New Reporting Requirements for "Confidential Transactions" Reach Many Routine Transactions

4.9.2003

Recently-issued Treasury Regulations intended to require disclosure of tax shelter transactions cast a net sufficiently wide to create problems for taxpayers using confidential and nondisclosure agreements commonly seen in mergers, acquisitions, licensing or distribution arrangements, private equity investments, asset purchases, joint venture and similar transactions that would not be thought of as tax shelters. The regulations also impose list-keeping requirements on "material advisers" with respect to such transactions and alter the reporting obligations of transaction promoters.

There are six categories of reportable transactions. While some of these involve transactions we normally associate with tax shelters, such as transactions with substantial book-tax differences, those expected to produce substantial losses, and those providing for a refund of fees if tax consequences are not realized, the broadest category of reportable transactions covers so-called "confidential transactions."

Confidential transactions subject to reporting
The regulations broadly define a "confidential transaction" as any transaction where the taxpayer's disclosure of the tax treatment or tax structure of the transaction is limited by an understanding or agreement with or for the benefit of a person who makes a statement about the transaction's potential tax consequences. "Tax structure" is also defined very broadly to include any fact that may be relevant to the tax treatment of a transaction. It is immaterial whether the agreement or understanding limiting disclosure is legally binding; even an informal understanding is sufficient to trigger the reporting requirements. It is also immaterial whether the statement of potential tax consequences is oral or written, significant or routine (such as a statement that no partnership is intended to be formed by a research collaboration agreement or a recital that a merger is intended to qualify as a reorganization). Any person whose ability to disclose the "tax structure" or "tax treatment" of a transaction is limited will be deemed to have participated in a confidential transaction if the person's tax return reflects a tax benefit, again very broadly defined, from the transaction.

Although a confidentiality restriction that benefits only one party does not create a confidential transaction as to the benefited party for purposes of these rules, it is a confidential transaction as to the other parties. In addition, the benefited party may be a "promoter" under the rules requiring reporting by promoters, and all parties to the transaction may be required to be listed by the "material advisers" for the transaction. The practical effect of this is that potentially any transaction involving some recitation of tax treatment in the transactional documents or in the negotiation process can be swept into the reporting regime simply by reason of a standard confidentiality clause.

Exceptions to the reporting requirements for confidential transactions
There are two principal exceptions to the reporting requirements for confidential transactions:

• Securities Law. Transactions are not offered to a taxpayer under conditions of confidentiality if disclosure of a transaction's tax treatment or tax structure is subject to restrictions reasonably necessary to comply with applicable securities laws and such disclosure is not otherwise limited.
• M&A. In the case of a merger or acquisition that involves the purchase of (i) the historic assets of a corporation that constitute an active trade or business that the acquirer intends to continue, or (ii) more than 50% of the stock of a corporation that owns historic assets used in the active trade or business that the acquirer intends to continue, the transaction is not considered a confidential transaction if (x) the taxpayer's ability to consult a tax advisor regarding the tax treatment or tax structure is not limited in any way, and (y) the taxpayer is permitted to disclose the tax treatment and tax structure of the transaction no later than the earliest of the date discussions relating to the transactions are publicly announced, the date the transaction is publicly announced and the date an agreement to enter into the transaction is executed.

In addition, there are limited exceptions for transactions by registered investment companies and for leases of personal property. There is no general exception to the reporting requirements for a taxpayer that participates in a confidential transaction based on whether the transaction is in the ordinary course of business of the taxpayer.

Safe harbor
Taxpayers may rely on a "safe harbor" presumption of non-confidentiality by adding the following exception to the confidentiality and non-disclosure provisions of their transaction documents. This language should be considered for all transactions where a "tax statement" is likely to be made and the confidentiality agreement is broad enough to otherwise prohibit disclosure of the tax structure:

Notwithstanding anything herein to the contrary, any party to this Agreement (and any employee, representative, or other agent of any party to this Agreement) may disclose to any and all persons, without limitation of any kind, the tax treatment and tax structure of [the transactions] contemplated by this Agreement and all materials of any kind (including opinions or other tax analyses) that are provided to it relating to such tax treatment and tax structure.

Where a transaction involves an acquisition of the assets or more than 50% of the stock of an entity conducting an active business, the following proviso to the above language may be added:

provided, however, that such disclosure may not be made until the earliest of (i) the date of the public announcement of discussions relating to the transactions, (ii) the date of the public announcement of [the transactions], and (iii) the date of the execution of an agreement to enter into [the transactions], provided further, that this limitation on the timing of disclosure shall not be construed to limit the ability by any party to this Agreement to consult any tax advisor (including a tax advisor independent from all other entities involved in [the transactions]) regarding the tax treatment or tax structure of [the transactions].

In addition, wherever there is a specific securities law reason why full disclosure of the "tax structure" (including opinions and tax analyses) may be limited, the following can be added:

[Notwithstanding the above,] any such information and materials shall be kept confidential to the extent necessary to comply with applicable securities laws.

For example, where a public company merger agreement is signed on a Friday the parties may decide not to disclose until the following Monday. In that case, the language provided by the Treasury Regulations would not cover the weekend gap period. Similarly, the securities exception may be needed for temporary non-disclosure of material transactions not involving the acquisition of a business.

Unless the M&A or the securities laws exception applies, the safe harbor is available only where the taxpayer is permitted to disclose the tax treatment or tax consequences of the transaction "immediately upon commencement of discussions" regarding the transaction. This permission must be granted in writing within 30 days from the date the taxpayer is given a statement as to the transaction's tax consequences. Thus, merely incorporating the waiver language into the final transaction documents does not satisfy the terms of the safe harbor. The suggested language should therefore be incorporated in any preliminary agreements that contain non-disclosure provisions, such as letters of intent or exclusivity agreements. If preliminary documents do not contain the appropriate carve-out, follow-on agreements that do should be concluded within the 30-day window to avoid triggering the reporting obligation. Because these regulations were effective on their publication on February 28, 2003, language similar to that shown above should be considered for inclusion in final documents where preliminary documents not expressly permitting disclosure were signed after that date.

Reporting procedures for non-exempt transactions
Participants in reportable transactions not excepted from the reporting requirements must attach Form 8886 ("Reportable Transaction Disclosure Statement") to their tax return for each taxable year in which they participate in the transaction. A copy of Form 8886 must be sent to the IRS's Office of Tax Shelter Analysis, and copies of all records related to the reportable transaction that are material to an understanding of the transaction's tax treatment or tax structure must be retained. In cases involving confidential transactions for which the safe harbors do not afford sufficient protection, filing may be the preferable course.

Requirements for promoters and material advisers
A "promoter" of a transaction that is confidential, a significant purpose of which is the avoidance of federal income tax, and for which all "promoters" may receive fees of $100,000 or more in the aggregate, is required to report the transaction to the Office of Tax Shelter Analysis before the initiation of discussions on the transaction. In addition, a "material adviser" with respect to a reportable transaction, including an accountant or attorney, is required to keep a list of all participants and of persons required to disclose the transactions and extensive documentation of the transactions themselves for seven years. A person is a material adviser if it makes a statement regarding the tax consequences of the transaction and receives fees of more than a minimum amount.