It’s Raining SPACs: Tax Issues Facing Investors
By Stuart E. Leblang, Michael J. Kliegman, Menachem Danishefsky and Amy S. Elliott
Special purpose acquisition companies (SPACs)—or, as they are often called, blank check companies—have proliferated during recent months, to the extent that it seems even citing the most recent transactions in this opening paragraph is doomed to become dated before the ink is dry on the page. 1
According to Intelligize’s database of registered offerings, there were about 304 blank check IPO registrations in 2020, 2 making up nearly 50 percent of all IPOs in 2020 (a significant increase, given that their prior peak was at about 15 percent of all IPOs 3 ). In its SPAC 2020 Year-in-Review, Citi Banking, Capital Markets and Advisory reported that there were 231 completed SPAC IPOs in 2020 (compared to only 54 in 2019 and 38 in 2018) and that those 2020 SPAC IPOs raised about $80 billion over the course of the year. 4
SPACs have been around many years, but they have only recently taken on a much more important role in the capital markets. The blank check company is well suited to cash or combination stock-and-cash purchases of other companies, but private companies have found it an especially attractive vehicle for going public without undergoing the normal IPO route.
A blank check company (we will use the terms “SPAC” and “blank check company” interchangeably) is a new corporation, ordinarily backed by a private equity or hedge fund sponsor, that goes public without any assets or businesses other than a mission to find a suitable acquisition target. In many cases, the sponsor and management have a particular industry focus, and in other cases the scope for potential acquisitions is very open-ended.
Although there are some differences among these transactions, they bear a strong similarity to one another in the formation stage and we can discuss this on a fairly generic basis. In theory, the subsequent acquisition stage could take as many different forms as there are possible M&A structures, but they have tended to fall broadly into either a purchase of another company with cash being at least a significant part of the consideration or an all-stock merger that is the means for a private company to go public.
Typical SPAC IPO Structure and Tax Considerations
In virtually all cases, for just $10 per unit, investors may purchase an investment consisting of one share of common stock and a fraction (e.g., one-third, but the fractions vary) of a warrant to purchase common stock. 5 Often on the 52nd day following the date of registration, the warrant begins trading separately from the common stock.
Under established tax rules, where the unit is separable into its parts, the investor’s $10 tax basis in the unit must be allocated between the stock and warrant based on their relative values. 6 A whole warrant entitles the holder to one share of common stock upon exercise (generally at an exercise price of $11.50). Although the terms vary, the warrants generally become exercisable after some period (e.g., the later of 30 days after the completion of the initial business combination (IBC) and 12 months from the closing of the IPO), at which point the SPAC may decide to redeem outstanding warrants.
There is some question whether tax basis should be allocated between the stock and warrant based on their relative values at the time of the IPO or at the time the two instruments are “decoupled” (i.e., they begin to be traded separately). Implicit in the argument that the allocation is deferred until separate trading begins is the assumption that an investor could not separately dispose of one piece of the unit (the stock or warrant) without disposing of the other.
The disclosures typically conclude that the allocation should be done at the time of the IPO, 7 but note that the position is not certain. 8
In this regard, while in theory the timing of the allocation should not make a big difference, we think that in practice there is more likely to be a greater allocation of the $10 basis to the warrant, and less to the stock, if made at the time of separate trading. This is because—again, more from a practical standpoint—before separate trading, it may be reasonable to allocate nearly all of the $10 cost to the stock that is redeemable for $10. After trading, there is no room for presumptions or judgment, and it would not be unusual for the warrant to show substantial value. For investors intending to sell the stock and hold the warrant, a greater allocation of basis to the stock would be preferable.
While it would be an overstatement to say that the sponsor’s equity arrangements indicate the SPAC is a full substitute for the traditional private equity sponsor’s carry arrangement, the similarity is apparent. 9 Using the “founder shares” model from the entrepreneurial world, the sponsors purchase what are initially all of the common shares (a separate Class B or Class F to be converted later—often the conversion occurs automatically at the time of the de-SPAC transaction or IBC—into the Class A owned by public investors) for $25,000 or a similarly nominal sum. In connection with the IPO, these shares will represent approximately 20 percent of the outstanding stock of the company. In many cases, the sponsor will invest additional amounts in the IPO and also commit to purchase warrants in connection with the IPO. These proceeds from the private warrant placement provide additional funding for payment of expenses and redemption of common stock.
Generally, the SPAC commits to complete an IBC within 24 months of the IPO or return the investors’ money, which it has held in trust (subject to certain operating expenses). The IBC must be with one or more target businesses with an aggregate fair market value equal to at least 80 percent of the assets held in the trust account at the time of signing of a definitive agreement. 10
In the case of an outright acquisition, the 80-percent threshold figures directly into funding the equity portion of the target purchase price. In the more prevalent all-equity IPO transactions, this results in the SPAC’s cash being used for working capital and ongoing business purposes for the target business, usually supplemented by a private investment in public company (PIPE) investment in connection with the IBC.
At the time of the IBC transaction, a public stockholder can choose to redeem all or a portion of its shares for an amount equal to its pro rata share of the amount held on deposit in the trust account. It is intended that there will be sufficient cash held to pay $10 per share to investors exercising the redemption right, but the amount available may be reduced not only by amounts used to pay expenses but also by amounts required in connection with the IBC transaction.
Timing and other aspects of the redemption right are affected by the nature of the IBC and whether there is a shareholder vote for the transaction. For example, a merger likely would involve a shareholder vote whereas a stock purchase of a target likely would not. If there is no shareholder vote, the redemption is effected by way of a tender offer by the SPAC to the investors. If there is a shareholder vote, redemptions are offered in connection with the proxy solicitation process. If the amount of cash required to satisfy all redemption requests plus the amount of cash committed to the IBC exceeds the amount held by the SPAC, it will not go through with the IBC. 11
Provisions governing the exercise of the warrants can be complicated. Once the warrants become exercisable (generally, the later of 30 days after the IBC and 12 months from the IPO), the SPAC may effectively force exercise by redeeming them for a penny per warrant following 30 days’ notice of redemption, but only if the stock has recently traded for $18 or more per share. If the stock has been trading at between $10 and $18, the company may eventually redeem the warrants for 10 cents each provided that holders are given the opportunity to exercise their warrants on a cashless basis prior to redemption.
In respect of the holding period, the common stock and the warrant will have a holding period as of the date of the IPO. The holding period for shares acquired through exercise of the warrants could be more complex. Without going too much into the tax minutia, it is generally accepted that both a regular exercise and a cashless exercise are tax-free to the holder. In a regular exercise, the holder’s tax basis in the common stock includes its basis in the warrant (which was determined based on an allocation of the original purchase price of the unit) and the $11.50 exercise price, and a new holding period in the stock starts on the exercise date.
There is more uncertainty in the case of a cashless exercise. We think the prevailing view is that the cashless exercise is tax-free, and the holder takes a tax basis in the stock equal to that in the exchanged warrants, such that the holding period in the stock includes the holding period in the warrants. However, there is a contrary view that is noted in tax disclosures that the holding period may have to start fresh on the date of or the date following a cashless exercise. 12
SPAC tax disclosures typically indicate a risk that the company could be subject to personal holding company (PHC) tax, primarily during the period before the IBC. Generally, a company may be subject to the PHC tax based on its meeting certain stock ownership requirements as well as certain passive income requirements. The latter is a given during the period in which the company holds only cash, and as to the stock ownership requirements, it will depend on how concentrated the ownership is in the SPAC, taking into account ownership attribution rules.
Foreign or Domestic SPAC
Sponsors considering acquiring a non-U.S. business may form a SPAC in a foreign jurisdiction to avoid the U.S. anti-inversion and other cross-border limitations under Section 367 of the Internal Revenue Code. Those rules make it difficult for a domestic SPAC to combine with a foreign company, unless the parties are willing to end up with a U.S. parented structure for what may be primarily a non-U.S. business.
The main area of concern for a U.S. shareholder in a foreign SPAC is the passive foreign investment company (PFIC) rules. Those rules are complex, but the PFIC rules generally attribute gain recognized on disposition of PFIC stock to the holding period in the stock, impose an interest charge on the tax attributed to prior periods and tax the gain at the highest ordinary income tax rate.
Ordinarily, U.S. taxpayers can avoid the punitive impact of a PFIC by making a qualifying electing fund (QEF) election. Under a QEF election, a U.S. shareholder is taxed currently on undistributed PFIC income, generally keeping the same character as the underlying income of the PFIC (e.g., capital gain or ordinary income). Alternatively, a shareholder can avoid the above PFIC consequences by making an election to recognize gains and losses on PFIC stock on a mark-to- market basis. However, while the PFIC rules apply to warrants as well as stock, neither the QEF election nor the mark-to-market election is generally available on warrants of the SPAC.
Investment funds that otherwise mark-to-market under Section 475(f) may be in a position to avoid the PFIC rules even in respect of the warrants and without making any QEF election, provided the SPAC investment is not excluded from Section 475(f) property. Of course, in these circumstances, long-term capital gain will not be available.
Absent a special exception, a foreign SPAC is fairly likely to qualify as a PFIC prior to an IBC, given the passive nature of both its assets and its income. 13 However, under a so-called start-up exception, a foreign corporation will not be considered a PFIC despite meeting the passive income or assets test in its first tax year if it will not be a PFIC during either of the two subsequent tax years. Because most targets in an IBC are not expected to be PFICs, the policy behind the start-up exception would appear promising. 14
However, the start-up exception is not always as useful as its name may imply. And here, timing is everything. The start-up exception essentially only allows for a company to meet the PFIC tests for one year without becoming a PFIC. It may be widely assumed that the SPAC will meet the PFIC test in its first tax year, and therefore, the IBC will need to occur no later than the tax year immediately following the IPO. Even then, the IBC would need to occur at a point in the year that would allow the SPAC to avoid being a PFIC for that tax year. Given that the SPAC is generally afforded 24 calendar months to perform an IBC, meeting these timing thresholds should not be taken as a given.
The fact that we are dealing with tax years, which may be less than 12 months, makes this even trickier. For example, if a calendar-year SPAC goes public late in the year, then there is a reasonably good chance that it could go through a second tax year holding only cash and not complete an IBC until its third tax year, thus flunking the start-up exception. On the other hand, if a SPAC goes public early in its first tax year (e.g., February, if using a calendar year), it is a good deal more likely (but not a sure bet) that it will complete an IBC before the close of its second tax year, thereby (assuming the numbers work) satisfying the start-up exception criteria.
If a foreign SPAC goes public late in the calendar year—say, in November—it might do well to adopt an October 31 tax year end to enhance its chances of being able to make use of the start- up exception.
We have seen SPACs formed as foreign corporations but ending up as domestic corporations following a combination with a domestic company. In general, it is a fairly smooth path for a foreign corporation to domesticate, certainly much smoother than doing the reverse (setting aside the previously discussed hurdle involving PFICs).
Regardless of whether the foreign SPAC does a stand-alone domestication before combining with a target or merges into a domestic target, the SPAC shareholders (and warrant holders) have a realization event that can trigger PFIC consequences. Also, the domestication will close the tax year of the SPAC, which could complicate reliance on the start-up exception. 15
Additional Tax Issues
Most of the above tax issues are addressed to some extent in SPAC prospectus tax disclosures and are of generic relevance to investors. Below we address some additional issues that are not generally found in the prospectuses and which may be of particular interest to investors with both domestic and foreign investors.
- Debt Versus Equity
The extraordinary arrangement whereby holders of the common stock have a largely unqualified right to exchange it for a (largely) fixed amount of cash raises the question of whether it should be treated as debt rather than equity for U.S. income tax purposes. Leaving aside the merits of that question, what consequences would flow from such a recharacterization?
Ordinarily, the principal effect for investors of the debt versus equity question is whether payments to the investor are treated as dividends or as interest. For domestic taxable investors, dividends and interest are taxed at different rates. Dividends are generally taxed at long-term capital gain rates for individuals and subject to a favorable dividends-received deduction for corporate investors. In addition, if the stock is treated as debt with original issue discount (OID), the investor would be required to accrue interest, subject to certain exceptions.
If the redeemable common stock were treated as debt for tax purposes, it seems likely that the “maturity date” on the instrument would be the date by which the SPAC must complete the IBC or redeem the stock, ordinarily two years. Though the precise amount payable on redemption depends on exactly how much is in the SPAC’s trust account, the target amount is the original $10 investment plus some interest that is earned on the cash. The excess of this amount payable on maturity over the issue price of the instrument would be treated as OID, interest income to the holder and deductible by the issuer.
To illustrate, if the original $10 investment in a SPAC unit is allocated $9 to the redeemable common stock and $1 to the warrant, this would set the tax basis in each, and there would be $1 of OID on the debt instrument (as the redeemable common stock would be treated in this hypothetical). As noted above, domestic taxable investors would have to accrue the OID as interest income over the two-year period between the IPO and the outside “maturity date.”
For foreign investors, both debt and equity are generally subject to withholding tax, but with different treaty exemptions, and interest may be subject to exemption under the portfolio interest rule. 16 If there is OID in a debt instrument, then—absent the portfolio interest exemption—there could be withholding tax at the time of conversion. However, unless a foreign investor (applied on a full look-through basis) holds 10 percent of the voting shares in a company, the portfolio interest exemption is expected to apply.
For the SPAC itself, interest would be deductible but dividends are not. The market presumes the shares issued in the IPO to be equity, and the SPAC is not expected to take a deduction. SPACs are not generally expected to make distributions on the common stock prior to consummation of the IBC, and thereafter, the put right will be gone and so should any question about treatment of the common stock as debt. We are more interested in the possibility of OID on the SPAC common stock which, if it were treated as debt, could have adverse tax consequences to foreign and domestic investors. We noted above that the $10 paid for a unit is allocated between the common stock and warrants based on their relative fair market values. If the value of the warrants creates more than a de minimis amount of OID, then the OID would need to be accrued. To reiterate though, as a practical matter, we do not expect that investors will treat the instruments as debt.
All of this begs the question: Is there a significant risk that the Internal Revenue Service (IRS) would, or could, argue that the redeemable common stock should be treated as debt for U.S. tax purposes? We think the risk is fairly low, for reasons both technical and practical. While there is an abundance of case law over many decades addressing whether an instrument should be treated as debt or equity for tax purposes, in nearly all cases where the IRS sought a recharacterization, the form and taxpayer’s position were that the instrument was debt and the IRS argued that in substance it was equity. It has been very rare for the IRS to seek to treat purported equity as debt, even when dealing with “debt-like” preferred stock that included redemption rights.
We note that financial statements of the SPACs show the potential redemption as a liability, which weighs somewhat in favor of debt characterization. But the fact that there is a legal right to redeem is likely not enough to ignore the important equity features of the common stock and treat it as debt for tax purposes. Importantly, there is no limit on the upside legal and economic features of the common stock enjoyed by the holder. The unprecedented nature of the substantive arguments in favor of debt treatment, coupled with daunting administrative challenges, make it unlikely the IRS would pursue debt treatment.
- Tax Risks Associated with Large Participations in SPAC IPOs
There is something seemingly anomalous in the deal offered by SPACs to their IPO investors: invest $10, receive a share of common stock that can be redeemed for $10 and a fraction of a warrant to buy the common stock at $11.50. If there’s no acquisition within two years, you get your money back. If they do an acquisition and you don’t love it, you get your money back and you can keep the warrant just in case you were wrong. But as the saying goes, “there’s no law against that.” More to the point, subject to securities laws, rules of the exchanges and other laws, it is an arrangement that works for all parties, and the tax laws do not generally interfere.
Does that change if the investor is a fund with foreign investors that, along with several others, collaborates with the sponsor in its goal of launching a successful SPAC IPO and follow-on IBC?
The degree of “extra” involvement that an investor can have in a SPAC offering can vary substantially in degree. The most benign form of extra involvement is simply a commitment (generally a soft commitment) to participate in a certain minimum portion of the IPO. In this case, the investor is generally giving the sponsor an assurance that the IPO will be successful. No direct financial inducement is given to the investor for its commitment. The investor is not directly involved in crafting the terms of the SPAC (which in any case are fairly generic). Ultimately, the investor participates in the SPAC on the same economic terms as all other public participants. This type of low-level extra involvement probably does not give rise to any U.S. trade or business concerns.
Some have indicated reason to tread a bit more carefully when an investor is offered sponsor shares in connection with their commitment to participate in the IPO. The sponsor or founder shares are issued for nominal value. In some cases, the investor may participate in the receipt of founder shares, commit to buy a prescribed percentage of stock issued in the IPO (and to vote it in favor of the IBC and not submit it to redemption, along with a further commitment to purchase warrants and possibly participate as a PIPE investor in the IBC).
When an investor is offered founder shares (in the context of a Sponsor Syndicate, as we will call it for convenience), the question has arisen as to why it is being offered the opportunity to buy shares at a nominal value. Is the sponsor simply making the offer to induce the investor to come along for the ride?
At the same time, an investor receiving founder shares may consider whether it is being offered the shares either as an inducement to commit a certain amount of equity or for providing some kind of assistance or advisory role in the IPO or IBC.
We see the questions raised by some investors as entailing two potential tax issues raised by the Sponsor Syndicate. One involves the receipt of the founder shares and the other involves the broader role of the investor in the IPO. With respect to the founder shares, the sponsor itself is committed to the position that there is no compensatory aspect to issuance of the founder shares, but merely represents a modest investment in what is initially a new company with no assets other than the minimal amount of cash used to buy the stock. Selling the same stock (more or less) to other investors in the IPO at a much higher price is fundamentally the same as occurs any time a founder of a successful company sells stock to investors for more than he or she originally paid.
In some respects, having other investors participate in the Sponsor Syndicate may help validate the founder shares model, since, while it may be argued that the founder will be performing services to the SPAC, that is presumptively not the case with respect to non-sponsor investors receiving founder shares. Depending on particular facts, one cannot rule out the risk that the IRS could view the initial capitalization of the SPAC with nominal capital and the much larger capitalization through the IPO as an integrated whole, which would seem to indicate that the sponsor and its syndicate paid less than the public for very similar securities. In this regard, we note that since the founder shares do not carry with them redemption rights, are not issued with warrants and are subject to certain other limitations, their lesser value at the time of issuance should be justified. And to be clear, respecting the separateness of the initial capitalization of the SPAC by the sponsor and any co-investors and subsequent IPO remains the accepted tax analysis of these transactions.
Even assuming, for purposes of discussion, that issuance of the founder shares was viewed as part of the same transaction in which the public investors purchased their units, the compensation rules of Section 83 only come into play if the recipient of stock or other property is a service provider to the company. Non-sponsor investors are presumably not providing services to the company, and accordingly, Section 83 compensation rules should not apply.
The broader question raised be some investors considering participating in the Sponsor Syndicate is whether this participation exposes foreign investors in the participating fund to U.S. taxation as a result of the fund’s being engaged in a U.S. trade or business with which resulting income is treated as effectively connected income (ECI). The concern is that the Sponsor Syndicate member might be playing a role along with the sponsor beyond that of an investor, such as an underwriter.
These issues are complex and very dependent on particular facts. Greater concern has been expressed in the case of founder shares and commitments with respect to the IBC transaction and other supportive actions. In any case, there are strong arguments against characterizing the role of the Sponsor Syndicate member as being engaged in the business of underwriting the issuance of securities. For one thing, an underwriter is primarily engaged to bring about the successful distribution of the securities and does not ordinarily seek to take investment risk in the securities. By contrast, in the more extreme example of the Sponsor Syndicate member (where the fund gets founder shares and makes commitments with respect to large IPO investment), the investor is, in fact, committed to maintaining a significant long position in the SPAC and may not take actions to distribute units to third parties. Indeed, a better description for the role of the Sponsor Syndicate member might be that of an anchor investor, rather than an underwriter.
Additionally, the tax law provides an ECI safe harbor when the trading of stock or securities is for the fund’s own account, provided the taxpayer is not a dealer in stocks or securities. 17 This safe harbor is generally expected to be available to non-US SPAC investors. The investment fund may consider whether the founder shares are being offered to it directly or through a partnership with the sponsor. The investment fund may also consider whether to hold the founder shares through a separate vehicle (perhaps a blocker corporation) as a means of segregating these questions from the broader trading activities of the fund. 18
- Foreign Investment in Real Property Tax Act (FIRPTA)
We have not seen a lot of SPAC activity in the real estate area, but there has been some. Extraction industries also usually generate concerns about U.S. taxation of foreign investors under the FIRPTA rules. Generally, under those rules, a foreign investor is subject to U.S. income tax (and backstop withholding tax) upon the disposition of stock in a U.S. corporation that has met the definition of a U.S. real property holding corporation (USRPHC) at any time during the preceding five years. A USRPHC is generally a corporation a majority of the value of whose assets meets the definition of U.S. real property. An important exception is if the corporation’s stock is publicly traded and the foreign holder has not held more than 5 percent of the corporation’s stock at any time during the previous five years. 19
Investors may not anticipate any FIRPTA related issues when participating in a SPAC offering, because the initial investment entails a company that holds only cash or treasuries. The non-U.S. investor may assume that by the time a business combination occurs, it will hold 5 percent or less of the SPAC (or at least be in a position to reduce its holdings to 5 percent or less). However, as indicated above, the 5-percent exception is unavailable if the foreign investor held 5 percent or more at any time during the preceding five years. It has been argued that this look- back rule seems to apply even to a period before the corporation ever became a USRPHC. For example, suppose an investment fund’s offshore feeder purchases 9 percent of a SPAC’s shares in a public offering and sells half of its interest prior to a business combination. A year after the offering, the SPAC purchases an oil and gas company that amounts to a USRPHC in a business combination. The offshore feeder may be subject to FIRPTA if it sells its share within four years of the business combination, even though at the time of the combination it held only 4.5 percent.
Securities Issues Unique to SPACs
Purchasers of SPACs should consider the effects of the changes of the capitalization of the SPAC on the purchasers’ filing obligations and potential liabilities under securities laws as the SPAC moves through its life cycle from pre-IPO, to IPO, pre-IBC capital raising, IBC dilution or merger and de-SPACing. SPACs also create unique issues for persons who acquire securities other than in the public market or public offerings due to U.S. Securities and Exchange Commission rules relating to the resale of restricted securities issued by a blank check shell company or former shell company and the resale of securities acquired in a merger with a SPAC. These SPAC-related resale issues are frequently addressed through the filing of a resale shelf registration statement after the de-SPACing process.
[1] Apologies for the reference to an earlier, simpler time when a scribe wrote in “hard copy” with ink on a physical page.
[2] Date is by first filing, with blank check IPOs identified by SIC Code 6770.
[3] Tom Zanki, Ackman’s Record-Smashing Deal Raises Profile For SPACs, Law360, July 22, 2020 (https://www.law360.com/articles/1294603/ackman-s-record-smashing-deal-raises-profile-for-spacs); “In 2007, the last peak of SPAC IPO volumes, SPACs made up about 14% of the IPO market,” Sanghamitra Saha, 2020 Has Been the Year of SPAC IPOs: Here Are the Prominent 4, Dec. 28, 2020, Nasdaq, Inc. (https://www.nasdaq.com/articles/2020-has-been-the-year-of-spac- ipos%3A-here-are-the-prominent-4-2020-12-28).
[4] CITI SPAC 2020 Year-In-Review December 2020, Citi Banking, Capital Markets and Advisory.
[5] An outlier was the extraordinarily large $4 billion IPO sponsored by Pershing Square [add more specifics – name, etc.], whose terms were substantially the same as others, but apparently due to the scale of the offering, the per-unit price was doubled.
[6] See Treas. Reg. §1.1012-1.
[7] For example, language in the registration statement for FTAC Olympus Acquisition Corp. states: “For U.S. federal income tax purposes, each holder of a unit must allocate the purchase price paid by such holder for such unit between the one Class A ordinary share and the one-half of one warrant based on the relative fair market value of each at the time of issuance” (https://www.sec.gov/Archives/edgar/data/1816090/000121390020020736/fs12020_ftacolympus.htm).
[8] See IRC §1273(c)(2). This provision is applicable to debt instruments, but the approach is widely understood to apply to investment units involving corporate stock as well. (https://www.weil.com/~/media/mailings/2020/q4/cutting-edge-tax-issues-with-spacs--creative-approaches-and-pragmatic- solutions.pdf).
[9] According to a presentation by Weil, Gotshal & Manges LLP, a SPAC sponsor’s equity arrangements “may be economically ‘better’ than typical private equity carried interest as it sometimes covers contributed capital and future appreciation”
[10] This is often due to rules imposed by the exchange. For example, Nasdaq IM-5101-2(b) requires that a SPAC must complete one or more business combinations having an aggregate fair market value of at least 80% of the value of the SPAC trust account within 36 months of the offering or such shorter time period as specified by the SPAC.
[11] According to a presentation by Weil, Gotshal & Manges LLP, oftentimes if more than about 30% of the public shareholders choose redemption rather than voting for the IBC, the IBC cannot be consummated (https://www.weil.com/~/media/mailings/2020/q4/cutting-edge-tax-issues-with-spacs--creative-approaches-and-pragmatic- solutions.pdf).
[12] For example, language in the registration statement for FTAC Olympus Acquisition Corp. states: “It is also possible that a cashless exercise may be treated as a taxable exchange . . . In this case, . . . It is unclear whether a U.S. holder’s holding period for the Class A ordinary shares would commence on the date of exercise of the warrants or the day following the date of exercise of the warrants” (https://www.sec.gov/Archives/edgar/data/1816090/000121390020020736/fs12020_ftacolympus.htm).
[13] A PFIC is a company that meets either the so-called “income test” or the so-called “asset test.” The income test is met if at least 75% of the company’s gross income in a taxable year is passive. The asset test is met if at least 50% of its assets are passive.
[14] Some foreign SPACs have indicated the possibility that, unlike conventional SPACs, their IPO cash may be invested in non- interest bearing accounts. Commentators have suggested that this approach could make it easier for a foreign SPAC to qualify for the start-up exception (see DC Bar Communities 2021 Tax Legislative and Regulatory Update Conference, January 13, 2021, Panel on Corporate Taxation: M&A Update). However, disclosures on this topic remain noncommittal. Past discussion on this topic, unrelated to SPACs, leaves the effectiveness of this approach unclear.
[15] For example, assume a calendar-year foreign SPAC began operations in September 2020 and found a domestic target in March 2021. If it engages in a domestication or merger in March 2021, that would cut off its second tax year that began on January 1, 2021. It would have met the PFIC passive income and asset tests in each of its first two tax years and would thereby fall outside of the start-up exception. If it did not have to engage in a transaction cutting off its tax year, then its second tax year could run from January to December 2021 and include the active balance sheet and income statement of the target company.
[16] See IRC §§871(h), 881(c).
[17] In considering whether founder shares create U.S. trade or business concerns for an investment fund, attention may be given to the IRS position in CCA 201501013 and the ongoing YA Global litigation in the Tax Court (YA Global Investments LP et al. v. Comm’r). The facts in that case are very different from a SPAC offering in general. But the IRS’s apparent preparedness to argue the presence of a U.S. trade or business on the basis of a fund playing an underwriter or dealer role may warrant some additional attention. The convertible debt-like features of a SPAC issuance described above may enter into this analysis as well. Whether a particular set of facts gives rise to an underwriter/dealer risk is very complex and fact-specific. Relevant facts could include the degree of risk the investors take in connection with the IPO.
[18] Investment funds with foreign feeders generally rely heavily on the so-called trading safe harbors in IRC §864(b)(2) to prevent the foreign feeder from being deemed to be engaged in a U.S. trade or business and are wary of engaging directly in any activity that is not necessarily eligible for the safe harbors. Some investment funds may also have non-U.S. investors (particularly sovereign investors) that invest directly and have a particularly low appetite for U.S. trade or business risk.
[19] IRC §897(c)(3).
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