Does this really happen? - schweser, corporate finance - pg. 345

In a stock purchase acquisition…“Also, shareholders will bear any tax consequences associated with the transaction. Shareholders must pay tax on gains, but there are no taxes at the corporate level. If the target company has accumulated tax losses, a stock purchase benefits the shareholders because under U.S. rules, the use of a target’s tax losses is allowable for stock purchases, but not for asset purchases.”

If I am a shareholder of the target company, is this excerpt saying that the losses on my company’s accumulated losses (I’m assuming NOLs?) can be used to offset my capital gains when I file for taxes? Sounds crazy. Am I reading this wrong?

thinking about this, I am probably reading it wrong. Any thoughts? How does it work when your company is acquired and has losses…how does that affect the shareholder’s taxes?

Goign to ask a question and found this exact question from three years ago. The page number for Kaplan is still the same 3 years later smiley

Can someone help explain?

The way I see it is that when you buy a company in a stock purchase acquisition (say more than 50% of shares) - you have to consolidate everything that is on the target’s balance sheet (including tax losses). So the acquirer may use these tax losses to reduce his tax payments (if he is profitable).

When it is an asset acquisition - you don’t have to consolidate, increase an asset account and reduce cash

This is good to know. Thank you!

I believe all this is saying is that the acquirer gets to use the target’s NOLs if the transaction is a stock deal. NOLs are quite valuable and there have been companies that were acquired solely for their NOLs. As such, it would makes sense that the target’s shareholders would prefer a stock deal (in this case) because then they can factor the NOLs into the negotiations. While the shareholders have to pay taxes on the sale, the corporate taxes are bypassed and they’re taxed at a lower capital gains tax rate compared to an asset deal, especially because some assets can be taxed as ordinary income and because there’s a double taxation aspect to asset deals (i.e. taxes on the sale of assets at the corporate level and then taxes when the proceeds are distributed to the target’s shareholders).

There are also benefits to selling the entire legal entity rather than just it’s assets. Sure, the proceeds would be used to payoff liabilities, but there are still risks (think lawsuits). This is also one reason buyers tend to prefer asset deals (in general) because then they don’t have to take on any of the target’s baggage. In an asset deal, the buyer also gets a stepped-up tax basis in the target’s assets and thus also gets tax benefits in the form of depreciation and amortization (for goodwill and other intangible assets). Now, in the case of an asset deal where the target has considerable NOLs, the acquirer only gets to use the target’s NOLs immediately and only to offset the gains on the sale of the assets. Any remaining NOLs are lost.

With a stock deal (in the case of considerable NOLs) there’s also an IRC Section 338 election component to deal with, but I think that’s beyond Level 2 and there are other ways around the limitations on NOLs.