contingent consideration and contingent liabilities in acquisitions

133
ALI-ABA Course of Study
Corporate Taxation
Cosponsored by the ABA Section of Taxation
April 10 - 11, 2008
Washington, D.C.
Contingent Consideration and Contingent Liabilities in Acquisitions
By
Robert H. Wellen
Ivins, Phillips & Barker, Chartered
Washington, D.C.

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CONTINGENT CONSIDERATION AND
CONTINGENT LIABILITIES IN ACQUISITIONS
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OUTLINE
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MARCH 2008
ROBERT H. WELLEN
IVINS, PHILLIPS & BARKER
WASHINGTON, D.C.
TABLE OF CONTENTS
INTRODUCTION ...........................................................................................................................1
NOMENCLATURE ........................................................................................................................3
TAXABLE ASSET AND STOCK ACQUISITIONS.....................................................................4
I. Contingent Purchase Price in Acquisitions of Assets and Acquisitions of Stock
Without Section 338(h)(10) Elections .......................................................................................4
A. Treatment of Seller – Choice Between Installment Method and Election Out....................4
B. Treatment of Seller – Election Out of Installment Method .................................................4
1. Amount Realized at Closing ..........................................................................................4
2. Contingent Payments After Closing – Closed Transaction ...........................................7
3. Amounts Received After Closing – Open Transactions..............................................18
4. Allocation of Amounts Realized Among Assets Sold.................................................18
5. Possible Treatment of Contingent Purchase Price Obligation as Target Stock...........19
C. Treatment of Seller – Installment Method.........................................................................19
1. Application...................................................................................................................19
2. Election ........................................................................................................................19
3. Deferral Charge............................................................................................................19
4. Method of Calculating Gain Recognized.....................................................................20
5. Allocating Installment Obligation to Certain Assets ...................................................23
6. Net Benefits and Detriments of Installment Sale Method to Seller.............................24
D. Treatment of Acquiror .......................................................................................................24
1. Allocation of Contingent Purchase Price Among Assets Purchased...........................24
2. Specific Allocations – Intangible Assets .....................................................................25
3. Timing of Effects on Basis and Interest Deductions ...................................................25
4. Contracts for Use of Intangibles ..................................................................................25
5. Interest..........................................................................................................................25
E. Reporting Requirements ....................................................................................................26
1. Section 1060 Acquisitions ...........................................................................................26
2. Installment Method – Electing Out..............................................................................26
3. Installment Method ......................................................................................................26

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II. Contingent Purchase Price and Contingent Liabilities in Stock Acquisitions with
Section 338(h)(10) Elections – New 338 Regulations.............................................................26
A. Introduction........................................................................................................................26
B. Treatment of Old T ............................................................................................................27
1. Installment Method ......................................................................................................27
2. Election Out of Installment Method ............................................................................29
3. Allocation of Amounts Realized Among Assets Deemed Sold...................................32
4. Character of Amounts Realized...................................................................................32
C. Treatment of New T...........................................................................................................33
1. Allocation of Contingent Purchase Price and Contingent Liabilities Among Assets
Deemed Purchased.......................................................................................................33
2. Timing of Effects on Basis ..........................................................................................33
3. Elimination of Phantom Income ..................................................................................35
4. “Breaking the Link” Between ADSP and AGUB........................................................35
D. Reporting and Administrative Requirements.....................................................................36
1. Forms 8023 and 8883...................................................................................................36
2. Other Administrative Requirements ............................................................................37
II*. Contingent Purchase Price in Stock Acquisitions with Section 338(h)(10)
Elections – Old 338 Regulations..............................................................................................37
A. Treatment of Old T ............................................................................................................37
1. Installment Method Not Available...............................................................................37
2. Amount Realized at Closing ........................................................................................38
3. Amount Realized Upon Receipt ..................................................................................38
4. Allocation of Amounts Realized Among Assets Deemed Sold...................................38
5. Post-Closing Adjustments............................................................................................38
6. Recovery of Asset Basis ..............................................................................................39
7. Character of Amounts Realized – Actual and Imputed Interest ..................................39
B. Treatment of New T...........................................................................................................39
1. Allocation of Contingent Purchase Price Among Assets Purchased...........................39
2. Timing of Adjustments to New T’s Asset Basis..........................................................39
III. Escrows and Other Returns of Purchase Price.........................................................................39
A. Whose Property Is the Escrow .........................................................................................40
1. Inclusion of Escrowed Funds in Seller’s Amount Realized at Closing.......................40
2. Income on Escrowed Funds.........................................................................................40
B. If Escrow Is Acquiror’s Property.......................................................................................41
1. Escrow as Acquiror’s Property – Treatment at Closing to Seller................................41
2. Escrow as Acquiror’s Property – Treatment at Closing to Acquiror...........................41
3. Escrow as Acquiror’s Property – Income Earned on Escrowed Funds – Prop. Reg.
§ 1.468B-8....................................................................................................................41
4. Escrow as Acquiror’s Property – Treatment on Payment to Seller .............................42
5. Escrow as Acquiror’s Property – Treatment on Return of Escrowed Funds to
Acquiror .......................................................................................................................42
6. Escrow as Acquiror’s Property – Treatment on Use of Escrowed Funds to Pay
Seller Liabilities...........................................................................................................42
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C. If Escrow Is Seller’s Property............................................................................................43
1. Escrow as Seller’s Property – Treatment at Closing to Seller.....................................43
2. Escrow as Seller’s Property – Treatment of Escrow at Closing to Acquiror...............43
3. Escrow as Seller’s Property – Income Earned on Escrowed Funds ............................43
4. Escrow as Seller’s Property – Treatment on Payment to Seller ..................................44
5. Escrow as Seller’s Property – Treatment on Return to Acquiror ................................44
6. Escrow as Seller’s Property – Treatment on Use of Escrowed Funds to Pay Seller
Liabilities .....................................................................................................................45
D. If Escrowed Property Is Stock of Acquiror or Acquiror’s Parent in a Taxable
Acquisition.........................................................................................................................45
1. Escrowed Stock – Taxable Gain to Acquiror ..............................................................45
2. Escrowed Stock – Tax on Dividends...........................................................................46
IV. Contingent Liabilities in Taxable Asset Acquisitions .............................................................46
A. Introduction........................................................................................................................46
B. Whose Liability Contingent Liability or Defect in Assets What Is at Stake................46
1. Target’s or Acquiror’s Liability – Consequences........................................................46
2. Alternative Analysis.....................................................................................................47
3. Authorities....................................................................................................................47
4. Authorities on Employee and Retiree Compensation and Benefits.............................49
C. Treatment of Expenditures That Are Expenses of Acquiror .............................................51
1. Treatment at Closing and upon Payment by Acquiror.................................................52
2. Treatment of Indemnity Payment by Seller or Target to Acquiror..............................52
D. Treatment if Target’s Liability Assumed...........................................................................53
1. Non-Deductible Items..................................................................................................53
2. Deductible Items ..........................................................................................................54
3. Delayed Deductible Items – Section 404(a)(5)............................................................58
4. Capital Items of Target ................................................................................................58
5. Indemnity by Target to Acquiror – Retained Contingent Liabilities...........................58
E. Treatment if Target’s Liabilities Assumed – James M. Pierce Corp. Analysis ................59
1. Prior Use of Pierce Analysis........................................................................................59
2. Limits on Use of the Pierce Analysis ..........................................................................59
3. Consequences of Pierce Analysis................................................................................59
F. Treatment if Target’s Liabilities Assumed – Alternative Analyses...................................61
1. Acquiror Steps into Target’s Shoes .............................................................................61
2. Surprise Expenses ........................................................................................................61
3. Discounted Deduction..................................................................................................62
4. Possible IRS Guidance.................................................................................................62
V. Contingent Liabilities in Taxable Stock Acquisitions Without Section 338(h)(10)
Elections...................................................................................................................................62
A. Contingent Liabilities in General.......................................................................................62
B. Contingent Liabilities as Built-in Loss ..............................................................................62
1. Section 382(h)..............................................................................................................62
2. Consolidated Return Matters .......................................................................................63
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C. Indemnity by Seller for Target’s Contingent Liabilities....................................................64
1. General.........................................................................................................................64
2. Treatment to Seller.......................................................................................................64
3. Treatment to Acquiror and Target ...............................................................................65
D. Other Indemnities or Compensation Payments Between the Parties.................................66
1. Payments as Part of the Original Transaction..............................................................66
2. Payments as Part of a New Transaction.......................................................................66
TAX-FREE ACQUISITIONS .......................................................................................................66
VI. Contingent and Escrowed Stock in General ............................................................................66
A. Background and General Treatment ..................................................................................66
B. Advance Ruling Guidelines ...............................................................................................67
C. Commentary.......................................................................................................................67
D. Contingent and Escrowed Stock and the Continuity-of-Interest “Fixed”
Consideration Rule.............................................................................................................68
1. Background..................................................................................................................68
2. Proposed Regulations...................................................................................................68
3. Temporary Regulations................................................................................................68
VII. Escrowed Stock........................................................................................................................68
A. Escrowed Stock as “Stock”................................................................................................68
B. Treatment at Closing..........................................................................................................69
1. General.........................................................................................................................69
2. Stock Basis...................................................................................................................69
3. No Imputed Interest .....................................................................................................69
4. Effect on Continuity of Interest ...................................................................................69
C. Effect of Return of Escrowed Stock to Acquiror...............................................................69
1. Possible Analyses.........................................................................................................69
2. Returned Stock Valued at Closing...............................................................................69
3. Changes in Stock Value Taken into Account ..............................................................69
4. Effect of Return of Escrowed Stock on Continuity of Interest....................................70
VIII. Contingent Stock......................................................................................................................70
A. Contingent Stock as “Stock” – Continuity of Interest .......................................................70
B. Treatment at Closing..........................................................................................................70
C. Second Acquisition ............................................................................................................70
D. Treatment of Receipt by Former Target Shareholders – Imputed Interest ........................70
1. Imputed Interest ...........................................................................................................70
2. Interest Income to Target Shareholders as Received...................................................71
3. Deduction to Acquiror .................................................................................................71
4. Advantage of Escrowed Stock.....................................................................................72
E. Treatment of Receipt of Contingent Stock by Former Target Shareholders –
Effect on Basis of Acquiror Stock .....................................................................................72
F. Effect of Non-Receipt by Former Target Shareholders.....................................................72
IX. Options to Acquire Stock.........................................................................................................72
A. Treatment of Options as Zero-Principal Securities............................................................72
B. Treatment of Options as Boot in Certain Exchanges.........................................................72
C. Effect on Continuity of Interest .........................................................................................73
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X. Target’s Contingent Liabilities ................................................................................................73
A. “Assumption” of Liabilities ...............................................................................................73
1. Cross-Collateralized Debt -- Section 357(d)................................................................73
2. BOSS Transactions -- Reg. § 1.301-1(g).....................................................................74
3. Contingent Liability Shelters -- Notice 2001-17Section 358(h) and Section 362(e)...74
4. Partnership Liabilities ..................................................................................................75
B. Possible Effect of Assumption of Target’s Contingent Liabilities on Tax-Free
Reorganization Status ........................................................................................................79
1. Proposed Regulations on “Transactions Involving the Transfer of No Net Value”....79
2. Identity of the “Acquiring Corporation”......................................................................80
3. “Cause-to-Direct” Acquisitions ...................................................................................80
C. Deductions to Acquiror and Related Matters.....................................................................80
1. Acquisitive Reorganizations – “Step-in-the-Shoes” Treatment ..................................80
2. Acquisitive Reorganizations – Indemnities for Contingent Liabilities Paid by
Acquiror .......................................................................................................................80
3. Section 351 Exchanges – General................................................................................81
4. Section 351 Exchanges – Scope and Meaning of “Step-in-the-Shoes” Treatment .....82
5. Note on Contingent Liabilities in Divisive Type-D Reorganizations..........................84
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