11/23/2010
Chapter 9 - Acquisitive
Corporate Reorganizations
Concept of a “corporate reorganization” - the
exchange of an equity interest in the old
corporation for shares in the new corporation;
cf., §1001.
Effects of tax-free corporate reorganizations:
1) Corporate parties to the transaction - no gain or
loss on transfers of properties.
2) Exchanging shareholders - no gain or loss.
3) Tax attributes transferred to the acquirer.
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AcquisitiveReorganizations
(cf., Divisive Reorgs), p.415
One corporation acquires the stock or assets of
another corporation in exchange for stock of the
acquiring corporation:
1) "A" reorganization - statutory merger
2) "B" reorganization - stock/stock exchange
3) "C" stock for assets exchange, and
4) certain “triangular” variants (e.g., using
acquisition subsidiaries).
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Judicial Limitations Tax “Common Law”
2
p.415
1) “Business purpose” doctrine.
2) Continuity of interest (COI) (or ownership)
requirement.
3) Continuity of business enterprise
(COBE) requirement.
Note: a “step” or “integrated” transaction rule or
an “old and cold” rule also often applies.
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Concepts of Tax-free
Corporate Reorganizations
1) Limit on the character of the consideration
received - a proprietary interest in the acquirer.
Must be stock in the acquirer (cf., nonqualified
preferred).
2) Substantially all the transferor's properties
must be acquired, i.e., the operating “business”
must be acquired.
3) A business purpose (i.e., non-tax objective) for
the transaction must exist.
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Tax Code Provisions re
Tax-free Reorgs
p.416
§354 - no gain or loss is to be recognized upon an
exchange of shares by shareholders who are parties
to a reorganization.
g
Cf.,, §§351.
§361 - no gain or loss to the acquired corporation.
Also, §1032 for the stock issue.
§§356/357 - treatment of boot received and
liabilities assumed in the transaction.
§358/362(b) - substitute tax basis rules.
§381 - carryover of tax attributes.
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How Assure Tax-free
Reorganization Treatment?
Options:
1) IRS Private Letter Ruling – but, limited
availability, unless a “significant issue.”
- See Rev. Proc. 2010-3.
- See Rev. Proc. 77-37 re guidelines for issuing
corporate reorganization tax rulings.
Is this Rev. Proc. substantive law?
2) Law firm tax opinion letter.
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Statutory Merger or
Consolidation
p.417
Code §368(a)(1)(A).
1) Merger: Shareholders of the target corporation
receive shares of the acquiring corporation as a
result of a “statutory merger” of target into
purchaser, i.e., under local law merger statute.
2) Consolidation: mergers of two existing
corporations into a third (often new)
corporation.
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Divisive Mergers
(i.e., not “acquisitive”)
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p.418
Rev. Rul. 2000-5 – for tax-free corporate
reorganization treatment the merger must be
acquisitive,
q
, rather than divisive (i.e.,
( , subject
j to
the §355 rules).
Mere compliance with the local corporate law
merger statute (i.e., calling the transaction a
“merger”) does not constitute a merger
transaction as a tax-free corporate
reorganization.
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Mergers involving
Disregarded Entities p.419
Example: Mergers between a corporation and a
disregarded entity.
A Merger of a target corporation into a
A.
disregarded entity (e.g., LLC) is treated as a
“merger” into another corporation.
B. Merger of an LLC into a corporation does not
qualify (since only divisional assets are
transferred, presumably not all of the assets of
the transferor corp., owner of the LLC).
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Continuity of Proprietary
Interest – Quantity Test
Southwest Natural Gas Co.
p.420
Merger of Peoples Gas into Southwest.
Less than 1% of the consideration received was
paid in acquirer’s common stock. The remaining
portion was paid in bonds or cash.
Held: No “continuity of interest” results.
The stock received was not a substantial part of the
value of the property transferred.
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Rev. Rul. 66-224
p.422
50% of Consideration as Stock
Four 25 percent shareholders - A & B received cash
for their 25% interests;
C & D received stock for their 25% interests.
Held: COI requirement was satisfied.
Alternative: COI requirement is satisfied if each
shareholder received 1/2 cash and 1/2 stock (total
50% in the form of stock as the consideration for
the acquisition).
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What Stock % is Required?
P. 423
1) Nelson case (Sup. Ct – 1935) – 38% nonvoting
preferred stock OK.
2 To obtain an IRS PLR – Rev. Proc. 77
77-37
37
requires a 50% stock value issuance.
3) Reg. §1.368-1T(e)(2)(v), Example 1.
What is large firm practice re a merger opinion?
What is “stock”? Cf., “nonqualified preferred
stock” (as “boot”?).
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Other COI Issues:
p. 424
1) Remote Continuity – can assets be dropped
down into subsidiaries by Acquirer and not
violate COI requirement?
q
2) When to measure COI text compliance?
- Day before the binding contract if fixed number of
shares.
- Alternative if variable consideration, i.e., shares
are increased if Acquirer’s share value declines.
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J.E. Seagram Corp. case
Reorg. Treatment
p.425
Competing tender offers for Conoco between
Seagram and DuPont. Neither gets 50%.
DuPont then acquires the remaining Conoco shares
for DuPont stock (including Seagram shares –
purchased previously for cash).
Seagram claims a loss - but IRS is successful in
asserting that this was a reorganization (i.e.,
continuity of interest did exist).
Pre-deal trading not negating the tax-free status.
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Continuity by Historic
Target Shareholders
Kass v. Commissioner
p. 428, note 1
Squeeze-out upstream merger after a cash stock
q
in a tender offer and a p
prior 80% p
plus
acquisition
purchase of Target’s stock.
5.82 percent of the outstanding stock was not
tendered but then subjected to a squeeze-out. This
enabled acquisition of the entire business.
Held: Not a merger - even though the shareholder
received exclusively shares of Acquirer.
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Continuity of Interest (COI)
Regulations
Reg. § 1.368-1(e)(1)(i).
Disposition of stock prior to a reorganization to
unrelated
l t d persons will
ill be
b disregarded
di
d d and
d will
ill nott
affect continuity of interest into the acquirer by
exchanging party.
Requirement: exchange Target stock for Purchaser
stock to have at least 50 percent of the entire
consideration received being equity.
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Post-Acquisition Continuity
p. 430
How long must the target shareholders hold their
stock in the acquiring corporation after their
acquisition?
q
What is the impact of a pre-arranged stock sale
commitment by majority shareholders?
The COI regulations focus on exchanges between
target shareholders and the purchaser corp.
Sales of stock by the former target shareholders
generally are disregarded (unless made to P).
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Rev. Rul. 99-58
p. 431
Open Market Repurchase
Reorganization acquisition (50/50 stock & cash)
followed by open market reacquisitions of the
Purchaser’ss stock (redemptions? § 302(b)(2)).
Purchaser
302(b)(2))
The purpose of the reacquisition was to prevent
stock ownership dilution for Purchaser.
No understanding that the P share ownership by T
shareholders would be transitory.
No impact on the COI status.
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Continuity of Business
Enterprise (COBE)
p.433
Bentsen v. Phinney Corporation was engaged in
land development business and transferred
property to a life insurance company.
Shareholders received stock of insurance co.
Type of business carried on by the survivor entity
was the insurance business (acquirer).
No IRS private letter ruling re tax-free status.
Held: COBE requirement was satisfied - need not
engage in the same business – only some business
activity. Appropriate
result in tax refund suit? 19
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Rev. Rul. 81-25
p.436
Transferor Business Important
COBE requirement – per IRS:
Look to the business assets of the transferor
corporation (not the transferee corporation) to
determine whether the continuity of business
enterprise (COBE) test is satisfied in the acquisition
transaction.
Reg. § 1.368-1(d)(1980).
Must look to the transferor's historic business; no
relevance to business of the Acquirer.
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Continuity of Business
Enterprise Regulations
COBE regulations - Reg. §1.368-1(d).
COBE requires that the issuing corporation either
continue the Target
Target'ss historic business or use a
significant portion of the Target's historic business
assets.
COBE requirement is not violated if P transfers
acquired T assets or stock to (1) controlled
subsidiaries or (2) a controlled partnership.
Reg. §1.368-1(d)(4).
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Problem 1(a)
All Cash Merger
p.438
"All cash" merger - valid under state law.
Lacks continuity of interest (but does satisfy the
§368(a)(1)(A) mechanical rules)
rules).
No continuing proprietary interest exists (see
Southwest Natural Gas).
Therefore, the transaction is taxable to:
(i) Target (i.e., a cash asset sale), and (ii) its
shareholders (a §331 taxable liquidation).
Who has the liability for the corporate tax?
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Problem 1(b)
p.438
Non-Voting Preferred Stock
T shareholders receive P non-voting preferred
stock in exchange for their T stock.
The “continuity
continuity of interest
interest” rule is satisfied.
satisfied
This stock is a “proprietary interest”;
the nature of the equity interest is not considered in
an “A” reorganization.
But, cf., what result if “nonqualified preferred
stock” is received?
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Problem 1(c)
p.438
Commitment to Sell Stock
Shareholders holding 75% of Target have a binding
commitment to sell one week after the merger
transaction is completed.
completed
The only consideration received is stock and,
therefore, a tax-free merger has occurred.
But, what is the adverse impact (if any) of the postacquisition stock disposition? None (on other
25%). See Reg. §1.368-1(e)(7), Example 1(i).
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Problem 1(d)
Target Assets Sold
p.438
P sells T’s assets (after the merger and as part of
the plan) to an unrelated party and uses proceeds to
expand another P business.
The COBE requirements are not satisfied.
Reg. §1.368-1(d)(1).
A significant line of T’s business must be continued
after the merger, and T’s business is not continued
here.
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Problem 1(e)
p.438
Stock & Notes Received
Nonvoting preferred stock ($120,000) and notes
($180,000) are received in the merger.
40% of the consideration received by T
shareholders is P stock.
Is the continuity of interest rule satisfied? (see Regs.
- 40% test; 50% test under Rev. Proc. 77-37).
Nonrecognition to the shareholders - except to the
extent that they receive "boot” - again assuming no
nonqualified preferred stock.
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Problem 1(f)
p.439
P Stock Value Declines
As in (e) –stock (120,000) and notes (180,000) but
stock declines to 60,000 prior to closing. At closing
stock of 60
60,000
000 and notes of 180
180,000
000 equals 25% for
stock. Invalidate tax-free merger treatment (for the
60,000 stock)?
Reg. §1.368-1T(e)(2)(i) says value deal measured on
the last day before the binding contract – here 40%
& acceptable for continuity of interest test.
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Problem 1(g)
p.439
More Non-Stock Consideration
Nonvoting preferred worth $100,000 is received
and bonds worth $200,000 are received. Less than
50% of the consideration received in the merger
g
consists of P stock.
Does 331/3% stock consideration represent an
adequate continuity of proprietary interest? Kass
- 5.82% not sufficient to satisfy test.
Will the boot cause taxable gain for all? Yes.
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Problem 1(h)
Convertible Debt
28
p.439
(not Stock)
Facts: Bonds issued in the exchange transaction
are convertible into P nonvoting preferred stock.
The convertibility feature of debt is to be
disregarded for purposes of applying the
“continuity of interest” rule (unless the bonds are
recharacterized as equity?).
Similarly, warrants will not be treated as stock for
this purpose.
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Problem 1(i)
p.439
Larger $ Stock Consideration
75% of shareholders owning 1/3 of the stock receive
the notes worth $100,000 and 25% of the
shareholders owningg 2/3rds of the stock receive P
stock worth $200,000.
The “continuity of interest” rule is satisfied.
Continuity measurement is by reference to the prorata values of the consideration received and not to
the shareholder numbers.
See Rev. Rul. 66-224 (p.422).
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Problem 1(j)
p.439
“Old & Cold” Cash Purchase?
70% of T stock was acquired by P for cash five
years ago. T merges into P and the 30 percent
minority shareholders of T receive 20 percent stock
and 80 percent cash.
Is this a “creeping A” acquisition?
70 percent of the T stock is “old and cold”.
If P's holdings are counted - 70% continuity, plus a
small percentage for the minority (6%) and a
qualifying “A” reorg. does occur.
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Problem 1(k)
p.439
Step Transaction & Cash?
A acquired 80 percent of T stock six months ago in a
tender offer for $240,000 cash. T merges into A and
the remaining shareholders receive $60,000 of P
stock in exchange for their T stock.
The 80% stock interest (for cash) is not "old and
cold”.
Only a 20% “continuity of interest” results and,
therefore, gain or loss recognition occurs to the
minority shareholders.
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The “B” Reorganization Stock-for-stock Exchange
Code §368(a)(1)(B).
Stock-for stock exchange (completed at the Target
shareholder level):
Step 1. A stock exchange occurs between the
Target shareholders and the Purchaser
Corporation (for P Shares).
Step 2. The acquired Target Corporation becomes
a subsidiary of the Purchaser as a result of the
stock acquisition transaction.
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Chapman case
p.439
ITT/Hartford “No boot in a B”
Motion for Summary Judgment:
ITT as the Purchaser of Hartford acquires 8% for
cash and then an 80% exchange of “stock
stock for stock”
stock
occurs.
Held: Cannot exclude the prior acquisition for cash
- if linkage exists. The 8% is not essentially
irrelevant. The entire payment must not contain
any non-stock consideration.
On remand: are the two transactions linked?
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Rev. Rul. 67-274
p.449
“C”, not a “B” Reorganization
1) Y corporation acquired X corporation shares
from X corporation shareholders.
2) Y corporation then liquidated X corporation
into Y Corp. & Y then conducted the X business.
Held: A step transaction - not a "B"
reorganization, but a "C" reorganization -i.e., a
“stock for assets” exchange.
Why differentiate between the “B” and “C”?
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Rev. Rul. 55-440
p.450
Preferred Previously Called
X corporation acquired Y corp. common stock in
exchange solely for X corp. common.
Y corp. voting preferred was outstanding and the
voting control test would not be satisfied.
But, preferred previously called for redemption.
Held: Rights of the preferred terminated upon the
redemption call and shareholder rights transformed
into a claim for payment. Therefore, the preferred
was not outstanding at the time of exchange.
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“B” Reorganization
Limitations on Eligibility
No "boot" in a B reorganization.
Voting preferred is possible.
Wh t if preferred
What
f
d only
l votes
t iin the
th eventt off
dividend arrearages?
Is a fractional share cash-out OK? Yes. Why?
Payment of target’s expenses by acquirer (yes, but
not expenses of the shareholders).
How to deal with the problem of dissenters?
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“B” ReorganizationsContingent Stock p.453-4
Contingent stock arrangements are acceptable (for
B reorg. treatment) if:
1) Only additional stock can be issued.
2) Five year limit is applicable.
3) Valid business reason, e.g., valuation.
4) Maximum 50% of the deal limit applies.
5) Contingent rights are not transferable.
6) No control by seller of triggering event.
Cf., escrow arrangement – outstanding stock
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Problem 1(a)
p.455
Voting Preferred Received
Target shareholders receive voting preferred with
value of $1,000 per share (ten times the value of
common stock)) & 1:1 voting
g rights.
g
Treated as solely “voting stock”? yes
Need not be common stock; can receive voting
preferred stock in the B reorganization.
What if substantially diluted voting rights compared
to common stock?
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Problem 1(b)
p.455
“Solely” Requirement Not Met
Transfer of 85% voting stock and 15% warrants to
Target shareholders.
W
Warrants
t are nott voting
ti stock.
t k
The “solely" for voting stock requirement is
violated and the transaction is not a "B"
reorganization.
No "boot" is permitted in a "B" reorganization.
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Problem 1(c)
p.455
Fractional Share Cash-out
Voting shares are received with an additional
payment for the fractional share cash-out.
A
Assuming
i "not
" t separately
t l bargained
b
i d ffor"
"
consideration, the “solely for voting stock”
requirement is deemed satisfied.
The fractional share cash received is treated as
received from a separate §302 redemption
distribution (not under §356).
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Problem 1(d)
P pays T’s Expenses
41
p.455
P pays Target's legal and related transaction fees in
addition to issuing P voting common stock.
If related
l t d to
t the
th reorganization:
i ti
th
the solely
l l ffor
voting stock requirement is not violated.
Why? Payment must be made directly to the
creditors, rather than to Target (per Rev. Rul. 7354, p. 452).
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Problem 1(e)
p.455
B Reorg Status Not Available
P pays attorney's fees incurred by T's majority
shareholders for legal and tax advice relating to the
exchange transaction.
This payment would constitute "boot", i.e.,
consideration which is other than solely "voting
stock“ to the shareholders.
The amount is paid to the shareholders (as
shareholders), not on behalf of the Target
corporation.
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Problem 2(a)
Minority Shareholder
43
p.455
Dee Minimis is unwilling to participate in
transaction. Disregard Dee (a 5% minority
shareholder) in the acquisition transaction since
Dee does not want to participate?
Yes, but then Dee is a minority shareholder
in Target & fiduciary obligations are imposed on
the majority towards the minority (under state
corporate/business law).
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Problem 2(b)
p.455
5% Shareholder Redeemed
1) T redeems Dee prior to exchange with P.
The prior redemption does not violate the “solely
f voting
for
ti stock”
t k” requirement.
i
t
2) Loan situation - is the P loan bona fide?
a) if so, the arrangement should be OK;
b) if not, the loan proceeds constitute additional
consideration, disqualifying the attempted “B”
reorganization.
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11/23/2010
Problem 2(c)
p.455
Post-Acquisition Purchase
P redeems Dee's P shares one month after the
exchange - pursuant to an oral understanding with
Dee.
IRS would argue step transaction treatment and
that this transaction with Dee constitutes a violation
of the “solely for voting stock” B reorganization
requirement.
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Problem 2(d)
p.455
Third Party Share Purchase
Majority shareholders of T buy Dee's stock and
then enter into an exchange with P.
This qualifies as a “solely
solely for voting stock
stock”
exchange.
Assuming: The cash did not come from P but from
the shareholders’ own funds.
And, no indirect funding from P to the purchasing
shareholders.
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Problem 3(a)
p.455
Creeping “B”? “Old & Cold”?
(1) P acquired 30% of T for cash 5 years ago.
(2) Now P acquires the remaining 70% of T stock for
g transaction (g
(going
g
P votingg common stock in a single
above 80% ownership).
Step transaction doctrine is not applied here.
The statute does permit “creeping control,” i.e., the
entire 80% voting stock interest need not be
acquired in one transaction.
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11/23/2010
Problem 3(b)
Step Transaction?
p.455
P acquired 85% of T in a cash tender offer one year
ago. P acquires the remaining 15% from T
shareholders in exchange for P voting common
shares.
A valid "B" reorganization exists for the 15% T
shareholders if that acquisition is unrelated to the
acquisition of the 85 percent for cash.
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(c) William P. Streng
Problem 3(c)
Multiple Acquisitions
49
p.456
Prior 30% ownership. Staggered acquisition of the
remaining 70% occurs: 40% (for stock) in year one
and 30% (for stock) in year two.
1) The final 30% acquisition (70 to 100%) should be
a "B" reorganization transaction.
2) An issue exists whether the earlier 40%
transaction is integrally related to the later 30%
stock transaction (or is it a separate, ineligible
transaction?). Reg. §1.368-2(c).
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Problem 3(d)
p.456
Intermediate Cash Purchase
Facts: An additional 40% is acquired (for cash) and
later the remaining 30% (from 70% to 100%
ownership) is acquired for stock.
Issue: Are (i) the cash acquisition and (ii) the
subsequent acquisition for stock (a) related or (b)
unrelated transactions? If unrelated, the 30%
acquisition qualifies for “B” reorg. treatment. But,
not the 40% for cash transaction. If related - what
impact on 30%?
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11/23/2010
Problem 3(e)
p.456
Purchase & Sale of T Stock
P bought 10% of T stock for cash 1 year ago.
Then P sold the 10% interest to Friendly.
P then in a single transaction acquired 100% of the T
stock solely for P stock.
Issue: 1) Are the cash and the subsequent acquisition
separate and unrelated?
If yes, then 100% is a qualifying "B” reorg.
2) If not, then questions about the transfer and the
reacquisition from Friendly Bank.
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The “C” Reorganization The “Practical Merger”
Criteria for a valid "C" reorganization:
1) Voting stock of the acquirer is received.
2) A ttransfer
f off ““substantially
b t ti ll all”
ll” properties.
ti
3) Liquidation of Target with the distribution to the
shareholders of the Acquirer’s stock.
4) Assumption of some liabilities is permitted.
5) Limited "boot" exception - but a 20% limitation
rule (including liabilities assumed).
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The “Substantially All”
Requirement
p.457
IRS ruling position: 70% of gross & 90% of net
assets (for ruling purposes) are to be acquired.
Emphasis on “operating
operating assets
assets” (even if the
percentage tests are not met).
Cannot be a divisive transaction; e.g., consider Rev.
Rul. 88-48 (p.457) permitting the sale of 50% of the
historic assets if the cash proceeds are also
transferred by Target corporation to Purchaser.
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Liquidation of the Target
Corporation
p.457
§368(a)(2)(G) requires the Target to distribute all
its assets (including the shares of purchaser) in
liquidation.
Possible waiver of the liquidation requirement can
be obtained from the Service. Then treated as if
(1) the distribution to Target shareholders had
occurred, and
(2) the assets were then contributed to the capital
of a new corporation.
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Creeping Acquisitions
p.458
Prior purchase of stock of the Target - is this
purchase transaction “old and cold”?
Purchaser’ss prior holding of stock not invalidating
Purchaser
the “solely for voting stock” requirement. See the
prior Bausch & Lomb history.
Under the boot relation rule the non-qualifying
consideration cannot exceed 20% of the value of all
of the Target’s properties.
Reg. § 1.368-2(d)(4)(i) & (ii).
11/23/2010
(c) William P. Streng
Problem 1(a)
70% Operating Assets
56
p.459
T has $70,000 of operating assets and $30,000 of cash
and securities & A issues voting stock worth $70,000.
T liquidates (stock & cash).
Tax issue concerns whether "substantially all" the
properties have been transferred?
The “70 percent of gross and 90 percent of net” test
(Rev. Proc. 77-37) has not been satisfied.
But, only non-operating properties are retained and
all assets transferred to shareholders in liquidation.
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19
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Problem 1(b)
p.459
Operating Assets Retained
A acquires (1) $40,000 (of a total of $70,000) of the
operating assets and (2) $30,000 of the investment
g in exchange
g for A votingg stock.
assets of Target
T then liquidates, distributing $70,000 of A stock
and $30,000 of T’s operating assets.
Here, operating assets have been retained by Target
shareholders in the exchange and a failure occurs to
satisfy the "C" reorganization “substantially all”
requirement.
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Problem 1(c)
p.459
Assumption of Liabilities
T has $100,000 of operating assets and $30,000 of
liabilities.
A issues $$70,000
,
of voting
g stock in exchange
g for the
T assets & liabilities.
“Substantially all” the T assets are acquired.
The assumption of liabilities is permitted in this
situation without losing tax-free “C” reorganization
treatment. See §368(a)(1)(C) re liability assumption.
What if $90,000 of liabilities?
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Problem 1(d)
p.459
Cash & Liability Assumption
A issues $60,000 of its voting stock and $10,000 cash
in exchange for all of T's assets and the assumption
of the $30,000 of liabilities.
T liquidates, distributing A stock and cash.
See the "boot relaxation rule"- §368(a)(2)(B).
Assumed liabilities are treated as additional cash.
60% of assets are acquired for stock and 40% for
cash. The boot relaxation rule is not satisfied and
no “C” reorganization occurs.
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20
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Problem 2(a)
“B” or “C” Reorg?
p.459
T owns (1) $70,000 of operating assets and (2)
$30,000 cash and investment securities.
T redeems 30% of the stock for the cash and
investment securities.
Acquiring issues $70,000 worth of voting stock to the
remaining T shareholders in exchange for T stock
and T then liquidates.
If no step transaction: a valid "B” reorg?
If a step transaction: a "C" reorganization? Yes?
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Problem 2(b)
Step Transaction?
61
p.459
T redeems 30% shareholders by distributing
operating assets rather than cash and investment
securities.
1) If the redemption is separate: a "C"
reorganization occurs (since then all assets are
acquired in the transaction).
2) If the redemption is not separate: not a valid "C"
reorganization, since substantially all the assets are
not transferred to P.
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Problem 2(c)
“C” Reorg Status?
62
p.459
A has held 30 percent of T stock (old & cold).
A exchanges voting stock of A for the remaining 70
percent of T stock & liquidates.
Under (now obsolete) Bausch & Lomb case A would
be treated as obtaining 30% of T's assets for T stock,
not A stock and not a "C" reorganization. See Rev.
Rul. 67-274 re testing as a “C” reorganization.
The “solely for voting stock” requirement is not
satisfied. But, cf. Reg. §1.368-2(d)(4), Ex. 1
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Triangular Reorganizations
p.460
Alternative structures: (see supp. charts)
1. “A” Reorg. (§368(a)(1)(A)) & then an asset drop
down to a subsidiary
subsidiary. §368(a)(2)(C).
§368(a)(2)(C)
2. Forward Triangular Merger. §368(a)(2)(D).
3. Parenthetical "B" Reorg. §368(a)(1)(B).
4. Parenthetical "C" Reorg. §368(a)(1)(C).
5. Reverse Triangular Merger. §368(a)(2)(E).
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Objectives of Triangular
Reorganizations
To satisfy business (i.e., non-tax) objectives.
E.g., Parent avoids hidden liabilities in the
transferred assets (through the isolation of the
liabilities of Target into a separate sub).
E.g., to facilitate the acquisition of non-transferable
assets (through maintaining the Target
corporation’s separate existence).
E.g., to avoid shareholder votes.
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Structures of Triangular
Reorganizations
p.460-2
See the separate charts concerning the structuring
of these triangular reorganization transactions.
(Charts available on W. Streng UH Law
Center/faculty website: corporate tax slides).
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Multi-Step Transactions
Objectives in multi-step transactions:
1) Achieve business plan –including regulatory and
fi
financial
i l accounting
ti issues
i
2) Tax result based on overall transaction basis
3) Relevance of Section 338/cash asset purchase
transaction treatment.
Overall objective: (1) get assets acquired; (2) then
restructure to rationalize operations.
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Multi-Step Transactions
Rev. Rul. 2001-26
p.463
§368(a)(2)(E) reverse triangular merger issue:
Transaction: (1) tender offer of P stock for 51% of
( ) merger
g of P’s sub into T
T’s stock,, followed byy (2)
and remaining T shareholders receive P voting stock
and cash combination (83%+ consideration is stock).
(Alternative: Sub initiates the tender offer).
Held: When segments are integrated at least 80% of
the T stock was acquired for P stock & tax-free
reorg. status is available (under §368(a)(2)(E)).
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Multi-Step Transactions
Rev. Rul. 2001-46
p.466
(1) Purchaser’s wholly owned transaction sub
merges into Target and then (2) Target merges into
acquiring corporation.
Holding: Step transaction treatment and therefore
a statutory merger into Purchaser and §368(a)(1)(A)
reorg. treatment.
Situation one: if not a step-transaction, would be a
qualified stock purchase for §338 purposes and asset
basis step-up would be applicable. continued
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Multi-Step Transactions
Rev. Rul. 2001-46, cont.
Situation two: In an acquisition merger (1) the
Target shareholders receive solely acquiring
corporation stock
stock, and then (2) an upstream merger
of the acquired corporation into the parent occurs.
This transaction qualifies as a §368(a)(2)(E) reorg.
However, the transaction is still treated as a single
statutory merger qualifying under §368(a)(1)(A).
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Multi-Step Transactions
Rev. Rul. 2008-25
Supp.
1) P forms merger sub which merges into T.
Consideration paid to T shareholder is 10x cash and
90X P voting stock.
2) T then liquidates into P (not a merger) & then P
conducts the T business.
If separate: § 368(a)(2)(E) and then §332 .
If integrated: Not an (a)(2)(E) reorg since T does not
hold substantially all properties.
Holding: not reorg & purchase of stock under 338.
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Triangular Reorganizations
Problems
p.471
See the separate charts concerning the
elements
l
t off the
th ttransactions
ti
identified
id tifi d in
i these
th
problems.
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Acquisitive Reorganization
Treatment of the Parties
Consider the income tax treatment from a tax-free
corporate reorganization for the following parties:
1) Th
The shareholders
h h ld
off th
the T
Targett C
Corporation
ti
2) The Acquiring Corporation & any Acquisition
Subsidiary
3) The Target Corporation
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Shareholder Consequences
in a Reorganization p.473
§354 - no gain or loss to be recognized on the share
exchange.
§358 - carryover/substituted stock basis.
§1223(1) - tacked holding period.
What if "boot"? §356(a)
including "excess securities" treated as boot.
§356(a)(1) & §356(d)
Tax basis for any “boot” received - FMV.
Tax "characterization” of boot? §356(a)(2).
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Commissioner v. Clark
p. 474 (n. 10) Code §356(a)(2)
Code §368(a)(2)(D) reorganization.
Received 300,000 P shares and $3.25 mil. cash.
Could have received 425
425,000
000 P shares.
shares
What is the Code §356(a)(2) applicability?
1) deemed pre-reorganization redemption of Target
acquired shares (Shimberg case); or,
2) deemed post-reorganization redemption of
acquiring corp. (P) shares (Wright case)?
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Characterization of Boot as
Dividend or Capital Gain
Boot dividend is limited to the gain amount.
§356(a)(2) - (dividend within gain)
T rate
Tax
t off 15% on both
b th di
dividend
id d and
d capital
it l gain
i
reduces tax significance, but:
1) Prefer dividends received deduction (DRD) – for
a corporate shareholder?
2) Boot gain is received as installment notes –
not if dividend characterization applies.
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Basis and Holding Period for
Target Shareholders
p.475
§358 – basis in the property received is derived from
the basis of the property transferred.
B t takes
Boot
t k a ffair
i market
k t value
l basis.
b i
What about multiple “tax lots”? – tracing or pro
rata allocation? Allocation to each block of
stock is required. Average basis method not
available – Cf., basis reporting by brokers §6045(g) regulations (effective in 2011).
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Problem (a)
p.477
Merger “A” Reorganization
Each shareholder receives 4,000 ($40,000) of voting
common stock and nonvoting (not nonqualified)
preferred stock worth $10,000.
p
,
1) Nontaxable - solely “stock for stock” §354(a)
2) Substituted basis. §358(a)(1) - $20,000 total;
common-16,000; preferred - 4,000
3) Tacked holding period. §1223(1).
4) Preferred stock - §306 stock. §306(c)(1)(B).
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26
11/23/2010
Problem (b)
p.477
Note & Not Stock Received
Shareholder receives voting common stock plus a 20
year $10,000 interest bearing note (rather than the
preferred stock).
p
)
Necessitates a Clark case analysis re §302(b)(2)
redemption status.
Treatment as if (1) each shareholder received 1,000
shares and (2) subsequently transformed those
shares into the $10,000 note.
continued
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Problem (b)
continued
Note & Stock Received
1) Each shareholder before redemption:
5,000 shares = $50,000 (1,000 shares are boot).
550,000
,
shares equals
q
.909 shareholder %
%.
2) After redemption:
4,000 (actual shares retained by each)
540,000 equals .741 percent.
3) 80% times .909% equals .727% and
§302(b)(2) is not satisfied. But, is §302(b)(1) (“not
essentially equivalent”) applicable?
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Problem (c)
p.477
High Tax Basis Limits Gain
Each shareholder has $45,000 basis in her T stock.
Only a $5,000 amount of realized gain.
The recognized gain is limited to $5,000.
Tax character of gain – see the Clark case analysis.
Notes have a $10,000 FMV basis. §358(a)(2).
Stock has an exchanged basis. §358(a)(1).
-$45,000 less $10,000 equals $35,000, plus
- the $5,000 gain recognized equals a $40,000 basis.
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27
11/23/2010
Problem (d)
p.477
Notes Paid for Redemption
Two shareholders receive notes - $100,000.
The remaining shareholders receive voting common
stock worth $400,000.
1) Shareholders receiving solely voting stock:
Non-recognition under §354(a)(1).
$20,000 substituted basis under §358(a)(1).
2) Shareholders receiving solely securities.
Not boot, since no non-recognition property is
received. Treated as §302 redemptions to each.
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82
Problem (e)
p.478
Boot & T has limited E&P
T had $50,000 E&P, not $100,000 E&P.
Assume boot is received as a dividend. §356(a)(2).
What is the amount of the §356(a)(2) dividend:
1) only $50,000 of T's E&P? or,
2) also the E&P of the acquiring corporation?
Cf., the §304(b)(2) result. Assuming only T’s E&P
to be relevant: $5,000 dividend and $5,000 gain
from stock sale or exchange.
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Target Corporation
p.478
Consequences - Issues
Income tax realization events:
1) Reorganization exchange of its property for stock
(and boot) (e.g., “A”,
A , “C”
C or forward triangular
reorganization).
2) Distribution in corporate liquidation of stock
received (or boot) (or sale of stock prior to the
corporate liquidation).
Tax recognition on these events occurring?
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Reorganization Exchange
Target Level Treatment
§361(a) - no gain or loss recognized on the transfer
of assets in the reorganization transaction.
§357(a) - assumption of the target
target'ss liabilities is not
treated as boot.
These rules apply to (1) "A“ & "C"
reorganizations, and (2) forward triangular
mergers; but, not for "B" reorganizations, or
reverse triangular mergers, since stock, not assets,
acquired in those transactions.
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Shareholder Distribution
- Tax Effects to the Target
No gain or loss is recognized to Target when it
distributes qualified property - §361(c).
"Qualified
Q
property"
p p y requirement
q
under §§361(c)
( )stock of the other party in the reorganization.
Distribution of other than “qualified property” e.g., boot - gain recognition on the distribution is
required. §§361(c)(1) & (2) (but prior step-up when
transferred by P)?
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Acquiring Corporation
Consequences - Asset Deal
§1032(a) - issuance of its shares by the acquiring
corporation is not a taxable event.
Same result if issuance of debt securities by the
acquirer. But, other assets as “boot”?
Tax basis for assets received by Acquirer:
§362(b) carryover from the transferor.
This relevant in acquisition of target's assets:
“A” or “C” & forward triangular merger.
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Acquiring Corporation
Consequences - Stock Deal
What tax basis result to a Acquirer when receiving
stock from the “seller” shareholders in exchange for
Acquirer stock?
If a "B" reorganization (or reverse triangular?) take shareholders’ tax bases.
Sampling is acceptable to determine stock basis of
the shareholders if multiple shareholders of the
Target.
Rev. Proc. 81-70 is under review.
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88
Acquiring Corporation Triangular Reorganization
What if issuance by sub of parent's stock – constitute
a transfer of appreciated property by the sub to the
target shareholders? No.
What tax basis to parent for the target stock
received in a triangular reorganization (i.e., merger
of (i) target into sub, or (ii) sub into target)?
Not basis of the stock of subsidiary (often zero).
Rather - treat as (i) an asset acquisition and (ii) an
asset drop down transaction into the sub.
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Rev. Rul. 72-327
89
p.482
1) Recipient corporate shareholder receiving
dividend boot can obtain dividends received
deduction (under §243(a)).
2) FMV basis for the asset received by shareholder
as dividend boot.
3) Acquiring corporation using appreciated
property for acquisition recognizes gain on use of
that appreciated property (40x less 10 x equals 30x
gain). Davis case. continued
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11/23/2010
Rev. Rul. 72-327
continued
p.482
4) Acquirer’s E&P is increased by the gain
recognized.
5) Acquirer succeeds to the Target
Target’ss E&P
E&P.
6) Corporate shareholder receiving realized gain is
required to recognize that gain to extent of boot
and to include that boot amount in its E&P.
11/23/2010
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Problem 1(a)
“C” Reorganization
91
p.484
P transfers voting stock worth $80,000 in exchange
for T's assets (fmv $100,000) subject to $20,000
liabilities, and T distributes shares. P - no gain on
i
issuance
off its
it stock
t k - §1032.
§1032 P takes
t k T’s
T’ E&P.
E&P
P takes assets with $60,000 basis - §362(b).
T has no gain recognition for the $40,000 realized
gain - §361(a). No gain recognition to T on the
liquidation distribution - §361(c).
Nonrecognition to T’s shareholders & exchanged
basis ($20,000) under §358(a)(1).
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92
Problem 1(b)
p.484
Cash Used for Liabilities
P transfers $80,000 of voting stock and $20,000 of
cash to T used to pay liabilities. C reorg & boot.
Stock is distributed in complete liquidation.
Target - recognizes no gain on transfer of its assets
to P - §361(a) & (b)(1)(A). “C” Reorg.
T received $20,000 boot from P but no recognition
to P. §1032. Boot is distributed.
Distribution: No T gain on distribution of P stock all is qualified property - §361(c)(1).
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11/23/2010
Problem 1(c)
p.484
Securities as “boot.”
1) P transfers (a) voting stock worth $80,000 and
(b) investment securities with a basis of $10,000 and
a value of $20,000 for all T's assets not subject to
any liabilities. Gain of $10,000 is recognized to P.
2) T immediately distributes the consideration
received. T recognizes no gain on receipt of boot
(§361(b)(1)(A)) but on the distribution of boot (if
any gain, probably not here).
3) Shareholders realize $80,000 gain & recognize
$20,000 boot gain.
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94
Problem 1(d)
p.484
C Reorg & No Liquidation
1) P transfers $80,000 of its voting stock, $10,000 of
its bonds and $10,000 of cash to T in exchange for
its assets. T receives permission not to liquidate and
retains
t i th
the cash,
h b
bonds
d and
d stock.
t k P - no gain
i
recognition for stock or securities.
2) T - waiver for distribution? Treated as a
constructive liquidation. T has no gain recognition
on the deemed distribution.
3) Shareholders receive boot (dividend?).
11/23/2010
(c) William P. Streng
Problem 1(e)
Two Types of Stock
95
p.484
P transfers $80,000 of voting stock and $20,000 of
nonvoting preferred stock to T in exchange for all of
T's assets. No debt.
T liquidates and distributes the voting and
nonvoting preferred (§306) stock to its shareholders
prorata & tax basis allocation.
P – no gain – under §1032.
No T gain on either its asset transfers or the
distribution of P stock. §361(a), (c)(1).
No gain recognition to the shareholders. §354(a)(1).
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32
11/23/2010
Problem 2(a)
C Reorganization
p.484
Valid “C” reorganization?
P - no gain on the distribution of P’s stock, but
$8,000 ggain on the transfer of the Bell stock ((& E&P
increase by the $8,000).
T - no gain on transfer of its operating assets.
T’s basis for the P stock is $8,000.
Sale by T of $40,000 P stock - gain to be recognized.
Target distribution to shareholders – recognition
($22,000) for the Bell stock & the land (but not the P
stock).
11/23/2010
(c) William P. Streng
Problem 2(b)
C Reorganization
97
p.484
Transfer of stock by T to creditors as part of
reorganization plan.
Code §361(c)(3) permits non
non-recognition
recognition of gain (i.e.,
(i e
$36,000 gain not recognized).
The transfer is treated as a distribution to the
shareholders, entitling T to nonrecognition under
§361(c)(3).
E&P does not reflect the 36,000 gain.
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98
Problem 3(a)
p.485
Forward Triangular Merger
Code §368(a)(2)(D).
Formation of S - no gain.
P’ basis
P’s
b i in
i its
it S stock
t k - equall to
t T’s
T’ basis
b i in
i assets
t $100,000.
S - no gain on its issuance of its own stock.
S has no gain on its transfer of P stock.
S takes T’s assets - $100,000 carryover basis.
T’s shareholders - no gain recognition.
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33
11/23/2010
Problem 3(b)
p.485
Reverse Triangular Merger
§368(a)(2)(E).
Parent - non-recognition on formation of S.
P’ss basis in S stock - adjusted as if T had merged
P
into S in a forward triangular merger.
S - No gain on S issuing its own stock (§1032) or
when transferring P stock to T (§361).
T – nonrecognition (T stock for P stock).
Shareholders – nonrecognition when receiving P
stock for T stock. §354(a)(1) & substituted basis.
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100
Problem 3(c)
p.485
Forward Triangular Merger
Failed §368(a)(2)(D) – forward triangular.
Parent - non-recognition on formation of S.
S - No gain on issuing its own stock.
stock
S gain when transferring P stock to T.
T gain recognition on transfer of its assets.
S §1012 cost basis for T’s assets.
T’s shareholders recognize 150x cap. Gain and have
200x fmv basis for P stock held.
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101
Problem 3(d)
p.485
Reverse Triangular Merger
Failed §368(a)(2)(E).
Parent - non-recognition on formation of S.
S - No
N gain
i on issuing
i i its
it own stock.
t k
S gain when transferring P stock to T.
T transfers T stock for P stock and no gain
recognition - §1032.
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34
11/23/2010
End of Chapter 9
information
11/23/2010
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103
35