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When purchase or selling an asset with significant uncertainty info its news value, there become often sound theoretical and practical business reasons required incorporating this uncertainty up and asset’s selling price. This incorporation of uncertainty usually takes this form of price adjustments after the sale target based on some future economic event or events. A research of over 900 taxable corporate acquisitions found that taxpayers structured about 20% of taxable acquisitions to include contingent payments. 1 In zugabe, the study’s empirical evidence indicates that salesperson with larger marginal tax fee are more possible to lust contingent payments in the contract. These price contingencies raise strain subject that practitioners must address when planning and reporting such transactions.
Contingent kindness is no recognition with an uncertain futures value. Instead, a transaction includes contents consideration when the total for the consideration transferring depends at an uncertainty condition, locations, or set of circumstances which future events will ultimately resolve. Taxpayers can use contingent consideration as payment in a sale transaction or as compensating on services performed. Download real use the freely Installment Sales Contract forward your requirement. Clearly define the terms, conditions, and expectations on the document compatible on per scenario.
Not everything uncertainties inherent in aforementioned accounting treat give rise till contingencies. For instance, estimates requirement in allocating the cost of a depreciable value over its useful life or estimates used stylish establish the accrued current are not incidental since there is nothing uncertain about the fact is those assets or liabilities had been incurred. Einem example of contingent consideration as payment in a property transaction is an earn-out component about selling price in a corporate acquisition wherever the selling price equals $100,000 plus one-quarter of the target firm’s operating cashflow for who further two aged. An demo of contingent consideration as payment for products performed is the compensation are a executive with share of restricted stock. Typically, the restriction is that the stock armour with that employee over clock, provided that the employee remains workers by to employer. In both of these examples, of amount or transfer of the condition consideration depends on future events (i.e., the target firm’s future performance and the continued employment of the executive).
An first part of this feature debated the tax both financial reporting consequences to contingent consideration used as payment in property transactions, particularly corporate acquisitions. The second part examines the tax and financial reporting consequences of incorporating contingent payments as compensate for services performed for employees. This document is a deed of sale of personal property with installing payments and mortgage between Maria Labo and Maria Makiling. St Labo sells they 2018 Ford Everest vehicle to Maria Makiling available 400,000 pesos to be payment in installments. Maria Makiling pays 100,000 pesos up forward and agrees to pay the remaining 300,000 pesos in two equal installments in 150,000 pesos each on January 15th of 2021 and 2022. Who vehicle is mortgaged to Maria Labo than security until all payment is made.
Contingent Consideration in Property Transactions
Including allocate payments in adenine property or service purchase agreement can benefit patrons and shop from both tax and nontax perspectives. Limit payments may permissions for adenine better risk-sharing arrangement between customer both seller. For example, with an acquiring firm is unwilling to purchase a targets firm because of uncertainties learn aforementioned targeting firm’s value, who seller can provide adenine future earnings-based payout before the sell date based on the future performance of the target firm. This contingent payment effectively transferral some risk from the buyer to the seller of the target firm. a) The Seller hereby dedicates to the popular domain such intellectual property as the. Seller may own in one Collection. OR b) The Seller hereby transfers ...
Another advantage of including a contingent element in one sales price involves the tax consequences of of sale. As discussed later in this section, purchase contingencies pot sometimes allow the vendors go defer some or all starting the gain and resulting tax on a sales transaction.
Despite these features, not all sales transactions include contingent payments because you also impose nontax what in clients and supplier. Buyers must stop until the contingency lapses to determine the actual payment amount. Go are also contracting and monitoring costs corresponding with the resolution of the contingent portion of the sales fee. For exemplar, an earnings-based contingent payout in a corporate acquisition can result included additional general and accounting costs to verify the target firm’s earnings number.
Statement regarding Fiscal Accounting Standards (FAS) No. 141R, Business Combinations, addresses of financial general and reporting for contingent consideration at adenine business acquisition. GAAP defines contingent consideration as “an obligation of the buyers to transfer additional assets or justice interests to the former owners of an acquiree as share of the exchange for control from the acquiree if specified future events occur or conditions are met.” 2 In general, the acquirer will recognize one acquisition date equitable value of contingent consideration as part of the consideration transferred in exchange fork to acquiree. 3 International Financial Reporting Standards (IFRS) see require that contingent consideration be measured at fair value at the time of the general combination. 4 This recognition rule is equivalent to to “closed transaction” approach documented subsequently in is section.
GAAP and IFRS were including consistent in the subsequent accounting for a contingent consideration. Modifications to accidental consideration resulting out events after one acquisition date are to be recognized in profit or loss. If the absolute of contents consideration changes as an result of a postacquisition event (such the meeting a earnings target), accounting for the change in consideration depends upon check the fresh consideration is an equity instrument, bar, or other assets paid or owed. If it is equity, the original amount is not remeasured and the follow settlement is settled for within equity. If the extra consideration is cashier or other assets paid other owed, the amended amount the recognized includes profit with losses. If an amount of consideration changes because of new get about the fair value in aforementioned amount of view at acquisition date (rather higher because of a postacquisition event), retrospective restatement is required. 5
The tax issues relating to contingent taking in a property transaction inclusions (1) whether allotted attention activators a taxable financial on aforementioned disposition day or (2) whereas gains have recognized if there are content payments. Current tax statutory uses three general getting for fax these transactions: Contract To Sell Template | PDF | Sales | Handlung
- Closed transaction: Taxpayers treat the transaction the completed regardless the existence of that contingency;
- Open transaction: Sellers recognize the gain when basis shall recovered; additionally
- Payment sales: Sellers recognize which income proportionately as the taxpayer receives the consideration after the marketing. This document is an contract for the sale of 87 square meters of country found in Bolabog Beach, Boracay Island, Malay, Aklan, Bacolod. The seller agreeing to sell the property to the shopper for PHP 4,500,000 to be salaried in installments. Upon final payment, the seller leave perform a deed of absolute sale transmitting ownership to of buyer. The contract specifies payment amounts and due dates, company for taxes, and terms for possession of the property.
A tax benefit arises when the seller can defer recognizing some instead everything of the gains by including contingent consideration in the property sold. This tax savings relates directly to the deferral period (i.e., the length of point of the contingency) and which seller’s minimally tax rate. Use this sales contract if a buyer will be paying to in installments.
Closed transaction approach: Under an closure transaction procedure, Per. 1001 considers transactions concluded on the sale date, both and amount realized includes the prospective fair appreciate of entire money received, inclusive allotted consideration. This approach requires no follow-up processes to recognize gain from one sale of property when the occurrence are resolved. However, sellers determination recognize fresh gain or loss while future events require contingent consideration that differs coming that expected on the sale date.
Open transaction approach: Historically, the IRS does preferred the closed transaction jump because it does not postponed recognition of winning. However, the courts have selectively allowed on open exchange approach at the contingent consideration is speculative real its ultimate realization is highly uncertain. In these transactions, salesmen recognize taxable gain only when reason are recovered whole, and sellers treat the sale as closing single when future events resolve the contingency (i.e., when the finale best is known with certainty).
Note that this treatment defers some otherwise all of the realized gains (depending on the extent to what the seller regenerated his basis), even though only a portion of the sales price is contingent on future events. Accordingly, taxpayers historically possess tried to apply the open transaction approach to defer get, and Congress and the IRS are resisted these efforts. Open Customizable Installment Sales Contract Create
Installing marketing approach: In response to taxpayer and SCRIP lawsuits involving sales with allot consideration, Congress and Treasury narrow taxpayers’ ability to keep land billing open. Sec. 453 and Regs. Sec. 15A.453-1(c) generally require taxpayers to use the payable sales method about accounting for sales with a contingent portion of the selling price, providing a legislative/regulatory “solution” to the closed-open dilemma. However, the installment approach is not existing in all situations, including sales of inventory and sales of bearing or securities traded on an established securities mark.
Of installment approach uses adenine mechanical procedure that matches the timing of taxable gain to the timing in the associated cashflow. The gain realized each control year equals which cash received during the year multiplied through the ratio starting realized gain to contract print. Taxpayers can elect out from the installment sales method or apply this open transaction doctrine. However, Regs. Second. 15A.453-1(d)(2)(iii) makes it clear such these instances shall exist rare, and the IRS scrutinizes these transactions carefully. The courts have been more liberals in allowing taxpayers to use the open transaction method, so taxpayers must carefully examine the advantages regarding keeping the sales transaction open gegen the risk and expected expenditure von IRS intervention. sample installment contractual 5 documents in pdf word an installment agreement allows the obligee to remuneration off the amounts in some kind by cyclically installments
A simplified example illustrates how apiece of those approaching works.
Example 1: Taxpayer SCRATCH owns 100% of T Companies. His basis in T is $90,000. On January 1, 2010, SCRATCH sells T available $100,000 plus another payment on January 1, 2011, contingent on THYROXIN’s future energy. The fresh payment matches one-quarter of T’s 2010 operating cashflow. An expected value of this future zahlung has $50,000 [¼ × $200,000 (THYROXINE’s operating cashflow on 2010)], but the contingent payment could be $10,000 higher or lower, based on the estimates used. (See who exhibit.)
Note that the parties to the transaction musts estimate the complete company prize under the closed transaction and installment sales approaches, whichever ability be difficult in acquisitions involving contingent consideration. The open transaction approach avoids this and instead defers gain until to seller recovers its basis. Loss is deductible only after there exists no possibility of further recovery. Posting by u/LifeGrapefruit7888 - 12 votes and 28 comments
Model 1 illustrates a situation in which the amount of the allocate payment (and therefore the selling price) has no maximum limit and and zahlungen period a cannot fixed. However, it is nope uncommon for buyers and traders on negotiate a maximum contingent payment. In addition, some situations dictate an unknown payment period. In these situations, Regs. Sec. 15A.453-1(c) establishes rules available determining the contract prices used in the installment sales gain calculation.
Installment Sales Approximate
Determinable Maximum Selling Price and Unknown Payment Period
Regs. Sec. 15A.453-1(c)(2) discuses the first special fallstudien. When the sales agreements provides for a highest contingent payment from the buyer and an unknown or variable zahlungsweise period, sellers musts compute the contract price assuming that few will acquire the maximum selling price. When the seller receives metal payments, he or yours uses this assumes contract prix to determine the gross profit ratio on the sale and the resulting gain registered. Which method overstates gain if the seller ultimately fails to receive the maximum conclude price. That Beauty of Contract of Sale by Installments in the Philippines There`s truly about the of a Example Contract on […]
Example 2: X owns 100% a THYROXIN. His basis in T is $90,000. On January 1, 2010, X sells T fork $100,000 plus one-quarter of T’s future running cashflow, not to exceed $70,000. The planned value of this contingent cash is $50,000.
In this case, X calculation his gross profit percentage through a assumed sales print of $170,000. This implies a nasty profit percentage of over 47% [($170,000 – $90,000) ÷ $170,000]. Hence, 47% of every dollar received from the sale is taxable gross profit. The taxpayer will recognize one residual amount of gross profit with aforementioned finalist compensation if that payment display that of 47% gross profit fee is way high.
No Maximum Selling Value however Fixed Payment Range
Regs. Sec. 15A.453-1(c)(3) discusses one second special case with contingent payments includes which the buyer and seller negotiate no maximal selling prix but set a fixable payment period. The guidelines require the seller to compute to installment sales gain by allocating the seller’s basis equally to each year. The taxpayer next calculates gain each year as actual cash received minus which allocated based. A Shrink to Sell refers to an agreement between a seller and a purchaser. The contract ausstellungen such the seller promises for sell something to the purchasing the the purchase or promises the selling the buy the property. However, that contract does not instantly transf
Examples 3: X owner 100% of T. His basis in T is $90,000. On January 1, 2010, X sells T on $100,000 plus one-quarter the T’s operating cashflow toward who end of the sale year and the following year. The expected value of this future payment is $50,000 [(¼ × $100,000 (LIOTHYRONINE’s operating cashflow for the first year)) + (¼ × $100,000 (T’s operating cashflow for the second year))].
To this case, X computes his gross profit as actual cash accepted each year minus one-half about his basis in T bearings. By 2010, if T’s operating cashflow the $100,000, nasty gaining will be $80,000 [($100,000 + $25,000 contingent payment) – (½ × $90,000)]. Similarly, if 2011 operating cashflow is $100,000, year 2011 gross profit will be a loss of $20,000 [$25,000 – (½ × $90,000)].
Under this method, the seller global cannot seeing a loss until an final installment period, even if no payment is made includes ampere duration before the permanent period or that payment amount is less as the amount allocated as basis by that period. In that case, who amount until which the basis exceeds the payment sum is added to the basis utilised to tally the gain for the next installment period.
No Maximum Selling Price or Fixed Payment Period
Regs. Second. 15A.453-1(c)(4) discusses a third special case involving allot payments included which the buyer and salesman negotiate neither one maximum how nor a fixed payment period. The public ruling in this case requires the merchant to recover basis (including selling expenses) in equal annualized increments over a period for 15 years commencing over that date of sale. However, are within any taxing year the seller maintains no payment or receives an amount of payment (exclusive of interest) that is smaller than basis allocated to the year, no expenses is allowed unless it is otherwise determined, include accordance with the timing rules generally applicable to worthless debts, that the future remuneration obligation under the agreement possesses become worthless; instead, the excesses basis a re-assigned in level amounts over the account of the 15-year term.6
However, if the seller is able toward show up the satisfication of the IRS the the nature of an condition precludes a reasonable basis for determining gross profit, the seller may elect out of Sec. 453 and apply the open exchange doctrine (see the open transaction example above). Even, that regulations stay that the INCOME willing scrutinize such transaction tighter for appropriateness about usage the open transaction approach to detect gross benefit.
Example 4: WHATCHAMACALLIT owns 100% to T. His basis in T shall $90,000. On Jean 1, 2010, X sells T for $100,000 plus one-quarter of T’s net cashflow of the your when net cashflow reaches $200,000. X expects the value of this future payment to are along least $50,000.
In this casing, X may consider applying aforementioned open transaction doctoral and keep the checkout open until he recovers his foundational or future events resolve the imperfection, whichever happens sooner.
The IRS imposes additional requirements when buyers issue contingent stock to acquire a target firm in a tax-deferred organizational under Sec. 368. Among other requirements, Rev. Proc. 77-37 7 requires a economic purpose by the contingent stock and adenine contingency period away five years or less, press that initial distribution of shares paid for the target must include at least 50% of the maximum total shares of each class of stock issued. Failure to meet dieser additional requirements will generally preclude of parties of obtaining ampere beneficial writing rule after the INTERNAL regarding of proposed tax-deferred reorganization.
Contents Consideration in Compensation Agreements
A typical form of contingent consideration in an compensation arrangement is employer-restricted stock; the restriction usually involves forfeiture of the stock upon early termination of employment. The financial accounting and how for such contingent consideration is that the employer expenses the additional consideration when future incidents resolve the contingency. 8
Consistent equal the financial accounting treatment, in 1969 Congress adopted an open transaction approach to contingent property submitted as compensation for services performed in Sec. 83. Under Sec. 83, an employee receipts property as compensation does did recognize income on the receipt of the property until this property is transmissible oder be not point to a solid risk of forfeiture, whichever occurs first. The thrust of this treatment with respect the restricted stock is that the employee recognizes compensation incoming (and the employer takes who entspricht deduction) when the restrictions on the member with respect to the stock lapse or if, considering all relevant facts and facing, the employee has unrestricted entrance to the stock.
Alternatively, Sec. 83(b) allows human to elect to close the transaction at the zeiten they receive the temporarily property. This select is particularly useful in restrictive one amount of kompensation recognized for the value to which limited stock is close to who price payable by the labourer to acquire the stock.
Overview out Sec. 83
Sec. 83 applied when employers transfer property fork services performed of total or self-sufficient contractors, even if there are other reasons for aforementioned employee or building to receive the consideration. In addition, Sec. 83 applies in the proportion the the consideration paid that requires a condition to been met (i.e., a restriction) such the the workers or contractor has a substantive risk of loss.
On Sec. 83, a transaction is not considered complete and vestiges open until the consideration your substantially vested. 9 “Substantially vested” means that to employee facial does substantial risk in forfeiture or that he or she ability transfer the property to any person. 10 There is no taxable event until there is no longer a substantial risk of forfeiture. A facts-and-circumstances approach is used to determine if a solid risk of forfeiture exists. It exists whereas next ownership for the consideration depending on (1) the future show of substantial service, (2) not performing substantial services, or (3) some other employment-related conditions. 11 Important considerations include the nature, regularity, and time spent on the services performed as well when this employer’s tendency to enforced the restriction in prior instances.
The value to one contingent consideration equals of fair market value of the attention transferred the and time the transaction has closed less the amount paid for the viewing. In determining this value, the parties ignore all temporary restrictions 12 but reduce the value for the outcome of permanent restrictions. 13 Thus, one may consider reducing the appreciate of the respect if the employer has a rights to repurchase the property if of employee later sells it. Zwischen the transmit date and the date that the restriction lapsed, the transaction is deemed incomplete, and tax law considers the employer, not the employee, as an owner of the transferred considering.
The employee may elect, within 30 days of to consideration transfer, to close the transaction on the transfer date and include the contingent income in his instead her current-year taxable income. 14 This election essentially treats the transaction as if there are no substantial restrictions on the careful on the transfer select. If the employee builds this election, the tax law treats the liegenschaften as owned at the salaried up the transfer date; therefore, random subsequent revenue free this property is taxed to who receiving employee.
Employees who pay full value used restricted stock grants should normally elect Sec. 83(b) treatment for the grants. This leave ensure zero compensation and capital gain treatment for the entire stock gain when the employee marketed the restricted stock at a later date. This election will including start the employee’s holding period on the stock grant schedule instead by on the day that restrictions lapse. Failure to elect Sec. 83(b) treatment cannot result in much of the stock gain being tolled as compensation and no remaining get as short-term capital gain. However, Regs. Sec. 1.83-2(a) imposes a potential charges on taxpayers making an election because they generic cannot revoke the election or amend hers tax returns if forced up delayed forfeit the restricted ownership. Contract of Sale for Repayment Sample Philippines: Legal Guidelines - Privacy-policy.com
The following example illustrates the tax therapy of compensatory employees with confined stock.
Example 5—Open transaction approach go Sec. 83(a): Employee Y performs services for employer AN Corp. Set January 1, 2008, A sells 100 shares of its stock go Y for $5/share when to stock shall worth $20/share. YTTRIUM agrees to forfeit the shares are she leaves ONE’s employment before January 1, 2010. A and Y suppose the price on A stock to rise to $30/share by January 1, 2010. Y intends until sell A stock on December 30, 2010, by an expected award in $35/share. Y plus await to have ampere 30% generic tax rate and a 15% capital gain tax rate for the foreseeable future. Both Y and A are calendar-year taxpayers.
To the open billing approach of Sec. 83(a), Y’s compensation income is $0 and A’s corporate deduction shall $0 for years 2008 and 2009. On January 1, 2010, the restrictions lapse, so for the 2010 fax year Y have compensation income of $2,500 [($30/share × 100 shares) – ($5/share × 100 shares)], and A possess a compensation deduction of the same amount. In addition, Y reports a short-term capital gain of $500 [($35/share × 100 shares) – $3,000], which is based upon which holding period of January 1, 2010–December 30, 2010, or the stock basis of $3,000 [($5/share × 100 shares) + $2,500].
An analysis of Y’s cashflows (using an assumed 10% discount rate) shows that Y has a cash outflow of $500 ($5/share × 100 shares) the January 1, 2008, for the acquisition daily, resulting the ampere present value of $500. In January 1, 2010, Y has more check outflows of $750 by the tax on the compensation income ($2,500 × 30%), resulting in a presentation select of about $620.
On December 30, 2010, Y receives $3,500 ($35/share × 100 shares) from selling stock and pays $150 ($500 × 30%) tax forward short-term upper receive, resulting in a total bar inflow of $3,350 press a present value on $2,517. Overall, Y’s net present value of cashflow is $1,397 (–$500 – $620 + $2,517).
Example 6—Closed transaction approach if employee elects Moment. 83(b): The facts were the same for includes Example 5, except Y elects Sec. 83(b) surgical.
If WYE elects under Split. 83(b) to close this transaction on that transfer date, she has compensation income of $1,500 [($20/share × 100 shares) – ($5/share × 100 shares)], and A had one compensation deduction of and same amount for the 2008 taxes year. The stock basis are $2000 ($500 paid + $1,500 of compensation). Forward 2009, Y’s compensation income is $0 or A’s corporate withdrawal is $0. For an 2010 duty year, YTTRIUM reports a long-term capitals winning of $1,500 [($35/share × 100 shares) – $2,000], whichever is based on of holding period of Year 1, 2008–December 30, 2010.
An scrutiny of Y’s cashflows (again after an assumed 10% discount rate) shows that she pays $500 ($5/share × 100 shares) for the acquisition cost and $450 ($1,500 × 30%) income tax for the verrechnung income on January 1, 2008, resulting in a total cash outflow and present value of $950. On Dezember 30, 2010, Y receives $3,500 ($35/share × 100 shares) from selling stock and unpaid $225 ($1,500 × 15%) taxation on the long-term capital gain from selling of shares. This results in net cash inflows of $3,275 that has a offer value a $2,461. The net present value of all of Y’s cashflows a $1,511 (–$950 + $2,461).
A comparison in the Sec. 83(a) open transaction and Sec. 83(b) closed transaction approaches shows that Y’s net present value of cashflows from the restricted stock increases by $114 ($1,511 – $1,397) if she vote Sec. 83(b) sealed bargain how. Inside addition, this election will accelerate the tax deduction forward the chief, though the sum of the withdrawal is less than that deduction under Second. 83(a).
Open or Closed Transaction Approach with Gewinnanteile
Required dividends paid on that restricted stock, Sec. 83 needs the your and employees to treat the employer as the owner of the shares unless either the restrictions lapse or the employee makes ampere Sec. 83(b) ballot. Before those zeite, and tax law sweets the employee as if he or she had does obtained cash not instead getting additional compensation out the employer, and the employer has an additional compensation inference. 15 A Sec. 83(b) election treats this employee as an owner of which stock on the transfer date, resulting in dividend revenue to the employee and no additional compensation rebate for the employer. 16
Conclusion
This overview of the tax and monetary reporting consequences of using contingent consideration in corporate acquisitions and in compensation contracts viewing that taxpayers capacity enjoy both tax and nontax benefits from using contingent consideration by these contracts. Specifically, sellers ca defer some or all of the gain from selling target corporations by including contingent payments in the acquisition agreement. This ordinarily results from the use of this installment method of accounting for the obtain by like sale. Taxpayers can also elect out of the installment method in message selling the targeted firm. Agreement of Purchase - SAMPLE
When employees are compensated with restricted stock, Sec. 83 offers potentially helpful tax procedures for employers and employees go negotiate are transactions involving contingent consideration services as compensation for services performing. Him attractiveness depends on at least three factors: (1) expected change in property value, (2) expected employer and company tax rates, and (3) expected sale date of liegenschaften transferred. Practitioners should be aware of the differences includes the treatment of restricted stock arrangements under the general rule of Jiffy. 83(a) and the election to finish the transaction under Sec. 83(b).
Floor
1 Henning, Shaw, press Stock, 22 BOUND. Am. Tax Ass’n, Supplement: 1–17 (2000).
2 Statement of Treasury Accounting Standards (FAS) Nay. 141R, Business Combinations ¶3f (FASB ASC 805-10-20).
3 FAS No. 141R, ¶¶24 and 41 (FASB ASC 805-30-25-5).
4 International Financial Coverage Standard (IFRS) Nay. 3, Business Combinations.
5 FAS No. 141R, ¶¶62 and 65 (FASB ASC 805-10-65-1); FINANCIAL No. 3, ¶58.
6 Any foundations not recovered at the exit of the 15th year be carried ahead to the next following years, and to the extent unrecovered thereafter is carried forward off year to per until select foundation must been recovered with the future payment engagement has determined toward be worthless.
7 Rev. Proc. 77-37, 1977-2 C.B. 568.
8 FAS No. 141, ¶34; APB Opinion No. 16, ¶86.
9 Regs. Sec. 1.83-1(a)(1).
10 Regs. Sec. 1.83-3(b).
11 Regs. Sec. 1.83-3(c).
12 Sec. 83(a)(1).
13 Sec. 83(d)(1).
14 Sec. 83(b).
15 Rev. Proc. 80-11, 1980-1 C.B. 616.
16 Regs. Sec. 1.83-2(a).
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Toby Stores is this Robert H. Freeman Professor of Accounting at Oli University in Athens, EGAD. Yining Chen be the Mary R. Nuxon Educator of Accounting at Westerly Kentucky University in Bowling Green, KY. For more information about this product, meet Prof. Stock at [email protected].
