CONTINGENT CONSIDERATION AND CONTINGENT LIABILITIES IN ACQUISITIONS —————————— OUTLINE —————————— FEBRUARY 2012 —————————— AMERICAN LAW INSTITUTE-AMERICAN BAR ASSOCIATION FOURTH ANNUAL ADVANCED COURSE OF STUDY CORPORATE TAXATION —————————— MARCH 29-30, 2012 WASHINGTON, D.C. —————————— ROBERT H. WELLEN IVINS, PHILLIPS & BARKER WASHINGTON, D.C. —————————— TABLE OF CONTENTS Page* NOMENCLATURE .....................................................................................................................1 INTRODUCTION ........................................................................................................................2 TAXABLE ASSET AND STOCK ACQUISITIONS ..................................................................4 I. Contingent Purchase Price in Acquisitions of Target Assets and Acquisitions of Target Stock Without Section 338(h)(10) Elections ............................................................4 A. Treatment of Seller – Choice Between Installment Method and Election Out ..............4 B. Treatment of Seller – Installment Method .....................................................................4 1. Installment Method -- Application...........................................................................4 2. Installment Method – Election Out .........................................................................4 3. Installment Method – Method of Calculating Gain Recognized .............................5 4. Allocating Installment Obligation to Certain Assets ...............................................7 5. Installment Method – Deferral Charge ....................................................................8 6. Advantages and Disadvantages of Installment Sale Method to Seller ..................10 * Internal pagination. i C. Treatment of Seller – Consequences of Electing Out of Installment Method .............10 1. Timing and Character of Amount Realized ...........................................................10 2. Closed Transaction Method ...................................................................................11 3. Open Transaction Method......................................................................................22 D. Proposal to Replace Closed Transaction, Open Transaction and Installment Methods of Reporting Contingent Purchase Price .......................................................26 E. Treatment of Acquiror .................................................................................................26 1. Allocation of Contingent Purchase Price Among Assets Purchased .....................26 2. Specific Allocations – Intangible Assets ...............................................................27 3. Timing of Effects on Basis and Interest Deductions .............................................27 4. Contracts for Use of Intangibles ............................................................................27 5. Interest....................................................................................................................27 6. Payment to Third Party ..........................................................................................28 F. Allocation of Amount Realized Among Assets Sold ..................................................28 1. Section 1060...........................................................................................................28 2. Commissioner v. Danielson, 378 F.2d 771 (3d Cir. 1967) ....................................28 G. Possible Treatment of Contingent Purchase Price as Target Stock, Acquiror Stock or Partnership Interest ........................................................................................28 H. Reporting Requirements ..............................................................................................29 1. Section 1060 Acquisitions .....................................................................................29 2. Installment Method ................................................................................................29 3. Election Out of Installment Method ......................................................................29 II. Contingent Purchase Price and Contingent Liabilities in Stock Acquisitions with Section 338(h)(10) Elections – Current 338 Regulations ..................................................30 A. Introduction .................................................................................................................30 B. Treatment of Old T ......................................................................................................30 1. Installment Method ................................................................................................30 2. Election Out of Installment Method ......................................................................32 3. Allocation of Amounts Realized Among Assets Deemed Sold .............................34 4. Character of Amounts Realized .............................................................................35 C. Treatment of New T .....................................................................................................35 1. Allocation of Contingent Purchase Price and Contingent Liabilities Among Assets Deemed Purchased .....................................................................................36 2. Timing of Effects on Basis ....................................................................................36 3. Elimination of Phantom Income ............................................................................37 4. “Breaking the Link” Between ADSP and AGUB ..................................................38 D. Reporting and Administrative Requirements ...............................................................38 1. Forms 8023 and 8883.............................................................................................38 2. Other Administrative Requirements ......................................................................39 II*. Contingent Purchase Price in Stock Acquisitions with Section 338(h)(10) Elections – Old 338 Regulations .......................................................................................39 A. Treatment of Old T ......................................................................................................40 1. Installment Method Not Available .........................................................................40 2. Amount Realized at Closing ..................................................................................40 3. Amount Realized Upon Receipt ............................................................................40 4. Allocation of Amounts Realized Among Assets Deemed Sold .............................40 ii 5. Post-Closing Adjustments ......................................................................................40 6. Recovery of Asset Basis ........................................................................................41 7. Character of Amounts Realized – Actual and Imputed Interest ............................41 B. Treatment of New T .....................................................................................................41 1. Allocation of Contingent Purchase Price Among Assets Purchased .....................41 2. Timing of Adjustments to New T’s Asset Basis ....................................................41 III. Escrows and Other Returns of Purchase Price...................................................................41 A. Whose Property Is the Escrow? ...................................................................................42 1. Inclusion of Escrowed Funds in Seller’s Amount Realized at Closing .................42 2. Income on Escrowed Funds ...................................................................................43 3. Disputed Ownership Funds ....................................................................................43 4. Case Study – E&Y-Cap Gemini Transaction ........................................................43 B. Escrow as Acquiror’s Property ....................................................................................50 1. Escrow as Acquiror’s Property – Treatment at Closing to Seller ..........................50 2. Escrow as Acquiror’s Property – Treatment at Closing to Acquiror .....................51 3. Escrow as Acquiror’s Property – Income Earned on Escrowed Funds – Prop. Reg. § 1.468B-8 .....................................................................................................51 4. Escrow as Acquiror’s Property – Treatment on Payment to Seller .......................52 5. Escrow as Acquiror’s Property – Treatment on Return of Escrowed Funds to Acquiror .................................................................................................................52 6. Escrow as Acquiror’s Property – Treatment on Use of Escrowed Funds to Pay Seller Liabilities ..............................................................................................52 C. Escrow as Seller’s Property .........................................................................................52 1. Escrow as Seller’s Property – Treatment at Closing to Seller ...............................52 2. Escrow as Seller’s Property – Treatment of Escrow at Closing to Acquiror .........52 3. Escrow as Seller’s Property – Income Earned on Escrowed Funds ......................53 4. Escrow as Seller’s Property – Treatment on Payment to Seller ............................53