Then may qualify as good tax-free partnership division

1
Use of Limited Liability Companies in Mergers
Acquisitions

• Robin Gilden, Esq.
• Charles Kolstad, Esq.
• Reish Luftman Reicher Cohen, PC
• January 29, 2008

2
Overview

• LLCs and Other Acquisition Vehicles
• Advantages and Disadvantages of LLCs
• Transactions Involving US Targets
• Partnership Transactions
• Corporate Transactions
• Transactions Involving Members of a Consolidated
  Group
• Transactions Involving Foreign Targets

3
LLC and Other Disregarded Entities

• Limited Liability Companies
• Disregarded Entity - 1 member
• Partnership - 2 or more members
• Corporation - Elective by filing Form 8832
• Partnerships
• Classified as a Partnership unless elect to be
  classified as a corporation or PTP rules apply
• Business Trusts
• Classifications similar to an LLC
• Form 8832, Entity Classification Election

4
Advantages and Disadvantages of LLCs in MA
Transactions

• Advantages
• Avoid consolidated tax return group rules
• Effect tax-free divisions of assets without
  violating the substantially all requirement
• Isolate assets for liability purposes
• Disadvantages
• Transactions structured as mergers may in fact be
  taxable asset sales

5
Transactions involving US Targets
6
Acquisition of 100 of Target LLC
X
P
Target LLC
7
Acquisition of 100 of Target LLC

• Taxable Purchase - characterized as sale of Ts
  Assets by X, rather than as a sale of T Stock.
• Non-Taxable Purchase - if X and P are
  corporations, then may qualify as a C
  reorganization if P issues stock as consideration

8
Acquisition of Less Than 100 of Target LLC
Sale of Partial Interest
X
P
Target LLC
9
Acquisition of Less Than 100 of Target LLC

• Target LLC is deemed converted from a disregarded
  entity to a partnership.
• P treated as acquiring its percentages of Target
  LLC assets from X, and contributing those assets
  to a newly formed partnership. Rev. Rul. 99-5
• If X is a partnership, then the Sec 708 rules
  would apply rather than Rev. Rul. 99-5

10
Merger of Single Member LLCs
X
P
X
P
Target LLC2
Target LLC1
Merged LLCs
Merger
11
Merger of Single Member LLCs

• State law merger of Target LLCs, with designated
  LLC as the surviving entity.
• Affects which LLCs assets have to be retitled
  etc.
• For federal tax purposes, characterized as a
  contribution of assets of Target LLC1 and Target
  LLC2 to newly formed partnership
• New TIN, accounting methods etc. to be adopted by
  newly formed partnership

12
Merger of Multi-Member LLCs
C D
A B C D
A B
LLC1
LLC
LLC2
Merger
13
Merger of Multi-Member LLCs

• State law merger of LLC1 and LLC2 with identified
  partnership as the surviving entity
• For federal tax purposes, characterized as a
  merger of LLC1 and LLC2, with the larger of the
  two treated as the surviving entity4
• Default treatment is Assets-over merger
• Can elect Assets-up merger treatment

14
Merger of Multi-Member LLCs

• Assets-over merger - default rule. Treated as a
  contribution of assets to newly formed
  partnership followed by distribution of the new
  partnership interests
• Assets-up Merger - treated as a sale of assets
  by X to P, followed by contribution by P of
  assets to newly formed partnership. Must convey
  assets to old partners under state law to qualify
  for assets-up treatment.

15
Merger of LLCsBuyout of a Member
A B C
D E F
25
50
25
Cash
LLC2 Interests
LLC1
LLC2
16
Merger of LLCsBuyout of a Member

• Did LLC1 use its own resources to cashout C?
• If yes, then treated as LLC1 liquidating Cs
  Interest in LLC1
• If no, then treated as a sale of 25 of each of
  LLC1s assets to LLC2, with contribution of 75
  for LLC2 interests (i.e., no Reg. 1.708-1(c)(4)
  election)

17
Merger of LLCsBuyout of a Member

• Did LLC1 use its own resources to cashout C?
• If no, and Reg. 1.708-1(c)(4) election is made,
  then LLC2 treated as purchasing Cs interest in
  LLC1
• Sec. 754 implications and possible basis step-up
  for purchased portion of LLC1 assets

18
Private Equity Group Acquisition of S Corp.
LLC acquisition rights
S Corp
PEG
Cash
Cash
Assets
LLC
19
Private Equity GroupAcquisition of an S Corp

• S Corp stays in existence S Corp election not
  terminated or affected
• One level of tax at the individual shareholder
  level on the S Corps share of LLC income
• Use of LLC allows PEG to pick which assets it
  will acquire avoids involvement in historic
  business of S Corp

20
Private Equity GroupAcquisition of an S Corp

• What if LLC assumes liabilities of S Corp in
  connection with transfers of assets to LLC
• Disguised Sales Rules
• Qualified liabilities
• Non-qualified liabilities

21
Private Equity GroupAcquisition of S Corp

• Transfers to LLC should be tax-free under Sec.
  721
• Cash distribution to S Corp - may result in gain
  recognition under the disguised sale rules of
  Secs. 707(b) and 737
• Subsequent transfers by S Corp of LLC interests
  to PEG are taxable transfers

22
Private Equity Group Acquisition of LLC Assets.
LLC1 acquisition rights
LLC
PEG
Cash
Cash
Assets
LLC1
23
Private Equity GroupAcquisition of LLC Assets

• Allows PEG to pick which LLC assets and
  liabilities it will acquire
• Same Analysis as Acquisition of S Corp

24
Private Equity Group Acquisition of C Corp.
C Corp
PEG
Cash
Convertible Loan
Assets
LLC
25
Private Equity GroupAcquisition of C Corp

• Transfers to newly formed LLC should be tax-free
  since LLC is disregarded entity
• Cash distribution to Target tax-free since LLC
  is disregarded entity
• C Corp elects S Corp status
• Conversion of Loan into LLC interests after 2
  years
• Disguised sales implications

26
Single Member LLC Division
P
PEG
Sale
Target LLC
27
Single Member LLC Division

• Treated as a taxable asset sale

28
Multi-Member LLC Division
C D
A B
30
30
20
20
Distribution of Assets to C and D
LLC1
LLC2
29
Multi-Member LLC DivisionSingle LLC

• Non-taxable partnership division
• LLC1 treated as being divided into two
  partnerships, LLC1 and LLC2. Sec. 708(b)(2)(B)
  Reg 1.708-1(d)

30
Multi-Member LLC DivisionSingle LLC

• The Continuing Partnership is LLC1 since the
  remaining members had more than 50 of the
  capital and profits interests in LLC1
• The TIN, accounting methods etc. remain with the
  continuing partership
• LLC2 is treated as a newly formed partnership
• New TIN, accounting methods, etc. adopted by LLC2

31
Multi-Member LLC DivisionMultiple LLCs
A B C
D E
PEG
x y
p q
LLC2
LLC1
32
Multi-Member LLC DivisionMultiple LLCs

• Interests in LLC1 distributed to A, B and C
• Interests in LLC2 distributed to D and E.
• If LLC1 and LLC2 do not receive any assets from
  PEG in connection with restructuring, then no
  receiving partnership and probably NOT a
  partnership division of PEG
• What if PEG transferred assets/liabilities to
  LLC1 and/or LLC2?
• Then may qualify as good tax-free partnership
  division

33
Multi-Member LLC DivisionMultiple LLCs

• If not a division, then treated as distributions
  in redemption of partnership interests under Sec.
  731
• Larger of LLC1 or LLC2 will be the divided
  partnership, inherits and takes over LLC1
  attributes, TIN, etc.
• If LLC1, LLC2 and PEG had elected to be taxed as
  corporations, then division may qualify as a
  tax-free Sec. 355 distribution

34
A Reorganization
Shareholders
P
Voting Stock
Voting Stock
Merger
Target
LLC
35
Merger of LLC andCorporate Target

• Under 2006 Final Sec. 368 regulations, if LLC is
  disregarded entity, then a good statutory merger,
  and qualifies as a tax-free A reorganization
• T Shareholders receive P voting stock
• T can be a C Corp or an S Corp
• If S rather than P owns LL, then should qualify
  as forward triangular merger under Sec.
  368(a)(2)(D) although would not qualify as such
  if LLC were a C Corp.

36
Merger of LLC andCorporate Target

• Does not have to satisfy the substantially all
  requirement applicable to forward triangular
  mergers,
• Can be used to acquire only the wanted assets
• Unwanted assets transferred to Xs shareholders
  pre-merger

37
Merger of LLC andCorporate Target
Shareholders
P
LLC Interests
Merger
Target
LLC
38
Merger of LLC andCorporate Target

• After the merger LLC is a partnership, not a
  corporation, since T shareholders receive LLC
  interests and not P stock
• So, merger does not qualify as a Sec.
  368(a)(1)(A) statutory merger since P is not
  treated as having received Targets assets and
  liabilities
• Merger may be a tax-free partnership formation
  under Sec. 721

39
Acquisition of 100 of Target LLC
P Stock
X
P
Merger
Target LLC
40
Acquisition of 100 ofTarget LLC

• Merger does not qualify as tax-free Sec.
  368(a)(1)(A) statutory merger since LLC is a
  disregarded entity
• Transaction should be characterized as a taxable
  purchase of LLC assets by P for P stock
• If X is a corporation, then may qualify as a C
  reorganization

41
Merger of LLC and Corporate Target
Target
P
Merger for P stock
LLC2
LLC1
42
Merger of LLC and Corporate Target

• Target mergers into LLC1 and LLC2 under state
  statutory merger law
• Since P owns all of the assets and liabilities of
  Target post-merger, and LLC1 and LLC2 are
  disregarded, treated as a tax-free Sec.
  368(a)(1)(A) statutory merger
• Simple method of separating Target assets into
  separate companies

43
B Reorganization
Shareholders
P
Voting Stock
Target
LLC
44
B Reorganization

• LLC acquires T stock from Shareholders in
  exchange for P voting stock
• LLCs existence is disregarded, so treated as a
  good tax-free Sec. 368(a)(1)(B) reorganization

45
C Reorganization
Shareholders
P
Voting Stock
Voting Stock
P Stock T Assets etc
Target
LLC
46
C Reorganization

• LLC acquires Target assets and assumes Targets
  liabilities for P Stock Target liquidates and
  distributes the P stock to Shareholders
• Transaction should be a tax-free Sec 368(a)(1)(C)
  reorganization
• Since LLC is disregarded, P should be treated as
  assuming T liabilities for federal tax purposes,
  even though LLC has a separate legal existence
  for state law purposes

47
C Reorganization

• Have recourse Target liabilities been converted
  into non-recourse liabilities via-a-vis P? Since
  they are now LLC and not P liabilities,
  presumably they are now non-recourse to P

48
Transactions involving Members of a Consolidated
Group
49
Inter-company Reorganizations
Parent
Sub1
Sub2
Sub3
Sub4
50
Inter-company Reorganizations

• P wants to transfer certain business operations
  of Sub 1 to Sub 2 and Sub 3.
• Could be done as a dividend/contribution
• Sec. 311(b) issues and deferral of gain under
  Reg. 1.1501-13
• Possible Sec. 355 transaction
• Could be done as a sale of assets
• Again, deferral of gain under Reg 1.1501-13
• Gain may have to be restored

51
Inter-company Reorganizations

• If Sub1 was an LLC characterized as a disregarded
  entity, then no consolidated tax return issues
• Use of LLCs rather than corporate subsidiaries
  avoids the complications of the consolidated tax
  return regulations
• Reorganizations of subsidiaries and divisions are
  entirely non-taxable events

52
Ineligible Subsidiaries
US Parent
Foreign Target
US Subsidiaries
US Holding Company
Foreign Subsidiaries
53
Ineligible Subsidiaries

• Certain entities, such as foreign corporations,
  are not eligible members of a consolidated tax
  return group.
• By checking the box with respect to Foreign
  Target, US Parent now treated as holding stock of
  US Holding Company
• US Holding Company and US subsidiaries now
  includible in US Parents consolidated group

54
Ineligible Subsidiaries

• 80 Vote and Value requirement
• Use LLC rather than corporate subsidiary to
  achieve consolidation when there are significant
  minority shareholders

55
Corporate Conversions

• Convert Sub1, Sub 2 and Sub 3 into LLC1, LLC2 and
  LLC3 through mergers with the LLCs as the
  surviving entities
• Should be tax-free transactions if members of
  consolidated group and Subs are solvent.
• Liquidation/reincorporation doctrine not an issue
  since not transferred to a corporation
• Loss of outside basis in Sub stock what is the
  inside basis?

56
Merger of Partnership into C Corp.
Shareholders
P
Target
LLC
Merger
S
57
Merger of Partnership into C Corp.

• Good merger under state law
• Treated as contribution of Target
  assets/liabilities to LLC tax-free partnership
  contribution under Sec. 721.
• Followed by taxable liquidation of Target and
  distribution of LLC interests to Shareholders

58
Acquisition of Foreign Target
59
Acquisition of Foreign Target

• Check the Box in a Foreign Context
• Per Se Corporations under Reg. 301.7701-2(b)(8)
• Barbados v. Bermuda
• If not a Per Se corporation, then disregarded
  entity or partnership
• Form 8858, Information Return of US Persons with
  Respect to Foreign Disregarded Entities

60
Merger of US LLC with Foreign Entity
Shareholders
USP
P Stock
P Stock
LLC
F Target
Merger
61
Merger of US LLC withForeign Entity

• Under 2006 Final Sec. 368 regulations,
  requirement that the merging entities be
  domestic was removed.
• Merger can be a good Sec. 368(a)(1)(A) statutory
  merger
• However, Sec. 367 may override Sec. 368
• Same result if Foreign LLC merged with F Target

62
Post Acquisition Loss Utilization
USP
Target CFC
63
Post Acquisition Loss Utilization

• In the left example, CFC is a hybrid foreign
  entity a corporation for local tax law purposes
  and a branch of USP for federal tax purposes
• Losses of Target CFC flow-through and can be used
  by USP on a current basis to reduce its US tax
• Subject to subsequent recapture when Target CFC
  becomes profitable
• Dual consolidated loss issues

64
Post Acquisition Loss Utilization

• In the right example, CFC is a hybrid foreign
  entity
• Losses of CFC flow-through and can be used to
  reduce EP of Target CFC
• Increase effective foreign tax rate of Target CFC

65
Avoid Subpart F Income
USP
US Acq Sub
Dividends
Dividends
Target CFC
66
Avoid Subpart F Income

• If CFC1, CFC2 and CFC3 are not incorporated in
  same jurisdiction as Target CFC, then dividends
  would be FPHCI under Subpart F Income.
• Avoid FPHCI by checking the box
• However, results in blended effective tax rate,
  so need to compare foreign tax rates before
  deciding which to convert to hybrids

67
Post-Acquisition Disposition
68
Post-Acquisition Disposition

• Assume CFC is an unwanted asset
• If CFC is not a hybrid entity, then gain from a
  sale of the CFC stock by Target CFC results in
  FPHCI under Subpart F
• IF CFC is a hybrid entity, then a sale of CFC
  stock is treated as a sale of assets and not a
  stock sale.
• If CFC is engaged in active business, then gain
  may qualify as general limitation income

69
Foreign Tax Credit Planning

• Under Sec. 902, a US corporate taxpayer may claim
  an indirect foreign tax credit for taxes paid by
  certain foreign subsidiaries.
• Originally, limited to 1st, 2nd and 3rd tier
  foreign subsidiaries changed to up to 6th tier.
• Use of hybrid entities may allow USP to claim FTC
  for 7th and lower tier foreign subsidiaries