6 3 20pm - mergers & acquisitions

© 2012 McGladrey LLP. All Rights Reserved.© 2012 McGladrey LLP. All Rights Reserved.

Mergers & Acquisitions

Nick Gruidl - McGladrey Washington National TaxRon Kolodkin – McGladrey Los Angeles

48th Annual Bank & Capital MarketsAnnual Tax Institute

© 2012 McGladrey LLP. All Rights Reserved.

Section 382: Cash issuance exception: How it works. Investment advisers and family of funds: Who is a 5% shareholder? Loan loss reserves as recognized built-in losses: Notice 2003-65 safe harbor AMT Basis following an ownership change ILM 201326013 on application of Notice 2008-83 Taking out TARP and the 382 impact Sub Chapter S corporations and Section 382

ASC 740: Purchase Accounting Issues

Section 597: Treatment of Federal Financial Assistance transactions

M&A Transaction Costs: Expanded application of success based fee safe harbors and the next-day

rule

Topics

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Section 382 & Related Topics

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Many banks have and continue to be required to to raise significant capital through equity issuances

If the bank is a loss corporation (e.g. company with NOLs, built-in losses etc.), the issuance could cause an ownership change under section 382 thereby limiting the usage of NOLs as well as post-transaction losses (e.g. bad debts)

An ownership change occurs when there has been a greater than 50% increase in the ownership held by 5% shareholders

Limitation is based upon equity value, so depressed stock values could result is a drastic limitation

However, under the right circumstances, the cash issuance exception greatly decreases the likelihood of incurring an ownership change

Cash issuance exception: How it works.

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To the extent the cash issuance exception applies, the stock subject to the exception is allocated to the existing public groups

Cash issuance exception:- Issuance solely for cash- Amount of issuance not subject to segregation equal to the

lesser of:• Total stock issued for cash multiplied by % equal to 50% of the %

owned by public groups immediately before the issuance• Amount of the issuance not acquired by non-5% shareholders

Examples to follow


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Example 1: 1. Direct 5% shareholders own 20% of LossCo and 20% is the

lowest during the testing period

2. Public group (PG1) owns 80% LossCo and 50% was the lowest during the testing period

3. LossCo has 10M shares prior to the issuance

4. LossCo issues 20M shares for cash in an issuance• CIE applies to 40% of the cash issuance (50% x 80% owned by

public groups) or 8M shares• Up to 12M shares could be acquired by direct 5% shareholders while

still fully utilizing the CIE• No shares are acquired by the existing direct 5% owner


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Example 1: 1. Direct 5% shareholder owns 2M/30M or 6.7% = 0% increase

over lowest %

2. PG1 owns 16M/30M or 53.3% = 3.3% increase over lowest %• 5M acquired under the CIE

3. PG2 owns 12M/30M or 40% = 40% increase

4. Cumulative increase = 43.3% and no ownership change has occurred despite the fact the number of shares increased from 10M to 30M


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Example 2: 1. Direct 5% shareholders own 70% of LossCo and 70% is the

lowest during the testing period

2. Public group (PG1) owns 30% LossCo and 30% was the lowest during the testing period

3. LossCo has 10M shares prior to the issuance

4. LossCo issues 20M shares for cash in an issuance• CIE applies to 15% of the cash issuance (50% x 30% owned by

public groups) or 3M shares• Up to 17M shares could be acquired by direct 5% shareholders while

still fully utilizing the CIE• No shares are acquired by the existing direct 5% owner


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Example 2: 1. Direct 5% shareholder owns 7M/30M or 23.3% = 0% increase

over lowest %

2. PG1 owns 6M/30M or 20% = 0% increase over lowest %• 3M acquired under the CIE

3. PG2 owns 17M/30M or 56.7% = 56.7% increase

4. Cumulative increase = 56.7% an ownership change has occurred

5. Key issue in CIE is the amount owned by existing public groups prior top the issuance


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SEC SC 13D/G filings by 5% Shareholders: Regulations allow SEC filiers to rely upon SC 13D/G filings in

determining the existence or nonexistence of 5% shareholders

However, SEC ownership is based upon “beneficial ownership” while Sec. 382 is based upon “economic ownership”- Right to proceeds and distributions

Most Investment Advisers (IA) do not hold shares for their own account, but rather they are reporting the shares held on behalf of their clients for which their clients are the economic owners

As a result, many IAs are not 5% economic owners and the changes in their ownership can be disregarded- PLR 200747016

Investment Adviser: 5% shareholder or not?

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Example:1. LossCo Bank has significant NOLs and BILs that would be

subject to a severe Sec. 382 limitation in a change occurs2. LossCo intends to raise capital through a stock issuance3. The issuance (after taking into account the CIE) would bring

the cumulative shift to 52% and would cause an ownership shift

4. One of the 5% shareholders is an IA that reported 8% ownership resulting in an 8% cumulative increase

5. However, the IA states in the SC 13 that the shares are held on behalf of their clients and that to the best of their knowledge no client own 5% or more of Lossco

6. As a result, the IA is disregarded as is the 8% cumulative increase resulting in only a 44% cumulative increase

Investment Adviser: 5% shareholder or not?

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SEC SC 13D/G filings by 5% Shareholders: Family of funds generally file a single SC 13 reporting their

ownership (e.g. XYZ Fund I, II, III) However, the funds generally have different owners and may

share a GP that makes investment decisions In general, these funds do not represent shareholders

making a “coordinated acquisition” and therefore would not generally represent a single 5% shareholder - PLR 200806008

As a result, only a fund that itself owns 5% or more of LossCo would generally represent a 5% shareholder- So, a family of funds reporting 12% with 3 funds each owning

4% may be disregarded entirely in determining whether an ownership change has occurred

- As with prior example this distinction could significantly reduce the likelihood of a change

Family of Funds: 5% shareholder or not?

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In general, any built-in loss recognized by a net unrealized built-in loss (NUBIL) company during the 60 month period following an ownership change

Recognized built-in losses include OREO and bad debt deductions recognized on loans held at the time of an ownership change

Notice 2003-65 provides two safe harbor approaches for determining built-in gains and losses- Section 1374 method treats any bad debt deduction incurred

within the 12 month period following the ownership change as RBIL if the debt was owed to LossCo on the date of the ownership change

- Recognition period therefore shortened to 12 months on loans where taxpayer applies the Section 1374 method

- IRS confirmed in PLR 201105031

Loan Loss Reserves and Built-in Losses

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Despite the 12 month bad debt safe-harbor provided in Notice 2003-65, significant AMT exposure may exist for a NUBIL company following an ownership change

Sec. 56(g) provides rules for determining adjusted current earnings (ACE), which is used in determining AMTI

Sec. 56(g)(4)(G) requires that if a NUBIL undergoes an ownership change, the asset basis for ACE is reduced to the assets proportionate of the FMV of total assets

As a result, despite the fact that a bad debt may not represent an RBIL, the loan generating the bad debt may be written down for ACE purposes thereby increasing AMTI- Assuming the annual section 382 limitation is very low the

company may generate AMTI liability Could also impact E&P and treatment of future distributions as

dividends versus return of capital

Built-in Losses & AMT: ILM 201326013

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Notice 2008-83 (Wells Fargo/Wachovia): short lived notice that provided bad debt following an ownership change did not represent RBIL - Basically expanding the Sec. 1374 method to bad debts within

12 months- Notice only applied until January 16, 2009

Taxpayer took the position that Notice 2008-83 allowed the taxpayer to remove the loans from the NUBIG/NUBIL calculation thereby causing the company to be a NUBIG- Would serve to eliminate all RBIL including OREO

In the ILM (and two others almost identical) the IRS held that Notice 2008-83 had no impact on NUBIG/NUBIL as it only dealt with the treatment of bad debt and RBIL- RBIL & NUBIL are separate calculations and analyses

ILM 201326013: NUBIL & Notice 2008-83

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Numerous banks are raising funds to take out TARP financing Various IRS Notices provided rules to alleviate the Sec. 382

impact of the Treasury’s TARP acquisitions- Notices 2008-84 & -100, 2009-14 & -38

One of those notices provides that the Treasury will not be considered a new 5% shareholder upon a conversion of TARP preferred into non TARP securities (e.g. common stock)

However, the notices do not alleviate the impact of increases related to issuances of funds used to repurchase the TARP- e.g. Bank issues stock for cash to the public

Is it possible to have the treasury convert their TARP shares for common and then sell those shares to the public?

If so, then sales by the treasury to less than 5% shareholders would not result in an increase in ownership

Taking out TARP

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Example: LossCo has 50 shares of common with FMV $20M LossCo has 50 TARP shares with FMV $20 If LossCo raises $20M for 50 shares of new common there will

be an increase in ownership for Sec. 382 (subject to CIE) Assume Treasury converts to common and then sells the

shares in an offering to the public and no one shareholders becomes a 5% shareholder as a result - New public group is created and owns 50% of LossCo; however,

under the notices 50% is the lowest % deemed owned by the group resulting in a 0% increase

Taking out TARP

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M&A activity and the need to raise capital has resulted in numerous S corporation banks losing their Subchapter S status

Loss of an S election results in the bank becoming a Subchapter C corporation

A loss company includes a company with NOLs as well as a company with a net unrealized built-in loss (NUBIL)

An S corporation that becomes a C corporation and is in a NUBIL position is subject to section 382 despite the fact that no NOLs exist

Section 382 & S Corporations

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ASC 740

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Stock Sale vs. Asset Sale

GAAP tax treatment on M&A transactions

Deferred taxes on Goodwill

Deferred taxes on other assets

Purchase Accounting Issues:

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Section 597

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General Overview

Financial statement treatment

Treated as taxable asset acquisitions for tax purposes

Six year rule and highest guaranteed value

Other issues

Treatment of Federal Financial Assistance Transactions:

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M&A Transaction Costs

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M&A Costs: Expanded Safe Harbor for Success Based Fees

Success based fees paid to an investment banker/adviser Rev. Proc. 2011-29 provides 70% safe harbor from

capitalization Recent IRS directive allows application of the safe harbor to

certain milestone payments paid to an investment adviser if such payments are nonrefundable and creditable against the success based fee


M&A Costs: Next-Day Rule

When a corporation undergoes and M&A transaction there are there are generally M&A related costs incurred on or around the transaction date

When the target is entering a consolidated group the “next-day” rule may allow the target to deduct the costs on the post transaction period return- Must be reasonable and consistently applied by each party

Recent GLAM issued by the IRS confirms the position of the service that the next-day rule is not reasonably applied to success based fees and compensation deductions for prior services- Taxpayers often seek to push these deductions into the post

transaction period Premiums and other deductions related to debt paid off at

closing may be eligible for the next-day rule


Circular 230 Disclosure:

This analysis is a not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer.


DisclaimerThe information contained herein is general in nature and based on authorities that are subject to change. McGladrey LLP guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. McGladrey LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations.

Circular 230 DisclosureThis analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer.

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6 3 20pm - mergers & acquisitions