Tax Update
www.pepperlaw.com
Protecting Your NOL
Carryforward with a Poison Pill
As a result of the recent downturn in the economy, many
companies have been incurring significant operating and
tax losses. At the same time, corporate stock values have
plunged. This confluence of events creates the potential
for a company to lose the potentially valuable future tax
benefits that may be realized from federal tax net operating
loss (NOL) carryforwards.
Over an extended period of economic weakness, NOL
carryforwards can become one of the largest assets on a
company’s balance sheet. Under normal circumstances, the
NOLs can serve to offset future taxable income, resulting
in tax savings as the company begins to be profitable.
However, current tax laws impose significant limits on
the ability to use NOLs to offset taxable income in the
event of an ownership change. Thus, a company can be in
a situation in which one of its largest assets can become
impaired if ownership changes. Recent steep declines in
equity markets have made it less expensive for investors
to acquire significant percentages of a company’s publicly
traded stock, aggravating the risk of a possible limitation.
Section 3821 limits a loss corporation’s ability to use its tax
net operating losses following an “ownership change.” An
ownership change is triggered if one or more 5-percent
shareholders of the loss corporation increases their
ownership in the aggregate by more than 50 percentage
points during a testing period.2 Once an ownership change
has occurred, the amount of NOLs that the corporation
may use to offset taxable income in any year is limited to
the “Section 382 limitation” resulting from the ownership
change.3 Thus, corporations with large NOL carryforwards
are concerned with monitoring shareholder shifts that
might trigger an ownership change and impair the NOL
asset on their books. Boards of directors of publicly traded
companies with large NOL carryforwards are increasing
their efforts to protect this asset, and some companies
are adopting “poison pill” plans to restrict the ability of
shareholders to take actions that could trigger a Section
382 ownership change.4
May 2009
speakers’ corner
• On June 1, Joan Arnold spoke on “Recognizing
When a Permanent Establishment Exists” at The
OECD’s Evolving Role in Shaping International
Tax Policy conference in Washington, DC.
• Lisa Jacobs spoke at the PEI Investor Relations
& Communications forum on June 11. Her
topic was “Working Most Effectively with Legal
Counsel: Keeping Legal Counsel Calm When
Conversations Get Heated” on the “Web Based
Branding & Publicity for the PE/VC Firm” panel.
• Joan Arnold will speak on “‘Check-the-Box’
Planning” at the Practising Law Institute’s Tax
Planning for Domestic & Foreign Partnerships,
LLCs, Joint Ventures & Other Strategic Alliances
2009 Conference in San Francisco, Ca. on
June 12.
• On June 15-16, Joan Arnold, Steven Bortnick
and Leonard Schneidman will speak at the
Institute for International Research, Private
Equity Tax Practices seminar in Boston, Ma. Ms.
Arnold and Mr. Schneidman will speak on “Host
Country Issues for Funds and Managers.” Mr.
Bornick will lead a panel on “Basics of Private
Equity Tax Practices” and speak on “Ensuring
in this issue
1 Protecting Your NOL Carryforward with a Poison Pill
1 Speakers’ Corner
4 Peppercast: Stimulus Package - Buy Back Debt Today,
Pay Tax Later
5 New Avenue for IRS to Issue Rulings on Select Issues in
Section 355 Spin-Offs
6 Pepper Hamilton’s Tax Practice Group
 Tax Update

Poison Pills

Since the 1980s, corporate America has used “poison
pills” as a tool to discourage hostile and unsolicited
investors from taking large stakes in a corporation’s
publicly traded stock. Most corporate poison pills take the
form of a stockholder rights plan where purchase rights
are distributed to existing shareholders, entitling them
to acquire one share of common stock (or a preferred
stock equivalent) for each share owned, at a specified
purchase price that exceeds the market price on the date
of adoption. The key deterrent effect of the plan is realized
if any investor (herein the “hostile investor”) acquires
beneficial ownership of more than a specified trigger
amount. In that event, in exchange for payment of the
purchase right’s exercise price, all shareholders other than
the hostile investor are permitted to purchase shares of
common stock (or preferred stock equivalents) having a
fair market value equal to two times the exercise price. This
effectively allows the public shareholders to buy common
shares at a 50 percent discount, while denying the hostile
investor the same benefit. A trigger of the poison pill will
thus significantly dilute the percentage of the company’s
common stock owned by the hostile investor, making it
more expensive for the hostile investor to acquire control
of the company.
Typically, the anti-dilution rights in a poison pill are set
to be triggered once a shareholder acquires beneficial
ownership of more than a 10, 15 or 20 percent stake in the
corporation. Since Section 382 is concerned with tracking
the increases in 5-percent shareholders, many of the NOL
poison pills have a lower triggering percentage ranging
from 4.75 to 4.99 percent. These lower threshold triggers
are designed to deter further acquisitions by stockholders
whose share purchases or sales might affect the ownership
change calculation. Some NOL poison pills include
additional provisions imposing an outright prohibition
against exceeding the threshold percentage of beneficial
ownership without obtaining pre-approval for a proposed
share acquisition.
speakers’ corner continued
Debt Buybacks Are Financially Lucrative
through In-Depth Grasp of Tax and Legal
Ramifications.” Mr. Schneidman will speak on a
panel titled, “Regulatory and Rule Roundtables:
Evaluate Impact of Financial Crisis on Tax
Practices for PE Funds and Ensure You Are in
Compliance.”
• On June 20, Steven Bortnick will present
“Avoiding ECI in Funds and Carried Interest
Legislation Update” at a client training session in
London, England.
• Steven Bortnick will speak on “Acquiring
Portfolio Company Debt” at a client training
session in London, England on June 20.
quotable
• Todd Reinstein was quoted in the May 29 issue
of Tax Notes Today regarding current issues in
Section 382.
webinar
• Leonard Schneidman will speak at a live webcast
on “FY2010 Budget Greenbook Proposes
Sweeping Changes to the International Tax
Provisions of the Internal Revenue Code.” This
event is being presented by The Knowledge
Congress on July 14, from 12:00 to 2:00 p.m.
(EDT). For more information, visit www.
knowledgecongress.org/event_2009_bluebook.
html.

Some loss corporations have been reluctant to adopt rights

plans with low triggering percentage levels, fearing it will
discourage future investment in their stock. The existence
of a low percentage trigger, as exists in NOL rights plans,
is thought by some to dissuade institutional investors
from taking a position in the stock. To avoid an unwanted
trigger of the rights plans and encourage investment,
some companies have included discretionary controls in

-2-
 Tax Update
the plans. Many shareholder rights plans also provide for
automatic termination of the plans if the board determines
that the NOLs have been fully used to offset taxable
income. Other plans include rules allowing a board to
waive the application of the discount purchase provisions
upon a triggering acquisition at the discretion of the board.
Rights Plans under the Option Rules
Under Section 382, an option to acquire stock is treated
as exercised if the exercise would result in an ownership
change.5 The regulations provide an extensive set of rules
for option attribution. Generally, the option attributions
rules reverse the presumption that an option is deemed
exercised, if doing so causes an ownership change, and
treats only options issued for a principal purpose of
avoiding or accelerating the impact of an ownership change
as deemed exercised and counted as stock under Section
382. These attribution rules can bring about unfortunate
results when a seemingly benign equity issuance can
be counted for Section 382 owner shift purposes. For
example, the shareholder rights distributed to the existing
shareholders under a poison pill are considered options
under the regulations and thus, an analysis must be
performed to determine whether or not they would be
considered exercised for Section 382 purposes.
In Revenue Ruling 90-11, the IRS ruled that certain rights
issued to shareholders to acquire loss-corporation stock
at a reduced price pursuant to a poison pill adopted to
fend off a hostile takeover are not subject to the option
attribution rules.6 The ruling holds that such rights would
be exempted from option attribution as long as the
loss corporation could redeem the rights for little or no
consideration without shareholder approval, a standard
provision in poison pills. Although the ruling holds
that the distributions of rights did not constitute stock
for Section 382 purposes, corporations implementing
NOL plans need to be careful when drafting their poison
pills and work to ensure that rights to be granted under
such plans do not carry with them attributes of equity
ownership that would cause the rights to be treated as
outstanding equity.7 These can include the right to vote, a
seat on the board, a deep in the money exercise price, etc.8
Selectica Case
Before creating an NOL poison pill, companies should
note a pending case, Selectica, Inc. v. Versata Enterprises,
Inc., in the Delaware Court of Chancery involving the
-3-
An NOL poison pill can be an effective
tool for loss corporations looking to
protect their NOL carryforward assets.
Loss corporations, however, should
carefully think through all of the
possible ramifications.
intentional triggering of an NOL poison pill.9 Selectica,
Inc., a microcap company that provides enterprise software
solutions, amended its conventional shareholder rights
plan in 2008 in order to protect its NOL carryforwards
from possible impairment, by lowering the triggering
percentage under the plan from 15 percent to 4.99
percent. Selectica’s rights plan grandfathered all then-
existing 5-percent or greater shareholders and provided
that the plan would not be triggered unless they were to
acquire beneficial ownership of at least an additional 0.5
percent of the common stock. Two existing shareholders –
commercial competitors of Selectica that were engaged in
ongoing business disputes with the company – thereafter
announced that they had purchased more than the
number of additional shares necessary to trigger Selectica’s
rights plan. In response, Selectica exercised the exchange
feature of its rights plan, issuing an additional share
for each share held by every shareholder other than the
triggering shareholders, in exchange for the cancellation
of all outstanding rights under the plan. This doubled
the number of shares held by all shareholders other than
the triggering shareholders and effectively diluted the
ownership percentage of the triggering shareholders by
approximately half. Selectica also renewed its NOL poison
pill and distributed a new purchase right to all of the non-
triggering shareholders. Finally, Selectica filed a lawsuit
in the Delaware Chancery Court seeking a declaratory
judgment confirming the validity of its rights plan.
Aside from the obvious disruption and expense resulting
from the triggering of the poison pill and the resulting
litigation, Selectica suffered the additional insult of having
the trading in its common stock suspended for a month
while the company and its transfer agent sorted out which
shareholders were entitled to receive the distribution of free
shares as a result of the exchange feature, and which were
affiliated with the triggering shareholders and were thus
not so entitled. The word of caution here is that although
 Tax Update

most poison pills will serve as an effective deterrent to the Endnotes

acquisition of triggering share percentages, one or more
shareholders with other than purely share-related motives,
such as competitors, can subvert the intention of the
rights plan and “buy through” the triggering percentage of
shares, thereby putting at risk the loss corporation’s NOL
carryforwards. This was the case with Selectica, and the
matter is currently being litigated in Delaware.
Pepper Perspective
An NOL poison pill can be an effective tool for loss
corporations looking to protect their NOL carryforward
assets. Loss corporations, however, should carefully think
through all of the possible ramifications, including the
potential consequences associated with the administration
of the plan if the pill is triggered, and the potential effect
of the ownership limitation imposed by the plan on the
attractiveness of their stock in the market.
Authors:
Robert A. Friedel
215.981.4773
friedelr@pepperlaw.com
Todd B. Reinstein
202.220.1520
reinsteint@pepperlaw.com
1 Unless otherwise stated, all references to “Section” are
to the Internal Revenue Code of 1986 (the Code),
and all references to “Treas. Reg. Sec.” are to the
Treasury Regulations promulgated thereunder (the
Regulations).
2 Section 382(g).
3 The Section 382 limitation is a formulaic calculation
that is basically equal to the product of the value of
the loss corporation (subject to certain adjustments)
and the long-term tax-exempt rate. The long-term
tax-exempt rate is published on a monthly basis
by the IRS and can be found in IRS publications,
including the Internal Revenue Bulletin. Taxpayers
are required to use the long-term tax-exempt rate for
the month in which the ownership change occurs
when calculating their Section 382 limitation for any
ownership change. For example, the long-term tax-
exempt rate for June 2009 was 4.61 percent per Rev.
Rul. 2009-16, 2009-23 IRB.
4 Recently, a number of companies have adopted rights
plans to protect against limitations in their ability to
use their net operating loss carryforwards. See Sirius
XM Radio, Inc. Form 8-A filed with the SEC on April
29, 2009.
5 Section 382(l)(3)(A)(iv). Treas. Reg. Section 1.382-
4(d).
6 Rev. Rul. 90-11, 1990-1 C.B. 10. Note that this Rev.
Rul. was issued before the option attribution rules
were substantially changed by T.D. 8440, 10-2-92.

Peppercast: Stimulus Package - Buy Back Debt

Today, Pay Tax Later
As market conditions continue to depress the value of outstanding debt, private equity funds and other debt
issuers have the opportunity to acquire their indebtedness at significant discounts.

Pepper Hamilton attorney Steven D. Bortnick, a partner in the Princeton and New York offices and a member
of the firm’s Tax Department, recently authored an article with fellow Pepper attorney Timothy J. Leska titled
“Stimulus Package: Buy Back Debt Today, Pay Tax Later.”

In this podcast, Mr. Bortnick discusses how the American Recovery and Reinvestment Act affects private equity
funds and other debt issuers and discusses examples that is featured in the article.

Listen today by visiting the Tax section of www.pepperpodcasts.com.

-4-
 Tax Update
7 Also See PLR 200841021 (October 10, 2008) (rights
plan adopted as part of a Section 368(a)(1)(E)
recapitalization will not be considered an acquisition
of stock for Section 382 purposes). Under Section
6110(k) a private letter ruling may not be cited as
precedent by a taxpayer who did not receive the ruling.
However, a private letter ruling may be considered
under Treas. Reg. Section 1.6662-4(d)(3)(iii) in
determining whether a tax position is supported by
substantial authority.
8 See Treas. Reg. Section 1.382-4(G)(6).
9 Amended Verified Complaint, Selectica, Inc. v. Versata
Enterprises, Inc., No. 4241-VCN (Del. Ch. Jan. 3,
2009).
New Avenue for IRS to Issue
Rulings on Select Issues in
Section 355 Spin-Offs
In Rev. Proc. 2009-25, the IRS modified the no-rule
provisions that apply to reorganizations and other
transactions that occur in the context of a Section
355 transaction and certain aspects of the Section 355
requirements to allow for taxpayers to request private letter
rulings on a single legal issue or issues.1 These new rules
allow taxpayers to seek “single issue” rulings and, therefore,
the taxpayer is not required to go through the process
of submitting all of the information usually required to
obtain rulings on the entire transaction. This new process
is available to taxpayers whose transaction raises issues that
are within the IRS Associate Chief Counsel’s responsibility.
Thus, the taxpayer cannot ask for resolution of issues that
relate to partnership issues or international tax issues and
still qualify for the “single issue” ruling process under Rev.
Proc. 2009-25.
As an example of the relaxation of the no-rule policy
in this area, the IRS notes that it will address certain
redemption issues under Section 355(e) if “an adverse
ruling on such question would result in there being a
direct or indirect acquisition by one or more persons of
stock representing a 50-percent or greater interest in the
distributing corporation or the controlled corporation that
is part of a plan under Section 355(e).” In addition, even
if an aspect of the transaction is in the general no-rule
-5-
area, such as whether certain steps of an overall transaction
qualify under Section 351, the IRS will nevertheless rule
on the significant issue under Section 351 if a negative
resolution of the 351 issue would cause some aspect of the
overall transaction to fail one or more of the requirements
of Section 355. Also, in the case of a request for a ruling
on an issue under Section 351, for example, the IRS will
require the taxpayer to submit the relevant representations
as contained in Rev. Proc. 83-59, 1983-2 C.B. 575, that
relate only to the significant issue, as well as to provide
a general representation that the other requirements of
Section 351 are met.
Mandatory Pre-Submission Conference and Other
Logistics
The IRS requires that the taxpayer call its Associate
Chief Counsel (Corporate) and request a pre-submission
conference to see if the IRS agrees that the taxpayer’s
situation warrants a ruling under this new procedure. As
a practical matter, most taxpayers seek a pre-submission
conference in the Section 355 ruling process because of
the many nuances involved with the IRS’ interpretation
of some of the more factual issues raised in a Section 355
spin-off transaction and the time and expense necessary to
assemble and discuss all the information that is required to
support a request for a private letter ruling under Section
355. Taxpayers generally seek to identify very early in the
process any issues that might be raised by their particular
facts that would cause the IRS to refuse to rule, or seek an
alternative structure or another change in certain terms
of the transaction in order to proceed with processing a
ruling.
Rulings under this Rev. Proc. will be processed under
the expedited rulings procedures. This addition to the
processing of these types of limited rulings indicates that
the IRS is hoping to address situations in which taxpayers
do not have the time to apply for and go through the
entire process needed for a full set of rulings on a Section
355 transaction, but where they still need help resolving
a particularly difficult legal issue raised in the transaction
in order to close their business deal. Generally, filing,
processing, and generating a ruling letter for most Section
355 rulings takes between four to six months. Therefore,
certain taxpayers may not be able to take advantage of the
letter ruling process because of the specific business need
to get their transaction completed. While it is possible
to obtain a ruling on a Section 355 transaction after the
spin-off is completed, the level of protection afforded to

a taxpayer who comes under IRS
exam on that transaction is not as
favorable.
Pepper Perspective
Rev. Proc. 2009-25 represents a
step toward flexibility by the IRS
in helping taxpayers find certainty
in their corporate transactions in a
timeframe that is responsive to the
taxpayer’s business needs. It allows
the IRS more leeway in providing
targeted guidance if it chooses to do
so, without being restrained by the
very broad no-rule provisions of Rev.
Proc. 2009-3. However, it is up to
the IRS to allow a particular taxpayer
to take advantage of this new
process, because a taxpayer must be
pre-approved for the process prior to
submitting a ruling request that seeks
a single or limited issue ruling.
Author:
Annette M. Ahlers
202.220.1218
ahlersa@pepperlaw.com
Endnotes
1 Rev. Proc. 2009-25 amplifies
Rev. Proc. 2009-1, 2009-1
I.R.B. 1 and Rev. Proc. 2009-3,
2009-1 I.R.B. 107.
Berwyn | Boston | Detroit | Harrisburg | New York | Orange County | Philadelphia | Pittsburgh | Princeton | Washington, D.C. | Wilmington
Tax Update
Pepper Hamilton’s Tax Practice Group
Federal and International Tax Issues
Annette M. Ahlers 202.220.1218 ahlersa@pepperlaw.com
Joan C. Arnold 215.981.4362 arnoldj@pepperlaw.com
James W. Barson 412.454.5077 barsonj@pepperlaw.com
Steven D. Bortnick 212.808.2715 bortnicks@pepperlaw.com
609.951.4117
Gordon R. Downing 215.981.4434 downingg@pepperlaw.com
W. Roderick Gagné 215.981.4695 gagner@pepperlaw.com
Howard S. Goldberg 215.981.4955 goldbergh@pepperlaw.com
Benjamin M. Hussa 215.981.4728 hussab@pepperlaw.com
Bryan D. Keith* 202.220.1220 keithb@pepperlaw.com
Timothy J. Leska 215.981.4008 leskat@pepperlaw.com
Ellen McElroy 202.220.1589 mcelroye@pepperlaw.com
Marc D. Nickel 202.220.1618 nickelm@pepperlaw.com
Michelle Parten 215.981.4894 partenm@pepperlaw.com
Lisa B. Petkun 215.981.4385 petkunl@pepperlaw.com
Todd B. Reinstein 202.220.1520 reinsteint@pepperlaw.com
Joan M. Roll 215.981.4515 rollj@pepperlaw.com
Leonard Schneidman 617.204.5104 schneidmanl@pepperlaw.com
James H. Stevralia 212.808.2724 stevraliaj@pepperlaw.com
Laura D. Warren 215.981.4593 warrenl@pepperlaw.com
State and Local Tax Issues
Philip E. Cook, Jr. 412.454.5075 cookp@pepperlaw.com
Lance S. Jacobs 202.220.1202 jacobsls@pepperlaw.com
Employee Benefits Issues
Jonathan A. Clark 215.981.4436 clarkja@pepperlaw.com
David M. Kaplan 215.981.4620 kapland@pepperlaw.com
Andrew J. Rudolph 215.981.4749 rudolpha@pepperlaw.com
*Admitted in the Commonwealth of Virginia only; supervision by principals of Pepper Hamilton llp who
are members of the DC Bar.
The material in this publication is based on laws, court decisions,
administrative rulings and congressional materials, and should not be c
onstrued as legal advice or legal opinions on specific facts. The information in this
publication is not intended to create, and the transmission and receipt of
it does not constitute, a lawyer-client relationship.
Please send address corrections to phinfo@pepperlaw.com.
www.pepperlaw.com
© 2009 Pepper Hamilton llp. All Rights Reserved.
This publication may contain attorney advertising.
-6-