Explore a recent M&A case involving a creative stock acquisition strategy with unexpected tax consequences. Learn how an IRS ruling imposed $10 million in penalties and interest on investors. Get insights into the legal complexities of midco transactions and their potential risks.
February 3, 2020
Introduction:
When a business is sold, choosing whether to sell its stock or its assets impacts the after-tax proceeds for the owner. Despite stock sales often favoring owners, buyers usually prefer asset acquisitions due to tax benefits. A recent case demonstrates a unique transaction aiming to give investors a stock sale and buyers an asset sale. The IRS, however, ruled it as an asset sale, leading to penalties of $10 million (plus interest) imposed on outside investors.
The Deal:
In this case, a company owned middle market TV stations, a production facility, and small market radio stations. The founders and outside investors held shares. Although the founders and investors preferred a stock sale for better after-tax profits, buyers wanted asset acquisitions. To balance this, a creative approach was used: the shareholders sold company stock to a facilitator for $117 million. The facilitator-owned corporation then sold TV and radio assets to separate buyers for $168 million and $7.5 million, respectively.
The Lawsuit:
The IRS audited the transaction and reclassified it as an asset sale, imposing $10 million in penalties and additions on the corporation. Since the corporation had no assets, it didn’t pay the penalties, or interest. The IRS utilized the transferee liability procedure under the Internal Revenue Code Section 6901 to collect these amounts from the outside investors. The investors contested this in Tax Court but lost. The court permitted using the Internal Revenue Code transferee liability provision, as investors received proceeds from the corporation when it was insolvent, amounting to constructive fraud under the Wisconsin Uniform Fraudulent Transfer Act.
Comment:
The transaction structure, termed a “midco transaction,” involves a middle entity buying company stock, followed by the company selling assets to the intended buyer. While this creative tax planning, if successful, can result in lower taxes, it also carries significant risks of taxes, penalties, and interest.
Case Reference:
This case is referred to as Alta V Limited Partnership v. Commissioner of Internal Revenue, Docket Nos. 26828-08, 26829-08, 26865-08, 26867-08, United States Tax Court (Filed January 13, 2020).
By John McCauley: I help companies and their lawyers minimize tax risk associated with small U.S. business mergers and acquisitions (transaction value less than $50 million).
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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