SLIDEREAD

Tax Due Diligence in theMergers and Acquisitions ProcessThomas J. (T.J.) NevilleJ. Brian DavisTEI Baltimore/Washington Chapter13th Annual Tax Education DayDecember 4, IPB and J. Brian Davis

IPB and J. Brian DavisAgenda Overview Domestic aspects International aspects Purchase accounting Key negotiation issues Trends

IPB and J. Brian DavisOverviewParadigms and perspectives Types of deals– Taxable vs. non‐taxable– Stock vs. asset acquisition – incl. “hybrid” deals (stock/asset deals combined)– Fusion deals – attributes carry‐over Perspectives of the parties– Buyer / Acquirer Goal is to maximize tax benefits and limit costs Asset or similar gives most flexibility– Seller If cashing out, stock sales generally most beneficial Tax‐free deals are good, but typically require continuing relationship

IPB and J. Brian DavisOverviewBuyer and seller tax focus in M&ABuyer; Considerations Representations regarding targetattributes and historical filingpositions (incl. support documents) Springing exposures, and quality ofearnings Asset, stock basis and E&P; studies Change‐limited attributes (e.g., §382) Ongoing effect of prior year auditadjustmentsSeller Considerations Providing sufficient information forBuyer’s diligence Ability to claim and use tax attributes(or obtain value via purchase price) Ability to exit particular investment intax‐efficient manner Potential for purchase priceadjustment for audit adjustmentsfrom pre‐sale tax years Payment on indemnity claims Purchase accounting and/orcash flow Tax‐efficient financing and structureUnified Loss Rules

IPB and J. Brian DavisOverviewSTRATEGY REVIEW &GREENLIGHTINGBirdseye; view of M&A; processDILIGENCE NTSANTICIPATORYPHASE Screening meetings Final NWC computed Financial modeling Initial tax planning LOI Allocations and filings Regulatory approvals Post‐acq. integration Transition exercisesFULL BLOWNDILIGENCE PHASE Financing preparedness Funding Review target data Interview target personnel Further tax planning anddeal / document negotiation(diligence findings are key) Signing of definitives Litigation Indemnity claims

IPB and J. Brian DavisOverviewPlanning for tax diligence At outset, develop internal plan for tackling deal / diligence– Deal structure – assess whether fixed or in flux– Timeframes – get in with BD and Strategy teams early Avoid tax being afterthought (it will not be if something goes wrong)– Objectives – known what is (should be) important to internal stakeholders Scope task and guide diligence teams– Identify areas to cover (based on deal profile/timing)– Guide as to risk tolerance– Identify exposures / successor liability– Develop appreciation for tax attributes– Focus on industry relevant issues

IPB and J. Brian DavisOverviewDiligence procedureSummary of key tax diligence tasksPurposeReview legal andorganizational chart Understand the Target’s tax structure, and obtain documentation for key elections (e.g., § 338, CTB, etc.)Identify where the Target operates jurisdictionally and where its group entities are residentIdentify special purpose entities and existing tax planning strategiesCopies of prior tax diligence reports, transactions (e.g., stock purchase agreements) and board minutesReview 10‐K and taxworkpapers Analyze the effective tax rate to identify variances from expectationsAnalyze current and deferred taxes payable to identify significant differences b/t GAAP and taxable incomeAnalyze the tax contingency reserve (provision) to understand management’s view of tax exposuresReview of FIN 48 documentation, analysis of UTPs (incl. former FAS 5 liabilities for non‐income taxes) Understand historical and prospective implications of tax reporting (e.g., tax accounting methods, specialelections, permanent book/tax differences), and assess compliance with tax authority agreements (e.g., PLRs)Review appropriateness of tax reporting for historical transactionsReconcile tax reporting in GAAP financial statements to tax return reporting, including review of schedule M‐3Understand Target’s SALT / int’l nexus and income allocation / apportionment to ensure that it is reasonableReview incometax return filings Review taxexamination historyManagement andTax Advisor interviews Review the Target’s examination history and supporting documentation for income taxes, non‐income taxes(e.g., sales and use, property, payroll) and indirect taxes (e.g., customs, GST/VAT)Identify issues raised in historical examinations and assess prospective impactUnderstand current and historic relationship with exam teams Understand policies and procedures with re to non‐income taxes (e.g., sales and use, property, payroll)Understand management’s risk posture with respect to taxesUnderstand any prior or prospective tax planning

IPB and J. Brian DavisOverviewInitial information request Any initial information request should include:– Legal entity organizational chart For all entities: need to identify jurisdiction of tax residency and US tax classification– Copies of all tax returns – all jurisdictions Request for documentation supporting all elections, actg. method changes, credits and claims Supporting schedules and materials for all material items (incl. FTCs, state income tax calcs., etc.) Includes sales and payroll tax returns, withholding/FATCA compliance materials, etc.– Accountants’ workpapers – provision and tax returns– All written analysis / documentation of positions and completed transactions Legal opinions, FIN 48 workpapers, UTP analyses, FAS 5 positions, documents supplied to attest firm All internally‐initiated studies (basis, E&P;, § 382, transfer pricing, etc.) Materials, analyses and step‐plans from prior M&A; activities (incl. prior diligence reports, prior dealdocuments such as SPAs, list of areas of continuing liability, copies of tax sharing agreements, etc.)– Controversy / audit files and all correspondence with tax authorities All agreements with tax authorities (e.g., closing agreements, etc.) Filings with any tribunal regarding tax matters (incl. matters in arbitration)

IPB and J. Brian DavisOverviewOverarching things to remember Inheriting risk– Asset deals Typically able to leave liabilities behind, but consider bulk sale– Stock and fusion deals Consolidated return liability (incl. under Treas. reg. § 1.1502‐6) Transferee / successor liability (e.g., § 381 transactions), tax sharing agreements Impact of § 338 Typical value items– NOLs – but change of ownership considerations– Credits and credit carryforwards– Deferred deductions– Booked refunds– Low ETRs and tax holidays

IPB and J. Brian DavisDomesticCommon US tax exposures Existing § 382 limitations– In many cases, acquisition targets were subject to various rounds offinancing; however, ownership changes have not been tracked Intragroup transactions (e.g., DITs, ELAs, etc.) § 481, § 108(i) and other large book‐to‐tax differences Treatment of deferred revenue Withholding taxes (e.g., bank debt, distributions) State nexus Sales and similar indirect taxes

IPB and J. Brian DavisDomesticCommon US tax exposures(cont.) Nexus– SALT issues are increasingly important and, in some cases, can constitute amore significant exposure than federal tax liabilities Sales & use tax– Target’s compliance with sales and use taxes in the applicable states inwhich it does business should be reviewed by specialists.– Above the line exposures may be considered a quality of earnings issue Employee compensation matters– Golden parachute rules– Deferred compensation

IPB and J. Brian DavisInternationalGeneric and foreign tax diligence Transfer pricing– Policies / documentation– Dovetailing Permanent establishment– Restructurings / existing structures– Mobile workforce Local tax attributes and limitations– NOLs and debt– Withholding taxes– Tax rulings / holidays Indirect taxes

IPB and J. Brian DavisInternationalUS specific diligence E&P; and FTCs Post‐acquisition planning considerations– Inside / outside basis (local and US)– Cash pools Blocked income Hook stock If previously foreign‐owned– Treaty‐based return positions If previously US‐owned– General US compliance / documentation– Specific attribute profiles (e.g., PTI, OFL)

IPB and J. Brian DavisInternationalPractical considerations Consider deal and financing impact on present operations Opportunities for greater benefit?– Foreign cash / other working capital assets– Argument for change– Local incentives Transition issues– Extracting from prior systems / operations– Renewing beneficial items Develop appreciation of local tax environment– Does the local administration have a particular reputation?

IPB and J. Brian DavisPurchase accountingDiligence considerations General framework and background Reserves for uncertain tax positions– Mirror Accounting for Tax Indemnifications– Subsequent Adjustments Recognition of deferred tax assets / reversal of deferred taxliabilities– Jurisdictional change in control tax rules– Cash tax modeling Acquisition / integration structuring

IPB and J. Brian DavisNegotiationProcess Typically runs in parallel with diligence– LOI– Process for signaling findings to deal teams / stakeholders? Posture of deal is key– Public vs. private seller– Auction vs. exclusive / no‐shop– Standard vs. simultaneous sign‐and‐close Mind other aspects of agreement– Bake‐in desired structuring (but remain flexible)– How is acquisition price conceptualized? Balance sheet date and bring‐down timing Dividend stripping? Other provisions providing value?

IPB and J. Brian DavisNegotiationRepresentations & warranties Functions– Confirmatory diligence– Termination rights– Buyer protection Laundry list– All advisors have list– Watch out for duplicative / repetitive Talk it out with counterparty Qualifiers– Materiality / knowledge– Schedules or data room

IPB and J. Brian DavisNegotiationCovenants Pre‐closing– No elections / settlements / changes / etc. without permission– In special situations, will take steps – Continued access and cooperation Post‐closing– Preparation and filing of returns– Payment of taxes (incl. re straddle periods)– Joining in elections– Steps to fully effectuate separation; continued access / cooperation– Handling disputes– Consultation rights– Consistency

IPB and J. Brian DavisNegotiationTax indemnity Inevitably is last thing negotiated– Availability? Seller’s responsibility– Pre‐closing periods and breaches– Taxes of other persons (as successor, by contract or otherwise) Limitations / carve‐backs– Usually no baskets / caps– Notification requirement– Offset with tax benefits Survival period– Should be statute of limitations in most cases

IPB and J. Brian DavisNegotiationMiscellaneous Control of disputes / refund claims– Typically purchaser controls, subject to seller participation if indemnity– Exception perhaps for refund claims relating to indemnified period Withholding taxes on purchase price– Consider Vodafone Escrows, earnouts and purchase price adjustments– Consider impact of payments from escrows, earnouts, etc.– Characterization of indemnity payments– Reporting purchase price adjustments for tax and GAAP purposes

IPB and J. Brian DavisTrendsWorking capital strategy Definition of working capital– “Working capital” current assets minus current liabilities– Adjustments – purchase price is typically adjusted based on the degree towhich WC on the closing date differs from the “target WC” (the amountthat was agreed between the parties)– Important to consider tax impact as the language often not drafted by taxprofessionals and may be written in a way that has unintended taxconsequences– Interplay with tax matters section and tax indemnities– Options to consider – because WC is generally a GAAP balance sheetconcept, it is important to consider how taxes reflected on the balancesheet are accounted for in the WC adjustment. Some options: Exclude all taxes (income, non‐income)Include all taxes (income, non‐income) Exclude only deferred income taxesInclude only non‐income taxes– In any event, floors and ceilings on WC should be considered

IPB and J. Brian DavisTrendsTransaction‐related deductions Tax benefits for transaction‐related deductions– Generally – Capitalize amounts paid to facilitate certain transactions: Acquisition of assets constituting a trade or businessAcquisition where two parties are related immediately after the transactionAcquisition of an ownership interest of the taxpayerRestructurings, recapitalizations, reorganization of capital structureTransfers described in § 351 or § 721Formation or organization of a disregarded entityAcquisition of capital, borrowing, writing an option, etc.– Bright‐line test for certain acquisitive transactions– Capitalize any inherently facilitative amount– Capitalize any amount related to activities performed after the earlier of: The date on which a LOI or exclusivity agreement is executedby representatives of the buyer and the seller; or The date on which the material terms of the transaction areauthorized or approved by the taxpayer’s board of directors

IPB and J. Brian DavisTrendsTransaction‐related deductions (cont.) Factors to consider–Target employee items – cash‐out options, change in control payments, bonuses,and plan rollovers–Success fees ‐‐ Rev. Proc. ‐29 creates a safe‐harbor election for taxpayers seekingto allocate success‐based fees between facilitative and non‐facilitative amount. Underthe safe‐harbor, an election is available to treat 70% of all success‐based fees incurred asnon‐facilitative (i.e., deductible) and to treat the remaining 30% as facilitative (i.e., non‐deductible and capi