Overview of QSPs and post-acquisition events
If a purchaser makes a section 338 election for its acquisition of target stock, then “new” target is treated as purchasing “old” target’s assets. This election is typically made so the purchaser has the benefit of a stepped-up basis in the target’s assets (e.g., amortization and depreciation). To be eligible for a section 338 election, the purchaser’s acquisition of target stock must meet the definition of a qualified stock purchase (QSP). A QSP is any transaction or series of transactions in which a purchasing corporation acquires stock of the target corporation (meeting the requirements of section 1504(a)(2)) by purchase within a 12-month acquisition period.3 As it relates to the QSP definition, a “purchase” essentially involves transactions in which the purchaser and seller of target stock are unrelated and the seller fully recognizes all gain or loss realized on the sale.4
Where a U.S. purchaser acquires the stock of a foreign target corporation, any stepped-up basis resulting from a section 338 election can, going forward, reduce the GILTI inclusion for U.S. shareholders—e.g., through increased depreciation / amortization or reduced gain if Target sells assets. Further, the “new” target does not inherit the E&P or accounting methods of the “old” target, as it is deemed to acquire the old target’s assets in a fully taxable sale.
Critically, the purchaser must be a corporation for the acquisition to qualify as a QSP; it cannot be an individual(s) or a partnership. An individual (or partnership) may form a corporation to acquire target stock, but only if that corporation is respected as the purchaser of target for all Federal tax purposes. Certain factors may indicate a newly formed corporation should not be respected as the purchaser of target stock, such as it merging downstream into target, liquidating or otherwise disposing of the target stock subsequent to the intended QSP.5 If a newly formed corporate purchaser is thereafter acquired by another corporation in a tax-free reorganization, it still must be respected as the true purchaser of target for federal tax purposes in order to qualify as a QSP.6
Congress intended section 338 election as the only way for taxpayers to treat an actual stock purchase as an asset acquisition.7 Consistent with Congressional intent, the IRS concluded in Rev. Rul. 90-958 that a QSP of a target followed by a merger of the target into the corporate purchaser is treated as a stock purchase followed by a section 332 liquidation of the target into the purchaser. This ruling is noteworthy because the IRS did not integrate the stock acquisition and merger under step transaction principles to treat the buyer as directly purchasing target’s assets.9 Thus, a purchaser’s acquisition of target stock it generally is respected as independent of any post-acquisition events if it otherwise qualifies as a QSP. The exception to this is when the stock purchase and post-transaction events would qualify as a tax-free reorganization when integrated under step transaction principles.10
QSPs followed by the amalgamation of purchaser and target
Does CanadaCo’s purchase of Target stock qualify as a QSP if CanadaCo and Target subsequently amalgamate, and is CanadaCo respected as the purchaser of Target for Federal tax purposes?
Consider the following facts:
- U.S Holdings, an LP treated as a partnership, forms CanadaCo, a Canadian corporation, solely to acquire the stock of Target, also a Canadian corporation.
- CanadaCo purchases 100% of the stock of Target for cash in what would otherwise meet the definition of a QSP.
- Immediately thereafter, CanadaCo and Target amalgamate pursuant to Canadian law.
In prior rulings, the IRS has characterized an amalgamation differently depending on which entity is considered the survivor. In situations where a parent and its subsidiary amalgamate, the IRS has treated the parent as the survivor and as becoming the owner of the subsidiary’s assets and liabilities. In these cases, the IRS has ruled that the amalgamation constitutes a tax-free liquidation of the subsidiary into its parent under section 332.11
In other rulings, where multiple targets amalgamate into newly formed AmalCo, the IRS has treated AmalCo as acquiring the assets and liabilities of each target corporation in a tax-free reorganization under section 368(a)(1).12 Arguably, this treatment can inform how companies assess the effect of a post-acquisition amalgamation on a purchase intended to be a QSP.
Scenario 1: CanadaCo is considered the survivor.
If CanadaCo is considered the survivor, Target is likely treated as liquidating into CanadaCo immediately after the purchase of Target stock. CanadaCo, the acquirer, remains in existence.
This result falls squarely within the facts of Rev. Rul. 90-95. As a result, CanadaCo’s purchase of Target stock is likely respected as a QSP.
The question becomes more involved if CanadaCo is not treated as the surviving entity in the amalgamation.
Scenario 2: AmalCo is considered the survivor.
If AmalCo is instead considered the survivor, both Target and CanadaCo are likely treated as transferring their assets and liabilities to newly formed AmalCo in an apparent reorganizations under section 368(a)(1).
As discussed, a stock purchase cannot qualify as a QSP unless the purchaser is a corporation. The key issue is whether CanadaCo, which was formed to acquire Target but ceases to exist after the amalgamation, is respected as the corporate purchaser of Target for Federal tax purposes. Though not clear, there are strong arguments for respecting CanadaCo as the purchaser. CanadaCo only ceases to exist as part of a section 381(a) transaction (reorganization) into AmalCo. Thus, AmalCo is not only the successor to CanadaCo and Target.
If the parent U.S. company (U.S. Holdings, in example above) were a corporation rather than a partnership, the post-acquisition amalgamation of Target and CanadaCo would not be an issue. In that instance, there would still be a clear corporate purchaser of Target. As such, our discussion here relates only to situations in which the parent U.S. company is a partnership (or at least not a corporation).
Summary
A U.S. company’s ability to make a section 338 election with respect to the purchase of a Canadian target corporation is impactful for U.S. federal income tax purposes, as it can affect its exposure to GILTI and subpart F income and eliminate certain attributes of the target (i.e., E&P, accounting methods etc..). If CanadaCo and Target amalgamate in the scenario discussed above, there is a question whether CanadaCo is respected as the corporate purchaser of Target stock and the transaction qualifies as a QSP. If Target is treated as liquidating into CanadaCo, then CanadaCo is likely respected as purchasing Target in a valid QSP. The answer is less clear cut if CanadaCo and Target are treated as amalgamating into newly formed AmalCo, the surviving entity. Even so, there is a solid basis for respecting CanadaCo as the purchaser of Target stock in a valid QSP.
This article expresses no views on when, in the scenarios above, CanadaCo, Target or AmalCo would be treated as the surviving entity or as ceasing to exist in an amalgamation. Each scenario is based only on the facts, assumptions and analysis of the rulings cited above involving the characterization of amalgamations for federal tax purposes.
