Tax Consequences of Pershing Square SPAC Liquidation

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

On July 11, Pershing Square Tontine Holdings, Ltd. (NYSE:  PSTH) (PSTH), a special purpose acquisition company (SPAC) controlled by William Ackman, announced that, in view of its inability to complete an initial business combination (IBC) within 24 months of its initial public offering on July 24, 2020, it will liquidate.¹  This follows by nearly a year the August 19, 2021 letter by Ackman²  to shareholders detailing efforts to obtain approval for the launch of an alternative vehicle, Pershing Square SPARC Holdings, Ltd. (PS SPARC).  That letter, in turn, followed the July 19, 2021 announcement ³ that PSTH’s plans to purchase a 10-percent interest in Universal Music Group (UMG) from Vivendi SE ⁴ were being withdrawn, largely due to questions over whether the structure of the combination qualified under New York Stock Exchange (NYSE) rules.  Ackman’s hedge fund Pershing Square Holdings, Ltd. instead acquired the UMG stake.  ⁵ 

According to the press release, PSTH will cease all operations, its shares will cease trading at the close of business on July 25, 2022, and it will redeem all of its common stock for approximately $20.05 per share, net of taxes.  Redemption proceeds will be paid on July 26.  Warrants will receive no consideration from the company and will expire worthless.

Also on July 11, the company released a letter from Ackman to PSTH shareholders summarizing the events leading up to the company’s liquidation and announcing concrete plans (previously discussed in his August 19, 2021 letter) to launch PS SPARC, a new vehicle to succeed PSTH. ⁶  The letter states that “we” intend to distribute long-term warrants issued by PS SPARC to PSTH investors.  Specifically, holders of PSTH common stock as of the close of business on July 25, 2022 will receive one-half of a SPAR (the name of the warrants issued by PS SPARC) per PSTH  share (or one SPAR for every two PSTH shares) and holders of warrants will receive one SPAR per warrant.

In this report, we will discuss the federal income tax consequences to holders of PSTH stock and warrants from the liquidation of the company and the issuance of SPARs (the long-term warrants issued by the new investment vehicle PS SPARC).  As background, we first review at a high level the principal terms of the SPAC and, to the extent relevant to what is in store for investors, what had been laid out in connection with the aborted UMG transaction.

Overview of PSTH Terms and Aborted UMG Deal

Going back to PSTH’s July 2020 IPO, several features distinguished it from the many SPACs that went public during the past few years.  One is its sheer size, $4 billion, from the sale of units priced at $20 rather than the conventional $10. ⁷  Pershing Square Capital Management, L.P. (PSCM) did not purchase founder shares, instead committing to invest additional capital in a couple of ways.  Investment funds managed by PSCM entered into forward purchase agreements with PSTH for an additional $1 billion to $3 billion in units.  PSTH’s sponsor, Pershing Square TH Sponsor, LLC, also purchased warrants at fair value⁸  that would not be transferable or exercisable until three years after the IBC.  Other features of the PSTH SPAC directly affecting public investors will be discussed below.

Another unique feature of PSTH is that, instead of limiting itself to an IBC in which it would acquire a controlling position in another company, PSTH’s prospectus indicated that it might instead acquire a minority interest in a large-capitalization company.  And indeed, that’s exactly what they planned to do in the UMG deal.  In connection with Vivendi’s plan to take its UMG subsidiary public and distribute a 60-percent interest to its shareholders, it had agreed to sell 10 percent of UMG to PSTH for approximately $4.1 billion. ⁹  The purchase was subject to approval by PSTH shareholders.  Funds managed by PSCM were to exercise about $1.6 billion of forward purchase agreements prior to closing of the UMG stock purchase. ¹⁰  As a result, following the purchase, PSTH would hold approximately $1.5 billion in cash and would continue to have $1.4 billion in unexercised forward purchase contracts held by the funds.

Because the purchase of 10 percent of UMG was a permissible IBC within the terms of PSTH’s prospectus, if the deal had closed, the two-year time clock for its existence as a SPAC would have tolled and it would have been free to pursue subsequent transactions on a more open-ended basis.  However, as Ackman’s recent letter states, the nature of the Vivendi transaction and concerns raised by the SEC required that PSTH terminate its investment in UMG and it assigned its rights to invest in UMG to the Pershing Square Funds.  Because PSTH was not able to sign up and consummate any transaction during the two-year period, it is now liquidating and providing its investors with the opportunity to participate in the new PS SPARC vehicle.

PS SPARC

Information about this new entity and the proposed distributions is found in an amended Form S-1 filed by PS SPARC on June 16, 2022. ¹¹  PS SPARC is a recently formed Delaware corporation whose purpose, like that of a SPAC, is to pursue an IBC, but using a new, and purportedly better, business model than that of a SPAC.  We offer here only a very brief summary of its terms.  PS SPARC will initially be capitalized with $1,971,880 of common equity and an additional $30 million of convertible preferred equity both from the Sponsor ¹² (which is a newly formed entity managed by PSCM that will own both common and preferred stock in PS SPARC).  In addition to issuance of the SPARs, PS SPARC will issue Sponsor Warrants and Director Warrants, as well as enter into a forward purchase agreement with affiliates of the Sponsor, in which they will commit to purchase $500 million of common stock at $10 per share, or to pay a higher price based on the Final Exercise Price of the SPARs (discussed below).

The SPARs are options to purchase newly issued common stock in PS SPARC, exercisable in connection with PS SPARC’s entering into an agreement to consummate an IBC.  Each SPAR is exercisable for two common shares at a Minimum Exercise Price of $10 per share.  The PS SPARC board will determine the Final Exercise Price based on the actual pricing of the IBC, which may be greater than $10 per share.  The SPARs generally expire on the earlier of the consummation of an IBC or 10 years from their issuance.  PS SPARC intends to seek a market maker to file an application with the Financial Industry Regulatory Authority (FINRA) for the SPARs to be quoted on the OTCQX marketplace of the OTC Markets Group or another quotations service.

Tax Treatment of Liquidation Plan and Migration from SPAC to SPARC

Receipt by PSTH shareholders of cash should be treated as capital gain or loss because the distribution is in complete liquidation of the corporation. ¹³ For foreign investors, there should not be any withholding tax with respect to the cash distribution. Since the warrants will expire with no consideration distributed to warrant-holders by PSTH, holders should generally be entitled to a capital loss to the extent of their tax basis in the warrants. ¹⁴ 

Where things get less clear is with respect to the distribution by the new PS SPARC of SPARs to both shareholders and warrant-holders of PSTH.  There is no direct corporate relationship between PSTH and PS SPARC.  Nevertheless, PS SPARC will be gratuitously issuing its SPARs to both PSTH shareholders and warrant-holders, as indicated above.  Generally, the SPARs represent subscription warrants to purchase stock in PS SPARC after it enters into a definitive agreement to engage in a business combination.  The SPARs will be distributed to holders of PSTH stock or warrants as of the close of business on July 25, 2022, and the SPAR distribution will occur after PS SPARC’s registration statement becomes effective, currently estimated to be in the Fall of 2022. ¹⁵ 

Because PSTH shareholders are not receiving the SPARs from PSTH, they are not dividends and not liquidation proceeds.  The amended Form S-1 contains a summary of U.S. federal income tax consequences to recipients and holders of the SPARs.  We generally agree with the tax disclosure that the most likely U.S. tax treatment of the receipt of the SPARs by U.S. taxpayers, whether stockholders or warrant-holders, is ordinary income based on the initial trading value of the SPARs.  For foreign investors, withholding tax is an issue because PS SPARC is a Delaware corporation.  Here, the Form S-1 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).^[16] 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.

There is no disclosure about how the withholding tax will be paid.  It seems reasonably clear that PSTH is not legally connected with the distribution of SPARs, notwithstanding that recipients are its shareholders and warrant holders.  Therefore, we do not expect withholding tax on the SPARs to be deducted from the $20.05 being distributed to PSTH shareholders. ¹⁷  As in other instances where withholding tax is imposed with respect to a distribution of securities, we expect that the withholding agent will withhold 30 percent of a foreign investor’s SPARs and sell them to provide for cash payment to the Internal Revenue Service.

Possible Alternative Tax Treatment?

This is indeed an unusual situation: one corporation (PS SPARC) is gratuitously issuing consideration to a group of shareholders of another corporation (PSTH).  What connects the two companies are their sponsors, which are related, and it is reasonable to suggest that they are arranging for this benefit due to their economic interests in both entities.  This should probably not affect the tax treatment of the receipt of the SPARs by the PSTH shareholders unless one were to argue that the PSTH sponsor should be viewed as receiving the warrants from the SPARC and contributing them to PSTH which, in turn, would distribute them to its shareholders and warrant-holders.  Such a characterization could transform receipt of the SPARs by the PSTH shareholders to capital gain or loss liquidation proceeds rather than ordinary income.  Viewing the SPARs as being contributed to PSTH and distributed by PSTH to shareholders would raise the possibility of taxing PSTH on the excess of the SPARs’ value over what was paid for them. ¹⁸  

And what of the PSTH warrant-holders? Each holder of a PSTH Distributable Warrant will receive one SPAR with respect to each PSTH warrant.  PSTH warrant-holders are not engaging in a formal exchange, and, officially, their warrants are considered to be expiring and worthless.  However, there may be technical bases for U.S. PSTH warrant-holders to assert capital gain rather than ordinary income with respect to receipt of the SPARs. ¹⁹ 

^{[1] Press Release, PSTH, Pershing Square Tontine Holdings, Ltd. Will Redeem Its Public Shares and Will Not Consummate an Initial Business Combination (July 11, 2022) (https://pstontine.com/wp-content/uploads/2022/07/PSTH-PressRelease-7.11.22.pdf).}

^{[2] Press Release, PSTH, Pershing Square Tontine Holdings, Ltd. Releases Letter to Shareholders (Aug. 19, 2021) (https://pstontine.com/wp-content/uploads/2021/08/8.19.2021-PSTH-Letter-to-Shareholders.pdf).}

^{[3] Press Release, PSTH, Pershing Square Tontine Holdings, Ltd. Releases Letter to Shareholders (July 19, 2021) (https://pstontine.com/wp-content/uploads/2021/07/Letter-to-Shareholders-from-PSTH-CEO-Bill-Ackman.pdf).}

^{[4] Press Release, PSTH, Pershing Square Tontine Holdings, Ltd. (“PSTH”) to Acquire 10% of the Ordinary Shares of Universal Music Group (“UMG”) from Vivendi S.E. for Approximately $4 billion, Representing an Enterprise Value of €35 Billion (June 20, 2021) (https://pstontine.com/wp-content/uploads/2021/06/Final-Announcement-Press-Release-6.20.2021.pdf).}

^{[5] On Aug. 10, 2021, Pershing Square Holdings, Ltd. announced that it and certain of its affiliated entities had acquired an initial 128,555,017 ordinary shares (7.1%) of UMG from Vivendi S.E.; Press Release, Pershing Square Holdings, Ltd., Pershing Square Acquires Initial Stake in Universal Music Group (Aug. 10, 2021) (https://pershingsquareholdings.com/pershing-square-acquires-initial-stake-in-universal-music-group/); Press Release, Vivendi, Vivendi sells an additional 2.9% stake of UMG to Pershing Square (Sept. 9, 2021) (https://www.vivendi.com/wp-content/uploads/2021/09/20210909_VIV_PR_Closing-UMG-Pershing-additionnal-2.9.pdf).}

^{[6] Press Release, PSTH, Pershing Square Tontine Holdings, Ltd. Releases Letter to Shareholders (July 11, 2022) (https://pstontine.com/wp-content/uploads/2022/07/PSTH-Letter-to-Shareholders-7.11.22.pdf).}

^{[7] PSTH Prospectus (https://www.sec.gov/Archives/edgar/data/1811882/000119312520197776/d930055d424b4.htm).}

^{[8] Fair market value of the sponsor warrants was determined to be $65 million with the help of a third-party, nationally recognized valuation firm (see PSTH Prospectus).}

^{[9] Having previously sold a 20% stake to Tencent Holdings Ltd., this will leave Vivendi with a retained 10% interest in UMG.}

^{[10] Supra note 2.}

^{[11] Amendment No. 1 to Form S-1 for Pershing Square SPARC Holdings, Ltd. filed June 16, 2022 (https://www.sec.gov/Archives/edgar/data/1895582/000119312522175635/d349381ds1a.htm).}

^{[12] Specifically, PS SPARC’s sponsor is Pershing Square SPARC Sponsor, LLC, a Delaware limited liability company that is an affiliate of PSCM.}

^{[13] IRC §331.}

^{[14] IRC §§1234, 1234A.}

^{[15] Supra note 6.}

^{[16] IRC §871(a)(1).}

^{[17] Another practical reason for this is that while the cash is to be distributed on July 26, the SPARs will not be distributed and their value established until months later.}

^{[18] See IRC §311(b) for a non-liquidating distribution or IRC §336 for a liquidating distribution.}

^{[19] See IRC §§1234, 1234A.}