3 45p mergers & acquisitions

Mergers & Acquisitions November 14, 2013 3:45 pm– 5:15 pm James Goeller: Tax Partner – Crowe Horwath LLP Lori St. Marie, CPA: VP, Tax Manager – Sterling Bank Sheryl Vander Baan: Tax Partner – Crowe Horwath LLP

Agenda • Overview – Deal Structure & Target Profile • Taxable / Asset Acquisition Deals – Key

Issues • Carryover Basis Deals – Key Issues • Select Income Tax Accounting Issues – Day

1 & Day 2, incl. SOP 03-3 Loans • Other Matters

OVERVIEW – DEAL STRUCTURE & TARGET PROFILE

OR

WA

MT

ID

NV

CA UT

AZ NM

CO

WY

ND

SD

NE

KS

OK

TX LA

AR

MO

IA

MN WI

IL

IN

MI

OH

KY TN

MS AL GA

FL

SC

NC

VA

WV

PA

NY

ME

VT

NH

MA

RI

CT

NJ DE MD DC

Source: SNL Financial YTD through October 3, 2013

New England# of Transactions 17 Median Deal Value (millions) 19.1$ Median Assets 187,264$ Median ROA 0.26%Median NPAs/Assets 1.75%Median Price/Tang. BV 118.27%Median Price/Earnings 28.73x

Midwest# of Transactions 149 Median Deal Value (millions) 8.4$ Median Assets 75,359$ Median ROA 0.57%Median NPAs/Assets 1.48%Median Price/Tang. BV 117.06%Median Price/Earnings 17.66x

West# of Transactions 50 Median Deal Value (millions) 30.0$ Median Assets 227,305$ Median ROA 0.37%Median NPAs/Assets 2.77%Median Price/Tang. BV 121.22%Median Price/Earnings 17.78x

Southwest# of Transactions 72 Median Deal Value (millions) 20.4$ Median Assets 124,293$ Median ROA 0.74%Median NPAs/Assets 1.03%Median Price/Tang. BV 131.42%Median Price/Earnings 17.73x

Mid Atlantic# of Transactions 37 Median Deal Value (millions) 40.5$ Median Assets 309,777$ Median ROA 0.27%Median NPAs/Assets 2.22%Median Price/Tang. BV 116.75%Median Price/Earnings 20.32x

Southeast# of Transactions 67 Median Deal Value (millions) 32.3$ Median Assets 272,068$ Median ROA 0.13%Median NPAs/Assets 4.47%Median Price/Tang. BV 96.82%Median Price/Earnings 19.34x

Bank/Thrift Transactions by Region 2012 – YTD 2013

Transaction Activity Since 2001

Source: SNL Financial Annualized 2013 is based on activity through 10/4/13

0

50

100

150

200

250

300

350

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013A

Open Bank Deals FDIC Deals

Number of Troubled Institutions Per The FDIC

Source: FDIC

0

200

400

600

800

1,000

1,200

1,400

1,600

How many of the following types of acquisitions has your institution done in the past 3 years?

Source: 2013 Bank M&A Research Summary Report, a Crowe Horwath LLP Study produced in association with BankDirector

Over the next 12 months, is your institution intending to buy any of the following?


Over the next 12 months, is your institution intending to make any of the following acquisitions, outside of your core branch banking franchise?


Types of Deals from a Tax Perspective • Taxable / Asset Acquisition Deals

• FDIC-assisted deals • Branches or other assets • Subsidiary or S Corporation stock with a §338(h)(10)

election or new §336(e)(2) election

• Carryover Basis Deals • Tax-free mergers/reorganizations • Cash purchases of stock (without the above elections) • Bankruptcy transactions (§363 deals)

Target Profile & Deal Pricing • When does target tax profile impact –

• Deal structure? • Pricing?

• Key factors to know about target, particularly a “distressed” target • Future realizability of tax attributes, opportunities to

maximize same • Tax sharing / cash settlement of taxes • Any debt cancellation issues

TAXABLE / ASSET ACQUISITION DEALS – KEY ISSUES

§1060 Allocations • Does the purchase agreement spell out allocation of the

deal consideration or designate who controls same? • Purchaser desires: follow GAAP fair values vs. greater

allocation to assets resolving/depreciating faster • Seller desires: greater allocation to §1231 vs. ordinary

assets (if capital gains being sought) • Form 8594 won’t be identical – buyer consideration

includes buyer’s transaction costs; seller’s consideration reduced by seller’s deal costs

Loans Acquired at a Discount - Tax • If tax basis assigned < outstanding principal, tax

market discount exists • Unless loan can be placed on nonaccrual for tax purposes,

interest should still be accrued at contractual rates • For installment loans, market discount must be accrued

using constant interest rate or declining interest balance (aka interest-over-interest) methods; need not be recognized until payment received

• GAAP will likely differ --

Loans Acquired at a Discount - GAAP • If accounted for as Purchased Credit Impaired Loans under

(formerly) FASB Statement of Position (SOP) 03-3:

• Subsequent adjustments depend on continued evaluation of expected cash flows

§475 Mark to Market of Loans • Absent purchasing software to account for Tax v.

GAAP accounting differences, marking acquired loans to market could help identify end-of-year tax basis • Will not distinguish between MTM gain/loss and

correct amount of tax interest + recognizable accrued market discount

• Can only be elected by a “dealer in securities” and purchased loans must be identified as MTM no later than day acquired

FDIC Loss-Sharing • §597 adjusts §1060 allocations to a) treat loss-sharing

“covered assets” as Class II assets, b) assign tax basis to them that is > of FMV or maximum guaranteed under loss sharing, and c) potentially create §597 6-year amortized gain

• MTM solution is tempered by Reg. Sec. 1.597-3(f) prohibition against marking a loan below > of FMV or maximum guaranteed value under loss-sharing

• When loss-sharing ends – if a loan charge-off for GAAP or regulatory purposes was not deducted for tax due to 1.597-3(f), can it be deducted when loss-sharing ends for that loan?

CARRYOVER BASIS TRANSACTIONS - KEY ISSUES

Carryover Basis Transactions • Review of Key Issues

– More tax due diligence is required – Tax attributes of the acquired entity

• The value of tax assets to the seller may differ than the value to the buyer • Tax limitations [§382 and §383]

– Bankruptcy deals

• Limits the amount of net operating loss and tax credit carryforwards that can be utilized after a corporation experiences an ownership change

• Also applies to built-in losses that are realized within 5 years of an ownership change (with a special one-year period applied to loan charge-offs)

• KEY QUESTION – for a bank contemplating a takeover transaction or a significant capital raise – “What will be the value of the accumulated deferred tax

benefits after the transaction (and how much should I pay for them)?”

IRC §382 Limitation

• The answer depends on several determinations: 1) Does the transaction trigger an ownership change (a

>50% change in the ownership of 5% shareholders over a 36 month period)?

2) If so, what is the annual limitation (value of the corporation immediately before the transaction multiplied by a long-term interest rate published by the IRS)?

3) Be aware of the effect of built-in losses (if applicable) – Limiting losses incurred within the 5-year window – Limiting loan charge-offs within the 1-year window

IRC §382 Limitation

§382 Limitation • The following transactions most commonly contribute to

or result in an ownership change: – A tax-free reorganization/merger or qualifying stock purchase – A significant capital infusion (over a 36 month period) – A large-block stock purchase (over a 36 month period)

• For purposes of measuring whether the ownership of 5% shareholders increases by >50%, all <5% shareholders are aggregated and viewed as a single shareholder, but different groups and sub-groups are segregated based upon discrete transactions and events

§ 382 Primer • Look at 5% shareholders and see if any shareholders

collectively increased ownership by more than 50% in the 36 month look-back period.

• First, who is a 5% shareholder? • ‘Look through’ to the ultimate shareholder or not? • In defining an ‘entity’ to determine who is the shareholder for

Section 382 testing, Reg.§1.382-3(a)(1)(i): An entity is any corporation, estate, trust, association, company, partnership or similar organization. An entity includes a group of persons who have a formal or informal understanding among themselves to make a coordinated acquisition of stock

§ 382 – 5% Shareholders • Problems

– Cede & Co. [Street Name] – Mutual Funds and Pension Plans

• The owner is the person who has the right to the dividends and proceeds from sale, even though that person may have given to another (such as an investment advisor) the right to vote and/or dispose of the stock. [PLR 9533024]

§ 382 Primer – Section 13(d)

• SEC Filings – Section 13(d) of the Securities Act of 1934

requires any person who beneficially owns 5% or more of a class of equity securities of a publicly traded company to file a report with the SEC within 10 days of reaching the 5% ownership threshold.

§ 382 Primer – Section 13(g)

• SEC Filings – There is an alternative to the Schedule D filing

requirement if a fund manager falls within certain categories they can file the less onerous Schedule 13G.

§382 Primer – Section 13(f) • SEC Filings

– An institutional investment manager who exercises investment discretion over $100 million or more in Section 13(f) securities must report its holdings on Form 13F with the Securities and Exchange Commission (SEC). Form 13F is required to be filed within 45 days of the end of a calendar quarter.

§ 382 Primer – 5% Shareholder • CCA 201215007

– Loss Company was owned by 6 private investment funds which had varying amounts of overlapping beneficial ownership, and which were managed by a common group of individuals who acted through several entities and LLCs, which the group of individuals owns.

– For the purposes of testing the acquisition and ownership of Loss Company, the Funds were found to be treated as an “entity” within the meaning of §1.382-3(a)(1).

§ 382 - Capital Raising Issues • Just raising capital can trigger a change-in-control • The more that is raised, the more the Bank needs to be

aware of: – The 5% owners and how many shares can be issued to a >%

shareholder and how many shares can be issued to a group of < 5% shareholders before there would be a Section 382 problem; and

– Whether any prior offerings would be treated as subject to the “anti-stuffing” provisions with respect to valuation of the entity.

§ 382 - Capital Raising Issues • The “Cash Issuance Exception” Reg. Section 1.382-3(j)(3).

– In general, an offering subscribed by < 5% shareholders creates a new < 5% shareholder group (post-offering there is a new and old < 5% shareholder Group).

– Allows for the assumption that some of the old public group purchased shares in the offering.

– The rules limit this reallocation amount to 50% of the aggregate percentage ownership interest of direct public groups (the <5% shareholders) immediately before the issuance.

§ 382 - NUBILs • There is one calculation of overall Net

Unrealized Built-In Gain/Loss • FMV of assets compared to -- • Adjusted tax basis of the assets

• Threshold for NUBIL / NUBIG – must be greater than the lesser of:

• 15% of the FMV of the variable assets • $10 million

§ 382 - NUBILs • Calculation and allocation issues • If NUBIL, only RBILs matter, as their deductibility

is limited by the annual 382 amount • RBILs in excess of the annual limitation are carried

forward and treated as if pre-change losses • The RBILs are used before NOLs; resulting in the

NOLs being pushed out closer to expiration

§ 382 - NUBILs • Notice 2003-65

– Section 1374 Approach – Section 338 Approach

• Banks, and the 1-year and 5-year NUBIL rules • 50% change-in-control versus 80% change-in

control

§ 382 – Other Problems (ACE) • Section 56(g)(4)(G) ACE Basis Adjustment:

56(g)(4)(G) Treatment of certain ownership changes . If— (i) there is an ownership change (within the meaning of section 382) in a taxable year beginning after 1989 with respect to any corporation, and (ii) there is a net unrealized built-in loss (within the meaning of section 382(h)) with respect to such corporation,

then the adjusted basis of each asset of such corporation (immediately after the ownership change) shall be its proportionate share (determined on the basis of respective fair market values) of the fair market value of the assets of such corporation (determined under section 382(h)) immediately before the ownership change.

§336(e)(2) – Other Problems • T.D. 9619 finalized regulations allowing domestic

corporations that sell, exchange or distribute at least 80% of a Target corporation to make a joint election with the Target to treat the transaction as a sale of Target assets (similar to a §338(h)(10) deemed asset purchase)

• Has the effect of changing the inside tax basis of Target assets, and losing Target tax attribute carry forwards

• If Buyer of Target does not want this change, consider addressing in purchase agreement

U.S. Bankruptcy Code §363 Transactions • HC files Ch. 11 bankruptcy with a plan to sell stock

of bank(s) and, potentially, all other subs & assets • Buyer typically required to simultaneously infuse

capital into acquired bank(s) • HC might file Ch. 7 bankruptcy after deal closes • Often, HC debt will be cancelled in bankruptcy • Typically, both HC and subsidiaries have significant

tax loss and credit carry forwards

Bankruptcy §363 Deals – Buyer Concerns • Have cash tax settlements between bankrupt HC &

its subs been made as if the bank always filed separately with its own subsidiaries? If not, is bank owed more $$?

• Are there tax authority refunds due to bank subs? • U.S Court of Appeals, 11th Circuit, ruled in two cases that

HC held refunds due to other consolidated group members only as escrow, not debtor-creditor relationship

• No. 12-11392 (BankUnited Fin Corp) & No. 12-13965 (Net Bank, Inc.)

Bankruptcy §363 Deals – Buyer Concerns • Final bankrupt HC consolidated/unitary returns that

include sold subsidiaries • If sold subs are departing mid-year, must wait till year-

end to know final tax attributes allocated to them • If parent debt is cancelled, it could reduce attributes

coming to acquirer (consider requiring §108(b)(5) election to be made or foregone)

• If parent reports loss on sale of subs, it could reduce attributes coming to acquirer (consider requiring Reg. §1.1502-36(d) election)

Bankruptcy §363 Deals – Buyer Concerns • Final bankrupt HC consolidated/unitary returns that

include sold subsidiaries • Are there existing consolidated §382 annual limitations

that Buyer would want acquired subs to have? (Consider requiring Reg. §1.1502-95(c)(1) election)

• Who pays for return preparation if parent has no $$ left? • Can sold subs become “substitute agents” under Rev.

Proc. 2002-43?

SELECT INCOME TAX ACCOUNTING ISSUES – DAY 1 & DAY 2, INCL.

SOP 03-3 LOANS

Goodwill v. Bargain Purchase Gain A = • Acquisition date fair value of consideration transferred (incl. FV or

any previously-held interest in Target) • Plus : Fair value of any noncontrolling interest in Target B = • Fair value of identifiable asset acquired (GW is not identifiable) • Less: Fair value of liabilities assumed • Plus/minus: deferred taxes on inside GAAP v. Tax basis of assets

acquired & liabilities assumed (where Target is a sub of Acquirer) A > B = Goodwill; B > A = Bargain Purchase Gain (BPG)

FASB Interpretation Issue - BPG • FASB guidance is not abundantly clear as to whether

the prior page “boxed” item (deferred taxes) should be part of the “B” equation in every circumstance

• Interpretation impacts whether Bargain Purchase Gain, which is not taxable, is a temporary or permanent Schedule M, and whether it is recorded “gross” or “net of taxes”

• See ASC 805-30-30-1; 805-740, paragraphs 25-2, 25-3, 55-2, and 55-3

FASB Interpretation Issue - BPG • Where an entity is acquired that stays a sub of

Acquirer (so there is outside basis in sub stock; inside basis in sub assets) • Sub records deferred taxes on its inside basis differences • BPG is recorded at Acquirer/Parent, not at sub • BPG is already “net” of taxes recorded at sub • BPG increases Acquirer’s outside GAAP basis in sub stock • BPG is temporary or permanent depending upon whether

Acquirer records deferred tax on outside basis differences in sub stock

FASB Interpretation Issue - BPG • Where acquired assets/liabilities are recorded within

Acquirer (e.g., an FDIC-assisted asset deal) • No inside v. outside basis issues • Recording BPG at “gross” and treating it as a temporary

difference “creates” the deferred tax needed on GAAP v. Tax basis differences

• Recording deferred taxes on GAAP v. Tax basis differences results in BPG already “net” of tax (permanent treatment)

• Interpretation / application varies

Goodwill • Component 1 GW = amount that is the same for GAAP and Tax • Component 2 GW = the excess: GAAP > Tax or Tax > GAAP

• Analysis of preliminary Components 1 and 2 is done at each entity after recording all other deferred taxes on inside basis differences

• If Tax goodwill > GAAP goodwill, record deferred tax asset on the Component 2 excess

• If GAAP goodwill > Tax goodwill, no deferred tax is recorded

Day 1 Acquisition Method Tax Adjustments • The following items are recorded or adjusted as part

of acquisition method accounting at Day 1 • Deferred taxes on assets / liabilities / subsidiaries acquired

or created as a result of the acquisition • Recorded at tax rates applicable to the structure as it

exists immediately after the acquisition date trigger • Valuation allowances on the above deferred tax assets • Uncertain tax positions related to Target’s open tax years

that will remain Target’s or Acquirer’s responsibility

Day 1 Acquisition Method Tax Adjustments • The following items are recorded or adjusted as part

of acquisition method accounting at Day 1 • Tax uncertainties created by tax positions taken relative to

the acquisition structure • Current tax return liabilities / obligations of Target, if

assumed (or current tax receivables, if expected) • Deferred taxes on expected consequences of contingent

consideration settlement (only on Day 1 expectations)

Tax Adjustments Outside of Acquisition Method Accounting

• Changes in Acquirer’s tax positions caused by the acquisition e.g., -- • Adjustments to Acquirer’s deferred state taxes • Judgment changes about realizability of Acquirer

deferred tax assets • Intention changes, e.g., decision to repatriate

Acquirer’s foreign subsidiary earnings to pay for acquisition


• Acquisition-related costs – • Target expenses for GAAP as incurred / as

services received; Tax follows Reg. §1.263(a) • Acquirer Side -- GAAP expenses as incurred / as

services received, except for – • Debt or equity issuance costs – both GAAP

& Tax generally capitalize (and amortize debt, but not equity, costs)


• Acquisition-related costs – Acquirer Side • Taxable Deals – included in purchase price allocated to

tax basis of assets; analysis of GAAP v. Tax Goodwill, for purposes of determining whether to record a deferred tax asset on Tax goodwill in excess of GAAP goodwill, is performed before allocating these transaction costs

• Nontaxable Deals – deductibility determined by Reg. §1.263(a); in a stock purchase, non-deductible costs increase Acquirer’s outside tax basis in Target stock


• Tax effects of Subsequent Transaction Steps, regardless of whether they affect Target or Acquirer tax positions

• Example – • Acq HC owns Bank A; they file unitary State A return • THC owns Bank B, which files separate State B return • THC merges into Acq HC - State A taxes recorded on THC & Bank B

assets/liabilities are part of acquisition method accounting • On same day Bank B merges into Bank A; this is a subsequent step;

all adjustments to State B deferreds recorded outside acquisition method accounting

Day 2 - Measurement Period Adjustments • Post-Day 1 changes to any positions that were

recorded or adjusted through acquisition method accounting that are -- • Made during the measurement period (generally a year

from the Day 1 date) AND • Due to new information about facts & circumstances that

existed at the acquisition date • Qualifying adjustments recorded first through any GAAP

goodwill recorded in the acquisition (until zero), then as BPG

Day 2 – SOP 03-3 Loans • As discussed earlier, GAAP accounting for Purchased

Credit Impaired Loans differs significantly from Tax accounting for loans, regardless of whether Day 1 Tax v. GAAP basis equals or differs

• PCI Loan accounting could be present in any type of acquisition, not just FDIC deals

• In any transaction, it will be necessary to develop a plan to address ongoing GAAP v. Tax differences

Other Matters

• Deferred Tax Assets under BASEL III • Transaction Cost update • Compensation Issues • Information Reporting

Deferred Tax Assets -- Basel III • Old Tier 1 Capital rules related to DTAs phase out under

Basel III. New Rules: • First, NOLs and other carry forwards are not included • Second,

– 10% Limitation on DTAs; but – A new overall limitation (collectively 15% for DTAs,

mortgage servicing assets and significant investment in unconsolidated financial entity).

• Goodwill is removed

Overview of Basel III DTA Limitations • New rules are effective –

• January 1, 2014 for banks with total assets in excess of $250 billion

• January 1, 2015, generally, for all other banks • Contain some similarities to the existing rules – e.g.,

placing no limitation on net DTAs that can be recovered through carryback to prior periods

• Also contain significant differences that require the segregation of certain DTAs and apply special rules for netting DTLs against

Transaction Cost Update • General Rules

– Generally, Reg. Section 1.263(a)-5(a) provides that a taxpayer must capitalize an amount paid to facilitate the acquisition of assets that constitute a trade or business, whether the taxpayer is the target or acquirer.

– Costs that are facilitative are capitalized – Post “Whether & Which”

Deducting Success-Based Fees in M&A Transactions

• In 2011, IRS issued Revenue Procedure 2011-29 • 70% elective safe harbor • Protection is substantial – eliminates uncertainty

with respect to these expenditures (if elected) • Requires a formal election • IRS also indicated it would generally allow prior

year deductions under audit if they did not exceed 70% (LB&I-04-0511-012)

Milestone Payments and Success Based Fees • In July 2012, the IRS ruled (CCA 201234027) that

nonrefundable “milestone payments” that are due under a service agreement cannot qualify as contingent fees for the purpose of the 70% deduction safe harbor election because they are not contingent upon the successful completion of the transaction.

• This was so even if these fees can be credited against the success-based fee charged for the successful completion of the transaction.

• The deductible portion of these amounts could still be supported in the traditional manner with no safe harbor.

Success Based Fees – IRS Exam Position • On April 30, 2013, the IRS issued audit guidance (LB&I-04-

0413-002) reversing the CCA position and instructing its agents not to disallow the application of the 70% deduction safe harbor to “eligible milestone payments.”

• The guidance specifically applies to eligible milestone payments for investment banker fees that are part of a success-based arrangement.

• No mention of other types of success-based fee arrangements (i.e., legal or other).

Compensation Issues • Golden Parachute payments and cost of

severance must be considered • Severance / CIC payments

– General legal advice memorandum – GLAM or AM 2012-010

• “end-of-the-day rule” in Reg. Section 1.1502-76(b)(1)(ii)(A)

• “next-day rule” in Treas. Reg. section 1.1502-76(b)(1)(ii)(B)

Information Reporting • Target information reporting

• W-2s and Payroll • Forms 1098/1099 and 5498

• Basis Reporting Requirements – Form 8937 • Mergers and tax-free reorganizations • Stock dividends • Stock splits • Non-dividend distributions

Basis Reporting Requirements • The rules also require securities issuers to report

organizational actions that impact the tax basis of their issued securities

• Examples: – Mergers and tax-free reorganizations – Stock dividends – Stock splits – Non-dividend distributions

• Form 8937 is the means by which securities issuers are to report the tax basis effect of organizational actions

Disclaimers The views expressed do not necessarily represent those of Crowe Horwath LLP. This material is for informational purposes only and should not be construed as legal, tax, accounting or other professional advice. Please seek guidance specific to your organization from qualified advisers in your jurisdiction.

Questions?

Crowe Horwath LLP is an independent member of Crowe Horwath International, a Swiss verein. Each member firm of Crowe Horwath International is a separate and independent legal entity. Crowe

Horwath LLP and its affiliates are not responsible or liable for any acts or omissions of Crowe Horwath International or any other member of Crowe Horwath International and specifically disclaim any and all responsibility or liability for acts or omissions of Crowe Horwath International or any other Crowe Horwath International member. Accountancy services in Kansas and North Carolina are rendered by

Crowe Chizek LLP, which is not a member of Crowe Horwath International. This material is for informational purposes only and should not be construed as financial or legal advice. Please seek guidance specific to your organization from qualified advisers in your jurisdiction. © 2013 Crowe

Horwath LLP

3 45p mergers & acquisitions

Business

Transcript of 3 45p mergers & acquisitions