Understanding Tax Receivable Agreements

The passage of the tax reform last December gave investors more certainty about corporate tax rates in the near future. One of the consequences of this situation is an increased interest by some investors in the acquisition of payment rights under so-called “tax-receivable agreements” (“TRAs”). In short, ARBs are agreements entered into by a company (a “pubco”) under an initial public offering (“IPO”) to monetize the tax attributes of the post-IPO pubco for the benefit of pre-IPO owners and investors who acquire payment rights under THE TRAs from those pre-IPO owners. Our previous article on TRAs focused on some of the ways in which tax reform could affect the value of TRA payment entitlements. Since the adoption of the tax reform, we have seen a significant increase in investor interest in acquiring TRA payment rights, particularly by hedge funds, family offices and private special funds. This article describes some of the characteristics of an TRA that an investor should analyze before acquiring rights under an TRA. Tax claims agreements have recently made their way into the financial news. Robert Willens explains how they work, noting that while such deals are properly reported by the company, many IPO investors may not be aware of the significant tax benefit the deals offer to founders, but not to subsequent investors. It should be noted that these agreements are disclosed in a complete and sometimes fairly complete manner and are likely to be considered by a potential purchaser of the Company`s shares.

However, notwithstanding the “efficient market” theories, which state that all information is fully disseminated (and understood) by all market participants, it is not inconceivable that the full meaning of these CRAs is not fully recognized by all investors and, therefore, to the extent that these ARBs are not sufficiently taken into account by these investors, market inefficiencies may well occur. Given the reaction to the Journal`s article on Carvana, one might suggest that in the case of TRAs, the theory of the efficient market does not work – as its proponents would like to imagine – at full capacity. While the article focused much of its attention on specific stock market transactions that the company facilitated in favor of these founders, another aspect of Carvana`s “governance structure” – the onerous tax claims agreement (TRA) it is responsible for – also warranted scrutiny. Under the TRA, founders will be eligible for additional payments, which could amount to more than $1 billion, provided the business can generate sufficient taxable income over the next decade. These ATRs have become an integral part of IPOs and often appear in PSPC transactions. At this stage, it is not clear whether public investors in companies burdened by TRAs are fully aware of its implications. Before making a value judgment about the “legitimacy” of ARBs, it is important to assess the tax regulations that make them possible. If a partnership (or other entity without legal capacity, such as . B a one-person limited liability company) becomes a company to facilitate a public offering of ownership shares (or if such an entity joins a PSPC), the newly formed company becomes a partner of the so-called “operating company”, while the remaining shares of it continue to be held by the founders. happen.

Although the fruits of the basic increase, as expressly provided for in paragraph 743(b), “belong” to the company, the contracting party. Eventually, the company paid a price for the shares of the partnership that reflected the value of the company`s assets. The TRA, which, as we have already mentioned, has become almost the standard procedure for IPOs (and PSPC acquisitions) of previously unregistered companies, “transfers” these tax benefits to the people, i.e. the founders, who transferred the company`s shares to the company. This column does not necessarily reflect the views of the Office of National Affairs, Inc. or its owners. ARBs have been described by some critics as “bizarre” and “sneaky,” but the economic and fiscal consequences of different types of ARBs have remained largely unexplored in the literature. This article examines whether the reviews of ARBs are justified or whether ARBs are simply an effective contract between owners prior to the IPO and publicly traded companies.

It examines ARBs in the broader financial transaction landscape and shows that the way ARBs are used in the public market differs from similar private transactions in a way that is likely to be detrimental to public shareholders. This article also shows how Up-C, a type of IPO transaction in which ARBs are most commonly used, allows owners to take money before the IPO that should be aimed at public shareholders in an undisclosed manner, and suggests remedies for this problem. Bloomberg Tax Insights articles are written by experienced practitioners, academics, and policy experts who discuss current developments and issues in the field of taxation. To contribute, please contact us at TaxInsights@bloombergindustry.com. For more information on investing in TRAs, please contact one of the following members of the Ropes & Gray team: Each individual TRA investment should be considered in light of the specific provisions of the TRA and the facts applicable to the respective pubco. These specific facts may give rise to specific due diligence issues. However, there are a number of aspects to consider that apply to most TRA payment entitlement purchases, including the following: Private-Benefits-in-Public-Offerings-Tax-Receivable-Agreements-in-IPPo Thus, the newly created company does not conduct direct business activities, but rather becomes a partner in the operational partnership in which the assets and activities of the company are deposited. One of these companies is known as “Up-C”, a name borrowed from the real estate investment trust (REIT) community in recognition of the fact that most REITs operate through operational partnerships, of which the REIT is a member. A REIT that does business in this way is commonly referred to as a “bottom-up REIT”. The newly created company will issue “low voting” shares to public investors in exchange for money.

Such a company will then use the money to buy operational partnership interests from the founders. In addition, and this is a key feature, these founders also receive “high voting” shares in exchange for the operational partnership shares they sell to the company. This high voting share typically involves a majority of the combined total voting rights of all classes of voting shares, so that control of the company remains securely in the hands of the founders. Typically, this high share of votes is without “economic rights” in the sense that it is not entitled to dividends or distributions in liquidation if the company undergoes a “solvent” liquidation. The financial accounting of these agreements is relatively discreet. The Company will recognise a “deferred tax asset” to reflect the fact that the tax base of its share of the Company`s assets exceeds the carrying amount. The company will also specify a liability to reflect its obligation to pay “tax relief transfer payments” to founders. In some cases, the entity will find it appropriate to make a “value adjustment” to the deferred tax asset, reflecting some uncertainty about its ability to generate taxable income that can be used to “realize” the deferred tax asset. A typical TRA is described by the newly created company in a language that makes its results clear, but no less sobering: “We will (the company will say) enter an TRA with our existing owners (the founders), which provides for the payment by us of 85% of the tax benefits we will receive due to the current tax base in the company`s assets and base increases, resulting from our purchases or the exchange of partnership units. We expect (the company is obliged to say) that these payments will be substantial. (In PSPC transactions, the public is often completely excluded, as 85% of tax savings go to the founders and the remaining 15% is credited to the PSPC SPONSORS account.) Before 2005, ARTs were almost never used in IPOs. .

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