Monday, July 30, 2012

Investing in Breweries - A Sample Treatment

So, posting around here has been a little slow lately. A lot of that is related to a busy personal life and a busy professional life. Luckily, we have a new writer, Kevin Ramakrishna, to pick up some of the slack. He's written two great articles about two great bars in the Madison area. He's got some more stuff in the works that I hope you'll like.

One of the things that I am working on is a handbook. Since it's about beer, I thought you might be interested in reading what I have to say about beer. This particular sample section is about investing in breweries; namely the complex IRS rules around what happens when you invest in multiple breweries. There are a lot of other things to note about investing in breweries, as well; for example, return on investment isn't nearly as awesome as other industries because of the high capital costs and low margins.

Keep in mind, this is still a draft and will likely change considerably to its final form.

Also, please note: this is not legal advice and me writing this and you reading this does not constitute an attorney-client relationship. If you have any questions and need legal advice about investing in breweries - please talk to an attorney.

Investing in Breweries

Brewing Groups

It is entirely feasible that someone will have a financial stake in multiple breweries.  If that someone owns a large enough stake in the breweries, the State of Wisconsin calls them a “Brewers Group” or “Brewpub Group”, the federal government calls them a “Controlled Group”; for the sake of simplicity we’ll call them “Brewers Groups” because it makes more sense and the Wisconsin definition merely references the IRC definition of “Controlled Group”[1]. Brewers Groups are treated as breweries and must abide by the same rules as if all of the breweries under management were the same brewery.

For this section, a hypothetical might be illustrative: Sam, Miller, and Bud love beer and have money that they want to invest in Wisconsin breweries. They have identified 2 breweries across the state, Brewery A and Brewery B.

A Controlled Group is a term of art defined by the Internal Revenue Code (“IRC”) for the purpose of determining who owes taxes where a group owns multiple companies[2]. The theory is that if there is a sufficient nexus of ownership, the Controlled Group owes taxes for the sum of the companies under management of the Controlled Group; in other words, for tax purposes, all of the companies under management are considered the same company. The IRC defines 3 types of Controlled Groups: Parent-Subsidiary Groups, Brother-Sister Groups, and Combined Groups.  

Parent-Subsidiary Group

A Parent-Subsidiary Group exists where the parent company owns more than 50% of the voting stock or more than 50% of the total value of shares in each subsidiary[3].

Turning to our hypothetical: our group of intrepid investors forms a company, InvestCo Inc in which all three investors own an equal share. InvestCo invests in Brewery A (5,000 bbls) and Brewery B (10,000 bbls). In exchange for their investment, InvestCo receives 50% of the common stock of Brewery A and 60% of the common stock of Brewery B. In this first example, InvestCo is not considered the Parent of Brewery A (not more than 50%), but would be considered the parent of Brewery B; InvestCo is thus responsible for ensuring Brewery B’s taxes are paid for 10,000 bbls of output. If we change this example, so that InvestCo receives 51% of the common stock of Brewery A, then InvestCo is a Parent of both Brewery A and Brewery B, and would pay taxes on 15,000 bbls of beer.

Controlled Groups particularly become an issue where the excise taxes are stepped or tiered. For example, in Wisconsin, a brewery under 300,000 bbls only pays $1 per barrel on the first 50,000 bbls, and the $2 per bbl over 50,000 bbls[4]. If the brewery is over 300,000 bbls, it owes $2 per barrel on every barrel produced.

Returning to our hypothetical: if Brewery A produces 25,000 bbls and Brewery B produces  25,000 bbls, the InvestCo owes taxes on 50,000 bbls ($1 per bbl). However, if Brewery A produces 30,000 bbls, and Brewery B produces 40,000 bbls, then InvestCo owes taxes as if it produced 70,000 bbls. In other words, while independently each brewery would only owe $1 per barrel (total $70,000), together InvestCo (as the Parent) owes $1 per barrel on the first 50,000 bbls ($50,000) and $2 per barrel on the remaining 20,000 bbls ($40,000), for a total of $90,000. You can see how this only multiplies if the Brewers Group is pushed over 300,000 bbls.

Brother-Sister Group

A Brother-Sister Group exists where 1-5 individuals[5] cumulatively own more than 50% of the voting stock or more than 50% of the total value of shares in the companies. This rule comes with a caveat: the ownership interest is considered only to the extent that the stock ownership is the same for each investment[6].

Hypothetical: Sam, Miller, and Bud decide not to form InvestCo because they don’t want to risk being a “Parent” to their investments. Instead, they each decide that they will buy stock in Breweries A and B individually. Sam buys 10% of the common stock of Brewery A and 20% of the common stock of Brewery B. Miller purchases 30% of the common stock of Brewery A and 20% of the common stock of Brewery B. Bud purchases 20% of the common stock of Brewery A and 20% of the common stock of Brewery B.

Brewery A
Brewery B

Under the IRS definition, Sam, Miller, and Bud do not constitute a Brewers Group because, to the extent the stock ownership is identical, the common ownership does not exceed 50%, even though all three have the majority of common shares of both breweries. If Sam had purchased 11% of Brewery A instead of 10% (or Miller had purchased 21% of Brewery B), the group would be considered a Brewers Group because the Group would cumulatively own more than 50%.

Combined Group

A Combined Group happens when a company that is part of a Brother-Sister Group is the Parent in Parent-Subsidiary Group. Then, the Subsidiary is also considered part of the Brewers Group.

Our hypothetical hits the big stage here:  Sam, Miller, and Bud went in and purchased Breweries A and B as shown in Table 1, except that Sam actually purchased 11% of Brewery A, thus making a Brewers Group. Breweries A and B are swinging along nicely; Brewery A produced 110,000 bbls, and Brewery B produced 150,000 bbls. Brewery B is looking to expand to the East Coast, but rather than open a new brewery there, Brewery B chooses to just purchase 55% of Brewery C, a 30,000 bbl brewery that is currently operating under-capacity. Brewery B has an additional 20,000 bbls brewed at Brewery C to kick-off its East Coast distribution. Under the Combined Group Rule, Brewery C is considered part of the same Brewers Group and Breweries A and B, and the combined barrel production is 310,000 bbls.

The excise tax math follows:
Brewery A (if independent): 110,000 bbls: (50K * $1) + (60K * $2) = $180,000
Brewery B (if independent): 150,000 bbls: (50K * $1) + (100K *2) = $250,000
Brewery C (if independent): 30,000 bbls + 20,000 bbls (contracted by Brewery B): (50K * $1) = $50,000
Total as independents: $480,000

Combined Brewers Group: 110K + 150K + 50K = 310K bbls: (310K * $2) = $620,000

One final note: this treatment has only dealt with Wisconsin taxes. Federal excises taxes, which also have to be paid, are stepped as well.

[1] Wis. Stat. 125.02(2d)(2p)
[2] 26 USC 1563
[3] In the usual case, the rule is 80%, however, 26 USC 5051(a)(2)(B) amends this to 50% for Brewer Groups.
[4] Wis. Stat. 139.02
[5] Or estates or trusts.
[6] 26 USC 1563(a)(2): “…taking into account the stock ownership of each such person only to the extent such stock ownership is identical with respect to each such corporation.” For comment and explanation see: COMMENT: Proposed Revision of I.R.C. § 1563(a)(2): A New Definition for Brother-Sister Controlled Groups., 34 Hastings L.J. 665

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