Pershing Square SPARC Launch Raises Tax Questions

By Stuart E. Leblang, Michael J. Kliegman and Amy S. Elliott

On September 30, Pershing Square SPARC Holdings, Ltd. (PS SPARC)—the unique public vehicle created by William Ackman in November 2021 in connection with the liquidation of the failed special purpose acquisition company (SPAC) Pershing Square Tontine Holdings, Ltd. (NYSE:  PSTH) (PSTH) that Ackman controlled—distributed some 61 million subscription warrants after finally securing Securities and Exchange Commission (SEC) approval for its launch.^[1] Former shareholders of now-liquidated PSTH, which was wound up after it failed to timely complete an initial business combination with Universal Music Group^[2](the combination took the form of a “somewhat unusual structure”^[3]that did not get regulatory approval), will receive the warrants (referred to as special purpose acquisition rights or SPARs) at no cost to them.^[4]

Ackman, the founder and CEO of hedge fund Pershing Square Capital Management, L.P., has stated publicly that the new SPARC investment vehicle could be used to take a multibillion- dollar private company public.^[5] As a reminder, SPACs are public companies formed with investor cash to acquire an often-private operating company, whereby the merger effectively serves to take the target public under set deal terms.  Ackman has said he wants to reverse the typical IPO process, so that a private company can avoid the usual hoops of disclosing detailed financial information to the public (via a prospectus) before knowing whether its IPO will be successful.^[6]

Ackman first informed PSTH shareholders about the formation of PS SPARC—which is not a SPAC but rather a special purpose acquisition rights company—in June 2021.^[7] Unlike a SPAC, PS SPARC will not raise capital from investors who are committing to a future combination without knowing the identity of the target.  Instead, investors have rights (the SPARs) to acquire PS SPARC common stock (each SPAR confers the right to acquire two shares—although the price will vary based on the deal^[8])—but those rights can only be exercised once a target has been identified and a definitive agreement for the combination has been entered into.  According to a release, PS SPARC’s structure “remove[s] the time pressure of the two-year investment period, which can impair . . . negotiating leverage.”^[9] That is to say, the SPARs have a much longer term (up to 10 years to secure a target).  In addition, the Pershing Square Funds “would make a large co-investment in SPARC on precisely the same terms and at the same time as SPARC warrant holders can exercise their warrants to buy stock in SPARC’s initial business combination.”^[10]

That means former shareholders of the failed SPAC PSTH (who had their $4 billion in cash returned to them in July 2022) just received a “ticket to a new party”^[11] in the form of the SPARs (now that the rights have been approved).  The 61 million SPARs give holders the chance to “be the first in line”^[12]once an acquisition target has been identified (and an agreement at a fixed price has been entered into and the prospectus has been approved, among other requirements), at which point the SPARs (the PS SPARC warrants) will be tradeable on the New York Stock Exchange and the rights holders can decide whether or not to invest in the deal.  Even though it has been approved, PS SPARC hasn’t yet received any cash from public investors.

In July 2022, we wrote about the since-aborted plan to activate PS SPARC in connection with the liquidation of the SPAC PSTH.^[13]  In it, we had to wrestle with some tax uncertainties resulting from the fact that the SPARs were to be issued as part of the SPAC liquidation.  These issues were interesting, but the fact that the liquidation of SPAC PSTH is fully in the rear-view mirror now that the new SPARs have finally been issued certainly simplifies the matter.  We agree with the tax disclosure in the PS SPARC prospectus^[14]that the gratuitous issuance of SPARs to former PSTH shareholders should give rise to ordinary income to U.S. taxpayers in an amount equal to the fair market value of the SPARs.  Given that they will not initially trade and the exercise price is unknown, that value will be very speculative and likely low, and it remains to be seen whether a suggested value will be indicated in a future communication or filing by the company.

For foreign investors, U.S. withholding tax is an issue because PS SPARC is a Delaware corporation.  Here, the prospectus states that it expects that foreign investors will be subject to a 30-percent withholding tax on receipt of the SPARs (unless reduced by treaty).  Since the distribution of the SPARs does not fit into any specific category that might be exempt, it likely falls into the general definition of “fixed or determinable annual or periodical gains, profits, and income” (so-called FDAP).^[15] While we think there are some arguments to the contrary with respect to withholding tax, the key point is that the company is indicating that investors should expect withholding tax to be imposed.  The prospectus is silent as to how the withholding tax will be collected, but since the only items of value being distributed are the SPARs, then presumably there would be a corresponding reduction in the number of SPARs disbursed to a foreign investor.^[16]

For both foreign and domestic investors, tax basis in the SPARs would be equal to the value ascribed to them upon issuance, and the holding period begins on the date they are received.  Consideration received upon a subsequent sale would be capital gain or loss and should not be subject to further U.S. withholding tax.  Exercise of a SPAR in connection with a business combination should not give rise to a taxable event, and the holder’s basis in the SPAR would be included, along with the exercise price, in the basis of the stock purchased.

^{[1] PS SPARC Form 8-K filed Sept. 29, 2023 (https://www.sec.gov/Archives/edgar/data/1895582/000119312523247567/d553088d8k.htm).  Note that the SEC had to approve a New York Stock Exchange (NYSE) rule change as part of this process.}

^{[2] Our prior report on this, “Tax Consequences of Pershing Square SPAC Liquidation” (July 24, 2022), is appended.  Note that a fund controlled by Ackman ended up buying a stake in Universal Music Group.  As of Dec. 31, 2022, Ackman indirectly held 10.27% capital interest in Universal Music Group through PS VII Master L.P. (https://view.publitas.com/cfreport/umg-annual- report-2022/page/106).}

^{[3] Bill Ackman speaking on CNBC’s Squawk Box Oct. 2, 2023 (https://www.cnbc.com/video/2023/10/02/bill-ackman-on-new- sparc-structure-potential-deal-with-elon-musks-x.html).}

^{[4] Press Release, PS SPARC, Pershing Square SPARC Holdings, Ltd. Announces Launch and SPAR Distribution (Sept. 29, 2023) (https://www.businesswire.com/news/home/20230929101720/en/Pershing-Square-SPARC-Holdings-Ltd.-Announces-Launch- and-SPAR-Distribution).}

^{[5] The SEC approved SPARC to raise at least $1.5 billion from public investors, not including the expected anchor investor contribution from Pershing Square Funds.}

^{[6] Supra, Note 3.}

^{[7] Press Release, PSTH, Pershing Square Tontine Holdings, Ltd. (“PSTH”) Confirms Discussions to Acquire 10% of the Ordinary Shares of Universal Music Group (“UMG”) for Approximately $4 billion, Representing an Enterprise Value of €35 Billion (June 4, 2021) (https://www.sec.gov/Archives/edgar/data/1811882/000119312521181942/d172721dex991.htm).}

^{[8] When SPARs were originally conceived, PSTH shareholders were told the minimum exercise price of a SPAR would be $20 ($10 per share) (https://www.sec.gov/Archives/edgar/data/1811882/000119312521256432/d216395dex991.htm).}

^{[9] Pershing Square Tontine Holdings, Ltd. Releases Excerpt from Pershing Square Holdings, Ltd. Report (https://www.sec.gov/Archives/edgar/data/1811882/000119312521256432/d216395dex991.htm).}

^{[10] Id.}

^{[11] Supra, Note 3.}

^{[12] Id.}

^{[13] Supra, Note 2.}

^{[14] PS SPARC Prospectus, dated Sept. 29, 2023, at pg. 195 (https://www.sec.gov/Archives/edgar/data/1895582/000119312523247555/d305814d424b3.htm).}

^{[15] IRC §871(a)(1)(A).}

^{[16] In PS SPARC’s Form 10-Q filed Nov. 8, 2023, the company disclosed that “[a]s of October 31, 2023, . . . the final SPAR register currently presents 60,971,015 SPARs as outstanding,” which is less than the 61,111,111 planned distribution (https://www.sec.gov/ix?doc=/Archives/edgar/data/1895582/000119312523273601/d532973d10q.htm).}