1、1,Introduction to US Taxation of Mergers and Acquisitions Prof. Charlotte Crane Graduate Tax Program Northwestern University School of Law Chicago, Illinois,2,Basic Principles of Taxation of US Corporations,Two levels of tax Corporation pays tax on earnings as earned Shareholders pay tax when earnin
2、gs distributedWorldwide income of US corporation taxed by US Mitigated by foreign tax creditTax law not always linked to state corporate law,3,Double taxation of Corporate Earnings Domestic,Corporation honored as separate taxable entityCorporation taxed at 35% $1000 -350= 650 Pre-2004 Individual sha
3、reholders taxed at 30-35% on receipt of dividend Pre-2004 650-195=455Post-2004 individual shareholders taxed at 15% Post-2004 650-97.50=552.50No shareholder credit for corporate taxes paid No corporate deduction for dividend paid No rate difference between income distributed and income not distribut
4、ed Except when penalty taxes for accumulations,4,US corporate tax rates,2004 stated rates Up to $50,000 15% Over 50,000 but not over $75,000 25% Over 75,000 but not over $10,000,000 34% Over $10,000,000 35%2004 rates including phaseout of lower brackets Up to $50,000 15% Over 50,000 but not over $75
5、,000 25% Over 75,000 but not over $100,000 34% Over 100,000 but not over $10,000,000 39% Over $10,000,000 but not over $15,000,000 35% Over $15,000,000 but not over 18,333,333 38% Over $18,333,333 35%,5,But only double taxation,Dividends received deductionWith control 100% for 80% or greater ownersh
6、ipWithout control 80% for 20-80% ownership 70% for under 20%But more than double tax not always avoided,6,And not always of single entity,Election of affiliated group to file consolidated returns Only US corps may consolidate And contiguous in some cases Only ownership not operation requirements for
7、 eligibilityDisregarded entities (also called Tax Nothings) Partnerships and LLCs when owned by one shareholder will be treated as if they did not exist for tax purposes when box is checked to treat as pass-through entity,Corp,Corp,7,Meaning of control,1504 vote and value368(c) all voting and stock
8、by classSubpart F 50% owned by 10% shsAll can be subject to their own attribution and look-through rules,8,Disregarded status extends to foreign entities,Regulations specify certain per se entities Others may be pass-through Some tension in possibility of market in foreign entities,9,Tax law not cor
9、porate law controls tax treatments,Corporate law determined primarily by states Corporate charters controlling governance and relations with shareholders Relations with creditors Procedures for and results of restructuring for non-tax purposes Federal law governs access to public capital markets Sec
10、urities offerings (except very small scale) Fraud on shareholders (shares with states) Federal tax law not tied to state charter or governance law “corporation”, “dividend,” “earnings and profits,” “stock,” “debt” State law may be necessary for federal tax treatment, but not determinative-”merger” a
11、s one route to tax-free restructuring State law may be easiest but not only way-”complete liquidation”,10,Sources of US income tax law,Internal Revenue Code enacted by Congress Regulations promulgated by Treasury Department, written with Internal Revenue Service Published rulings by IRS Unpublished
12、rulings by IRS Private letter rulings Field Service advice, Technical advice memoranda (designations have changed) Court interpretationsonly with litigation over actual deficiency Treaties,11,What will be taxed as corporation?,Historically very difficult problem to administer Sometimes taxation as c
13、orporation preferred, sometimes not Previously, if entity provided limited liability to owners, must be taxed as corporation Lawyers found ways to offer effective limited liability “Check the box” now allows any entity that does not have a Charter as a corporation under state law Market made in its
14、interests Not available to those corporations that are taxed as bank or insurance coompanies, or certain foreign entitiesElection to be taxed as partnershipcalled “pass- through”Cannot change election more often than every 60 monthsIf “passthrough” single owner, will be disregarded,12,Foreign entiti
15、es that will be taxed as corporations,Austria, Aktiengesellschaft Belgium, Societe Anonyme France, Societe Anonyme Germany, Aktiengesellschaft Italy, Societa per Azioni Japan, Kabushiki Kaisha Mexico, Sociedad Anonima Netherlands, Naamloze Vennootschap United Kingdom, Public Limited Company,13,Earni
16、ngs: based on taxable income of corporations,No general conformity between book income and tax income Schedule M required, but not always useful Schedule M may be revised to require more useful information Book (financial) income rarely has impact on tax income Cost recovery used as incentive Costs
17、of many self-developed intangibles deductible Costs of purchased intangibles amortizable since 1993 Original issue discount,14,Double Tax only applies to earnings,With debt of 60% at 10% 1000 gross corporate earnings 60 interest 940 net taxable income 329 tax on net 611 earnings to shareholders 91.6
18、5 tax by sh519.35 after tax to shareholders 39 after tax to creditors558.35 combined after tax,Creates enormous pressure for debt financing,Without debt 552 after tax to shareholders,15,Computation of Earnings and Profits,16,Distinguishing debt from equity,Section 385(b) five factors (1) whether the
19、re is a written unconditional promise to pay, on demand or on a specified date, a fixed amount in money in return for an adequate consideration and to pay a fixed rate of interest; (2) whether there is a subordination to, or a preference over, other debt; (3) the ratio of debt to equity; (4) whether
20、 there is convertibility of debt into stock; and (5) the relationship between stockholdings and holdings of the interest in question Other factors: Whether regular creditors remedies are available Extent to which participate in corporation gains OR losses Participation in governance (rarely determin
21、ative),17,Distinguishing debt from equity other approaches,No fixed standards limiting shareholder debtNo single statutory or regulatory standard Especially difficult when related parties Concern about excess debt for non-tax reasons (?)Other limitsdeny debt feature Section 269 denial of deduction f
22、or acquisition indebtedness when debt and equity stapled Section 163(j) denial of deduction “excess interest” to extent more than 50% of income (using special definition of income, closer to cash flow) Paid to related party (50% common ownership) Debt to equity ratio 1.5 to 1 or less Can include thi
23、rd party debt guaranteed by related party Section 263(l) “payment in kind Other sections may deny equity features of securities denominated “stock”,18,Debt /Equity Ratio,In some places statutorily defined, but in others notFrequently tax basis of assets (not book or fmv) used for tax purposesLiabili
24、ties/Total basis-liabilitiesNot likely to produce same result as bankers or other analysts would useEvidence of problems in structuring Code in which same rules apply to small closely held as to large publicly-heldcommon law nature of evolution of US code,19,Assets of Target Corporation,20,Domestic
25、property transactions: Capital Gains,Nature of assets involvedMost stock, financial instruments Not inventory, depreciable property Land All taxable unless taxpayer not taxabletax-exempt charity pension plangovernment unless specific transaction not taxable tax-free exchanges of certain types of pro
26、perty Tax-free corporate restructuring unless held by individual at deathstepped up basis to fmv,21,Domestic property transactions: Capital Gains,Rate and limitations Individuals taxed at favorable rate15% Includes most individual holding of corporate stock Except by dealers Except in personal retir
27、ement accounts Dividends now at 15% also No special corporate rate for capital gains Limitations on losses for both individuals and corporations,22,Domestic property transactions: depreciable property,Nature of assets involved Machinery and equipment Improved real estateSpecial treatment Prior deduc
28、tions may be “recaptured”1245 and 1250 Recapture income may be triggered when other income not,23,Extent of Double Tax Regime,Alternative regimes Passthrough of current income, corporate level asset gain Subchapter S Full pass-through; no entity level tax Partnership Limited Liability Company Full-p
29、assthrough entities may “check the box” If single owner, become “disregarded entities” Not eligible if market made in interests,24,Distributions to Shareholders,Included in income of shareholders to extent of earnings ignore intricate rules making current e&p available if past losses No basis offset
30、 for receipt of dividend Shareholder can have dividend even if holds stock at a loss Shareholder can have dividend even if just purchased stock No change in shareholder basis as result of income earnedNo shareholder credit for corporate level taxes paid Proposal last year was modified version of thi
31、s, giving shareholder exemption for fully taxed corporate income Only if NO earnings and profits will shareholders have return of capital Return of capital distributions NOT income for US tax purposesno withholding,25,Example of treatment of individual shareholder,Purchased for $1000 Now worth $800
32、Shareholder receives dividend of $65 from earnings and profits (100 of corporate income) 65 of dividend is taxable at 15% Leaving shareholder with $55.25 of $100 corporate earningsIf stock decline in value in connection with dividend to 760 shareholder basis in stock still 1000 shareholder recognize
33、s loss of 240 only on sale of stock Dividend treatment avoided if sale possible,26,Individual preference for cashing in stock gains,Before rate reduction, individual shareholders sought to avoid dividendsall taxed, highest rate Very low dividend payouts by many US corporations With rate reduction, l
34、ess concerned unless very high basis Large enough change to effect corporate behavior? Rate reduction set to expire in 2009,27,Distributions to Corporate Shareholders,Dividends received deduction available for corporations section 243 Varies with level of ownership 100% if 80% or more 80% if 20-80%
35、70% if less than 20%,28,Corporate preference for cashing in stock gains,Corporate shareholders may prefer dividends to sale or exchange Corporate shareholder may pay itself dividend from subsidiary before selling,29,Non-liquidating distributions of property to shareholders generally taxable,Treated
36、as dividend received by shareholders Triggers gain to distributing corporations No losses triggered Losses triggered only on sale No losses on sale to related party Even to unrelated party, sale not honored if buyer not take economic risk Even of subsidiary stock unless qualifies as spin-off under r
37、eorganization rules,30,Share Repurchases-Redemptions,Share repurchases in US are legal so long as shareholders not preferred over others inappropriately “Greenmail” Designation of transaction as sale to issuing corporation will not control,31,Recharacterization of sales of stock to issuing corporati
38、on,Special rules under section 302 determine when shareholders have changed position in corporation enough to have sale not dividend treatment Generally not problem for small shareholders in publicly held corporations When redemption honored as “sale or exchange” basis allowed Of less concern genera
39、lly with rate reduction in effect,32,Corporate Liquidations: section 336,Since 1986 all corporate level gain to be taxed when leaves “corporate solution” to be held by individualsPrior law ( first set out in General Utilities case) allowed liquidations in any circumstances to escape corporate level
40、taxationExtended by statute to sales made in connection with liquidation,33,Significance of “repeal of General Utilities”,General approach to prevent escape of corporate level gains Some implementation rules assume that corporation should not be able to sell part of its assets in taxable transaction
41、 and other part in tax-free reorganization Removed much of flexibility in corporate restructuring Enormous pressure now on reorganization rules Enormous pressure to reduce corporate tax in other ways,34,Measure of gain in corporate liquidation,Law still undeveloped Too costly to try Perhaps more law
42、 will develop now that more assets may be held at loss May have difficulty avoiding more gain than actual gain on sale Gain to be computed on each asset as if sold separately Separate computation for liabilities in excess of tax basis Extent to which unbooked losses will be allowed not clear,35,Asse
43、ts of Target Corporation with liability problems on liquidation,36,Liquidations of Controlled subsidiaries: 332 and 337,Nonrecognition on liquidation if 80% owned by corporation Implementing idea that only Double Tax Corporate basis in stock never used Controlling corporation takes subsidiarys basis
44、 in stock Controlling corporation inherents other tax attributes In general as if subsidiary never existed In minority shareholders, corporate gain as if 336, no loss,37,Nontaxable Transfers to Corporation under section 351,Same rules apply whether existing or new corporation 80% of corporate stock
45、must be held by control group after Nonvoting stock may be used But nonvoting stock that is too much like debt will trigger gain 351(g) Debt may be swapped, but possible gain to both corporation and shareholder Control group must retain “immediately after” Obligation to transfer will defeat nontaxab
46、ility unless new transferee can be counted as transferor,38,A corporations dealings in its own stock,Under section 1032, corporation not recognize gain or loss in dealings with own stock No difference if “Treasury stock” or repurchased on market Special rules in regulations allow subsidiaries in som
47、e circumstances the same treatment Generally subsidiary must dispose of stock promptly Corporation given basis credit for use of stock Departure from ordinary expection in US tax law that no basis if no tax paid on property used as consideration Significant visible issue in relation to employee stoc
48、k options Financial accounting treatment different Currently being studied Other limitations on the deductibility of interest Section 269 Acquisition indebtedness Section 163(j) anti- “Earnings stripping” Section 163(l),39,Net Operating Loss Carryovers,Generally, allowed limited carryback and more g
49、enerous carryforward of net operating losses and capital losses Character as operating or capital preserved Sections 172 and 381 Change in ownership (whether taxable or not) can result in limit of use of losses to present value in hands of old shareholders Section 382,40,Consolidated returns,Affilia
50、ted groups (defined in section 1504) may elect Only US subsidiaries FINANCIAL ACCOUNTING STANDARDS DIFFER FASB 94 In general, all US subsidiaries included if election Gains and losses for transfers within group excluded Losses of members can offset gains of other members Intricate rules attempt to limit to losses not incurred while a member of the group,
