1021-00001 · Verimark Hospitality Group · Opinions

tax-opinion-oid-ahydo.docx DOCUMENT Finance & Banking

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CALDERWOOD & HARKNESS LLP

One Liberty Plaza, 52nd Floor New York, New York 10006

PRIVILEGED AND CONFIDENTIAL ATTORNEY WORK PRODUCT — PREPARED IN ANTICIPATION OF TAX FILING

MEMORANDUM

I. Executive Summary

This memorandum has been prepared at your request in connection with the pending $700,000,000 Senior Secured Term Loan B refinancing (the "New TLB") by our client, Verimark Hospitality Group Inc., a Delaware corporation ("VHG" or the "Borrower"). Its purpose is to analyze the material U.S. federal income tax consequences to VHG arising from the New TLB, with particular focus on two questions: (a) whether the New TLB constitutes an "applicable high yield discount obligation" ("AHYDO") within the meaning of Section 163(i) of the Internal Revenue Code of 1986, as amended (the "Code"), and (b) the proper treatment of the $7,000,000 of original issue discount ("OID") arising from the 1.00% issue discount at which the New TLB is being issued, under Code Sections 1271 through 1275 and the regulations promulgated thereunder (Treas. Reg. §§ 1.1271-1 through 1.1275-5).

Our principal conclusions are as follows:

1. The New TLB does not constitute an AHYDO. The yield to maturity of the instrument (approximately 6.29% based on rates prevailing at signing) is well below the threshold of the applicable federal rate plus 5 percentage points (approximately 8.07% as of July 2022). Accordingly, none of the deduction deferral or dividend-equivalent recharacterization rules of Section 163(e)(5) will apply.

2. The $7,000,000 of OID falls within the de minimis threshold under Treas. Reg. § 1.1273-1(d), and VHG is entitled to deduct the full amount as interest expense over the 7-year term of the New TLB. We recommend that VHG elect constant-yield amortization under Treas. Reg. § 1.163-7 in order to accelerate the timing of the deduction relative to the pro rata default.

3. Ancillary items, including the $3,125,000 prepayment premium payable to the existing lenders under the Greystone Federal Credit Corp. facility, the unamortized debt issuance costs from that facility, and the approximately $8,100,000 of new issuance costs attributable to the New TLB, are also addressed below.

For the avoidance of doubt, this memorandum constitutes internal tax analysis prepared for use by the deal team and, ultimately, VHG's in-house tax function. It is not a formal opinion letter, is not intended to be relied upon by the Lenders, the Administrative Agent (Crescent Harbor Bank, N.A.), or any other third party, and shall not be delivered outside the firm and the client without our prior written consent.

II. Background — Transaction Summary

A. The New TLB

The Borrower is Verimark Hospitality Group Inc., a Delaware corporation with common stock listed on the New York Stock Exchange under the ticker symbol "VMRK," headquartered at 8200 West Palmetto Park Road, Suite 1500, Boca Raton, Florida 33433 (EIN: 82-3741956). The New TLB is a senior secured term loan B facility in the aggregate principal amount of $700,000,000, arranged and administered by Crescent Harbor Bank, N.A. as sole Lead Arranger and Administrative Agent.

The material economic terms of the New TLB are as follows:

B. The Existing TLB Being Refinanced

VHG's existing senior secured term loan B was originated on February 14, 2020 in the original principal amount of $625,000,000, with Greystone Federal Credit Corp. serving as administrative agent (CUSIP: 92347LAA0). That facility bears interest at LIBOR + 425 bps. As of the anticipated payoff date, scheduled amortization of $3,125,000 will have reduced outstanding principal to $621,875,000. The total payoff amount is estimated at approximately $627,916,667, comprising:

• Outstanding principal: $621,875,000

• Accrued and unpaid interest through payoff date: approximately $2,916,667

• Prepayment premium (0.50% × $625,000,000 original commitment): $3,125,000

C. Use of Proceeds

The proceeds of the New TLB will be applied as follows: first, to refinance the Greystone facility in full (approximately $627,916,667 as described above); second, to fund transaction costs (arrangement fee of $3,500,000 to Crescent Harbor Bank, N.A.; advisory fee of $1,400,000 to Meridian Strauss Advisory LLC; and estimated legal and closing costs of approximately $3,200,000); and third, to provide incremental proceeds of approximately $75,000,000 (i.e., the difference between the $700,000,000 New TLB and the $625,000,000 existing facility) for permitted acquisitions and general corporate purposes. Net proceeds to VHG after all of the foregoing, and after giving effect to the $7,000,000 OID, are approximately $60,483,333.

D. VHG Financial Profile (Relevant to Tax Analysis)

For fiscal year 2021, VHG reported consolidated revenue of $1,420,000,000, EBITDA of $318,000,000, and Adjusted EBITDA of $341,000,000. Immediately after closing, VHG's consolidated debt will consist of the $700,000,000 New TLB, an undrawn $400,000,000 revolving credit facility (the "RCF"), and $245,000,000 in senior unsecured notes maturing in 2028. Pro forma net leverage at closing is approximately 2.52x ($858,000,000 of net debt divided by $341,000,000 of Adjusted EBITDA). These figures are relevant to the analysis under Code Section 163(j) discussed in Section V below.

III. Original Issue Discount — General Tax Treatment

A. Statutory and Regulatory Framework

Under Code Section 1273(a), OID with respect to a debt instrument equals the excess, if any, of the instrument's "stated redemption price at maturity" over its "issue price." The stated redemption price at maturity is the sum of all payments to be made on the instrument other than "qualified stated interest," and the issue price of a debt instrument issued for money is the first price at which a substantial amount of the debt instrument is sold for money (Treas. Reg. § 1.1273-2(a)).

Applying these principles to the New TLB:

• Stated redemption price at maturity: $700,000,000 (the aggregate of the quarterly amortization payments and the balloon at maturity).

• Issue price: $693,000,000 (99.00% of par, being the first price at which a substantial amount of the New TLB is sold to lenders for money).

• OID: $700,000,000 − $693,000,000 = $7,000,000.

The stated interest on the New TLB — Adjusted Term SOFR plus a fixed margin of 375 basis points, payable in cash on a quarterly basis — constitutes "qualified stated interest" within the meaning of Treas. Reg. § 1.1273-1(c) because it is unconditionally payable at least annually at a variable rate that is itself a qualified floating rate under the VRDI regulations. Qualified stated interest is not part of the stated redemption price at maturity and is therefore excluded from the OID computation.

The New TLB is a "variable rate debt instrument" ("VRDI") within the meaning of Treas. Reg. § 1.1275-5. Adjusted Term SOFR is a "qualified floating rate" under Treas. Reg. § 1.1275-5(b)(1), being a rate that can reasonably be expected to measure contemporaneous variations in the cost of newly borrowed funds in the currency in which the debt is denominated. The fixed spread of 375 basis points does not affect qualification. Consequently, the VRDI rules of Treas. Reg. § 1.1275-5(e) govern accruals on the instrument: the qualified stated interest is accounted for as it accrues, and the $7,000,000 OID is accounted for separately as described below.

B. De Minimis OID Test

Section 1273(a)(3) and Treas. Reg. § 1.1273-1(d) provide that if the OID on a debt instrument is less than a specified de minimis threshold, the OID is treated as zero for federal income tax purposes. The threshold is calculated as 0.25% of the stated redemption price at maturity multiplied by the number of complete years from issuance to maturity.

Applying this test:

• 0.25% × $700,000,000 × 7 years = $12,250,000

• Actual OID = $7,000,000

• $7,000,000 < $12,250,000

The OID is therefore de minimis. The consequence of de minimis treatment is that the OID is not required to be accrued under the constant-yield method of Section 1272; rather, under Treas. Reg. § 1.1273-1(d)(5), the de minimis OID is includible in income by a holder (or deductible by the issuer) pro rata as principal payments are made.

C. Treatment of De Minimis OID by VHG (Issuer/Borrower)

Notwithstanding the default pro rata treatment described above, Treas. Reg. § 1.163-7(b) permits an issuer to elect to deduct de minimis OID on a constant-yield basis, thereby treating the instrument as if the OID were not de minimis. This is often the preferable route for a corporate borrower because it front-loads the deduction relative to the pro rata alternative, which — given a bullet-heavy amortization profile — would push the bulk of the deduction to maturity.

We recommend that VHG affirmatively elect constant-yield treatment. A high-level comparison of the two methods is as follows (with a more granular schedule set forth in Appendix C):

• Constant-yield method. Under Treas. Reg. § 1.163-7 and the constant-yield rules of Section 1272 (as adapted for VRDIs under Treas. Reg. § 1.1275-5), the $7,000,000 OID is amortized over the 7-year term based on the yield to maturity of the New TLB. Amortization averages approximately $1,000,000 per year, with somewhat lower amounts in the earliest periods and somewhat higher amounts in later periods due to compounding, though the effect is muted given the modest size of the OID relative to par.

• Pro rata method. Under the default, the $7,000,000 OID is allocated to each scheduled principal payment in proportion to the principal repaid. Because 93% of principal ($651,000,000) is repaid at maturity, roughly $6,510,000 of the OID would be deductible only in FY2029, with the remaining $490,000 spread pro rata over the interim quarters.

Under either method, the entire $7,000,000 OID is ultimately deductible as interest expense by VHG. The distinction is one of timing, not entitlement. Given VHG's current corporate income tax posture and expected future taxable income, accelerated deductions under the constant-yield method are more valuable in present-value terms.

IV. AHYDO Analysis — Code Section 163(i) and (e)(5)

A. Overview of the AHYDO Rules

Code Section 163(e)(5) imposes two adverse consequences on an issuer of an "applicable high yield discount obligation": (i) the deduction for OID accrued on the instrument is deferred until such OID is actually paid in cash (or otherwise treated as paid under the statute), and (ii) a portion of the OID — the so-called "disqualified portion," equal to the OID that would exist if the yield to maturity were reduced to the AFR plus 6 percentage points — is permanently disallowed as a deduction and treated in the hands of a corporate holder as a dividend for purposes of the dividends-received deduction.

Under Section 163(i)(1), an obligation is an AHYDO if and only if all three of the following tests are satisfied:

1. Maturity Test. The instrument has a term of more than 5 years from the date of issue;

2. Yield Test. The yield to maturity on the instrument equals or exceeds the sum of the AFR (in effect for the month of issuance and for obligations of comparable maturity) plus 5 percentage points; and

3. Significant OID Test. The instrument has "significant OID," meaning that as of the close of any accrual period ending after the fifth anniversary of issuance, the aggregate amount that would be includible in income with respect to the obligation for prior periods exceeds the sum of (i) the aggregate amount of interest to be paid in cash before the close of such accrual period, plus (ii) the product of the issue price and the yield to maturity of the instrument.

An instrument is not an AHYDO unless each of the three tests is met. Failure of any single test is dispositive.

B. Application of the Three-Part AHYDO Test to the New TLB

1. Maturity Test. The New TLB matures on July 21, 2029, exactly seven years after the July 21, 2022 closing date. Because 7 years exceeds the statutory 5-year threshold, the Maturity Test is satisfied. This conclusion is not affected by the quarterly amortization schedule or the balloon payment structure; what matters for Section 163(i)(1)(A) purposes is the stated maturity date. The Maturity Test is SATISFIED.

We therefore proceed to the Yield Test.

2. Yield Test. The yield to maturity of the New TLB is to be computed taking into account both the OID and all stated interest payable on the instrument (Treas. Reg. § 1.1272-1(b)). For a VRDI, yield-to-maturity is generally determined at issuance using the initial value of the qualified floating rate, treating that rate as if it were fixed for the term (Treas. Reg. § 1.1275-5(e)).

Using the rates prevailing at signing:

• 1-month Term SOFR: 2.29%

• SOFR credit spread adjustment: 10 bps

• Applicable margin: 375 bps

• All-in coupon: approximately 6.14% per annum

• Adjustment for OID amortization over 7 years: approximately +15 bps

• Estimated effective yield to maturity: approximately 6.29%

The applicable AFR for a debt instrument with a 7-year maturity is the mid-term AFR (Code Section 1274(d)(1)(A) treats obligations with maturities greater than 3 years but not greater than 9 years as mid-term). Per Rev. Rul. 2022-12 (July 2022), the annual mid-term AFR for July 2022 was approximately 3.07%. Adding 5 percentage points yields a threshold of approximately 8.07%.

Because the yield to maturity of the New TLB (approximately 6.29%) is materially below the threshold of AFR + 5% (approximately 8.07%) — a margin of approximately 178 basis points — the Yield Test is not satisfied. This alone is sufficient to conclude that the New TLB is not an AHYDO. For completeness, however, we also address the Significant OID Test.

3. Significant OID Test (for Completeness). Even if the Yield Test were satisfied — which, as noted, it is not — the Significant OID Test would independently fail. The essence of the Significant OID Test is that an instrument accrues income at a materially faster rate than it pays cash interest. The New TLB, by contrast, is a current-pay instrument: interest at Adjusted Term SOFR + 375 bps is payable in cash quarterly on the full $700,000,000 principal amount, with no PIK, no toggle, and no deferral feature.

Aggregate cash interest payable over the first five years is estimated at approximately $700,000,000 × 6.14% × 5 = approximately $214,900,000. Against this, the total OID that would accrue in the first five years is at most a fraction of the $7,000,000 aggregate OID — a rounding error by comparison. It is not conceivable that accrued but unpaid amounts could exceed the sum of five years of cash interest plus the product of issue price and yield to maturity. The Significant OID Test would NOT be satisfied.

C. Conclusion on AHYDO

For the reasons set forth above, the New TLB is not an applicable high yield discount obligation within the meaning of Code Section 163(i). The Yield Test is not satisfied, and the Significant OID Test would independently not be satisfied. Accordingly, Code Section 163(e)(5) has no application to VHG's OID deduction on the New TLB, and no portion of the $7,000,000 OID is deferred or permanently disallowed under those rules.

We note for the deal team's awareness that the AHYDO determination is made at issuance and is not revisited over the life of the instrument. If interest rates were to rise materially in the future such that a comparable newly issued instrument would fail the AHYDO tests, this would have no retroactive effect on the New TLB. Conversely, we do not opine on the treatment of any future amendment, extension, incremental facility, or repricing that could constitute a "significant modification" of the New TLB under Treas. Reg. § 1.1001-3, which would trigger a new AHYDO determination at that time.

V. Code Section 163(j) — Business Interest Deduction Limitation

Code Section 163(j) limits the deductibility of a taxpayer's "business interest expense" in any taxable year to the sum of (i) business interest income, (ii) 30% of "adjusted taxable income" ("ATI"), and (iii) floor plan financing interest. For post-2021 taxable years, ATI is computed without adding back depreciation, amortization, or depletion, materially tightening the limitation.

Applying the framework to VHG:

• FY2021 Adjusted EBITDA of $341,000,000, adjusted downward to reflect the post-2021 ATI definition (no D&A add-back), yields an ATI estimate materially below Adjusted EBITDA but still substantial. Even on a conservative basis, 30% of post-2021 ATI is expected to provide meaningful headroom.

• Estimated annual interest expense post-closing: approximately $43,000,000 on the New TLB (assuming ~6.14% on $700,000,000, gradually declining with amortization), plus interest on the $245,000,000 senior unsecured notes, plus OID amortization of approximately $1,000,000/year, plus commitment fees on the undrawn RCF. Total estimated interest expense is expected to be materially below the 30% ATI cap on current projections.

We recommend that VHG's tax department monitor compliance quarterly, given that the coupon on the New TLB floats with Term SOFR and total interest expense will accordingly move with rates. Any sharp move in benchmark rates could compress headroom.

VHG should also, in consultation with Clearmont & Wharton LLP (independent auditors; engagement partner Ronald Ashby), evaluate whether it may elect out of Section 163(j) as an "electing real property trade or business" under Section 163(j)(7)(B). Given VHG's hospitality real estate operations, the election may be available with respect to some or all of its business segments. The election is irrevocable and requires the use of the alternative depreciation system ("ADS") for nonresidential real property, residential rental property, and qualified improvement property, which lengthens depreciable lives and forgoes bonus depreciation on the affected assets. The trade-offs should be evaluated on a modeling basis before any election is made.

VI. Tax Treatment of the Prepayment Premium on the Existing TLB

In connection with the payoff of the Greystone Federal Credit Corp. facility, VHG will pay a prepayment premium of $3,125,000 (calculated as 0.50% × $625,000,000 original principal). Under Code Section 162 and Treas. Reg. § 1.163-7(c), and consistent with well-established case law treating call premiums and yield maintenance payments as additional interest, the prepayment premium is deductible as interest expense in the taxable year of repayment — here, FY2022.

The premium compensates the existing lenders for the early termination of their loan and, economically, functions as a yield maintenance payment. It is not a payment for the acquisition of an asset or the settlement of a separate liability; accordingly, no capitalization is required. The deduction is subject to the Section 163(j) limitation described in Section V above, and should be aggregated with all other business interest expense for FY2022 in computing headroom under that section.

VII. Treatment of Unamortized Debt Issuance Costs from the Existing TLB

The existing Greystone facility was originated on February 14, 2020, and VHG capitalized the associated debt issuance costs (legal fees, agent and arrangement fees, and any OID) for amortization over the original 7-year term (i.e., through February 2027). As of the anticipated payoff date of July 21, 2022, approximately 29 months of the original term will have elapsed, and a material unamortized balance will remain on VHG's books.

The proper federal income tax treatment of that unamortized balance depends on whether the refinancing is characterized as a "significant modification" of the existing debt instrument (in which case the old and new instruments are treated as a single continuing instrument, and the unamortized costs continue to be amortized) or as a "retirement" of the old debt and "issuance" of a new debt instrument (in which case the unamortized balance is written off in the year of retirement).

Treas. Reg. § 1.1001-3 provides a series of tests for identifying a significant modification. In the present case, the transaction plainly effects a retirement rather than a modification: (i) the identity of the administrative agent and the composition of the lender syndicate change, with Crescent Harbor Bank, N.A. replacing Greystone Federal Credit Corp.; (ii) an entirely new credit agreement is entered into, with different economic and covenant terms; and (iii) the change in interest rate, tenor, and principal amount would each independently exceed the significance thresholds under the regulations. The transaction is therefore a retirement of the old debt and issuance of new debt.

This characterization is favorable to VHG because it permits an immediate deduction of the unamortized issuance costs under Code Section 165 and Treas. Reg. § 1.446-5 as a loss on retirement of indebtedness, rather than continued amortization over the original term. VHG's tax department should confirm the exact unamortized balance with Clearmont & Wharton LLP and appropriately reflect the deduction in FY2022.

VIII. Debt Issuance Costs — New TLB

VHG will incur various third-party costs in connection with the issuance of the New TLB, which we expect to aggregate approximately $8,100,000, comprising:

• Arrangement fee to Crescent Harbor Bank, N.A.: $3,500,000

• Advisory fee to Meridian Strauss Advisory LLC: $1,400,000

• Estimated legal fees and other closing costs: $3,200,000

For financial accounting purposes (ASC 835-30), these amounts are presented as a direct deduction from the carrying amount of the debt liability and amortized to interest expense over the term of the debt using the effective interest method. For federal income tax purposes, Treas. Reg. § 1.446-5 provides parallel treatment: debt issuance costs are amortized over the term of the debt using a constant-yield method that parallels the OID rules of Sections 1271 through 1275.

Applied to the New TLB, the approximately $8,100,000 of capitalized issuance costs will be amortized over 7 years, yielding an average annual deduction of approximately $1,157,000 (with the actual amounts in each year determined under the constant-yield method — slightly less in earlier years and slightly more in later years).

Although the $7,000,000 OID and the $8,100,000 of debt issuance costs are conceptually similar — both reduce the net proceeds received by VHG below the face amount of the New TLB — they are tracked separately for federal income tax reporting purposes. The OID is governed by Sections 1272–1275 (and, for de minimis OID, by Treas. Reg. § 1.163-7 and § 1.1273-1(d)); the debt issuance costs are governed by Treas. Reg. § 1.446-5. Both give rise to interest deductions and are subject to the Section 163(j) limitation.

IX. State and Local Tax Considerations (Brief)

VHG is headquartered in Florida, which does not impose a state corporate income tax on entities other than banks, and does not conform to Section 163(j). VHG and its subsidiaries, however, conduct business operations in approximately 18 states, some of which decouple from the federal treatment of OID and interest expense (including, notably, some states that impose their own Section 163(j)-style limitations calculated on a stand-alone basis, and others that require add-backs of related-party or intercompany interest).

A detailed state-by-state analysis is beyond the scope of this memorandum. We recommend that VHG's internal tax team, working with Clearmont & Wharton LLP, evaluate the state tax consequences of the OID deduction, the prepayment premium, the write-off of unamortized issuance costs from the Greystone facility, and the amortization of new issuance costs in advance of FY2022 state filings.

X. Summary of Conclusions and Recommendations

1. AHYDO. The $700,000,000 New TLB, with $7,000,000 of OID (1.00% discount), is not an applicable high yield discount obligation under Code Section 163(i). The Yield Test is not satisfied (yield to maturity of approximately 6.29% versus the AFR + 5% threshold of approximately 8.07%), and the Significant OID Test would independently not be satisfied given the substantial current-pay cash interest. Code Section 163(e)(5) does not apply, and no portion of the OID deduction is deferred or permanently disallowed on AHYDO grounds.

2. OID Treatment. The $7,000,000 OID falls below the de minimis threshold of $12,250,000 (0.25% × $700,000,000 × 7 years). We recommend that VHG elect constant-yield treatment under Treas. Reg. § 1.163-7 to accelerate the timing of the deduction relative to the pro rata default. The entire $7,000,000 is deductible as interest expense over the term of the New TLB.

3. Prepayment Premium. The $3,125,000 prepayment premium payable to Greystone Federal Credit Corp. is deductible as additional interest expense in FY2022, subject to the Section 163(j) limitation.

4. Unamortized Costs from Existing TLB. The remaining unamortized debt issuance costs from the February 2020 Greystone facility are deductible in FY2022 upon retirement of that facility. The refinancing constitutes a retirement rather than a significant modification under Treas. Reg. § 1.1001-3.

5. New Debt Issuance Costs. Approximately $8,100,000 of issuance costs incurred in connection with the New TLB should be capitalized and amortized over the 7-year term using the constant-yield method under Treas. Reg. § 1.446-5.

6. Section 163(j). VHG has substantial headroom under the 30% ATI limitation on current projections. We recommend that VHG (in consultation with Clearmont & Wharton LLP) evaluate the merits of the electing real property trade or business election under Section 163(j)(7)(B), taking into account the associated requirement to use ADS depreciation for real property.

7. Action Items.

(a) Confirm unamortized balance of the Greystone facility's issuance costs with Ronald Ashby at Clearmont & Wharton LLP. (b) VHG tax department to make an affirmative election for constant-yield treatment of the de minimis OID under Treas. Reg. § 1.163-7. (c) State tax analysis to be completed separately for FY2022. (d) Establish quarterly Section 163(j) monitoring given the floating-rate coupon on the New TLB.

•

Please contact me with any questions regarding this analysis. I am available to discuss with the deal team, with VHG's tax department, or with Clearmont & Wharton LLP as necessary.

Respectfully submitted,

________________________________________

Leonard Cross Specialist Partner, Tax Calderwood & Harkness LLP One Liberty Plaza, 52nd Floor New York, New York 10006 Direct: (212) 555-0184

Email: lcross@calderwoodharkness.com

Billing Rate: $1,550/hr Engagement No.: 1016-00009

Appendix A — AHYDO Yield Calculation Worksheet

The following worksheet sets forth the step-by-step derivation of the yield to maturity of the New TLB and its comparison to the AHYDO trigger threshold.

Conclusion: The yield to maturity of the New TLB is approximately 178 basis points below the AHYDO trigger threshold. The Yield Test under Section 163(i)(1)(B) is not satisfied.

Appendix B — De Minimis OID Threshold Calculation

The following worksheet sets forth the derivation of the de minimis OID threshold under Treas. Reg. § 1.1273-1(d) and its comparison to the actual OID on the New TLB.

Conclusion: The OID of $7,000,000 is less than the de minimis threshold of $12,250,000. The OID is de minimis for federal income tax purposes.

Appendix C — Comparison Table: Constant-Yield vs. Pro Rata OID Deduction Methods

The following table sets forth the estimated year-by-year OID deduction under each of the two available methods. Amounts are illustrative and are based on the assumed all-in yield described in Appendix A; actual constant-yield amounts will be finalized at closing based on the definitive economic terms of the New TLB.

Present value comparison (at 6.14% discount rate, illustrative):

• Constant-yield method: approximately $5,375,000 (PV of deductions)

• Pro rata method: approximately $4,690,000 (PV of deductions)

• Timing advantage of constant-yield election: approximately $685,000 in present-value terms

Note on interaction with amortization schedule. Pro rata deductions under the default de minimis rule are allocated in proportion to principal repayments. Because the New TLB amortizes at $1,750,000 per quarter (aggregating $7,000,000 per year, or 1.00% of par) with a $651,000,000 balloon at maturity, approximately 93% of the pro rata OID deduction is deferred to FY2029. The constant-yield election under Treas. Reg. § 1.163-7 eliminates this deferral and spreads the deduction ratably (with modest compounding) over the 7-year term.

This memorandum is confidential and constitutes attorney work product prepared in anticipation of the FY2022 federal and state tax filings of Verimark Hospitality Group Inc. It is not intended for delivery to, or reliance by, any third party. Any tax analysis herein is based on the Internal Revenue Code, Treasury regulations, published rulings, and case law in effect as of the date hereof, all of which are subject to change (potentially with retroactive effect). No opinion is expressed as to any matter not specifically addressed herein.

TO:

Sophie Tremblay, Lead Associate, Banking & Finance

FROM:	Leonard Cross, Specialist Partner, Tax
DATE:	July 18, 2022
RE:	U.S. Federal Income Tax Analysis — Original Issue Discount and AHYDO Considerations in Connection with the $700,000,000 Senior Secured Term Loan B Refinancing by Verimark Hospitality Group Inc.
ENGAGEMENT:	1016-00009
CLIENT:	Verimark Hospitality Group Inc. ("VHG")
Term	Description
Principal Amount	$700,000,000
Issue Price	99.00% of par (1.00% OID)
Net Funding Amount	$693,000,000
OID (dollar amount)	$7,000,000
Stated Interest Rate	Adjusted Term SOFR + 375 bps (SOFR floor of 0.50%)
Illustrative All-in Rate at Signing	~6.14% p.a. (1-mo. Term SOFR 2.29% + 10 bps CSA + 375 bps)
Maturity Date	July 21, 2029 (7-year tenor)
Amortization	1.00% p.a. ($7,000,000/yr; $1,750,000/qtr)
Balloon at Maturity	$651,000,000
Closing Date	July 21, 2022 (simultaneous sign-and-close)
CUSIP	92347LAB8
Line	Item	Value
1	Principal amount (stated redemption price at maturity)	$700,000,000
2	Issue price (99.00% of par)	$693,000,000
3	OID (Line 1 − Line 2)	$7,000,000
4	Quarterly amortization	$1,750,000
5	Balloon payment at maturity	$651,000,000
6	Term to maturity	7.00 years
7	1-month Term SOFR at issuance	2.29%

8	SOFR credit spread adjustment	0.10%
9	Applicable margin	3.75%
10	All-in coupon (sum of Lines 7–9)	6.14%
11	Incremental yield from OID amortization	~0.15%
12	Effective yield to maturity (Line 10 + Line 11)	~6.29%
13	Mid-term AFR (July 2022, annual compounding)	3.07%
14	AHYDO spread over AFR	5.00%
15	AHYDO trigger threshold (Line 13 + Line 14)	~8.07%
16	Margin of safety (Line 15 − Line 12)	~178 bps
Line	Item	Value
1	Stated redemption price at maturity	$700,000,000
2	De minimis rate	0.25%
3	Complete years from issuance to maturity	7
4	De minimis threshold (Line 1 × Line 2 × Line 3)	$12,250,000
5	Actual OID on the New TLB	$7,000,000
6	Excess of threshold over actual OID (Line 4 − Line 5)	$5,250,000
Fiscal Year	Constant-Yield Method	Pro Rata Method
FY2023	$950,000	$70,000
FY2024	$980,000	$70,000
FY2025	$1,000,000	$70,000
FY2026	$1,020,000	$70,000
FY2027	$1,015,000	$70,000
FY2028	$1,020,000	$70,000
FY2029	$1,015,000	$6,580,000
Total	$7,000,000	$7,000,000

CALDERWOOD & HARKNESS LLP
One Liberty Plaza, 52nd Floor New York, New York 10006
PRIVILEGED AND CONFIDENTIAL ATTORNEY WORK PRODUCT — PREPARED IN ANTICIPATION OF TAX FILING
MEMORANDUM
I. Executive Summary
This memorandum has been prepared at your request in connection with the pending $700,000,000 Senior Secured Term Loan B refinancing (the "New TLB") by our client, Verimark Hospitality Group Inc., a Delaware corporation ("VHG" or the "Borrower"). Its purpose is to analyze the material U.S. federal income tax consequences to VHG arising from the New TLB, with particular focus on two questions: (a) whether the New TLB constitutes an "applicable high yield discount obligation" ("AHYDO") within the meaning of Section 163(i) of the Internal Revenue Code of 1986, as amended (the "Code"), and (b) the proper treatment of the $7,000,000 of original issue discount ("OID") arising from the 1.00% issue discount at which the New TLB is being issued, under Code Sections 1271 through 1275 and the regulations promulgated thereunder (Treas. Reg. §§ 1.1271-1 through 1.1275-5).
Our principal conclusions are as follows:
1. The New TLB does not constitute an AHYDO. The yield to maturity of the instrument (approximately 6.29% based on rates prevailing at signing) is well below the threshold of the applicable federal rate plus 5 percentage points (approximately 8.07% as of July 2022). Accordingly, none of the deduction deferral or dividend-equivalent recharacterization rules of Section 163(e)(5) will apply.
2. The $7,000,000 of OID falls within the de minimis threshold under Treas. Reg. § 1.1273-1(d), and VHG is entitled to deduct the full amount as interest expense over the 7-year term of the New TLB. We recommend that VHG elect constant-yield amortization under Treas. Reg. § 1.163-7 in order to accelerate the timing of the deduction relative to the pro rata default.
3. Ancillary items, including the $3,125,000 prepayment premium payable to the existing lenders under the Greystone Federal Credit Corp. facility, the unamortized debt issuance costs from that facility, and the approximately $8,100,000 of new issuance costs attributable to the New TLB, are also addressed below.
For the avoidance of doubt, this memorandum constitutes internal tax analysis prepared for use by the deal team and, ultimately, VHG's in-house tax function. It is not a formal opinion letter, is not intended to be relied upon by the Lenders, the Administrative Agent (Crescent Harbor Bank, N.A.), or any other third party, and shall not be delivered outside the firm and the client without our prior written consent.
II. Background — Transaction Summary
A. The New TLB
The Borrower is Verimark Hospitality Group Inc., a Delaware corporation with common stock listed on the New York Stock Exchange under the ticker symbol "VMRK," headquartered at 8200 West Palmetto Park Road, Suite 1500, Boca Raton, Florida 33433 (EIN: 82-3741956). The New TLB is a senior secured term loan B facility in the aggregate principal amount of $700,000,000, arranged and administered by Crescent Harbor Bank, N.A. as sole Lead Arranger and Administrative Agent.
The material economic terms of the New TLB are as follows:
B. The Existing TLB Being Refinanced
VHG's existing senior secured term loan B was originated on February 14, 2020 in the original principal amount of $625,000,000, with Greystone Federal Credit Corp. serving as administrative agent (CUSIP: 92347LAA0). That facility bears interest at LIBOR + 425 bps. As of the anticipated payoff date, scheduled amortization of $3,125,000 will have reduced outstanding principal to $621,875,000. The total payoff amount is estimated at approximately $627,916,667, comprising:
• Outstanding principal: $621,875,000
• Accrued and unpaid interest through payoff date: approximately $2,916,667
• Prepayment premium (0.50% × $625,000,000 original commitment): $3,125,000
C. Use of Proceeds
The proceeds of the New TLB will be applied as follows: first, to refinance the Greystone facility in full (approximately $627,916,667 as described above); second, to fund transaction costs (arrangement fee of $3,500,000 to Crescent Harbor Bank, N.A.; advisory fee of $1,400,000 to Meridian Strauss Advisory LLC; and estimated legal and closing costs of approximately $3,200,000); and third, to provide incremental proceeds of approximately $75,000,000 (i.e., the difference between the $700,000,000 New TLB and the $625,000,000 existing facility) for permitted acquisitions and general corporate purposes. Net proceeds to VHG after all of the foregoing, and after giving effect to the $7,000,000 OID, are approximately $60,483,333.
D. VHG Financial Profile (Relevant to Tax Analysis)
For fiscal year 2021, VHG reported consolidated revenue of $1,420,000,000, EBITDA of $318,000,000, and Adjusted EBITDA of $341,000,000. Immediately after closing, VHG's consolidated debt will consist of the $700,000,000 New TLB, an undrawn $400,000,000 revolving credit facility (the "RCF"), and $245,000,000 in senior unsecured notes maturing in 2028. Pro forma net leverage at closing is approximately 2.52x ($858,000,000 of net debt divided by $341,000,000 of Adjusted EBITDA). These figures are relevant to the analysis under Code Section 163(j) discussed in Section V below.
III. Original Issue Discount — General Tax Treatment
A. Statutory and Regulatory Framework
Under Code Section 1273(a), OID with respect to a debt instrument equals the excess, if any, of the instrument's "stated redemption price at maturity" over its "issue price." The stated redemption price at maturity is the sum of all payments to be made on the instrument other than "qualified stated interest," and the issue price of a debt instrument issued for money is the first price at which a substantial amount of the debt instrument is sold for money (Treas. Reg. § 1.1273-2(a)).
Applying these principles to the New TLB:
• Stated redemption price at maturity: $700,000,000 (the aggregate of the quarterly amortization payments and the balloon at maturity).
• Issue price: $693,000,000 (99.00% of par, being the first price at which a substantial amount of the New TLB is sold to lenders for money).
• OID: $700,000,000 − $693,000,000 = $7,000,000.
The stated interest on the New TLB — Adjusted Term SOFR plus a fixed margin of 375 basis points, payable in cash on a quarterly basis — constitutes "qualified stated interest" within the meaning of Treas. Reg. § 1.1273-1(c) because it is unconditionally payable at least annually at a variable rate that is itself a qualified floating rate under the VRDI regulations. Qualified stated interest is not part of the stated redemption price at maturity and is therefore excluded from the OID computation.
The New TLB is a "variable rate debt instrument" ("VRDI") within the meaning of Treas. Reg. § 1.1275-5. Adjusted Term SOFR is a "qualified floating rate" under Treas. Reg. § 1.1275-5(b)(1), being a rate that can reasonably be expected to measure contemporaneous variations in the cost of newly borrowed funds in the currency in which the debt is denominated. The fixed spread of 375 basis points does not affect qualification. Consequently, the VRDI rules of Treas. Reg. § 1.1275-5(e) govern accruals on the instrument: the qualified stated interest is accounted for as it accrues, and the $7,000,000 OID is accounted for separately as described below.
B. De Minimis OID Test
Section 1273(a)(3) and Treas. Reg. § 1.1273-1(d) provide that if the OID on a debt instrument is less than a specified de minimis threshold, the OID is treated as zero for federal income tax purposes. The threshold is calculated as 0.25% of the stated redemption price at maturity multiplied by the number of complete years from issuance to maturity.
Applying this test:
• 0.25% × $700,000,000 × 7 years = $12,250,000
• Actual OID = $7,000,000
• $7,000,000 < $12,250,000
The OID is therefore de minimis. The consequence of de minimis treatment is that the OID is not required to be accrued under the constant-yield method of Section 1272; rather, under Treas. Reg. § 1.1273-1(d)(5), the de minimis OID is includible in income by a holder (or deductible by the issuer) pro rata as principal payments are made.
C. Treatment of De Minimis OID by VHG (Issuer/Borrower)
Notwithstanding the default pro rata treatment described above, Treas. Reg. § 1.163-7(b) permits an issuer to elect to deduct de minimis OID on a constant-yield basis, thereby treating the instrument as if the OID were not de minimis. This is often the preferable route for a corporate borrower because it front-loads the deduction relative to the pro rata alternative, which — given a bullet-heavy amortization profile — would push the bulk of the deduction to maturity.
We recommend that VHG affirmatively elect constant-yield treatment. A high-level comparison of the two methods is as follows (with a more granular schedule set forth in Appendix C):
• Constant-yield method. Under Treas. Reg. § 1.163-7 and the constant-yield rules of Section 1272 (as adapted for VRDIs under Treas. Reg. § 1.1275-5), the $7,000,000 OID is amortized over the 7-year term based on the yield to maturity of the New TLB. Amortization averages approximately $1,000,000 per year, with somewhat lower amounts in the earliest periods and somewhat higher amounts in later periods due to compounding, though the effect is muted given the modest size of the OID relative to par.
• Pro rata method. Under the default, the $7,000,000 OID is allocated to each scheduled principal payment in proportion to the principal repaid. Because 93% of principal ($651,000,000) is repaid at maturity, roughly $6,510,000 of the OID would be deductible only in FY2029, with the remaining $490,000 spread pro rata over the interim quarters.
Under either method, the entire $7,000,000 OID is ultimately deductible as interest expense by VHG. The distinction is one of timing, not entitlement. Given VHG's current corporate income tax posture and expected future taxable income, accelerated deductions under the constant-yield method are more valuable in present-value terms.
IV. AHYDO Analysis — Code Section 163(i) and (e)(5)
A. Overview of the AHYDO Rules
Code Section 163(e)(5) imposes two adverse consequences on an issuer of an "applicable high yield discount obligation": (i) the deduction for OID accrued on the instrument is deferred until such OID is actually paid in cash (or otherwise treated as paid under the statute), and (ii) a portion of the OID — the so-called "disqualified portion," equal to the OID that would exist if the yield to maturity were reduced to the AFR plus 6 percentage points — is permanently disallowed as a deduction and treated in the hands of a corporate holder as a dividend for purposes of the dividends-received deduction.
Under Section 163(i)(1), an obligation is an AHYDO if and only if all three of the following tests are satisfied:
1. Maturity Test. The instrument has a term of more than 5 years from the date of issue;
2. Yield Test. The yield to maturity on the instrument equals or exceeds the sum of the AFR (in effect for the month of issuance and for obligations of comparable maturity) plus 5 percentage points; and
3. Significant OID Test. The instrument has "significant OID," meaning that as of the close of any accrual period ending after the fifth anniversary of issuance, the aggregate amount that would be includible in income with respect to the obligation for prior periods exceeds the sum of (i) the aggregate amount of interest to be paid in cash before the close of such accrual period, plus (ii) the product of the issue price and the yield to maturity of the instrument.
An instrument is not an AHYDO unless each of the three tests is met. Failure of any single test is dispositive.
B. Application of the Three-Part AHYDO Test to the New TLB
1. Maturity Test. The New TLB matures on July 21, 2029, exactly seven years after the July 21, 2022 closing date. Because 7 years exceeds the statutory 5-year threshold, the Maturity Test is satisfied. This conclusion is not affected by the quarterly amortization schedule or the balloon payment structure; what matters for Section 163(i)(1)(A) purposes is the stated maturity date. The Maturity Test is SATISFIED.
We therefore proceed to the Yield Test.
2. Yield Test. The yield to maturity of the New TLB is to be computed taking into account both the OID and all stated interest payable on the instrument (Treas. Reg. § 1.1272-1(b)). For a VRDI, yield-to-maturity is generally determined at issuance using the initial value of the qualified floating rate, treating that rate as if it were fixed for the term (Treas. Reg. § 1.1275-5(e)).
Using the rates prevailing at signing:
• 1-month Term SOFR: 2.29%
• SOFR credit spread adjustment: 10 bps
• Applicable margin: 375 bps
• All-in coupon: approximately 6.14% per annum
• Adjustment for OID amortization over 7 years: approximately +15 bps
• Estimated effective yield to maturity: approximately 6.29%
The applicable AFR for a debt instrument with a 7-year maturity is the mid-term AFR (Code Section 1274(d)(1)(A) treats obligations with maturities greater than 3 years but not greater than 9 years as mid-term). Per Rev. Rul. 2022-12 (July 2022), the annual mid-term AFR for July 2022 was approximately 3.07%. Adding 5 percentage points yields a threshold of approximately 8.07%.
Because the yield to maturity of the New TLB (approximately 6.29%) is materially below the threshold of AFR + 5% (approximately 8.07%) — a margin of approximately 178 basis points — the Yield Test is not satisfied. This alone is sufficient to conclude that the New TLB is not an AHYDO. For completeness, however, we also address the Significant OID Test.
3. Significant OID Test (for Completeness). Even if the Yield Test were satisfied — which, as noted, it is not — the Significant OID Test would independently fail. The essence of the Significant OID Test is that an instrument accrues income at a materially faster rate than it pays cash interest. The New TLB, by contrast, is a current-pay instrument: interest at Adjusted Term SOFR + 375 bps is payable in cash quarterly on the full $700,000,000 principal amount, with no PIK, no toggle, and no deferral feature.
Aggregate cash interest payable over the first five years is estimated at approximately $700,000,000 × 6.14% × 5 = approximately $214,900,000. Against this, the total OID that would accrue in the first five years is at most a fraction of the $7,000,000 aggregate OID — a rounding error by comparison. It is not conceivable that accrued but unpaid amounts could exceed the sum of five years of cash interest plus the product of issue price and yield to maturity. The Significant OID Test would NOT be satisfied.
C. Conclusion on AHYDO
For the reasons set forth above, the New TLB is not an applicable high yield discount obligation within the meaning of Code Section 163(i). The Yield Test is not satisfied, and the Significant OID Test would independently not be satisfied. Accordingly, Code Section 163(e)(5) has no application to VHG's OID deduction on the New TLB, and no portion of the $7,000,000 OID is deferred or permanently disallowed under those rules.
We note for the deal team's awareness that the AHYDO determination is made at issuance and is not revisited over the life of the instrument. If interest rates were to rise materially in the future such that a comparable newly issued instrument would fail the AHYDO tests, this would have no retroactive effect on the New TLB. Conversely, we do not opine on the treatment of any future amendment, extension, incremental facility, or repricing that could constitute a "significant modification" of the New TLB under Treas. Reg. § 1.1001-3, which would trigger a new AHYDO determination at that time.
V. Code Section 163(j) — Business Interest Deduction Limitation
Code Section 163(j) limits the deductibility of a taxpayer's "business interest expense" in any taxable year to the sum of (i) business interest income, (ii) 30% of "adjusted taxable income" ("ATI"), and (iii) floor plan financing interest. For post-2021 taxable years, ATI is computed without adding back depreciation, amortization, or depletion, materially tightening the limitation.
Applying the framework to VHG:
• FY2021 Adjusted EBITDA of $341,000,000, adjusted downward to reflect the post-2021 ATI definition (no D&A add-back), yields an ATI estimate materially below Adjusted EBITDA but still substantial. Even on a conservative basis, 30% of post-2021 ATI is expected to provide meaningful headroom.
• Estimated annual interest expense post-closing: approximately $43,000,000 on the New TLB (assuming ~6.14% on $700,000,000, gradually declining with amortization), plus interest on the $245,000,000 senior unsecured notes, plus OID amortization of approximately $1,000,000/year, plus commitment fees on the undrawn RCF. Total estimated interest expense is expected to be materially below the 30% ATI cap on current projections.
We recommend that VHG's tax department monitor compliance quarterly, given that the coupon on the New TLB floats with Term SOFR and total interest expense will accordingly move with rates. Any sharp move in benchmark rates could compress headroom.
VHG should also, in consultation with Clearmont & Wharton LLP (independent auditors; engagement partner Ronald Ashby), evaluate whether it may elect out of Section 163(j) as an "electing real property trade or business" under Section 163(j)(7)(B). Given VHG's hospitality real estate operations, the election may be available with respect to some or all of its business segments. The election is irrevocable and requires the use of the alternative depreciation system ("ADS") for nonresidential real property, residential rental property, and qualified improvement property, which lengthens depreciable lives and forgoes bonus depreciation on the affected assets. The trade-offs should be evaluated on a modeling basis before any election is made.
VI. Tax Treatment of the Prepayment Premium on the Existing TLB
In connection with the payoff of the Greystone Federal Credit Corp. facility, VHG will pay a prepayment premium of $3,125,000 (calculated as 0.50% × $625,000,000 original principal). Under Code Section 162 and Treas. Reg. § 1.163-7(c), and consistent with well-established case law treating call premiums and yield maintenance payments as additional interest, the prepayment premium is deductible as interest expense in the taxable year of repayment — here, FY2022.
The premium compensates the existing lenders for the early termination of their loan and, economically, functions as a yield maintenance payment. It is not a payment for the acquisition of an asset or the settlement of a separate liability; accordingly, no capitalization is required. The deduction is subject to the Section 163(j) limitation described in Section V above, and should be aggregated with all other business interest expense for FY2022 in computing headroom under that section.
VII. Treatment of Unamortized Debt Issuance Costs from the Existing TLB
The existing Greystone facility was originated on February 14, 2020, and VHG capitalized the associated debt issuance costs (legal fees, agent and arrangement fees, and any OID) for amortization over the original 7-year term (i.e., through February 2027). As of the anticipated payoff date of July 21, 2022, approximately 29 months of the original term will have elapsed, and a material unamortized balance will remain on VHG's books.
The proper federal income tax treatment of that unamortized balance depends on whether the refinancing is characterized as a "significant modification" of the existing debt instrument (in which case the old and new instruments are treated as a single continuing instrument, and the unamortized costs continue to be amortized) or as a "retirement" of the old debt and "issuance" of a new debt instrument (in which case the unamortized balance is written off in the year of retirement).
Treas. Reg. § 1.1001-3 provides a series of tests for identifying a significant modification. In the present case, the transaction plainly effects a retirement rather than a modification: (i) the identity of the administrative agent and the composition of the lender syndicate change, with Crescent Harbor Bank, N.A. replacing Greystone Federal Credit Corp.; (ii) an entirely new credit agreement is entered into, with different economic and covenant terms; and (iii) the change in interest rate, tenor, and principal amount would each independently exceed the significance thresholds under the regulations. The transaction is therefore a retirement of the old debt and issuance of new debt.
This characterization is favorable to VHG because it permits an immediate deduction of the unamortized issuance costs under Code Section 165 and Treas. Reg. § 1.446-5 as a loss on retirement of indebtedness, rather than continued amortization over the original term. VHG's tax department should confirm the exact unamortized balance with Clearmont & Wharton LLP and appropriately reflect the deduction in FY2022.
VIII. Debt Issuance Costs — New TLB
VHG will incur various third-party costs in connection with the issuance of the New TLB, which we expect to aggregate approximately $8,100,000, comprising:
• Arrangement fee to Crescent Harbor Bank, N.A.: $3,500,000
• Advisory fee to Meridian Strauss Advisory LLC: $1,400,000
• Estimated legal fees and other closing costs: $3,200,000
For financial accounting purposes (ASC 835-30), these amounts are presented as a direct deduction from the carrying amount of the debt liability and amortized to interest expense over the term of the debt using the effective interest method. For federal income tax purposes, Treas. Reg. § 1.446-5 provides parallel treatment: debt issuance costs are amortized over the term of the debt using a constant-yield method that parallels the OID rules of Sections 1271 through 1275.
Applied to the New TLB, the approximately $8,100,000 of capitalized issuance costs will be amortized over 7 years, yielding an average annual deduction of approximately $1,157,000 (with the actual amounts in each year determined under the constant-yield method — slightly less in earlier years and slightly more in later years).
Although the $7,000,000 OID and the $8,100,000 of debt issuance costs are conceptually similar — both reduce the net proceeds received by VHG below the face amount of the New TLB — they are tracked separately for federal income tax reporting purposes. The OID is governed by Sections 1272–1275 (and, for de minimis OID, by Treas. Reg. § 1.163-7 and § 1.1273-1(d)); the debt issuance costs are governed by Treas. Reg. § 1.446-5. Both give rise to interest deductions and are subject to the Section 163(j) limitation.
IX. State and Local Tax Considerations (Brief)
VHG is headquartered in Florida, which does not impose a state corporate income tax on entities other than banks, and does not conform to Section 163(j). VHG and its subsidiaries, however, conduct business operations in approximately 18 states, some of which decouple from the federal treatment of OID and interest expense (including, notably, some states that impose their own Section 163(j)-style limitations calculated on a stand-alone basis, and others that require add-backs of related-party or intercompany interest).
A detailed state-by-state analysis is beyond the scope of this memorandum. We recommend that VHG's internal tax team, working with Clearmont & Wharton LLP, evaluate the state tax consequences of the OID deduction, the prepayment premium, the write-off of unamortized issuance costs from the Greystone facility, and the amortization of new issuance costs in advance of FY2022 state filings.
X. Summary of Conclusions and Recommendations
1. AHYDO. The $700,000,000 New TLB, with $7,000,000 of OID (1.00% discount), is not an applicable high yield discount obligation under Code Section 163(i). The Yield Test is not satisfied (yield to maturity of approximately 6.29% versus the AFR + 5% threshold of approximately 8.07%), and the Significant OID Test would independently not be satisfied given the substantial current-pay cash interest. Code Section 163(e)(5) does not apply, and no portion of the OID deduction is deferred or permanently disallowed on AHYDO grounds.
2. OID Treatment. The $7,000,000 OID falls below the de minimis threshold of $12,250,000 (0.25% × $700,000,000 × 7 years). We recommend that VHG elect constant-yield treatment under Treas. Reg. § 1.163-7 to accelerate the timing of the deduction relative to the pro rata default. The entire $7,000,000 is deductible as interest expense over the term of the New TLB.
3. Prepayment Premium. The $3,125,000 prepayment premium payable to Greystone Federal Credit Corp. is deductible as additional interest expense in FY2022, subject to the Section 163(j) limitation.
4. Unamortized Costs from Existing TLB. The remaining unamortized debt issuance costs from the February 2020 Greystone facility are deductible in FY2022 upon retirement of that facility. The refinancing constitutes a retirement rather than a significant modification under Treas. Reg. § 1.1001-3.
5. New Debt Issuance Costs. Approximately $8,100,000 of issuance costs incurred in connection with the New TLB should be capitalized and amortized over the 7-year term using the constant-yield method under Treas. Reg. § 1.446-5.
6. Section 163(j). VHG has substantial headroom under the 30% ATI limitation on current projections. We recommend that VHG (in consultation with Clearmont & Wharton LLP) evaluate the merits of the electing real property trade or business election under Section 163(j)(7)(B), taking into account the associated requirement to use ADS depreciation for real property.
7. Action Items.
(a) Confirm unamortized balance of the Greystone facility's issuance costs with Ronald Ashby at Clearmont & Wharton LLP. (b) VHG tax department to make an affirmative election for constant-yield treatment of the de minimis OID under Treas. Reg. § 1.163-7. (c) State tax analysis to be completed separately for FY2022. (d) Establish quarterly Section 163(j) monitoring given the floating-rate coupon on the New TLB.
•
Please contact me with any questions regarding this analysis. I am available to discuss with the deal team, with VHG's tax department, or with Clearmont & Wharton LLP as necessary.
Respectfully submitted,
________________________________________
Leonard Cross Specialist Partner, Tax Calderwood & Harkness LLP One Liberty Plaza, 52nd Floor New York, New York 10006 Direct: (212) 555-0184
Email: lcross@calderwoodharkness.com
Billing Rate: $1,550/hr Engagement No.: 1016-00009
Appendix A — AHYDO Yield Calculation Worksheet
The following worksheet sets forth the step-by-step derivation of the yield to maturity of the New TLB and its comparison to the AHYDO trigger threshold.
Conclusion: The yield to maturity of the New TLB is approximately 178 basis points below the AHYDO trigger threshold. The Yield Test under Section 163(i)(1)(B) is not satisfied.
Appendix B — De Minimis OID Threshold Calculation
The following worksheet sets forth the derivation of the de minimis OID threshold under Treas. Reg. § 1.1273-1(d) and its comparison to the actual OID on the New TLB.
Conclusion: The OID of $7,000,000 is less than the de minimis threshold of $12,250,000. The OID is de minimis for federal income tax purposes.
Appendix C — Comparison Table: Constant-Yield vs. Pro Rata OID Deduction Methods
The following table sets forth the estimated year-by-year OID deduction under each of the two available methods. Amounts are illustrative and are based on the assumed all-in yield described in Appendix A; actual constant-yield amounts will be finalized at closing based on the definitive economic terms of the New TLB.
Present value comparison (at 6.14% discount rate, illustrative):
• Constant-yield method: approximately $5,375,000 (PV of deductions)
• Pro rata method: approximately $4,690,000 (PV of deductions)
• Timing advantage of constant-yield election: approximately $685,000 in present-value terms
Note on interaction with amortization schedule. Pro rata deductions under the default de minimis rule are allocated in proportion to principal repayments. Because the New TLB amortizes at $1,750,000 per quarter (aggregating $7,000,000 per year, or 1.00% of par) with a $651,000,000 balloon at maturity, approximately 93% of the pro rata OID deduction is deferred to FY2029. The constant-yield election under Treas. Reg. § 1.163-7 eliminates this deferral and spreads the deduction ratably (with modest compounding) over the 7-year term.
This memorandum is confidential and constitutes attorney work product prepared in anticipation of the FY2022 federal and state tax filings of Verimark Hospitality Group Inc. It is not intended for delivery to, or reliance by, any third party. Any tax analysis herein is based on the Internal Revenue Code, Treasury regulations, published rulings, and case law in effect as of the date hereof, all of which are subject to change (potentially with retroactive effect). No opinion is expressed as to any matter not specifically addressed herein.
TO: | Ian Blackwood, Responsible Partner, Banking & Finance
Sophie Tremblay, Lead Associate, Banking & Finance
FROM: | Leonard Cross, Specialist Partner, Tax
DATE: | July 18, 2022
RE: | U.S. Federal Income Tax Analysis — Original Issue Discount and AHYDO Considerations in Connection with the $700,000,000 Senior Secured Term Loan B Refinancing by Verimark Hospitality Group Inc.
ENGAGEMENT: | 1016-00009
CLIENT: | Verimark Hospitality Group Inc. ("VHG")
Term | Description
Principal Amount | $700,000,000
Issue Price | 99.00% of par (1.00% OID)
Net Funding Amount | $693,000,000
OID (dollar amount) | $7,000,000
Stated Interest Rate | Adjusted Term SOFR + 375 bps (SOFR floor of 0.50%)
Illustrative All-in Rate at Signing | ~6.14% p.a. (1-mo. Term SOFR 2.29% + 10 bps CSA + 375 bps)
Maturity Date | July 21, 2029 (7-year tenor)
Amortization | 1.00% p.a. ($7,000,000/yr; $1,750,000/qtr)
Balloon at Maturity | $651,000,000
Closing Date | July 21, 2022 (simultaneous sign-and-close)
CUSIP | 92347LAB8
Line | Item | Value
1 | Principal amount (stated redemption price at maturity) | $700,000,000
2 | Issue price (99.00% of par) | $693,000,000
3 | OID (Line 1 − Line 2) | $7,000,000
4 | Quarterly amortization | $1,750,000
5 | Balloon payment at maturity | $651,000,000
6 | Term to maturity | 7.00 years
7 | 1-month Term SOFR at issuance | 2.29%
8 | SOFR credit spread adjustment | 0.10%
9 | Applicable margin | 3.75%
10 | All-in coupon (sum of Lines 7–9) | 6.14%
11 | Incremental yield from OID amortization | ~0.15%
12 | Effective yield to maturity (Line 10 + Line 11) | ~6.29%
13 | Mid-term AFR (July 2022, annual compounding) | 3.07%
14 | AHYDO spread over AFR | 5.00%
15 | AHYDO trigger threshold (Line 13 + Line 14) | ~8.07%
16 | Margin of safety (Line 15 − Line 12) | ~178 bps
Line | Item | Value
1 | Stated redemption price at maturity | $700,000,000
2 | De minimis rate | 0.25%
3 | Complete years from issuance to maturity | 7
4 | De minimis threshold (Line 1 × Line 2 × Line 3) | $12,250,000
5 | Actual OID on the New TLB | $7,000,000
6 | Excess of threshold over actual OID (Line 4 − Line 5) | $5,250,000
Fiscal Year | Constant-Yield Method | Pro Rata Method
FY2023 | $950,000 | $70,000
FY2024 | $980,000 | $70,000
FY2025 | $1,000,000 | $70,000
FY2026 | $1,020,000 | $70,000
FY2027 | $1,015,000 | $70,000
FY2028 | $1,020,000 | $70,000
FY2029 | $1,015,000 | $6,580,000
Total | $7,000,000 | $7,000,000

CALDERWOOD & HARKNESS LLP

MEMORANDUM

Record

Parties

Dates

Amounts