PRIVILEGED AND CONFIDENTIAL — ATTORNEY-CLIENT PRIVILEGE / ATTORNEY WORK PRODUCT
MEMORANDUM
TO: Sandra Tung, Responsible Partner, M&A, Calderwood & Harkness LLP Priya Deshmukh, Managing Partner, Fund IV, Harrowgate Capital Management IV LLC Thomas Eriksen, Partner, Head of FinTech, Harrowgate Capital Management IV LLC
FROM: Leonard Cross, Specialist Partner, Tax, Calderwood & Harkness LLP
DATE: March 14, 2025 (updated from initial draft circulated February 28, 2025)
RE: Tax Due Diligence — VeloPay Systems, Inc. and Subsidiaries — Project Velocity
MATTER NUMBER: 1003-00003
Calderwood & Harkness LLP 787 Seventh Avenue, 38th Floor New York, NY 10019
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I. EXECUTIVE SUMMARY
This memorandum sets forth the findings and conclusions of the tax due diligence review conducted by Calderwood & Harkness LLP ("we," "our," or "Calderwood & Harkness") in connection with the proposed acquisition (the "Transaction") of VeloPay Systems, Inc. ("VeloPay" or the "Company") (EIN: 82-3019478; a Delaware corporation headquartered at 1455 Innovation Parkway, Suite 800, Austin, TX 78759) and its five subsidiaries by Harrowgate Private Equity Fund IV LP ("HPE Fund IV" or the "Buyer"). This memorandum is prepared at the direction of, and for the benefit of, legal counsel and is intended to be protected by the attorney-client privilege and the attorney work product doctrine.
Transaction Structure. The Transaction is structured as a reverse triangular merger under Section 251 of the Delaware General Corporation Law ("DGCL"). Harrowgate Velocity Merger Sub Inc. ("Merger Sub"), a newly formed Delaware corporation and wholly-owned subsidiary of HPE Fund IV, will merge with and into VeloPay, with VeloPay surviving as a wholly-owned subsidiary of HPE Fund IV.
Merger Consideration. The aggregate merger consideration is $1,900,000,000 (the "Merger Consideration"), payable in cash, representing $20.00 per share on a fully diluted, as-converted basis (approximately 95,000,000 fully diluted shares, inclusive of outstanding options, restricted stock units, and warrants). Certain stockholders will roll over a portion of their merger consideration into Harrowgate Velocity Co-Invest LP, as described more fully in Section XII.B below.
Scope of Review. Our tax due diligence review covered the following areas: federal income tax; state and local income and franchise tax across all jurisdictions in which VeloPay or its subsidiaries file returns; international tax positions (Canada and Portugal); transfer pricing; employee benefits and compensation tax; sales and use tax; payroll tax; unclaimed property; tax attributes (including net operating loss carryforwards and tax credits); and analysis of potential Section 338(h)(10) and Section 338(g) elections.
Data Room Access. Access to the electronic data room was opened on December 12, 2024. The tax diligence data room was populated by Whitford Jessup & Crane LLP (Ellen Fairchild, Tax Partner), outside tax counsel to VeloPay, and by VeloPay's Chief Financial Officer, Marcus Langford. We have also reviewed information provided directly by Vance Thornbury & Co. LLP (engagement partner: Robert Paulsen), VeloPay's independent auditor, which has issued audited financial statements through the fiscal year ended December 31, 2024 ("FY2024").
Overall Risk Assessment. Based on our review, we assess the overall tax risk profile of VeloPay as Moderate. The key areas of tax risk and focus include:
(a) Transfer Pricing Exposure — Intercompany arrangements with VeloPay Canada Inc. and VeloPay Europe, Unipessoal Lda. present moderate-to-elevated risk, particularly with respect to the Portuguese entity where documentation is incomplete;
(b) State Nexus and Filing Positions — VeloPay has not filed income tax returns in four states where it arguably has economic nexus through its payments processing activities, resulting in an estimated exposure of $1.2 million to $1.8 million;
(c) Section 280G Parachute Payment Exposure — The change of control will trigger potential excess parachute payments for certain executives, with estimated excise tax exposure of $3.5 million to $5.0 million absent mitigation through the shareholder vote safe harbor; and
(d) Section 338(h)(10) Election — As discussed in detail in Section VII, a Section 338(h)(10) election is not available for this Transaction; a regular Section 338(g) election is available but not recommended due to prohibitive tax cost.
Financial Snapshot (FY2024):
VeloPay's employees are located across Austin, Texas; Denver, Colorado; Toronto, Ontario, Canada; and Lisbon, Portugal. The Company processes approximately $87 billion in annualized gross payment volume for more than 14,000 merchants.
Our aggregate estimated tax exposure across all identified risk areas is approximately $8.4 million to $11.1 million, which is manageable in the context of a $1.9 billion transaction. No "deal-breaker" tax issues have been identified. Our detailed findings and recommendations are set forth in the sections that follow.
II. SCOPE AND METHODOLOGY
A. Scope of Engagement
Calderwood & Harkness LLP was retained by HPE Fund IV on October 7, 2024, to serve as tax counsel to the Buyer in connection with the potential acquisition of VeloPay Systems, Inc. and its subsidiaries (the "VeloPay Group"). The tax due diligence workstream formally commenced upon the opening of the electronic data room on December 12, 2024, and has continued through the date of this memorandum. This memorandum represents an update of the initial draft circulated to the recipients on February 28, 2025, and incorporates additional information obtained through March 14, 2025, including certain supplemental materials provided by VeloPay's counsel during the second and third rounds of diligence requests.
Our review covers VeloPay Systems, Inc. and the following wholly-owned subsidiaries (collectively, the "VeloPay Group"):
1. VeloPay Processing LLC — a Delaware limited liability company; wholly-owned by VeloPay Systems, Inc.; classified as a disregarded entity for federal income tax purposes.
2. VeloPay Canada Inc. — an Ontario corporation; wholly-owned by VeloPay Systems, Inc.; classified as a controlled foreign corporation ("CFC") for U.S. federal income tax purposes.
3. VeloPay Europe, Unipessoal Lda. — a Portuguese sociedade unipessoal por quotas de responsabilidade limitada (single-member limited liability company); wholly-owned by VeloPay Systems, Inc.; classified as a CFC for U.S. federal income tax purposes.
4. VeloPay Fraud intelligence Inc. — a Delaware corporation; wholly-owned by VeloPay Systems, Inc.; included in VeloPay's consolidated U.S. federal income tax return.
5. PayStream Gateway LLC — a Delaware limited liability company; wholly-owned by VeloPay Systems, Inc.; classified as a disregarded entity for federal income tax purposes. PayStream Gateway was acquired by VeloPay in 2021 for an aggregate purchase price of $45 million.
B. Materials Reviewed
In connection with this engagement, we reviewed the following principal categories of documents and materials, as made available through the electronic data room and through supplemental information requests:
• U.S. federal income tax returns (Forms 1120) for VeloPay Systems, Inc. and its domestic subsidiaries for fiscal years 2020 through 2024, inclusive;
• State and local income and franchise tax returns for all filed jurisdictions for fiscal years 2020 through 2024;
• Canadian federal corporate income tax returns (T2) and Ontario provincial corporate tax returns for VeloPay Canada Inc. for fiscal years 2021 through 2024;
• Portuguese corporate income tax filings (Modelo 22) for VeloPay Europe, Unipessoal Lda. for fiscal years 2022 through 2024;
• FY2024 audited consolidated financial statements of VeloPay Systems, Inc., prepared by Vance Thornbury & Co. LLP (Robert Paulsen, engagement partner);
• Transfer pricing documentation, including benchmarking studies, intercompany services agreements, and related economic analyses for the Canadian and Portuguese subsidiaries;
• Tax provision workpapers prepared under ASC 740 (Income Taxes) and schedules of uncertain tax positions under ASC 740-10 (formerly FIN 48);
• Documentation relating to VeloPay's prior acquisition of PayStream Gateway LLC in 2021, including the asset purchase agreement, Section 1060 allocation schedules, and integration materials;
• Equity compensation plan documents, including the VeloPay Systems, Inc. 2018 Equity Incentive Plan and all amendments thereto, stock option agreements, restricted stock unit award agreements, and warrant instruments;
• Employment agreements and severance arrangements for key executives, including Nathan Aldridge (Chief Executive Officer), Sonia Reyes-Watkins (Chief Technology Officer), Marcus Langford (Chief Financial Officer), and Danielle Moreau (General Counsel);
• Sales and use tax filings, registration certificates, and exemption certificates across all applicable jurisdictions;
• Property tax filings and assessments for personal property in Texas and Colorado;
• Correspondence with the Internal Revenue Service and state and local tax authorities, including any audit notices, information document requests, private letter ruling requests, and closing agreements;
• Existing credit facility documents between VeloPay and Meridian Commercial Credit Corp., including the credit agreement, security agreements, and payoff-related documentation;
• Organizational documents, including certificates of incorporation, certificates of formation, limited liability company agreements, articles of association, and related governing instruments for all entities within the VeloPay Group; and
• Section 409A valuation reports obtained by VeloPay from external valuation firms for purposes of establishing the fair market value of VeloPay common stock at the time of equity awards.
A comprehensive index of tax-related data room documents reviewed is set forth in Appendix G to this memorandum.
C. Limitations
Our analysis is based on the documents and information provided to us through the electronic data room, supplemental document productions, and management representations made by VeloPay's officers and advisors. We have not independently verified the positions taken on VeloPay's tax returns or in its tax provision workpapers absent the identification of specific red flags warranting further investigation. We have relied on the accuracy and completeness of the information provided.
Our analysis of Canadian and Portuguese tax matters has been performed in coordination with local tax counsel retained by VeloPay in each jurisdiction, as identified in the data room. We did not independently retain or directly engage Canadian or Portuguese tax counsel, and our review of foreign tax positions is necessarily limited to the information and analyses provided by VeloPay's local advisors. We have, however, applied our independent judgment to the assessment of transfer pricing risk and the computation of GILTI inclusions and foreign tax credit positions for U.S. federal income tax purposes.
This memorandum does not constitute a guarantee or assurance that the tax positions taken by VeloPay are correct or will be sustained upon audit or examination. The tax laws and regulations applicable to the matters discussed herein are inherently complex and subject to varying interpretations by taxing authorities and the courts.
III. CORPORATE STRUCTURE AND TAX CLASSIFICATION
A. Organizational Chart — Tax Entity Classification
The VeloPay Group's corporate structure is set forth in diagrammatic form in Appendix A. For tax purposes, the entities within the VeloPay Group are classified as follows:
1. VeloPay Systems, Inc. — C-corporation, incorporated in the State of Delaware. VeloPay serves as the common parent of the consolidated group and files a consolidated U.S. federal income tax return. VeloPay is the direct owner of all entities within the VeloPay Group.
2. VeloPay Processing LLC — Organized as a Delaware limited liability company with VeloPay as its sole member. For U.S. federal income tax purposes, VeloPay Processing LLC is classified as a disregarded entity under Treasury Regulation § 301.7701-3. Its activities are reported directly on VeloPay's consolidated federal income tax return. No Form 8832 (Entity Classification Election) was required as the default classification for a single-member domestic LLC is disregarded entity status.
3. VeloPay Fraud intelligence Inc. — A Delaware corporation; wholly-owned by VeloPay. As an "includible corporation" within the meaning of Section 1504(a) of the Internal Revenue Code, VeloPay Fraud intelligence Inc. is included in VeloPay's consolidated U.S. federal income tax return.
4. PayStream Gateway LLC — Organized as a Delaware limited liability company with VeloPay as its sole member following VeloPay's acquisition of PayStream in 2021. PayStream is classified as a disregarded entity for U.S. federal income tax purposes and is included on VeloPay's consolidated return. The 2021 acquisition was treated as an asset purchase for tax purposes (as discussed in Section IV.F below).
5. VeloPay Canada Inc. — An Ontario corporation; wholly-owned by VeloPay. As a foreign corporation not eligible for inclusion in VeloPay's consolidated U.S. federal income tax return, VeloPay Canada files its own Canadian federal and Ontario provincial income tax returns. For U.S. tax purposes, VeloPay Canada is a controlled foreign corporation ("CFC") within the meaning of Section 957(a) of the Internal Revenue Code, and its income is subject to GILTI (Global Intangible Low-Taxed Income) inclusion and Subpart F analysis on VeloPay's U.S. return.
6. VeloPay Europe, Unipessoal Lda. — A Portuguese sociedade unipessoal por quotas de responsabilidade limitada (single-member limited liability company); wholly-owned by VeloPay. VeloPay Europe files Portuguese corporate income tax returns (Modelo 22). For U.S. tax purposes, VeloPay Europe is a CFC, and its income is likewise subject to GILTI inclusion and Subpart F analysis on VeloPay's U.S. return.
B. Consolidated Return Filing
VeloPay Systems, Inc. files a consolidated U.S. federal income tax return with its only eligible includible corporation, VeloPay Fraud intelligence Inc. The two domestic disregarded entities — VeloPay Processing LLC and PayStream Gateway LLC — are not separate taxpayers and are included on VeloPay's return by operation of the disregarded entity rules.
VeloPay Canada Inc. and VeloPay Europe, Unipessoal Lda. are foreign corporations and, as such, are excluded from the consolidated federal return under Section 1504(b)(3) of the Internal Revenue Code. Income from these entities is included on VeloPay's U.S. return through the GILTI and Subpart F provisions, as described in Section VI below.
We have confirmed that VeloPay has properly filed Form 1122 (Authorization and Consent of Subsidiary Corporation to be Included in a Consolidated Income Tax Return) with respect to VeloPay Fraud intelligence Inc., and that the consolidated return has been properly filed for each year in which a consolidation election has been in effect.
C. EIN and Filing Identifiers
VeloPay Systems, Inc. bears Employer Identification Number ("EIN") 82-3019478 and Delaware File Number 5748392. We have reviewed the EINs and tax identification numbers for all domestic and foreign subsidiaries in the data room materials. No irregularities were noted with respect to the assignment or use of identification numbers by any entity within the VeloPay Group. All entities appear to be properly registered with applicable taxing authorities.
IV. FEDERAL INCOME TAX
A. Tax Return Filing History and Compliance Status
VeloPay Systems, Inc. has timely filed all U.S. federal income tax returns (Form 1120, consolidated) for fiscal years 2014 through 2024, inclusive. In certain years, VeloPay availed itself of the automatic six-month extension of time to file under Section 6081(b) of the Internal Revenue Code; however, no extensions beyond the automatic six-month period were observed. All federal income tax liabilities have been timely paid, and we have not identified any outstanding tax balances, assessed deficiencies, or federal tax liens relating to any entity within the VeloPay Group.
For the period FY2020 through FY2022, VeloPay's consolidated returns reflected net operating losses, consistent with the Company's growth-stage investment in its payments platform and the expansion of its workforce and technology infrastructure. FY2023 was the first year in which VeloPay reported positive taxable income for federal income tax purposes. For FY2024, VeloPay reported federal taxable income of approximately $38 million (after application of net operating loss carryforwards and other adjustments).
B. Tax Attributes — Net Operating Losses (NOLs)
VeloPay has accumulated federal net operating loss carryforwards of approximately $67.4 million as of the beginning of FY2023 (prior to utilization in FY2023 and FY2024). The composition of these NOLs is as follows:
Pre-2018 NOLs (generated FY2016–FY2017): Approximately $12.1 million. These NOLs are subject to the former 20-year carryforward period. Under the Tax Cuts and Jobs Act of 2017 ("TCJA"), pre-2018 NOLs are no longer eligible for carryback (with limited exceptions), but retain the 20-year carryforward limitation. Based on their years of generation, these NOLs expire in the period FY2036–FY2037. Pre-2018 NOLs may offset 100% of taxable income (not subject to the 80% limitation).
Post-2017 NOLs (generated FY2018–FY2022): Approximately $55.3 million. Under TCJA Section 13302 (codified as Section 172(a)(2) of the Internal Revenue Code), post-2017 NOLs have an indefinite carryforward period but may offset only 80% of taxable income in any given year.
Utilization History:
As of December 31, 2024, VeloPay's estimated remaining federal NOL carryforward is approximately $29.6 million (comprising approximately $12.1 million of pre-2018 NOLs and approximately $17.5 million of post-2017 NOLs). A detailed year-by-year NOL schedule is set forth in Appendix B.
Section 382 Limitation Analysis
The reverse triangular merger will result in HPE Fund IV acquiring 100% of VeloPay's stock, constituting an "ownership change" within the meaning of Section 382 of the Internal Revenue Code. Section 382 applies when the percentage of stock owned by one or more "5-percent shareholders" increases by more than 50 percentage points during a three-year "testing period." Here, HPE Fund IV will become a new 100% shareholder, clearly triggering an ownership change.
Upon the ownership change, VeloPay's pre-change NOLs (and certain other pre-change tax attributes) will be subject to an annual limitation under Section 382. The annual limitation is calculated as follows:
Annual Section 382 Limitation = Equity Value of VeloPay Immediately Before the Ownership Change × Applicable Long-Term Tax-Exempt Rate
• Equity Value: Approximately $1.9 billion (equal to the merger consideration, subject to adjustments under Treasury Regulation § 1.382-4 for certain items such as substantial non-business assets and capital contributions).
• Long-Term Tax-Exempt Rate: The applicable rate is the highest of the adjusted federal long-term rates in effect for any month in the three-month period ending with the month in which the ownership change occurs. As of the expected closing date, we estimate the long-term tax-exempt rate to be approximately 4.5%. This rate must be confirmed based on the IRS-published rates for the actual month of closing.
• Estimated Annual Limitation: $1,900,000,000 × 4.5% = approximately $85.5 million per year.
Because the estimated annual Section 382 limitation of approximately $85.5 million significantly exceeds VeloPay's remaining pre-change NOL carryforward balance of approximately $29.6 million, the practical impact of Section 382 on post-closing NOL utilization is expected to be minimal. VeloPay should be able to fully utilize its remaining NOLs within the first year post-closing (subject to the 80% taxable income limitation for post-2017 NOLs and the availability of sufficient taxable income).
Notwithstanding the favorable preliminary analysis, we recommend that a formal Section 382 study be conducted at or immediately following closing to (i) confirm the equity value calculation, (ii) verify the applicable long-term tax-exempt rate as of the closing date, (iii) determine whether any prior ownership changes occurred that would impose a more restrictive limitation, and (iv) analyze any impact of the rollover equity contributed by Nathan Aldridge and Sonia Reyes-Watkins (which may affect the ownership change calculation).
Built-In Gains/Losses Analysis — Section 382(h)
Under Section 382(h), if VeloPay has a "net unrealized built-in gain" ("NUBIG") position at the time of the ownership change, recognized built-in gains during the five-year recognition period may increase the Section 382 limitation for the year in which such gains are recognized. Given that the enterprise value of VeloPay in the Transaction is approximately $1.9 billion and VeloPay's aggregate net tax basis in its assets is substantially lower (total book assets of $689.4 million, with tax basis potentially lower due to intangible assets and depreciation timing), VeloPay is very likely in a NUBIG position. This could provide additional headroom for utilizing pre-change attributes, though the effect is largely academic given the already-favorable annual limitation relative to remaining NOLs. A detailed NUBIG/NUBIL analysis should be included in the formal Section 382 study. A preliminary calculation is set forth in Appendix F.
C. Research and Development Tax Credits
VeloPay has claimed federal research and development tax credits under Section 41 of the Internal Revenue Code in each of fiscal years 2020 through 2024. The aggregate R&D credits claimed over this period total approximately $8.7 million, as summarized below:
VeloPay's R&D credit claims are supported by R&D credit studies performed by an external tax advisory firm retained by the Company. We have reviewed the documentation supporting the R&D credit studies and believe the methodologies and conclusions are reasonable and consistent with applicable guidance. The Company's qualified research activities include the development and improvement of its proprietary payments processing platform, fraud detection algorithms, and related software technologies.
Risk Assessment: Moderate. The IRS has demonstrated elevated scrutiny of software-related R&D credits in recent years, and VeloPay's credits are not insignificant in amount. The Company's uncertain tax position reserve includes approximately $1.8 million attributable to R&D credit positions, reflecting management's assessment of the probability of sustaining the full amount of credits claimed. We recommend that VeloPay continue to maintain robust contemporaneous documentation of qualified research activities, qualified research expenses, and the four-part test under Section 41(d) (technological in nature, uncertainty, process of experimentation, and permitted purpose) for all credited activities.
Section 174 Capitalization Requirement. For tax years beginning after December 31, 2021, the TCJA requires capitalization and amortization of "specified research or experimental expenditures" under Section 174 over a five-year period for domestic research and a fifteen-year period for research performed outside the United States. We have confirmed through our review of VeloPay's FY2022 through FY2024 returns and tax provision workpapers that VeloPay has properly capitalized and amortized its research expenditures in compliance with amended Section 174. Domestic R&D expenditures are amortized over five years using the half-year convention, and R&D expenditures attributable to foreign-performed research (i.e., work performed by VeloPay Canada and VeloPay Europe) are amortized over fifteen years. A detailed year-by-year R&D credit summary is set forth in Appendix C.
D. ASC 740 Tax Provision and Uncertain Tax Positions
VeloPay's FY2024 effective tax rate, as reported in its audited consolidated financial statements, is approximately 22.8%. This rate compares to the statutory U.S. federal income tax rate of 21%, with the variance attributable primarily to state and local income taxes, permanent differences (including certain non-deductible expenses and the benefit of the Section 250 GILTI deduction), and the impact of R&D credits. The effective rate appears reasonable and is not indicative of aggressive tax planning.
VeloPay maintains an uncertain tax position ("UTP") reserve under ASC 740-10 (formerly FIN 48) of approximately $3.2 million as of December 31, 2024. The UTP reserve is attributable to the following positions:
We have reviewed the UTP schedules and supporting analyses and believe the reserves appear conservatively stated. No material changes to the UTP reserve are anticipated based on currently available information. Vance Thornbury & Co. LLP (Robert Paulsen, engagement partner) has issued clean, unqualified audit opinions on VeloPay's consolidated financial statements for FY2022, FY2023, and FY2024, with no tax-related qualifications or emphasis-of-matter paragraphs.
E. IRS Audit History
VeloPay has not been audited by the IRS for any tax year. We have reviewed correspondence files maintained by VeloPay and confirmed that no examination notice, information document request, revenue agent report, or other indication of a pending or threatened IRS audit has been received.
Statute of Limitations. Under the general three-year statute of limitations prescribed by Section 6501(a) of the Internal Revenue Code, VeloPay's FY2021 and subsequent tax years remain open for assessment. FY2020 may remain open under certain circumstances, including the extended statute of limitations applicable where NOLs or tax credits are carried back or forward. For purposes of this analysis, we treat FY2020 as potentially open. Tax years prior to FY2020 are closed for federal income tax purposes.
Recommendation: We recommend that the Merger Agreement include standard representations and warranties confirming that (i) VeloPay has not been subject to any IRS audit or examination for any tax year, (ii) no audit is pending or threatened, and (iii) VeloPay has not received any private letter rulings, entered into any closing agreements, or entered into any similar arrangements with the IRS.
F. Tax Treatment of Prior Acquisitions
PayStream Gateway LLC (2021; $45 Million). VeloPay acquired 100% of the membership interests in PayStream Gateway LLC in 2021 for an aggregate purchase price of $45 million. Because PayStream was a single-member LLC classified as a disregarded entity for federal income tax purposes at the time of the acquisition, the acquisition of the LLC interest was treated as an asset acquisition under Section 1001 of the Internal Revenue Code (the buyer acquired the assets of a disregarded entity, not stock of a corporation). This treatment is consistent with Revenue Ruling 99-5 and Treasury Regulation § 301.7701-2(c)(2)(i).
VeloPay obtained a stepped-up basis in the acquired assets of PayStream equal to the $45 million purchase price, allocated among the acquired assets in accordance with the residual method prescribed by Section 1060 and Treasury Regulation § 1.1060-1. Pursuant to the Section 1060 allocation agreement between VeloPay and the sellers, the purchase price was allocated as follows:
• Tangible assets (equipment, fixtures): ~$3.8 million
• Customer relationships and contracts: ~$6.2 million (15-year amortization under Section 197)
• Developed technology: ~$3.8 million (15-year amortization under Section 197)
• Goodwill: ~$31.2 million (15-year amortization under Section 197)
• Total: $45.0 million
As of December 31, 2024, the remaining amortizable basis in the Section 197 intangible assets is approximately $24.9 million (reflecting approximately three and one-half years of amortization). The annual Section 197 amortization deduction is approximately $2.7 million, which will continue to benefit VeloPay post-closing.
No other material acquisitions or dispositions of businesses or assets were identified during our review.
V. STATE AND LOCAL TAX
A. Filing Jurisdictions and Nexus
VeloPay files income or franchise tax returns in the following principal jurisdictions:
• Delaware — Statutory state of incorporation; subject to Delaware franchise tax;
• Texas — State of headquarters (Austin); subject to Texas franchise (margin) tax;
• Colorado — Denver office; subject to Colorado corporate income tax;
• California — Economic nexus through substantial merchant customer base; subject to California corporate income tax and franchise tax;
• New York — Economic nexus through merchant customer base and financial institution relationships; subject to New York State corporate franchise tax; and
• Approximately 38 additional states — VeloPay has established nexus in these jurisdictions through a combination of its payments processing activities, money transmitter licensing obligations, employee presence, and post-Wayfair economic nexus thresholds.
In total, VeloPay files income or franchise tax returns in approximately 43 states and the District of Columbia. VeloPay's aggregate state income and franchise tax expense for FY2024 was approximately $4.8 million. A comprehensive state filing jurisdiction matrix is set forth in Appendix D.
B. Texas Margin Tax
VeloPay is headquartered in Austin, Texas, and is subject to the Texas franchise tax, commonly referred to as the "margin tax," under Chapter 171 of the Texas Tax Code. VeloPay's FY2024 Texas margin tax liability was approximately $1.1 million.
VeloPay computes its margin tax base using the cost of goods sold ("COGS") method, which we have confirmed is permissible for VeloPay's business activities. The COGS method generally produces the lowest taxable margin for companies with significant technology infrastructure and processing costs. We have not identified any outstanding audit issues with the Texas Comptroller of Public Accounts.
Post-Acquisition Impact. Following the Transaction, VeloPay's Texas margin tax apportionment and computation may be affected depending on whether Harrowgate elects to include VeloPay in a combined report with other Texas-domiciled portfolio companies. This analysis should be completed as part of post-closing tax integration planning.
C. Delaware Franchise Tax
VeloPay Systems, Inc. and its domestic corporate subsidiary, VeloPay Fraud intelligence Inc., pay Delaware franchise tax under the authorized shares method. VeloPay's FY2024 Delaware franchise tax was approximately $180,000. Both entities are current on all Delaware franchise tax obligations, and we have confirmed that their status with the Delaware Division of Corporations is in good standing.
Harrowgate Velocity Merger Sub Inc. was incorporated in Delaware on February 24, 2025 (Delaware File Number 7291034) for the sole purpose of effecting the reverse triangular merger. Merger Sub's Delaware franchise tax will be prorated for its limited period of existence, and Merger Sub will cease to exist upon the effective time of the merger.
D. State Nexus Risk — Economic Nexus Positions
VeloPay processes payments for more than 14,000 merchants across all 50 states and maintains money transmitter licenses in 47 states and the District of Columbia. As a result of its widespread economic activity, VeloPay has established economic nexus in virtually every state.
Identified Risk. Through our review, we have identified four states in which VeloPay arguably has economic nexus sufficient to give rise to an income or franchise tax filing obligation but in which VeloPay has not filed returns. In each case, VeloPay has no physical presence in the state but exceeds the state's economic nexus thresholds through its processing activities, merchant agreements, or customer-facing revenue. We have withheld the specific identification of these states from this memorandum and will provide the details separately to Sandra Tung; however, the estimated aggregate tax exposure for these unfiled positions is as follows:
• Estimated tax liability (all four states): $800,000–$1,200,000
• Estimated interest: $200,000–$350,000
• Estimated penalties: $200,000–$250,000
• Aggregate estimated exposure: $1.2 million–$1.8 million
Recommendation. We recommend that VeloPay (or, post-closing, HPE Fund IV) initiate voluntary disclosure agreements ("VDAs") with the affected jurisdictions. VDAs typically provide for the filing of back returns for a limited look-back period (generally three to four years) with waiver of penalties and, in some cases, reduced interest. The VDA process should be initiated promptly after closing. The identified unfiled positions should be disclosed in VeloPay's disclosure schedules under the Merger Agreement.
E. Sales and Use Tax
VeloPay's Software-as-a-Service ("SaaS") subscription fees — which include access to the Company's analytics dashboard and its fraud detection suite — are subject to sales and use tax in certain jurisdictions that tax the delivery of software as a service. VeloPay has registered for sales tax collection purposes and currently collects sales tax in 22 states.
Identified Risk. The taxability of SaaS products varies significantly across jurisdictions, and several states have expanded or clarified their position on the taxability of SaaS in recent years. Our review indicates that VeloPay may have undercollected or under-remitted sales tax on SaaS subscriptions in three to five additional states where SaaS is now clearly or arguably taxable. The estimated exposure is as follows:
• Estimated undercollected/under-remitted sales tax: $400,000–$600,000
• Estimated interest and penalties: $200,000–$300,000
• Aggregate estimated exposure: $600,000–$900,000
Recommendation. We recommend conducting a comprehensive post-closing sales tax nexus and taxability study to (i) confirm VeloPay's current sales tax obligations in all jurisdictions, (ii) identify states where VeloPay should register for sales tax purposes, and (iii) implement appropriate collection and remittance procedures going forward. Remediation of past undercollection may involve VDAs or direct filings in affected states.
F. Unclaimed Property / Escheatment
VeloPay processes approximately $87 billion in annualized gross payment volume. Given the nature and scale of its payments processing operations, the Company has material unclaimed property obligations, including uncashed merchant settlement checks, unclaimed account balances, and unredeemed stored-value instruments.
VeloPay maintains an active unclaimed property compliance program and files annual unclaimed property reports in Delaware (as the state of incorporation and holder of last resort under the Texas v. New Jersey framework) and in certain other key states. We have confirmed that VeloPay has not received any unclaimed property audit notices or examination requests from any jurisdiction.
Risk Assessment: Moderate. Given VeloPay's substantial payment volume and the increasing aggressiveness of state unclaimed property audit programs (many of which are conducted by third-party audit firms on a contingent-fee basis), unclaimed property remains an area of ongoing monitoring. We have not identified any specific compliance failures, but the inherent risk in this area is meaningful given the dollar volumes involved.
VI. INTERNATIONAL TAX
A. VeloPay Canada Inc.
1. Overview. VeloPay Canada Inc. is an Ontario corporation, wholly-owned by VeloPay Systems, Inc. The entity was incorporated in 2019 and currently employs approximately 120 employees at its offices in Toronto, Ontario. VeloPay Canada performs three principal functions: (i) software development and engineering for VeloPay's payments platform, (ii) customer support for Canadian and certain North American merchants, and (iii) operation of VeloPay's Canadian merchant business.
For FY2024, VeloPay Canada reported:
• Canadian revenue: Approximately $28.5 million (comprising both intercompany services revenue and third-party Canadian merchant revenue)
• Net income: Approximately $4.1 million
• Effective Canadian corporate income tax rate: Approximately 26.5% combined (15% federal rate plus 11.5% Ontario provincial rate)
VeloPay Canada files both a Canadian federal corporate income tax return (Form T2) and an Ontario provincial corporate tax return on an annual basis. We have reviewed the returns for FY2021 through FY2024 and have not identified material discrepancies or filing deficiencies.
2. Transfer Pricing
VeloPay Canada provides software development services and customer support under an intercompany services agreement (the "Canadian ICA") with VeloPay Systems, Inc. Under the Canadian ICA, VeloPay Canada is compensated on a cost-plus basis, with a markup of 12% applied to total operating costs (inclusive of direct and indirect costs attributable to the services performed).
VeloPay has contemporaneous transfer pricing documentation, prepared by an external transfer pricing advisory firm, benchmarking the 12% cost-plus margin against comparable uncontrolled transactions. The documentation covers FY2022 through FY2024 and employs the transactional net margin method ("TNMM") with operating cost-plus as the profit level indicator. The benchmarking study identified an interquartile range of 10% to 18% for comparable service providers.
Risk Assessment: Moderate. The 12% cost-plus margin falls within the interquartile range but is positioned at the lower end of the comparables. The Canada Revenue Agency ("CRA") has been active in challenging transfer pricing arrangements that it perceives as providing inadequate compensation to Canadian service entities, particularly where the Canadian entity performs valuable software development functions. The CRA could potentially assert that VeloPay Canada's compensation should be at or above the median of the interquartile range (approximately 14%–15%), which would result in additional taxable income in Canada and a corresponding reduction in the U.S. deduction.
VeloPay maintains an uncertain tax position reserve of approximately $0.9 million attributable to its Canadian transfer pricing positions, which is included in the aggregate ASC 740 UTP reserve discussed in Section IV.D above. This reserve amount appears reasonable given the magnitude of the risk.
There are no pending audits by the CRA. The Canadian statute of limitations for corporate income tax assessments is generally three years from the date of the original notice of assessment (or six years in cases involving transfer pricing adjustments or fraud). Accordingly, FY2021 and later tax years remain open.
Recommendation. We recommend that the transfer pricing study for VeloPay Canada be updated post-acquisition to (i) reflect HPE Fund IV's ownership and any changes in the functional analysis, (ii) reassess whether the 12% cost-plus margin remains defensible, and (iii) consider whether an adjustment to the markup (potentially to 14%–15%) is appropriate to reduce audit risk.
3. Subpart F and GILTI
VeloPay Canada is a CFC, as VeloPay Systems, Inc. (a U.S. shareholder within the meaning of Section 951(b)) owns 100% of its stock. As such, VeloPay includes its pro rata share of VeloPay Canada's income on its U.S. consolidated federal income tax return under the GILTI provisions of Section 951A.
For FY2024, VeloPay's GILTI inclusion attributable to VeloPay Canada was approximately $2.8 million, computed as follows:
• Tested income of VeloPay Canada: ~$4.1 million
• Less: QBAI (qualified business asset investment) deduction attributable to VeloPay Canada's depreciable tangible property: ~$1.3 million
• Net GILTI tested income from VeloPay Canada: ~$2.8 million
VeloPay claims the Section 250 deduction (50% of GILTI for tax years before 2026) and indirect foreign tax credits under Section 960 with respect to Canadian taxes deemed paid. We have not identified any Subpart F income from VeloPay Canada, as all income is attributable to active business operations (payment processing, software development, and customer support activities do not constitute "foreign personal holding company income," "foreign base company sales income," or "foreign base company services income" under Section 954).
Post-Acquisition Impact. The Section 382 ownership change resulting from the merger will not affect GILTI inclusions on a going-forward basis, as GILTI is computed annually based on current-year tested income. However, any deferred tax assets related to foreign tax credits generated pre-change should be analyzed for potential limitation under Section 383.
4. Investment Canada Act
A notification under the Investment Canada Act was filed on May 1, 2025, with Innovation, Science and Economic Development Canada in connection with the acquisition. We understand that clearance was obtained on June 3, 2025. No tax implications arise from the Investment Canada Act notification itself.
B. VeloPay Europe, Unipessoal Lda.
1. Overview. VeloPay Europe, Unipessoal Lda. is a Portuguese sociedade unipessoal por quotas de responsabilidade limitada (single-member limited liability company), wholly-owned by VeloPay Systems, Inc. The entity was established in 2021 and currently employs approximately 80 employees at its offices in Lisbon, Portugal. VeloPay Europe functions primarily as an R&D center and software engineering hub, with limited European business development activities.
For FY2024, VeloPay Europe reported:
• Total revenue: Approximately $6.2 million, of which approximately $4.4 million was intercompany services revenue from VeloPay Systems, Inc. (the parent) and approximately $1.8 million was external revenue from European clients
• Net income: Approximately $0.8 million
• Effective Portuguese corporate income tax rate: Approximately 23% (comprising the standard 21% rate, a municipal surcharge (derrama municipal) of up to 1.5%, and a state surcharge (derrama estadual) applicable to higher-income taxpayers)
VeloPay Europe files Portuguese corporate income tax returns (Modelo 22) on an annual basis. We have reviewed the returns for FY2022 through FY2024, the period during which VeloPay Europe has been operational, and have not identified material filing deficiencies.
2. Transfer Pricing
VeloPay Europe provides software development and engineering services under an intercompany services agreement (the "Portuguese ICA") with VeloPay Systems, Inc. Under the Portuguese ICA, VeloPay Europe is compensated on a cost-plus basis, with a markup of 10% applied to total operating costs.
Transfer Pricing Documentation. VeloPay engaged an external transfer pricing advisory firm to prepare a benchmarking study for FY2023. That study employed the TNMM with operating cost-plus as the profit level indicator and identified a comparable range. However, the study for FY2024 is currently in progress but has not been completed as of the date of this memorandum. This documentation gap is a concern.
Risk Assessment: Elevated. The 10% cost-plus margin is at the low end of comparable ranges for Portuguese R&D service entities. The Portuguese tax authority (Autoridade Tributária e Aduaneira) has become increasingly aggressive on transfer pricing matters in recent years, consistent with broader European trends. The combination of a low margin, an incomplete documentation record, and the growth of VeloPay Europe's operations creates an elevated risk profile. While no specific monetary exposure has been separately reserved in the UTP schedule (the Portuguese transfer pricing risk is subsumed within the broader transfer pricing and international tax reserves), we view the risk as higher than the Canadian transfer pricing risk.
Section 174 Capitalization. R&D services performed by VeloPay Europe are treated as foreign-performed research for purposes of Section 174 of the Internal Revenue Code and are capitalized and amortized over 15 years on VeloPay's U.S. consolidated return. We have confirmed that VeloPay has properly applied the 15-year amortization period to Portuguese-performed R&D expenditures.
Audit Status. There are no pending audits by the Portuguese tax authorities. The Portuguese statute of limitations for tax assessments is generally four years from the end of the tax year in which the tax obligation arises (extendable in certain circumstances). Accordingly, FY2021 and later tax years remain open.
Recommendation. We strongly recommend that VeloPay complete the FY2024 transfer pricing study immediately — ideally before closing of the Transaction. Post-closing, the transfer pricing documentation should be updated to reflect HPE Fund IV's ownership. The adequacy of the 10% cost-plus markup should be critically evaluated, and consideration should be given to increasing the markup to reduce audit risk and to better align with the interquartile range of comparables. Robust documentation is essential for defense in the event of a Portuguese tax authority inquiry.
3. Subpart F and GILTI
VeloPay Europe is a CFC, and VeloPay includes its pro rata share of VeloPay Europe's income under the GILTI provisions of Section 951A. For FY2024, VeloPay's GILTI inclusion attributable to VeloPay Europe was approximately $0.6 million (tested income of approximately $0.8 million, reduced by the QBAI deduction attributable to VeloPay Europe's depreciable tangible property). We have not identified any Subpart F income from VeloPay Europe; substantially all income is attributable to active software development and engineering services.
Foreign tax credits attributable to Portuguese taxes paid by VeloPay Europe are available as indirect credits under Section 960 for inclusion in VeloPay's foreign tax credit computation.
4. Portuguese Withholding Tax
We have analyzed the withholding tax implications of intercompany payments from VeloPay Europe to VeloPay Systems, Inc. (U.S.) as follows:
Services Fees. Intercompany services fee payments from VeloPay Europe to VeloPay (U.S.) are not subject to Portuguese withholding tax under Article 7 (Business Profits) of the Convention Between the United States of America and the Republic of Portugal for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income, provided that VeloPay does not have a permanent establishment in Portugal beyond VeloPay Europe itself. Based on the information reviewed, VeloPay's activities in Portugal are conducted exclusively through VeloPay Europe, and no separate permanent establishment exists.
Dividends. Under Article 10 of the U.S.-Portugal Treaty, dividends paid by a Portuguese company to a U.S. corporate parent may be subject to a reduced withholding rate of 5% (where the beneficial owner is a company holding at least 10% of the voting power of the distributing company). VeloPay Europe has not historically distributed dividends to its U.S. parent. As of December 31, 2024, VeloPay Europe's accumulated earnings are approximately $3.8 million. If dividends are distributed post-closing, the 5% withholding rate would apply, and VeloPay would be eligible for a foreign tax credit for the withholding tax paid.
Interest. VeloPay Europe has no intercompany indebtedness with VeloPay Systems, Inc. or any other member of the VeloPay Group. Accordingly, no withholding tax issues arise with respect to interest payments.
C. Controlled Foreign Corporation Summary and Foreign Tax Credit Position
The table below summarizes VeloPay's aggregate CFC income inclusions and foreign tax credit position for FY2024:
VeloPay has a foreign tax credit carryforward of approximately $0.3 million, generated in FY2023 due to timing differences between tested income and creditable taxes. Under Section 904(c), unused foreign tax credits may be carried forward for up to ten years.