Mergers, Acquisitions, &
Divestitures
Reasons
 Types
 Tax Issues
 Non-Tax Issues
 Methods
 Tax Deductibility of Goodwill

Reasons for
Mergers/Acquisitions

1) To improve economic efficiency

2) To extend the power base of
management

3) To effect transfers of wealth between
classes of stakeholders
Reasons for Divestitures

1) To focus on core competencies

2) To free managers of the divested
business to focus on the divested firm

3) To solve market mispricing

4) To gain greater access to capital markets
Types of Mergers/Acquisitions

Freestanding companies can acquire:
–
–

1) Other freestanding companies
2) Subsidiaries of other companies
Acquisitions can be structured to be:
–
–
1) Taxable (when the acquirer uses cash)
2) Tax-free (when the acquirer uses mostly
stock)
Types of Divestitures

Tax-Free Spin-off: Involves the division of
the parent corporation into two or more
distinct corporations.

Equity Carve-out: Involves the sale of a
portion of a subsidiary’s equity for cash.
Major Tax Issues
1) Shareholder tax liabilities
 2) Effect on tax attributes
 3) Corporate-level tax effect of the
merger, acquisition, or divestiture
 4) Change in the tax basis of the assets of
the target or divested subsidiary
 5) Effect of leverage on mergers and
acquisitions

Shareholder Tax Liabilities-Mergers/Acquisitions

If taxable:
Purchase price
- Basis in stock
= Gain recognized by target shareholders

Requirement for a tax-free acquisition:
–

Target shareholders must maintain a continuity
of interest--50% of total consideration paid is
acquiring-firm stock
Note: “Tax-free” transactions can result in a taxable gain
for target shareholders to the extent they receive cash!
Shareholder Tax Liabilities-Divestitures

Spin-off: No taxable gain or loss recognized by
the divesting corporation’s shareholders

Equity Carve-out: No taxable gain or loss
recognized by shareholders

Sale of Division or Subsidiary for Cash: No
taxable gain or loss recognized by the divesting
corporation’s shareholders unless proceeds are
distributed to them by the divesting corporation
Effect on Tax Attributes
Attributes
Survive?
Limited
Attributes:
Attributes
Reside With:
Taxable
Acquisitions
Usually
NOLs,
credits
Acquirer*
Tax-free
Mergers
Always
NOLs
Acquirer
Divestitures
Always
Use of NOLs
Depends on
Structure
* If not eliminated
Corporate-Level Tax Effect-Mergers/Acquisitions
If acquisition is accomplished through the
purchase of assets in a taxable transaction,
a taxable gain or loss is recognized by the
target corporation
 If acquisition is accomplished through the
purchase of stock in either a taxable or taxfree transaction, no gain or loss is
recognized at the corporation level

Corporate-Level Tax Effect-Divestitures

Subsidiary Sale:
Purchase price of stock or assets
- Seller’s basis in stock or assets
= Taxable gain (loss) recognized by seller

Equity Carve-out: Generally does not result in a
taxable gain or loss for the divesting corporation

Spin-off: Since a spin-off is usually tax-free, no
taxable gain is recognized under typical
circumstances
Change in Tax Basis of Assets of
the Target or Divested Subsidiary
A step-up in the tax basis of assets of an
acquired business to the purchase price
creates increased future depreciation
deductions, which provide valuable tax
savings.
 This is common in subsidiary sales, but
acquisitions of freestanding C corporations
are limited in this practice by the Tax
Reform Act of 1986.

Non-Tax Issues in Mergers,
Acquisitions, and Divestitures

Financial Reporting Costs
–
–
Purchase Accounting
Pooling of Interests Accounting*
Transaction Costs
 Contingent or Unrecorded Liabilities
 Managerial and/or Control Issues

* FASB eliminated this method after 2001
Five Basic Methods to Acquire
a Freestanding C Corporation





A’s taxable purchase of C’s (for C Corp) assets
A’s taxable purchase of C’s stock followed by
an I.R.C. § 338 election
A’s taxable purchase of C’s stock not followed
by an I.R.C. § 338 election
A’s acquisition of C’s stock in a tax-free
exchange
A’s acquisition of C’s assets in a tax-free
exchange
Four Methods to Divest a
Subsidiary or Line of Business
Subsidiary Stock Sale
 Subsidiary Asset Sale
 Spin-off
 Equity Carve-out

Tax Deductibility of Goodwill
Under I.R.C. § 197
I.R.C. § 197 makes goodwill tax-deductible.
However, goodwill is only tax-deductible
when the tax basis of the acquired firm’s
assets is stepped up.
This occurs frequently in subsidiary sales and
in acquisitions of conduits but not in
acquisitions of freestanding C corporations.
Structures Employed in Acquisitions
of Freestanding C Corps
and Tax Implications
Taxable Acquisitions
Structural
and Tax Factors
Typical Form of
Consideration
Taxable to Target
Shareholders?
Target Corporation
Level Taxable Gain?
Step-up in the Tax Basis
of the Target’s Assets?
Target’s Tax Attributes
Survive?
Tax-free Acquisitions
Stock
Stock
Acquisition Acquisition
Asset
w/ 338
w/o 338
Asset
Stock
Acquisition Election
Election Acquisition Acquisition
Cash
Cash
Cash
Stock
Stock
Yes
Yes
Yes
No
No
Yes
Yes
No
No
No
Yes
Yes
No
No
No
No
No
Yes
Yes
Yes
Divestiture Methods and Tax
Implications
Tax Issue or
Structural Factor
Subsidiary Subsidiary Spin-off
Stock Sale Asset Sale
Equity
Carve-out
Cash received by
divesting parent?
Yes
Yes
No
Yes
Taxable gain to
divesting parent?
Yes
Yes
No
Not usually
Taxable gain to
divesting parent’s
shareholders?
Step-up in the Tax
Basis of the divested
subsidiary’s assets?
Not usually Not usually Not usually Not usually
No
Yes
No
No