Tax on corporate transactions in United States: overview

A Q&A guide to tax on corporate transactions in the United States.

The Q&A gives a high level overview of tax in the United States and looks at key practical issues including, for example: the main taxes, reliefs and structures used in share and asset sales, dividends, mergers, joint ventures, reorganisations, share buybacks, private equity deals and restructuring and insolvency.

To compare answers across multiple jurisdictions, visit the Tax on Corporate Transactions Q&A tool Country Q&A tool. The Q&A is part of the Practical Law global guide to tax on corporate transactions. For a full list of jurisdictional Q&As visit www.practicallaw.com/taxontransactions-mjg.

Contents

Tax authorities

1. What are the main authorities responsible for enforcing taxes on corporate transactions in your jurisdiction?

The primary authority responsible for administering and enforcing federal taxes (including taxes relating to corporate transactions) in the US is the Internal Revenue Service (IRS), a bureau of the US Department of Treasury. In addition, each state has a separate taxing authority that administers and enforces taxes imposed by that state.

Pre-completion clearances and guidance

2. Is it possible to apply for tax clearances or obtain guidance from the tax authorities before completing a corporate transaction?

In certain situations taxpayers can request a written determination from the Internal Revenue Service (IRS) regarding the tax consequences of a transaction (either before the transaction is completed or before the tax return is filed for the year of the transaction) by requesting a private letter ruling. This process is governed by the Associate Chief Counsel (Corporate) of the IRS. However, a private letter ruling is in the discretion of the IRS and is typically reserved for cases where the underlying issue is not clearly addressed in published authorities (that is, unlike in many jurisdictions, the IRS does not issue "comfort rulings" that apply settled law to a clear factual situation). The IRS annually publishes a list of specific areas and issues for which no clearance or guidance will be issued. A private letter ruling can usually be relied on by the taxpayer that requested it, but can also be revoked or modified if found to be issued in error or if there is a change in law. A taxpayer can also seek oral guidance from the IRS; however, any oral guidance given is advisory and is not binding on the IRS. Certain state and local taxing authorities also have ruling processes available for certain state and local tax issues.

 

Main taxes on corporate transactions

Transfer taxes and notaries' fees

3. What are the main transfer taxes and/or notaries' fees potentially payable on corporate transactions?

The federal government does not generally impose transfer taxes, but many state or local tax authorities do.

Real property transfer tax

Key characteristics. Real property transfer tax is the most common type of transfer tax. It is payable on the transfer of real property physically located within the relevant state or local jurisdiction. The rate and rules applicable to real property transfer taxes vary considerably depending on the particular state or local jurisdiction. Also subject to considerable variation, is whether the tax applies only to an actual transfer of the real property, or whether the tax applies to a transfer of an interest in an entity that owns the real property.

Triggering event. The tax is triggered on transfer of real property physically located within the relevant state or local jurisdiction, and may be triggered by a transfer of an interest in an entity that owns the real property.

Liable party/parties. The rules applicable to real property transfer taxes vary considerably depending on the particular state or local jurisdiction.

Applicable rate(s). The rates applicable to real property transfer taxes vary considerably depending on the particular state or local jurisdiction.

Sales tax

Key characteristics. Sales tax is another common type of transfer tax. The rate and rules applicable to sales taxes vary considerably depending on the particular state or local jurisdiction, but the tax applies generally only to sales of goods in the ordinary course of business at retail. Sales taxes often do not apply to sales of services, and sales of goods to persons who resell the goods in the ordinary course of business are generally exempt from sales tax. Many states also exempt bulk sales of inventory and the transfer of an entire trade or business from sales tax. The obligation to collect sales taxes generally applies only to corporations with a sufficient presence within the relevant state or local jurisdiction.

Triggering event. The tax is triggered generally only by sales of goods in the ordinary course of business at retail.

Liable party/parties. The rules applicable to sales taxes vary considerably depending on the particular state or local jurisdiction.

Applicable rate(s). The rates applicable to sales taxes vary considerably depending on the particular state or local jurisdiction.

Stamp duty

Jurisdictions in the US do not generally impose non-de minimis stamp duties on transfers of corporate shares.

Corporate and capital gains taxes

4. What are the main corporate and/or capital gains taxes potentially payable on corporate transactions?

Corporate income tax

Key characteristics. A corporation organised under the laws of the US or any state (including for this purpose, the District of Columbia) is subject to US corporate tax on its worldwide income and gains. Corporate income tax is imposed at graduated rates up to 35% (plus any applicable state or local corporate tax). While the Internal Revenue Code distinguishes between "capital gain" and "ordinary income", both capital gain and ordinary income of a corporation are taxed at the same rate. The principal significance of the character distinction is that capital losses are only available to offset capital gains, so a corporation with excess capital losses will have a preference for capital gains over ordinary income. Corporations may also be eligible for certain reliefs (for example, a "dividends received deduction" for dividends received from other corporations, or the ability to file a consolidated tax return with other members of an 80%-controlled affiliated group). Significantly more complicated tax rules apply to non-corporate entities, such as partnerships and limited liability companies. This discussion assumes that all relevant entities are organised in corporate form and have corporate shareholders.

Most corporations use a calendar year with the annual taxable year running from 1 January through to 31 December. For a calendar year corporation, quarterly estimated tax payments are required throughout the year, and the corporate income tax is due on 15 March of the immediately following year. The corporate income tax return is due on 15 March of the immediately following year as well, although most corporations obtain an automatic six-month extension for filing the tax return until 15 September (but not for payment of the tax). The due dates for the tax and the tax return are appropriately adjusted for corporations that use a taxable year other than the calendar year.

Corporate taxable income is calculated according to rules specified in the Internal Revenue Code and by Internal Revenue Service (IRS) authorities. Unlike in many jurisdictions, income as calculated for accounting or book purposes is not used as the starting point for corporate taxable income, and in fact, corporate taxable income tends to be calculated in a very different manner from accounting or book income.

Triggering event. Corporate income tax is triggered when a corporation receives income/gain during its taxable year.

Liable party/parties. Corporations receiving income/gain during their taxable year.

Applicable rate(s). Corporate income tax is imposed at graduated rates up to 35% (plus any applicable state or local corporate tax). While the Internal Revenue Code distinguishes between "capital gain" and "ordinary income", both capital gain and ordinary income of a corporation are taxed at the same rate.

Value added and sales taxes

5. What are the main value added and/or sales taxes potentially payable on corporate transactions?

Sales tax

Key characteristics. There is no federal sales tax, but state and local sales taxes are common. The rate and rules applicable to sales taxes vary considerably depending on the particular state or local jurisdiction, but the tax generally applies only to sales of goods in the ordinary course of business at retail. Sales taxes often do not apply to sales of services, and sales of goods to persons who resell the goods in the ordinary course of business are generally exempt from sales tax. Many states also exempt bulk sales of inventory and the sale of an entire trade or business from sales tax. The obligation to collect sales taxes generally applies only to corporations with a sufficient presence within the relevant state or local jurisdiction.

Triggering event. The tax is triggered generally only by sales of goods in the ordinary course of business at retail.

Liable party/parties. The rules applicable to sales taxes vary considerably depending on the particular state or local jurisdiction.

Applicable rate(s). The rates applicable to sales taxes vary considerably depending on the particular state or local jurisdiction.

Value added tax

No jurisdiction in the US currently imposes a value added tax.

Other taxes on corporate transactions

6. Are any other taxes potentially payable on corporate transactions?

The taxes identified above in Questions 3, 4 and 5 are the principal taxes applicable to corporations.

Taxes applicable to foreign companies

7. In what circumstances will the taxes identified in Questions 3 to 6 be applicable to foreign companies (in other words, what "presence" is required to give rise to tax liability)?

Corporate income tax

A corporation organised outside the US is subject to corporate income tax only on:

  • Income and gains that are effectively connected with the conduct of business in the US (and if required under the terms of a relevant treaty, if that conduct is attributable to a "permanent establishment" as defined under the terms of the treaty).

  • Certain US-source income that is fixed, determinable, annual, or periodic (for example, dividends, interest, royalties, annuities, and so on).

For these purposes, gain from real estate owned by such a corporation in the US, or in shares of a US corporation that principally holds real estate assets is treated as effectively connected income, subject to US taxation under special rules (including enforcement through withholding on the gross proceeds of any disposition of those assets).

Unlike many jurisdictions, mere "presence" or "management and control" within the US does not make a foreign corporation subject to US corporate income tax on its worldwide income or gains.

Real property transfer tax

Real property transfer tax applies in the same manner to US and foreign corporations (see Question 3, Real property transfer tax).

Sales tax

Sales tax applies in the same manner to US and foreign corporations (see Question 3, Sales tax and Question 5, Sales tax).

 

Dividends

8. Is there a requirement to withhold tax on dividends or other distributions?

A corporate distribution is treated as a dividend to the extent that the distribution is made from the corporation's current year or historic earnings and profits. A dividend paid by a US corporation to non-US stockholders is generally subject to a 30% withholding tax, subject to reduction or elimination by an applicable income tax treaty. Corporate distributions in excess of current and historic earnings and profits are generally not subject to withholding tax. A foreign corporation that conducts business in the US must pay a branch profits tax that attempts to mimic the withholding tax that would apply if the foreign corporation conducted its US business through a wholly-owned US corporate subsidiary. In addition, any dividends can become subject to withholding under the FATCA rules if the recipient corporation does not comply with FATCA's information reporting requirements.

 

Share acquisitions and disposals

Taxes potentially payable

9. What taxes are potentially payable on a share acquisition/share disposal?

A corporation that disposes of shares of another corporation recognises gain or loss for US corporate income tax purposes.

Corporate income tax

US corporate income tax is at graduated rates up to 35% (plus any applicable state or local corporate tax). See Question 4.

Note that a corporation that sells stock of another member of the same consolidated group may be able to make an election under section 338 or 336(e) of the (Internal Revenue Code) to treat the sale as a disposition of assets for tax purposes.

A corporation is not taxed on the acquisition or disposal of its own shares.

Exemptions and reliefs

10. Are any exemptions or reliefs available to the liable party?

Offsetting

Unlike many jurisdictions, the US does not have a "participation exemption" or other exemption for gain recognised on sale of stock by a corporation. However, a corporation can generally offset other capital or ordinary losses against gain on sale of corporate stock. A corporation may also be able to carry excess capital or ordinary losses forward or backward from other taxable years in order to offset gain on sale of corporate stock.

If the seller exchanges corporate stock for stock of an acquiring corporation, in certain cases it may be possible for the exchange to qualify as a tax-deferred exchange on which no gain or loss is recognised (see Questions 20 and 21).

Deduction on dividends received

A corporation that receives a dividend from another corporation may be eligible for a "dividends received deduction" ranging from 70% to 100% of the dividend, depending on the corporation's ownership interest in the payer and certain other factors.

Tax advantages/disadvantages for the buyer

11. Please set out the tax advantages and disadvantages of a share acquisition for the buyer.

Advantages

If the target has valuable tax attributes (such as net operating losses, capital losses, or tax basis) those tax attributes remain with the target in the hands of the buyer. However, various US tax rules can limit use of tax attributes where a corporation undergoes an ownership change. Acquiring stock of the target also minimises the expense and administrative inconvenience of transferring assets and may facilitate transactions where assets cannot effectively be transferred.

Disadvantages

In a stock acquisition, the target's asset basis is unaffected by the ownership change. Therefore, if the target's assets have a value greater than the target's asset basis, the target will generally not receive a "basis step-up" to fair value as a result of a stock acquisition (unless the acquisition is eligible for, and the parties agree to make certain elections to treat the transaction as an asset sale) whereas, an asset purchase would result in a basis step-up to fair value. Therefore, by buying stock, the buyer foregoes a basis step-up and the associated depreciation and amortisation deductions that typically result. In addition, the buyer generally inherits the tax history of the target, including any historic liability.

Tax advantages/disadvantages for the seller

12. Please set out the tax advantages and disadvantages of a share disposal for the seller.

Advantages

Sale of stock of the target minimises the expense and administrative inconvenience of transferring assets and may facilitate transactions where assets cannot effectively be transferred. A share disposition is also advantageous if the seller's tax basis in the target stock is greater than the target's basis in its assets, because in that case, the sale of stock results in less taxable gain than a sale of assets.

Disadvantages

A share disposition is disadvantageous if the seller's tax basis in the target stock is less than the target's basis in its assets, because in that case, the sale of stock results in more taxable gain than a sale of assets.

Transaction structures to minimise the tax burden

13. What transaction structures (if any) are commonly used to minimise the tax burden?

There are no structures commonly used to minimise the corporate tax burden associated with share dispositions. If cash consideration is received after the taxable year in which the transaction occurs (for example, through payment of a note or an earnout) it may be possible to defer the recognition of gain under the instalment method of reporting.

 

Asset acquisitions and disposals

Taxes potentially payable

14. What taxes are potentially payable on an asset acquisition/asset disposal?

Corporate income tax

A corporation that disposes of assets recognises gain or loss for US corporate income tax purposes. US corporate income tax is at graduated rates up to 35% (plus any applicable state or local corporate tax). Gain or loss recognised may be capital or ordinary depending on the nature of the assets (see Question 4).

Real property transfer tax

Federal government does not generally impose transfer taxes, but many state or local tax authorities do. The most common type of transfer tax is on the transfer of real property physically located within the relevant state or local jurisdiction. The rate and rules applicable to real property transfer taxes vary considerably depending on the particular state or local jurisdiction. Also subject to considerable variation is whether the tax applies only to an actual transfer of the real property, or whether the tax applies to a transfer of an interest in an entity that owns the real property.

Sales tax

There is no federal sales tax but state and local sales taxes are common. The rate and rules applicable to sales taxes vary considerably depending on the particular state or local jurisdiction, but the tax generally applies only to sales of goods in the ordinary course of business at retail. Sales taxes often do not apply to sales of services, and sales of goods to persons who resell the goods in the ordinary course of business are generally exempt from sales tax. Many states also exempt bulk sales of inventory and the transfer of an entire trade or business from sales tax. The obligation to collect sales taxes generally applies only to corporations with a sufficient presence within the relevant state or local jurisdiction.

Exemptions and reliefs

15. Are any exemptions or reliefs available to the liable party?

Offsetting

A corporation can generally offset unrelated ordinary losses against capital or ordinary gain on sale of assets. Capital losses can only be used to offset capital gains. A corporation may also be able to carry excess capital or ordinary losses forward or backward from other taxable years to offset gain on sale of assets.

In certain cases, if assets are exchanged for corporate stock or for certain types of other assets similar to the exchanged assets, it may be possible for the exchange to qualify as a tax-deferred exchange on which no gain or loss is recognised.

Tax advantages/disadvantages for the buyer

16. Please set out the tax advantages and disadvantages of an asset acquisition for the buyer.

Advantages

If the target's assets have a value greater than the target's asset basis, the purchaser will receive a "basis step-up" to fair value as a result of acquisition of the assets, whereas, a stock acquisition would result in a (lower) carryover basis. Therefore, by buying assets the buyer obtains the benefit of the basis step-up and the associated depreciation and amortisation deductions that typically result. In addition, except under unusual circumstances, the buyer generally does not inherit the tax history and historic tax liabilities of the target.

Disadvantages

If the target has valuable tax attributes (such as net operating losses, capital losses or tax basis) these tax attributes remain with the target and do not carry over to the buyer (although various US tax rules can limit use of tax attributes where a corporation undergoes an ownership change, so the tax attributes may be more valuable in the hands of the target). There can also be substantial expense and administrative inconvenience in transferring assets and there may be difficulty transferring particular assets.

Tax advantages/disadvantages for the seller

17. Please set out the tax advantages and disadvantages of an asset disposal for the seller.

Advantages

An asset disposition may be advantageous if the target's tax basis in its assets is greater than the stock basis in the target's shares because in that case, the sale of assets will result in less taxable gain than a sale of stock.

Disadvantages

An asset disposition is disadvantageous if the target's tax basis in its assets is less than the stock basis in the target's shares because in that case, the sale of assets results in more taxable gain than a sale of stock. An asset disposition is also disadvantageous if it results in substantial state or local transfer taxes or if it requires the transfer of assets that cannot be easily transferred.

Transaction structures to minimise the tax burden

18. What transaction structures (if any) are commonly used to minimise the tax burden?

There are no structures commonly used to minimise the tax burden associated with an asset sale. If cash consideration is received after the taxable year in which the transaction occurs (for example, through payment of a note or an earnout) it may be possible to defer the recognition of gain under the instalment method of reporting.

 

Legal mergers

Taxes potentially payable

19. What taxes are potentially payable on a legal merger?

Corporate income tax

The effects of a taxable merger generally depend on the structure of the merger and the nature of the consideration. A taxable reverse subsidiary merger (where the acquirer forms a shell company that merges with and into the target, with the target surviving the merger) is treated as a stock purchase by the acquirer, in which the shareholders of the target generally recognise capital gain. A forward taxable merger (whether a forward merger of the target into the acquirer with the acquirer surviving or a forward subsidiary merger of the target with and into a newly formed shell subsidiary of the acquirer) is generally treated as an asset sale by the target in which the target is taxable on the gain in its assets, followed by a liquidation of the target. See also Question 4.

The potential impact arising from the nature of the consideration (for example, the stock of the acquirer or cash) is discussed in Question 20 below.

Exemptions and reliefs

20. Are any exemptions or reliefs available to the liable party?

Offsetting

Unlike many jurisdictions, the US does not have a "participation exemption" or other exemption for gain recognised on sale of stock by a corporation. However, a corporation can generally offset other capital or ordinary losses against gain on sale of corporate stock. A corporation may also be able to carry excess capital or ordinary losses forward or backward from other taxable years in order to offset gain on sale of corporate stock.

If the seller exchanges corporate stock for stock of an acquiring corporation in a merger, in certain cases it may be possible for the exchange to qualify as a tax-deferred exchange on which no gain or loss is recognised (see Tax-free reorganisation provisionsbelow).

Tax-free reorganisation provisions

If the merger satisfies all of the formal requirements of a "reorganisation" as described in section 368(a) of the Internal Revenue Code, taxation of the transaction will generally be deferred for US federal income tax purposes for the target corporation, the acquiring corporation and their shareholders. There are seven enumerated transactions that qualify as a "reorganisation". Each of them that are most relevant to mergers generally require that:

  • The combined entity continues to conduct its historic business.

  • The shareholders of the target entity receive a specified percentage of their consideration in the form of stock of the combined entity (or stock of an immediate parent).

  • There is a legitimate business purpose.

The availability of the reorganisation provisions and the requirements necessary to access the relief, depend on the structure chosen for the transaction.

If a merger qualifies as a reorganisation, the transferring shareholders do not recognise gain or loss except that gain is recognised to the extent of any cash or the fair market value of other ineligible property received in the transaction. This gain is generally treated as capital gain (unless treated as "essentially equivalent to a dividend" under applicable rules). Shareholders take a carryover basis in the stock of the combined entity received in the merger (increased by any gain recognised). The target corporation also generally does not recognise gain or loss on the deemed transfer of its assets in the merger (if the transaction is otherwise structured as a forward merger).

Transaction structures to minimise the tax burden

21. What transaction structures (if any) are commonly used to minimise the tax burden?

Tax-free reorganisation provisions

If the merger satisfies all of the formal requirements of a "reorganisation" as described in section 368(a) of the Internal Revenue Code, taxation of the transaction will generally be deferred for US federal income tax purposes for the target corporation, the acquiring corporation and their shareholders (see Question 20, Tax-free reorganisation provisions).

"Double Dummy" Structure

Most commonly used in a "merger of equals" scenario, this is a transaction structure where each of the combining corporations is simultaneously acquired by a newly formed corporation through a reverse subsidiary merger or by contribution of shares. The structure can achieve tax deferral if certain conditions are met.

 

Joint ventures

Taxes potentially payable

22. What taxes are potentially payable on establishing a joint venture company (JVC)?

In general, JVCs can be formed by joint venture partners without incurring tax. There are exceptions if:

  • The joint venture partner receives cash or property other than equity in exchange for its contribution to the JVC.

  • The liabilities transferred to the JVC by the joint venture partner exceed the basis in the assets it transferred.

To the extent that the transaction is taxable, the joint venture partner pays tax at corporate rates.

Corporate income tax

See Question 4.

Sales tax

In addition, it is possible that the transfer of property to a JVC could attract state and local transfer or sales tax (see Question 5).

Exemptions and reliefs

23. Are any exemptions or reliefs available to the liable party?

Offsetting

A corporation can generally offset other capital or ordinary losses against any gain realised on the transfer of assets to a JVC. A corporation may also be able to carry excess capital or ordinary losses forward or backward from other taxable years in order to offset such gain.

Transaction structures to minimise the tax burden

24. What transaction structures (if any) are commonly used to minimise the tax burden?

In general, JVCs can be formed by joint venture partners without incurring tax.

Formation of a JVC as a corporation

Provided that immediately after the contribution, the contributing joint venture partners own 80% or more of the total combined voting of the corporation and 80% of the total number shares of all other classes of stock of the corporation, the simultaneous contribution of assets to a JVC formed as a corporation by joint venture partners in exchange for equity in the JVC is generally not taxable. There are exceptions if:

  • The joint venture partner receives cash, property other than equity, or certain types of limited and preferred equity in exchange for its contribution to the JVC.

  • The liabilities transferred to the JVC by the joint venture partner exceed the basis in the assets it transferred.

Formation of a JVC as a partnership

The formation of a JVC as a limited partnership or limited liability company treated as a partnership for US federal income tax purposes can also be accomplished without tax unless the contributing partner receives cash or property other than equity in the JVC (including liability relief) and certain other conditions are met.

 

Company reorganisations

Taxes potentially payable

25. What taxes are potentially payable on a company reorganisation?

Corporate income tax

Single company reorganisations (such as the mere movement of the place of incorporation from one state to another or a recapitalisation of the equity and other "securities" of the corporation) can generally be accomplished without corporate tax. A corporation can however recognise cancellation of indebtedness income subject to tax in a single corporation recapitalisation if its debt securities are exchanged for stock or other securities with a value less than the then-current adjusted issue price of those debt securities.

Multi-company reorganisations can be subject to corporate tax if they do not meet the requirements to be treated as a tax-free reorganisation.

Exemptions and reliefs

26. Are any exemptions or reliefs available to the liable party?

Tax-free reorganisation provisions

If the transaction satisfies all of the formal requirements of a "reorganisation" as described in section 368(a) of the Internal Revenue Code, taxation of the transaction will generally be deferred for US federal income tax purposes for the target corporation, the acquiring corporation and their shareholders (see Question 20, Tax-free reorganisation provisions).

Transaction structures to minimise the tax burden

27. What transaction structures (if any) are commonly used to minimise the tax burden?

Offsetting

If a reorganisation transaction is taxable, a corporation can generally offset other capital or ordinary losses against any gain realised on the transfer of assets or stock or upon realisation of cancellation of indebtedness income. A corporation may also be able to carry excess capital or ordinary losses forward or backward from other taxable years in order to offset such gain.

 

Restructuring and insolvency

28. What are the key tax implications of the business insolvency and restructuring procedures in your jurisdiction?

Tax implications for the business

Generally a corporation that has filed for bankruptcy is taxed in the same manner as a corporation that has not filed for bankruptcy.

Even if the payment of its debt in full is not certain, there is a position that the corporation may continue to deduct interest on its debt as it accrues.

On emerging from bankruptcy (or such earlier time as its debts are discharged) the corporation will generally recognise cancellation of indebtedness income to the extent of its debt relief. Provided that the corporation has filed for bankruptcy, that cancellation of indebtedness income is excluded from income, though the corporation must reduce its available tax attributes (including loss carried forward, credits, and tax basis in assets) by the amount of such cancellation of indebtedness income (but not below the amount of the liabilities of the corporation at the time of emergence). An insolvent debtor that has not filed for bankruptcy can also exclude cancellation of indebtedness income to the extent of its insolvency.

If the restructuring constitutes a change of control, the ability of the corporation to use its loss carried forward in the future is limited. There are special and beneficial rules for calculating the amount of this limitation for a corporation emerging from bankruptcy.

Tax implications for the owners

Generally the owners of a business in bankruptcy are also taxed in the same manner as owners of a business outside of bankruptcy. If and at the time the stock held by the owner becomes wholly worthless (including option value) the owner may be entitled to a worthless stock deduction in amount equal to its remaining basis in the business.

Tax implications for the creditors

In general, the creditors of a business in bankruptcy continue to be taxed in the same manner as the owner of a business outside of bankruptcy. However, there is a position that if it is unlikely that the holder's debt will be paid in full, the holder may cease to accrue interest on the debt. In addition, if and at the time the debt becomes wholly worthless (including option value) the holder may be entitled to a bad debt deduction in amount equal to its remaining basis in the business.

The exchange of debt for equity or other securities of the debtor upon emergence from bankruptcy can be treated either as a taxable transaction or as a "recapitalisation" that is not subject to tax, depending on the facts and circumstances.

 

Share buybacks

Taxes potentially payable

29. What taxes are potentially payable on a share buyback? (List them and cross-refer to Questions 3 to 6 as appropriate.)

In general, a corporation buying back its own shares is not subject to tax on the buyback. The shareholder:

  • Is treated as if it received a dividend to the extent of the earnings and profits of the corporation, if the share buyback does not significantly reduce the shareholder's proportionate share of the corporation.

  • Recognises taxable gain or loss as if it sold its shares, if the share buyback does not significantly reduce the shareholder's proportionate share of the corporation.

Withholding tax

Where a share buyback is treated as a dividend, withholding tax may be due on share repurchases from foreign persons. A corporation that is treated as receiving a dividend from another corporation under these rules may be eligible for a "dividends received deduction" ranging from 70% to 100% of the dividend, depending on the corporation's ownership interest in the payer and certain other factors.

Exemptions and reliefs

30. Are any exemptions or reliefs available to the liable party?

Offsetting

A corporation can generally offset other capital or ordinary losses against any gain realised on the transfer of stock. A corporation may also be able to carry excess capital or ordinary losses forward or backward from other taxable years in order to offset such gain.

Transaction structures to minimise the tax burden

31. What transaction structures (if any) are commonly used to minimise the tax burden?

There are no transaction structures commonly used to minimise the tax burden of a share buyback.

 

Private equity financed transactions: MBOs

Taxes potentially payable

32. What taxes are potentially payable on a management buyout (MBO)?

Capital gains tax

A MBO generally involves the acquisition of a corporation using a newly incorporated entity funded with cash from a third party, debt and rollover equity from management. The same tax issues applicable to any other acquisition of an entity apply to a MBO. However, capital gains of individuals are taxable at a 20% rate (plus a 3.8% medicare tax on "net investment income").

Individual income tax

Where management is cashed out of stock options or bonus plan arrangements to facilitate the MBO, management is taxed as compensation income for the amount of any cash received. The top marginal individual income tax rate is currently 39.6%. Compensation is also subject to withholding for social security and medicare taxes.

Where management is cashed out of restricted stock to facilitate the MBO, the tax consequences are more complicated and depend on:

  • Whether an election was made to treat the receipt of such stock (rather than the vesting) as the taxable event under section 83(b) of the Internal Revenue Code.

  • Whether the restricted stock is vested or unvested as of the time of the cash-out.

Exemptions and reliefs

33. Are any exemptions or reliefs available to the liable party?

Management rollover

It is often possible to structure the rollover of management's current equity interest or options of the target into equity interests or options (as applicable) of the newly incorporated entity for tax deferral.

Transaction structures to minimise the tax burden

34. What transaction structures (if any) are commonly used to minimise the tax burden?

Management rollover

It is often possible to structure the rollover of management's current equity interest or options of the target into equity interests or options (as applicable) of the newly incorporated entity for tax deferral.

Tax consolidation

After the transaction, the newly incorporated entity and the target generally elect to file a consolidated US federal income tax return so that the target can offset its income against the deductions generated by the interest on the newly incorporated entity's third party debt.

 

Reform

35. Please summarise any proposals for reform that will impact on the taxation of corporate transactions.

At any given point in time, there are proposals for reform of the US tax rules that, if enacted, could impact the consequences described above. These proposals range from comprehensive tax reform to changes in the way specific transactions are taxed. Following the November 2014 national elections, the Republican Party holds a majority of seats on both houses of the legislative branch of government. Republican leadership has stated that tax reform is one of their primary objectives. However, given that the President (whose term expires in early 2017) is a member of the Democratic Party, it is unclear what, if any, tax reforms will be enacted.

 

Online resources

Internal Revenue Code, Regulations and Other Guidance

W www.irs.gov/Tax-Professionals/Tax-Code,-Regulations-and-Official-Guidance

Description. This site contains a series of links to certain primary federal tax authorities, including the Internal Revenue Code (maintained by The Legal Information Institute of Cornell University Law School), Treasury regulations and certain other guidance.

US Income Tax Treaties

W www.irs.gov/Businesses/International-Businesses/United-States-Income-Tax-Treaties---A-to-Z

Description. This site is maintained by the Internal Revenue Service (IRS) and contains links to current US income tax treaties with other nations, as well as the technical explanations where available.

FATCA Resources

W www.treasury.gov/resource-center/tax-policy/treaties/Pages/FATCA.aspx

Description. This site is maintained by the Department of Treasury and contains significant resources relating to FATCA, including an updated list of all IGAs currently in effect.



Contributor profiles

Gregory W Gallagher, PC, Partner

Kirkland & Ellis LLP

T +1 312 862 2087
F +1 312 660 0536
E gregory.gallagher@kirkland.com
W www.kirkland.com

Professional qualifications. Licensed to practice law in Illinois.

Areas of practice. Mergers and acquisitions; cross-border tax structuring; bankruptcy, restructuring and insolvency transactions; capital markets transactions; real estate investment trusts.

Russell S Light, Partner

Kirkland & Ellis LLP

T +1 212 446 6470
F +1 212 446 4900
E russell.light@kirkland.com
W www.kirkland.com

Professional qualifications. Licensed to practice law in New York, Illinois and the District of Columbia.

Areas of practice. Mergers and acquisitions; cross-border tax structuring; bankruptcy, restructuring and insolvency transactions; capital markets transactions; investment fund formation; real estate investment trusts.

Sara Zablotney, Partner

Kirkland & Ellis LLP

T +1 212 446 6470
F +1 212 446 6460
E sara.zablotney@kirkland.com
W www.kirkland.com

Professional qualifications. Licensed to practice law in New York.

Areas of practice. Mergers and acquisitions; cross-border tax structuring; bankruptcy, restructuring and insolvency transactions; capital markets transactions; investment fund formation; real estate investment trusts.


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