New Details of Macquarie Infrastructure Corporation’s Restructure and Sales Sharpen Focus on Tax Impacts
By Stuart E. Leblang, Michael J. Kliegman and Amy S. Elliott
As a follow-up to our March 26 report,[1]which is appended, newly released details of Macquarie Infrastructure Corporation’s (NYSE: MIC) (MIC’s) plans to reorganize and sell off its two remaining businesses—Atlantic Aviation and MIC Hawaii—give investors a clearer picture of the tax impacts of MIC’s effective unwinding. Offshore investors concerned about the risk of withholding tax should be aware that the risk has significantly increased since our last report primarily because of how the company is handling tax associated with the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA).
On June 7, MIC entered into an agreement to sell Atlantic Aviation for $4.475 billion to an entity controlled by funds affiliated with Kohlberg Kravis Roberts & Co. L.P. Following closing of the sale, which should occur in the fourth quarter of 2021 after the planned restructuring (discussed below) and subject to certain conditions, including MIC shareholder approval, it is expected that about $3.298 billion in net proceeds will be distributed to MIC holders in the form of a cash distribution of about $37.35 per unit.[2]
Then, on June 14, MIC entered into an agreement to sell MIC Hawaii to AMF Hawaii Holdings, LLC, an affiliate of Argo Infrastructure Partners, LP. The sale will be effected by way of a merger, also subject to MIC shareholder approval, in which MIC holders will receive a cash distribution of about $3.83 per unit at closing, which is expected to occur in the first half of 2022.[3]
Before either the Atlantic Aviation sale or the MIC Hawaii sale, MIC will proceed with its planned restructuring (which is designed to minimize the amount of tax it will have to pay on the gain from the sale of its businesses), first placing MIC under a publicly traded partnership—Macquarie Infrastructure Holdings, LLC (Holdings LLC)—and then removing MIC Hawaii from the MIC corporate box (the Hawaii Distribution). The planned restructuring was approved by MIC shareholders on May 6.
As discussed in our prior report, from the MIC shareholder’s (soon to be MIC unitholder’s) perspective, the Hawaii Distribution will be taxable as a dividend to the extent of MIC’s current and accumulated earnings and profits or E&P (allocated pro rata among unitholders). Any excess will be treated first as non-taxable return of capital up to Holdings LLC’s tax basis in its MIC stock (which is a carryover of the shareholders’ tax basis from the MIC stock-to-MIC unit exchange), and then any remainder will be taxed as capital gain to the unitholder.[4]
The Hawaii Distribution will not result in a distribution to the unitholders but rather to Holdings LLC. However, the company must meet its associated withholding obligation with a payment to the Internal Revenue Service (IRS). After having multiple discussions with MIC’s head of investor relations and tax counsel to clarify our understanding of the public disclosures, we believe that MIC intends to reduce the affected foreign investors’ cash distributions associated with the Atlantic Aviation sale (expected to be about $37.35 per unit and expected to occur within a matter of days—no more than about 10 days—of the Hawaii Distribution) to account for the Hawaii Distribution withholding.
The size of the Hawaii Distribution is expected to be equal to the fair market value of the limited liability interests in MIC Hawaii distributed up to Holdings LLC. Although we do not know for sure what that amount is, we might expect that the Hawaii Distribution would be comparable in size to the value of MIC Hawaii net of debt as implied by the June 14 merger announcement (so likely something less than the enterprise value for MIC Hawaii of $514 million,[5]reflecting a per-unit value of about $5.87,[6]and greater than the $3.83 per unit that will be distributed to unitholders).
Some portion—maybe the entire amount—of the Hawaii Distribution will be subject to 30 percent withholding in the case of non-U.S. investors without a lower treaty rate (with the withholding from investors actually effected in the context of the later $37.35 Atlantic Aviation distribution)—but how much? It is possible that MIC’s current and accumulated E&P may be enough to render the entire amount of the Hawaii Distribution to be a taxable dividend subject to 30 percent withholding.
To the extent that the amount of the Hawaii distribution exceeds the company’s current and accumulated E&P, it is treated first as a tax-free return of basis, and then capital gain to the holder. Gain with respect to a share of MIC stock presents a FIRPTA tax problem with corresponding tax costs to foreign holders. Section 897 generally treats gain from the disposition of a U.S. real property interest (USRPI) by foreign persons as income effectively connected with a U.S. trade or business (also referred to as ECI), which in this case could potentially trigger a Section 1446 withholding obligation on Holdings LLC. We discuss this risk in more detail in the “Outstanding FIRPTA Questions” section of the report.
As was done when MIC announced the details of its January 8 special dividend associated with the sale of its International-Matex Tank Terminals (IMTT) business, we would expect that—closer to the time of the distribution—MIC will provide an estimate of the portion that will be treated as a taxable dividend based on its estimate of MIC’s E&P. For example, about 47.5 percent of the January special dividend was estimated to be treated as a taxable dividend subject to withholding.[7] Such guidance will be critical to ensure that withholding agents do not take an overly conservative stance on withholding for offshore investors. Absent such guidance, they would reasonably be expected to assume that the entire amount of the Hawaii Distribution is a dividend subject to withholding tax.
Still yet to be worked out by the company is how to ensure that the reduction in the $37.35 distribution to a foreign investor for dividend withholding tax on the Hawaii distribution hits the investor that held the unit on the date of the Hawaii distribution. We await confirmation from the New York Stock Exchange that MIC will trade with so-called due bills (promissory notes that “resolve the problem of ensuring that the correct owner receives a stock’s dividend when the stock is traded near its ex-dividend date”[8]) around the time of the Atlantic Aviation cash distribution. Due-bill trading was in effect for MIC’s January special dividend as the payment represented more than 25 percent of the stock price on the announcement date.[9] Note that it is possible that MIC will end up setting the record date for the Atlantic Aviation distribution so that it falls before the effective date of the Hawaii Distribution.
Investors concerned about the effects of timing of the Hawaii Distribution and the Atlantic Aviation distribution should consult their brokers before trading, as MIC may defer to the brokers and other withholding agents for securing documentation as to whether a partner is foreign or domestic and the type of partner (for example, individual or corporate, which impacts the tax rate of Section 1446 withholding, discussed in more detail in “Outstanding FIRPTA Questions”).
While we indicated in our prior report that MIC may be able to restructure the Hawaii Distribution so that it qualifies as a redemption, thereby avoiding dividend withholding, the latest information indicates that they have not made such a change. This means that Zenz[10]planning is off the table.
The Atlantic Aviation Sale
Following the Hawaii Distribution, the MIC corporate box will essentially just contain Atlantic Aviation. The June 7 agreement makes clear that the Atlantic Aviation sale will proceed as planned by way of a stock purchase agreement whereby the buyer (KKR Apple Bidco, LLC) will purchase all of the outstanding shares of MIC common stock from Holdings LLC for $37.35 per unit (totaling $3.298 billion in net proceeds).
The Atlantic Aviation sale will generally give rise to taxable gain to each unitholder to the extent of the unitholder’s allocable share of the excess of the purchase price over the tax basis of the contributed MIC common stock. There is also a risk that the Atlantic Aviation sale might be considered a disposition of a USRPI,[11]in which case gain or loss from such a disposition would be treated as ECI pursuant to Section 897(a) and would be subject to Section 1446 withholding in the case of offshore investors (discussed in more detail in “Outstanding FIRPTA Questions”).
The MIC Hawaii Sale
The final step in the effective unwinding of MIC is the sale of MIC Hawaii. While there was some uncertainty regarding how this would be structured, the June 14 agreement makes clear that the parties plan for the sale to occur by way of a merger where the buyer (AMF Hawaii Holdings, LLC) will merge its merger sub with and into Holdings LLC, with Holdings LLC surviving as a wholly-owned subsidiary of the buyer. MIC unitholders will get $3.83, assuming the merger is completed by July 1, 2022. This transaction will separately need to be approved by MIC shareholders in order to proceed.
From the MIC unitholders’ perspective, the MIC Hawaii sale will give rise to capital gain or loss based on the excess of the $3.83 sale price over the tax basis in MIC Hawaii. Each unitholder should have a tax basis in the Holdings LLC units equal to Holdings LLC’s basis in MIC Hawaii, which in turn will be equal to the fair market value of MIC Hawaii at the time of the Hawaii Distribution, adjusted only by any income or loss that may be allocated to the unitholders for the period following the Hawaii Distribution and prior to the Hawaii sale.[12] Insofar as the value attributed to MIC Hawaii for purposes of the tax treatment of the Hawaii Distribution is based directly on the expected sale price, there should generally be no gain or loss realized on the sale.[13]
Outstanding FIRPTA Questions
In our prior report, we discussed what the company’s public disclosures had to say about the impact to foreign investors of FIRPTA. MIC disclosed that, after the Hawaii Distribution, it is likely that MIC Corp. will be treated as a U.S. real property holding corporation (USRPHC) such that the Atlantic Aviation sale “generally would cause each non-U.S. holder to be subject to U.S. federal income tax pursuant to FIRPTA on such holder’s allocable share of any gain realized from such sale,” subject to a possible exception.[14]
A reader may infer from the phrasing of the tax disclosure that MIC will not have presented a FIRPTA concern at any point prior to the Hawaii Distribution and will only meet the technical criteria for being a USRPHC after the divestiture of MIC Hawaii.[15] In fact, the company’s concern about FIRPTA seems to be more a result of the look-back provisions in defining what U.S. corporations are considered U.S. real property interests (USRPIs) subject to the tax.
Generally, stock in a U.S. corporation is considered a USRPI unless the taxpayer establishes that the corporation was not a USRPHC at any time during the preceding five years.[16] The USRPHC test generally looks at whether the value of the corporation’s U.S. real property equals or exceeds the value of its other tangible and intangible assets.[17] Fluctuations in public market valuations of companies can impact this by even temporarily reducing the market’s valuation of the entire enterprise, so that the value of the real estate may exceed 50 percent even though it ordinarily may not. So, for example, regardless of whether MIC would meet the test at this point in time, it would have to look back to its asset mix and market valuation prior to its December 2020 sale of its real estate heavy IMTT business.
What portion of the Atlantic Aviation distribution made to foreign partners will be subject to Section 1446 withholding (generally at a rate of 21 percent in the case of a foreign corporation or 37 percent in the case of other foreigners, not including potentially an additional 30 percent federal branch profits tax in the case of foreign corporations)?
While we understand that MIC is still working through the mechanics navigating the unresolved issues, right now they are of the view that for purposes of Section 1446 withholding, they may end up assuming that the entire Atlantic Aviation distribution is gain (effectively assuming all shareholders have zero basis) such that withholding would be on the gross amount of the distribution. Foreign investors that suffer from over-withholding could file a claim for refund or they could reach out to MIC in advance (as the company indicated it might be open to working with individual foreign investors to arrange for separate basis determinations to avoid this result). MIC acknowledged that because of this rough-justice approach to the Section 1446 withholding issue, they expect most foreign investors will likely get out of the trade before MIC becomes a publicly traded partnership.
These uncertainties should not affect domestic investors, for whom the FIRPTA rules are not applicable and gain on the Atlantic Aviation sale of MIC stock should be calculated based on the investor’s actual tax basis in the MIC stock.
Assuming the company’s view does not change and FIRPTA does apply, then to the extent that the Hawaii Distribution exceeds E&P, it could give rise to FIRPTA gain that would trigger Section 1446 withholding in the case of foreign investors. As for the Atlantic Aviation sale, assuming the company’s view that MIC stock is a USRPI, then Holdings LLC’s sale of the MIC stock will be treated as a sale by a U.S. partnership of a USRPI and, as a result, ECI taxable to foreign investors in the partnership, also triggering Section 1446 withholding.
Presumably because the Atlantic Aviation buyer (KKR Apple Bidco, LLC) will be purchasing the MIC stock from a U.S. partnership rather than directly from one or more foreign sellers, it does not address FIRPTA in its purchase agreement.[18] In such a situation, it is the partnership rather than the purchaser that is charged with ensuring compliance with the FIRPTA tax by paying over withholding tax on the foreign partners’ share of FIRPTA gain.
As discussed in our prior report, the proxy statement provides that foreign investors holding less than 5 percent of MIC may be eligible for a FIRPTA exemption for sales of publicly traded USRPHC stock and should consult their own tax advisors.[19] In view of the structure of the transactions and the tax rules, this exception might only be helpful in the case of the MIC Hawaii sale. In that later transaction, the unitholders are deemed to sell their publicly traded units and so directly benefit from the exception. While, in the case of the Atlantic Aviation sale, it is the partnership that is selling interests in the USRPHC (the MIC stock), which is not publicly traded at the time of the sale. And, of course, a foreign investor that has not held more than 5 percent of MIC should be able to sell its stock before the restructuring transactions commence.
As we look through the MIC Hawaii merger agreement, there is no specific reference to these FIRPTA matters, though there are the conventional representations made by Holdings LLC about having properly filed returns and paid taxes. Disclosure schedules to the merger agreement might ultimately contain information about the FIRPTA issue and Holdings LLC’s intended approach to it, but they are not publicly disclosed. We suspect that the Hawaii merger itself does not present a FIRPTA concern, provided MIC Hawaii is not USRPI (and so far MIC has given no indication that it thinks it may be).
Foreign investors concerned about the FIRPTA implications of MIC’s planned transactions but interested in retaining the economics of the distributions without the withholding risk might consider holding MIC synthetically on swap. The rules of Section 871(m) will not allow avoidance of withholding tax on the Hawaii Distribution, but the issues are quite different with respect to FIRPTA, particularly where the investor would meet the 5 percent or less shareholding test for FIRPTA exemption if it had actually sold shares in the public company.
[1] “Macquarie Infrastructure Corporation to Restructure Under Partnership Parent to Facilitate Liquidation” (March 26, 2021).
[2] Press Release, MIC, “Macquarie Infrastructure Corporation Announces Agreement to Sell Atlantic Aviation to KKR for $4.475 Billion” (June 7, 2021) (https://www.sec.gov/Archives/edgar/data/0001289790/000110465921077415/tm2118970d1_ex99-1.htm Purchase Agreement dated June 7, 2021 by and among KKR, MIC and others (https://www.sec.gov/Archives/edgar/data/0001289790/000110465921077415/tm2118970d1_ex2-1.htm).
[3] Press Release, MIC, “Macquarie Infrastructure Corporation Announces Agreement to Sell MIC Hawaii; Completes Pursuit of Strategic Alternatives” (June 14, 2021) (https://www.sec.gov/Archives/edgar/data/1289790/000110465921081256/tm2119603d1_ex99-1.htm); Agreement and Plan of Merger by and among AMF Hawaii Holdings, LLC, MIC and others dated as of June 14, 2021 (https://www.sec.gov/Archives/edgar/data/1289790/000110465921081256/tm2119603d1_ex2-1.htm).
[4] Technically, the tax-free return of basis is determined on a share-by-share basis, so that there may be more capital gain with respect to one share and less with respect to another. The tax rules generally envision that this is tracked back to the investors that exchanged those MIC shares for Holdings LLC units, so that an MIC investor with higher tax basis in its MIC shares would be allocated less capital gain than another investor with lower tax basis. In any case, this presupposes that the value of the Hawaii Distribution exceeds MIC’s earnings and profits.
[5] The $514 million includes assumed debt and transaction costs, including “a disposition payment to MIC’s external manager of approximately $82 million if the merger closes on or before July 1, 2022 or $57 million if the merger closes after this date,” according to Press Release, MIC, “Macquarie Infrastructure Corporation Announces Agreement to Sell MIC Hawaii; Completes Pursuit of Strategic Alternatives” (June 14, 2021) (https://www.sec.gov/Archives/edgar/data/0001289790/000110465921081256/tm2119603d1_ex99-1.htm).
[6] 514,000,000 / 87,593,632 = about $5.87 per share/unit
[7] Press Release, MIC, “MIC Announces Closing of Sale of IMTT, Record Date for Special Dividend of $11.00 Per Share” (Dec. 23, 2020) (https://www.micinc.com/about/news/2020/mic-announces-closing-sale-imtt.html).
[8] https://www.theice.com/publicdocs/NYSE_Group_Corporate_Actions_Client_Specification.pdf
[9] Press Release, MIC, “MIC Announces Closing of Sale of IMTT, Record Date for Special Dividend of $11.00 Per Share” (Dec. 23, 2020) (https://www.businesswire.com/news/home/20201223005513/en/MIC-Announces-Closing-of-Sale-of-IMTT-Record-Date-for-Special-Dividend-of-11.00-Per-Share).
[10] Zenz v. Quinlivan, 213 F.2d 914 (6th Cir. 1954); Rev. Rul. 75-447, 1975-2 C.B. 113
[11] This is because it is likely that MIC Corp. will be treated as a U.S. real property holding corporation (USRPHC)—see discussion at “Outstanding FIRPTA Questions.”
[12] The rules are quite complex, but the way the partnership tax rules operate, following the sale of Atlantic Aviation and distribution of the proceeds to the investors, the tax basis remaining in their units should be the same as Holdings LLC’s basis in MIC Hawaii. Also, we do not know whether the MIC Hawaii entities include any operating subsidiaries that are pass-through entities, though what the company has disclosed with regard to the publicly traded partnership rules implies that the answer is likely not.
[13] If there is gain on the sale, then the holding period will be important for purposes of determining whether the gain is long-term or short-term. While it is likely that the period between the Hawaii Distribution and the Hawaii sale will be less than one year, the applicable holding period for the unitholders should be that of the Holdings LLC units that are being sold, which should include the investor’s holding period for the MIC shares exchanged for the units.
[14] MIC proxy statement/prospectus dated April 5, 2021 (https://www.sec.gov/Archives/edgar/data/0001845290/000110465921046471/tm216862-7_424b3.htm).
[15] After the Hawaii distribution, it is believed that Holdings LLC will only own stock in corporations and all of the business activity will be within those corporations.
[16] IRC §897(c)(1)(A)(ii).
[17] IRC §897(c)(2).
[18] Section 2.3(b) of the Stock Purchase Agreement requires Holdings LLC to provide a Form W-9 attesting to its U.S. residency.
[19] IRC §897(c)(1)(B)(3) provides “If any class of stock of a corporation is regularly traded on an established securities market, stock of such class shall be treated as a United States real property interest only in the case of a person who, at some point during the [previous 5 years] held more than 5 percent of such class of stock.” See also Treas. Reg. §1.897-1(c)(2)(iv) indicating that this exception may be applicable to sales of interests in a publicly traded partnership.
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