Exhibit 10.7
CORPORATION TAX ALLOCATION
AND INDEMNIFICATION AGREEMENT
THIS CORPORATION TAX ALLOCATION AND INDEMNIFICATION AGREEMENT (the
"Agreement") is made and entered into this 26th day of September, 1997 between
PAPER WAREHOUSE, INC., a Minnesota corporation (the "Company"), and YALE X.
XXXXXXXX and XXXXX X. XXXXXXXXX (collectively, the "Stockholders") (the Company
and the Stockholders are hereinafter referred to individually as a "party" and
collectively as the "parties").
W I T N E S S E T H
WHEREAS, the Company contemplates an initial public offering of its Common
Stock in order to raise additional equity capital for the purpose of expanding
its stores, reducing indebtedness of the Company, making payment of an S
Corporation distribution and other corporate purposes (the "Public Offering");
WHEREAS, the Company distributed on September 18, 1997 a dividend to the
Stockholders in an aggregate amount equal to the Company's estimate of its
accumulated taxable income from the time of its S Corporation election through
the first six months of fiscal 1997 to the extent such taxable income had not
previously been distributed (the "First Dividend");
WHEREAS, upon completion of such Public Offering, the Company plans to
distribute a second dividend (the "Second Dividend") (collectively with the
First Dividend, the "Dividend") to the Stockholders in an amount equal to the
balance of any accumulated taxable income from the date of the First Dividend
through the close of the Short S Year (as hereinafter defined);
WHEREAS, the Company and the Stockholders have entered into this Agreement
as a condition to the foregoing distribution and the contemplated Public
Offering;
WHEREAS, from its inception through January 31, 1993, the Company was taxed
as a C corporation (as defined in the Code), and the Company became an S
corporation (as defined in section 1361 of the Code) on February 1, 1993 and
will continue to be an S corporation until the Termination Date (as hereinafter
defined), after which it will again be taxed as a C corporation;
WHEREAS, the Stockholders currently are the only stockholders of the
Company, and will continue to be so until immediately prior to the effectiveness
of the Public Offering; and
WHEREAS, the Company and the Stockholders wish to provide for a tax
allocation and indemnification agreement in connection with the Company's
termination as an S corporation.
NOW, THEREFORE, the parties agree as follows:
ARTICLE 1
DEFINITIONS
1.1 Definitions. The following terms, as used herein, have the following
meanings:
"C Short Year" means that portion of the S Termination Year of the Company
defined in Section 1362(e)(1)(B) of the Code.
"Code" means the Internal Revenue Code of 1986, as amended.
"S Corporation Period" means the period commencing February 1, 1993 and ending
on the Termination Date.
"S Corporation Taxable Income" means the taxable income of the Company from all
sources during the S Corporation Period.
"S Short Year" means that portion of the S Termination Year of the Company
defined in Section 1362(e)(1)(A) of the Code.
"S Termination Year" shall have the meaning set forth in Section 1362(e)(4) of
the Code.
"Termination Date" means the date on which the S corporation status of the
Company is terminated pursuant to section 1362(d)(l) of the Code.
ARTICLE 2
ELECTION TO TERMINATE; S TERMINATION YEAR
2.1 TERMINATION OF S STATUS. The parties intend to terminate the
Company's status as an S corporation by electing to do so under Code Section
1362(d)(l).
2.2 EFFECTIVE DATE. Pursuant to Section 1362(d)(1) of the Code, the
election to terminate the Company's status as an S corporation shall be
effective on the date immediately preceding the date of the Public Offering
which shall be the "Termination Date."
2.3 S TERMINATION YEAR. The Company's fiscal year in which the S
corporation status of the Company is terminated will be an S Termination Year
for federal tax purposes.
2.4 S SHORT YEAR. Pursuant to Section 1362(e)(1) of the Code, the S
Termination Year of the Company shall be divided into two short taxable years:
an S Short Year and a C Short Year. The S Short Year of the Company shall be
that portion of the Company's S Termination Year beginning on the first day of
such fiscal year and ending on the day immediately preceding the Termination
Date. For federal income tax purposes, the Company will be treated as an S
corporation during its S Short Year.
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2.5 C SHORT YEAR. Pursuant to Section 1362(e)(1)(B) of the Code, that
portion of the S Termination Year of the Company beginning on the Termination
Date and ending on the last day of the 1997 fiscal year, shall be the C Short
Year of the Company. For federal income tax purposes, the Company will be taxed
as a C corporation during its C Short Year.
ARTICLE 3
ALLOCATION OF INCOME
3.1 ALLOCATION ELECTION. The Company intends to allocate tax items to its
S Short Year and C Short Year pursuant to the method contained in Section
1362(e) (3) of the Code, but may allocate pursuant to any other permitted method
under Section 1362(e) of the Code.
ARTICLE 4
TAXES
4.1 LIABILITY FOR TAXES INCURRED DURING S CORPORATION YEARS INCLUDING S
SHORT YEAR. The Stockholders, severally and not jointly, covenant and agree
that they shall pay any and all taxes attributable to their allocable shares of
taxable income of the Company they are required to pay for all taxable periods
(or that portion of any period including the S Short Year) during which the
Company was an S corporation.
4.2 LIABILITY FOR TAXES INCURRED DURING C CORPORATION YEARS INCLUDING C
SHORT YEARS. The Company covenants and agrees that the Company shall pay any
and all taxes attributable to taxable income of the Company required to be paid
by the Company for the C Short Year and all taxable periods thereafter during
which the Company is a C corporation.
4.3 COMPANY'S INDEMNIFICATION FOR TAX LIABILITIES. The Company hereby
agrees to indemnify, defend and hold harmless each Stockholder from and against
any and all losses, liabilities, obligations, damages, impositions, assessments,
fines, deficiencies, costs and expenses, including without limitation,
attorneys' and accountants' fees and expenses, with respect to all federal and
state income taxes of any kind whatsoever (computed at the highest federal
and/or state income tax rate in effect for the year of adjustment) including
interest, penalties and additions to taxes, imposed upon a Stockholder as a
result of any final determination of an adjustment (by reason of an amended
return, claim for refund, audit or otherwise) including any increase in items of
income or gain or any decrease in items of loss, deduction or credit, reported
to such Stockholder by the Company with respect to the Company's S Corporation
Period, but such adjustment or change shall not include (i) an adjustment or
change which results in an increase in an item of income or gain reported to a
Stockholder by the Company with respect to one or more of the taxable years
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falling within the Company's S Corporation Period and a corresponding decrease
in an item of income or gain with respect to one or more of the other taxable
years falling within the Company's S Corporation Period; or (ii) an adjustment
or change which results in a decrease in an item of loss, deduction or credit
reported to a Stockholder by the Company with respect to one or more of the
taxable years falling within the Company's S Corporation Period and a
corresponding increase in an item of loss, deduction or credit with respect one
or more of the other taxable years falling within the Company's S Corporation
Period. Any such payment to a Stockholder pursuant to this Section 4.3 shall be
made on a "grossed-up" basis, so that in the event any amount received hereunder
by a Stockholder constitutes taxable income to such Stockholder, the amount of
such payment hereunder shall be computed so that the Stockholder receives full
indemnification hereunder on an after-tax basis.
The Company acknowledges further that it shall be solely responsible for any
federal, state and local taxes (including interest and penalties, if any)
relating to the Built-In Gains tax imposed by Section 1374 of the Code and the
tax on Excess Passive Investment Income imposed by Section 1375 of the Code.
4.4 STOCKHOLDERS' INDEMNIFICATION FOR TAX LIABILITIES. The Stockholders,
severally (according to the percentage of the outstanding shares of the
Company's Common Stock owned by each Stockholder for the years of adjustment)
and not jointly, hereby agree to indemnify, defend and hold harmless the Company
from and against all liability with respect to all federal and state income
taxes of any kind whatsoever (computed at the highest federal and/or state
income tax rate in effect for the year of adjustment) including interest,
penalties and additions to taxes resulting from any final determination of an
adjustment (by reason of an amended return, claim for refund, audit or
otherwise) to the Stockholders' taxable income resulting in a decrease in the
Stockholders' S corporation taxable income and a corresponding increase in the
federal or state, as the case may be, income tax liability payable by the
Company. Notwithstanding the foregoing, the amount of the payments made by a
Stockholder pursuant to this Section 4.4 shall not exceed an amount, if any, by
which (i) the amount of the reduction in the federal and state income tax
liability and interest thereon of the Stockholder which results from the
shifting of S corporation taxable income to a C corporation taxable year of the
Company, exceeds (ii) all reasonable costs incurred by the Stockholder
reasonably attributable to securing such reduction in tax liability.
4.5 PAYMENTS. The Stockholders or the Company, as the case may be, shall
make any payment required under this Agreement within thirty (30) calendar days
after receipt of notice from the other party that a payment is due by such party
to the appropriate taxing authority.
4.6 SUBROGATION. The party (or parties) providing the indemnity under
either Section 4.3 or Section 4.4 (defined solely for purposes of this
Section 4.6 as the "Indemnifying Party") shall be subrogated to all rights of
recovery (the "Subrogation Claims") that the party (or parties) being
indemnified under Section 4.3 or Section 4.4, respectively (defined solely
for purposes of this Section 4.6 as the "Indemnified Party"), may have
against any person or organization in respect of the tax liabilities for
which the Indemnifying Party is providing indemnity. Such right of
subrogation shall not exceed the amount paid by the Indemnifying Party to the
Indemnified Party. The Indemnified Party shall execute and deliver
instruments and papers and do whatever else is reasonably necessary to secure
such rights of subrogation for the Indemnifying Party. The
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Indemnified Party shall provide all reasonable assistance as requested by the
Indemnifying Party in order for the Indemnifying Party to pursue the
Subrogation Claims. The Indemnified Party shall do nothing after any
Subrogation Claim arises to prejudice the rights of the Indemnifying Party.
4.7 PAYMENTS AFTER POST-TERMINATION TRANSITION PERIOD. If any Stockholder
is required to include any payment received pursuant to this Agreement after the
expiration of the "post-termination transition period" (as defined in Section
1377(b) of the Code) in computing his gross income in a tax return, other than
any payment made under Section 4.3 where the Stockholder failed to give the
Company timely notice to allow the Company to make such payment prior to the
expiration of the "post-termination transition period", then (i) the Stockholder
shall notify the Company of such inclusion in income, and (ii) in addition to
all other payments made under this Agreement, the Company shall also pay to the
Stockholder an amount which, when added to the payment so included, will place
the recipient Stockholder in the same net after-tax position that he would have
been in had the payment not been so included.
4.8 NOTICES OF AUDITS AND ADJUSTMENTS.
(a) If any Stockholder receives notice of an intention by a taxing authority to
audit any return of the Stockholder that includes any item of income, gain,
deduction, loss or credit reported by the Company with respect to the Company's
S Corporation Period, such Stockholder shall inform the Company, in writing, of
the audit promptly after receipt of such notice If any Stockholder receives
notice from a taxing authority of any proposed adjustment for which the Company
may be required to indemnify the Stockholder hereunder (a "Proposed
Adjustment"), the Stockholder shall give notice to the Company of the Proposed
Adjustment promptly after receipt of such notice from a taxing authority. Upon
receipt of such notice from a Stockholder, the Company may, by in turn giving
prompt written notice to each of the Stockholders, request that the Stockholders
contest such Proposed Adjustment. If the Company shall request that any
Proposed Adjustment be contested, then the Stockholders shall, at the Company's
expense, contest the Proposed Adjustment or permit the Company and its
representatives, at the Company's request and expense, to contest the Proposed
Adjustment (including pursuing all administrative and judicial appeals and
processes). The Company shall pay to the Stockholders on demand all costs and
expenses (including attorneys' and accountants' fees) that the Stockholders may
incur in contesting such Proposed Adjustments. No Stockholder shall make,
accept or enter into a settlement or other compromise with respect to any taxes
indemnified hereunder, or forego or terminate any proceeding undertaken
hereunder without the consent of the Company, which consent shall not be
unreasonably withheld.
(b) If the Company receives notice of an intention by a taxing authority to
audit any return of the Company that includes any item of income, gain,
deductions, loss or credit reported by the Company with respect to the period
during which the Company was a S corporation, the Company shall inform the
Stockholders, in writing, of the audit promptly after receipt of such notice. If
the Company receives notice from a taxing authority of any proposed adjustment
for
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which any of the Stockholders may be required to indemnify the Company
hereunder (a "Company Proposed Adjustment"), the Company shall give notice to
each of the Stockholders of the Company Proposed Adjustment promptly after
receipt of such notice from a taxing authority. Upon receipt of such notice
from the Company, any of the Stockholders may, by in turn giving prompt
written notice to the Company, request that the Company contest such Company
Proposed Adjustment. If any of the Stockholders shall request that any
Company Proposed Adjustment be contested, then the Company shall contest the
Company Proposed Adjustment (including pursuing all administrative and
judicial appeals and processes) at the Company's expense and shall permit the
Stockholder to participate in such proceeding. The Company shall not make,
accept or enter into a settlement or other compromise with respect to any
taxes indemnified hereunder, or forego or terminate any proceeding undertaken
hereunder without the consent of the Stockholders, which consent shall not be
unreasonably withheld.
ARTICLE 5
DISTRIBUTIONS
5.1 DISTRIBUTION OF ACCUMULATED ADJUSTMENTS ACCOUNT. Prior to the
consummation of the Public Offering, the Company's board of directors shall
declare the Second Dividend payable to the Stockholders. The Second Dividend
will be equal to the Company's estimated accumulated adjustments account (as the
term is defined in Section 1368 of the Code) (the "ALA") as of the Termination
Date. The Company agrees to pay the Second Dividend to the Stockholders
promptly following the Public Offering and that: (a) if the Second Dividend
exceeds the ALA as finally determined by the Company's accountants in the course
of preparing the Company's tax returns for the 1997 year (the "Final ALA"). such
excess shall be paid by the Stockholders to the Company, and (b) if the Final
ALA exceeds the Second Dividend, such excess shall be paid by the Company to the
Stockholders, in either case, within thirty (30) days of the date of such
determination and together with interest thereon, at the Applicable Federal Rate
(as defined in Section 1274 of the Code) in effect as of the date of such
payment, for the period from the date the Second Dividend was paid to the date
of such payment. The Final ALA shall be determined by the Company's tax return
for the Company's S Short Year in a manner consistent with prior practice.
ARTICLE 6
MISCELLANEOUS
6.1 COUNTERPARTS. This Agreement may be executed in several counterparts,
each of which shall be deemed an original, but all of which counterparts
collectively shall constitute one instrument representing the Agreement between
the parties hereto.
6.2 CONSTRUCTION OF TERMS. Nothing herein expressed or implied is
intended, or shall be construed, to confer upon or give any person, firm or
corporation, other than the parties hereto
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or their respective successors and assigns, any rights or remedies under or
by reason of this Agreement.
6.3 COST OF ENFORCEMENT; INTEREST. If, within thirty (30) days after
demand to comply with the obligations of one of the parties to this Agreement
served in writing on the other, compliance or reasonable assurance of compliance
is not forthcoming, and the other party engages the services of an attorney to
enforce rights under this Agreement, the prevailing party in any action shall be
entitled to recover all reasonable costs and expenses (including reasonable fees
of attorneys and legal assistants, whenever incurred, whether before trial or
appellate proceeding, at trial, on appeal or otherwise).
6.4 GOVERNING LAW. This Agreement shall be governed by, and construed and
enforced in accordance with the laws of the State of Minnesota, other than those
provisions relating to the conflict of laws of different jurisdictions if the
effect of the application of such provisions would be to cause the laws of a
jurisdiction other than Minnesota to apply hereto.
6.5 NOTICES. All notices and other communications required or permitted
to be given hereunder shall be in writing and shall be deemed to have been duly
given when received, if personally delivered; when transmitted, if transmitted
by electronic fax, telecopy or similar electronic transmission method; the day
after it is sent, if sent by recognized expedited delivery service; and five
days after it is sent, if mailed, first class mail, postage prepaid each case
notice shall be sent to the parties at 0000 Xxxxxxxxx Xxxxxxxxx, Xx. Xxxxx Xxxx,
Xxxxxxxxx 00000, or to such other address as any party shall have specified by
notice in writing to the other parties.
6.6 AMENDMENT AND MODIFICATION. This Agreement may be amended, modified
or supplemented only by a written agreement executed by all of the parties
hereto.
6.7 ASSIGNMENT. This Agreement and all of the provisions hereof shall be
binding upon and inure to the benefit of the parties hereto and their respective
heirs, successors and permitted assigns, but neither this Agreement nor any of
the rights, interests or obligations hereunder shall be assigned by any of the
parties hereto without the prior written consent of the other parties, nor is
this Agreement intended to confer upon any other person except the parties any
rights or remedies hereunder.
6.8 INTERPRETATION. The title, article and section headings contained in
this Agreement are solely for the purpose of reference, are not part of the
agreement of the parties and shall not in any way affect the meaning or
interpretation of this Agreement.
6.9 SEVERABILITY. In the event that any one or more of the provisions of
this Agreement shall be held to be illegal, invalid or unenforceable in any
respect, the same shall not in any respect affect the validity, legality, or
enforceability of the remainder of this Agreement, and the parties shall use
their best efforts to replace such illegal, invalid or unenforceable
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provisions with an enforceable provision approximating, to the extent
possible, the original intent of the parties.
6.10 ENTIRE AGREEMENT This Agreement embodies the entire agreement and
understanding of the parties hereto in respect of the subject matter contained
herein. There are no representations, promises, warranties, covenants, or
undertakings, other than those expressly set forth or referred to herein. This
Agreement supersedes all prior agreements and the understandings between the
parties with respect to such subject matter.
IN WITNESS WHEREOF, the parties have executed this Agreement effective as
of the date set forth above.
PAPER WAREHOUSE, INC.
By /S/ Xxxxxx X. Xxxxxx
---------------------------------
Name: Xxxxxx X. Xxxxxx
Title: Chief Financial Officer
/S/ Yale X. Xxxxxxxx
---------------------------------
Yale X. Xxxxxxxx
/S/ Xxxxx X. Xxxxxxxxx
---------------------------------
Xxxxx X. Xxxxxxxxx
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