May 23, 2019
This responds to comment request 12 within Section A(1)(b) of the Securities and Exchange Commissions (the Commission) Release 33-10635 (S7-05-19). We generally are supportive of the proposed rules with one exception. We believe that the proposed use of income or loss from continuing operations after income taxes for the income test of significance could result in significant distortions in the event the subsidiary or acquisition target to be tested is taxed as a pass-through entity rather than as a corporation pursuant to Subchapter C of the Internal Revenue Code of 1986, as amended (the IRC) (i.e., a C-corp).
The vast majority of registrants are C-corps. In many cases, however, these registrants subsidiaries are taxed as pass-through entities, as part of a consolidated tax group, and acquisition targets are often also taxed as pass-through entities as is typical of privately-held limited liability companies, publicly-held and private partnerships (including master limited partnerships), as well as privately-held corporations taxed under Subchapter S of the IRC. The tax obligations of these pass-through entities could vary significantly based upon entity type, exposure to state income taxes and certainly are vastly different from registrants taxed as C-corps. As a result, the significance of an acquired company or a disposed subsidiary or component of a business that is not taxed as a C-corp could be materially distorted if after-tax income is utilized as a significance test.
One alternative to redress this concern would be simply to modify the current income from continuing operations before taxes test to use an income, before taxes test. This would have the effect of capturing all income and expense as does the proposed after-tax test, but would eliminate the potential distortion caused by differing income tax status of each tested entity. Another alternative would be to adjust the income of a pass-through entity by applying the C-corp entitys effective tax rate or statutory tax rate for the tested year. Although this latter alternative would also provide an apples-to-apples comparison, the volatility of tax laws on statutory rates and the impact of tax planning and other transactions on effective rates introduce potentially arbitrary factors.
Accordingly, we believe that the use of pre-tax income provides the best distortion-free measure of significance based on income. Based on the foregoing, we respectfully request that the Commission consider retention of the current income from continuing operations before taxes standard, albeit slightly modified to be based on pre-tax income.
Please note, this comment represents the views of Ira N. Rosner and Shawn M. Turner and does not purport to represent the views of Holland Knight LLP or any client thereof.