Many decisions made during an acquisition will have tax implications for the entities on both sides of the transaction. One of most important decisions is which basic deal structure to use-an asset purchase or a stock purchase. In an asset purchase, all or nearly all of the assets and liabilities of the target are transferred. In a stock purchase or equity purchase, the corporate stock or partnership interests are transferred. This month's newsletter will address general tax consequences of either basic deal structure, with a focus on how asset purchase deals are often preferable from a buyer's position.
Choosing a Deal Structure
In a deal structured as a stock purchase, the buyer purchases a controlling interest in, or all of the outstanding shares of the target company's stock, causing the target to become a subsidiary of the buyer. Stock purchases differ from asset purchases because they leave the existing target company intact, making a stock purchase simply a change of control rather than an assignment. This distinction carries several implications, including a reduction in the number of contractual consents needed from suppliers and other implicated third parties as well as tax benefits for the seller.
From a tax perspective, sellers generally prefer stock sales and buyers generally prefer asset purchases. In an asset purchase, the purchase price is treated as a set of separate transfers with each asset acquired and each liability assumed. Buyers and sellers should agree to an allocation of the purchase price. The seller's gains are calculated by taking the difference between the allocated purchase price and the adjusted basis of the property transferred. Each gain will be characterized separately based on different properties sold. In a whole-business sale with liquidation of the corporation following the asset sale, gains may be taxed at two levels-the corporate and the shareholder level, with the result that stock sales generally more attractive to sellers.
When a buyer acquires assets in an asset sale, they receive a new purchase price bases in each asset, which means the asset bases are set at fair market value. This often creates a beneficial tax consequence for the buyer, allowing the buyer to depreciate property over a new useful life and reduce future income by the purchase price of each asset. In contrast, stock purchases often leave the buyer with no such future deductions. Asset deals also allow the buyer to pick and choose which assets to acquire and avoid assuming some, or even all, of the target's liabilities, including, in most cases, future costs of uncertain amount from issues such as pending litigation.
The Section 338 Advantage
As mentioned above, stock purchases are typically less advantageous to buyers due to the loss of depreciation and the potential for unknown future liabilities. If the target is a subsidiary of another corporation or an S-Corp, the target stockholders and the buyer may make a Section 338 election (assuming other requirements are satisfied) to treat the transaction as if it were an asset sale, for federal income tax purposes. This election allows the buyer to get the benefits of an asset sale and can transfer important assets, like certain contracts, easily.
Creating Mutual Benefit
The choice between basic deal structures is not always a zero-sum game though. Many scenarios create an opportunity for a net economic benefit. There are multiple ways to structure a deal to achieve the parties' business goals and it is challenging to find the right structure without experienced, legal advice. HMS Law Group can provide this experienced advice early in the negotiation process in order to help businesses reach their economic goals.