Tax planning considerations for a future sale or purchase of a bank
INSIGHT ARTICLE |
For the past several years there has been a consistent wave of mergers and acquisitions within the banking industry. There are many reasons why the banking industry continues to shrink but clearly the trend is expected to continue for the foreseeable future. While only a handful of new bank charters have been approved on a national basis in the past five years, the pace of consolidation has averaged 270 deals per year. From a percentage basis, this translates to 4.5 percent of total U.S. bank charters disappearing each year.
With all this M&A activity and excitement, it’s likely that your bank is at least considering either a sale of the company or actively looking for strategic acquisitions to grow your balance sheet. While tax should never be the only driver of a business decision you make, it certainly should be heavily considered. RSM would like to help your planning by releasing a series of banking industry focused M&A tax articles to guide you through the potential tax challenges and road blocks that you may encounter.
Over the next several months, we will take an in-depth look into various tax related current topics and developments related to banking M&A. The emphasis of our M&A tax series will be on what your bank can do and plan for in advance of a deal to either position your bank to maximize your value to a prospective acquirer or protect your bank from surprises with respect to the acquisition of a target.
Pre-merger or pre-acquisition tax planning and considerations
Whether your bank is a potential target or a potential buyer, it always makes sense to plan ahead from a tax perspective (i.e. “getting your house in order”). Negotiating a deal can be a time consuming and costly exercise as it is. If you anticipate that you might be pursuing a deal in the next year or so, tax planning in advance is a smart idea to maximize shareholder value and to avoid any tax pitfalls or unnecessary marks to your purchase price which could pop up during deal negotiations.
First and foremost, both the buyer and seller should consider the form/substance of the transaction that suits each party best from both a structuring perspective and from a tax perspective. In different situations, it may make sense to structure a deal as a sale of assets and sometimes as a merger and/or sale of stock. In many instances, other business reasons drive this decision.
As a seller, there are several items to consider. It is important that you step back and perform a tax due diligence analysis on yourself. Do you have any uncertain tax positions (ASC 740-10) that may have not been disclosed properly which would be discovered in the due diligence process by the buyer? These positions could represent unrecorded contingent liabilities from future IRS/State audits. Do you have any other tax exposures such as sales/use, city, or property taxes that need to be resolved? Are you filing an income tax return in every state that you should be filing in given the complex state nexus requirements (if not, the statute of limitations on a potential tax assessment never closes)?
In addition, you may want to execute strategies to obtain more value from a buyer for your deferred tax assets. Will there be a “change in control” event upon the sale under section 382 which would limit the use of your tax attributes by the buyer? Will a buyer thus pay you full value for such deferred tax assets or will they adjust downward their proposed purchase price? It may be in your best interest to sell appreciated assets or modify tax accounting methods to accelerate taxable income to utilize key deferred tax assets prior to expiration and/or limitation in value to the buyer.
A buyer of course will want to perform a due diligence review of any target they are considering as well. Any potential limitation on deferred tax assets to be acquired such as net operating losses, unrealized built in losses, and tax credit carry-forwards (under section 382) should be analyzed prior to the purchase price negotiation process. The IRS recently changed how they compute the Applicable Federal Rate (AFR) which is used in computing the limitations imposed on use of tax attributes by a buyer. This change may decrease the future utilization of tax attributes by 25 percent (where section 382 applies) starting in September of 2016. It’s even more critical that a buyer understands the true economic value of the deferred tax assets being purchased.
Another key area both the buyer and seller should review is their transaction costs including investment banker success based fees, legal fees, consulting fees, and due diligence investigation fees for opportunities to deduct what otherwise may be required to be capitalized for tax purposes.
Finally, one other key tax area of discussion between buyer and seller which we will explore in greater detail in future articles involves executive management contracts, severance payments, and any change in control payments resulting from a proposed transaction. From a tax perspective we have certain “golden parachute” tax provisions. The tax golden parachute limitations on tax deductibility and possible individual excise tax penalties may materially impact the final purchase price on a per share basis.
Both the buyer and seller should review any of these types of pre-acquisition tax liabilities being assumed by the buyer or being paid at closing. The timing of these payments and the timing of the deductions on the seller’s final tax return or in the buyers post transaction tax returns may present tax planning opportunities which should be considered.
Overall, both the buyer and seller should consult with their tax advisors to make sure each party understands how the deal is structured and the tax impact to buyer, seller, and their respective shareholders.
Purchase accounting tax considerations
One challenging key area is the “day 1” opening purchase accounting entries on the financial statements of the buyer and how the tax considerations need to be reflected on the day 1 balance sheet. In a taxable stock purchase or tax free merger, the tax basis of the various assets & liabilities of the target generally carry over. Does the acquirer have enough information to adequately revalue the various deferred tax assets and liabilities acquired based on the purchase account fair market value marks? Are the deferred tax inventory records of the target adequate or do certain items need to be validated? Does the acquirer have enough information to compute any potential tax attribute limitations under the section 382 change in control rules? Should a valuation allowance be considered on certain net operating losses which might be expiring soon? The acquirer’s day 1 balance sheet must address the buyer’s determination of the overall adequacy of the target’s tax reserve accounts whether they be deferred tax assets or tax reserves for future tax exposures related to contingent tax liabilities. The risk is that typically a buyer only has a short window of time to set their purchase accounting in stone.
Post-Merger Tax Planning & Considerations
We typically bear witness to the lack of proper tax planning that acquirers have to deal with once a deal has closed. As a buyer, it is generally advisable to have a tax game plan in case issues pop up post-closing. In addition, the buyer should pay special attention to preserving all key tax historical data. In particular, the source general ledger data for all tax information supporting the prior tax returns whether prepared internally or by a third party accounting firm.
In addition, careful consideration should be taken into which accounting firm and/or internal tax department will assist with the final tax return of the target. Will the acquirer be allowed to review such final tax filings and provide feedback prior to the filing? Do both parties agree with the tax positions taken? Are there expenses that should really be deducted on the tax return of the acquirer? Should the target forgo tax deductions on the final return to increase the use of tax attributes to limit potential section 382 limitations on the use of those attributes by the buyer?
We’re sure that your head may be spinning with all of the considerations to think about. Every deal is unique so not all of these considerations may apply to your individual situation. That said, we do strongly encourage you to hire a tax advisor that can guide you through this process. With proper planning in advance, it is possible that the Company can save significant dollars from a tax perspective and/or improve shareholder value on the deal. Please look for our next article in the series which will begin with a deeper discussion into pre-deal planning in the upcoming months.