General Electric Co. announced March 9 that it entered into an agreement to sell its aircraft-leasing business to Dublin-based AerCap Holdings N.V.
The agreement provides that GE will convey its GE Capital Aviation Services (GECAS) business to AerCap for total consideration consisting of:
- approximately $24 billion in cash,
- 111.5 million ordinary shares of AerCap with a market value of approximately $6 billion, and
- $1 billion paid in AerCap promissory notes and/or cash (at AerCap’s election) at closing.
The ordinary shares to be received by GE will represent approximately 46% of the pro forma AerCap ordinary shares outstanding upon completion of the transaction. GE will transfer approximately $34 billion of net assets in the transaction, and will sustain a charge to reflect the excess of the carrying amount of the net assets transferred over the consideration to be received in exchange therefor.
The agreement is quite complex and entails a number of steps the purpose of which is not readily apparent, but undoubtedly accomplishes an important objective(s) of the parties. As far as the tax aspects of the transaction go, suffice it to say that the transaction is a taxable one, and all the consideration, including the AerCap ordinary shares, received by GE will enter into the “amount realized” in calculating GE’s gain or loss from the conveyance. See tax code Section 1001.
Qualified Stock Purchase
An important aspect of the transaction is the commitment on the part of GE and AerCap to jointly make an election under Section 338(h)(10) with respect to any “Company Group Member” that is a domestic corporation for U.S. federal income tax purposes. In general, a Section 338(h)(10) election “converts” a stock sale and purchase (of a “consolidated target”) into an asset sale and purchase, and in the process affords the purchaser a “cost basis” in the assets held by the subsidiary whose stock is so purchased. Securing such a cost basis is of great benefit to the purchaser since it increases the tax deductions, in the form of depreciation and amortization, the purchaser will enjoy.
Such enhanced tax deductions, it goes without saying, will reduce the purchaser’s taxable income and, in the process, reduce its tax liability. In fact, the benefits of a cost basis are even greater in the era of “bonus depreciation,” since the amount paid for certain items of qualified property can be entirely “recovered” in the year in which the property is placed in service, rather than depreciated over its assigned life. Bonus depreciation is permitted even with respect to “used” property. See Section 168(k)(2)(E)(ii)(I).
In light of the fact that GE will own such a large proportion of the stock of AerCap, the ability of the parties to jointly elect under Section 338(h)(10) was by no means assured. However, it appears that the parties have navigated this hurdle and, therefore, such an election seems to be in order.
In order for the election to be successfully made, AerCap’s acquisition of the stock of the GE subsidiaries holding the operating assets of GECAS must constitute a “qualified stock purchase.” A qualified stock purchase is the non-negotiable predicate for a Section 338 election, be it a “regular” Section 338 election or a Section 338(h)(10) election. A qualified stock purchase is defined in Section 338(d)(3) as any transaction or series of transactions in which stock (meeting the requirements of Section 1504(a)(2), i.e., at least 80% of the voting power and value of the entity’s stock) of one corporation (i.e., the GE subsidiary to be acquired by AerCap) is acquired by another corporation by purchase during the 12-month acquisition period.
Thus, the key is to ensure that the stock of the GE subsidiaries acquired by AerCap will be secured by AerCap by means of “purchase.” Section 338(h)(3) provides that the term “purchase” means any acquisition of stock, but only if: The stock is not acquired from a person the ownership of whose stock would, under Section 318(a) (other than paragraph (4) thereof), be attributed to the person acquiring such stock. See Section 338(h)(3)(A)(iii). Thus, if GE and AerCap are treated, within the meaning of Section 318(a), as “related” to one another, the acquisition of the stock of the GE subsidiaries will not have occurred by means of purchase.
Section 318(a)(3)(C) provides that if 50% or more in value of the stock in a corporation (AerCap) is owned, directly or indirectly, by or for another person (GE) such corporation shall be considered as owning the stock owned, directly or indirectly, by or for such person. Thus, if GE owns 50% or more in value of the stock of AerCap at the relevant time the stock of the GE subsidiaries would be treated as acquired from a person the ownership of whose stock would, under Section 318(a) (other than paragraph (4) thereof), be attributed to the person acquiring such stock. Such stock, therefore, would not be acquired by purchase, with the result that a qualified stock purchase will not have occurred and, therefore, a Section 338 election could not be made.
Treasury Regulation 1.338-3(b)(3) tells us that “stock acquired by a purchasing corporation from a related corporation is not considered acquired by purchase.” The regulation goes on to say: “A purchasing corporation is treated as related to another person if the relationship...exists—In the case of a single transaction, immediately after the purchase of the stock.” Thus, whether GE and AerCap are related, within the meaning of Section 318(a)(3)(C), is “tested” immediately after the completion of the transaction. The fact that the companies were not related prior to the transaction is of no moment.
It appears that the relationship between GE and AerCap, upon completion of the transaction, will not be described in Section 318(a)(3)(C). After all, GE will own, as a result of the transaction, approximately 46% of the stock of AerCap, below the 50% threshold needed to attribute stock owned by GE to AerCap. Needless to say, the parties are well aware of these rules and have taken steps to ensure that GE does not breach the Section 318(a)(3)(C) threshold. Thus, the agreement provides that GE will disclose to AerCap if GE (or its affiliates) owns any ordinary shares (other than the “acquisition shares”) directly or indirectly through the ownership attribution rules under Section 318(a) (other than paragraph (4) thereof) except ordinary shares owned by GE (or its affiliates) through an entity in which GE (and its affiliates) owns less than 5% of the equity interests.
In cases where a Section 338 election is desirable with respect to the acquisition of the stock of a corporation, and the transaction consideration includes a meaningful amount of the acquirer’s stock, it is imperative that the parties insure that the seller does not own, taking into account such acquisition shares, 50% or more, by value, of the purchaser’s stock. If it does, the acquisition of the target’s stock will not constitute a qualified stock purchase (since such target’s stock will not have been acquired “by purchase”), and the absence of a qualified stock purchase will conclusively eliminate the possibility of a Section 338 election.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Robert Willens is president of the tax and consulting firm Robert Willens LLC in New York and an adjunct professor of finance at Columbia University Graduate School of Business.
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