United States: New Regulations Provide Advantageous Acquisition Structures

Last Updated: July 22 2013
Article by Howard S. Goldberg, Todd B. Reinstein and Clayton Garrett

New regulations issued by Treasury under Section 336(e)1 permit certain stock acquisitions to be treated as asset purchases, allowing buyers access to stepped-up asset basis and corresponding depreciation and amortization deductions.

Buyers lament that corporate dispositions frequently are structured as stock sales. A stock sale many times is the most practical structure because of difficulties that arise in assigning contracts and licenses, or satisfying regulatory approval, in the asset sale context. Further, sellers often prefer stock sales because they result only in shareholder-level tax. In contrast, asset sales generally result in corporate-level tax on the disposition of the assets and additional shareholder-level tax on the distribution of net proceeds.

Buyers, on the other hand, prefer asset acquisitions from a tax perspective because the assets' basis is stepped up, leading to greater depreciation and amortization tax benefits. In contrast, a stock acquisition provides a buyer with a purchase price basis in the stock acquired but historic (and often lower) asset basis inside the target.

A stock sale treated as an asset sale in which the seller is subject to only one level of tax, therefore, represents the best of both worlds.

For some time, this result has been available under Section 338(h)(10).2 That section, however, requires (among other criteria) that the purchasing entity be a corporation. Thus, unless a non-corporate purchaser forms a corporate acquiring intermediary, asset basis step-up is unavailable in the stock acquisition context for a non-corporate purchaser absent significant restructuring. Section 336(e) changes this and thus changes the playing field in corporate acquisitions.

Section 336(e) Requirements

Under Section 336(e), if a corporate seller or S corporation shareholder disposes of stock of a target corporation in a qualified stock disposition, an election may be made to treat the transaction as a sale of the target corporation's assets. For this purpose, in general:

  • a seller is a domestic corporation that makes a qualified stock disposition of stock of another corporation
  • an S corporation shareholder is a shareholder of the target corporation (if the target corporation is an S corporation)
  • a disposition of stock includes a sale, exchange or distribution. Notably, for this purpose, certain tax-free and related party transactions are excluded
  • the target corporation must be a domestic corporation (including an S corporation)
  • a qualified stock disposition is a transaction or series of transactions in which stock of the target corporation representing 80 percent of the vote and value is sold, exchanged or distributed (or any combination thereof) during a 12-month period
  • the purchaser can be one or more persons and/or entities (and is not restricted to corporate acquirers as in Section 338(h)(10)). This makes it easier to accommodate multiple buyers who have different profiles and want different end structures
  • the election is made by seller and the target corporation. If seller and target are members of the same consolidated group, the common parent of the group must attach the election to the group's return for the year that includes the disposition. If the target is an S corporation, it must attach the election to its return for the year that includes the disposition.

As stated above, if the Section 336(e) election is made, the seller is not treated as having disposed of the target corporation's stock but rather the target corporation is deemed to have sold its assets and then, generally, distributed the sale proceeds in liquidation, typically resulting in only one level of tax to the seller.

Pepper Perspective

Section 336(e) provides another tool in the M&A kit. In circumstances in which it applies, a stock sale can provide basis step-up to a buyer with only one level of tax to the seller. Importantly, and unlike in the Section 338(h)(10) context, the buyer need not be a corporation. Thus, pass-through entities can engage in basis step-up stock acquisitions without significant restructuring and then, in certain circumstances, proceed to operate the target in pass-through form.

For example, a fund can now acquire S corporation stock, achieve basis step-up via the Section 336(e) election and then convert the S corporation into a (wholly-owned) single-member limited liability company disregarded for tax purposes (via state statute or merger into a sister LLC) at no additional tax cost (provided there is no appreciation between the time of acquisition/election and the time of conversion). This would allow the fund to operate the business in pass-through form going forward.3

Section 336(e) is not without its twists and uncertainties, however. Because the election is made between the seller(s) and the target corporation, the buyer must be clear in any purchase agreement whether the election is (or is not) to be made.

Further, there is no provision for automatic extension for failure to timely file a Section 336(e) election. This might take some familiar with Rev. Proc. 2003-33, 2003-1 I.R.B. 803, which provides for such an extension in certain circumstances in the Section 338 context, by surprise.

Lastly, regulations under Section 3384 provide that certain transactions outside the ordinary course of business occurring on the date of acquisition are properly taken into account as occurring on the next day. This can have numerous effects. There is no such corresponding provision in the Section 336(e) regulations.

Overall, though, the Section 336(e) regulations provide the benefit of much greater flexibility in structuring corporation acquisitions. They are a welcome addition to the transactional quiver.


1 All Section references are to the Internal Revenue Code of 1986, as amended.

2 Provided certain criteria are met, Section 338(h)(10) permits a corporate acquisition of a threshold level of stock in an S corporation or affiliated group subsidiary to be treated as an acquisition of the target's assets with a net result of only one level of tax to the selling S corporation shareholder or affiliated corporate seller.

3 Before undertaking the conversion, the fund would have to make certain no unrelated business taxable income concerns arose from this structure.

4 Treas. Reg. Section 1.338-1(d).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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