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Private equity and investment
banking associate training:
Tax diligence and
transaction structuring
fundamentals
October 20, 2020
11 a.m. ET
Speakers

Sunil Taneja Lamar Weeks Maggie Bafia Guin Seaward Trinh Tran
Senior Manager Senior Manager Senior Manager Senior Manager Senior Manager
M&A Tax M&A Tax M&A Tax State and Local Tax State and Local Tax

sunil.taneja@us.gt.com lamar.w eeks@us.gt.com maggie.barfia@us.gt.com guinevere.seaw ard@us.gt.com trinh.tran@us.gt.com

© 2020 Grant Thornton LLP | All rights reserved | U.S. member firm of Grant Thornton International Ltd 2
Learning objectives
Describe deal terms and their impact on identification
1 and remediation of tax exposures

Identify opportunities to monetize the value of tax

2 attributes or step-up in tax basis as part of the
transaction

Cite an overview of tax considerations in various

3 transaction structures

© Grant Thornton LLP. All rights reserved. 3

Today's agenda
M&A Tax Due Diligence 40 minutes
M&A Tax Structuring 30 minutes
CARES Act & Election preview 10 minutes
Q&A 10 minutes

© 2020 Grant Thornton LLP | All rights reserved | U.S. member firm of Grant Thornton International Ltd 4
Private equity and investment
banking associate training

M&A Tax
What is buy-side tax due diligence?
Fundamentals

Buy-side tax due diligence is intended to assist the Buyer in evaluating Target company’s tax history
• General rule: Any tax imposed can be assessed within three years after a return is filed (longer in certain
circumstances)
• At its core, due diligence is intended to provide the potential acquirer/investor timely information to be
used in making the best decision regarding the potential transaction
• Tax due diligence is not an audit
• R&W insurance
Buy-side transactions can take a number of forms, including:
• Acquisition of the entire business
• Acquisition of certain divisions, geographic units or product lines (carve-out)
• Acquisition of certain assets
• Minority positions, recapitalizations and mezzanine financing

© 2017 Grant Thornton LLP | All rights reserved | U.S. member firm of Grant Thornton International Ltd 6
What is sell-side tax due diligence?
Fundamentals

Sell-side tax due diligence is intended to assist a Seller in positioning themselves to go to market
• Although sell-side diligence takes on a similar form to buy-side in substance, the process is different
• More collaborative nature – the Seller is interested in discovering issue areas that can be cleaned up
prior to going to market as well as getting ahead of risks that a Buyer may surface
• Gets a Seller ready for buy-side diligence
• Ability to present opportunities to a potential Buyer and highlight additional value

© 2017 Grant Thornton LLP | All rights reserved | U.S. member firm of Grant Thornton International Ltd 7
 Taxes to be considered during tax due diligence
Typical tax due diligence scope based on form of transaction

Type of tax
Federal income Employment Unclaimed
State income tax Sales and use tax Property tax
tax taxes property

C Corp stock
X X X X X X
purchase

S Corp stock
Limited Limited X X X X
purchase

Asset purchase Limited or N/A Limited X X X X

LLC/partnership Depends; “new”

Limited X X X X
interest purchase audit rules

© 2017 Grant Thornton LLP | All rights reserved | U.S. member firm of Grant Thornton International Ltd 8
Federal income tax
Concepts for consideration by tax type

C Corp
• Look at federal income tax profile holistically – all areas could be subject to successor liability
• NOLs – limitations and statue of limitations
• Interest expense deductibility
• R&D tax credits
• M&A transactions
• Special deductions (worthless stock deduction, intercompany bad debts, related-party losses)
S Corp
• Validation of the S Corp election
• Signed election and acceptance
• Trust shareholders
• Distributions
• Employee shareholders
• Personal expenses

© 2017 Grant Thornton LLP | All rights reserved | U.S. member firm of Grant Thornton International Ltd 9
International tax
Concepts for consideration by tax type

Concepts
• Income tax levied on income at the foreign jurisdiction level
• Withholding tax paid by the payer of the income rather than by the recipient of the income
• VAT is assessed incrementally, based on the increase in value of a product or service at each stage of
production or distribution. Also referred to as goods and services tax (GST) in certain countries
• Payroll tax withheld by the employer on behalf of the employee, usually based on the earnings of the
employee. Many countries have social security withholding regimes that employees are required to
follow
• Transfer pricing rules and methods for pricing transactions within and between enterprises under
common ownership or control

© 2017 Grant Thornton LLP | All rights reserved | U.S. member firm of Grant Thornton International Ltd 10
State income tax
Concepts for consideration by tax type
Concepts
• Nexus: the requirement for companies doing business in a state to collect and pay taxes in that state
• Physical presence
• Inventory including inventory held on consignment
• Performance of services including solicitation not protected by P.L. 86-272
• Economic presence
• Varies by state and tax type
• Apportionment
• Gross receipts
• Tax on gross revenues of a company
• Ex. Washington B&O and Ohio CAT
• Franchise taxes
• Generally based on net worth of or capital held by the entity
• State modifications (deductions, credits, etc.)
• Audits/notices
• Exposures for state gross receipts based taxes may be considered on adjustment to EBITDA

© 2017 Grant Thornton LLP | All rights reserved | U.S. member firm of Grant Thornton International Ltd 11
Sales and use tax
Concepts for consideration by tax type

Concepts
• Transfer and/or possession of tangible personal property
• Some services subject to tax
• Sales tax vs. use tax
• Nexus – Lower threshold than income tax
• Wayfair – economic nexus, physical presence is not required
• Exemption certificates
• Taxability of sales/purchases
• Transfer of title software as a service (SaaS)
• Exposures for sales and use taxes may be considered on adjustment to EBITDA

© 2017 Grant Thornton LLP | All rights reserved | U.S. member firm of Grant Thornton International Ltd 12
Employment tax
Concepts for consideration by tax type

Concepts
• Must withhold income tax where employees work
• Watch for traveling employees
• States may have de minimis exceptions
• Unemployment tax generally follows employee's home state
• Independent contractors: risk of misclassification

© 2017 Grant Thornton LLP | All rights reserved | U.S. member firm of Grant Thornton International Ltd 13
Property tax
Concepts for consideration by tax type

Concepts
• Potential successor liability on stock and asset acquisitions for failure to file/pay
• Minimize exposure via representations and indemnifications in acquisition agreement
• Prior to closing, negotiate FILOT transferability (and extension)
• Expect possible revaluation but also evaluate favorable write-downs

© 2017 Grant Thornton LLP | All rights reserved | U.S. member firm of Grant Thornton International Ltd 14
Unclaimed property
Concepts for consideration by tax type

Concepts
• Potential successor liability on stock and asset acquisitions for failure to file/pay
• Priority rules
• First priority – Owner's last known address (if known)
• Second priority – Holder's state of incorporation
• Typical property – Outstanding vendor checks and payroll checks, customer credits, refunds and
rebates and gift cards/certificates

© 2017 Grant Thornton LLP | All rights reserved | U.S. member firm of Grant Thornton International Ltd 15
Items to consider
Historical review

Assess tax exposures for the contract and Identify hidden assets/liabilities for inclusion in
escrow Buyer's model
• Has target paid all of its tax liabilities? • Tax attributes (but usually limited)
• Significant events in target’s life cycle • Tax accounting methods
• Common issues: • Appropriate tax reserves (GAAP)
• Sales tax
• VAT/GST
• State income tax nexus/economic nexus

Historical Current Prospective

© 2017 Grant Thornton LLP | All rights reserved | U.S. member firm of Grant Thornton International Ltd 16
Items to consider (cont'd)
Current and prospective impacts

Assess tax liabilities and opportunities Post-transaction planning

attributable to transaction • Type and number of legal entities (rationalize
• Structuring alternatives for a tax step-up legal entity structure)
• Asset versus stock deal • Location of acquisition debt
• Taxable versus nontaxable transactions • Maximizing the tax benefits associated with
transaction costs
• Looking for value drivers — avoiding tax dis-
synergies

Historical Current Prospective

© 2017 Grant Thornton LLP | All rights reserved | U.S. member firm of Grant Thornton International Ltd 17
Transaction structure

© 2017 Grant Thornton LLP | All rights reserved | U.S. member firm of Grant Thornton International Ltd 18
Entity structure
Fundamentals
C corporation LLC
• Legal entity that is separate from its owners • Limited liability to its owners
• Corporation owned by shareholders • Can be taxed as a:
• Income is taxed at the corporate level • C corporation
• Potential gain exclusion – Section 1202 • S corporation
• Partnership
• Division or branch

S corporation Partnership (LP, LLP)

• Small business corporation (elective and • Limited liability to its owners
restrictive) • Income taxed at the partner level
• 100 shareholders or less • Anti-churning
• Generally treated as a flow-through entity
for tax purposes
• Income is taxed at the shareholder level

© 2017 Grant Thornton LLP | All rights reserved | U.S. member firm of Grant Thornton International Ltd 19
 Entity type key considerations
Type of entity
C corporation LLC S corporation Partnership
Ownership Generally no limit on Unlimited # of members 100 shareholders or less. Unlimited # of partners
shareholders but dependent Cannot be owned by C
on state corporate law corporation, other S
corporations, certain trusts,
LLCs, or partnership
Liability Shareholders typically not Members typically not liable Shareholders typically not Members can be liable
liable liable unless LP, LLP, LLLP

Taxes Double taxation: corporation Has different tax Shareholders taxed on Members taxed on allocable
and shareholders are taxed personalities - can be treated allocable share of income share of income
separately as a flow-through (division or
partnership) or as a taxable
C corporation
Transaction treatment Can sell assets or stock of C Depending on its tax Can sell assets or stock of S Asset sale for federal income
corporation; may be able to classification an asset sale corporation; generally can tax purposes if one
elect Section 338 or 336(e) for federal income tax elect Section 338/336(e) for purchases 100% of the
for deemed asset sale purposes can be achieved, deemed asset sale treatment partnership interests. If less
treatment but may require certain than 100% is purchased
elections be made to achieve special elections can be
the result of an asset sale made to achieve asset sale
treatment
© 2017 Grant Thornton LLP | All rights reserved | U.S. member firm of Grant Thornton International Ltd 20
 Typical transaction structures
Asset deal Stock deal
• Seller retains ownership of the shares of stock of • Buyer purchases the entire entity which most
the business often involves a corporation's stock
• Buyer must either create a new entity or use an • All of the outstanding shares of stock of the
existing entity to facilitate transaction business are transferred from the Seller to the
• Only assets and liabilities which are specifically Buyer
identified in the purchase agreement are • Buyer will be liable for past U.S. federal, state
transferred to the Buyer and local income tax liabilities of Target
• Historic income tax liabilities typically remain • Additionally, Buyer will be liable for any non-
with Seller income tax liabilities of Target
• Buyer will be liable for any non-income tax
liabilities of Target
• Can be driven by Buyers not willing to take on
potential legacy liabilities such as legal,
environmental and pension
© 2017 Grant Thornton LLP | All rights reserved | U.S. member firm of Grant Thornton International Ltd 21
Taxable stock acquisition
Stock for property
Form: A purchases T stock from Seller for cash and/or notes

Transaction: Result:

Cash
Target
Acquirer Acquirer
shareholders
(A) (A)
(Seller)
T stock

Target Target
(T) (T)

© 2017 Grant Thornton LLP | All rights reserved | U.S. member firm of Grant Thornton International Ltd 22
 Taxable stock acquisition
Tax consequences
Seller/T’s perspective: A’s perspective:
• Seller generally recognizes capital gain/(loss) on • T’s assets and liabilities remain with T
sale • Carryover tax basis in T's assets for A (i.e., no tax
• T does not recognize gain/(loss) step-up to cost)
• Consider: • Corporate attributes carryover (e.g., NOLs)
• Maximum federal U.S. tax rate for individuals: subject to Sections 382 and 384. In carve-out
• 20% on long-term capital gains other than situations, special rules could govern tax
real estate and other collectible assets attributes coming out of a consolidated return
• 37% on short-term capital gains (held <1yr) • T's tax liabilities carry over and, in certain
situations, so do the tax liabilities of an affiliate.
• 3.8% additional tax on net investment
The joint and several liability of an affiliate is
income generally seen in carve-out transactions

© 2017 Grant Thornton LLP | All rights reserved | U.S. member firm of Grant Thornton International Ltd 23
Taxable asset acquisition
Contractual
Form: Transfer some or all of assets to A (or A’s subsidiary) in exchange for cash and/or notes

Transaction: Result:
Target
shareholders Acquirer
(A)
(Seller)

Cash
Acquirer Target
(A) (T) Target assets
Target
assets

Consider:
• In regulated industries, this structure may not be feasible
• Sale or transfer of state licenses or permits might be restricted (i.e., must remain in the corporate shell of Target)
• Other contracts may have anti-assignment provisions that restrict their ability to be transferred

© 2017 Grant Thornton LLP | All rights reserved | U.S. member firm of Grant Thornton International Ltd 24
 Taxable asset acquisition
Taxable acquisitions
Seller/T’s perspective: A’s perspective:
• Double taxation (T subject to tax at corporate • A entitled to cost stepped-up basis (SUB)
level; second level of tax when proceeds (SUB = amount paid + liabilities assumed)
distributed to Seller) • Purchase price allocation under Section 1060
• Gain taxable at maximum federal U.S. tax rate (intangibles such as goodwill qualify for 15-year
for corporate level tax = 21% amortization)
• Character issues (ordinary versus capital) • Corporate attributes do not carry over; they stay
• For actual asset transaction (not a merger): with T, and can then be applied to offset taxable
• Historic T income tax liabilities remain with gain on the asset sale
Seller/T • For actual asset transaction (not a merger):
• Actual asset transactions are often difficult to • Ability to choose which assets to acquire and
execute because of the challenges which liabilities to assume
associated with title transfers, modifications • Transfer of each asset required (state asset
of key contracts and potential transfer taxes transfer taxes generally apply)

© 2017 Grant Thornton LLP | All rights reserved | U.S. member firm of Grant Thornton International Ltd 25
Allocation of tax purchase price in taxable
asset acquisitions
Overall FMV
• Allocate purchase price among the assets acquired:
• By relative fair market value (FMV)
• Residual purchase price is tax goodwill

• Allocation of purchase price affects:

• Character of gain recognized by the Seller
Asset classes • Future depreciation/amortization deductions to the Buyer

• Agreement on allocation of purchase price:

• Binding on both parties
• Generally respected by IRS as long as at arm's-length
• Independent appraisals are common depending on the
size of the transaction
I.R.C. § 197

© 2017 Grant Thornton LLP | All rights reserved | U.S. member firm of Grant Thornton International Ltd 26
Taxable stock acquisition
§ 338(h)(10)
Target is a subsidiary
Cash
Acquirer Acquirer
Seller
(A) (A)
T
stock

New Target Target

target (T) (T)

Seller/T’s perspective: A’s perspective:

• Seller recognizes gain inherent in underlying T • Inside basis step-up
assets instead of recognizing gain on the sale • May have incremental tax benefit attributable
of T stock to depreciation/amortization
• Results in deemed asset sale to new target • No T corporate attributes survive to A, but may
be retained by Seller

© 2017 Grant Thornton LLP | All rights reserved | U.S. member firm of Grant Thornton International Ltd 27
Taxable stock acquisition
§ 338(h)(10)

Buyer
• Step-up in basis (SUB) in target’s assets allows for an increase in after-tax cash flow by reducing the
income tax payable through future deductions
• Taxpayer should discount future tax savings to present value

Seller
• May be indifferent as it relates to an (h)(10) sale versus a stock sale. However, there may be additional
taxes due on the sale (federal and/or state) depending on Seller’s individual tax posture, including
character of the gain. Any disparity is often taken care of by a gross-up payment from Buyer. Therefore,
an indemnity in the share purchase agreement is generally desirable
• If target has rolling shareholders (i.e., management rollover), consult tax advisers for possible issues
that could adversely impact the tax step-up

© 2017 Grant Thornton LLP | All rights reserved | U.S. member firm of Grant Thornton International Ltd 28
Corporate tax attributes
Net operating losses

Net operating loss = Tax deductions > Gross income

• If generated pre-tax reform – carryback two years and forward 20 years
• If generated post-tax reform* – no carryback, no expiration, but subject to limitation (80% of taxable
income)
• *CARES Act –
• If generated in 2018, 2019 or 2020 – allows for a five-year carryback
• Suspended NOL limitation to 80% of taxable income

Ability to carry over depends on form of the transaction

• Asset purchase or (h)(10) – NOLs do not carry over, but may potentially offset Seller’s gain on sale
• Stock purchase – NOLs do carry over, but are subject to an annual § 382 limitation from change of
ownership

© 2017 Grant Thornton LLP | All rights reserved | U.S. member firm of Grant Thornton International Ltd 29
Corporate tax attributes
5 dangerous and often untrue assumptions and traps regarding NOLs

1 Target can use 100% of its NOLs to shield its post-close taxable income as needed

2 Target’s NOLs can be applied fully against its worldwide taxable income, wherever
such income is derived
NOLs generated in post-close periods can be carried back to obtain refunds of pre-
3
closing taxes

4 The equity contraction caused by a leveraged buyout ("LBO") is ignored when

determining the annual limitation on using target’s NOL post-close

5
Failing to consider whether target’s NOLs may already be impaired because of previous
ownership changes

© 2017 Grant Thornton LLP | All rights reserved | U.S. member firm of Grant Thornton International Ltd 30
Possible tax structure decision tree*
What is the legal form of
the target?

LLC or GP, LP, LLLP  80% of

C corporation  80% subsidiary
(tax partnerships) S corporation

Was target or a predecessor

Basis step-up Significant NOLs or Asset deal or
entity form erly a C
likely available other tax attributes? §338(h)(10)/
corporation w ithin 5 years?
§336(e) is likely
No Yes Yes No available
Partial or full step-
up m ay be available
depending on Stock deal if § Principal considerations:
am ount of equity Asset deal or 1374 corporate Possible asset Stock deal or
deal or §338(g)/ reverse • Compare Seller’s stock basis
being purchased — §338(h)(10)/ tax is > net
certain elections §336(e) or cash present value §336(e) election m erger; NOLs versus asset basis for net basis
if NPV of step- and credits disconformity; consider the NPV
m ay need to be in forw ard m erger (NPV) of the
up > NPV of subject to of the step-up versus the
place (i.e., § 754); step-up
NOLs; NOLs various Seller's tax on the disconformity
consider tax
and other tax lim itations amount to evaluate the cost of a
character to Seller
Principal Seller issues: attributes do (e.g., § § 382, potential step-up transaction
• State taxes not carry over 383, 384, etc.) • State taxes
• Character of income (ordinary vs. capital) • Business and legal complexity
of an asset deal outside of an
• Rollover equity based on after-tax dollars
*General considerations. 338(h)(10)/336(e)
• Business and legal complexity of an asset © 2017 Grant Thornton LLP | All rights reserved | U.S. member firm of Grant Thornton International Ltd 31
deal outside of an 338(h)(10)/336(e)
Tax changes due to COVID-19

Change in tax filing due dates

CARES Act
• 5 year NOL carryback for NOLs arising after 2017 and before 2021
• Suspended NOL 80% TI limits until 2021
• Bonus depreciation on qualified improvement property
• Increased interest expense limitation under Section 163(j) from 30% to 50%
• Immediate AMT credit refunds
• Payroll tax deferral (6.2%): 50% due by 12/31/2021 and 50% due by 12/31/2022
• Employee retention credits
• Paid leave tax credits
• PPP loan and related expense tax treatment

© 2017 Grant Thornton LLP | All rights reserved | U.S. member firm of Grant Thornton International Ltd 32
Election preview – Impact on M&A

Comparison of proposed tax rates affecting M&A activity

Donald Trump Joe Biden

Corporate rate 21% 28%

Top individual rate 37% 39.6%

Top effective rate on pass through income

29.6% 39.6%
eligible for Section 199A deduction

Top rate on long term capital gains 20% 39.6%

© 2017 Grant Thornton LLP | All rights reserved | U.S. member firm of Grant Thornton International Ltd 33
Election preview – Impact on M&A
Continued
Proceeds Rate Tax After tax proceeds

Corporate sale

Trump plan $300M 21% $63M $237M

Biden plan: Full tax increase $300M 28% $84M $216M

Pass through sale

Trump plan $300M 20% $60M $240M

Biden plan: Full tax increase $300M 39.6% $119M $181M

© 2017 Grant Thornton LLP | All rights reserved | U.S. member firm of Grant Thornton International Ltd 34
Any final questions?

© 2020 Grant Thornton LLP | All rights reserved | U.S. member firm of Grant Thornton International Ltd 35
Speakers

Sunil Taneja Lamar Weeks Maggie Bafia Guin Seaward Trinh Tran
Senior Manager Senior Manager Senior Manager Senior Manager Senior Manager
M&A Tax M&A Tax M&A Tax State and Local Tax State and Local Tax

sunil.taneja@us.gt.com lamar.w eeks@us.gt.com maggie.barfia@us.gt.com guinevere.seaw ard@us.gt.com trinh.tran@us.gt.com

© 2020 Grant Thornton LLP | All rights reserved | U.S. member firm of Grant Thornton International Ltd 36
Disclaimer
• This Grant Thornton LLP presentation is not a comprehensive analysis of
the subject matters covered and may include proposed guidance that is
subject to change before it is issued in final form. All relevant facts and
circumstances, including the pertinent authoritative literature, need to be
considered to arrive at conclusions that comply with matters addressed in
this presentation. The views and interpretations expressed in the
presentation are those of the presenters and the presentation is not intended
to provide accounting or other advice or guidance with respect to the matters
covered
For additional information on matters covered in this presentation, contact
your Grant Thornton LLP adviser
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