kaiser m&a and transaction cost tax treatment
TRANSCRIPT
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TAX ASPECTS OF TRANSACTION COSTS IN M&A DEALS
Kevin KaiserCo-panelist
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AGENDA
WHAT ARE TRANSACTION COSTS
CASE STUDIES
OVERVIEW OF RELEVANT TAX RULES
DEAL ISSUES/STRATEGIES
Q&A
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Transaction Costs
• Compensation payments made in connection with the transaction
– Cash bonuses, deferred compensation payouts, option cancellation payments and severance payments
– Not payments in respect of "profits interests"
• Investment banker fees/success fees
• Financing expenses/Debt Issuance Costs
• Legal and accounting expenses
• Unamortized loan expenses in respect of indebtedness that is satisfied at closing
• Other deals costs, e.g., appraisals, fairness opinion, etc.
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CASE STUDY #1
120+Shareholders
Target
Option Holders
Public Co
Merger Sub
20%80%
Merger consideration:$21.5 million cash
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Case Study #1
Purchase Price $21,500,000
Deductible Payments to Option Holders $2,900,000
Tax Benefit (34% effective tax rate) $986,000
Total Value to Shareholders $22,486,000
Tax Benefit as Percentage of Total Value to Shareholders
4.38%
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Case Study #1
• Tax benefits from transaction costs resulted from the target's capital structure (arguably those benefits should go to sellers)
• Tax benefits from transaction costs not addressed in LOI nor included in purchase price discussions
• Tax benefits were in effect additional purchase price to shareholders
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CASE STUDY #2
PE Fund
Target
Mgmt
Purchaser
Merger Sub
5%95%
Parent
PE Fund
Merger consideration:$135 million cash
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Case Study #2
• Seller was seeking to have buyer pay as additional purchase price:
"38% X Transaction Related Expenses"
• Transaction Related Expenses Set Forth on a Schedule to the Purchase Agreement
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Case Study #2
Transaction Related Expenses
Unamortized Loan Expenses $45,000
Management Option Payout $5,000,000
Medicare Withholding on Option Payout $70,000
Deductible Portion of Investment Banker Fees (assumed to be 80% of total)
$1,800,000
Deductible Portion of PE Fund Deal Fee (assumed to be 80% of total)
$800,000
Total $7,715,000
Assumed Tax Rate 38%
Transaction Tax Benefit $2,931,700
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Case Study #2• Given Target's current tax situation, most of
deductions from transaction costs would actually be used to reduce pre-Closing taxes (normally a seller liability)
• Seller was asking buyer to pay additional purchase price for deductions that would ultimately benefit seller
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Case Study #2
• Deal relating to tax deductions from transaction costs was modified:
– Sellers were paid tax benefits transaction costs
"if, as and when" realized
• Important to understand how tax benefits from transaction costs will be utilized in the context of the target's actual tax situation
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Overview of Transaction Cost Rules
• Generally, businesses are allowed a deduction for ordinary and necessary expenses paid in connection with carrying on a trade or business
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Overview of Transaction Cost Rules
Exception 1 to Business Deduction Rule
• Taxpayer must capitalize an amount paid to acquire an intangible an amount paid to facilitate the acquisition of an intangible, whether the taxpayer is the acquirer or the target
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Overview of Transaction Cost Rules
Exception 2 to Business Deduction Rule
• Taxpayer must capitalize an amount paid to facilitate the acquisition of a trade or business, including the cost of borrowing
• Facilitative costs include amounts paid on behalf of the taxpayer
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Overview of Transaction Cost Rules
Exception 2 to Business Deduction Rule
• Facilitative Costs (defined) – Costs incurred in the process of investigating or otherwise pursuing an acquisition
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Overview of Transaction Cost Rules
Capitalization - Timing
• "Bright-Line Date"
– Letter of intent
– BOD approval of material terms
• Generally, costs are deemed facilitative and therefore should be capitalized if incurred after the bright line test
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Overview of Transaction Cost RulesCapitalization - Timing
• "Inherently Facilitative" must be capitalized regardless of when incurred
– Appraisals and valuations
– Structuring and tax advice (transaction specific)
– Preparing transaction documents
– Regulatory approval
– Shareholder approval
– Conveying property
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Overview of Transaction Cost Rules
Success-Based Fees
• Capitalization required unless documentation to show that a portion of the fee is allocable to activities that do not facilitate the transaction
• Contemporaneous documentation
• IRS audit focus area
• New safe harbor - 70% deductible/30% capitalized
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Deal Issues and Strategies
• Nature and structure of the transaction
– Type of deal (asset or stock, taxable or nontaxable) will influence the tax treatment of the costs
• Opportunities for "tax benefit payments" are most likely to occur in stock purchase transactions
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Deal Issues and Strategies
• Preliminary considerations in negotiating the deal regarding tax benefits from transaction costs:
– What are the transaction costs and resulting tax benefits
– How will the tax benefits be realized – Immediate reduction in cash payments for taxes
– Refund of taxes in prior years from carryback of NOLs
– Reduction in post-Closing taxes from carryforward of NOLs
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Deal Issues and Strategies
• Not always the case that sellers receive compensation for tax benefits resulting from transaction costs
– Buyer may argue that the purchase price assumed receipt of tax benefits
– Buyer may insist on buyer-friendly terms relating to payment of tax benefits
• Consider addressing allocation of tax benefits from transaction costs in LOI
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Deal Issues and Strategies
• Other issues and considerations:
– When should the parties compensated for tax benefits?
• Paid at closing
• Paid when tax refunds are received
• Paid when buyer realizes benefit (when return filed or when estimated taxes are paid?)
– Does the target's tax year end at closing
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Deal Issues and Strategies
• How do you determine whether a tax benefit is in fact realized by a party?
• Are transaction deductions realized first before other deductions and credits are taken into account?
• Or are transaction deductions treated as the last item of deduction realized (so that a tax benefit arises only if there is a reduction in cash payments for taxes after all other items of deduction and credit are taken into account)?
– Which party determines whether a cost is deductible and makes other tax filing decisions?
– What happens if deductions are disallowed?
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Q&A
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Contact InformationKevin KaiserLindquist & Vennum PLLP4200 IDS Center80 South Seventh StreetMinneapolis, MN 55402
E-mail: [email protected]
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ANY TAX ADVICE CONTAINED IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN TO BE USED, AND CANNOT BE USED 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.
The information contained herein is general in nature and based on authorities that are subject to change. Applicability to specific situations is to be determined through consultation with your tax advisor.
TAX ASPECTS OF TRANSACTION COSTS IN M&A DEALS