Macquarie Restructuring Tax Issues—A Synthesis

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

On September 22, Macquarie Infrastructure Corporation (NYSE:  MIC) (MIC, sometimes referred to as Macquarie) announced that it had completed its planned reorganization and that its public parent is now Macquarie Infrastructure Holdings, LLC (MIH, sometimes referred to as Holdings LLC), a limited liability company treated as a partnership for tax purposes. ¹  On September 23, MIH announced that it had completed the Atlantic Aviation (AA) transaction. ² 

On March 26 ³ and July 6, ⁴ we issued reports outlining the complex series of transactions planned for the overall liquidation of Macquarie’s businesses (including Atlantic Aviation and MIC Hawaii).  The July 6 report in particular presented an unpleasant picture of how non-U.S. investors would be taxed, based on information publicly disclosed and clarified by our conversations with the company.

Then the August 23 definitive proxy indicated that the company had significantly refined its analysis of the tax issues, especially those affecting offshore investors.  We were relieved by the changes, although tax issues for offshore investors did not go away.  We highlighted the key favorable changes in our September 11 report. ⁵ 

Because of the unusual degree of complexity of the proposed transactions and associated tax issues, as well as what might be perceived as a dizzying variance between the way these were presented in July and then in September, we are attempting to lay out here where we see matters have landed following Macquarie shareholders’ September 21 approval of the sales of Atlantic Aviation and MIC Hawaii. ⁶ 

The Transactions

Let us recap the steps in the company’s plan.  Note that each one of these is at least potentially taxable to investors (we outlined them a bit more extensively in our March 26 report):

1. MIH Reorganization: Effected via a merger transaction completed September 22, all MIC shares were exchanged for units in MIH.  As a result, all shareholders now own partnership interests in MIH, whose sole asset is 100 percent of the stock of MIC.  Common units of MIH began trading on September 23 (under the symbol MIC).
2. Hawaii Distribution: Also on September 22, following the MIH Reorganization, MIC distributed 100 percent of its interest in MIC Hawaii Holdings, LLC (MIC Hawaii) as a dividend to MIH.  MIC Hawaii is treated as a corporation for U.S. tax purposes and holds the MIC Hawaii business.
3. Atlantic Aviation Sale: On September 23, MIH sold 100 percent of the stock of MIC, whose sole holding was the Atlantic Aviation business.
4. AA Sale Proceeds Distribution: On October 7, MIH will distribute the $37.386817 per share (originally estimated at only $37.35) net proceeds from the Atlantic Aviation sale to holders of record on October 4.  As discussed below, amounts will be generally withheld from offshore investors’ distributions for dividend withholding tax associated with the Hawaii Distribution.
5. Merger Sale of MIC Hawaii (MH Merger): Expected in the first half of 2022, investors will sell their interests in MIH via a merger transaction, indirectly selling their interests in MIC Hawaii and receive about $3.83 per unit following closing.

Immediately below is a summary of the U.S. tax consequences of the series of transactions.  In the proxy statement, the company introduced a new wrinkle—the possibility that the MIH Reorganization and the AA Sale Proceeds Distribution could be integrated into a “disguised sale.” Though the proxy statement is not definitive as to its view, it seems to lean in favor of the disguised-sale analysis.  We first outline the treatment of the transactions without the disguised- sale approach, and then we describe how the disguised-sale analysis changes the results.

Tax Treatment of Transactions (Assuming No Disguised Sale)

1. MIH Reorganization: The exchange of MIC stock for MIH partnership interests is generally a tax-free exchange under Section 721 of the Internal Revenue Code (IRC).  Each MIC investor will take a tax basis in the MIH units equal to its basis in the MIC stock exchanged.  MIH will take a carryover basis from the investors in the MIC stock.  Because most of what will happen after this reorganization will be done by MIH, the U.S. tax consequences will flow through to the investors as MIH partners.  Depending on whether the investor is U.S. or foreign, MIH will provide information for the investors on their Schedules K-1 in 2022 or withhold on distributions to foreign partners (discussed below).
2. Hawaii Distribution: The distribution by MIC of MIC Hawaii to MIH is a taxable dividend to the extent of the current and accumulated earnings and profits (E&P) of MIC.  The amount of the distribution is the fair market value of MIC Hawaii (which the company estimated to be $3.25 per unit, of which an estimated $1.79 per unit has been characterized as a dividend ⁷ ).  To the extent the value of MIC Hawaii exceeds MIC’s E&P, it is a tax-free return of capital/basis to the investor, and any excess is taxable as a sale of the MIC stock.
3. U.S. Investors: The tax treatment of the dividend will be the same as if received directly by the investor, based on whether an individual, corporate or tax-exempt entity (and for partnership investors, taxable to the partners of the investing partnership).
4. Foreign Investors: The dividend is subject to U.S. withholding tax of 30 percent, except to the extent reduced by a tax treaty.  However, withholding will not actually take place until the partnership makes a distribution to investors (as described below).
5. Atlantic Aviation Sale: Having removed MIC Hawaii, MIC will only be holding the Atlantic Aviation business.  MIH’s sale of all of the MIC stock will result in the recognition of taxable gain or loss.  The gain (or loss) will generally be equal to the sale proceeds minus MIH’s tax basis in the MIC stock (which was a carryover of the investors’ basis in their stock).  Under relevant tax principles, MIH should generally segregate the gain and loss on a share-by-share (or at least block-by-block) basis and, accordingly, report to each investor the gain on MIC shares contributed by that investor, rather than determine the gain or loss in bulk and report it pro-rata among all investors.  This requirement is acknowledged by the company in the proxy statement.⁸  The mechanics of how the company will work with brokers to provide investors with this investor-specific information is not directly addressed.
6. U.S. Investors: The investor will generally recognize capital gain or loss based on the tax basis of the MIC shares exchanged in the reorganization.  The holding period will be long- or short-term based on the investor’s pre-reorganization holding period in the MIC shares plus any time between the reorganization and the Atlantic Aviation sale.
7. Foreign Investors: The proxy statement indicates that the company does not expect that MIC will be a U.S. Real Property Holding Corporation (USRPHC) subject to FIRPTA ⁹ taxation, but notes that it is possible that the IRS could disagree.  Assuming the company’s view is not challenged by the IRS, then the sale of MIC by MIH should not result in any U.S. tax to foreign investors.  We think the view of the company is particularly important since, were FIRPTA to apply (as appeared to be the case prior to the recent update of the company’s view in the definitive proxy), MIH would withhold foreign investors’ U.S. tax on the MIC stock gain from the distribution of proceeds (discussed further below).
8. AA Sale Proceeds Distribution: The October 7 distribution of $37.386817 cash to holders of record on October 4 will generally be nontaxable to a partner except to the extent it exceeds the partner’s basis in the partnership interest.  In these circumstances, it is unlikely that an investor will have less tax basis than the $37.386817 distributed, since the partnership interest will generally include the investor’s basis in the MIC shares exchanged plus some MIC Hawaii dividend income as well as gain on the sale of the MIC stock.
9. U.S. Investors: Based on the above, the cash distribution should generally be a tax-free return of basis.  If there were any gain, it would ultimately be reported and tax paid by the investor.
10. Foreign Investors: The rules applicable to domestic investors generally also apply to foreign investors, with one important exception.  MIH will use the AA Sale Proceeds Distribution to fulfill its withholding tax obligations associated with any previous transaction occurring at the MIH partnership level that was taxable to foreign investors.  Based on the company’s view that it does not expect the MIC stock to be subject to FIRPTA, we would not expect it to withhold further amounts based on FIRPTA tax.

As indicated above, an estimated $1.79 per unit of the Hawaii Distribution will be a taxable dividend.  On September 27, MIH notified the Depository Trust & Clearing Corporation that $1.79 of the total $37.386817 per unit distribution declared on September 23 (for holders on or before September 22) to be paid on October 7 will be U.S. source dividend income subject to 30-percent withholding in the case of non-U.S. investors.  MIH is taking the position that any holder that acquired its MIH units after September 22 would not be allocated any U.S. source dividend income and would not be subject to withholding.  Note that the market price of MIH (which trades as MIC) has not yet adjusted to reflect the distribution (it was trading at $40.43 per unit as of market close September 28, which only reflects a 2 percent discount from the $41.216817 of value expected to be distributed in the next several months).

This also creates an interesting situation for any foreign investor that held MIC units on September 22 (effectively the record date for the Hawaii Distribution) but will not be holding them on October 4 (the record date for the AA Sale Proceeds Distribution).  While such holders will escape the withholding tax, MIH may not.  Presumably, MIH still has an obligation under the applicable tax rules to track such foreign investors and nevertheless pay over to the IRS the applicable withholding (eating the cost as a practical matter).

1. MH Merger: This is treated as a taxable sale of the investors’ MIH units in exchange for the cash consideration in the MH Merger.
2. U.S. Investors: Investors will generally recognize capital gain or loss, based on the tax basis in their partnership interest, taking into account their basis in the MIC stock exchanged, plus dividend income from the Hawaii Distribution and gain on the Atlantic Aviation sale, less the cash distributed in the AA Sale Proceeds Distribution.
3. Foreign Investors: At this point, the company is saying that it is “unclear” whether MIC Hawaii will be a USRPHC (in contrast to its position on MIC, which it says it does not expect to be).  If MIC Hawaii is a USRPHC, then foreign investors are taxable under FIRPTA on any gain realized in the MH Merger, and there would be a 15-percent withholding tax on the merger proceeds. ¹⁰  However, as the company notes, assuming the MIH units are regularly traded on an established securities market, even if MIC Hawaii is a USRPHC, any investor that has held no more than 5 percent of the MIH common units (including ownership by related parties) would be expected to benefit from the publicly traded 5 percent shareholder exception under the FIRPTA rules. ¹¹ 

Tax Treatment of Transactions (Assuming Disguised Sale)

The disguised sale analysis views the exchange of MIC stock for MIH partnership interests followed by the distribution of $37.386817 cash from the Atlantic Aviation sale as a bifurcated transaction, in which a relatively small portion of an investor’s MIC stock is transferred to MIH in a tax-free partnership contribution and most of the MIC stock is sold to MIH for the $37.386817 cash.  The MIC stock traded at about $40.21 at the time of the MIH Reorganization on September 22.  That means that approximately 93 percent (37.386817/40.21) of the MIC stock would be treated as sold for $37.386817 and 7 percent would be treated as contributed in a tax-free partnership contribution.

For U.S. investors, since the MIH Reorganization, Hawaii Distribution and AA Sale Proceeds Distribution occurred in 2021, it likely will not make much difference whether the fully tax-free partnership or disguised sale approach is followed.  We do not know whether the company will report the transactions under the disguised sale approach.

For foreign investors, we think the disguised sale approach may actually offer a bit more protection from an argument by the IRS that FIRPTA tax applies to MIH’s sale of MIC.  This is because, were MIC considered a USRPHC and foreign investors were treated as selling most (93 percent) of it to MIH in a taxable transaction, then the publicly traded 5 percent shareholder exception under the FIRPTA rules should apply for investors that meet the 5-percent or less holding requirement.

^{[1] Press Release, MIH, MIC Announces Completion of Reorganization into Limited Liability Company (Sept. 22, 2021) (https://www.sec.gov/Archives/edgar/data/1289790/000110465921118159/tm2128082d1_ex99-1.htm).}

^{[2] Press Release, MIH, MIC Announces Closing of Sale of Atlantic Aviation, Record Date for Distribution of Proceeds of $37.386817 per Unit” (Sept. 23, 2021) (https://www.sec.gov/Archives/edgar/data/1845290/000110465921118596/tm2128286d1_ex99- 1.htm).}

^{[3] “Macquarie Infrastructure Corporation to Restructure Under Partnership Parent to Facilitate Liquidation” (March 26, 2021).}

^{[4] “New Details of Macquarie Infrastructure Corporation’s Restructure and Sales Sharpen Focus on Tax Impacts” (July 6, 2021).}

^{[5] “Proxy Discloses Altered FIRPTA Tax Impacts of Macquarie’s Restructure and Sales” (Sept. 11, 2021).}

^{[6] Form 8-K, MIC, Sept. 21, 2021 (https://www.sec.gov/ix?doc=/Archives/edgar/data/1289790/000110465921117950/tm2128173d1_8k.htm).}

^{[7] Although “[a] final determination of the fair market value of the businesses of MIC Hawaii will be made following the closing of the sale of the Company’s Atlantic Aviation business.  The proportion of fair market value characterized as a dividend will be determined with finality following the calculation of full year 2021 tax year earnings and profits in January of 2022,” Press Release, MIH, MIC Announces Completion of Reorganization into Limited Liability Company (Sept. 22, 2021) (https://www.sec.gov/Archives/edgar/data/1289790/000110465921118159/tm2128082d1_ex99-1.htm).}

^{[8] See material beginning on page 174 of Aug. 23, 2021 definitive proxy statement regarding application of IRC §704(c). (https://www.sec.gov/Archives/edgar/data/1289790/000110465921108348/tm2121775-2_defm14a.htm)}

^{[9] Foreign Investment in Real Property Tax Act of 1980 (FIRPTA).}

^{[10] IRC §1445.}

^{[11] Treas. Reg. §1.897-1(c)(2)(iv).}