Final regulations under section 336(e) provide basis step-up opportunities for non-corporate acquirers

On May 10, 2013, the U.S. Treasury and the IRS published long-awaited final regulations under section 336(e), expanding the application of deemed asset sale transactions beyond section 338. These regulations now provide an opportunity for non-corporate acquirers (such as limited liability companies (LLCs) taxed as partnerships) to treat the acquisition of stock as a purchase of assets, creating a stepped-up basis and corresponding tax shield against future taxable income.  The final regulations under section 336(e) apply to any qualified stock disposition occurring on or after May 15, 2013.

The new regulations establish an election to treat certain qualifying stock sales, distributions and exchanges as asset sales, thereby providing a basis step-up to non-corporate acquirers. Previously, only corporate acquirers could make this type of election under section 338, which often led to the implementation of complex transaction structuring and additional administrative costs. Under these regulations, there is no need to create a corporate acquisition vehicle, and, of equal importance, it may not be necessary to retain a corporate structure if the acquiring entity or group wishes to operate as a flow-through entity. Like section 338, section 336(e) alleviates the imposition of multiple levels of taxation on the same economic appreciation upon the eventual sale of the target corporation’s assets by the purchaser.  Like a section 338(h)(10) acquisition, the section 336(e) rules apply to S corporation targets, as well as carve-out acquisitions of subsidiaries of a consolidated or affiliated group.

The election under section 336(e) provides the target with a tax step-up in the basis of the assets and a tax shield in the form of future tax deductions, such as depreciation and amortization on the premium paid.  Note that, unlike an election under section 338(h)(10), an election under section 336(e) does not require the consent of the purchaser.  As such, a buyer in a stock acquisition will need to require proper representations, warranties and covenants from the seller as to whether an election under section 336(e) will be made.

Because a corporate acquirer is not necessary, this election provides an opportunity for a Private Equity Fund (PE) to acquire a target and receive a basis step-up and tax shield, without creating a purchasing corporation or otherwise restructuring the target prior to the acquisition. Further, a PE now has the flexibility to restructure the target such that the ongoing activity is conducted through an LLC taxed as a partnership, which would allow the fund to pass on a full basis step-up upon exit and eliminate future corporate taxation on the target’s activities. In addition, the new regulations may provide the ability to separate multiple businesses post-acquisition in a much more tax-efficient manner than previously existed, thereby allowing a PE to better align its investments.

In summary, section 336(e) now opens an entire world of asset basis step-up transactions to non-corporate acquirers previously ineligible to make elections under section 338. 

For more information, please contact Al Cappelloni at 617.241.1353.

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