A transaction described in a private-letter ruling from the Internal Revenue Service resembles, but is not identical to, the recent divestiture by Citigroup of its Primerica stock. Similar to the case featured in the letter, the Citigroup transaction was carefully structured to achieve the benefits of Section 338(h)(10) of the tax code — benefits that often extend to the buyer and seller.
Indeed, Section 338 affords a newly formed company (Newco in the IRS letter) with a “cost” basis in the target company’s assets and, consequently, enhances depreciation and amortization deductions. The transaction begins with a four-company structure, in which a parent company owns all of the stock of AlphaCorp; Alpha owns 100% of the stock of SellerCorp; and Seller owns all of the stock of TargetCorp.
The parent, a publicly-traded corporation, is interested in exiting the line of whbusiness currently conducted by Target. To this end, the following steps will occur:
• Seller will enter into a binding agreement with a purchaser, which will be an unrelated party. Seller forms Newco to participate in the transaction, and the agreement facilitates the sale to the purchaser of all the Newco preferred stock that Seller receives in exchange for property. Note that the purchaser will not transfer any money or other property to Newco in connection with the proposed transaction.
• Seller will also enter into a firm commitment underwriting agreement in which Seller will be obligated to effect the sale of Newco common in an initial public offering (IPO);
• Target will distribute certain assets to Seller.
• Seller will transfer all of its equity in Target to Newco in exchange for 100% of the voting common stock and nonvoting preferred stock of Newco. Newco may also transfer a note to Seller.
• Seller will sell the Newco preferred stock to the purchaser and a portion (which may be less than 20%) of the Newco common stock to the underwriters for cash for resale to the public.
• A time limit exists with regard to Seller’s transfer of equity to Newco. As a result, Newco and the parent company (on behalf of Seller) will make elections under Section 338(h)(10) — in respect of Newco’s acquisition of Target’s stock — not later than the 15th day of the ninth month beginning after the month in which the transfer occurs.
• Within a specified number of months from the time Seller sells the Newco preferred stock, Seller will undertake additional public offerings of Newco common stock or “other alternative transactions.” The additional offerings will reduce Seller’s ownership of Newco to less than 50% of the value of all of Newco’s stock. This final step is important in establishing that a stock “purchase” took place.
Qualified Stock Purchase
To complete a Section 338(h)(10) election — which will provide Newco with a “cost” basis in Target’s assets — Newco’s acquisition of Target stock from Seller must constitute a qualified stock purchase.