Presentation:
Corporate Taxation
Chapter Eleven: Nonacquisitive &
Nondivisive Reorganizations
Professors Wells
April 13, 2015
Nonacquisitive & Nondivisive Reorgs.
p.518
§368(a)(1)(D) – Liquidation – Reincorporations
§368 (a)(1)(E) – Recapitalizations
§368(a)(1)(F) – Change in Form or Place of Incorporation
§368(a)(1)(G) – Insolvency Reorganizations
2 Recapitalizations
§368(a)(1)(E)
p.519
Rearrangement of a single corp’s capital structure. Business
objectives for a recapitalization:
1)  Improve the debt/equity ratio by shifting from debt into equity
ownership – i.e., a downstream recapitalization.
2)  Change the shareholder ownership relationships between the
preferred and common shareholders – e.g., an upstream
recapitalization (some shareholders acquiring preferred stock).
3 COBE & COI Not Relevant
p.518
“Continuity of business enterprise” (COBE) is not a requirement
to have “E” corporate reorganization treatment.
Similar treatment to Rev. Rul. 77-415 that “continuity of
shareholder interest” (COI) is also not required in an “E”
reorganization.
But, a business purpose is required.
This result is not impacted by the 1998 COI and COBE
regulations.
4 Types of Corporate
“Recapitalizations”
p.519
1)  A shift from debt into equity is tax-free. But, recognition is
required of the accrued interest element. See §354 (bondholder) &
§1032 (corp), but also §108 (re COD income).
2)  An exchange of bonds for new bonds. No gain recognition occurs
to the bondholder except (a) for bonds received for accrued interest,
or (b) if the principal amount of the bonds is increased. §354(a)(2)(A)
& (B). The corporate issuer may have COD income (subject to
§108(e)(10) and needs to resolve OID issues. See §163(e) and §1272
through §1275.
3)  Stock for stock exchanges: (a) exchange preferred and receive
common; or, (b) exchange common and receive preferred.
§§354, 356 & 358 (shareholder)
§1032 & §1036 (stock issuances/exchanges)
§305(c) (increase in proportionate share interest) & §306
5 stock (bailout effect?).
Rev. Rul. 84-114
Preferred and Cash Received
p.521
Nonvoting preferred stock and cash are received in an integrated
transaction in exchange for common shares (in an “E”
reorganization).
Is the cash “boot” received a “dividend equivalent” for §356(a)(2)
purposes?
Held: Not a dividend since the requirements of §301(b)(1) (no
dividend equivalency) are satisfied here (and, therefore, no §356(a)
(2) dividend distribution effect). See Davis case. A’s interest
reduced from 28.57% (120/420) to 23.08% (90/390). This was a
meaningful reduction of interest.
6 Bonds Received & Stock Transferred –
Bazley v. Commissioner
p.524
For old shares, shareholders received new shares and also callable
debenture bonds. Significant “earned surplus” (e&p) existed.
IRS asserts income to the extent of bonds.
Taxpayer asserts the securities were received in a tax-free corporate
reorganization.
Held: Receipt of the (callable) debenture bonds was equivalent to
the receipt of a cash dividend (i.e., an accumulated earnings
distribution).
7 Problem 1(a)
Exchange Transaction
Results to shareholders on this
exchange:
1)  “E” reorganization treatment.
2)  No gain recognition to the
shareholders on the exchange.
§354(a)(1).
3)  Substituted basis - §358(a)(1) –
1/3 for preferred and 2/3 for
common stock.
4)  Tacked holding period. §1223(1).
5)  Preferred stock received is §306
stock.
p.528
Shareholders
C.S.=20x
Pfd S.=10x
Recap
E&P=100,000
8 Problem 1(b)
Preferred Stock is Called
p.528
Question: What is the result if Recap calls the preferred stock?
Answer:
1)  §306(a)(2) redemption.
2)  $10,000 §301 distribution to each shareholder (assuming e&p
is at the $100,000 level).
3)  Reduction of the corp’s e&p to zero. §312(a)(1).
4)  Tax basis previously allocated from the common to the
preferred stock is allocated back to the common stock.
9 Problem 1(c)
Sale of the Preferred Shares
p.528
Question: What is the result if a shareholder sells preferred stock?
Answer:
1.  A Code §306(a)(1) “ordinary income” transaction occurs, as
measured by reference to the allocable e&p at the time of
the preferred stock issuance. No DRD is available to a
corporate recipient. 20% taxation on the amount received.
2.  Any excess over $10,000 is treated as: (i) tax basis recovery,
and after basis recovery then thereafter as (ii) capital gain.
3.  No e&p reduction occurs (even though deemed “dividend”
treatment for §1(h)(11)).
10 Problem 1(d)
E&P Deficit Upon Issuance
p.528
Question: What is the result if Recap had a deficit in its E&P at
the time of the distribution but it foresaw future profits?
Answer:
An e&p deficit existed at the time of the distribution of the
shares by the corporation would cause the preferred stock would
not to be §306 stock.
i)  Treatment of the stock redemption when occurring would be
determined under §302.
ii)  The share sale would produce capital gain (after tax basis
recovery).
11 Problem 2
Stock & Debt Issuance
p.528
C.S.
FACTS: Each of 10
(B=100x FMV=500x)
shareholders exchanges
Shareholders
common stock (FMV=$50,000
C.S.=250x
Security.=25x
B=$10,000) for common stock
(FMV=$25,000) and bonds
Shuffle
(FMV=$25,000). Shuffle has
E&P=$250,000.
E&P=250,000
RESULT: An “E” reorganization. The securities are “boot”.
§354(a)(2) & §356(d)(1). Each shareholder must recognize $25,000
of the $40,000 of gain realized in the exchange. The pro-rata
distribution is classified as a dividend distribution.
12 Problem 3(a)
Debt Principal is Reduced
p.529
FACTS: Exchange bonds with
Bondholders
Face=$1,000,000 and FMV of
Bonds
(Face=800x FMV=800x)
Bonds
$800,000 for bonds with
(Face=1,000x FMV=800x)
Face=$800,000; FMV=$800,000.
Leverage
RESULT: “E” Reorganization.
1.  Because the principal amount of the securities received
($800,000) does not exceed the principal amount of the securities
surrendered ($1,000,000) and there is no indication of any
accrued interest, the bondholders have no gain or loss. See
§354(a)(1) & (2)(B); §354(a)(2); §356(d)(2). The security holders
take an exchange basis per §358(a)(1) and tacked holding period
per §1223(1).
2.  Leverage has $200,000 of debt discharge income and has income
unless insolvent. See §108(e)(10)(A); §108(a)(a)(B).
13 Problem 3(b)
Debt Principal Increased
p.529
Bondholders
FACTS: Exchange bonds with
Bonds
Face=$800,000 and FMV of
(Face=1,000x FMV=800x)
Bonds
$800,000 for bonds with
(Face=800x FMV=800x)
Face=$1,000,000; FMV=$800,000.
Leverage
RESULT: “E” Reorganization.
1.  §356(d)(2)(B) says the fair market value of the excess principal
amount is treated as taxable “boot” under §356(a)(1) if the
securities have realized gain. So, 80% of $200,000 or $160,000 is
boot. If security holder is a stockholder, then need to test for
dividend treatment per §356(a)(2). If not a stockholder, then gain
is likely a capital gain and not a dividend.
2.  To the extent that the excess face amount ($200,000) exceeds the
FMV of this excess face amount ($160,000), the bonds have
original issue discount ($40,000) under §1272.
14 Problem 4
Receipt of Stock for Bonds
FACTS: Exchange of bonds
transferred for the receipt of stock by
shareholder is treated as an “E”
reorganization. This is a
“downstream” recapitalization.
RESULT:
p.529
Bondholders
Stock
Bonds
Leverage
1.  Bondholders: A nonrecognition event occurs to the old security
holders/new shareholders assuming a business purpose. Reg.
§1.368-2(e), Ex. 1. Business objective of this transaction: A
business purpose could be to improve the corporation’s debt/
equity ratio.
2.  Corporation: The corporation would have COD income to the
extent that the principle amount of the bonds exceed the fair
market value of its stock. See §108(e)(8).
15 “D” Reorganization
“Liquidation Reincorporation”
p. 529
Two alternative structures (involving two corporations & similar
shareholder groups):
Cash
1)  Operating assets are
transferred to the acquiring
corp. for cash; the selling
corporation then liquidates
with a cash distribution to its
shareholders.
D
Op Assets
D
Cash
Liquidate
Op Assets
2)  All assets are distributed to the
shareholders, then the
shareholders infuse only
operating assets into a new
corporation.
P
Liquidate
D
P
Op Assets
D
16 Smothers v. United States
Transfer of Operating Assets?
Taxpayer position: Distirbution was a
liquidation entitled to capital gain
treatment under §331(a)(1).
Liquidate
$149,162
IUS liquidated and then the operating
assets (15 percent of the FMV) were
inserted into TIL.
IUS
p.530
Smothers
Op Assets
$22,637
Cash
TIL
IRS position: the transaction was a “D” reorganization with §356(a)
(2) boot being received.
Held: The “substantially all” test was satisfied since all the
operating assets were transferred and so this transaction qualified as
a “D” reorganization. The Smothers received boot that was
characterized as a dividend distribution under §356(a)(2).
17 Nondivisive Reorganizations
All Cash D Reorganizations
Counter-Characterization: A
straight dividend would be taxable
under §301(c)(1) to the extent of
E&P with no basis offset.
Liquidate Shareholder
Cash
Objective: To extract cash with
basis offset. Boot is taxed to the
extent of gain realized (boot within
gain rule).
p.540
D
All Assets
C
Cash
18 Problem 1
p.541
Common Ownership – 2 Corps.
Liquidate Shareholders
$700 cash
FACTS: Shareholders have $200,000
basis in Brother. Brother has
operating assets (FMV=$500,000 B=
$150,000) and $200,000 cash (total
FMV $700,000) and $250,000 of
E&P. Sister has $300,000 of E&P.
Sister purchases Brother’s operating
assets for $500,000 cash and Brother
liquidates.
Brother
E&P=
250
B=200
Op Assets
B=150 FMV=500
$500 Cash
Sister
E&P=
300
RESULT: Boot of $700,000 to Shareholders and must recognize
dividend per §356(a)(2) to the extent of their gain ($500). Under
Davant, E&P of both companies are used to support the dividend
characterization
19 Problem 2
p.541
All Cash D Reorganization Transactions
Liquidate
A
B=200
Cash
FACTS: T sells all assets to S
for cash and liquidates.
RESULT: Dividend to A.
Reg. §1.368-2T(1)(3), Ex. 2.
All Assets
S
T
B=100,000 FMV=1,000,000
Control of S exists through
the family attribution rules.
$1,000,000
Cash
See Code §368(a)(2)(H)(i)
and §304(c). §368(a)(1)(D) & §354(b)(1)(B) are satisfied even though
no S stock is actually issued. The $1 million cash of distributed to A
is a dividend effect to the extent of E&P and thereafter is return of
basis and then §301(c)(3) gain.
20 “F” Reorganization
p.541
Mere change in identity, form or the place of corporate
organization of one corporation.
Often used to change the place of corporate organization (e.g., to
Delaware). Why to Delaware?
Prior attempt to blend multiple corporations together in an “F”
reorganization – The potential use of §381(b) in this context has
been eliminated.
F reorganization treatment is limited to one corp.
21 Rev. Rul. 96-29
Part of Step Transaction OK
p.543
Two transactions involving stock offering or acquisition – place of
organization changed.
Situation One: Change place of incorporation by merging Q into a
new corporation (R) formed in another state (probably Delaware).
R issued significant additional stock in a public offering. So two
steps were involved: merger and stock sale.
Situation Two: Forward triangular merger and the selling
shareholder received new preferred stock of Corp. which then
changed its place of organization by merger into corporation in
another state.
22 Problem
Change State of Organization
p.545
Change of corporate status from California to Arizona by an asset
transfer in exchange for stock and then the liquidation of the old
corporation.
RESULT: This is an“F” reorganization. It could also be a “D”
reorganization but probably best viewed as an F reorganization.
Under these facts, the § 351 (incorporation) and § 331 (liquidation)
transactions are telescoped to result in full nonrecognition to all
parties. See Whittell & Co., Inc. v. Commissioner, 34 B.T.A. 1070
(1936).
23 Insolvency Reorganizations
§368(a)(1)(G)
p.546
Transfer of assets to another corporation in a bankruptcy
restructuring. Liquidations are not bankruptcy reorganizations.
The “substantially all” test is not precluded when assets are used to
pay creditors.
The “continuity of interest” test must be satisfied, but creditors may
be counted for purposes of satisfying COI.
Shareholder or debtholders who receives an increased amount of
debt securities are taxable.
Creditor have interest income to the extent securities are received
for unpaid interest on the securities surrendered.
Possible NOL shifting to the corporation acquiring the assets.
No recognition to the transferring corporation on asset transfers;
24 carryover tax basis for assets.
Problem
Acquirer’s Stock to Creditors
p.551
Debtor in bankruptcy with assets (B=$75,000 FMV=$100,000), NOL
($200,000). Debts include (1) bonds outstanding (with no accrued
unpaid interest) of $100,000 and trade debts of $100,000. Debtor
transfers all of its assets to Relief Corporation in return for $100,000
of Relief stock which will pass half to the security holders and half to
trade creditors. Debtor’s shareholders will receive nothing.
RESULT:
1.  Valid G reorganization since the debtor transfers all assets and
then distributes the stock of Relief. Creditors are treated as
equity owners COI.
2.  Shareholders receive nothing – a §165(g) LTCL on their stock
(equal to their tax basis).
3.  Security holders exchange $100,000 of securities for $50,000
stock. No loss recognized and $100,000 basis.
4.  Trade creditors - $50,000 bad debt loss (no §354).
5.  Debtor corp has $100,000 of COD income that may be eligible
for §108(a)(1)(B) relief with the consequence that tax attributes
25 are reduced (i.e., the NOLs).