Explore a case study where a business owner’s merger decision resulted in a substantial tax impact of over $2 million. Learn how the chosen deal structure influenced tax outcomes and the implications for buyers and sellers. Seek expert tax advice to navigate complex M&A transactions effectively.
July 21, 2020
Introduction:
Selling a business has significant tax implications, but smart structuring can sometimes delay tax payments.
The Deal:
In this case, a business owner owned KFC and Pizza Hut franchises in Russia through a New Jersey corporation. The target company was owned 75% by the owner and 25% by a partner through a company in the British Virgin Islands. The owner sold the target to a Dutch company for $54 million – $23 million in cash and the rest in buyer stock. Just before closing, the owner bought out the partner for $14 million and later paid this amount post-closing. The merger finalized, and the owner received $31 million in stock and $23 million in cash.
Tax Issue:
The owner faced a tax dilemma due to having no tax basis in 75% of the target company. The purchase included buyer stock that could defer some gains. However, the owner’s tax position became complicated.
Lawsuit and IRS Argument:
The issue arose from how the owner received cash from the buyer. The owner received $9 million in cash, and the partner received $14 million. The IRS contended that if the partner had directly sold to the buyer, this split would make sense. But since the partner sold to the owner, the IRS argued the owner received $23 million cash, incurring over $2 million in immediate taxes.
Court Decisions:
Both the Tax Court and the U.S. Court of Appeals sided with the IRS. They reasoned that the owner had chosen the deal’s structure, impacting tax treatment. If the owner insisted the partner sold directly to the buyer, taxes would be different. But since the owner bought the partner’s stock before selling it to the buyer, taxes were based on the full cash amount received.
Takeaway:
This case emphasizes that the structure of a deal affects taxes. Seek expert tax advice when discussing the structure with a buyer or seller. Even if it seems unfair, the chosen structure determines tax outcomes. Unfortunately for taxpayers the reverse is not true. The IRS can disregard a taxpayer’s transaction’s form to match its substance, when it can generate higher taxes.
This case is referred to as Michael Tseytin v. Commissioner of Internal Reven, No. 16-1674 (3d Cir. 2017) https://law.justia.com/cases/federal/appellate-courts/ca3/16-1674/16-1674-2017-08-18.htmlTop
Conclusion:
This case underscores the importance of understanding the implications of deal structures on taxes. Seeking proper tax advice can prevent unexpected tax burdens. The story serves as a reminder that life isn’t always fair, and tax consequences can result from the chosen form of a transaction, regardless of its substance.
By John McCauley: I help manage the tax risks associated with buying or selling a business.
Email: jmccauley@mk-law.com
Profile: http://www.martindale.com/John-B-McCauley/176725-lawyer.htm
Telephone: 714 273-6291
Check out my book: Buying Assets of a Small Business: Problems Taken From Recent Legal Battles
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