Tax Implications You Need to Know Surrounding SPACs | Part 3
The third and final part of our series covering tax matters around Special Purpose Acquisition Companies (“SPACs”) and their shareholders takes a closer look at the acquisition transaction and what it means for the SPAC’s owners from a tax perspective.
Once the SPAC decides to complete an acquisition, there are three parties involved that will have a tax impact. These are the SPAC shareholders, the acquisition target shareholders, and the SPAC itself.
When the SPAC identifies the acquisition target and negotiates the deal, the SPAC shareholders will then generally be entitled to vote on whether to complete the transaction. If the shareholders vote to complete the acquisition then the individual shareholders will have the option to have their shares redeemed. If they do not choose this option, then they will remain shareholders in the SPAC post-transaction.
Generally, the SPAC shareholders will not have any income tax impact as a result of the SPAC completing the acquisition. The only impact would be to any SPAC shareholder who elects to redeem their shares. Those specific SPAC shareholders will recognize gain or loss since they will have sold their shares back to the company. The gain will be long term or short term based on the length of time they held those shares. SPAC shareholders who do not redeem their shares will not have any income tax impact from the acquisition.
Acquisition Target Shareholders
Upon completing the transaction with the SPAC, the taxation of the acquisition target shareholders are varied and numerous, but are all dependent on the form of the transaction itself. The SPAC documents in some cases will specify a minimum amount of ownership that the SPAC is required to acquire (80%) and in some cases the purchase price would need to be for at least 80% of the amount raised. In some cases, the target’s owners will receive shares in the SPAC as part of the transaction. This could lead to transactions that are part taxable and part non-taxable depending on the transaction structure used.
Assuming that the target is an entity taxable as a C Corporation, the acquisition target shareholders will generally be taxable to the extent that they receive cash in exchange for their stock in the target. Generally, if the acquisition target shareholders are going to continue holding shares after the de-SPACing transaction, the transaction will be structured as a tax free reorganization. The reason for the tax-free transaction is that the acquisition target shareholders will receive shares in the SPAC and if the transaction were taxable, the acquisition target shareholders would have a taxable gain but no cash from the transaction to pay the tax. The actual type and structure of the tax free reorganization will be dependent on the mix of cash and stock in the deal and whether all the assets of the target are being acquired.
If the target company is a pass-through entity, then there is potential to use an Up-C Structure to generate additional tax advantages to the SPAC and the target’s owners. An Up-C Structure uses a partnership that is jointly owned by the SPAC and the acquisition target owners. This structure will allow the acquisition target owners to convert portions of their ownership into shares of the SPAC which will then allow them to sell on the open market. There are benefits to the SPAC that are discussed below by this transaction. It is important for the SPAC and the acquisition target owners to have knowledgeable tax professionals involved early in the process when considering a transaction with an Up-C Structure.
Generally, upon the execution of the de-SPACing transaction the SPAC will not recognize any gain or loss except relating to certain deductible transaction expenses. Typically, there will be no changes in the historical tax basis in any of the acquisition target’s assets. Therefore, no future tax benefits will be generated by the transaction. This is true even where the SPAC purchases some of the shares in a taxable transaction. The increase due to the purchase price paid for the acquisition target will be in the stock and it will be extremely difficult to ever recognize any tax benefit for that basis.
The only exception is if the Up-C Structure is used. Because the Up-C Structure will be taxed as an asset acquisition, the tax basis of the assets will be increased for the portion of the entity that the SPAC acquires. This increase in basis will generate tax deductions over the life of the assets which will generally be about 15 years. This will result in future tax savings to the SPAC. Additionally, as future tranches of the partnership in the Up-C Structure are acquired from the acquisition target owners over time, these additional acquisitions will also result in tax basis increases which will also result in future tax savings. In an Up-C Structure, generally the utilization of the tax benefit will result in additional payments to the acquisition target owners over time so that both the acquisition target owners and the SPAC benefit from the savings.
Overall, the tax implications and risks of a SPAC transaction to its owners are dependent on whether the owner is a sponsor, investor or target shareholder. Additionally, the SPAC has its own income tax issues that need to be addressed.
As you can see from what we’ve covered in this three-part series, the nuances affecting SPACs and their financial reporting and tax obligations are complicated. Here are a few key takeaways to consider and to discuss with your Cherry Bekaert tax advisor:
- Potential tax issues may arise if founders do not pay adequate consideration for their shares. Because the founder shares can be difficult to value, the timing of the issuance of the shares can be critical to avoiding this issue.
- As part of the formation, the sponsor will need to determine the legal jurisdiction for incorporating the SPAC, which will have an impact on the taxation of the shareholders prior to the acquisition of a target company. Moving the jurisdiction of the SPAC after the acquisition could result in a taxable transaction to the SPAC and/or the SPAC shareholders.
- If a SPAC is considered to be a PFIC, unfavorable tax consequences could result for the U.S. shareholders. Elections are available to help mitigate some of these rules, but they are complex and have their own timing requirements. Overall, the filing requirements become significantly more complex for the U.S. shareholders of a foreign SPAC.
The structure of the transaction often dictates the extent of the tax impact from both a liability standpoint, as well as an overall transaction value standpoint. If you are thinking about SPACs, make sure you are working with knowledgeable tax and accounting advisors who can assist you in mitigating the various transaction risks and, ultimately, maximizing the transaction value. Cherry Bekaert’s team of advisors have the experience and holistic understanding of the tax implications affecting SPAC formations, and are ready to be your guide forward.