If you are selling your business as a sale of assets (rather than an sale of stock or some other form of equity interest), the allocation of your purchase price among the different kinds of assets can be critical in determining what the “after tax” proceeds will be. So it is common – but not legally required – that the parties to a transaction agree to the allocation of a purchase price as part of the asset purchase agreement. (Typically, that allocation is in the form of an exhibit or schedule to the asset purchase agreement, but in some cases the parties may agree in writing to such allocation after the actual closing.)
While that may seem straightforward, the actual determination of what is best for you, the Seller, can be both complicated and complex. And it is not unusual for the parties – who in some instances have entirely opposing interests – to continue to negotiate the allocation until the eleventh hour.
In recent weeks I have had several inquiries concerning purchase price allocation issues, and my good friend Ray Evans, a partner with the excellent northern California accounting firm RINA, has directed my attention to a recent decision of the Tax Court which highlights the importance of getting that allocation right.
In Peco Foods, Inc. v. Commissioner, TC Memo 2012-18, the taxpayer Peco, a corporation, had acquired two poultry processing plants by purchasing assets, and in each case had agreed as part of the asset purchase agreement to an allocation of the purchase price. In both cases, the parties agreed that the values would be used for all purposes, including tax and financial reporting. Subsequently the purchaser / taxpayer Peco determined that a potion of the purchase price allocated to a “building” was not really real property, but property eligible for more rapid appreciation, and it attempted to reclassify such items in a filing with the IRS.
The relevant tax code provision is Section 1060(a), which includes the following sentence:
“If in connection with an applicable asset acquisition, the transferee and transferor agree in writing as to the allocation of any consideration, or as to the fair market value of any of the assets, such agreement shall be binding on both the transferee and transferor unless the Secretary determines that such allocation (or fair market value) is not appropriate.” (Bold italics added.)
The Tax Court rejected Peco’s arguments, finding that the allocations were part of binding contracts, and that the last sentence of 1060(a), noted above, provides that only the IRS can challenge an agreed to allocation. In other words, for the taxpayer to succeed, it would be required to somehow prove that the agreed to allocation was unenforceable.
What are the implications to you as a Seller of a business in an asset sale?
- Allocation of the purchase price in an asset sale can be critical to your determination to proceed. Get your tax adviser – who should know and understand your balance sheet – involved early. If your tax adviser is not routinely involved in M&A, consider retaining someone with that specific experience.
- An agreement on allocation of the purchase price is NOT required as a matter of law, or by the IRS. Nevertheless, an agreed to allocation can make your subsequent dealings with the IRS much less painful, so if you and your tax adviser fully understand the ramifications, a written agreement on allocation is the preferred approach.
- If you cannot agree, or are in any way unsure of the ramifications, DO NOT agree in writing to an allocation, on the assumption that you can subsequently take a different approach with the IRS. You must “mean what you say,” and the IRS is not likely to allow you to subsequently take a different position, particularly if you request treatment that is inconstant with that requested by the Buyer.