When a corporate business is sold, it can be structured as either an equity sale or an asset sale. Typically, a corporate business sale is structured as an asset sale because of existing contracts and licenses that must remain with the company, requiring the buyer to renegotiate or obtain new contracts and licenses. As some industries have stringent regulatory requirements, an equity sale might be required to complete the sale.
However, a buyer that is confined to an asset sale can treat an equity sale as an asset sale for income tax purposes using an IRC 338(h)(10) election. This election is relevant in the context of corporate acquisitions where one corporation (the acquiring corporation) purchases another corporation (the target corporation) and wants to treat the transaction as a deemed asset purchase for tax purposes. The acquiring corporation is treated as if it purchased all of the assets of the target corporation for their fair market value on the day of the acquisition.
Buyer Advantages
The primary advantage of making an IRC 338(h)(10) election is that it allows the acquiring corporation to obtain a stepped-up basis in the target corporation’s assets. This means the assets are valued at their fair market value at the time of the acquisition, rather than their historical cost. The increased basis can lead to larger depreciation or amortization deductions, which can reduce taxable income in future years utilizing some or all of the consideration used in the acquisition.
Seller Advantages
While the target corporation will recognize a gain or loss on the deemed asset sale, the overall tax burden might be managed or mitigated depending on the target’s tax attributes, such as net operating losses or tax credits. This can be a strategic consideration in structuring the transaction to benefit both parties.
Requirements:
The election applies when a corporation (the selling subsidiary) is sold by its parent corporation (the selling parent) to an acquiring corporation. The parent company of the selling subsidiary will participate in the election. This parent corporation needs to be part of the same consolidated tax group as the selling subsidiary. The corporation acquiring the stock of the selling subsidiary also participates in the election.
To make the election under IRC 338(h)(10), the target corporation must be a U.S. corporation. The acquiring corporation must be a corporation that purchases at least 80% of the vote and value of the target corporation’s stock within a 12-month period.
Both the selling subsidiary and the acquiring corporation must jointly make the election by attaching a statement to their tax returns for the year of the transaction. The election must be made within a specific timeframe after the transaction. Typically, this is within a certain number of months after the transaction date, as specified in the IRS regulations. The election must be consistent among all parties involved in the transaction and reported consistently on their tax returns.
Summary
Overall, the IRC 338(h)(10) election is a mechanism provided by the IRS to facilitate corporate acquisitions while allowing for a step-up in the tax basis of acquired assets.