Pub. 8 2013-2014 Issue 4

www.nebankers.org 12 Extraordinary Service for Extraordinary Members. T his article is the second in a two-part series on taxation in bank mergers and acquisitions, intended to highlight some specific tax-related considerations that many banks and financial institu- tions should consider when evaluating consolidation opportunities. The first installment highlighted the general federal tax rules governing, and the options or requirements for adopting, various federal tax methods available to banks. There are myriad federal tax issues to consider when contemplating any merger, but today we will focus on two key issues for banks and financial institutions in merger transactions: (i) the preservation of deferred tax assets; and (ii) the treatment of cash payments in a tax-free merger. Loss Limitation of Tax Attributes As discussed in the last installment, there has been massive consolidation in the last decade. More recently, in the wake of the financial crisis, many financial institutions have accumulated significant amounts of tax attributes in the form of net operating loss (NOL) carryforwards, tax credit carryforwards, and other forms of built-in tax losses. 1 These deferred tax assets are attractive to potential investors or acquirers who can utilize them to offset their tax liabil- ity. However, Congress enacted law 2 to COUNSELOR’S CORNER limit, or at least deter, the “trading” or “trafficking” in corporations with NOL carryforwards, through limitations on the amount of NOL eligible to entities in certain transactions. The application of Section 382 may significantly reduce the benefit of a target’s deferred tax as- sets. Thus, determining the impact of Section 382 is an important step for an acquiring bank in determining the ap- propriate value of a target financial in- stitution. This determination is not only important for an outright acquisition of a target bank, but it is also important to an investor planning to participate in a significant stock offering by an institu- tion with such deferred tax assets. Section 382 applies to a transac- tion when a corporation experiences an ownership change 3 while it is a loss corporation. 4 This provision limits a corporation’s, or its successor’s, ability to deduct any realized built-in losses, use tax loss carryforwards, or use credit carryforwards. 5 Due to time limits on the carryforward of NOLs, the limita- tion imposed under Section 382 can lead to a permanent loss of tax benefits and a negative impact on a bank’s fi- nancial statement. 6 “Ownership Change” Under Section 382 Generally, an ownership change occurs if, immediately after any owner shift 7 or any equity structure shift, 8 the stock owned by one or more major shareholders 9 increases by more than 50 percent over a prescribed testing period. 10 Therefore, an ownership change can come from a bank’s acquisition or any form of stock issuance (including public offerings, private placements, or recapitalizations). Based on the rules, even a shareholder’s purchase of a sig- A Taxing Proposition Part II of II 1 These attributes which are not used for current-year taxes, but can be utilized in future tax periods are what are reported as “deferred tax assets” on an organization’s balance sheet, and are also referred to as such herein. 2 I.R.C. Section 382. All section references hereafter are to the Internal Revenue Code of 1986, as amended, unless otherwise noted. 3 Section 382(g). 4 Section 382(k). 5 It is important to note that the limitation will still apply even if the NOL is not used against the purchaser’s profits. 6 Section 172(b)(1)(ii). The carryforward for an NOL deduction is limited to 20 years. 7 An owner shift is a change in ownership that affects the percentage of stock owned (directly and through attribution) by any major shareholder (defined in footnote 9). 8 Equity structure shifts generally include most tax-free reorganizations other than certain divisive reorganizations or mere changes in corporate form. 9 Section 382(k). A “major shareholder” means any person holding 5 percent or more of the stock of the corporation at any time during the testing period. 10 Section 382(g). Jason Maus , Husch Blackwell LLP Banking Mergers & Structure Changes: