, withoutlimitation, any information return, claim for refund,amended return, or declaration of estimated Tax.

The seller may be concerned with this defi-nition if it thinks the buyer would interpret a“report or similar statement” to include filingswith respect to financial statements, althoughthat would generally not be the intent of thedefinition. The buyer may be concerned thatthe definition limits Tax Returns to those itemsthat are “filed.” If a target corporation did nottimely send its employees, independent con-tractors, or other payees correct 1099s or W-2s,would the above definition cover those forms?The Code distinguishes between filing an in-formation return4 and furnishing a payee state-ment “to the person to whom such statement isrequired to be furnished.”5 Since such forms arenot filed with, but rather furnished to, a payee,the buyer may try to modify the definition tosay “filed or furnished,” or provide some otheredit to cover the above scenario.

Net working capital. The definitions of Taxesand Tax Returns are not the only definitions relat-ing to taxes that the buyer and seller need to focuson. Many deals will include a purchase price ad-justment, with such adjustment based on the dif-ference between a target working capital amountand a net working capital amount. Whether or nottaxes are included in the working capital can affectthe purchase price adjustment and the indemnifi-cation provisions. Generally, net working capital is the excess

of current assets over current liabilities. Spe-cific adjustments to the purchase price, such asthe target corporation’s indebtedness, are usu-

4 CORPORATE TAXATION MAY / JUNE 2015 TAX PROVISIONS IN STOCK ACQUISITION AGREEMENTS

1 This article assumes that the transaction contemplated bythe agreement is a sale of 100% of the stock of target byseller to buyer for cash in a private taxable transaction wherethe parties do not make an election under Section338(h)(10).

2 For discussions related to tax provisions in other types ofcorporate acquisitions, see Ginsburg and Levin, Mergers,Acquisitions and Buyouts, Vol. 5 (Aspen, 2014); Looney andLevitt, “Due Diligence Issues Arising in Connection With theAcquisition of an S Corporation”, 115 J. Tax’n 4 (July 2011).

3 See Nagel, Griswold, Abrams, and Young, “Are States(Es)Cheating You?” State Tax Notes, April 29, 2013, p. 385;see Gagliano, “Unclaimed Property Briefing: Tracking theDramatic Changes in the Way States Enforce Abandonedand Unclaimed Property Laws,” (Spring/Summer 2011),http://www.pwc.com/en_US/us/state-local-tax/newsletters/abandoned-unclaimed-property/assets/pwc-aup-spring-summer-2011.pdf.

4 Section 6721. 5 Section 6722(a)(2)(A). 6 Generally, a pre-closing tax period is a tax period that endson or before the closing date, and a pre-closing tax is a tax

related to (1) a pre-closing tax period, and (2) with respectto a tax period that begins on or before the closing date andends after the closing date, the portion thereof ending on theclosing date.

7 Straddle periods are typically defined as tax periods thatbegin before or on the closing date and end after the clos-ing date.

8 Corporations must file their federal income tax returns on orbefore the 15th day of the third month following the end ofthe tax year. Section 6072(b). A corporation or an affiliatedgroup of corporations filing a consolidated return is allowedan automatic six-month extension of time to file its incometax return after the date prescribed for filing the return if cer-tain requirements are met. Reg. 1.6081-3(a). If the targetceases or becomes a member of a consolidated group, itstax year for federal income tax purposes will end on theclosing date. Reg. 1.1502-76(b).

9 See Rizzi, “Trafficking in Deal Costs: Who Gets the Benefit?,”35 Corp. Tax’n 25 (July/August 2008).

10 To the extent the target becomes or ceases to be a memberof a consolidated group as a result of the acquisition, theparties will need to take into consideration the end of the dayrule and the next day rule found in Reg. 1.1502-76(b)(1)(ii).

ally excluded from the net working capital def-inition. Net working capital definitions willalso typically exclude deferred tax assets anddeferred tax liabilities, as these are accountingconcepts that generally represent timing differ-ences, which the parties generally agree shouldnot affect the purchase price. But should gen-eral tax liabilities and assets be excluded? Vari-ous factors can go into this determination, suchas the extent and time for indemnification re-lated to tax matters and the time involved in thefinal determination of the net working capitaladjustment to the purchase price. If there is no pre-closing tax indemnity and

the buyer is just relying on the tax representa-tions for indemnification, all taxes should beincluded in the net working capital. If, however,there is a pre-closing6 tax indemnity, it may beadministratively easier to exclude certain taxesfrom net working capital and deal with such li-abilities through the tax indemnification provi-sions. What taxes should be excluded may de-pend on the time it takes to determine the finalpurchase price. The determination of the final net working

capital amount, and therefore the final adjust-ment to the purchase price, may be concluded,for example, 90 days after closing. In that pe-riod, final amounts related to certain straddleperiod tax returns,7 such as sales tax and em-ployment-related taxes, can be calculated andtherefore may be easily included in the networking capital. Other taxes, such as federal in-come taxes related to the tax year that includesthe closing date, may not be finalized until afterthe final purchase price is determined.8 Sincethere may only be an estimate of such liability,the parties may deem it easier to have such lia-bility run through the indemnification provi-sions and not be taken into account in the networking capital adjustment. As discussed below,to the extent that taxes are taken into account inthe net working capital adjustment, thereshould be an adjustment to the indemnificationobligation of the seller related to such taxes andcorrespondingly, the obligation of the buyer topay over pre-closing tax refunds to the seller.

Transaction tax deductions. Although the con-cept may have different labels, the seller may in-clude this term with the intent that, as describedbelow, it receives any tax benefits associated withcertain expenses, usually the seller’s deductible ex-penses associated with the sale of target stock.9The definition of transaction tax deductions canrange from the very broad to very specific, and

may be detailed in a schedule with amounts.These expenses may include fees paid to attorneys,accountants, and investment bankers; bonuses;severance payments; change of control payments;payments with respect to options and any relatedpayroll taxes; and any other costs associated withthe transactions. Although the parties at the timeof signing will probably not know the amount oftransaction tax deductions, they can usually agreeon the types of deduction, and with respect to suc-cess-based investment banker fees, agree that pur-suant to Rev. Proc. 2011-29, 2011-18 IRB 746,70% of such fees will be treated as deductible. Thebuyer and seller may agree to provide a schedule atsigning indicating estimates of such deductible ex-penses and when these expenses would be de-ductible (either pre-closing or post-closing).10

This schedule could be updated immediately afterclosing and agreed to as final and binding. If thebuyer accepts the concept of paying for such taxbenefits, one advantage to agreeing to such aschedule is that it would be applied to any applica-ble tax returns and therefore eliminates one areaof dispute between the parties when preparingthese returns.

Loss or Losses. The definition of “Losses” gen-erally is associated with a party’s indemnificationobligation pursuant to the agreement (i.e., Party Awill indemnify Party B for all Losses…. ). A typicaldefinition of Losses may include “damages, losses,liabilities, obligations, claims of any kind, interest,or expenses (including reasonable attorneys’ feesand expenses).” If the buyer is aggressive, it may tryto explicitly include a tax concept in the definitionthat would broaden the seller’s indemnificationobligation. The buyer may include “any reductionin Tax attribute” or “any reduction in net operatingloss” in the definition. To the extent that the partiesagree that the target’s tax attributes are valuable andpart of the deal, the buyer may reasonably expectthat if the value of those tax attributes decrease as aresult of an audit or other examination related to apre-closing tax period, the seller should indemnifythe buyer for the economic loss it suffers as a resultof the reduction, and the additional language iswarranted. If, however, the seller has not explicitlyagreed that the tax attributes are part of the deal

5 CORPORATE TAXATIONMAY / JUNE 2015TAX PROVISIONS IN STOCK ACQUISITION AGREEMENTS

The scope of the tax representations may bean area of great debate in the agreement andcan be influenced by the extent of the buyer’sdiligence, the scope of the seller’sindemnification obligation, and the relativenegotiating powers of the parties involved.

and such language is included, the seller could finditself indemnifying for losses it never contem-plated. Whether such indemnification should belimited to pre-closing tax periods or post-closingtax periods is discussed below.

Purchase and sale provisionsGenerally, the agreement will have a section de-scribing the acquisition, the closing procedures,and procedures regarding any purchase price ad-justments. This section may also contain provi-sions for an escrow, or some other form of hold-back, and a tax withholding provision.

Escrow. To the extent the buyer requires that aportion of the purchase price be escrowed in orderto secure funds for indemnification of breaches ofrepresentations and warranties, and the seller isselling its target stock at a gain, the seller generallywill insist that, to the extent available, it be entitledto use the installment method with respect to anyamounts it receives from the escrow account.11

Generally, if the amounts in escrow are subject toa substantial restriction, such amounts will betreated as property of the buyer and the gain fromthe sale can be reported on the installmentmethod.12 If, however, the escrow funds aredeemed to be property of the seller, the amount ofsuch funds would be treated as received by theseller on the closing date.13 Even though the Serv-ice has privately ruled that the installment methodmay be used where the seller directs the investingof escrowed funds14 and reports the taxable in-come of the escrow,15 the seller will generally insistthat the buyer be considered the tax owner of theescrow funds and report all taxable income withrespect to the returns on such funds.16

The seller’s position will usually result in thebuyer insisting on distributions from the es-crow account in order to cover its income taxliability associated with the taxable income ithas earned as a result of being the tax owner ofthe escrowed funds. On its face, this seems likea reasonable request, however, the buyer mayfinancially benefit from this arrangementwhereas, since the escrow is established for thebenefit of the buyer, the intent should be thatthe buyer be in a neutral financial position withrespect to the escrow account. The buyer’s ben-efit derives from the original issue discountrules under Sections 1271-1274. Generally, the seller and buyer will agree

that they will treat the amounts in the escrowaccount payable to the seller as subject to theoriginal issue discount rules. As a result of these

rules, the buyer will incur interest expense andthe seller will receive corresponding interest in-come. The seller will most likely take the posi-tion that the buyer’s deduction related to the in-terest expense should off set any taxableincome that the buyer may incur as a result ofany taxable returns earned on the escrowfunds. Since, the argument goes, the buyer willnot incur an overall tax liability with respect tothe escrow account, it should not receive anytax distributions and any such distributionswould represent a windfall to the buyer. De-pending on the party’s relative negotiatingpower, the parties may strike the tax distribu-tion provision, keep it, or compromise with atrue-up provision based upon actual tax liabil-ities incurred by the buyer as a result of its in-volvement in the escrow account.

Earn-out payments. In certain circumstances,where the buyer and the seller may not agree onthe value of the target corporation, the buyer mayinsist on tying a portion of the purchase price tofuture earnings. As the future earning hurdles aremet, the buyer will make additional considerationpayments to the seller. Since these payments arebased on contingencies, if the seller intends to usethe installment method to report its gain on thedisposition, it will have to contend with the con-tingent installment sale17 and original issue dis-count rules.18The seller will want to carefully con-sider whether such payments are capped at acertain amount, what that amount is, what hap-pens if early goals are not met, and the period overwhich payments are made. To the extent the sellermisjudges the potential future earnings of the tar-get, the seller could be faced with recognizing cap-ital gain in the early years of the payment schemeand losses in the later years.19

Withholding. The seller will generally agree thatpayments made to an option holder may be lessany applicable withholding taxes. The buyer, how-ever, will generally insist on a much broader with-holding provision that provides that the buyer, thetarget, the escrow agent, and, if applicable, thepaying agent may deduct from any paymentsmade to any person pursuant to the purchaseagreement (or related documents) any amountsrequired to be withheld under applicable tax lawand these withheld amounts will be treated as paidto such person. The buyer is generally concernedwith having a legal obligation to withholdamounts while contractually being obligated topay 100% of the consideration to the intended re-cipient and then having to seek indemnificationfor such tax payment. The buyer’s language would

6 CORPORATE TAXATION MAY / JUNE 2015 TAX PROVISIONS IN STOCK ACQUISITION AGREEMENTS

eliminate the need to seek indemnification. Thislanguage, for example, could come into play ifwithholding is required under the provisions ofSection 1445.20 In addition, the buyer’s languageprevents the seller from arguing that the seller isentitled to 100% of the consideration if, for in-stance, the seller did not present a valid form W-9and the escrow agent or paying agent decided towithhold because of such omission. The seller, however, may be concerned that

the buyer is adding such language because it in-tends to withhold based on some questionableinterpretation of tax law. Also, if the agreementrequires that proceeds from the sale be used tomake payments to certain non-sellers, such ascurrent creditors of the target, such paymentscould come within the scope of the buyer’swithholding language, leaving the seller liableto such non-sellers. The seller, therefore, mayinsist that such language be limited to pay-ments to the seller (and other deemed equityholders). The seller will usually insist that anywithheld amounts be timely paid over to theapplicable taxing authorities and sometimestake the position that the buyer must providesome reasonable notice regarding its intent towithhold. The buyer, however, should be cau-tious of adding notice language since a failureto meet an affirmative notice obligation couldeviscerate the withholding provision.

RepresentationsThe scope of the tax representations may be anarea of great debate in the agreement and can be in-

fluenced by the extent of the buyer’s diligence, thescope of the seller’s indemnification obligation,and the relative negotiating powers of the partiesinvolved. Besides being used to uncover potentialtax liabilities that were not revealed during dili-gence, a breach of a representation can trigger anindemnification obligation or, if such breach is dis-covered prior to closing, potentially create a meansfor the buyer to cancel the closing. Commentatorshave provided various lists of tax representationsto be included in purchase agreements21 and thisarticle does not try to duplicate such lists, but high-lights certain common representations and ex-plains how the parties may react to them. One of the primary tax representations is

that the target has filed all tax returns (as de-fined in the applicable agreement) required tobe filed and such tax returns are true, correct,and complete in all material respects. The sellermay try to limit this representation to materialtax returns. If, for example, a target files numer-ous Form 1099s or files sales tax returns in alarge number of states, it could be concernedthat a tax return, which reflected an immaterialamount, was not properly filed and thereforethe representation is breached unless such re-turn is included in the disclosure schedule. Ifthere is a full pre-closing tax indemnity and thebuyer has not uncovered any questionable fil-ing practices, the buyer may agree to a modifi-cation to the representation.22

The representation that the tax returns aretrue, correct, and complete in all material re-spects may cause an issue if a breach of suchrepresentation results in a loss in a post-closing

7 CORPORATE TAXATIONMAY / JUNE 2015TAX PROVISIONS IN STOCK ACQUISITION AGREEMENTS

11 Section 453 (generally providing that to the extent that atleast one payment with respect to the disposition of prop-erty is received after the close of the tax year in which thedisposition occurs, the income recognized from such dispo-sition is that proportion of payments received in that yearwhich the gross profit (realized or to be realized when pay-ment is complete) bears to the total contract price); Reg.15A.453-1(c). There are situations where it may be moreeconomically advantageous for the seller to elect out of theinstallment method, such as where there is an expectedlarge increase in the tax rates for subsequent years.

12 See Rev. Rul. 77-294, 1977-2 CB 173; see also Rev. Rul.79-91, 1979-1 CB 173 (providing that in order for an escrowarrangement to impose a substantial restriction, it mustserve a bona-fide purpose of the purchaser, that is, a realand definite restriction placed on the seller or a specific eco-nomic benefit conferred on the purchaser); IRS Publication537, Installment Sales, p. 7 (2013).

13 See Rev. Rul. 72-256, 1972-1 CB 222. 14 See Ltr. Rul. 8645029. 15 See Ltr. Rul. 200521007. See also Ginsburg, supra note 2at ¶ 203.5.4.

16 See also Prop. Reg. 1.468B-8. 17 Reg. 15A.453-1(c). 18 Sections 1271-1274.

19 See Gulbis, “Taxation of Earn-Out Payments in Taxable Ac-quisitions,” 38 Corp. Tax’n 3 (September/October 2011);see also Skinner, “Earn-Outs in Public Company Acquisi-tions: New CVRs Raise Unsettled Tax Issues,” 113 J. Tax’n360 (December 2010) for a discussion of making contingentpayments to target company shareholders based upon con-tingent value rights.

20 Section 1445(a) generally provides that if a foreign persondisposes of a United States real property interest (as definedin Section 897(c)), the transferee must deduct and withholda tax equal to 10% of the amount realized on the disposition.Section 897(c)(A)(1)(ii) provides that an interest in a domes-tic corporation will be considered a United States real prop-erty interest unless such corporation was not a UnitedStates real property holding corporation during the specifictesting period.

21 Ginsburg, supra note 2; Bittker, Emory & Streng: Federal In-come Taxation of Corporations & Shareholders: Forms¶ 12.10, Form 12.10(c) (4th ed. 1995, updated Oct. 2014);Prusiecki, “Tax Aspects of Agreements for Taxable Acquisi-tions of Corporate Businesses,” 18 J. Corp. Tax’n 3 (Autumn1991).

22 Usually a buyer’s principal focus is on income tax returnsand may agree to limit other tax returns to a materiality qual-ifier.

tax period. Is the seller obligated to indemnifythe buyer for such loss? The outcome generallyis determined by two factors: (1) the definitionof “Loss,” as discussed above, and (2), as dis-cussed below, whether the seller has affirma-tively excluded losses related to post-closing taxperiods from its indemnification obligation. Another very common representation is

that the target has paid all taxes that it owes.The seller may also try to limit this to materialtaxes or only to taxes shown on such tax re-turns. The buyer will also generally include arepresentation that the target has withheld andpaid over to the appropriate taxing authority alltaxes it is required to withhold and pay over.

This representation may help the buyer un-cover any employee/independent contractormisclassifications. The buyer will also generallyinclude that the target has also collected alltaxes it is required to collect, since, for example,a sales tax is collected with the receipt by thetarget of a payment, whereas an employee with-holding tax is withheld from a payment madeby the target to an employee. In addition, if therepresentation requiring withholding, collect-ing, and paying over of such tax is not included,the seller may argue that the general represen-tation that the target has paid all taxes it owesdoes not cover withheld or collected taxes sincesuch taxes are not taxes of the target, but rathertaxes of another person and the target acts onlyas a trustee with respect to such taxes. This is anargument the buyer would not want to get into. Other common representations include that

there has been no extension of any applicablestatute of limitations, there have been no auditsor examinations of any tax returns, there hasbeen no assessment of any taxes by any taxingauthority, there has been no claim by a taxingauthority in a jurisdiction where the target doesnot file a tax return that it is or may be subjectto taxation by that jurisdiction, and the targethas not entered into any “reportable transac-tions” within the meaning of Reg. 1.6011-4.23

As with sales tax, another tax the target maybe obligated to pay, but arguably may not be atax of the target, is the federal income tax liabil-ity of the consolidated group it had previouslybeen a member of during the time of its mem-

bership. Pursuant to Reg. 1.1502-6, a parentand each subsidiary which was a member of thegroup during any part of the consolidated re-turn year is severally liable for the tax of suchyear. Because such liability may be difficult touncover in diligence and has no bearing to cur-rent target taxable revenues, the buyer mostlikely will insist on a representation that the tar-get has not been a member of a consolidatedgroup and does not have any liability of anyother person as a result of the application ofReg. 1.1502-6 or similar state, local, or foreignlaw. In addition, Reg. 1.1502-6 may be referredto in the definition of Taxes and may also be in-cluded in a specific indemnification provision.

The representation may also be extended to in-clude a reference that the target is not liable forthe taxes of another person by reason of a beinga transferee, successor, or by contract. Theseller will sometimes try to modify this repre-sentation by adding language such as “otherthan an agreement or contract entered into inthe ordinary course of business the principalpurpose of which is not to indemnify for Taxes.”With this language, the seller avoids the need toschedule out standard commercial contractsthat it enters into that contain tax indemnifica-tion provisions. If the target has net operating losses or other

carryover losses that the buyer has placed valueon, the buyer may require that the seller make arepresentation that such losses are not subjectto limitations under any tax law. The buyer mayalso insist that the seller make a representationas to the amount of net operating losses.24 Theseller may find a representation regarding Sec-tion 382 hard to give if the target has not per-formed a Section 382 analysis and there havebeen ownership changes in the last few years.25

In addition, providing a schedule of theamount of net operating losses opens the sellerto possible indemnification obligations where,for example, a pre-closing tax audit reduces theamount of net operating losses, but there is noactual tax liability incurred in a pre- or post-closing tax period as a result of the adjustment. The buyer generally will also include some

form of representation that the target has notbeen involved in a distribution to which Sec-

8 CORPORATE TAXATION MAY / JUNE 2015 TAX PROVISIONS IN STOCK ACQUISITION AGREEMENTS

If there is a general pre-closing tax indemnity in addition to indemnification forthe breach of a tax representation, the post-closing tax covenants shouldaddress such items as the preparation of tax returns that are filed post-closing,disputes with taxing authorities, and refunds of taxes.

tion 355 is applicable, and that the target is nota U.S. real property holding corporation.Again, these facts may be difficult to uncover indiligence and may not be covered under a gen-eral pre-closing tax indemnity. If the target has operations or subsidiaries in

non-U.S. jurisdictions, the buyer may includerepresentations regarding Section 367(d), thattransactions between the target and its non-U.S. subsidiaries were at arm’s length, andwhether a non-U.S. subsidiary is a passive for-eign investment company or incurs Subpart Fincome. In addition to the above mentioned repre-

sentations, the buyer may insert representa-tions regarding Sections 409A and 280G. Theserepresentations may already be covered underthe ERISA representations and the seller maytry to push back on their inclusion in the taxrepresentation section. Further, the seller maytry to include language that the representationsin the tax section are the only representationsrelated to taxes in the agreement. The above tax representations are only a

sample of what may be included in the agree-ment. Depending on the particular business ofthe target or issues that the buyer uncovers dur-ing diligence, other tax representations can beadded.

CovenantsGenerally, depending on the scope of the indem-nification provisions and negotiating power of theparties, the covenants that involve taxes can bevery short or span pages of the acquisition agree-ment. If the parties agree that the only indemnifi-cation with respect to taxes is a breach of a tax rep-resentation, the post-closing tax covenants can berelatively short.26 If, however, there is a generalpre-closing tax indemnity in addition to indemni-fication for the breach of a tax representation, thepost-closing tax covenants should address suchitems as the preparation of tax returns that arefiled post-closing, disputes with taxing authorities,and refunds of taxes.

Pre-closing tax covenants. Unless the agree-ment provides for a simultaneous sign and close,the buyer will generally insist that restrictions beimposed on the target with respect to certain post-signing/pre-closing actions related to taxes unlessthe buyer grants approval for such action. Theserestrictions may include prohibitions on makingor changing tax elections, changing any account-ing method, filing any amended tax returns, set-

tling any tax claims, surrendering any right to a re-fund of taxes, and consenting to the extension orwaiver of the limitation period applicable to theany tax claim or assessment. Depending on thefacts and circumstances, the seller may respond byinserting materiality qualifiers, noting that, for in-stance, the target may file numerous sales tax re-turns and the seller should not need to seek thebuyer’s permission to settle an immaterial sales taxdispute.

Foreign Investment in Real Property Tax Act

(FIRPTA) certificate. The buyer will generally re-quire that at closing it receive a certificate that theseller is not a foreign person or that the target isnot a U.S. real property holding corporation, inorder to ensure that the buyer is not required towithhold any amounts from the purchase pricepursuant to Section 1445.27 The buyer may insertthis as a condition to closing or as a generalcovenant under the tax covenant section. Theseller may not want this as a condition to closing,since an administrative error in not preparing thecertificate could technically delay the closing.

General indemnification payments reduced by

tax benefits. In the general indemnification provi-sions, the seller may provide language that any in-demnification obligation owed by the seller to thebuyer should be off set by any reduction in the tar-get’s, or its affiliates’, taxes associated with the lossthat generates the indemnification payment. Theseller will argue that the buyer should be madewhole only for the loss it incurred, and any taxbenefit associated with such loss is an extra bene-fit to the buyer. For example, assume the target in-curs a $1 million loss and the loss generates a $1million deductible expense. If the target’s com-bined state and federal tax rate is 40%, the sellerwould argue that it should make an indemnity

9 CORPORATE TAXATIONMAY / JUNE 2015TAX PROVISIONS IN STOCK ACQUISITION AGREEMENTS

23 Note that the seller will usually try to limit a representation re-garding reportable transactions to listed transactions, orclaim that such representation is unnecessary because it iscovered under the representation that all tax returns havebeen filed and are true, correct, and complete in all materialrespects.

24 Note that the representation discussed above that all tar-get’s tax returns are true, correct, and complete in all mate-rial amounts may already provide some protection regardingthe amount of target’s net operating losses.

25 Generally, if a corporation experiences an ownershipchange, Section 382 imposes a limitation on the use of suchcorporation’s net operating losses in the post-change years.

26 An acquisition agreement that does not contain a pre-clos-ing tax indemnification provision will generally be consideredseller favorable. Presumably, in such an agreement, thebuyer will push much harder for a more expansive set of taxrepresentations. Regardless of the method of indemnifica-tion, however, the indemnification is only as good as theseller’s credit worthiness.

27 See above for the buyer’s general ability to withhold with re-spect to payments made pursuant to the agreement.

payment of only $600,000, and that the buyer willreceive the remaining $400,000 through the re-duction of the target’s tax liability. The buyer may not agree that the above ex-

ample is so clear cut. What if the loss creates anasset that is amortizable over 15 years? Shouldthe buyer have to wait 15 years to recover thefull amount of the loss? Should the time valueof money be taken into account? If the agree-ment provides that the seller make the full in-demnity payment and that the buyer must payto the seller any tax benefits it receives as a re-sult of the loss, should the buyer expect to makepayments to the seller over the 15-year periodthat the asset is amortized? What if the deduc-tion is not currently useable by the target or itsgroup? Since indemnification payments aregenerally treated as purchase price adjust-ments, should the reduction in any gain real-ized by the seller as a result of the payment betaken into account? Should the additional taxcosts incurred by the buyer, such as additionalgain on the subsequent disposition of the stock,be taken into account. Because the determina-tion of tax benefits can be extremely compli-cated, the buyer may reject the idea completely. The seller may counter the buyer’s rejection

by trying to simplify the procedures. The par-ties may agree to limit the number of years in-volved in determining the tax benefits recog-nized and may even limit it to just the year ofpayment. The agreement could also take intoaccount actual tax benefits realized and takeinto account the tax costs incurred by thebuyer.

Post-closing tax covenants—no pre-closing tax

indemnification. If there is no general pre-closingtax indemnification, the buyer will bear all the li-ability related to any tax returns of the target filedpost-closing. The seller will have an indemnifica-tion obligation only with respect to losses in-curred from a breach of a representation. As a re-sult, the agreement does not need to address thepreparation of tax returns filed post-closing or theallocation of taxes between straddle periods.28

Also, since the seller does not have a blanket obli-

gation to indemnify for pre-closing taxes of thetarget, the buyer will usually take the position thatthe buyer retains any refund of taxes related to apre-closing tax period.29

Even though the tax covenant section maybe simplified in an agreement where there is nopre-closing tax indemnity, the agreement willusually provide for cooperation between thebuyer and the seller regarding tax matters, in-cluding tax return preparation and defendingan audit, and responsibility for payment oftransfer taxes related to the sale of stock. In astock sale, as opposed to an asset sale, the par-ties could reasonably expect that any transfertaxes would not be material, but where the tar-get owns real property, certain jurisdictionsmay impose transfer taxes on the sale of corpo-rate stock.30Where there is an audit or other taxclaim by a taxing authority that could poten-tially cause a breach of a tax representation, theparties will usually assign responsibility forhandling such dispute as laid out in the generalindemnification provisions, as opposed to set-ting forth a specific tax dispute section.

Post-closing tax covenants—pre-closing tax in-

demnification.When the agreement includes a pre-closing tax indemnification, the tax covenant sec-tion will generally be much more expansive. If,however, the buyer is aggressive in its initial draftof the agreement, the agreement as proposed bythe buyer may not provide any additional taxcovenants. Even though the seller contractuallywill be liable for all pre-closing taxes, the onlyrights the seller will have with respect to thepreparation of pre-closing tax returns (and strad-dle period tax returns) filed post-closing are therights granted in the agreement. Therefore, if theagreement does not grant the seller rights with re-spect to the preparation of such target tax returns,the buyer may take positions on such tax returnsthat may be unfavorable to the seller and the sellerwill have no recourse. In addition, if the seller isnot granted rights with respect to certain tax mat-ters related to pre-closing tax periods, such as au-dits, the buyer will control the process unless oth-erwise specified.

Tax indemnification. When an agreement in-cludes a pre-closing tax indemnification, a buyermay try to remove such indemnification from thegeneral indemnification provisions of the agree-ment and place it in the tax covenant section sothat it is clear that the limitations and proceduresapplicable to the general indemnification rights ofthe buyer do not apply to tax indemnifications. Ifseparated, the tax indemnification section may

10 CORPORATE TAXATION MAY / JUNE 2015 TAX PROVISIONS IN STOCK ACQUISITION AGREEMENTS

28 The seller, for example, has represented that as of the sign-ing date (and the closing date if the representations arebrought down to closing) the target has filed all tax returnsthat it is required to file. After the closing, the seller has nomore obligations with respect to target tax returns that aredue after the closing date.

29 As noted above, if there is no pre-closing tax indemnifica-tion, to the extent there is a net working capital adjustment,such adjustment should take into account taxes.

30 See NYC Administration Code sections 11-2101 and 11-2102.

also include the indemnification for breaches oftax representations and warranties, tax covenants,liabilities with respect to Reg. 1.1502-6, successorliability or liability pursuant to a contract, and anyliability related to any tax sharing agreements.This provision would also include indemnifica-tion for any costs incurred with respect to such in-demnification. As noted above, the seller generally will

modify the indemnification provisions to takeinto account any taxes that are part of the networking capital calculation. This prevents thepurchase price from being reduced by tax lia-bilities while requiring the seller to indemnifythe buyer for the same taxes. The buyer maywant a clarification that such taxes have to re-duce the purchase price and are individuallyidentified in the net working capital.

Post-closing tax indemnification.When facedwith a pre-closing tax indemnity, the seller willsometimes insist that the agreement contain aprovision that the seller is not liable for anytaxes (or losses) that relate to a post-closing taxperiod. Alternatively, a provision may be in-serted that the buyer must indemnify the sellerfor any taxes related to a post-closing tax pe-riod. Generally, a seller will understand theneed to indemnify for pre-closing taxes sincethe incident that gave rise to such liability oc-curred under the seller’s watch. But the sellermay be surprised that it could be liable for taxesof target that occur in a post-closing tax periodunless the agreement prohibits such an indem-nification claim. As noted under the discussion

of the definition of Losses above, the amountand usability of the target’s net operating losses,for example, may be an item that the buyer hasplaced value on and expects such value to bethere in future tax periods. A pre-closing re-duction of such net operating losses may resultin an increase in the actual post-closing tax lia-bility of the target, or just the reduction in thevalue of such tax attribute. Depending on therepresentations given by the seller and the def-inition of Losses, and unless the agreementstates otherwise, the buyer may seek indemnifi-cation for such post-closing losses. In another example, assume the target made

an asset acquisition subject to Section 1060prior to the buyer’s acquisition of target. In suchasset acquisition, target acquired a valuable in-tangible asset subject to amortization over a 15-year period pursuant to Section 197. Assumefurther that at the time of the buyer’s acquisi-tion of target, there were 13 years of amortiza-tion left with respect to the intangible asset andthe buyer had factored such amortization intoits valuation of target. After the closing date ofthe buyer’s acquisition of target, the Service au-dits the pre-closing tax periods of target and re-duces the amortizable value of the intangibleasset, resulting in a reduction in amortizationexpenses post-closing and an increase in post-closing federal income tax liabilities. Whichparty should bear the cost associated with theextra taxes incurred in the post-closing tax pe-riods as a result of such audit? If the seller rep-resented that the target’s tax returns were true,

11 CORPORATE TAXATIONMAY / JUNE 2015TAX PROVISIONS IN STOCK ACQUISITION AGREEMENTS

DuCharme, McMillen & Associates ad

correct, and complete in all material respects,without similar language to that described inthe first two sentences of the preceding para-graph, the seller arguably could be liable forsuch taxes if the buyer sought indemnification.

Actions of the buyer. One concern the sellermay have with indemnification is whether ac-tions of the buyer can trigger a seller indemni-fication obligation. A typical acquisition agree-ment will provide that the pre-closing taxperiod will run through the end of the closingdate. The seller may be concerned that thebuyer or target may do something, or be treatedas doing something, on the closing date afterthe closing outside the ordinary course of busi-ness, resulting in a target tax liability. Suchevents could include transferring assets at theend of the closing day or making an electionunder Section 338(g).31 Such actions could re-sult in taxes of the target that would relate to apre-closing tax period for which the sellerwould be responsible, and therefore the sellermay want to insert a prohibition against suchactions. In addition, the seller may insert gen-eral language that would prevent the buyerfrom doing any post-closing activities thatcould result in an indemnification obligation ofthe seller.

In prohibiting a buyer action from causing aseller indemnification obligation, the buyermay have its own concerns. If the buyer has de-termined that the target’s past position on amatter may not withstand a challenge from ataxing authority, the buyer may want to takepreventive measures and not play the audit lot-tery. This issue may become even more impor-tant where there is a time limit on indemnifica-tion and the issue involves whether a tax returnshould have been filed. For instance, the targetmay have determined that it did not have nexuswith a particular state and therefore did notneed to file any tax returns with that state. Thebuyer, however, may have concluded otherwiseand wants to enter into a voluntary disclosureagreement (“VDA”) with the applicable statetaxing authority regarding these returns. As-suming that such disclosure would result in apre-closing tax liability, should the buyer bearthe burden of such pre-closing taxes? Assume

instead that the buyer did not enter into a VDA,but instead started filing tax returns in thatstate for post-closing tax periods. As a result ofthose filings, the applicable taxing authority de-termines that the target should have also beenfiling in the state for pre-closing tax periods.Should the buyer’s actions exculpate the sellerfrom an indemnification obligation? If theseller had successfully inserted a provision pre-venting any post-closing action of the buyerfrom generating an indemnification obligation,it would seem the buyer would bear the burdenof such pre-closing taxes. The seller will also want to ensure that the

buyer cannot unilaterally go back and amend apre-closing tax return without the seller’s con-sent. The buyer may note that the seller’s con-sent should be required only to the extent suchamendment could give rise to a seller indemni-fication obligation. The seller may still want tobe informed of any such amendment even if itwould not result in an indemnification obliga-tion. Regardless of how this anti-amendmentprovision is drafted, as noted below, the buyershould consider how such provision would af-fect the buyer’s desire to carryback post-closinglosses to pre-closing tax periods.

Survival, floors, and ceilings. The buyer willgenerally provide that the indemnification ob-ligation with respect to tax representations willsurvive until the expiration of the applicablestatute of limitations (“SOL”), or a certainnumber of days past the expiration of the ap-plicable SOL, in order to account for the timeneeded to communicate any claims. In addi-tion, the buyer may not put any limitations onthe survival period for indemnification relatedto pre-closing taxes. The seller may push toshorten the indemnification period, especially,for example, if the seller is a private equityfund. A fund may argue that it is required todistribute proceeds from the sale of the targetand it cannot practically pursue its investors ifyears down the road the buyer makes an in-demnification claim. A two- or three-year sur-vival period for tax claims is not unheard of inthese situations. Generally, though, if the indemnification

period is limited, the agreement may providethat the buyer can submit a claim within suchperiod and the indemnification period will re-main open until the claim is resolved. Butwhat constitutes a claim? Most parties wouldagree that an assessment by a taxing authoritywould constitute a claim. Would an audit that

12 CORPORATE TAXATION MAY / JUNE 2015 TAX PROVISIONS IN STOCK ACQUISITION AGREEMENTS

The seller will sometimes insist that theagreement contain a provision that the selleris not liable for any taxes (or losses) thatrelate to a post-closing tax period.

has just finished where target was still waitingfor the taxing authority to provide its conclu-sion be considered a claim? Would the noticeof an upcoming audit be sufficient? Theshorter the survival period, the stronger theargument becomes that the survival periodshould be extended where there is a notice ofan audit or inquiry, since such review wouldlikely not be completed before the indemnifi-cation period expires. The seller may insert provisions that before

it makes any indemnification payments, in-demnification claims must reach a certainthreshold level and that such payments willstop once claims reach a specific amount. Thebuyer will usually argue that the seller shouldbe liable for dollar one of any tax claims andthere be no cap on tax indemnities. As notedabove, a private equity seller may argue that ano cap provision is not workable based on theprivate equity fund’s investor configurationand the fund’s requirement to distribute pro-ceeds from a disposition of the target stock. Inthis type of situation, and based upon thebuyer’s diligence of the target, the buyer mayagree to a cap.

Tax return preparation. After the closing, targetwill have tax returns related to pre-closing andstraddle periods that have not been filed yet. If theagreement provides for a pre-closing tax indem-nity, the seller will be responsible for any taxes thatare shown as owing on the pre-closing tax returnsfiled post-closing and also be liable for the taxesrelated to the pre-closing portion of the straddleperiod tax returns. Who prepares the returns andwhat input the other party has in the preparationof such returns can be a subject of significant ne-gotiations. If the buyer is a large entity and the tar-get a comparatively small add-on, the buyer mayinsist that it prepares such tax returns and mayallow the seller some review rights. A commonformulation, however, is for the seller to prepareand file, or cause to be prepared and filed, pre-closing tax returns that are filed post-closing in amanner consistent with the target’s past practice.The buyer may not want to include the past prac-tice language if it has determined that the targethas taken questionable positions in the past. If the seller is preparing the pre-closing tax

returns, the buyer will want some review rightsand the ability to comment on those returns,even though the seller will have the obligationto pay any taxes related to such returns. Thebuyer may insist that a return be filed only withits consent. This would give the buyer a veto

right on any position the seller may take, whichthe seller may take objection to. The seller maypropose that it consider any reasonable com-ments made by the buyer, whereas the buyermay propose that the seller agree to accept anyreasonable comments that it may make with re-spect to such returns. Another approach to whether one party ac-

cepts another party’s comments is to includelanguage that any disputes be resolved by anindependent third party, generally an accept-able neutral accounting firm. Although a dis-pute resolution mechanism can add extra lan-guage to the agreement, it has the potential toavoid future conflicts. The buyer or the seller,however, may not like this approach if it is con-cerned that a third party may dictate how a taxreturn position it is associated with is reported.For instance, if a large strategic buyer has avery strict internal policy of how certain costsare reported, it may not want the possibilitythat a third party could require a different re-porting position. With respect to tax returns related to strad-

dle periods, the buyer will generally take theposition that it should prepare such returns andthat the seller may review such returns. Thisposition would generally be acceptable to theseller unless the target’s federal income tax yeardoes not end on the closing date. If a straddleperiod tax return includes the target’s incomeor franchise tax returns, the seller may insistthat it prepare such tax returns with the buyerhaving review rights. Acquisitions can be struc-tured so that the target’s tax year ends on theclosing date.32

Tax claims. Since the seller will be responsiblefor the taxes related to pre-closing tax periods, itgenerally will take the position that it should re-ceive notice from the buyer regarding any claimsmade by a taxing authority that could result in aseller indemnification obligation and that it hasthe right to control any defense of such tax claim.If the buyer is a large entity and the target is rela-tively small in comparison, the buyer may want tocontrol the process, but allow the seller to partic-ipate in any defense. It is not unusual, however,for the seller to take control of such pre-closingtax claims.

13 CORPORATE TAXATIONMAY / JUNE 2015TAX PROVISIONS IN STOCK ACQUISITION AGREEMENTS

31 In order to make the election, the buyer would have to betreated as a corporation for federal income tax purposes.

32 The buyer may form a corporation to acquire the target, andif the target joined such corporation as a member of the cor-poration’s consolidated group, the target’s tax year for fed-eral income tax purposes would terminate at the end of theclosing date. See Reg. 1.1502-76(b)(1)(ii)(A)(1).

If the parties agree that the seller can controltax claims related to pre-closing tax periods,the buyer may insist the seller have the obliga-tion to control, as opposed to the right to electto control, so that it is clear that the buyer doesnot need to expend resources defending a claimit may not have an interest in. In addition, thebuyer will likely require that the seller pay anycost or expense related to the seller’s defense ofthe tax claim, and that the buyer, and counsel ofits own choosing, may participate in such de-fense. Further, the buyer may take the positionthat the seller cannot settle any such tax claimswithout the buyer’s consent. The seller maypush back that the buyer may participate only ifsuch tax claim could affect a post-closing taxperiod and such consent cannot be unreason-ably withheld, delayed, or conditioned. With respect to tax claims related a straddle

period, both parties may have a vested interestin the resolution of the claim. The agreementmay provide that the parties jointly control thedefense without either party settling absent theconsent of the other. Another approach may befor the party that bears the larger portion of thepotential liability to take control of the defensewith the other party participating. Both of theseapproaches, and any other approach, will haveits pros and cons and the parties need to under-stand the potential impact of the proposedmethod of handling tax claims.

Refunds. If the seller is responsible for pre-clos-ing taxes, it would seem equitable that the sellershould be entitled to receive any refund of taxesrelated to a pre-closing tax period (or the pre-clos-ing portion of a straddle period). The seller mayalso claim that it should receive any tax creditsthat relate to a pre-closing tax period, includingany refunds of tax applied to estimated tax pay-ments. Generally, since a tax refund represents acash payment received by the target, the buyer willusually agree to this provision, subject to any timelimitations imposed on the corresponding tax in-demnification obligation and whether such re-funds were taken into consideration in any networking capital adjustments. The buyer, however,may object to the payment of a tax credit if thecredit has not off set a current tax liability. A tax credit may not represent a current re-

ceipt of cash, but may just represent the right tooff set a future tax liability. An obligation im-posed on the buyer to pay the seller for such taxcredits may result in the buyer making the pay-

ment out of pocket, while not currently realiz-ing the benefit for such payment. In addition, ifthe buyer is part of a large consolidated group,it may claim that the tracking of such tax creditwill be administratively burdensome. The sellermay then insist that the buyer cause the targetto claim any refunds it can, as opposed to ap-plying such amounts to subsequent tax years,and pay for any other credits when the buyer orits affiliates actually benefit from them. Although the seller should generally receive

refunds related to pre-closing tax periods, thebuyer will generally take the position that thebuyer should receive any tax refunds related tothe carryback of a net operating loss from apost-closing tax period to a pre-closing tax pe-riod. The buyer’s argument is that, but for thebuyer’s actions post-closing, there would be norefund of taxes and therefore the seller shouldnot benefit from such refund. In taking this po-sition the buyer should ensure that the sellercannot prevent the buyer from amending anyapplicable tax returns without reasonablecause.

Payment for transaction tax deductions.As notedabove, the seller may try to obtain extra valuefrom the sale by requiring that the buyer pay forthe tax benefits associated with any seller relatedtransaction costs that do not generate a pre-clos-ing tax benefit usable by the seller, either becausethe costs are deductible post-closing or they aredeductible pre-closing but create a pre-closing netoperating loss that cannot be carried back. Thisconcept creates a plethora of questions and issues.What are the transaction related costs? Are thetransaction related costs expensed or capitalized?What transaction related costs are required to bededucted in a pre-closing or post-closing tax pe-riod? If the deductions are properly taken in a pre-closing tax period, do they reduce a pre-closingtax liability or create a pre-closing net operatingloss?33 Before those questions are answered, thebuyer needs to determine whether it agrees withthe concept that it should pay for these tax bene-fits. To the extent that the buyer requires that theamount payable to the seller be reduced by trans-action costs, it would seem fair that the sellershould be entitled to the tax benefits related tosuch costs. The buyer may take the position that wher-

ever the law requires the deductions to fall, thatis where they fall and the buyer will not compen-sate the seller for such tax benefits. The buyercould further argue that since it is not receiving atax basis step-up in the target’s underlying assets,

14 CORPORATE TAXATION MAY / JUNE 2015 TAX PROVISIONS IN STOCK ACQUISITION AGREEMENTS

33 See note 9, supra.

If the seller ispreparing the pre-

closing tax returns,the buyer will wantsome review rights

and the ability tocomment on those

returns, eventhough the seller

will have theobligation to pay any

taxes related tosuch return.

it should not have to pay any additional amountsfor deductions. If the transaction costs contain alarge compensation component that is paidpost-closing and not allocable to a pre-closingtax period, or the transaction tax deductions cre-ate a net operating loss that cannot be carriedback, the seller may push harder for a transac-tion tax benefit payment. If the buyer agrees to the concept and the

parties agree which costs will potentially gener-ate a transaction tax benefit payment, the buyershould determine when the deduction can gen-erate a tax benefit to the buyer. If the buyer ex-pects initial losses after closing because of alarge debt load or other reasons, it may requirethat the payment be made only when an actualbenefit can be realized by the buyer. The buyer,in other words, will want to ensure that thetransaction costs are taken into account last indetermining its post-closing taxable income. In addition, as with payments related to tax

benefits derived from indemnification pay-ments, the buyer may want to limit the time forwhich it will be required to pay for any transac-tion tax benefits received. The buyer will notwant to be obligated to make payments to thebuyer over a course of years, especially if theperiod for the seller’s tax indemnification obli-gation is limited. Further, the buyer may want

to add a requirement that the seller be obligatedto repay any payments, or portions of pay-ments, that the buyer made with respect to suchtransaction tax benefits if a taxing authoritydisallows any deductions that contributed tosuch benefits.

Other tax covenants. In addition to thecovenants regarding cooperation and paymentof transfer taxes discussed above, the agreementmay also contain other tax covenants. Thebuyer may insert a covenant that all tax sharingagreements and any similar agreements enteredinto by the target will be terminated as of theclosing date and will not be enforceable there-after. If there is no specific representation or in-demnification regarding tax sharing agree-ments, this type of covenant can become veryimportant to the buyer. The buyer would gener-ally prefer to seek indemnification regardingpayments made pursuant to a tax sharing agree-ment under a breach of a tax covenant, as op-posed to a general covenant that certain con-tracts have been cancelled, since usually thebuyer will have greater indemnification rightswith respect to tax matters. If the target is a member of a consolidated

group, the buyer should be aware of the implica-tions of the consolidated group regulations, in-cluding the unified loss rules under Reg. 1.1502-

15 CORPORATE TAXATIONMAY / JUNE 2015TAX PROVISIONS IN STOCK ACQUISITION AGREEMENTS

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36.34 The general intent of the unified loss rulesis to prevent the selling group from recognizinga loss on the sale of the subsidiary stock while thesubsidiary retains the benefit of net operatingloss carryovers or built-in losses that reflect thatsame loss. The regulations generally require thatthe subsidiary’s net operating loss carryovers andasset tax basis be reduced to eliminate such du-plicate losses, but the regulations do provide foran election that can be made by the selling con-solidated group so that instead the loss recog-nized by the seller on the sale is reduced. Thebuyer may consider including a covenant thatthe parent of the target’s consolidated group willmake whatever election is necessary so that thetax attributes of the target are not reduced pur-suant to the unified loss rules.35

The tax covenant section may also containan exclusivity or conflict provision, which gen-

erally would provide that tax matters will begoverned by the tax covenant section. This pre-vents either party from cherry picking othermore favorable provisions of the agreement ina situation that was intended to be covered bythe tax covenant section.

ConclusionIn any acquisition agreement, tax can impactvarious provisions and the buyer and seller needto understand how such language can affectthem. The above discussion is not intended to bean exhaustive list of all tax provisions that can beincluded in a private taxable stock sale, but ratheran illustrative narrative of some common con-cepts that may be included and the buyer’s andseller’s intent and reaction to including such lan-guage. A party to an agreement will have its ownreasons for requesting certain provisions, but inaccepting certain terms, the other party shouldfully understand what the agreed-to language al-lows them to do and what it has exposed them to.Without that understanding, there may be somesurprises. n

16 CORPORATE TAXATION MAY / JUNE 2015 TAX PROVISIONS IN STOCK ACQUISITION AGREEMENTS

34 See Friedel and Wivagg, “New Solution Creates New Prob-lems When Buying Member of Consolidated Group,” 37Corp. Tax’n 3 (January/February 2010); Stratton and Sewall,“Buyer and Seller Considerations Under the New UnifiedLoss Rules,” 36 Corp. Tax’n 3 (January/February 2009).

35 Regs. 1.1502-36(d)(6), 1.1502-36(d)(8), ex. 8.

Thomson ReutersBK & CS

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