Professor Bret Wells
Law Center
University of Houston
Corporate Taxation
Supplemental Reading Materials
Spring Semester 2015
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Law students benefit from seeing how their tax analysis gets incorporate into actual transaction documents
and disclosure documents as a general rule, but this is particularly true with respect to acquisitive
reorganizations. This supplement provides a sample of public filings involving reorganization transactions. In
the first two articles, I provide press reports on two transactions that give you a flavor of how these transactions
are reported in the press. We will cover Section 355 in Chapter 10, so hold-off reading that particular article
until we commence analysis of the Chapter 10 reading.
The following documents represent portions of SEC filings that disclose tax-free reorganization treatment in
each of the mainline reorganization fact patterns that we discuss in Chapter 9. Please review these disclosure
documents.
1.
2.
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6.
Section 368(a)(1)(A). Range Resources acquisition of Stroud Energy, Inc. in a transaction that
utilizes the multistep technique set forth in Situation 1 of Rev. Rul. 2001-46.
Section 368(a)(1)(B). Mustang Geothermal Corp’s acquisition of North Homestake where the
company advises that it believes the transaction qualifies for Section 368(a)(1)(B). This transaction
is unusual in that the company states that it believes that a transaction qualifies for nonrecognition
treatment as a tax-free reorganization but then states that the company did not receive any tax
opinion with respect to this matter. Students should recognize that this disclosure is fraught with
risk. A company should not advise shareholders on the tax results of a transaction unless it has an
opinion from a qualified tax expert or has received an IRS private letter ruling confirming the
treatment.
Section 368(a)(1)(C). Armada Oil, Inc.’s acquisition of Mesa Energy Holdings Inc.
Section 368(a)(2)(D). Baker Hughes acquisition of BJ Services Company.
Section 368(a)(2)(E). United Airlines acquisition of Continental Airlines
Section 368(a)(2)(E) DOUBLE DUMMY TECHNIQUE. AOL’s acquisition of Time Warner.
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Sysco Deal Leaves Money on the Food Table
BY LYNNLEY BROWNING
The Sysco Corporation’s deal to acquire its chief
rival, US Foods, would put food on the table at a
wide swath of restaurants, schools and hospitals.
But it may have left money on the table as well.
The concern is the less-than-creative tax structure of
the $3.5 billion deal, which would create the largest
food distributor in North America with clients that
include the celebrity chef Daniel Boulud and public
schools.
Mark Duncan/Associated Press
A combination of Sysco and US Foods would create a
company with clients ranging from the celebrity chef
Daniel Boulud to public schools.
Under the merger, Sysco would use $3 billion of its
stock to acquire the bulk of US Foods’ shares and
would pay $500 million in cash for the rest. Some
tax experts say that the cash part of the deal is the
Wall Street equivalent of throwing away perfectly
good food — in this case, perhaps $200 million.
That is because the steps that Sysco is taking in the
merger do not allow it to use a lucrative tax benefit
involving extra value, in the form of lower future
tax bills, embedded in that cash.
The upshot of the steps, known in the tax world as a reverse triangular merger followed by a forward merger, is
that for the cash portion of the deal, Sysco inherits the relatively low value, for tax purposes, of the assets of US
Foods, which include machinery, equipment, vehicles and the like. That value, known as cost basis, reflects the
fact that US Foods had to depreciate and amortize those assets over time. A lower cost basis typically translates
into higher tax bills.
Had Sysco structured its deal differently, it could have increased its cost basis and created perhaps $200 million
in future tax savings, said Robert Willens, a tax and accounting expert in New York. If Sysco had instead set up
a structure known as a horizontal double dummy, it would have been able to include that $500 million in cash in
its cost-basis calculations, in turn lowering the combined company’s tax bills.
Mr. Willens said that “$500 million in basis is worth 35 percent in tax savings somewhere along the line, so
that’s nearly $200 million in value that’s being forfeited by the combined new company.”
That value is forfeited in part by the two private equity firms, Clayton, Dubilier & Rice and Kohlberg Kravis
Roberts, that own US Foods. The firms will end up with about 13 percent in the combined company.
Charley Wilson, a spokesman for Sysco, did not respond to requests for comment. Lisa Lecas, a spokeswoman
for US Foods, was not available for comment.
Horizontal double dummies may sound like two guys stretched out on sofas watching Sunday football, but they
have played a starring role in some significant deals, including Kmart’s $11 billion purchase of Sears, Roebuck
in 2004 and Oracle’s $5.8 billion acquisition of Siebel in 2005. The structure is legal under the tax code.
The tax structure involves two companies, an acquiring firm and a target firm, setting up a permanent holding
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company and below it two temporary subsidiaries — the “dummies.” The acquiring firm and the target firm
merge separately into the subsidiaries. Stock in both subsidiaries is transferred to the holding company, and the
dummies are dissolved. The holding company pays shareholders of the target firm for their equity, leaving the
acquiring firm, through the holding company, in control.
Michael L. Schler, a tax lawyer at Cravath, Swaine & Moore in New York, said that one deterrent to using
double dummies was the complexity of the structure and the need to reregister and list the merged entity as a
public company. But “if it is done correctly, the tax rules are clear cut and there is no reason for the Internal
Revenue Service to challenge it,” he said.
US Foods’ shareholders have to pay capital gains taxes on any cash they receive for their shares, regardless of
the tax structure used in the merger. So there is no compelling reason to use any structure other than a
horizontal double dummy, said Crawford Moorefield, an energy, oil and gas and corporate tax lawyer at
Strasburger & Price in Houston who has done such deals.
Mr. Willens added that in any acquisition involving stock and cash, the horizontal double dummy structure
“should be standard operating procedure.”
“It’s a mystery to me why they don’t get done more often,” he added.
Supplement Page #5
NOVEMBER 13, 2014
BULLETIN
Berkshire To Pursue Another "Cash Rich Split-Off"
Although details are sparse, it appears that Berkshire Hathaway, Inc. (BRK), this time with none other than
Proctor and Gamble (PG) as the counterparty, is engaging in one of its favorite transactions, a so-called "cash
rich" split-off. In the transaction, according to the press release, BRK will surrender to PG its stock therein; and
will receive in exchange all of the stock of Duracell Company (Duracell), a corporation engaged in the active
conduct of a trade or business that has been actively conducted for well in excess of five years, and that has
been "fattened" with a cash infusion from PG in the amount of $1.7 billion.
In light of the fact that the distribution appears to meet the requirements of Sec. 355 of the Code, including
the active business requirement, and the business purpose requirement; and in light of the fact that the device
test is inapplicable because of the non prorata nature of the distribution, the exchange should be tax-free to
BRK and the distribution should partake of the nonrecognition of gain benefits of Sec. 361(c) with respect to
PG. In short, neither party should recognize gain or loss with respect to the exchange. Thus, PG will have
"retired" a portion of its stock using appreciated property as the currency but on a wholly tax-free basis; and
BRK will have converted an appreciated asset (the PG stock owned by it) into property "differing materially in
kind or in extent" on the same tax-free basis.
Sec. 355(g) was amended in 2005 to make cash rich split-offs more difficult to accomplish. However, the
amendments have not in any way seriously undercut the effectiveness of these transactions. In order for Sec.
355(g) to operate (to render the split-off taxable at both the distributing corporation and distributee shareholder
levels), two conditions must be present: (i) either the distributing corporation or the controlled corporation is a
"disqualified investment corporation," and (ii) immediately after the distribution, any person (i.e., BRK) holds
50 percent or more of the stock of such corporation but only if such person did not own that quantum of stock
in the disqualified investment corporation immediately before the distribution.
In the instant case, BRK will hold 100 percent of the stock of Duracell immediately after the distribution,
and did not hold as much as a 50 percent interest therein before the distribution. However, Sec. 355(g) should
not operate here for the simple reason that Duracell is not a disqualified investment corporation. To be
characterized as such, at least 2/3 of the value of the total assets of the corporation must be "investment assets."
For this purpose, cash is such a "tainted" asset. Here, however, it seems clear that the active business assets (and
other "non-investment" assets) of Duracell will be well in excess of 1/3 of the value of its total assets. (In fact,
these "good" assets would appear to represent in excess of 50 percent of the value of Duracell's total assets).
Accordingly, since Duracell is not a disqualified investment corporation; and since BRK has owned the PG
stock surrendered to PG for more than five years (with the result that the distribution will not be, within the
meaning of Sec. 355(d), a "disqualified distribution,") the tax-free result sought by the parties ought to be
eminently achievable.
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