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Wednesday, January 04, 2012


There are acquisition companies out there that promote a benefit to ‘C’ corporation shareholders that are looking to sell their business. If the corporation sells its assets, there will often be substantial corporate gains and income tax. The acquisition companies instead offers to buy the shares of the company from the shareholders. The acquisition companies represent that they have available tax losses that can be used to offset the corporate gains, and thus indicate they can avoid or minimize the corporate taxes on the sale of assets. The assets of the corporation are sold and the proceeds of the sale are used to pay off the purchase price for the share purchase of the shareholders. The benefit to the shareholders in doing a stock sale is that the acquisition company will pay them more for their stock than they would receive if the corporation sold its assets, paid its income taxes on the sale, and then liquidated and distributed the remaining sale proceeds to the shareholders. Of course, the acquisition corporation retains some of the sale proceeds as its pay for its role. The additional payment to the shareholders and the compensation retained by the acquisition corporation is funded by the purported corporate tax savings from the tax losses of the acquisition corporation.

This is what occurred in a recent Tax Court case. Unfortunately, the Tax Court made three findings that potentially leave the shareholders in a bad place.

First, the Tax Court held that the asset sale by the corporation, followed by the sale of shares by the shareholders to the acquisition corporation, was recast as an asset sale followed by a liquidation and not a stock sale. This recharacterization alone may have been enough to blow up the tax planning, since presumably the acquisition corporation’s losses could not be used to offset the selling corporation’s gains on the asset sale – thus the anticipated tax savings that lubricated the transaction would not exist. The Tax Court did not need to take this tack. Instead, the Tax Court determined that the tax losses that the acquisition corporation claimed to have were not valid. The result was the same – the selling corporation had no losses to offset its gains, and thus unexpected corporate level taxes were incurred.

The third finding was that since the transaction was characterized as a corporate liquidation, the shareholders as recipient of corporate assets under the deemed liquidation were personally responsible for the unpaid corporate tax  liabilities as transferees under Code Section 6901. Since the acquisition corporation was paid through the retention of some of the sale proceeds that effectively should have gone for payment of corporate taxes, it is likely that the shareholders will end up with less after they pay the corporate taxes than if they had just sold the assets and liquidated. Of course, perhaps the shareholders can recover their shortfall, including potential interest and penalties, from the acquisition corporation. But then again, perhaps not.

It is notable here that the corporation sold its assets and ceased its business prior to the sale of the shares to the acquisition company. Perhaps if the sale of shares preceded the sale of assets, the court may not have found a constructive liquidation. However, it is likely that some risk of a constructive liquidation will nonetheless remain since one doubts whether the acquisition corporation would purchase the shares of the company absent a binding contract by the company to sell its assets to a third party shortly after the stock purchase. Such a binding arrangement would still leave plenty of room for a court to still impose its recharacterization.

Feldman, TC Memo 2011-297

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