TAX EFFECTS OF DISNEYMARVEL DEAL See S-4 Prospectus, pages 15 & 69 Disney-Marvel: Tax-Free for Marvel’s Shareholders • From the S-4 Prospectus (pg. 15): • Disney and Marvel expect that the transaction will qualify as a “reorganization” within the meaning of Section 368(a) of the Internal Revenue Code… • and it is a condition to closing that each of Disney and Marvel receive opinions from legal counsel to that effect [the former Dewey & LeBoeuf for Disney, Paul Hastings for Marvel) • If the transaction qualifies as a “reorganization,” a Marvel stockholder generally will recognize gain (but not loss)… equal to the lesser of… • (i) the amount of cash received in the transaction with respect to such block and • (ii) the excess, if any, of (a) the sum of the amount of cash and the fair market value of the Disney common stock received in the transaction with respect to such block over (b) the Marvel stockholder’s tax basis in its shares of Marvel common stock in Downside for Disney: Getting Marvel’s Basis • If Disney sells Marvel’s assets in the future, its recognized tax gain will be everything above Marvel’s basis • This may result in a larger tax bill for Disney (eventually…) • Disney’s ideal would have been a “step-up” in basis when it acquired Marvel’s assets, which would lower a its future tax bill • However, companies cannot step up the basis in the property if it is a 368(a) reorganization. • WHY would Disney agree to do this? • [The form of the merger transaction is negotiable, between parties] • Presumably, the same reason Disney would pay so much for Marvel • … they must really want to own Marvel. Disney acquires Marvel for $4.24b in December 2009 • What if Disney’s stock fluctuates in value? (as it does every day) • If the stock price gets too high or too low then Disney and Marvel are going to blow the 368(a) exemption, preventing the deal from being a tax-free (tax-deferred) reorganization • Marvel’s shareholders will then have to pay taxes on everything, immediately • Disney’s stock needs to be worth around $26.83 for the deal to work… Here is Disney’s stock, in the weeks around the deal: Disney acquires Marvel for $4.24b in December 2009 • What happens, business-wise? • Every shareholder of Marvel (MVL) receives $30 in cash, plus 0.7452 Disney shares, for each MVL share they own • (The deal is priced at ~$50 per MVL share, a 29% premium to Marvel’s stock price on the day it is announced) • Disney’s stock is meant to represent ~$20 per share (40% of the deal value), Here is Disney’s stock, in the weeks around the deal: Disney acquires Marvel for $4.24b in December 2009 • How to preserve the tax-free status? (pg. 6 of the prospectus) • However, if the aggregate value of all shares of Disney common stock that would be issued pursuant to the merger… • is less than 40% of the sum of the total stock consideration plus the total amount of cash paid to Marvel stockholders… • then the exchange ratio will be increased, and the amount of cash paid per share of Marvel common stock will be correspondingly decreased, • until the total stock consideration equals 40% of the total merger consideration. • In other words, do the math: • If Disney’s stock price drops from $26.84 to $25… (a 7.36% decrease) • Then Marvel shareholders will get more than 0.7452 Disney shares, per Marvel share • In particular, the new exchange ratio will be .80004672 • original exchange ratio .7452 * $26.84 = $20 new exchange ratio .80004672 * $25 = $20 plus the original $30 in cash Mergers & Acquisitions Tax Issues in M&A Transactions Basic Tax Principles Federal Taxation Principles •Any “accretion to wealth” can be taxable. –United States v. Kirby Lumber Co., 284 U.S. I, 3 (I93I). •The federal income tax code taxes “gains derived from dealings in property.” •IRC § 61(a)(3). Federal Taxation Principles Taxable Gain is calculated as follows: The excess of the amount realized (sale price) minus the adjusted basis (original cost). IRC § 1001(a). Amount Realized (Sale Price) -Adjusted Basis (Original Cost) ---------------------------Taxable Gain Taxable Loss is calculated as follows: The excess of the adjusted basis (original cost) minus the amount realized (sale price). IRC § 1001(a). Adjusted Basis (Original Cost) -Amount Realized (Sale Price) ----------------------------Taxable Loss Gain/Loss Calculation Blue Inc. purchased an asset for $100,000 two years ago. The asset is now worth $150,000, and Blue sells it to Green Company. On what amount of gain must Blue pay tax? Answer: Amount realized: Adjusted basis: gain $150,000 $100,000 $50,000 taxable Realization v. Recognition Realized Gain: A gain that has occurred financially, but is not necessarily taxed. Recognized Gain: A gain that is taxed. Why Does Tax Matter in a Deal? Consider the effect of tax rates on a deal’s value. Maximum Tax Rates as of 2014 Federal Federal Individuals Corporations Long-term capital gain (holding period greater than 12 months): Maximum of 20% 35% (ordinary income and capital gain) Short-term capital gain (holding period less than or equal to 12 months): Maximum of 39.6% State of State of California California 12.3% (ordinary income and capital gain) 8.84% (ordinary income and capital gain) TAX ISSUES IN M&A TRANSACTIONS • Buyer and Seller Preferences (different transaction structures trigger different tax treatment) • Taxable vs. tax-free transactions Transaction Preferences: Asset vs. Stock Asset Sale Stock Purchase Avoidance of double taxation Provides cost basis in assets Buyer Seller Preferred Transaction Type Asset Sale Stock Purchase Reason for Preference Provides cost basis in assets Avoidance of double taxation This provides greater depreciation deductions and reduces future tax consequences if assets are sold later. Only the shareholders pay tax; not the corporation. Other Considerations in Determining Transaction Type Structure Asset Purchase Defining Characteristics Pros Cons Seller counterparty = the Company Limit liability (subject to certain exceptions) Purchasing individual assets Tax benefit for buyer (can step-up basis in depreciable assets) Negative tax consequences for seller, especially if a C-corp (double taxation, taxed at income rate, not capital gains) Can pick and choose assets (cherry-picking) Need to individually assign/transfer each contract, IP, etc. Due diligence can be more limited in scope Can miss assets Seller counterparty = individual shareholders Acquire all assets necessary for business or parent company Easier to transfer contracts and IP Purchasing shares Easier to preserve customer base and goodwill Less tax advantageous for buyer Risk of assuming unknown or contingent liabilities (can mitigate this risk through reps and warranties, due diligence, indemnity, and carveouts) Easier to enforce non-compete Stock Purchase Potential securities laws compliance issues Can be simpler in terms of documentation needed Continuity for employees Generally need shareholder vote/unanimous shareholder approval (subject to merger rules) Taxable vs. Tax-Deferred Transactions As we will see later on, certain structures allow tax payable as a result of the transaction to be deferred. These are commonly—and somewhat inaccurately– referred to as tax-free reorganizations. Buyers and Sellers have different preferences as to whether to structure a deal as taxable or tax-free. Tax Preferences ✔ ✔ ✖ ✖ Buyer Seller Taxable Transaction ✔ ✖ Tax-Free Transaction ✖ ✔ So what are the common taxable transactions? TAXABLE M&A TRANSACTIONS Taxable M&A Transactions Participants in M&A transactions are taxed on gains arising from the transactions unless the transaction qualifies for tax-free treatment under a a specific provision of the tax code. • Example: Red Inc. purchases Blue Inc. in a deal structured as a merger, and uses cash as consideration. Each Blue shareholder receives $10 per share. If Mrs. Yellow has 1 Blue share she bought for $5, then she must pay tax on her $5 gain. Taxable M&A Transactions Type of Transaction Merger Tax Consequences if Taxable Selling Corporation 1. Seller pays tax on any gain from the sale of assets to Buyer. Selling Shareholders 1. Selling shareholders pay tax on any gain on the exchange of stock. 2. Selling shareholders’ amount realized (sale price) is reduced by tax paid by Seller Corporation. Buying Corporation 1. Buyer has no gain or loss upon the receipt of Seller’s assets. 2. Buyer’s basis in Seller’s assets is stepped-up to the cost of the assets plus any liabilities assumed (cost basis). Stock Purchase Selling Corporation 1. No tax effect on Seller. Selling Shareholders 1. Selling shareholders pay tax on any gain on the exchange of stock. Buying Corporation 1. Buyer has no gain or loss upon the receipt of Seller shares. 2. Buyer’s basis in Seller’s shares is stepped up to the cost of Seller shares (cost basis). Asset Purchase Selling Corporation 1. Seller pays tax on any gain from the sale of assets. Selling Shareholders 1. If Selling Corporation liquidates, Selling shareholders pay tax on any gain received in exchange for their shares. Buying Corporation 1. Buyer has no gain or loss upon the receipt of Seller’s assets. 2. Buyer’s basis in Seller’s assets is stepped up to the cost of the assets plus any liabilities from the assets (cost basis). Tax-Free M&A Transactions What are the common tax-deferred transactions? These are governed by I.R.C. §368 IRC § 368 Reorganizations (Tax Free Transactions) • • • • • • • Statutory merger or consolidation Stock for stock exchange Stock for assets exchange Divisive exchange Recapitalization Change in identity, form, or place of organization Transfers in bankruptcy or receivership Requirements to Qualify as TaxFree Federal tax code permits participants in certain M&A transactions to defer paying tax on gains resulting from the transactions. • Because tax is only deferred, no M&A transaction is really tax free. A transaction must meet all requirements set forth in IRC § 368 and judicially-created. » “Continuity of interest” is a critically important requirement. Continuity of Interest Requirement Transactions are tax-deferred when shareholders of the selling corporation maintain a substantial continuity of interest in the purchasing corporation. – In essence, there is no material change in the form of the shareholders’ investment which to tax. Generally: • Target shareholders must acquire substantial equity interest in Purchaser • Purchaser must continue to operate Target’s historical business/use Target’s assets • There must be a valid business purpose When is there a material change in the investment form that would be taxed? – Buyer purchases seller with stock: no material change. – Buyer purchases seller with cash: a material change. – Buyer purchases seller with both stock and cash: Depends. Tax-Free M&A Transactions Type of Transaction Merger § 368(a)(1)(A) Requirements To Qualify as Tax-Free 1. 2. 3. 4. Known as a Type A reorganization. Buyer must acquire all Seller’s assets and liabilities. Seller must cease its separate legal existence. Transaction must have a bona fide business purpose. Buyer must maintain a continuity of business enterprise. a. 5. 1. Known as a Type B reorganization. 2. 1. a. 2. Substantially all means: 90% of the fair market value of Seller’s net assets and 70% of the fair market value of Seller’s gross assets. Seller shareholders must exchange Seller stock solely for all or part of the voting stock of Buyer. a. b. 3. Thus, only consideration that can be used is voting stock. No cash is allowed. Buyer must purchase substantially all of Seller’s assets. § 368(a)(1)(C) Known as a Type C reorganization Control requires at least 80% of total combined voting power and quantity of shares. Seller shareholders must exchange Seller stock solely for all or part of the voting stock of Buyer. a. Asset Purchase Requires that at least 40% of consideration to purchase Seller be stock (voting or non-voting); the rest can be cash or other consideration. Buyer must have control over the Seller after the stock acquisition from Seller’s shareholders. a. § 368(a)(1)(B) Seller Corporation 1. Seller has no gain from transfer of assets or liabilities to Buyer. Seller Shareholders 1. Seller shareholders report no gain or loss on the exchange of stock. That is, no tax is paid. If they receive any cash in the deal, they will pay tax on that gain. 2. Seller shareholders’ basis in Buyer stock will be the same as that in their Seller shares. Buyer must maintain a continuity of interest. a. Stock Purchase Buyer must continue Seller’s historic business or use a significant portion of Seller’s historic business assets in a business. Tax Consequences if Tax-Free Requirement is met even if some of the consideration is the assumption of liabilities. Some cash can be used, but at least 80% of the fair market value of the assets purchased must be solely for stock (remaining 20% may be in cash). Seller must cease its separate legal existence. Buyer Corporation 1. Buyer has no gain or loss upon the receipt of Seller’s assets. 2. Buyer’s basis in Seller’s assets is the same as Seller’s basis in the assets. Seller Corporation 1. No tax effect on Seller. Seller Shareholders 1. Seller shareholders report no gain or loss on the exchange of stock. That is, no tax is paid. 2. Seller shareholders’ basis in Buyer stock will be the same as that in their Seller shares. Buyer Corporation 1. Buyer has no gain or loss upon the receipt of Seller shares. 2. Buyer’s basis in Seller’s shares is the same as the old Seller shareholders basis in those shares. (Statistical sampling used when Seller is publicly held.) Seller Corporation 1. Seller does not recognize any gain on the sale of its assets or assumption of liabilities. Seller Shareholders 1. Seller shareholders report no gain or loss on the asset exchange because Seller receives Buyer’s stock, not Seller shareholders. After the exchange, Seller will distribute Buyer’s shares to Seller shareholders. This is a tax-free event. 2. Seller shareholders’ basis in Buyer stock will be the same as that in their Seller shares surrendered upon Seller’s liquidation. Buyer Corporation 1. Buyer has no gain or loss upon the receipt of Seller’s assets. 2. Buyer’s basis in Seller’s assets will be same as Seller’s basis in the assets. Continuity of Interest: Planning Issue Transaction Type Maximum % of Cash Permitted Minimum % of Stock Required Type of Stock Permitted Type A (Merger) 60% 40% Voting or non-voting stock Type B (Stock Purchase) 0% 100% Only voting stock (80/80 rule) Type C (Asset Sale) 20% 80% Only voting stock 
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