Tax Planning on U.S. inbound investment
- Stock acquisitions -All assets and liabilities of the target as they exist immediately prior to the closing are assumed in the transaction. The acquirer receives a basis in the target stock acquired equal to the purchase price. Absent a section 338(h)(10) election as described below, there is no step-up in the basis of the target’s underlying assets and, consequently, no opportunity to utilise the purchase price paid to generate higher depreciation deductions on the target’s assets. In general, sellers prefer stock sales due to possible taxation at lower capital gains rates (generally 20 per cent) and the ability to divest all of the target’s liabilities. The acquirer receives the benefit of the target’s historic tax attributes (eg, net operating losses (NOLs)) as they remain with the target following the acquisition.
- Asset acquisitions - An asset acquisition provides the buyer with flexibility to choose which target assets to acquire and which target liabilities to assume. However, asset acquisitions generally present the seller with less opportunities to avail themselves of the lower 20 per cent US federal income tax rate on capital gains. Note, however, a corporate seller of assets will only be taxed at a rate of 21 per cent, which is marginally higher than the capital gains rate. Additionally, a second layer of US income taxation may be imposed when the sale proceeds are distributed to the target’s shareholders, which may be taxed as either a dividend or gain from the sale or exchange of a capital asset. Under certain circumstances where there are non-US shareholders, this second layer of taxation can be avoided in respect of such non-US shareholders via distribution of sale proceeds through a liquidation (as opposed to payment of a dividend). In an asset acquisition, the acquirer receives basis adjustments in the acquired assets, with the purchase price allocated among the assets (generally in a manner agreed upon by the acquirer and seller). Typically, acquirers prefer asset acquisitions owing to the ability to receive a step-up in basis in the target’s assets (which is discussed in question 2), resulting in higher post-acquisition depreciation deductions. In general, the acquirer will not benefit from the target’s tax attributes (eg, NOLs) as they remain with the target after closing.
- 338(h)(10) election option - A section 338(h)(10) election is used where the transaction must be structured as a stock acquisition for legal purposes, but the acquirer desires a basis step-up in the target’s assets so that it can receive higher post-acquisition depreciation deductions. If the parties can comply with its numerous requirements, upon making a 338(h)(10) election, old target generally is deemed to have sold all of its assets to new target, followed by a deemed liquidating distribution of the proceeds by old target to its shareholders immediately before the acquisition date. A section 338(h)(10) election can disadvantage the seller when the basis it has in the target’s assets is lower than its basis in its target company stock (which is often the case). In these situations, the acquirer and seller often negotiate additional consideration to be paid to the seller to offset some or all of the additional US federal income tax liability owed by the seller as a result of the election.
- Acquisitions via tax-free reorganisation - Corporate acquisitions in the US can be accomplished via tax-free reorganisation, provided that the strict conditions to qualify for the applicable reorganisation under the Internal Revenue Code (the Code) are met. Tax-free reorganisations come in many forms under US tax law, but in general such reorganisations are tax-free only to the extent that stock is exchanged as consideration. Therefore, they are appropriate where the acquirer’s stock will form a significant portion of the consideration tendered in the transaction. Where cash or other property (but not stock) (‘boot’) is received in what would otherwise be a tax-free reorganisation, the boot generally is subject to US federal income tax in an amount equal to the lesser of the seller’s gain or the amount of the boot received by the seller. Although these transactions are commonly referred to as ‘tax-free’, note that the tax that would otherwise be due upon receipt of acquirer stock is deferred rather than avoided altogether. The types of transactions that can qualify as tax-free reorganisations for US federal income tax purposes include:
Step-up in basis
Domicile of acquisition company
Company mergers and share exchanges
Tax benefits in issuing stock
Net operating losses, other tax attributes and insolvency proceedings
Limitations on net operating losses
Other limitations on tax attributes
Application of rules to bankrupt or insolvent entitles
Protections for acquisitions
Protections for stock and business asset acquisitions
Taxation of indemnity payments
Tax indemnity insurance
Migration of residence
Interest and dividend payments
Tax-efficient extraction of profits
Disposals of stock
Avoiding and deferring tax
Key developments of the past year
The most notable hot topic in the United States law of tax on inbound investment is the continued interpretation of the Tax Cuts and Job Act of 2017 (the Act). The Act made sweeping changes to the US federal tax code, many of which significantly affected both new and existing inbound investment structures. The important changes affecting inbound US investment included: