| ||The Least Fun Part of the Job or A Tax Lawyer's Guide to Acquisition Agreements |
Robert Rothman is of counsel to the New York office of Piper Rudnick LLP, where he practices in the area of federal income taxation.
Acting as tax advisor to a party to a corporate acquisition transaction is lots of fun. Initially, we get to enlighten our clients to the happy notion that, within certain limits, we can choose the tax consequences we want. We explain that, being exceedingly clever fellows, we can design a transaction that will yield any one of three basic sets of tax consequences. First, a transaction can be structured to yield the set of results that tax lawyers refer to as a "taxable stock sale"—that is, a single level of tax is paid by target shareholders, outside (stock) basis is stepped up to reflect the purchase price, but the target's assets retain their historic (often low) basis so that depreciation and amortization deductions going forward will be lower and taxes paid in the future will be higher. Second, we can choose the set of consequences which we refer to as a "taxable asset sale," which results in both corporate- and shareholder-level gain recognition on the seller side, but with a stepped-up asset basis for the buyer that will translate into lower taxes in the future. Finally, we can opt for a tax-free reorganization, in which there is no basis step-up, but the selling shareholders pay no current tax to the extent they receive stock of the buyer as consideration.
"Great!" your client says, with a mental nod of thanks to whatever politicians enacted this optional tax system, yet not quite believing that this is not going to land him in jail. "Don't bother me with the details—make it so I pay the least amount of tax."
At this point you get to watch the client's grin diminish slightly as you explain that what is best for him is probably not best for the other party. Therefore, and because the other party and his advisor are, possibly at this very moment, having the exact same conversation, we might encounter some resistance. After a while, the client understands that we will have to negotiate with the other party what set of tax consequences to choose, and instructs you to "work it out with the tax guy on the other side—let me know when you've resolved it."
"I've got some good news and some bad news," you explain. The happy look on your client's face has now turned to a look of cautious curiosity. The good news, of course, is that this is not a zero-sum game; frequently one of the three approaches results in a net overall savings so that everybody can come out ahead. The bad news is that the tax advisors cannot resolve this one on their own. Because the tax consequences are so critical in determining the real value of the deal to both parties, the choice of tax consequences is inherently tied up with price, and therefore is too important to leave to the lowly tax lawyers.
The time has come to let the other shoe drop. You explain that the "firm agreement" that your client and his counterpart reached on price (subject only to lawyers' mumbo-jumbo) is not really all that firm. It's sort of like going into an automobile dealer and agreeing on the price for your new car, without discussing whether that price will buy you a Rolls-Royce or a Chevrolet. As your client leaves your office muttering about !@#$% pettifoggers who always mess up the deal, you smile, content in the knowledge that you have educated your client, prevented him from making a serious mistake, and are generally entitled to congratulations for a job well done.
The fun isn't over yet. Once everybody has agreed on what the tax consequences are supposed to be, it's time to design a structure to achieve those results. Of course, a stock sale does not necessarily mean a stock sale; you can achieve "taxable stock sale" tax results by doing an actual stock sale, but you can also get there by a reverse triangular merger (in which the target corporation survives and becomes a subsidiary of the buyer). Similarly, the tax consequences associated with a taxable asset sale can be achieved not only by doing an actual asset sale, but also by a forward merger (in which the target corporation is merged out of existence). Amazingly, sometimes you can also achieve those results by doing a stock purchase and uttering the magic phrase "338(h)(10)." When it comes to tax-free reorganizations, we have five basic flavors to choose from, each with an almost infinite variety of toppings and variations.
Faced with such a plethora of structural choices and a lack of words with which to analyze them, we turn, naturally enough, to pictures. We fill reams of paper with scribbled boxes, circles, lines, and arrows, with the occasional triangle or trapezoid thrown in for good measure. It's almost as much fun as fingerpainting. And every tax lawyer secretly dreams of, someday, designing a structure so complex that it can only be modeled in three dimensions, perhaps using Tinker-Toy pieces.
Finally, however, there comes a time when the fun part of the job is over. One day, a document appears on your desk. It might be called "Acquisition Agreement"; other popular titles include "Merger Agreement," "Agreement and Plan of Merger," "Stock Purchase Agreement," "Asset Purchase Agreement," and "Agreement and Plan of Reorganization." Whatever it is called, this document is the fundamental piece of paper that will govern the manner in which one company buys another and the rights and obligations of all the parties.
Your first inclination may be to toss the darn thing in the trash or (what amounts to the same thing) put it on the "I need to get to this someday" pile on your desk. "After all," you say to yourself, "if I wanted to do this kind of work I would have become a corporate lawyer."
Pray, desist. Reading contracts isn't fun or glamorous, but the most clever, most elegant structure in the world won't save you from a malpractice suit if the execution is flawed. You're just going to have to get your hands dirty.
The first thing you may ask yourself is which section of the Code or Regulations do I look at to find out how to read the agreement. Well, you don't find this in the Code, you don't find it in the Regulations, and you don't even find most of it in the standard treatises on corporate taxation.
Fear not, dear reader. You need only read on and all will be made (at least relatively) clear.