Alternate transaction structures to consider during the COVID-19 pandemic

A fundamental tension can exist between buyers and sellers when negotiating transactions; buyers typically favor an asset purchase and sellers prefer to sell stock. The opposing methods are often born from conflicting perspectives regarding legal, logistical, and tax considerations of a transaction.

As the economic outlook and deal market remain uncertain during COVID-19, buyers, however, might have an uncommon opportunity to access the tax benefits of purchasing assets while still allowing sellers to sell stock. The opportunity can be completed without both sides losing other valuable tax benefits as well.

While there’s never a one-size fits all approach to transaction planning, considering and modeling alternative transaction structures — including stock, asset, and deemed-asset purchases — could help determine which is the best fit for increasing the present value of a company’s tax attributes.

Below, we explore these potential structures and how they could benefit your organization.

Limitation on tax attributes

Following a stock sale, an annual limitation on net operating losses (NOLs), built-in losses, and certain tax credits — collectively deemed tax attributes — can either limit or eliminate a buyer’s ability to use such attributes to reduce current and future tax payments.

This annual limitation on the use of tax attributes is generally the fair market value of a corporation’s stock multiplied by an applicable federal interest rate (AFR). The IRS publishes the AFR monthly, although the stock value for such purposes is subject to certain anti-abuse adjustments.

Decreasing AFRs

The June 2020 AFR was 1.09% and dropped to 0.89% for September 2020.

A low or decreasing AFR, coupled with depressed valuations, produces a significantly restrictive limitation. A buyer’s ability to utilize acquired tax attributes to reduce tax costs, when subject to such a limitation, is significantly impaired.

As the economic value of these tax attributes is diminished, so too is the seller’s ability to monetize the future benefit of the attributes via a premium to the purchase price.

Limitations on built-in losses

Moreover, if an acquired company’s tax-basis in its assets exceeds the assets’ fair market value at the time of an acquisition — for example, the company has an overall built-in loss — the benefit of recognizing that built-in loss during the five-year period following a transaction will be similarly limited.