The following article by James N. Phillips appeared in the February 13, 2019 issue of the Business Law Section Blog of the State Bar of Wisconsin and is being reposted from that site with the permission of the author and the State Bar of Wisconsin.


Jim Phillips, Iowa 1979, is a shareholder in the Milwaukee office of Godfrey & Kahn, S.C., where he practices tax and corporate law.


Section 1202 of the amended Internal Revenue Code of 1986 allows exclude up to 100 percent of the gain on sale of stock held more than five years, if such stock meets the definition of “qualified small business stock.” Jim Phillips discusses some of the requirements and traps of Section 1202.

An owner of C corporation stock may be able to exclude up to 100 percent of the gain on sale of stock held more than five years, if such stock meets the definition of “qualified small business stock” (QSBS) under Section 1202 of the Internal Revenue Code of 1986, as amended.

The gain might also be excludable from Wisconsin tax if the corporation is a qualified Wisconsin business and the requirements of Wis. Stat. section 71.05(25)(b) are met.

Given the significantly lower federal income tax rate on C corporation income (21 percent) compared to the federal income tax rate on flow-through income of S corporations and LLCs (37 percent or 29.6 percent, depending on whether the 20 percent deduction of Section 199A applies), the availability of the Section 1202 exclusion can, in some cases, tip the scales toward C corporation status when evaluating the proper choice of entity.

Here is a summary of the requirements and traps of Section 1202.

Section 1202 Offers Partial or Total Exemption from Tax for Certain Capital Gains

Section 1202 exempts from tax a specified percentage of a taxpayer’s gains from the sale of QSBS provided the taxpayer held the QSBS for more than five years (among other requirements discussed below).

The applicable exemption percentage for stock acquired on or after Sept. 27, 2010, is 100 percent. For stock acquired earlier, the exemption may be 50 percent or 75 percent, depending on the taxpayer’s stock acquisition date.

Congress has repeatedly changed the amount of the Section 1202 exemption with varying effective dates. For stock for which the 100 percent exclusion applies, the excluded gain is not a preference under the alternative minimum tax (AMT).

For other exclusion percentages, a portion of the excluded amount is an AMT preference.

The table below summarizes the interaction of Section 1202, AMT, and other code provisions.

 

Date of Stock Acquisition § 1202 Tax Exemption Percentage § 1202 Capital Gain Rate Effective Capital Gains Rate Effective Net Investment Income Tax Rate Effective AMT Tax Rate AMT rate savings vs. 23.8% regular capital gain rate
On or after Aug. 11, 1993, but before Feb. 17, 2009 50% 28% 14% 1.9% 14.98% 6.92%
On or after Feb. 17, 2009, but before Sept. 27, 2010 75% 28% 7% 0.95% 8.47% 14.38%
On or after Sept. 27, 2010 100% 28% 0% 0% 0% 23.8%

For example, assume that individual X acquired $1 million of Y corporation stock in 2019, and Y stock is a capital asset in X’s hands. If the Y stock is not QSBS and X sells it in 2026 for $6 million, then X realizes a gain of $5 million. In that case, X could potentially owe federal income taxes of $1.19 million ($5 million gain x 23.8 percent capital gains rate).

However, if the Y stock were QSBS in X’s hands, then X’s entire Section 1202 gain on the sale would be excluded and X would owe no federal income taxes attributable to the sale. Thus, X would have tax savings of $1.19 million. This would be in addition to the lower C corporate income tax rate over the 6-year period. However, choice of entity is usually not just a current or future tax rate issue. A number of factors need to be considered: expected dividend distributions, the flexibility of structuring a potential future sale as an asset sale, estate planning considerations, etc.

Requirements for the Section 1202 Exemption

For stock in a corporation to qualify for the exemption in Section 1202(a), the following requirements must be satisfied:

  • Five year holding period – the taxpayer must have held the stock for at least five years.
  • Shareholder other than a corporation – the taxpayer claiming the Section 1202 exclusion must not be a corporation.
  • Acquisition at original issuance for cash or services – the taxpayer must have acquired the stock at its original issuance either (i) in exchange for money or other property (not including stock) or (ii) as compensation for services provided to the corporation. However, this requirement is waived in certain cases. For instance, if QSBS is transferred by gift or at death, the donee or heir, respectively, steps into the donor or decedent’s shoes for purposes of the Section1202 original issuance requirement and five year holding period.
  • Domestic C Corporation – the stock must be a corporation created or organized in the U.S. or any State that is taxed under subchapter C of the Code.
  • Gross Asset Test – The aggregate gross assets of the corporation prior to and immediately after the taxpayer acquires the stock must not exceed $50 million. For this purpose, aggregate gross assets includes the amount of cash and the combined adjusted bases of other property held by the corporation. However, the adjusted basis of any property contributed to the corporation is determined as if the basis of such contributed property were equal to its fair market value at the time of contribution.
  • Qualified Active Business – The corporation must have conducted a “qualified trade or business,” which is defined in the negative to exclude the following types of businesses:
    • any business involving performing services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any business where the principal asset of the business is the reputation or skill of its employee(s),
    • any banking, insurance, financing, leasing, investing, or similar business,
    • any farming business (including the business of raising or harvesting trees),
    • any business involving the production or extraction of products of a character with respect to which a deduction is allowable under section 613 or 613A, and
    • any business of operating a hotel, motel, restaurant, or similar business.

Additionally, the corporation must be an “eligible corporation,” which primarily excludes a regulated investment company, REIT, REMIC or cooperative.

  • 80 percent of assets by value used in a qualified active business – At least 80 percent of the corporation’s assets must have been used in the active conduct of one or more qualified trades or businesses during “substantially all” of the taxpayer’s holding period for the shares.

Common Situations that Prevent Stockholders from Taking Advantage of the Section 1202 Exclusion

Stock redemptions may cause all stock not to be QSBS

Given that the Section 1202 exclusion is designed to incentivize new business investment, the code has two provisions designed to prevent the exclusion from applying when newly issued stock is simply a replacement of a prior investment.

Stock is not QSBS if at any time during the four-year period beginning two years before the stock was issued, the issuing corporation purchases more than a de minimis amount of its stock from the taxpayer or a person related to the taxpayer. Redeemed stock exceeds a “de minimis amount” only if (i) the amount paid for it is more than $10,000 and (ii) more than 2 percent of the stock held by the taxpayer and related persons is acquired.

Under the second provision, stock is not QSBS, if during the two-year period beginning one year before the stock was issued, the corporation repurchased stock in one or more transactions (i) each of which involves a repurchase of more than $10,000 of stock where more than 2 percent of all outstanding stock by value is repurchased and (ii) the sum of all repurchases during the two-year period have a value, at the time of redemption, in excess of 5 percent of the aggregate value of all the corporation’s stock at the beginning of the two-year period.

Large rounds of venture capital financing may cause the corporation to fail the qualified active business test or the gross asset test

The qualified active business test requires that during “substantially all of the taxpayer’s holding period” at least 80 percent (by value) of the corporation’s assets must be used in active conduct of a one or more qualified trades or businesses. Subject to certain allowances for working capital and financing research and experimentation, this means that if more than 20 percent of a corporation’s assets become cash or other non-qualified assets immediately after a venture capital round of financing or at any other time, such corporation may fail this “substantially all” test.

Additionally, in order for stock to qualify as QSBS, the aggregate gross assets of the corporation cannot exceed $50 million at either (i) any time prior to the taxpayer’s stock acquisition date and (ii) immediately after the taxpayer’s stock acquisition date.

Contributions of appreciated property in exchange for stock are subject to further limits

For purposes of the requirement that a qualified small business have aggregate gross assets of $50 million or less, aggregate asset value is generally measured as cash plus the adjusted basis of the other assets. However, the basis of any property contributed to the corporation is deemed to be equal to its fair market value (FMV) for purposes of this gross asset test.

The contribution rule also affects a shareholder’s basis in his QSBS and the calculation of gain on later sale. When a shareholder has contributed property to a qualified small business, the shareholder’s basis in her QSBS is also deemed to be the FMV of the contributed property at the time of contribution, even though for all other tax purposes, the shareholder has carryover basis in her stock equal to her adjusted basis in the contributed property. Only future appreciation is eligible for the Section 1202 exclusion.

Stock must be acquired at original issuance to qualify for Section 1202

Generally, a shareholder must acquire stock at original issuance in exchange for cash or other property or as compensation for the stock to qualify as QSBS. A purchase from an existing shareholder will not qualify for the exclusion.

This strict rule is relaxed a bit, however, in the realm of corporate reorganizations. When a shareholder exchanges QSBS for other stock in a tax-free reorganization, such as a merger or stock for stock acquisition, the new stock received by such shareholder can qualify as QSBS with the holding period tacking. However, the exception only applies to the built-in gain in the stock at the time of the tax-free reorganization. Future gains in the stock received do not qualify for the Section 1202 exclusion, unless the new corporation is also a qualified small business.

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Image result for public domain images navigationSmall business owners looking to sell their business in the near future need to be prepared for the complexities that will arise during the exit process. One complexity is the tangled web that comes with the Buyer of the business obtaining a loan backed by the Small Business Administration 7(a) program. Buyers of businesses are using the SBA 7(a) program in business acquisitions more and more frequently. The terms of the SBA financing package are favorable to Buyers compared to conventional financing, and due to a change in the SBA’s rules in early 2018, more Buyers are eligible for SBA financing because the down payment requirement minimum is now only 10% of the loan cost. Because the SBA is a federal government program backed by federal dollars, there are necessarily many rules and regulations that affect a Buyer’s eligibility for SBA backing as well as each individual lender’s underwriting process.

These complexities not only affect Buyers, but also affect Sellers, often impacting the flexibility of the terms of the transaction that would otherwise be available to the parties in a cash deal or even purely Seller financed transaction.  The reality of the market also makes SBA financing a common component of most small business sales.

While a cash transaction is ideal for a Seller looking to liquidate his or her equity in the business and carry no risk of reliance upon the success or failure of the business post-closing, cash buyers are scarce, and finding a cash Buyer may be difficult, especially if the Seller has legacy interests in transitioning to the next generation of the family or a top level employee that doesn’t have the financial wherewithal to pay cash.

On the other hand, a Seller financed deal  is a substantial risk to the Seller because it involves the Seller continuing to bear the risk of success or failure of the business post-closing to get paid, but without giving the Seller any direct control over the business operations.

The SBA 7(a) financed transaction may be an ideal middle ground for the Seller who wants to maximize the amount of cash received at closing, wishes to avoid the risk of Seller financing, but who doesn’t have a Buyer with the cash or that can qualify for conventional financing.

When negotiating a letter of intent or even the final purchase contract with a Buyer using the SBA 7(a) program, the Seller should know how the SBA 7(a) program may affect his or her goals and preferred terms of the transaction before even entertaining a deal involving such financing. Contemplating these issues  before signing a letter of intent or a purchase contract is critical for the Seller because it allows the Seller to pre-emptively deal with the issues at a time where the Seller still has significant leverage in the negotiations.

Here are some items of which a Seller should be aware before signing a letter of intent or purchase contract with an SBA Buyer:

Minimum Buyer’s Equity.

The SBA 7(a) program requires the Buyer to come to the table with 10% of his or her own money to pay toward the total loan cost (which includes the entire purchase price of the business and some SBA and lender fees and costs). For example, in a $2M transaction, this means that the Buyer will need over $200,000.00 from his or her own pocket to be able to close the deal. As a Seller, determining whether the Buyer has sufficient assets to meet the 10% down payment requirement is important to know before the Seller expends significant costs proceeding with a transaction.

Even if the Buyer doesn’t have the 10% in cash, the SBA will allow the Buyer to use a Seller financed promissory note for up to 5% of the down payment requirement. So, on a $2M transaction, if the Buyer only has $100,000.00 to put down, if agreeable to the Seller, the Buyer could execute a promissory note of $100,000.00 to the Seller to meet the 10% down payment requirement.

But, there’s a catch! No payment can be made by the Buyer on that $100,000.00 note during the entire term that the note to the bank is outstanding (typically 10 years). Not only that, but the bank providing the Buyer the financing will surely require that that note to the Seller (and any liens on collateral securing that loan) be subordinated to all of the bank’s notes and liens for the purchase, putting the Seller second in line to collect from the Buyer in the event of default. In transactions with much of the purchase value being in goodwill, this puts the Seller at a significant of risk of not receiving the 5% of the purchase price to be paid on that note if the Buyer were to default.

In light of this, when negotiating the letter of intent or contract, it is advisable for the Seller to obtain and analyze the Buyer’s financials to determine the likelihood of the Buyer being able to meet the equity requirements to go through with the transaction, as well as to determine the likelihood of the Seller being able to collect on any Seller financing that is involved in the transaction in the event of default.

Post-Closing Employment and Health Insurance

As a Seller, the SBA 7(a) program prohibits you from staying on as an officer, director, stockholder or key employee of the business after the Closing (though allows the Seller to be paid as a consultant for up to 12 months after closing for management transition purposes only). This is especially important for business owners who are not yet eligible for Medicare, yet need to have health insurance to bridge the gap until they are Medicare eligible. In a non-SBA financed transaction, the seller may stay on as an employee eligible to obtain benefits given to all other full-time employees, one of which is the group health insurance plan. An SBA rule prevents that arrangement.

The alternatives are to obtain such insurance out of pocket on the open market via an individual plan, or, if the Seller has a spouse that is employed and is offered health insurance, obtaining insurance through the spouse’s plan. Since having health insurance is so critical, finding a cost-effective way to bridge the gap from the date of a sale of the business to the date of Medicare eligibility is a major concern for many business Sellers.

Where a post-closing employment arrangement which includes health care can be structured into the deal in non-SBA transactions, it’s paramount for a Seller to be aware of this restriction on post-closing employment from the beginning of the negotiations of an SBA transaction, especially in negotiations of price or interest rate on an allowable Seller note. This additional out-of-pocket cost for health insurance should be accounted for by the Seller in these negotiations. In the very least, the Seller needs to have a plan in place for health insurance after the sale.

Required Independent Valuations

The SBA requires that where the parties are related (either by family or a close relationship such as a key employee, or co-owner), that an independent appraisal be conducted to justify the loan amount and/or purchase price. The SBA also requires this in transactions where the initial appraisal or purchase price allocation shows that the purchase price less fixed assets equals $250,000.00 or more. For many businesses, this latter scenario is common, as much of its value is in goodwill (typical in-service oriented businesses or where the price is based heavily on sales numbers, not the value of fixed assets). Often in the initial stages of negotiations, the Buyer may forego the cost of an appraisal and merely justify the purchase price based upon a review of the Sellers’ financials.

If the appraisal report determines the value of the business is a lower price than the agreed upon purchase price, in order for the transaction to occur, the bank may require that the Buyer infuse additional equity (either with cash or via a Seller standby note for the difference), or possibly allow an additional, non-standby Seller note to cover the difference between the appraised price and the agreed upon purchase price.

Often, when the independent appraisal is required by the bank, the parties are already under contract, with the Buyer obtaining a financing commitment being a contingency to closing. Where the contract has already been signed or a letter of intent heavily negotiated, there are costs that have been incurred by the parties in getting to that point. These sunk costs may make it a hard decision for the Seller to determine whether he or she is willing to walk away from the deal, and gives the Buyer leverage by threatening to walk. This may force the Seller to begrudgingly accept a lower price or unfavorable terms to accommodate the appraisal. The seller may not have been willing to accept these terms if they were contemplated before signing the letter of intent or purchase contract.

Taking pre-emptive steps to avoid getting into this position before signing the letter of intent or purchase contract can help avoid these outcomes. One good way to do so is for the Seller to obtain an independent valuation themselves prior to entering into a contract or letter of intent. Often Sellers have a rough idea of how much they believe their business is worth. It’s possible that that price is accurate, but sometimes the Seller’s idea may be completely unrealistic.

Getting a reality check on price via an independent valuation may save everyone’s time and money before signing a letter of intent or purchase contract. Or, if the Seller has a particular price in mind for his or her retirement that doesn’t match the valuation, if the Seller can afford to do so, knowing the realistic price ahead of time will give Seller the knowledge of how to get that desired price. The Seller may elect to hold onto the business for a period of time to earn enough income to bridge the gap between the valuation and the desired price, or take the time to look for a non-SBA Buyer willing to pay that price. If the conditions for an SBA required independent appraisal are present, having a realistic idea of price before signing a letter of intent or purchase contract will allow a Seller to avoid those outcomes or at least plan accordingly.

Contract to Closing Timing.

It’s also important for the Seller that the Buyer choose a lender that is reputable and experienced with the SBA 7(a) process. Some banks are deemed “preferred” lenders, which essentially means that the lender can make all of its own underwriting decisions without the requirement of the SBA going through an additional and independent underwriting process (which takes more time). A Seller looking to avoid a long, drawn out financing contingency period and get a deal closed quickly is advised to insist upon the Buyer using a preferred SBA lender from the start of the negotiation process and in the letter of intent or purchase contract if the deal is to be SBA financed.

The business attorneys at Schober Schober & Mitchell, S.C. are experienced in all types of privately held Wisconsin business purchase and sale transactions, including transactions involving SBA financing. Though the focus of this blog post is on Sellers, the business attorneys with Schober Schober & Mitchell, S.C. represent both Buyers and Sellers in such transactions. When considering buying or selling a business, it’s important to have an experienced attorney advising you at the beginning stages of the negotiations all the way through closing. Whether you’re a Buyer or Seller, the business attorneys at Schober Schober & Mitchell, S.C. will be happy to assist with your transaction. Contact me at jmk@schoberlaw.com or call me at 262-569-8300 to talk to me about how we can help you navigate through your deal.

This article was first posted by Benjamin Streckert on the State Bar of Wisconsin Business Law Section blog and is being used here with the permission of the State Bar of Wisconsin and its author.


Benjamin Streckert, Minnesota 2017, is an attorney with Ruder Ware in Wausau, where he concentrates his practice on various business transactional matters.


Did you know that the “full and equal enjoyment” requirement of the Americans with Disabilities Act also applies to websites maintained by places of public accommodation? Benjamin Streckert discusses the issue and provides tips for websites to become more accessible to those with disabilities.

Did you know that the Americans with Disabilities Act (ADA) applies to the websites as well as the physical facilities of places of public accommodation​?

A review of court dockets around the country shows that plaintiffs are filing an increasing number of lawsuits against companies alleging that their websites are not “accessible” to individuals with disabilities as required by the ADA.

In 2017, plaintiffs filed 814 website accessibility lawsuits in federal court alone, according to the ADA Title III website. This trend is not only a national one – these types of lawsuits are being threatened in Wisconsin as well. Businesses would be well advised to get out ahead of the potential threat.

The Americans with Disabilities Act

According to the ADA, a disability includes “a physical or mental impairment that substantially limits one or more major life activities.” Title III of the ADA prohibits discrimination by a “place of public accommodation” against individuals with disabilities.

Although business owners and managers may want to consult with an attorney to determine if their business qualifies, hotels, restaurants, theaters, grocery stores, pharmacies, offices of health care providers, museums, golf courses, banks, and many other areas open to the community generally qualify as places of public accommodation. These places are required to provide “full and equal enjoyment of [their] goods, services, privileges, advantages or accommodations” to people with disabilities.

Application to Websites

The ADA mandates that brick and mortar locations have certain ramps, counter heights, and other accommodations, so as to ensure that individuals with disabilities have access to full and equal enjoyment of the facilities and the services offered inside of them.

However, many people are not aware that the “full and equal enjoyment” requirement also applies to websites maintained by places of public accommodation. An individual with a disability must be able to equally access a website or mobile application with the aid of a commonly used assistive technology.

A good example of this is that a visually impaired person must be able to navigate a website using a screen reader. Screen readers are software programs that allow users to read the text displayed on a computer screen with a speech synthesizer or braille display. Not all websites are conducive to, or compatible with, screen readers, however.

In fact, websites must have very specific characteristics in order to be compatible with screen readers and other tools used by those with various disabilities.

Legal Standard for Accessibility

Currently, there is no definitive standard for accessibility. But the World Wide Web Consortium’s Web Content Accessibility Guidelines Version 2.0 with AA (intermediate) success criteria (WCAG 2.0 AA) has become the presumptive standard.

Websites that conform with WCAG 2.0 AA are generally deemed ADA compliant. Although not an exclusive list, in order to conform to WCAG 2.0 AA, websites must have capabilities that include:

  • captions for any videos;
  • certain levels of color contrast and minimum font sizes;
  • clear labels and section headings;
  • audio descriptions for video content;
  • allowing keyboard-only navigation (i.e., navigation without a mouse);
  • using icons and buttons consistently; and
  • automatically suggesting fixes when users make input errors.

Maintaining a website that conforms to WCAG 2.0 AA requires periodic updates.

Consequences of a Non-ADA Compliant Website

If a place of public accommodation’s website does not conform to the above standards, both the United States Department of Justice and private citizens can bring suit.

The Department of Justice can obtain monetary damages, attorneys’ fees and costs, monetary penalties, and a court order requiring an institution to bring its website into compliance. An individual may not obtain money damages, but he or she can obtain a court order requiring the institution to bring its website into compliance and recover attorneys’ fees and costs. The costs to a noncompliant organization can be significant.

Action Steps

Given recent ADA litigation trends, and so as not to be an easy target for an accessibility suit, places of public accommodation should consider:

  • Engaging a consultant with experience in WCAG 2.0 AA when building a new website or modifying an existing website;
  • Posting an accessibility statement offering technical assistance for disabled customers on the website home page;
  • Ensuring that customer complaints regarding accessibility issues are addressed promptly;
  • Hiring a vendor with extensive knowledge of WCAG 2.0 AA to conduct a compliance audit of the organization’s current website;
  • Building WCAG 2.0 AA compliance provisions into agreements with website designers and web service providers; and
  • Scheduling periodic updates to make sure websites keep up with ever-changing standards and technological specifications.

Proactively taking the above action steps can help mitigate the risk of an ADA suit.

 


This article was originally written for the Business Law Section blog of the State Bar of Wisconsin and appears here with the permission of the State Bar and the article’s authors.


THOMAS J. NICHOLS & JAMES DECLEENE

Thomas J. Nichols, Marquette 1979, is a shareholder with Meissner Tierney Fisher & Nichols S.C., Milwaukee, where he focuses his practice on business law and tax law.

James W. DeCleene,Marquette 2015, is an attorney with Meissner Tierney Fisher & Nichols S.C., Milwaukee, where he practices in business law, estate planning, health care law, and intellectual property law.

 

 


Investing in a qualified Wisconsin business may provide certain tax benefits to individuals. Thomas Nichols and James DeCleene discuss these benefits and some potential pitfalls.

 

Wisconsin law currently provides tax-favored status to certain investments made in qualified Wisconsin businesses.

First, where an individual realizes long-term capital gain from the sale of an investment in a qualified Wisconsin business made after 2010 and held for 5 or more years, that individual may be entitled to exclude all or a part of that gain in determining his or her Wisconsin taxable income.1

Second, where an individual realizes long-term capital gain from the sale of any capital asset, that individual may be entitled to defer that gain so long as he or she invests all of the gain in a qualified Wisconsin business within 180 days of the sale.2

Qualified Wisconsin Businesses

A business is treated as a qualified Wisconsin business for a given year only if it is registered with the Wisconsin Department of Revenue.3

Importantly, the registration filing must be made before the end of the calendar year when it takes effect.4 The sole exception to this deadline is that, for the first year in which an entity begins doing business in Wisconsin, that business must register in the following calendar year.5

Since each filing only covers one calendar year, businesses desiring continuous qualified status should file every year.6 These filing requirements create hard and fast deadlines. There are no procedures for retroactive filings.

Only certain businesses can register with the department as a qualified Wisconsin business. In particular, a business must, with respect to its taxable year ending immediately prior to its registration, meet the following requirements:

  1. The business must have had 2 or more full-time employees.
  2. 50 percent or more of the business’s payroll must have been paid in Wisconsin.
  3. 50 percent or more of the value of the business’s real and tangible personal property (owned or rented) must be located in Wisconsin.7

With respect to the year in which a business first starts doing business in Wisconsin, these requirements are deemed satisfied if the business registered for the following year.

For purposes of the two 50-percent requirements listed above, persons employed by a professional employer organization or group are considered as employed by the organization’s or group’s client, and property owned by the business is valued at its cost, while property rented by the business is valued by taking the annual rental paid by the business for such property, subtracting out the annual sub-rental received by the business for such property and multiplying by 8.8

Lists of the businesses that have requested to be classified as qualified Wisconsin businesses for calendar years 2011-18 can be found on the Department of Revenue website.

Businesses are automatically added to these lists as part of the registration process for a given year.9

Since a business’s registration for its first year is determined by reference to the following year, a business must request to be added to the list for the first year in which it does business in Wisconsin. This request is made by sending an email to DORISETechnicalServices@wisconsin.gov and providing the business’s legal name as well as the confirmation number for its registration for the following calendar year.

Be aware that these lists do not signal the department’s acknowledgement that a business is in fact a qualified Wisconsin business for a given year. Rather, it merely identifies those businesses that have self-identified as meeting the above requirements.

Accordingly, obtain representations, covenants, or other assurances as to a business’s qualified status when helping clients identify a qualified Wisconsin business in which to make an investment.

Exclusion on Sale of Investment

As noted above, one of the benefits of investing in a qualified Wisconsin business is that the long-term capital gain on the eventual sale of that investment may be wholly excluded.10

To qualify for this exclusion, the business must be a qualified Wisconsin business “for the year of investment” and “at least two of the four subsequent” calendar years, provided that the investment was made after 2010 and held for at least five uninterrupted years.11 To claim this exclusion, an individual must file a Schedule QI with his or her Wisconsin tax return.

There are a number of issues to be aware of in applying this provision. To start, this exclusion only applies after the sale of an “investment” in a qualified Wisconsin business.12 For these purposes, an investment is defined as an “amount[] paid to acquire stock or other ownership interest in a partnership, corporation, tax-option corporation, or limited liability company treated as a partnership or corporation.”13

While the statute requires an “amount[] [to be] paid” for such stock or ownership interest, we confirmed in a phone call with the Wisconsin Department of Revenue that this definition is broad enough to cover transactions involving noncash consideration. We also confirmed that the statute should also apply to cross-purchases where the ownership interest is being acquired from an owner of the entity, rather than from the entity itself. In order for an investment in a single member LLC to qualify, the LLC must have elected to be treated as an S or C corporation for Wisconsin purposes. 2017 Form I-177.

Be aware that late-year investments in entities that have not yet started doing business in Wisconsin may not be eligible for gain exclusion. For example, take the situation where an individual invested in an LLC in November 2017, but the LLC did not actually start doing business in Wisconsin until March 2018. Under those facts, the LLC would be prohibited from registering with the department as a qualified Wisconsin business for calendar year 2017 since it would not have started doing business in Wisconsin until 2018.14

Because of this, the business could not be qualified during the year of the investment, and no exclusion would apply on the eventual sale of the investment, even if the business registered as a qualified Wisconsin business for each calendar year in which it did business in Wisconsin.15 Thus, it’s good to advise clients whether to wait to invest in a business until the calendar year in which the entity starts doing business in Wisconsin.

Note that gain passed through to an individual from a partnership, limited liability company, limited liability partnership, tax-option corporation, trust or estate can qualify for the exclusion.16 As an example, an individual investing in a limited partnership that made an investment in an LLC would be able to exclude the gain passed through from the limited partnership’s sale of its interest in the LLC, provided that the limited partnership held the interest for five years and all other requirements are satisfied.

Deferral upon Rollover

Taxpayers may also be able to defer long-term capital gain so long as all of the gain is invested in a qualified Wisconsin business within 180 days of the sale of the capital asset.17 In addition to rolling the gain over into a qualified Wisconsin business, the individual must also file a Schedule CG with his or her tax return in order to claim this deferral.18 Note that this gain deferral provision is applicable to a large number of transactions, given that it could be used to defer any long-term capital gain.19

As with the gain exclusion provision above, there are a number of issues to be aware of when applying this deferral provision. For example, this deferral provision uses the same definition of “investment” noted above, so be aware that the investment in the qualified Wisconsin business for these purposes could also be made with noncash consideration or in a cross-purchase transaction.20

Additionally, the same problem with respect to late year investments in an entity that has not yet started doing business in Wisconsin is also applicable to this deferral provision. Further, gain passed through to an individual from a partnership, limited liability company, limited liability partnership, or tax-option corporation qualifies for deferral as well.21

For purposes of the deferral provision, however, it is unclear whether gain passed through from a trust or estate could be deferred since the instructions to Schedule CG are silent on this point. That being said, Form I-177, the instruction form for Schedule QI, allows for the exclusion of gain passed through from trusts and estates, and both the exclusion provision and the deferral provision have an identical definition of “claimant,” so it seems likely that an individual could defer gain passed through from such entities as well.22

On top of these overlapping issues, when advising a client with respect to the deferral provision, be careful to ensure that your client “invests all of the gain [from the sale] in a qualified Wisconsin business.”23 No partial deferral is allowed.

Also, given that this investment must be made within 180 days of the sale, apprise clients before the sale closing of this potential deferral opportunity and the relatively short deadline associated with it, in order to give clients time to make arrangements to acquire an interest in a qualified Wisconsin business.

Last, note that gain deferred under this provision will eventually be recognized. The statute accomplishes this by reducing the individual’s basis in the investment in the qualified Wisconsin business by the amount of gain deferred.24 Then, to prevent any slippage between the exclusion and deferral provisions, the statute prevents the deferred gain from being treated as qualifying gain for purposes of the gain exclusion provision.25

Note, however, that if the investment in the qualified Wisconsin business is held in a manner sufficient to qualify for the exclusion above, the gain on the eventual sale of the investment could qualify for exclusion to the extent it exceeds the gain previously deferred.

Conclusion

Investing in a qualified Wisconsin business provides clear benefits to individual taxpayers. If the investment is held long enough and all other requirements are met, the gain could be wholly excluded in determining the individual’s Wisconsin taxable income.

Additionally, if the investment closely follows the sale of a capital asset, the gain from that sale could be wholly deferred.

In either event, it’s good to bear these considerations in mind when navigating these provisions.

This article was originally published on the State Bar of Wisconsin’s Business Law Blog. Visit the State Bar sections or the Business Law Section web pages to learn more about the benefits of section membership.

Endnotes

1 Wis. Stat. § 71.05(25)(b).

2 Wis. Stat. § 71.05(26)(bm)(1).

3 Wis. Stat. §§ 71.05(25)(a)(1s), 73.03(69)(a).

4 Tax § 2.986(4)(a).

5 Tax § 2.986(4)(b).

6 Tax § 2.986(4)(a).

7 Wis. Stat. § 73.03(69)(b)(1)-(2).

8 Wis. Stat. § 73.03(69)(b)(1); Tax § 2.986(3).

9 Wis. Stat. § 73.03(69)(d).

10 Wis. Stat. § 71.05(25)(b).

11 Wis. Stat. § 71.05(25)(a)(2).

12 Wis. Stat. § 71.05(25)(a)(2).

13 Wis. Stat. § 71.05(25)(a)(1m).

14 Tax § 2.986(2), (4)(b); see Wis. Stat. § 71.22(1r) (defining “[d]oing business in this state” for this purpose).

15 Wis. Stat. § 71.05(25)(a)(2).

16 Wis. Stat. § 71.05(25)(a)(1); see 2017 Form I-177 (listing trusts and estates as well).

17 Wis. Stat. § 71.05(26)(bm)(1).

18 Wis. Stat. § 71.05(26)(bm)(2).

19 Wis. Stat. § 71.05(26)(bm).

20 Compare Wis. Stat. § 71.05(26)(a)(2m), with Wis. Stat. § 71.05(25)(a)(1m).

21 Wis. Stat. § 71.05(26)(a)(1).

22 Compare Wis. Stat. § 71.05(26)(a)(1), with Wis. Stat. § 71.05(25)(a)(1); see 2017 Form I-177.

23 Wis. Stat. § 71.05(26)(bm)(1) (emphasis added).

24 Wis. Stat. § 71.05(26)(c).

25 Wis. Stat. § 71.05(26)(f).​

The EU’s new data privacy law, the General Data Protection Regulation, represents far-reaching changes that make it one of the strictest in the world. Randal Brotherhood discusses this new law and why U.S. businesses need to pay attention to it.


This post was originally posted on the “State Bar of Wisconsin Business Law Section Blog” and was written by Attorney Randal J. Brotherhood ,Washington University 1981, who is a shareholder in the Milwaukee law firm of Meissner Tierney Fisher & Nichols S.C., where he practices primarily in the areas of corporate law, representing both for-profit and tax-exempt entities, intellectual property, and securities law.


Virtually all U.S. businesses, nonprofit organizations, and other enterprises collect data from their customers or other individuals with whom they interact. All such enterprises should be aware of the European Union’s new General Data Protection Regulation, 2016/679, commonly known as the GDPR,1 which became effective on May 25, 2018.

The GDPR is a regulation under EU law pertaining to privacy and data protection for individuals within the EU and the European Economic Area. It is a sweeping legislative enactment generally considered to be the most far-reaching change in EU data protection law in many years, and possibly the strictest privacy law in the world.

The GDPR also governs the export of personal data outside the EU, and applies to parties – regardless of location – that collect personal data of individuals within the EU.

Because of this, businesses and other enterprises worldwide, and particularly in the U.S., have devoted considerable attention and resources to complying with the GDPR by the May 25 deadline, and still others are continuing to grapple with its requirements.

Applies Outside EU

The primary objective of the GDPR is to enhance the control individuals within the EU have over their personal data, and to simplify the regulatory environment for data collectors as to data privacy by establishing a single set of data privacy rules that apply throughout Europe.

It is noteworthy, however, that the GDPR has important implications for businesses and other enterprises well beyond the EU/EEA. This includes businesses in the United States, in that its provisions apply to enterprises located in the EU that process data of individuals residing in the EU, as well as any enterprise, regardless of location, that holds or processes personal data of an EU resident.2

Accordingly, any U.S. business that has individual EU customers or otherwise holds or processes transactions or data for individuals within the EU are subject to the GDPR’s requirements and its rigorous enforcement provisions.

Express Consent Required

For many businesses, the GDPR will change how data collectors approach the notion of data security, as evidenced by its requirement that an EU individual’s data, first, be stored only on systems designed and developed with a specific view toward data protection and, second, that such systems employ privacy settings set by default at the highest possible level of protection (these concepts being referred to in the GDPR as data protection “by design” and “by default,” respectively).3

The underlying notion is that an individual’s data are not to be publicly available (and cannot be used to identify the subject absent additional, separately stored information) without the express, opt-in consent of the individual data subject.4

Unless the individual has provided such express consent (rather than just a tacit failure to object) to the processing of his or her data for one or more specifically-stated purposes, the individual’s data may not be processed unless there is a specified legal basis for such processing and the purpose(s) of such data processing is disclosed to the individual.5 The data collector must be able to prove that it obtained such express consent from the data subject, who may revoke such consent at any time.6

Key GDPR Concepts

Although an exhaustive explanation of the GDPR is beyond the scope of this post, the following is a summary of some of its key concepts.

The GDPR Applies to Personal Data
The GDPR applies to the processing of “personal data” or any information relating to an “identifiable natural person”7 – that is, an individual who can be identified, directly or indirectly, by reference not just to common identifiers such as name, home address, telephone number, a photograph, or an email address, but also by less obvious identifiers such as bank or medical information, social networking posts, IP addresses, or any other data pertaining to location or to the physical, physiological, genetic, mental, economic, cultural, or social identity of such individual.8

These identifiers are considered to be personal data even if on their face they do not identify an individual, as long as they can be (or are capable of being) traced back to the subject individual without undue effort. It does not matter whether the individual’s personal data pertains to his or her personal or work-related capacities; if the data falls within the scope of “personal data,” regardless of whether it is personal, work-related or otherwise – it is subject to GDPR regulation.

It should be noted, however, that the GDPR does not apply to processing data “for a purely personal or household activity and thus with no connection to a professional or commercial activity.”9

Controllers and Processors
The GDPR directs most of its requirements toward “data controllers” (businesses or organizations the collect the data) and “data processors” (organizations that process data on behalf of a data controller, such as a third-party software or other service that a business may use to process data on its behalf).10

Data controllers are required under the GDPR to utilize only those data processors that provide sufficient assurances that they will implement appropriate technical and organizational measures to meet the GDPR’s requirements and protect the rights of individual data subjects.11

Privacy Management
Both data controllers and data processors are required to implement programs to assure compliance and be able to demonstrate such compliance to data subjects and regulatory authorities.12

Overall, the GDPR calls for a risk-based approach, that is, the utilization of controls which correspond to the degree of risk associated with the data processing activities. To this end, businesses that are data controllers must, for instance, put in place procedures to prevent data from being processed unless necessary for a specified purpose.13

Further, such businesses must incorporate technological and organizational measures appropriate to the nature of the business to ensure the protection of individuals’ personal data,14 including:

  • pseudonymization and/or encryption of data so that it cannot be attributed to individual without use of additional information;
  • restoring the availability of data in a timely manner in the event of a loss of data; and
  • regularly testing and evaluating the effectiveness of security measures.

Data controllers must maintain records of their processing activities, although there is an exclusion for small businesses (less than 250 employees) where data processing is not a significant risk.15

Additionally, controller/processor relationships must be documented and managed with contracts that specifically set forth the parties’ privacy and data protection obligations.

Data Protection Officers
Businesses that are data controllers or data processers are required under the GDPR to appoint a “data protection officer” if their essential activities involve, on a large-scale, regular monitoring of personal data or processing of sensitive data.16

A data protection officer must have IT processing, data security, and business continuity competence in personal data processing.

Lawful Basis for Processing of Personal Data
Unless a subject individual has provided express, affirmative consent to the processing of his or her personal data for one or more stated purposes, such data may not be processed unless there is at least one specified legal basis to do so.17

If the individual’s consent has not been obtained, the subject’s personal data may be processed only:

  • to comply with a legal obligation;
  • to perform a contract with the data subject;
  • to protect vital interests of the data subject when he or she is unable to give consent;
  • for the performance of a task carried out in the public interest or the exercise of official authority; or
  • for the purposes of legitimate interests of the data controller or a third party (but subject to certain fundamental rights and freedoms).18

Consent
If the data subject’s consent is the basis for the processing of his or her data, such consent must consist of:

 

“any freely given, specific, informed and unambiguous indication of his or her wishes by which the data subject, either by a statement or by a clear affirmative action, signifies agreement to personal data relating to him or her.”19

That is, such consent must be explicit for the data collected and for each purpose that the data are used, so that the controller can clearly show when and how the consent was obtained.

Accordingly, the purpose(s) for the individual’s data will be collected and used must be clearly and expressly disclosed to the data subject so that it is obvious what the data are going to be used for.

Consent must be demonstrable and freely given. A controller cannot require the disclosure of data as a prerequisite or condition of, for instance, the provision of services or the performance of a contract.20

Additionally, the data subject must be allowed to revoke consent in a manner no more burdensome than the manner in which consent was given.21

Information Provided at Data Collection
Individual data subjects have enhanced rights under the GDPR to access and obtain copies their data, as well as rights to require rectification or erasure of their personal data, to restrict further processing, and to lodge a complaint with a supervisory authority.22

Individuals must be informed of these rights and, in addition they must be given information about how their data will be processed.23

Breach and Notification
In the event a breach of security of an individual’s data in the hands of a data controller which gives rise to the destruction, loss, or unauthorized disclosure of such individual’s data, the data controller must notify the appropriate supervisory authority “without undue delay,” and “where feasible,” within 72 hours after having become aware of such breach.24 If such notification is not made within 72 hours, the data controller must provide a “reasoned justification” for the delay.25

Such notice is not required if the data breach is “unlikely to result in a risk for the rights and freedoms” of subject individuals,26 although how this exception is to be interpreted will likely require future clarification.

If the data controller determines that a personal data breach “is likely to result in a high risk to the rights and freedoms” of subject individuals, it must – subject to certain exceptions – also notify the individuals affected by the data breach “without undue delay.”27

In the event of a data breach by a data processor, it must notify the data controller,28 but the GDPR does not otherwise impose any other notification or reporting obligation on the data processer.

Fines and Enforcement
Businesses should note that, for GDPR violations, the GDPR provides for liability, including fines, for both data controllers and data processors as well as remedies for data subjects.

Regulators may impose penalties equal to the greater of €10 million or 2 percent of the violator’s worldwide revenue, for violations of record-keeping, security, and breach notification requirements.29

Violations of obligations related to legal basis for processing, consent requirements, data subject rights, and cross-border data transfers are subject to penalties up to the greater of €20 million or 4 percent of the violator’s worldwide revenue.30 EU member states may impose additional penalties, which may include criminal penalties.31

Data subjects have the right to make complaints with “data protection authorities” maintained by EU member states, as well as to initiate judicial proceedings.32

Additionally, data controllers and processors can be held responsible to compensate affected data subjects for damages resulting from a GDPR violation.33

Considerations and Recommendations

Although many U.S. businesses may be tempted to disregard the GDPR as a non-U.S. regulation relevant only to large multinational corporations, this approach could do great harm to such enterprise if it has European customers or otherwise collects data from European individuals.

No matter the size or nature of the business, if it collects any kind of personal data on EU residents, it is very likely subject to the GDPR and its requirements.

Given the substantial monetary and other penalties for noncompliance, businesses of all sizes should clearly understand whether and how the GDPR applies to them, and establish a game plan for GDPR compliance as necessary.

Establishing a Game Plan for GDPR Compliance

Businesses and their legal advisers should start by assessing the extent to which they have EU customers and/or collect data from EU residents, and acknowledging that they may have to alter current data handling procedures in light of the GDPR.

This assessment should include a review of the types of personal data the business collects and holds, what the data are used for, and whether the business is collecting more information than is reasonably necessary for its legitimate business purposes.

Further, businesses should assess the documents (whether in written or electronic format) they require customers to sign when purchasing or obtaining products or services. It is likely that such documents may need revision in light of GDPR requirements, to ensure that customers know how the business is processing their data and why. This may include development and implementation of new processes for obtaining and verifying express (rather than tacit) customer consent to data collection, and for the transfer and deletion of such data when requested.

Given the GDPR’s reach well beyond the boundaries of the European Union, and the substantial fines and other sanctions that can arise for GDPR violations, businesses and other enterprises collecting data from EU residents are well advised to have a clear understanding of the GDPR and its applicability to their operations.

For more information on the GDPR, see Keith Byron Daniels’s article, New European Privacy Law: Its Effect on Wisconsin Lawyers, in the July/August 2018 issue of Wisconsin Lawyer magazine.

Endnotes

1The GDPR is formally known as “Regulation (EU) 2016/679 of the European Parliament and of the Council of 27 April 2016 on the protection of natural persons with regard to the processing of personal data and on the free movement of such data, and repealing Directive 95/46/EC (General Data Protection Regulation).”

2 GDPR, Article 3(3).

3 GDPR, Article 25 (Data protection by design and default).

4 GDPR, Article 6(1)(a).

5 GDPR, Article 6(1)(b)-(f).

6 GDPR, Article 7(3).

7 GDPR, Article (4)(1).

8 GDPR, Article 4(1).

9 GDPR, Article 2(2)(c).

10 GDPR, Article 24 (Responsibility of the controller) and Article 28 (Processor).

11 GDPR, Article 24(1).

12 GDPR, Articles 24, 28.

13 GDPR, Article 24(1).

14 GDPR, Article 24 (Responsibility of the Controller; Article 40 (Codes of Conduct).

15 GDPR, Article 30(1), (5).

16 GDPR, Article 37 (Designation of the data protection officer).

17 GDPR, Article 6 (Lawfulness of processing).

18 See Footnote 5, above.

19 GDPR, Article 4(11).

20 GDPR, Article 7 (Conditions for consent).

21 GDPR, Article 7(3).

22 GDPR, Article 15 (Right of access by the data subject).

23 GDPR, Article 7(2).

24 GDPR, 33(1); GDBR, Recital 85 (Notification obligation of breaches to the supervisory authority).

25 GDPR, Article 33(2).

26 GDPR, Article 33(1).

27 GDPR, Article 34(1) and (3); GDPR, Recital 86.

28 GDPR, Article 33(2).

29 GDPR, Article 83(4).

30 GDPR, Article 83(5).

31 GDPR Article 84 (Penalties); GDPR, Recital 149 (Penalties for infringements of national rules).

32 GDPR, Article 77(1).

33 GDPR, Article 82 (Right to compensation and liability).

​​

 

This post was originally posted on the “State Bar of Wisconsin Business Law Section Blog” and was written by Attorney James M. Ledvina.


James Ledvina, Marquette 2009, is an attorney with Conway, Olejniczak & Jerry S.C., Green Bay, where he focuses his practice on business law and estate planning.


Annual legal reviews for nonprofit corporations can help maintain their tax-exempt status. James M. Ledvina outlines the steps to conduct legal reviews for a nonprofit entity, and discusses why they are necessary.

Many attorneys are involved with nonprofit entities, whether they donate to them, sit on their boards, or even create them.

Nonprofit entities are unique business entities at both the state and federal levels and can be fraught with compliance issues that could jeopardize their nonprofit status and inherent liability protection.

Most Nonprofits are Nonstock Corporations

In Wisconsin, most nonprofit entities are nonstock corporations subject to Wis. Stat. chapter 181.

As the name implies, nonstock corporations do not issue shares of stock and do not have shareholders. However, a nonstock corporation can have members who act as de facto shareholders (without any ownership interest) with the ability to elect the corporation’s directors.

Typically, a nonstock corporation’s board of directors controls the entity’s high-level activities and appoint officers to conduct the entity’s daily business, much like a typical business corporation.

A key difference between a nonstock corporation and a business corporation (subject to Wis. Stat. chapter 180) is that a nonstock corporation’s volunteers, directors, and officers are – with some exceptions – immune from liability arising out of their activities associated with the nonstock corporation.

Maintaining Tax-exempt Status Requires the Proper IRS Forms

Another key component of any nonprofit entity is the acquisition of tax-exempt status from the Internal Revenue Service (IRS).

There are many different types of tax-exempt entities, but the most prevalent is a 501(c)(3). Depending on the amount of the entity’s annual gross receipts, amongst other factors, an entity can automatically be tax-exempt, or it must file either Form 1023-EZ or Form 1023 with the IRS to acquire tax-exempt status.

If a nonprofit entity fails to file its tax return with the IRS, fails to file its annual report with the Wisconsin Department of Financial Institutions (WDFI), or fails to maintain corporate formalities, it can lose tax-exempt status, corporate status, and liability protection for its volunteers, officers, and directors.

What to Include in the Annual Review

Accordingly, attorneys representing nonstock nonprofit corporations should have their clients perform the following review on an annual basis:

1) Update Registered Agent and Principal Office
Search the WDFI’s online corporate records and update them accordingly to ensure that the entity’s registered agent and principal office are correct. For small nonprofit organizations with high turnover of officers and directors, this becomes especially important, to ensure that the proper person is receiving notifications from the state in a timely fashion.

2) File WDFI Annual Report
The WDFI will send an entity’s registered agent a postcard on an annual basis reminding the registered agent to file the entity’s annual report. If the registered agent fails to file the entity’s annual report timely, the WDFI may administratively dissolve the entity, which negates the entity’s corporate existence and liability protection under chapter 181.

3) File WDFI Charitable Organization Report
Subject to several exceptions, if a nonprofit entity solicits donations from the public, the entity must register as a charitable organization with the WDFI, and also file a separate charitable organization report with the WDFI on an annual basis.

4) Check Sales and Use Tax Exemption Status
Under Wisconsin law, certain nonprofit entities are exempt from paying sales and use tax on its purchases. However, it must acquire a Certificate of Exempt Status from the Wisconsin Department of Revenue (WDOR), and must submit Form S-211 to its vendors to prove that its purchases are exempt from sales and use tax.

5) Review Sales Tax Collection and Remittance Compliance
Despite being exempt from paying sales and use tax on its purchases, the WDOR requires some nonprofit entities to collect and remit sales tax to the WDOR for its sale of certain items and services. A nonprofit entity should review its sales on an annual basis to ensure that it is compliant with the WDOR’s rules regarding the collection and remittance of sales tax. This is especially important, as the WDOR has the ability to pierce a corporation’s corporate veil and collect the taxes, penalties, and interest from whomever the WDOR deems was responsible for collecting and remitting such taxes to the WDOR.

6) File Federal Tax Return and Ensure Federal Tax Exempt Status
By May 15 of each year, an officer should file the nonprofit entity’s tax return with the IRS, which – depending on the gross receipts of the entity, amongst other factors – will be on Form 990-N, 990-EZ, 990-PF or 990. If an entity fails to file its tax return for three consecutive years, the IRS will automatically revoke the entities’ tax-exempt status. On an annual basis, an officer should search the entity’s name on the IRS’s online Tax Exempt Organization Search to ensure that it is still tax exempt, and that it can receive tax-deductible donations. If a nonprofit entity loses its tax-exempt status because it failed to file its tax returns, the entity can retroactively regain its tax-exempt status by resubmitting Form 1023 or 1023-EZ to the IRS.

7) Corporate Governance
The entity should memorialize its corporate activities, including the election of its board of directors and officers, in written resolutions in its corporate record book.

Avoid Costly Errors Through an Annual Review

With the transition of officers and directors and the complexity of the reporting requirements, it is easy for an entity to overlook a component of its legal compliance. An entity can correct these errors, but it is time consuming and costly to do so. Accordingly, it is important to be vigilant to remain compliant with all of laws applicable to a nonprofit entity.

 

This post was originally posted on the “State Bar of Wisconsin Business Law Section Blog” and was written by Attorney J. William Boucher.

Many business attorneys will recognize the WB-17 Offer to Purchase – Business Without Real Estate Interest form developed by the Wisconsin Department of Regulation and Licensing.  The WB-17 is popular because of its pre-printed nature, and thus apparent fairness, and its familiarity to attorneys, agents and business owners alike, especially in smaller sale-of-business transactions. Even though it is a pre-printed form, the WB-17 can be modified by addendum.   There are several important revisions that buyers and sellers should consider.

Buyer Considerations

Although it is more common that a buyer of assets submits the initial draft of a purchase agreement, the WB-17 is more pro-seller than a typical buyer’s first draft. Buyers should consider addressing the following issues:

  • Parties to the Contract. The WB-17 is worded to be a transaction between the buyer and a business selling assets. Therefore, shareholders, members, or other owners of the seller aren’t automatically parties to the transaction as defined at lines 6-12. Buyer’s counsel should be aware of this, as it affects the buyer’s remedies for any post-closing claims regarding the sale. Upon consummating the sale and distributing net sales proceeds to its owners, the seller may not have any remaining assets.  Any claim made by the buyer against the seller post-closing may be an empty remedy. For example, if the seller is a corporation, the buyer’s remedies against the shareholders of the corporation for claims under the WB-17 would be limited to amounts distributed to the shareholders in liquidation of the corporation (Wis. Stat. § 180.1408(2)). Unless the buyer is able to pierce the corporate veil of liability protection of the seller, this would be a difficult hurdle to overcome.
  • Definition of Purchased Assets. The buyer would normally agree to purchase all assets of the seller, other than those specifically excluded by the seller. The WB-17, on the other hand, requires the buyer to list all the assets it is buying. As a consequence, any asset inadvertently omitted by the buyer will remain an asset of the seller.
  • Excluded Liabilities. The WB-17 does not address assumed or excluded liabilities. The buyer will want to clarify that is not assuming any liabilities of the seller, other than any liabilities specifically assumed by the buyer in the agreement.
  • Working Capital Adjustment. A working capital adjustment to the purchase price (or other purchase price adjustments) would protect the buyer from actions taken by the seller before closing that were outside the ordinary course of business, such as accelerating the collection of accounts receivable. The buyer and the seller would agree on a target working capital amount at closing, and the purchase price would be adjusted up or down based on a post-closing calculation of the actual working capital of the seller as of the closing.
  • Qualifications of Seller’s Representations. Detailed at lines 91-102, all of the representations of seller in the WB-17 are qualified by the seller’s knowledge. There is no breach of a representation unless the seller had knowledge of the misrepresentation.  It is uncommon in a negotiated sale-of-business transaction for all representations to be qualified by knowledge, especially fundamental representations about the business. While the definition of Conditions Affecting the Business at lines 322-377 ostensibly provides protection for the buyer, adding clarity to the application of the knowledge qualifiers should be considered.
  • Additional Seller Representations. The buyer should strongly consider adding seller representations about the business that are not specified in the WB-17.  There are some glaring omissions, including the lack of any representations regarding  taxes, title to the assets, customers and suppliers, contracts, and due authorization.   The buyer may also want to strengthen the seller’s financial statement representation to provide that the financial statements fairly present the operations of the business or, if appropriate, were prepared in accordance with GAAP.
  • In lines 91-102 of the WB-17, the seller makes representations about Conditions Affecting the Business.   Buyers may want those seller representations to also be warranties of the seller for several reasons.   Elements of a cause of action for a warranty claim differ from those of a misrepresentation claim and may not require, for example, reasonable reliance by the buyer on the warranty.   In addition, the calculation of damages available under a warranty claim may in some instances be greater than the damages available under a misrepresentation claim.
  • The WB-17 does not contain an indemnification provision. Indemnification  provisions are very important, especially to the buyer, for several reasons:  (i) they allow  the indemnified party  to recover attorney fees; (ii) they expand the right to pursue claims against the seller to directors, officers, shareholders, employees, members, etc.; and (iii) they provide a mechanism for handling any third-party claims, including notice, and control of the defense .
  • Contingencies and Right to Cure. Other provisions that deserve review are the financing and appraisal contingencies at lines 394-471, and a seller’s right to cure at lines 472-479. While important for real estate deals or other deferred sign and close transactions, these provisions don’t serve much of a purpose for asset purchase agreements that utilize a simultaneous sign and close.
  • Non-Compete and Non-Disclosure. The WB-17 does not contain any language regarding non-competition or non-disclosure of confidential information by the seller or its owners. These issues could be addressed by separate agreements or an addendum, but identifying these issues and discussing the possible risks is paramount.

Seller Considerations

Even though the WB-17 is generally more favorable to sellers, several topics still deserve sellers’ attention.

  • Caps and Baskets. The seller should consider adding language via an addendum to limit claims brought pursuant to the seller’s representations at lines 91-102. While it mainly depends on the size and complexity of the deal, the concepts of caps and baskets limit the amount of recoverable damages. A cap provides a maximum amount that is recoverable from the seller, while a basket requires damages to reach a certain threshold before the buyer is able to recover any damages.
  • Survival Period. The WB-17 does not limit or state a survival period for the seller’s representations. As a result, claims for breach of any representation could be made within the statute of limitations (six years in Wisconsin for contract claims).   In a negotiated asset purchase agreement, the general survival period for representations is typically much shorter (e.g., 18-24 months), although a longer survival period is common for fundamental representations about the business.
  • Exclusive Remedy. Another method to reduce the seller’s exposure to potential claims is to add an exclusive remedy provision, which would limit the buyer’s remedies for breach of the seller’s representations to remedies specified in the agreement.
  • Non-Reliance on Other Representations. The seller should modify the WB-17 to confirm that the buyer is not relying on any representations or warranties made outside of the four corners of the WB-17.   This would limit the buyer’s ability to pursue a claim based on any statement made outside of the WB-17.
  • Specific Performance. Line 217 of the WB-17 states that the buyer may sue for specific performance if the seller defaults. The seller should strike this provision to eliminate the possibility of a forced sale in the event of a dispute.

Conclusion

The WB-17 Offer to Purchase – Business Without Real Estate Interest form contains many standard terms and conditions for the purchase and sale of assets of business and is a useful document for small sale-of-business transactions.  Nonetheless, sellers and especially buyers should consider modifying the WB-17 to suit their particular needs in a transaction.

J. William Boucher, University of Wisconsin Law School 2015, is an attorney with O’Neil Cannon Hollman DeJong and Laing in Milwaukee where he concentrates his practice on entity formation and organization, mergers and acquisitions and general business law.

 

This article was originally posted on the “State Bar of Wisconsin’s Business Law Section Blog,” and was written by Attorney James Phillips.

 

The passage of the Tax Cuts and Jobs Act brings significant changes to the structure, financing, and agreements in mergers and acquisitions transactions. James Phillips details the more noteworthy provisions that apply in 2018 and beyond.

At the end of 2017, President Trump signed into law the Tax Cuts and Job Act (Act), with many provisions effective for tax years beginning after Dec. 31, 2017.

The Act contains a number of changes that may affect the structure, financing, and agreements related to mergers and acquisitions (M&A) transactions.

Here is a summary of the more significant provisions:

Tax Rate and Certain Deduction Changes

  • Corporate Rates. The Act changes the federal income tax rate applicable to C corporations to a flat rate of 21 percent (down from a maximum of 35 percent).
  • Individual Rates. The Act changes the maximum individual income tax rate on ordinary income from 39.6 percent to 37 percent. The maximum income tax rate on long-term capital gain and qualified dividends remains unchanged at 20 percent and the net investment income tax rate remains unchanged at 3.8 percent. The Section 1202 exclusion of 100 percent of the gain on the sale of qualified small business stock (among other requirements, C corporation stock) held for more than five years remains unchanged.
  • Individual Deductions. Itemized deductions for state and local taxes for individuals are now limited to $10,000 in combined income and property taxes for tax years 2018 through 2025, provided that the deduction for state and local taxes incurred in carrying on a trade or business or for the production of income is retained (such as business taxes imposed on pass-through entities and taxes on Schedules C and E).
  • Pass-through Business Rate. The Act provides for a deduction of up to 20 percent of “qualified business income” earned through partnerships, S corporations and sole proprietorships (including single member LLCs). There are a number of special rules and limitations. This deduction is not available for capital gains, dividends and interest (other than interest allocable to a trade or business). Owners of certain service businesses are subject to phase out rules, and the deduction can be limited to a percentage of wages and depreciable property. This deduction can result in an effective marginal income tax rate of 29.6 percent on qualifying income (plus the 3.8 percent net investment income tax [NII] if applicable).
  • Choice of Entity. The new, lower corporate income tax rate will require more analysis of the preferable way to conduct business operations and structures transactions. The lower corporate rate permits businesses to grow their equity and pay down debt at a faster rate. In many circumstances the ability to avoid the higher shareholder rate applicable to a pass-through, the benefit of shareholders not being involved in corporate tax planning and compliance, the ability to capture net operating losses at the corporate level for carryforward, the potential for the 1202 capital gain exclusion upon a stock sale, the new foreign tax regime, the decrease in the value of a step up in asset basis upon a sale due to the lower corporate income tax rate, the deductibility of state taxes, and others, will make C corporations more desirable. On the other hand, if a business is likely to produce sizable cash distributions to the owners on a current basis, or a sale is likely to be structured for tax purposes as an asset sale (whether asset purchase, forward merger or sections 336 or 338 elections) in the not too distant future, pass-through structures may continue to be preferable, although potentially more costly in the short run.
  • Blocker Entities. The new lower corporate income tax rate may make blocker entities much more common in a variety of situations.
  • Valuation. The change in the income tax rates could result in a change in the value of a variety of assets, but how it will affect transactions is unclear. Some changes could increase value (larger after-tax cash flow due to lower rates) but some changes could decrease value (a reduction in value of tax assets). For example, the value of a step up in basis upon a transaction structured as an asset purchase for tax purposes is worth less with lower income tax rates.

Interest Deduction Limitations

In general, net business interest expense deductions will be limited to 30 percent of “adjusted taxable income,” plus business interest income. The annual tax increment (ATI) is initially related to earnings before interest, taxes, depreciation, and amortization (EBIDTA), but after 2022 will more closely relate to earnings before interest and taxes (EBIT). The amount of interest not allowed as a deduction for a year is treated as paid in the succeeding year, subject to that year’s limitation.

  • Exceptions. The interest expense limitation does not apply in certain cases, including taxpayers whose average annual gross receipts for the three-tax-year period ending with the prior tax period do not exceed $25 million, and electing real estate activities for which the taxpayer must then use a longer depreciation life.
  • Debt versus Equity. The lower corporate rate tax benefit of interest deductions, combined with the potential for deferral of interest deductions and the more favorable individual income tax rate for dividends, is designed to decrease the benefit of debt compared to equity, and in certain cases may lead to less leverage.

Corporate Alternative Minimum Tax and Net Operating Losses

The Act repeals the corporate alternative minimum tax (AMT), but puts in place new limitations on net operating losses (NOLs). The Act eliminates NOL carrybacks but allows indefinite carryforwards. NOL deductions can only offset up to 80 percent of taxable income. The inability to carry back a loss means NOLs arising from a transaction, such as extraordinary compensation payments or other transaction-related items, can no longer be carried back to produce a tax benefit for the seller. And the inability to carry back a loss of a target company to offset pre-closing tax liabilities may change the structure of tax indemnities.

Full Expensing of Certain Property

The Act provides for a deduction of the entire cost of certain property placed in service after Sept. 27, 2017, and before Jan. 1, 2023. Thereafter, the percentage immediately deductible is phased down over five years. The Act applies to not only new tangible personal property, but also used property and computer software.

  • Thus, a purchaser in acquisition structured as an asset sale for tax purposes could purchase tangible personal property at its tax basis and immediate expense the cost rather than step into the shoes of the seller and inherit the depreciation deductions that would otherwise could have been spread over seven years.
  • While asset-treatment acquisitions will still most likely be driven by purchase prices in excess of tax basis giving rise to increased intangible amortization and fixed asset depreciation, the ability to accelerate the cost of used property due to 100 percent expensing will produce some new and interesting negotiations for sellers and purchasers. The interplay of the 100 percent expensing and NOL and interest limitations for the purchaser, and recapture and tax cost for the seller, will require careful modelling of transactions.

Sale of US Partnership Interest by Foreign Partner

A foreign person’s gain on sales after Nov. 27, 2017, of interests in a partnership engaged in a U.S. trade or business will be taxed as effectively connected income up to the extent a sale of assets would have been so treated, requiring the selling partner to pay U.S. tax on the sale.

Sales of such partnership interests after Dec. 31, 2017, will be subject to withholding unless the seller provides an affidavit stating that the seller is a U.S. citizen. If the purchaser fails to withhold, the partnership is required to withhold from the transferee’s distributions the amount the transferee should have withheld.

  • The IRS has delayed the effective date for the withholding for administrative reasons for publicly-traded partnerships. The IRS has requested comments on the rules to be issued under the withholding requirement to, among other things, determine how liabilities of the partnership affect the amount realized.
  • Much like Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) certificates in the case of the sale of U.S. real property or U.S. real property holding corporations, affidavits will likely become the norm in a sale of a partnership interest.

International Taxation

There are significant changes to the taxation of international activity that will require taking a new look at the structure of domestic and foreign operations.

In many cases taxes on international operations can be lower if the U.S. owner is a C corporation. M&A transactions often present an opportunity to reorganize international operations in a more tax efficient manner.

Note: The foregoing is a summary and is not tax advice directed at any particular situation. The specific statutory provisions and tax advisors should be consulted before taking any particular action.

This article was originally published on the State Bar of Wisconsin’s Business Law Blog. Visit the State Bar sections or the Business Law Section web pages to learn more about the benefits of section membership.

 

James Phillips, University of Iowa College of Law 1979, is a shareholder with Godfrey and Kahn in Milwaukee where he practices in the areas of domestic and international tax structuring, planning and controversy matters, corporate and business law, acquisitions and venture capital.



We do a lot of non-profit work. Oftentimes, we are working with new startups that are driven by strong social motivation, but to form and survive need investment capital. This puts us at a crossroad: do we go non-profit and non-stock or conventional corporation? Now, Wisconsin, joining 33 other states, has another alternative: the Benefit Corporation.

Non-profit corporations must have certain characteristics in order to qualify as exempt entities under section 501(c) of the Internal Revenue Code. Charitable organizations qualify under 501(c)(3). Such qualification requires a charitable “purpose” and further requires that in no case may the corporation dissolve and distribute anything to its members or board, but instead, must go to another similarly organized entity. It also allow its donors to deduct contributions to the organization. Its income is not taxed.

If an entity is motivated to protect investor’s capital, make a return on such capital and distribute proceeds upon dissolution to its owners, then it is a “for profit” entity. As such, its income is taxed.

In the past, such entities could not “crossover.” They were one or the other. With the enactment of Chapter 204 of the Wisconsin Statures, on November 27, 2017, Wisconsin now allows corporations to be profit driven and to exist to promote one or more public purposes.

Why is this so important? Because, in the past, the directors of a non-profit had no owners to be responsible to. They promulgated the non-profit’s purpose, regardless of its impact upon the bottom line. Directors of profit corporations owed a fiduciary obligation to the owners to act in their best interests — which oftentimes meant they had to act primarily in consideration of what their actions would do to the bottom line. In addition, for-profit directors could consider three other factors in their decision making:

  • the effect upon employees
  • the impact upon customers
  • how their actions would be perceived by the communities within which they served

Under new Chapter 204, benefit corporation directors may now consider the following additional factors:

  • the effect upon subsidiaries and suppliers
  • any impact upon the local or global environment
  • the interests of customers as beneficiaries of the corporation’s benefit purposes
  • the short term and long term interests of the corporation
  • the ability and extent to which it may accomplish the corporation’s benefit purposes
  • other factors the directors or officers deem important

Note how the last item is a huge “catch all!”

So, what are these “public benefits” that the new benefit corporation must espouse? “A benefit corporation shall have a purpose of creating general public benefit.” Sec. 204.201(1) Wis. Stats. A “General public benefit” is “a material positive impact on society and the environment by the operation of a benefit corporation taken as a whole, through activities that promote some combination of specific public benefits.” Sec 204.120(5) Wis. Stats. Under that section’s subsection (7), “Specific public benefits” are:

  • (a) Providing low-income or under-served individuals or communities with beneficial products or services.
  • (b) Promoting economic opportunity for individuals or communities beyond the creation of jobs in the normal course of business.
  • (c) Preserving the environment.
  • (d) Improving human health.
  • (e) Promoting the arts, sciences, or advancement of knowledge.
  • (f) Increasing the flow of capital to entities with a public benefit purpose.
  • (g) The accomplishment of any other particular benefit for society or the environment.

The owners may sue directors who fail to consider the corporation’s benefit purposes. Directors are broadly protected if they do. Sec. 204.301(3) Wis. Stats. There shall be a designated “benefit director” who shall have the powers to carry out the statute’s intent. Sec. 204.302 Wis. Stats. The law promotes transparency, inasmuch as the corporation has to provide its shareholders an annual statement that includes:

  • objectives to promote public benefits, as set by the board
  • standards the board adopted to measure progress
  • factual information regarding the success of meeting objectives
  • an assessment regarding the success of meeting objectives

The articles or bylaws may extend such transparency by making such statement available to the public. Sec. 204.401 Wis. Stats.

While the concept of a benefit corporation is quite new, it may be the right form to do business for owners who are motivated to solve social or environmental issues. It assures such owners continued control in order to achieve such goals. Such goals may be used to promote the corporation and may be seen by others dealing with the corporation as a consideration when doing so. Employees may be drawn by such purpose; customers may choose to buy from such a company; communities may be proud to bring such operations into their midst; and owners may benefit by improving the world and making a profit at the same time!

If you, or any group you work with is interested in exploring this new form within which you may do business, please contact our business law experts at Schober Schober & Mitchell, S.C. at (262)785-1820.

Other reading:

By:   Ngosong Fonkem[1]

This article was originally posted on the “State Bar of Wisconsin’s Business Law Section Blog.”

The first five rounds of the scheduled seven rounds of the modernization and renegotiation of the North American Free Trade Agreement (“NAFTA”) has drawn to a close. Although the current administration has made reducing the U.S. bilateral trade deficits with its trading partners the benchmark for measuring success,[2] exports of U.S. made products to unauthorized end-user, end-use, or destination country without the required export license can lead an unaware U.S. exporter into legal trouble. This is of particular concern to small and medium-size businesses (“SME”) who often lack resources to employ necessary staff or counsel to assist them to navigate the very complex and cumbersome U.S. export control regulations. The U.S. International Trade Administration (“ITA”) reports that SME account for ninety-eight percent (“98%”) of all U.S. exporters,[3] and three-fourths of the exported items are controlled under U.S. export control regulations.[4] Thus, an elementary understanding of U.S. export regulation is vital to any small business looking to expand and benefit from new markets abroad.

What is an Export?

 The starting point for any export control compliance analysis is to understand how an export is defined under U.S. law. Specifically, if an item leaves the U.S. border via carried mail, email, fax, upload or download, mentioned in a phone conversation, or a U.S. exporter accepts a foreign client visit to its facility or permit visual inspection of plans or blueprints, such items or actions are considered an export and are thus subject to U.S. export license requirements.[5] Further, all foreign origin items shipped or transmitted through the U.S. are also considered exports.[6]

Which Federal Agencies Regulate Exports?

All U.S. exporters must fully comply with all applicable U.S. export regulations. Because these laws are administered by several different federal agencies, navigating through the myriad of applicable regulations is a daunting task. Although numerous federal agencies administer exports control regulations,[7] three agencies are of significance. These three agencies are within the following federal departments: The Department of Commerce, the Department of State, and the Department of the Treasury. First, within the Department of Commerce, the Bureau of Industry and Security (“BIS”) enforces the Export Administration Regulations (“EAR”). The EAR regulates the export and re-export of non-military and “dual use” commodities, software, and technology. The EAR also contains the Commerce Control List (“CCL”), which requires licenses for certain exports. Second, within the Department of State is the Directorate of Defense Trade Controls (“DDTC”) that administers the International Traffic in Arms Regulations (“ITAR”). ITAR contains the U.S. Munitions List (“USML”) and controls defense articles, defense services, and related technical data as these terms are defined by the USML and the Arms Export Control Act. Third, within the Department of Treasury is the Office of Foreign Assets Control (“OFAC”) that administers and enforces economic and trade sanctions based on U.S. foreign policy and national security goals. Note however that in 2009 the U.S. government began implementing the Export Control Reform Initiative (“ECRI”), which will make significant changes to existing export control system.[8] As of August 2015, Phase Two of the planned three phases is nearly complete.[9] When fully implemented, the ECRI will create a single control list, single licensing agency, unified information technology system, and enforcement coordination center.

What are the Penalties for Non-compliance?

 On June 22, 2016, the BIS published new Administrative Enforcement Guidelines,[10] which aimed to promote greater transparency and predictability to the administrative enforcement process. Further, based on the BIS guidelines, fines for export violations can reach $1 million per violation in criminal cases and up to twenty years prison term, while for administrative cases, it can result in penalties of up to $250,000 and a denial of export privileges.[11] Further, based on the enforcement actions that have been carried out so far by the various agencies, it appears penalties have been applied non-discriminately for each export violation.

 What are the Processes for Determining Whether an Export License is Warranted? 

First determine whether the product at issue has an Export Control Classification Number (“ECCN”) by checking the product against the EAR. The EAR will list reasons why that particular product falls under BIS control. Use this information to determine whether an export license is required, based on where the product is being exported to. Any product that does not have and ECCN is designated as EAR99, which usually does not need an export license, unless it is exported to an embargoed country or in support of a prohibited end-use. If the product is controlled, compare the ECCN against the Commerce Country Chart in the EAR to determine whether or not a license is required. Last, the U.S. maintains a list of restricted parties, which are persons or entities that U.S. exporters are prohibited from exporting to without a license. This may include EAR99 items that otherwise do not require a license based on the country of export. It is important to note that even the most harmless product might be intended for uses not envisioned by the U.S. exporter.

Disclaimer: The views and opinions expressed in this article are those of the author and do not

necessarily reflect the official policy or position of Addison-Clifton.

[1]Ngosong Fonkem, JD.MBA.LLM.BA is a senior advisor at Addison-Clifton LLC, focusing on its Asian Market Services practice sector. His professional legal and business experience is diverse, working cross-culturally in the USA and internationally on a variety of issues involving commercial transactions and government procurements, energy consulting, compliance and risk management, and fulltime member of the Faculty of Law at Multimedia University in Malaysia. Ngosong received his B.A. from University of Wisconsin-Green Bay (2008), J.D./MBA from West Virginia University College of Law (2011), and LL.M. from Tulane Law School (2012).

[2] USTR Releases NAFTA Negotiating Objectives. https://ustr.gov/about-us/policy-offices/press-office/press-releases/2017/july/ustr-releases-nafta-negotiating. https://ustr.gov/sites/default/files/files/Press/Releases/NAFTAObjectives.pdf

[3] “Profile of U.S. Exporters Highlights Contributions of Small- and Medium-Sized Businesses,” International Trade Administration, April 8, 2015.  Available at http://blog.trade.gov/2015/04/08/profile-of-u-s-exporters-highlights-contributions-of-small-and-medium-sized-businesses.

[4] Data is obtained from a 2013 National Small Business Association and Small Business Exporters Association Exporting Survey. “2013 Small Business Exporting Survey,” National Small Business Association and Small Business Exporters Association, at p. 13. Available at www.nsba.biz/wp-content/uploads/2013/06/Exporting-Survey-2013.pdf

[5] 15 CFR §734.2(b)(1); 15 CFR §734.2(b)(4). https://www.bis.doc.gov/index.php/documents/regulation-docs/412-part-734-scope-of-the-export-administration-regulations/file

[6] Id.

[7] Some of these federal departments and agencies include, Department of Energy, Department of Agriculture, the Drug Enforcement Administration, Food and Drug Administration, Nuclear Regulatory Commission, and etc.

[8] https://2016.export.gov/ecr/

[9] Id.

[10] https://www.bis.doc.gov/index.php/enforcement/oee/penalties

[11] https://www.bis.doc.gov/index.php/enforcement/oee/penalties

 

Author’s Bio and contact information.

Ngosong Fonkem graduated from West Virginia University College of Law 2011 (JD/MBA) and Tulane Law School 2012 (LLM), is a senior advisor at Addison-Clifton LLC, Brookfield, Wisconsin, where he assists U.S. and foreign companies with day-to-day compliance with U.S. trade laws and related audits, investigations, intervention, and civil enforcement proceedings; and doing business in Asia.