The Choice is Yours

1. The Choice is Yours Alvarez & Marsal Taxand, LLC Acquisitions & Dispositions, Tax Planning, Choice of Entity

2. Contents • Introduction • Choice of Entity – Tax Considerations • Master Limited Partnership (MLP) • Basic Structuring • Elections Under Section 338 • Common Due Diligence Tax Issues • Recent Deals in the Marketplace

3. Layne J. Albert • Layne J. Albert, a Managing Director with Alvarez & Marsal Taxand, LLC, advises clients on the federal income tax ramifications of complex business transactions. He also advises clients on tax department design and operations, including creating a tax department or managing a tax department through adversity, assistance with accounting for income taxes and Sarbanes-Oxley compliance. Mr. Albert has significant experience with IRS and state tax controversies, as well as state income and franchise tax issues. • With more than 17 years of experience, Mr. Albert has significant experience in identifying, understanding and managing federal and state tax issues related to complex business transactions, including mergers, acquisitions, dispositions, financings, recapitalizations, reorganizations and bankruptcy.  Mr. Albert has advised Boards of Directors, and has worked closely with CEOs, CFOs, private equity investors, IRS staff and investment bankers. He brings experience in the manufacturing, energy and service industries. • Prior to joining A&M, Mr. Albert was Vice President of Tax at Dynegy.  Previously, he was Vice President of Tax at Encompass Services. Mr. Albert also served as Tax Counsel for Tenneco. Additionally, he has served in the public sector roles with Ernst & Young and Chamberlain, Hrdlicka, White, Williams & Martin. • Mr. Albert earned a bachelor's degree in business administration, with a concentration in accounting, at the University of Texas at Austin. He received a juris doctor from South Texas College of Law and a master of laws degree (LL.M.) in taxation from the University of Houston. He is a Certified Public Accountant (CPA) in Texas. 700 Louisiana StreetSuite 900Houston, TX 77002 Direct: (713) 221-3910Mobile: (713) 302-6506E-mail: lalbert@alvarezandmarsal.com Appendix I. Managing Director Biographies Layne J. Albert Managing Director

4. Christopher Howe A&M Professional Biographies • Chris Howe is a Senior Director with Alvarez & Marsal Taxand , LLC in New York. Mr. Howe has significant experience on transactional and general corporate tax matters in both the bankruptcy and non-bankruptcy setting. He brings experience in private equity, corporate tax and accounting, tax planning and tax controversy matters. His experience also includes advising financial and strategic investors on tax aspects associated with mergers and acquisitions and other transactional related matters including leveraged buyouts, reorganizations, spin-offs, cross-border financing, and cash repatriation. • Prior to joining Alvarez & Marsal, Mr. Howe was a Senior Manager with the Transaction Advisory Services practice of Ernst & Young. He is also a alumni of Deloitte & Touché and Arthur Andersen. • Mr. Howe holds both a Master’s of Science in Taxation and a Bachelor’s of Science in Business Administration from Northeastern University. He is a Certified Public Accountant (CPA) in the state of Massachusetts, and is a member of the American Institute of Certified Public Accountants (AICPA). Christopher Howe Senior Director Transaction Tax Contact Details 125 Park Avenue, 25th Floor New York, NY 10017 Direct: (212) 763-9607E-mail: christopher.howe@alvarezandmarsal.com NOTE: Alvarez & Marsal employs CPA’s but is not a licensed CPA Firm

5. Choice of Entity – Tax Considerations

6. Choice of Entity – Tax Considerations Three most common legal entities that are encountered in US private equity buyout transactions: • “C” corporation • A traditional statutory (state law) corporation where no election has been made to treat as an “S” corporation • “S” corporation • A traditional statutory (state law) corporation that, subject to certain requirements and restrictions, makes a special tax election or “S” election • LLC/partnership • A joint venture of two or more parties entered into for profit

7. Choice of Entity – Tax Considerations The “C” corporation tax considerations: • The C corporation is a separate taxpaying entity • Corporate income is usually subject to two levels of income tax (i.e., “double taxation”) • Entity level income tax • Shareholder level tax (dividend distributions) • Losses and other tax attributes are retained at the corporate level and do not flow through to shareholders • The treatment of these attributes to the corporation may be subject to limitation upon a purchase or “change in ownership”

8. Choice of Entity – Tax Considerations The “S” corporation tax considerations: • Generally, not subject to entity level income tax • Entity level income, gain or loss flows through to the shareholders • Shareholders report S corporation income, gain, or loss in their personal income tax returns and adjust their tax basis in their stock accordingly • No second level of income tax on distributions of previously taxed earnings

9. Choice of Entity – Tax Considerations The “S” corporation tax considerations (continued): • Eligibility requirements • Domestic corporation • Maximum number of shareholders is 100 • Eligible shareholders are limited to US citizen or resident individuals, certain estates, certain trusts and ESOPs • One class of stock • Private Equity (PE) consideration • PE funds and corporations are not eligible shareholders. Thus, it is likely a corporation’s S election will terminate in most transactions. As a result, a historic S corporation will operate as a C corporation after a PE transaction

10. Choice of Entity – Tax Considerations The LLC or Partnership tax considerations: • Generally, not subject to entity level income tax • Entity level income, gain or loss flows through to the member/partner and is taxed on member/partner tax return • PE considerations • Significant flexibility on the rights of equity interests and the types of equity holders. However, LLCs may be complex when compared to C corporations • Management incentive benefits and complexities in the use of profits interests vs. traditional corporate stock options • Single-member LLCs are generally disregarded for US federal income tax purposes

11. Master Limited Partnership - (MLP)

12. Master Limited Partnership (MLP) What is MLP? • A publicly traded limited partnership • Unique investment that combines tax benefits of limited partnership with liquidity of common stock Qualification for MLP status • Companies that receive 90% or more income from interest, dividends, real estate rents, gain from sale or disposition of real property, income and gain from commodities or commodity futures, and income and gain from mineral or natural resource activities

13. Master Limited Partnership (MLP) Nature of MLPs • Rather than buying shares, investors buy units of partnership commonly known as unit holders • Tend to operate in stable, slow-growing parts of energy industry • Typically grow by acquiring or constructing new pipelines and other facilities • General and Limited Partners • General partner paid on a sliding scale, receiving greater share of each dollar distributed as limited partner’s cash distribution rise. Its take can reach as high as 50%, thus riskier • General partner’s sliding scale gives extra incentive to increase limited partner distribution, which has higher yield and is less risky

14. Master Limited Partnership (MLP) Benefits and Drawbacks • Tax avoidance • Owners of partnership only taxed at individual level Entity level income • Attractive yield • Falls in 5%-7% range for limited and 3%-4% range for general partnership • Cash distributions exceed partnership’s taxable income • Tax complexity • Larger unit holders may require investor to file tax returns in various states in which the partnership operates • May owe taxes on partnership income if units are held in tax-free account like an IRA

15. Master Limited Partnership (MLP) Recent environment • Several general partners going public • New generation of E&P MLPs aiming to create cash flows by investing in oil and gas fields companies going public • Tax laws that restricted MLP by mutual funds rolling back • MLPs paying significantly higher prices to acquire assets

16. Basic Structuring

17. Basic Structuring - Straight Stock Purchase Example Buyer Seller Acquisition Newco Target Lenders Target Cash Capital 100% of stock of Target Debt

18. Basic Structuring - Straight Stock Purchase Example Target (T) is a C-Co Seller = individual owners of T 100% of stock is purchased for cash Tax consequences to Buyer • Newco takes cost basis in T stock • Book step-up in T net assets (purchase accounting) • No tax step-up in T assets Tax consequences to Seller • No tax gain to T • Seller receives cash and reports a capital gain equal to the difference between the proceeds and tax basis in the shares (20% federal and state individual capital gain tax rate)

19. Basic Structuring - Straight Stock Purchase Example Other issues • T’s legal identity is preserved and business will operate as subsidiary of acquiring company • Generally all liabilities of T (whether disclosed, undisclosed, or contingent) will remain with T • Target’s tax attributes such as NOLs and tax credits will remain with T subject to certain limitations (Sec. 382)

20. Basic Structuring - Stock Acquisition General Consequences • Carryover of target’s historical tax basis in assets • Target is a “C” Corporation • Typically the preferred exit for sellers (because of one level of tax at capital gains rates) • Target’s tax attributes (e.g., NOLs) carry over post-close, subject to change-in-control limitations • Target is an “S” Corporation • May not result in significantly lower taxes to seller than asset sale (or 338(h)(10) transaction) • Because an S Corporation is a flow-through entity, there are no tax attributes to carryover. • Prior C corporation attributes (e.g., NOLs) carry over post-close, subject to change-in-control limitations • Target is a “C” Corporation Sub. Of Tax Consolidated Group • Could be preferred exit for seller, if seller’s tax basis in target stock exceeds target’s tax basis in its assets, or seller has expiring capital losses • Target’s tax attributes (e.g., NOLs) may carry over post-close (depends on seller’s NOL position), subject to change-in-control limitations

21. Basic Structuring - Straight Asset Purchase Seller Buyer Target Lenders Liquidation $cash Capital Debt Cash Acquisition Newco Net assets

22. Basic Structuring - Straight Asset Purchase Target (T) is a C-Co Seller = Target C-Co 100% of assets from T Purchase price is all cash (can use other consideration such as debt) Tax consequences to Buyer • Book step-up in Target net assets to fair market value • Tax step-up in Target net assets to fair market value Tax consequences to Seller • T taxed on ordinary/capital gain income (40% federal and state tax rate) • Seller receives cash in liquidation and has capital gain (20% federal and state individual capital gain tax rate)

23. Basic Structuring - Straight Asset Purchase Value of basis step up

24. Basic Structuring - Straight Asset Purchase Other issues • May incur considerable expense with title transfers and state transfer taxes. Contract should specify who bears these costs. • If T is a C-Co, T’s shareholders will not be taxed on a straight asset acquisition unless T distributes the sale proceeds. • T’s NOLs and other tax attributes do not carry over to acquiring company. Attributes remain with T and can offset gain on sale. If T is liquidated, unused attributes are lost. • Acquiring company may “cherry pick” which T liabilities will be legally assumed. Undesired/ contingent liabilities can be left with seller.

25. Basic Structuring - Asset Acquisition General Consequences • Revalues target’s tax basis in assets to FMV • Target is a “C” Corporation • Generally undesirable for sellers; potential for double-tax on exit (at corporate and shareholder levels) • Sellers may not be adverse if target has significant NOLs to shield corporate tax gains on asset sale • Target is an “S” Corporation • Possible if legal conditions allow; sellers generally pay only one level of tax • If target (or predecessor) was a C corporation within past 10 years, some (or all) of the gains could be subject to built-in gains (“BIG”) taxes • Buyer might gross up seller for incremental taxes • Target is a “C” Corporation Subsidiary Of Tax Consolidated Group • Possible if legal conditions allow; depends on, among other things, whether target has equal or higher tax basis in its assets than seller has in its target stock • Buyer might gross up seller for incremental taxes

26. Elections under Section 338

27. Elections Under Section 338 -Tax elections to treat a Stock purchase as an Asset acquisition Qualified stock purchase required • Unrelated corporate acquirer • Purchase of 80% or more of vote and value • Election made by the 15th day of 9th month beginning after the month in which the acquisition occurs • For §338(h)(10) both the buyer and seller must sign; best to include in the stock purchase agreement

28. Elections Under Section 338 - Tax elections to treat a Stock purchase as an Asset acquisition T stock Corporation or S corp S/H ACQUIRER Cash and/or other consideration Deemed liquidation Actual sale of T stock ignored for tax purposes only Assets TARGET (New Co) TARGET (Old Co) Deemed taxable sale of assets

29. Elections Under Section 338 - Tax elections to treat a Stock purchase as an Asset acquisition • Elections under §338(h)(10) treated as a sale of assets by the Target while it is an S corporation owned by its shareholders or a C corporation owned by its corporate parent to a new corporation (“New Target”) followed by a deemed liquidation of the target. • Gain on asset sale is included in the final S corporation return or in the selling group’s consolidated return and gain on stock sale is ignored.

30. Elections Under Section 338 - Tax elections to treat a Stock purchase as an Asset acquisition • New Target assets get basis step-up equal to full fair market value. • Generally one level of seller tax but there can be exceptions in certain cases. • Note §338(h)(10) works in reverse in case of losses (FMV of Target’s assets is less than tax basis then tax basis may be stepped down).

31. Elections Under Section 338 - Stock Acquisitions Treated As Asset Acquisitions Section 338(h)(10) (Election to Treat Stock Purchase as Taxable Asset Purchase) - General Requirements: • Corporate purchaser unrelated to seller(s) • Seller must be: • (a) an 80% corporate subsidiary of an affiliated group of companies or • (b) an S corporation • Qualified Stock Purchase (“QSP”): Purchase of 80% or more of voting power and value of target’s stock (excludes certain preferred stock) • Joint election by purchaser and seller must be filed by the 15th day of 9th month following the month in which the acquisition occurs. Section 338(h)(10) Consequences • For Buyer • Tax basis step-up in target’s assets • Increase in after-tax cash flow • For Seller • May be additional taxes (federal + state) – “gross-ups” • Complications in rolling shareholders

32. Common Due Diligence Tax Issues

33. Common Due Diligence Tax Issues – Federal Historical Exposure • In a stock acquisition, any pre-closing tax exposures will remain with the acquired entity. Moreover, where a corporation is acquired from a consolidated group, it remains severally liable under Treas. Reg. §1.1502-6 for the entire group’s federal income tax during the period in which it was a member of the group.

34. Common Due Diligence Tax Issues – Federal Audit Exams • Inquire as to whether or not entities have been audited by the IRS and whether or not there have been any waivers or extensions of any statutes of limitations with respect to federal income taxes.

35. Common Due Diligence Tax Issues – Federal Hedging • If a transaction is timely identified as a hedge for tax purposes, the character of income and deduction recognized on each element of the hedge would be ordinary. If not, any loss on the hedge may be characterized as a capital loss that may not be used to offset ordinary income. • Generally, a hedging transaction must be identified for tax purposes in a taxpayer's books and records on the date on which the taxpayer enters into the transaction in order for any loss on the transaction to be treated as ordinary. The taxpayer’s identification must also identify the items or aggregate risk being hedged within 35 days of entering the hedging transaction.

36. Common Due Diligence Tax Issues – Federal Hedging • The absence of an identification that satisfies the requirements can cause any loss on the transaction to be treated as capital. For any transaction that is clearly a hedging transaction, however, the regulations provide that any gain is ordinary whether or not identification has been made. • While Treasury Regulations may grant taxpayers relief for an “inadvertent” failure to properly identify hedging transactions, it is not clear whether such relief would be available. As a result, any losses on the hedges could be treated as capital, while any gains would be ordinary for U.S. federal income tax purposes. Capital losses can only offset capital gains of a U.S. corporation and can generally be carried back 3 years and forward 5 years.

37. Common Due Diligence Tax Issues - Federal Net operating loss limitations – “Section 382” • After an ownership change, pre-change tax loss attributes are subject to annual “Section 382 limitation” • Limitation: • Generally = FMV of T stock x long-term tax exempt rate • Downward adjustments to FMV of T stock may be required • Redemptions and corporate contractions (LBO applicability) • Certain capital contributions • Certain non-business assets • Certain controlled group members • Unused limitation is cumulative • Potential increase for certain built-in gains

38. Common Due Diligence Tax Issues - Federal Net operating loss limitations – “Section 382” • Built in Gains and Built in Losses • Upon ownership change, T determines whether a net unrealized built-in gain (NUBIG) or net unrealized built-in loss (NUBIL) exists in its assets • NUBIG (NUBIL) = FMV of assets minus aggregate tax basis • If NUBIG - Built-in gains (BIGs) recognized during next 60 months increase the limitation • If NUBIL - Built-in losses (BILs) including depreciation/amortization recognized during next 60 months are subject to limitation • Rules are complex and create inherent difficulty in identifying/computing/tracking BIGs and BILs

39. Common Due Diligence Tax Issues - Federal Tax Contingency Reserves • Standards Codification (ASC) 740, Income Taxes, (ASC 740), establishes the financial accounting and reporting standards for capturing the income tax effects from an enterprise’s current and historic activities. • FASB Interpretation No. 48 (“FIN 48”) is FASB’s formal interpretation of ASC 740 and requires an enterprise to evaluate its income tax positions based on tax laws and regulations for financial reporting purposes. • In December 2008, FASB extended the deferral of the application of FIN 48 for non-public enterprises until years beginning after December 15, 2008 (that is, until 2009 for calendar-year companies). .

40. Common Due Diligence Tax Issues - Federal Tax Contingency Reserves • Upon adoption, corporations will recognize the effect of income tax positions only if those positions are more likely than not of being sustained. Recognized income tax positions are measured at the largest amount that is greater than 50% likely of being realized.

41. Common Due Diligence Tax Issues - Federal Transaction Expenses • Transaction expenses - $20 million in tax deductible items that will be realized on the date of the closing related to: • Stock option deductions - $12 million • Restricted stock grants - $2 million • Deferred financing cost on existing debt - $1 million • Investment banking fees, advisor fees, etc. - $5 million Seller advises that the tax benefit of these deductions should be considered in the bid price.

42. Common Due Diligence Tax Issues - Federal Transaction Expenses • What is the value of these deductions? When can the deductions be used? • Items to consider: • These amounts will generally be considered expenses incurred on the date of closing (pre-ownership change period). • The amounts will first be utilized against pre-close stub period taxable income (seller’s period and seller’s benefit). • Remaining amount may be carried back to the previous two tax years for refunds, and/or • Remaining amount could create an NOL carryforward or add to an existing NOL carryforward which could be limited going forward.

43. Common Due Diligence Tax Issues - Federal Transaction Expenses • As such, these amounts need to be considered in the cash tax model to determine timing of actual benefit (and NPV). In the example, these amounts are added to the existing NOL but must first be reduced by 2005 pre-closing taxable income. • Total NOL available to carry forward to post-change year of $40 million [subject to Section 382 limitation], as follows:

44. Common Due Diligence Tax Issues - Federal Limitations on deductibility of interest • Common limitations • Applicable high yield discount obligation (“AHYDO”) rules • Corporate acquisition indebtedness rules • Disqualified interest rules - “earnings stripping”

45. Common Due Diligence Tax Issues - Federal Limitations on deductibility of interest • AHYDO Rules • Defers tax deductions for original issue discount (“OID”), including payment in kind (“PIK”) interest, until interest is actually paid in cash if the yield-to-maturity (“YTM”) of the debenture exceeds the applicable federal rate (“AFR”) + 5% • Permanently disallows OID deductions to the extent that the YTM exceeds the AFR + 6% • Application • Borrower must be a C corporation. However, anti-abuse rules exist for non-corporate issuers • Maturity date must be greater than five years from date of issuance • YTM must be greater than or equal to the applicable federal rate (“AFR”) + 5% • Debt must also have “significant OID”, which exists whenever, at the end of any accrual period after the fifth anniversary of issuance, the total yield accrued on the debt exceeds the total amount paid in cash by more than the issue price x YTM (i.e., the first year’s yield)

46. Common Due Diligence Tax Issues - Federal Limitations on deductibility of interest • Corporate acquisition indebtedness rules • Disallows interest deduction for the lesser of: • Total acquisition interest greater than $5 million in such year, or • Interest for such year on tainted acquisition debt • Test is applied cumulatively to multiple acquisitions • Application • Proceeds are used to acquire at least 2/3rds of a target company • Debt is issued with equity kicker or conversion feature • The debt is subordinated to trade creditors or unsecured debt • D:E ratio is greater than 2:1 or interest is in excess of 1/3 of earnings

47. Common Due Diligence Tax Issues - Federal Limitations on deductibility of interest • Limitation applies to excess interest expense on debt due to a related person if no tax is imposed with respect to such interest income. • In the case of interest paid or accrued to a partnership (or LLC) the determination is made at the partner level. • Foreign owners, tax exempt owners, pension funds, etc. • Excess interest is interest expense in excess of adjusted taxable income. EBITDA is generally used as a proxy for adjusted taxable income. • Excess interest in a given year can be carried forward. • The rule does not apply if D:E does not exceed 1.5:1

48. Common Due Diligence Tax Issues – State and Local Income, Franchise Taxes – Nexus Issues Related to Inventory • Inventory held in a state, even if held by a third party, may result in a nexus with the state and create a filing obligation.  • Energy companies that are transporting their product across state lines and storing it, even temporarily, in a state while in transit which may create an income/franchise, sales, and property tax filing obligation. • Pipelines

49. Common Due Diligence Tax Issues – State and Local Sales Tax - Exemption for Resale • Energy Companies that produce their energy to sell to energy providers may be entitled to an exemption from sales tax as sales for resale.  • Energy companies should ensure they are diligently collecting exemption certificates from all customers. Specific exemptions per state • Certain states do not impose sales tax on the sale of energy, such as Massachusetts.  • It is important to review the specific state law regarding the taxability of energy.

50. Common Due Diligence Tax Issues – State and Local Use Tax – Manufacturing Equipment Exemptions • Many states have an exemption from sales/use tax for manufacturing equipment and replacement parts.  • In some instances, the bulk of the equipment purchased by an energy company that produces energy may be exempt from sales/use tax.  • This exemption is particularly useful for energy companies that produce energy.