Publications
02.03.12
Iron Handcuffs? Long-term Tax Implications of Asset Purchase Agreements
by Darren Mills, Principal
On January 17, 2012 the Tax Court in Peco Foods, Inc. and Subsidiaries, TC Memo 2012-18 held that Peco Foods, Inc (“Peco”) could not modify purchase price allocations of assets it bought through asset purchase agreements of two poultry plants. Once a taxpayer agrees to a purchase price allocation in a transaction, absent extenuating circumstances, the tax court believes the taxpayer is stuck with the tax consequences of that allocation.
In the mid-to-late 1990s Peco purchased two poultry processing plants in Mississippi through two separate asset purchase agreements. As part of those agreements, Peco agreed to allocate the purchase price “for all purposes (including financial accounting and tax purposes).” The agreement was very specific regarding allocation of assets. However, in 1999, Peco engaged a third party to perform a cost segregation study of the purchased poultry plants. The advisor subdivided the purchased assets associated with the plants into subcategories, resulting in a depreciation expense of $5,258,754 for tax years 1998 to 2002. In 2008 the Internal Revenue Service filed a notice of deficiency, which among other things, alleged that Peco was not entitled to subdivide the purchased assets after acquiring the plants.
The Internal Revenue Service argued that IRC § 1060 and the Danielson rule binds a buyer and seller to an agreed upon allocation of any consideration as part of an asset acquisition. The tax court agreed that IRC § 1060 and the Danielson rule apply to Peco and found that the asset purchase agreements were binding contracts on Peco. Consequently, Peco could not adjust the purchase price allocations and enjoy accelerated depreciation on those assets. The court noted:
“Allowing Peco to treat the acquired assets in a way other than the one in which it agreed to, subjects respondent [the Internal Revenue Service] to a potential whipsaw. Such a whipsaw might occur if, for example, Peco treated certain property as section 1245 property but Marshall Durbin [the seller] treated that property as section 1250 property. Respondent [the Service] would be made to treat two parties to the same transaction inconsistently. Even if a danger of whipsaw did not occur, binding Peco to the original Canton allocation schedule prevents it from realizing a better tax consequence than the one it bargained for.”
Simply put, the tax court concluded that taxpayers cannot reallocate assets for a better tax treatment after entering into a bargained for agreement due to possible inconsistencies in tax treatment among the parties.
The holding in this case is troubling. Should the taxpayer not appeal this case or if appealed and upheld by the appeals court, contract drafters and advisors will have to do more upfront work to allocate the purchase price in such a way that the tax benefits are maximized for both parties.
For the time being though, taxpayers who are negotiating asset purchase agreements must closely consider the purchase price allocations of assets, because if they don’t allocate the assets properly before entering into such agreements, the IRS may challenge their ability to do so post-acquisition. Consider requesting language is inserted that provides flexibility and requires the parties to work in conjunction to maximize the tax benefits to both parties post acquisition.
For more information on these regulations, please contact Darren Mills at 703-770-0542 or dmills@argy.com.
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1 (a) General rule
In the case of any applicable asset acquisition, for purposes of determining both:
(1) the transferee’s basis in such assets, and
(2) the gain or loss of the transferor with respect to such acquisition, the consideration received for such assets shall be allocated among such assets acquired in such acquisition in the same manner as amounts are allocated to assets under section 338(b)(5). 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.
2 In Commissioner v. Danielson, 378 F.2d 771, 775 (3d Cir. 1967) the Court of Appeals for the Third Circuit held a taxpayer can only challenge the tax consequences of a written agreement “only by adducing proof which in an action between the parties to the agreement would be admissible to alter the construction or to show its unenforceability because of mistake, undue influence, fraud, duress, etc.”
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