Recent tax legislation passed by Congress (the “Act”) generally eliminated a corporation’s ability to carry back net operating losses (“NOLs”) to prior years/ and instead allows the NOLs to be carried forward indefinitely.
What does this mean for your M&A transaction? Often times, target corporations generate substantial deductions in the year of sale due to compensatory change of control payments and other transaction expenses, such as investment-banking fees. Prior to the Act, a target corporation with taxable income in the two taxable years preceding the year of sale could utilize an NOL arising as a result of the sale to obtain a tax refund with respect to such prior years. Since this option is no longer available, sellers may request compensation from the buyer for the value of the target’s NOL carryforward more frequently.
Here are some considerations to keep in mind:
- If the sale occurs early in the target’s taxable year, it is more likely that the target’s taxable income for the year will be insufficient to fully offset deductions triggered upon closing, and thus, create an NOL carryforward.
- NOLs of a target corporation generally are not available to the buyer in an asset-type acquisition.
- A seller that expects the target corporation to have an NOL carryforward should state its intention to be compensated for the post-closing tax benefit to the buyer early in the negotiation process.
- A buyer should determine the section 382 limitation applicable to its use of target’s NOLs to ensure that the seller is not over-compensated for the NOL carryforward.
- In determining the value of an NOL carryforward, the buyer should give consideration to the accuracy of the deductions giving rise to the NOL, its ability to use the NOL, and the time value of money.