In case you haven’t heard of it, a SPAC or Special Purpose Acquisition Company is an investment vehicle used to acquire private companies with growth potential. SPACs are “blank check companies” created by sponsors to raise investor capital through an IPO in order to acquire a private company that enables it to go public. SPACs are also used to remove a significant shareholder from an existing public company, such as B. in the deal of BPW Acquisition Corp. with The Talbots Inc. in 2010.
The advantages of a SPAC
After a big year in 2020, there are several reasons SPACs continue to be popular. SPACs allow a private company to go public without the IPO process, even in the event of market instability, and allow it access to public markets. Not only do SPACs provide IPO investors with the opportunity to co-invest with successful founders, but there is also the option of their initial investment being risk-free if the investor can get in at the IPO price before a merger is completed. The investment risk depends on where in the market an investor is buying; if an investor buys above the IPO price, his floor is the IPO price.
SPACS founders are attracted to blank check companies because of the potential for a broader investor base and a simplified capital-raising process compared to using a private vehicle. Not to mention the potential for a very attractive uptrend.
The SPAC process
A SPAC is a company that goes public to raise capital, mostly from institutional investors but also from retail investors. After the capital increase, SPAC finds a private company (the target company) to buy. SPACs are traditionally created to pursue goals in a particular industry such as healthcare. The SPAC typically has two years to identify the target company, and if the target company is not identified during that time, the SPAC returns the funds to its investors.
Once a target company is identified, investors typically have a right to repayment of their investment prior to purchase. This allows flexibility for investors if they choose not to invest in the target company. Shareholders will record a gain or loss on the difference between the amount received and their base on redemption and, depending on the holding period, the gain may be treated as long-term or short-term.
Once the acquisition is approved, the target private company will become a publicly traded company through a merger transaction with SPAC, avoiding a formal IPO.
When looking to invest in a SPAC, look for sponsors with experience and reputations to help identify solid goals and forge business combinations with one or more target companies. Ideally, sponsors and management are firms and / or individuals with a proven record of identifying and operating growth businesses and with experience in public companies.
Investing in a SPAC is equivalent to investing in a public share. Target companies of a SPAC can be national or international. When a SPAC is established with the opportunity to acquire an international destination, the SPAC is mostly located off the coast, usually as a company in the Cayman Islands. Alternatively, domestic SPACs are mostly formed as Delaware Corporations.
A domestic SPAC is formed as a US corporation and is therefore subject to general US tax regulations. From the shareholders’ point of view, those shareholders who own a SPAC are treated the same as if they owned another domestic public entity. In general, any dividends received after the merger would be considered qualified dividends and would be subject to preferential tax rates on capital gains. Shareholders who sell their shares after one year are also subject to the preferred capital gains tax rates. Reference is made to the preferential tax rates in accordance with the applicable tax regulations.
Foreign SPACs are formed outside of the United States, typically in the Cayman Islands. US shareholders should carefully weigh the potentially adverse tax consequences before investing in a foreign SPAC. In most cases, a foreign SPAC will be considered a passive foreign investment company (“PFIC”), especially for shareholders who own less than 10% of the SPAC. Overall, the PFIC rules are quite complicated and create additional notification requirements. PFICs can also have adverse tax consequences for a US shareholder. Profits from the sale of stocks would be taxed as ordinary income compared to capital gains. In addition, an interest surcharge is levied in favor of any tax deferral. However, there are certain choices that can help mitigate these tax consequences. In these circumstances, it is generally advisable to conduct an election to the Qualified Electing Fund (“QEF”). The SPAC must provide the investor with an annual PFIC disclosure statement that reflects their share of the SPAC’s income. This income is currently recognized as income, which increases the tax base. When selling, any profit is converted from ordinary income into capital gain.
Founders of the target company, if it is a corporation, are usually taxed to the extent that they received cash for their shares. Should the target shareholders intend to hold the shares after the transaction, the transaction could be designed as a tax-free reorganization. Assets other than stocks called a “boat” acquired by shareholders are generally taxable. The number of boats allowed depends on the type of tax-free reorganization carried out. The shareholder is generally taxed in the amount of the boat received.
The shares of the SPAC founder are generally granted as blocked shares; Therefore, a choice according to Section 83 (b) should at least be considered. An election under Section 83 (b) allows a startup founder to pay taxes at normal income tax rates when the stock is granted, rather than at fair market value when the stock is granted, assuming the stock’s value increases . The shareholder then receives the preferential tax rates for capital gains when selling the stock. There are risks associated with an election under Section 83 (b); Therefore, consult a tax advisor before choosing.
SPAC shares are often sold with warrants, which can be compensatory or non-compensatory (investment warrants). Warrants will only become exercisable if the SPAC completes a business combination prior to the specified external date. Compensatory warrants from a SPAC are usually treated like stock options for tax purposes. You are taxable when exercising, as ordinary income (compensation), measured by the excess of the fair value of the underlying share over the exercise price. Investment warrants are issued with the share as part of a unit consisting of a share and a warrant. When an investor exercises a warrant to buy the stock, he pays the specified exercise price to the issuing company. The tax base of a warrant comprises the exercise price plus the amount originally assigned to the arrest warrant.
In summary, while SPACs have many benefits, there are also some risks associated with a SPAC investment. Investors do not know which target company a SPAC will merge with and such an unknown could pose a risk. SPACs can also be risky for investors as target companies don’t always go through the thorough review and due diligence of a traditional IPO, which can hurt future performance. It is important to weigh the benefits and risks, as well as tax considerations, before investing in a SPAC. State residency considerations, including for residents of Puerto Rico, can play a huge role in relation to tax considerations, especially for SPAC founders.
This article is based on current tax laws and results may vary with future tax law changes.
If you are considering a SPAC or have any questions, please contact one of our Citrin Cooperman consultants in the firm’s International Tax Practice or Financial Services Practice.
Patti Iengo is a tax partner at White Plains with over 20 years experience in public accounting. It offers its clients tax compliance and advisory services, including financial, inheritance and tax planning. Citrin Cooperman’s international tax practice has the resources and extensive experience to address the specific cross-border tax needs of our clients. Our team consists of experienced specialists in strategic planning in the public and private sectors as well as professionals with extensive backgrounds in negotiating with the Internal Revenue Service and foreign tax authorities.
Citrin Cooperman is one of the largest full-service insurance, tax, and business consulting firms in the United States and has grown steadily since 1979, serving a diverse and loyal clientele. Our daily mission is to help our customers focus on what matters. ”Rooted in our core values, we offer a comprehensive, integrated business approach to traditional services that includes proactive insights throughout our customers’ lifecycle, wherever they are doing business all over the world. citrincooperman.com