State and Local Tax Challenges in Mergers, Acquisitions ...media.straffordpub.com/products/state-and-local... · 6/26/2013 · Successor Liability (Cont.) Asset acquisitions (Cont.)

State and Local Tax Challenges in Mergers,

Acquisitions and Asset Sales Anticipating and Responding to Successor Liability, Bulk Sales,

Incentives, Records Retention and Other Issues

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WEDNESDAY, JUNE 26, 2013

Presenting a live 110-minute teleconference with interactive Q&A

Kim Krueger, Director, PricewaterhouseCoopers, New York

Benjamin Bacon, Director, PricewaterhouseCoopers, New York

Darren McCarthy, Principal, State and Local Tax – M&A Tax, KPMG, New York

Bob Buckley, Senior Manager, KPMG, New York

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State and Local Tax Challenges in Mergers, Acquisitions and Asset Sales Seminar

Bob Buckley, KPMG

[email protected]

Kim Krueger, PricewaterhouseCoopers

[email protected]

June 26, 2013

Darren McCarthy, KPMG

[email protected]

Benjamin Bacon, PricewaterhouseCoopers

[email protected]

mailto:[email protected]

Today’s Program

Due Diligence-Related Topics

[Darren McCarthy and Bob Buckley]

Structuring The Acquisition

[Benjamin Bacon and Kim Krueger]

Slide 8 – Slide 53

Slide 54 – Slide 81

Notice

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY

THE SPEAKERS’ FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY

OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT

MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR

RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.

You (and your employees, representatives, or agents) may disclose to any and all persons,

without limitation, the tax treatment or tax structure, or both, of any transaction

described in the associated materials we provide to you, including, but not limited to,

any tax opinions, memoranda, or other tax analyses contained in those materials.

The information contained herein is of a general nature and based on authorities that are

subject to change. Applicability of the information to specific situations should be

determined through consultation with your tax adviser.

DUE DILIGENCE-RELATED TOPICS

Darren McCarthy, KPMG

Bob Buckley, KPMG

© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated

with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

Agenda For This Section

Introduction

Target

Transaction

– Retained liability

– Successor liability

Tax risk identification

– Including transfer taxes

Tax risk mitigation

9

Introduction



Introduction

Always understand what you are

buying before taking the leap.

What state and local tax liabilities

remain with the business entity or

entities to be acquired?

What state and local tax liabilities

attach to acquired business assets?

What state and local tax liabilities do

not attach to assets?

Consider ways to mitigate

state & local tax risks.

How can you protect yourself

from acquiring identified and

unforeseen state & local tax

liabilities?



Tax Risk Mitigation Process

Know the target

Legal entity

Separate

company or

consolidated

group

Elections

affecting target

State tax

treatment

History of entity

structure

Know the deal

Stock v. assets

Multi-member

LLC treated as a

corporation or

partnership

Single-member

LLC treated as a

corporation or

disregarded entity

Applicable taxes

Income tax

Franchise tax

Gross receipts tax

Sales/use tax

Real property tax

Personal property tax

Employment taxes

Miscellaneous

industry taxes

Unclaimed property

Due diligence

Management

Income and non-

income tax filings

Income tax

provision

Financial

statements

Legal documents

Offering memo

Quantify

exposure

Protect your

company

Change the

structure

Purchase price

adjustments

Escrows

Indemnities

Transaction Target Types of tax

risk

Tax risk

identification

Tax risk

mitigation

12



What Creates Tax Risk In A Target?

Reasons for

historical risk

Target’s materiality threshold

Lack of knowledge of

law

Prior Transactions

Errors in filings

Aggressive planning

Limitations of accounting

systems

13

Target



What Are You Buying?

Stock of corporation

• Public v. private

• Elections under IRC Sect. 338(h)(10)

Stock of S corporation

• C corporation history

• Quality of election and status

• Elections under IRC Sect. 338(h)(10)

Interests in partnership

• Check entity status

• Check-the-box or not

Stock or interests in a disregarded entity

• Single-member LLC

• QSUB fiction

• Potential carryover of corporate liability when sub is checked or merged into DRE

Real, tangible and intangible assets

•Generally limited carryover of historical income tax liabilities

•Sales/use taxes, property taxes and, in some cases, employment taxes remain with acquired business assets.

•Some states impose successor liability for all taxes, including income taxes, when assets of trade or business are acquired,

Corporation

P'Ship

DRE

S corporation

15

Transaction

- Retained Liability

- Successor Liability



Retained Liability

Stock acquisitions

All SALT exposures remain with the target and are assumed by the buyer upon

acquisition.

Unclaimed property exposures remain with the target and are assumed by the

buyer upon acquisition.

17



Retained Liability (Cont.)

Stock acquisitions

Is it really a “stock” acquisition?

Acquisition of an interest in a flow-through entity is not an asset deal, for all

tax purposes.

State tax treatment of LLCs, partnerships and S corps

– Some states impose an entity-level income tax.

– Liable for income tax of non-resident partners

– Most states adopt non-resident income tax withholding requirements on

LLCs, partnerships and S corps.

Treated as a sale of an intangible for sales/use tax purposes

18



Retained Liability (Cont.)

Stock acquisitions

IRC

338(h)(10) election

Treated as a fictional sale of assets for federal, and most state, income tax

purposes

– Successor liability applies to a transaction for all taxes on which both

parties agree to make an IRC

338(h)(10) election.

Treated as a sale of an intangible for sales/use tax purposes

19


with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 20

Successor Liability

Asset acquisitions

Exposures generally not transferred:

Income/franchise taxes (net worth and capital-based tax)

Exposures generally transferred:

Sales and use taxes

Gross receipts taxes

State unemployment tax - successor employer

Property tax - lien date-driven

Unclaimed property (legal counsel should be consulted)



Successor Liability (Cont.)

Asset acquisitions (Cont.)

Successor liability statutes is typically embedded in the sales/use tax chapter

of the state tax code.

Certain states provide for successor liability for income tax and possibly other

taxes; for example:

Illinois (income tax)

Florida, Michigan, Pennsylvania and South Carolina (all taxes)

Texas (including the old and new franchise taxes)

Wisconsin (income and franchise, if the seller dissolves)

Missouri (personal income withholding tax)

21





Confirm whether a state adopts successor liability upon acquisition of “all” or

“substantially all” of the assets of the business or if it applies to partial

transfers of assets.

If the transaction involves the purchase of only certain assets (division),

ascertain whether successor liability applies to the buyer if the seller

continues business operations in the state.

Is there successor liability, for practical purposes?

Likely, if the seller is out of the business and terminates its tax presence in

the state in which the assets were located

Unlikely, if only some assets sold and seller will continue in business and

file tax returns in the state

22





Bulk sale notification requirements

Many states require a seller to advise the state of a proposed bulk sale of

business assets.

Some states require filing a final sales/use tax return by the seller.

Some states provide for a buyer to obtain a tax clearance with respect to

the seller’s tax liabilities.

23

Common SALT Exposures



Nexus

Nexus

In order for a state to impose tax on a company, the company must have sufficient contact to create nexus with the state. Generally, if a company has physical presence (property or employees) in the state, that will constitute nexus and create a filing requirement.

Public Law 86-272

Companies that merely solicit sales of tangible personal property from customers in a state, when the approval for the order of such property occurs outside the state, and the shipment of such property originates from a location outside the state, are generally not required to file an income tax return in the destination state.

Economic nexus

Approximately 30 states adopt economic nexus.

25

Slide Intentionally Left Blank



Nexus (Cont.)

Agency nexus (generally related to creating sales/use tax nexus)

In Scripto v. Carson, the U.S. Supreme Court held that the distinction between employees and independent contractors was without constitutional significance, and IC activities can create nexus in a state. See also, MTC Bulletin 95-1

Affiliate nexus (generally related to creating sales/use tax nexus)

Some states take the position that the existence of common ownership between a corporation with physical presence in a state and an out-of-state corporation that has no physical presence in the state but sells into the state is sufficient to create nexus for the out-of state affiliate.

Click-through nexus (generally related to creating sales/use tax nexus)

Some states take the position that an out-of-state, online retailer has nexus with the state if it enters into an agreement with an in-state resident to refer customers to the online retailer for a commission.

27



Nexus (Cont.)

Various localities impose income/franchise or other taxes at the local level:

New York City

District of Columbia

California cities, e.g., Los Angeles, San Francisco, others

Kentucky cities, e.g., Louisville, Lexington, others

Michigan cities, e.g., Detroit, others

Missouri cities, e.g., St. Louis

Ohio cities, e.g., Cleveland, Cincinnati, others

Pennsylvania cities, e.g., Philadelphia, Pittsburgh, others

Virginia cities, e.g., Alexandria, others

Various localities impose sales/use tax at the local level (i.e., home rule states).

28



Intercompany Transactions

State law addback requirements

Intercompany payments between related entities

Interest expense

Royalty expense

Management fee expense

Historical state tax planning opportunity to create deductions in separate

company states for operating companies

If the target group comprises several entities, consider whether

adjustments to inter-company income or expenses will result in increased

income in an entity, which could result in income tax exposure in a state

that requires income/franchise tax returns be filed on a separate-company

basis.

29



Intercompany Transactions (Cont.)

Disallowance of related member transactions; e.g., intercompany

interest or royalties

Exceptions to intercompany expense disallowance rules

Certain states provide exceptions to the intercompany expense

disallowance rules. For example, interest expense paid between related

members that is ultimately paid to a third party lender may qualify for a

conduit exception to the disallowance rule. Or, interest expense paid

between related members that is subject to income tax in another

jurisdiction may also qualify for an exception to the disallowance rule.

Management fees or allocated administrative expenses

General ability for state to reallocate intercompany expenses

30



Sales Factor Receipts Sourcing

Receipts from sales of tangible personal property

Destination test: Sales of TPP, other than sales to the U.S. government, are generally sourced to the numerator of the sales factor of the destination, or “shipped to” state.

Throwback rule

– Sales to U.S. government are sourced to the “shipped from” state.

– Sales to a state where the seller is not taxable (e.g., does not have nexus) are sourced based on the numerator of the sales factor of the “shipped from” state.

Combined reporting states: Joyce or Finnigan

– Joyce: Throwback is avoided if the selling member has nexus with the state.

– Finnigan: Throwback is avoided if any member has nexus with the state.

Throw-out sales

– Sales to a state where the seller is not taxable (e.g., does not have nexus) are excluded from the numerator and denominator of the state sales factor,

– New Jersey (ended in 2011), Maine, West Virginia

31



Sales Factor Receipts Sourcing (Cont.)

Receipts other than sales of tangible personal property

Cost of performance rule

Receipts generated from sales other than sales of TPP are considered in-state sales if the income-producing activity is performed in the state. If the income-producing activity is performed in two or more states, then the sale is assigned to the state where the greater proportion of the income-producing activity is performed, based on cost of performance.

All-or-nothing cost of performance approach

Pro-rata cost of performance approach

Inclusion/exclusion of costs incurred by independent contractors

Market-based approach

Receipts generated from performing services are sourced to the state where the customer receives the benefit of the service.

Where cost of performing services are incurred is not considered.

32



Sales Factor Receipts Sourcing (Cont.)

Receipts other than sales of tangible personal property

Royalties derived from patents, copyrights, trade names and other

intangibles are generally sourced to the state where the intangible is used

(i.e., apply a market-based approach).

Interest generally is sourced to the state where the assets securing the

loan are located. However, certain states look to where the solicitation,

investigation, negotiation, approval and administration (SINAA) activities

take place.

Industry specific apportionment rules

Financial services (e.g., bank, credit union, insurance)

Transportation (e.g., airlines, trucking, railroad)

Construction (e.g., engineering, architectural)

33



Non-Income Taxes

Various types of non-income taxes are also frequent exposure areas.

Sales/use tax

– Aggressive nexus determinations and complex taxability rules by state

Gross receipts taxes

– Both state and local

Property taxes

– Generally, personal property

Employment taxes

– Federal and state employment/payroll taxes

Miscellaneous industry specific taxes

– Fuel taxes, spill taxes, severance taxes, excise taxes (both federal and state)

34

Tax Risk Identification



Tax Risk Identification

Learn about target’s operations

Read the confidential information memorandum

Read public documents, e.g., Form 10-K

If available, read corporate organizational chart

Visit the target’s Web site

Gather information about the target’s geographic footprint in the U.S. and

overseas, including office locations, customer locations, consider job

postings and marketing materials

36



Tax Risk Identification (Cont.)

Interview the target’s management

Management discussions should take place following a review of the

documents provided and the information available in the public domain.

Management interview is essential to understanding nexus, revenue

streams, sales factor sourcing methodologies, etc.

Access to tax advisors is usually not sufficient.

Tax advisors rarely have answers to any non-income tax questions.

37




Read the financial statements

Income statement

Effective tax rate

Discontinued operations

Balance sheet

Deferred tax balances

ASC 740 (FIN 48 reserves)

Footnotes

Details of tax items

Acquisitions

Subsequent events

38




Read the federal income tax returns

What will we receive?

Stand-alone entity or an entire consolidated group: Signed federal income

tax returns will likely be provided,

Member of a federal consolidated group: Pro forma returns and separate

company state returns may be provided.

Asset purchase: Unlikely to receive any returns

39





What do we look at?

Consolidation or stand-alone

Net operating loss or income

Other attributes

Identify tax items relevant to state taxes

– Consolidating schedules included?

– Any amended federal returns? Were state amended returns also filed?

40





What do we look at?

Identify flows of funds - intercompany transactions

– Intercompany interest expenses

– Intercompany royalty payments

– Intercompany management fees

“Other deductions”

Do not limit your thoughts to income tax (e.g., travel expenses may indicate contact with other states, payments to consultants may indicate payroll tax issues)

“Taxes and licenses”

Real estate tax expense indicative of owned real estate

Gross receipts tax expense indicative of tax costs post-acquisition

41




Read significant agreements

Agreements related to acquisitions and dispositions

Debt agreements

Transfer pricing agreements

42




Create target’s state tax profile

Create a state tax calendar on which returns are filed

– Include income and non-income tax returns

Create apportionment worksheet for each relevant entity

– Create an Excel file incorporating apportionment formulas each year

– If apportionment work papers are not available, extract from the returns

– Include line items for total gross receipts and federal taxable income

– This information can be used for more than income taxes.

Identify potential property tax filing obligations

Identify state employment tax obligations

Identify gross receipts tax obligations

43




State and local income/franchise tax

Read the state income/franchise tax returns

Identify material states, in terms of apportionment

Intercompany expense addback requirements

– Consider safe harbors

Business income and non-business income positions

Business expense and non-business expense positions

Consider state modifications (depreciation, etc.)

Calculate the effective state tax rate – reasonable?

Consider material franchise taxes not subject to a cap

44




Gross receipts tax

Various states and localities adopt gross receipts taxes

Michigan Business Tax (GRT component)

– Repealed effective Jan. 1, 2011

– Remains relevant, from a due diligence perspective

Ohio commercial activity tax

Washington business and occupation tax

California localities

Ohio localities

Virginia localities

Washington localities

Others

45




Sales tax

Sales tax typically is imposed on retail sales of tangible personal property

and certain enumerated services.

Identify states where target has nexus and filing obligation

Request a taxability matrix identifying revenue streams by state as taxable

or not taxable

Depending on the target (number of states/number of entities), request all

sales/use tax returns or a sampling of sales/use tax returns

Question exempt status of sales and availability of documentation to

support the exempt nature of sales

Localities that adopt “home rule” reporting requirements

46




Use tax

Inquire about use tax policies and procedures

Taxable purchases of supplies and equipment

Identify promotional items and other products given away subject to use

tax (removed from inventory)

– Demonstration products or samples removed from inventory

– Promotional items distributed at trade fairs or as advertising

– Items distributed to customers free of charge

– Printed adverting materials

47




Property tax

Read personal property tax returns, bills and related proof of payment;

confirm/identify property reported on the returns

Read real estate tax bills and related proof of payment

Inquire about historical challenges to assessed values

Employment tax (federal and state)

Worker classification

– Employee vs. independent contractor

Multi-state personal income tax withholding

– States adopt de minimis thresholds before withholding is required.

48





Unclaimed property

Unclaimed property is not a tax.

– Legal counsel must determine what is unclaimed property.

The target likely has unclaimed property in the form of uncashed payroll or vendor checks.

Other types of unclaimed property:

– Unused advertising credits relating to advance payments

– Unused gift cards or gift certificates at retail establishments

Dormancy periods vary based on the type of property.

Issue occurs when the target has history of taking unclaimed property into income.

– Distortion of EBITDA

50




Transfer taxes

Stock acquisition (including LLC interests, partnership interests, etc.)

– Sales/use tax does not apply.

– Real estate transfer tax may apply.

Transfers of a controlling interest in an entity that holds an interest in real property

Asset acquisition (actual transfers of real and tangible business assets)

– Sales/use tax may apply.

Consider available exemptions by state

– Occasional sales, sales for resale, M&E used in manufacturing, etc.

– Exemptions from sales/use tax generally do not apply to transfers of motor

vehicles.

– Real estate transfer tax may apply.

Recording taxes

51

Tax Risk Mitigation



Purchase price

adjustment Restructure the deal Escrow Indemnities

Tax Risk Mitigation

Consider changing the

terms of the deal to

asset or DRE

transaction

Depending on the

structure, may

provide some

downside protection

May be cost -

prohibitive to seller

Collateral legal and

business issues

Bulk sale notification

Tax clearance

certificate

By adjusting purchase

price for quantifiable

tax risks, buyer is

protected from any

future cash tax

exposure.

Consider interest

and penalties in the

purchase price

adjustment

Be prepared to

negotiate based on

contingent nature of

risk and timing of

recognition

Business decision

An escrow can provide downside protection for quantifiable risks for a certain period of time.

Escrows normally won’t extend as long as the statute of limitations.

Cherry pick the risks to be included in escrow

Tax-only vs. general escrows

Be prepared to negotiate based on contingent nature of risk and timing of recognition

Business decision

Indemnities provide

protection but require a

recognition event and

subsequent legal action

to enforce contractual

provisions.

Work best for risks that cannot be quantified or are highly contingent in nature

Be aware of “seller” and the ability to enforce indemnity provisions (e.g., public targets)

Ensure indemnities survive through the closing of the statute of limitations

53

STRUCTURING THE ACQUISITION

Benjamin Bacon, PricewaterhouseCoopers

Kim Krueger, PricewaterhouseCoopers

PwC

Optimal State Tax Structuring Considerations

Stock v. asset overview

State tax treatment of IRC

338(h)(10)

• IRC

338(h)(10) - New York example

Characterization of gain – business vs. non-business

Combined reporting and instant unity

Intercompany debt considerations

Pushdown of acquisition debt

June 26, 2013 55

PwC

State Tax Considerations In Stock v. Asset Deals

• Overview

- Stock deals

◦ Carryover of tax liabilities, tax attributes, E&P, etc.

◦ Short-period filings, but retention of Tax ID numbers

◦ QSPs => state-only 338 elections

- Asset deals

◦ Generally, do not inherit tax liabilities except for sales taxes under successor liability rules

◦ Existing NOL/credit shields may be gone.

◦ Immediate impact to nexus profile

◦ Step-up in tax basis

› Capital tax implications

› 197 amortization can often be significant.

June 26, 2013 56

PwC

Deemed sale by Old T

Deemed sale of assets at FMV to New T at close of acquisition date → Old T (owned by P) recognizes gain/loss; tax attributes disappear/

IRC

338(h)(10) –

338

June 26, 2013

57

Deemed purchase by New T

Deemed purchase of assets at beginning of day after acquisition date → adjusted basis either stepped up or down in T’s assets.

Stock

Cash

Old T

S P

New T

Generally, 338 election is made when the present value of future tax savings resulting from the “step-up” in basis of T’s assets (e.g., increased depreciation deductions) exceeds the current tax cost of such a step-up.

Deemed sale of assets

Deemed purchase of assets

PwC

IRC

338(h)(10)

June 26, 2013 58

Stock

Cash

Old T

S P

New T

• Election jointly made by P & S

• Consequences of

338(h)(10) to S:

• Old T will recognize gain or loss on deemed sale of its assets while included as a member of the selling group.

• No gain or loss will be recognized by members of the selling group on their sale of T stock.

• S inherits T’s tax attributes

• Consequences of

338(h)(10) to P:

• New T gets stepped-up basis.

Deemed sale of assets

Deemed liquidation

Deemed purchase of assets

PwC

State Treatment Of IRC § 338(h)(10)

• The majority of states generally conform to IRC §338(h)(10).

• Some states conform to IRC §338(h)(10) by using federal taxable income, before NOL and special deductions, as the starting point for computing state taxable income.

• In other states, a corporation that makes a IRC §338(h)(10) election for federal income tax purposes does not have to make a separate election for state purposes.

• However, several states impose special rules permitting the parties to make (or not make) an IRC §338(h)(10) election for state purposes.

• For instance, in California and Wisconsin, a corporation that has not made an IRC §338(h)(10) election for federal purposes can still make one for state purposes, by making an affirmative election within the designated time period.

June 26, 2013 59

PwC

IRC §338(h)(10): New York Example

June 26, 2013

60

• P purchased the stock of T for cash. Seller (S) and P made

338(a) and

338(h)(10) elections.

•

338(a) resulted in T recognizing ordinary income on the deemed sale of its assets (other than its stock of Tsub).

• The subsequent transfer of assets pursuant to

338(h)(10) qualified as a

332 liquidation.

• T sold the stock of Tsub to P. No 338 elections were made. T recognized a capital loss from the sale of Tsub stock.

NYS/C Group #1

S

T

Tsub

NYS/C Group #2

P

PwC

IRC §338(h)(10): New York Example (Cont.)

June 26, 2013

61

Issues:

1. Does NY conform to IRC

338(h)(10)?

• TSB-M-87(4)C: New York declined to recognize unless NYS group is identical to federal consolidated group

• Thus, if the groups are different, the transaction would be treated as if only a

338(a) election were made. Seller

would recognize gain from the sale of the target’s stock; however, it may constitute income from subsidiary capital.

• TSB-M-91(4)C: In all cases, 338(h)(10) election should be ignored.

• TSB-A-99(22)C: 338(h)(10) election is available as long as the selling parent corporation qualifies as a “selling affiliate.”

• Thus, the ordinary income recognized by T on the deemed sale of its assets to P pursuant to 338(a)(1) would be included in T’s ENI.

PwC

New York IRC §338(h)(10): Example (Cont.)

June 26, 2013 62

Issues (Cont.):

2. Whether the capital loss recognized by T on the sale of Tsub stock constitutes income from business capital, and whether such loss is allowed in determining the ENI of Combined Group #2’s ENI.

• Bausch & Lomb/TSB-M-08(3)C

• Gain/loss from a parent corporation’s sale of stock in a subsidiary included in the combined report → business income (not subsidiary income – which is a subtraction modification)

• Gain/loss not included in the receipts factor

• Tsub is included in T’s combined group in the year of sale. Thus, the capital loss recognized by T on the sale of Tsub constitutes income from business capital.


PwC

New York IRC §338(h)(10): Example (Cont.)

June 26, 2013 64

Issues (Cont.)

3. To the extent the Combined Group #2 is unable to use the capital loss (i.e., due to insufficient capital gains) or a portion thereof, whether S would succeed to the remaining capital loss following the deemed liquidation of T under IRC

338(h)(10), and whether such

loss constitutes income from business capital

• Deemed liquidation = complete liquidation under IRC

332

• IRC

381(c): Acquiring corporation (S) succeeds to any capital loss carryover of the transferor corporation (i.e., T).

• Classification of loss

PwC

Taxation And Characterization Of Gain

• Business vs. non-business

• UDITPA definition of business income: “Income arising from transactions and activity in the regular course of the taxpayer’s trade or business and includes income from tangible and intangible property if the acquisition, management, and disposition of the property constitute integral parts of the taxpayer’s regular trade or business operations.”

• Business income → apportioned by formula (property, payroll, sales)

• Non-business → allocated based on the location of the underlying property. Non-business income from intangible assets is generally allocated to the state of commercial domicile.

• Transactional test: Whether the transaction or activity that gave rise to the income arose in the regular course of the taxpayer’s trade or business

• Functional test: If the acquisition, management and disposition of the property are “integral parts” of the taxpayer’s regular trade or business, regardless of whether the income was derived from an occasional or extraordinary transaction

• Certain states do not conform to business/non-business distinction.

June 26, 2013 65

PwC

Combined Reporting And “Instant” Unity Issues

• When the stock of a subsidiary is purchased, an important tax return filing issue is whether the purchased subsidiary is included with the taxpayer’s unitary group in combined reporting states.

• California has taken the position that, in general, a newly acquired affiliate is not unitary with the purchasing group in the initial year of acquisition.

• When an entire business is purchased, it is often difficult to demonstrate that the new basis is “instantly” unitary with the acquiring group.

• Accordingly, although many taxpayers claim to be instantly unitary with a newly acquired business unit, such a filing position may be challenged by the state.

• Assuming the target and the new parent are able to demonstrate that they are working towards integrating their operations and there are sufficient indicia of unity as of the beginning of the first full tax year following the year of acquisition, the new member will be allowed to join the combined report of the purchasing group.

• A growing number of states (including Oregon, Massachusetts, Texas, Vermont and Wisconsin) have addressed instant unity in their statutes or regulations.

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Intercompany Debt Planning: Transfer Of Affiliate Receivables

P

S

• P files in New Jersey

• P receives $100 million dividend from S

• P breaks even in current year before dividend

Contribution of a note

June 26, 2013 67

P

S

Distribution of a note

PwC

Intercompany Debt Considerations

• For contributions, monitor impact of an franchise tax posture

• For distributions, consider effects that dividend income may have on Pennsylvania capital stock tax base

• Separate company earnings and profits and stock basis studies can be critical to determining state tax cost of distributions.

• A distribution in excess of E&P and basis will not result in deferral treatment in a stand-alone state.

• Dividend-received deductions are not always 100% in a separate state, despite federal treatment of wholly owned distributors.

June 26, 2013 68

PwC

Pushdown Of Acquisition Debt

Optimal placement of push-down debt

• Identify best candidates to receive debt – profitable, expansive separate company footprint

• Intercompany notes - 482, floating rates, principal payments

• Ability to borrow, E&P/basis of distributor, solvency

• Push down via restructuring – consideration of basis

• I/C interest expense addback – confirm safe harbor exception

• Economic nexus considerations for lender

• Debt v. equity

June 26, 2013 69

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State M&A Considerations

Post-Transaction Integration Considerations

PwC

Post-Acquisition Considerations

• Overview

• Application of consolidated return regulations

• Legal entity simplification

• State tax attributes and financial statement impact

• California IRC 355 conformity and DISA updates

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State Income Tax Restructuring

• After a corporate restructuring takes place, companies will need to determine the impact of the planning on their state tax footprint.

• Opportunities may arise to realign a taxpayer’s state filing methodology upon the acquisition or disposition of an entity or group of entities.

• Combined reporting may be advantageous to a taxpayer if it:

- Allows losses to shield operating income from tax

- Brings less-profitable entities into the group

- Brings entities with lower in-state apportionment into the group

- Keeps administrative and recordkeeping burdens low

- Allows operating companies to benefit from interest expense at holding company level

• Consideration should be given to separate company footprint, in addition to unitary concerns.

June 26, 2013 72

PwC

Application Of Consolidated Return Regulations

• Certain combined reporting states have incorporated the federal consolidated return regulations (e.g., Treas Reg. 1.1502 et al) into their own rules, in part or in their entirety.

• For multi-state corporate taxpayers, it is important to know which states have partially adopted the consolidated regulations and the provisions that were not included.

• For example, some states that are considered “1502 states” do not follow the consolidated loss rules in 1.1502-21 (e.g., loss allocation based on pooling of losses), but instead provide that the net operating loss is tracked on a combined basis or based on each group member’s apportionment factor in the state (e.g., intrastating method).

• Some incongruities exist for unitary states that follow or adopt consolidated return regulations, but do not respect separate federal consolidated groups when the two groups are unitary.

June 26, 2013 73

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Legal Entity Simplification LLC Conversion

P

S

• P files in New Jersey

• P receives $100 million dividend from S

• P breaks even in current year before dividend

Deemed distribution of assets

P

S SMLLC

June 26, 2013

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Legal Entity Simplification Conversions And Mergers

• State income tax issues

• Determine post-transaction filing footprint

• Receipt sourcing study

• Deferral/elimination of intercompany transactions

• Availability of attributes

• 382 studies for state

• Stand-alone state NOL limitations

• Existing intercompany balances

• Alternative or special apportionment

• Deferred tax impact based on new balances and separate effective tax rate shifts

June 26, 2013 75

PwC

Check-The-Box Conformity And Entity Level Taxes On Flow-Throughs

• Most states recognize federal check-the-box treatment, but some states do not respect these rules and tax flow-throughs on a stand-alone basis.

• Some states impose franchise taxes or fees on all types of entities, regardless of federal classification.

• Certain states require partnerships to file and remit income and/or gross receipt taxes (e.g., Tennessee, Illinois).

• Texas subjects single-member limited liability companies to tax despite its federal treatment.

• New Hampshire imposes BPT on single-member LLCs, and these entities should be filing as members of a combined group.

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Net Operating Losses

• Once acquired, a company should revisit its available tax attributes.

• Combined reporting states differ in their treatment of net operating losses by employing the following methodologies for tracking:

• The combined level, resulting in one loss for the entire group

• Apportioning total group losses pursuant to each member’s apportionment numerators over group denominators (commonly known as the “intrastated approach” that is employed in California and Minnesota)

• Adopting federal consolidated return rules and attributing group losses pursuant to pro forma losses (e.g., a member receives its portion of the combined NOL based on its pro forma loss over all pro forma losses)

• Many states will require taxpayers to impose IRC §381 and §382 limitations on net operating losses of newly acquired corporations.

• Some states that require net operating losses to be tracked on a post-apportioned basis state that taxpayers must apportion any §382 limitations, while others do not.

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Tax Accounting Considerations

• State ETR – current provision impact

• State ETR – measurement of deferred tax items

• Valuation allowances – potential state attribute realization and re-measurement

• Restatement of target’s pre-acquisition financial statements

• Determine financial statement impact of any items discovered during diligence and whether reserve is necessary

• FIN 48 review

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PwC

Treatment Of 355: Differing State Approaches

• California

- In 2oo9, California passed IRC conformity legislation that adopted the Internal Revenue Code as of 2009 for tax years beginning on or after 1/1/2010 (S.B. 401).

- California had last adopted the IRC as of 1/1/2005.

- In 2006, the IRS issued relaxed 355 requirements with respect to its active trade or business definition.

- In 2010, California issued Proposition 26, which provided that any legislation that resulted in any taxpayer paying a higher tax not passed by a 2/3 supermajority vote by Nov. 3, 2011 may be void. S.B. 401 was passed 4/12/2010 by a simple majority vote.

- Accordingly, there is some uncertainty surrounding spin transactions that do not meet the more stringent pre-2006 355 requirements.

• Mississippi

- In 2012, Mississippi passed legislation to conform with IRC 355, no longer subjecting distributions of subsidiary stock to gain in the state.

- Note that most states conform to new IRS spin treatment

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California has proposed several recent changes to its intercompany regulation, including several DISA fixes. Interested party hearing in July 2013 and likely late-year passage

• Capital contributions:

- A subsequent capital contribution from the parent can reduce an existing DISA created by a subsidiary’s distribution to that parent.

- The contribution will first offset the DISA until full elimination, before increasing the parent’s basis in its subsidiary stock.

• Mergers:

- A merger between members of a combined reporting group will no longer require a DISA to be taken into account as income or gain, provided the majority of the stock of merging entities is owned by other group members.

• Tiered corporate distributions:

- Any DISA created when a subsidiary distributes property to its parent which, in turn, distributes the same amount to its parent will be treated as earnings and profits to the first (lower-tier) parent, for purposes of determining the DISA to the second parent that could result from the second distribution.

Proposed Changes To California DISA Rules

June 26, 2013 81

Documents

State and Local Tax Challenges in Mergers, Acquisitions ...media.straffordpub.com/products/state-and-local... · 6/26/2013 · Successor Liability (Cont.) Asset acquisitions (Cont.)