M&A Tax Update
Recent Developments
Alan Barton
February 27, 2004
1
Recent Developments
•
Section 382 – Notice 2003-65
•
Section 108 – Treas. Reg. Sections 1.108-7T and 1.150228T
•
Section 338(h)(10) – Treas. Reg. 1.338(h)(10)-1T
•
Section 355 – Rev. Proc. 2003-48 and Rev. Ruls. 2004-23,
2003-74, 2003-75 & 2003-79
2
Section 382 – Notice 2003-65
Section 382(h)
•
Section 382 Ownership Change
•
Net Unrealized Built-in Gains (Losses)
•
Recognized Built-in Gains (Losses)
•
Built-in Income and Deduction Items
•
No Regulations / Limited Guidance on Built-in Income and
Deduction Items
4
Notice 2003-65
•
Identification of Built-in items for purposes of Section 382(h)
•
Two Methods

Section 1374 Approach

Section 338 Approach
•
Can use either approach for each ownership change
•
Retroactive Application
5
Notice 2003-65 - Section 1374 Approach
•
Identifies built-in items by incorporating the rules of section
1374.
•
NUBIG or NUBIL is the net amount of gain or loss that would be
recognized in a hypothetical sale of the assets of the loss
corporation immediately before the ownership change.
•
This approach generally treats items of income and deduction
as attributable to the pre-change period if such items accrue for
tax purposes prior to the ownership change.
•
This approach may be preferable for those taxpayers seeking
to avoid characterization of deductions (including contingent
liabilities) as recognized built-in losses.
6
Notice 2003-65 – Section 338 Approach
•
NUBIG or NUBIL is calculated in the same manner as under the
section 1374 approach – NUBIG or NUBIL is not redetermined for
contingent consideration (including contingent liabilities).
•
Identifies built-in items by comparing the loss corporation’s actual
items of income, gain, deduction and loss with those that would
have resulted if the loss corporation had been acquired in a section
338 election transaction on the ownership change date.
•
Additional income resulting from forgone depreciation or
amortization on a wasting asset can be treated as recognized builtin gain, and deductions for liabilities that were contingent on the
change date can be treated as built-in losses, even though neither
such item accrues for tax purposes prior to the ownership change.
•
This approach may be preferable for those taxpayers seeking to
treat income generated by wasting assets as recognized built-in
gain.
7
Notice 2003-65 – Examples
Ownership Change
LossCo 1
NUBIL Position
Contingent Tort Liability
Ownership Change
LossCo 2
NOL Carryforwards
NUBIG Position
High Value Low Basis Goodwill
8
Section 108
Section 108
•
Gross Income includes Cancellation of Debt Income
•
Cancellation of Debt Income Excluded under Section 108(a)
•
•

Bankruptcy

Insolvency
Attributes are Reduced under Section 108(b)

Net operating losses, general business credits, minimum tax
credits, capital losses

Basis

Passive activity losses and credits, foreign tax credits
Timing of attribute reduction

Net operating losses and other attributes

Basis
10
Treas. Reg. 1.108-7T
•
Timing of Section 108(b) attribute reduction – NOL
Carrybacks
•
Basis reduction and Section 381 Transactions
•

“G” Reorganizations

FSA 200145009

House Report of the Bankruptcy Tax Act of 1980
Effective for discharges occurring after July 17, 2003
11
Section 108 – Consolidated Return Groups
•
•
Government’s initial position on attribute reduction:

PLR 9121017

Reduction of attributes under section 108(b) should be
made on a separate company basis
Government’s recent position on attribute reduction:

FSA 199912007

CCA 200149008

Reduction of attributes under section 108(b) should be
made on a consolidated basis
12
Treas. Reg. 1.1502-28T
•
Determination of Insolvency – Separate Company
•
Attribute Reduction – Ordering Rule
•

Debtor Member’s Tax Attributes

Look Through Rule

Consolidated Tax Attributes
Effective for discharges occurring after August 29, 2003
13
Section 338(h)(10)
Section 338
•
New Final and Temporary Regulations

Address interplay between Section 338(h)(10) and step
transaction doctrine

Alleviates confusion caused by a series of IRS rulings
•
Rev. Rul. 90-95
•
Rev. Rul. 2001-46
15
Revenue Ruling 90-95
P
P
S/Hs
T S/Hs
100% Cash
S
Merge
Former
T S/Hs
P
Merge
T
T
Acquisition Merger
Upstream Merger
16
Revenue Ruling 90-95
• Rev. Rul. 90-95:

First step QSP accorded independent significance from
second step liquidation. Cites Congressional intent that a
Section 338 election replace any non-statutory treatment of a
stock purchase as an asset purchase under Kimbell Diamond
doctrine.
17
Revenue Ruling 2001-46
• Issues addressed in Rev. Rul. 2001-46

The Issue:
– After Rev. Rul. 90-95, it was unclear what tax result
prevailed when a first step taxable acquisition was
followed by a second step merger (or other asset
transfer) that could recast the transaction into a
reorganization.
– Practitioners argued that a first step QSP had
independent significance from any future step.
18
Revenue Ruling 2001-46
X s/h’s
T s/h’s
X
X s/h’s
70% X stock;
30% Cash
1. Merger
Y
2. Merger
Up
T
T s/h’s
X
T
X s/h’s
3. Resulting
Structure
T s/h’s
X
19
Revenue Ruling 2001-46
• Rev. Rul. 2001-46

Situation 1: X owns all of Y, a newco. Pursuant to an
integrated plan, X acquires all of T in a merger of T and Y,
with T surviving. In the merger, shareholders of T receive
70% X stock and 30% cash. As part of the plan, X then
merges T upstream.

First step would not qualify as a “B” reorg. as solely rule is
violated and does not qualify as an (a)(2)(E) because that
section requires that at least 80% of the acquisition
consideration be in the form of voting stock.

Viewed as a merger into X, however, the more liberal COSI
standard is met.
20
Revenue Ruling 2001-46
•
Issues addressed in Rev. Rul. 2001-46

Conclusion: Policies underlying Section 338 not violated by treating
Situation 1 as a single statutory merger that qualifies as a
reorganization because X acquires the assets with a carryover basis
under sec. 362, not cost basis under sec. 1012. Thus, steps do not
have independent significance.

However, ruling was given only prospective application.

Situation 2: Same as Situation 1 except that T shareholders receive
solely X voting stock.

Subsidiary merger would have qualified as an (a)(2)(E) by
itself. Service holds that this difference should not change the result
in Situation 1 – i.e., treated as a direct merger into parent.
21
Reg. Section 1.338(h)(10)-1T
•
Issued in response to comments urging IRS and Treasury to
allow Section 338(h)(10) elections in transactions identical to
Situation 1 of Rev. Rul. 2001-46.
•
Regulations give effect to Section 338(h)(10) in multi-step
transactions where a purchasing corporation’s initial acquisition
of target’s stock viewed independently, constitutes a qualified
stock purchase (QSP).
•
Step transaction doctrine will not be applied in such transactions
if a valid Section 338(h)(10) election is made.
•
4 new examples (11-14) were added to the Section 338(h)(10)
regulations
•
Allows for greater flexibility in structuring and planning – Elective
Carryover or Section 338(h)(10) Treatment
•
Effective July 9, 2003
22
Example 11
S/Hs
P
S
S
50% P Voting Stock
50% Cash
P
Merge
Y
T
T
Merge
Stock Acquisition Viewed Independently,
constitutes a qualified stock
purchase.
No Section 338(h)(10)
election made.
Upstream Merger Viewed independently
qualifies as a Section 332
liquidation.
23
Example 11
•
New regulation does not apply since no valid Section
338(h)(10) election was made.
•
Treated as a tax-free reorganization under Section 368(a).
24
Example 12
S/Hs
S
S
P
50% P Voting Stock
50% Cash
P
Merge
T
Y
T
Merge
Stock Acquisition Viewed Independently,
constitutes a qualified stock
purchase.
P and S make a valid joint
Section 338(h)(10) election for T.
Upstream Merger Viewed independently
qualifies as a Section
332 liquidation.
25
Example 12
•
Application of the step transaction doctrine results in the 2
step transaction being treated as P’s acquisition of T’s assets
in a tax-free reorganization
•
Applying new regulations:

Since a valid Section 338(h)(10) election was made, step
transaction doctrine does not apply and P’s acquisition of
T stock treated as a QSP and not a tax-free
reorganization under Section 368(a).
26
Example 13
S
S/Hs
S
P
50% P Voting Stock
50% Cash
X
Y
Merge
P
T
X
Stock Acquisition Viewed Independently, constitutes
a qualified stock purchase.
P and S make a valid joint Section
338(h)(10) election for T.
Merge
T
Brother-Sister Merger Viewed independently qualifies
as a reorganization under
Section 368(a).
27
Example 13
•
Application of the step transaction doctrine results in the 2 step
transaction being treated as P’s acquisition of T’s assets in a
tax-free reorganization
•
Applying new regulations:

Since a valid Section 338(h)(10) election was made, step
transaction doctrine does not apply and P’s acquisition of T
stock treated as a QSP and not a tax-free reorganization
under Section 368(a).
28
Example 14
•
Same facts as Example 12, except S (T’s shareholder)
receives only P voting stock as consideration for merger of
Y into T.
•
No Section 338(h)(10) election can be made since, viewed
independently, Y’s merger into T does not constitute a QSP
since S receives only P voting stock and transaction
independently is a tax-free reorganization.
•
New regulations do not apply.
•
Step transaction doctrine applies.
•
2 step transaction treated as one tax-free reorganization
under Section 368(a).
29
Change to Form 8023
• October 2002
• Form 8023 – Election Statement
• Form 8883 – Asset Allocation Statement
30
Section 355
Section 355
•
No gain or loss is recognized by the distributing corporation (D) or
its shareholders on a distribution of a controlled subsidiary (C)
•
Requirements
•

D must Control C before the distribution

Distribution must not be a Device for the distribution of E&P of
D or C

Must be a Continuity of Interest on the part of the D
shareholders after the distribution

Must be a Valid Business Purpose for the distribution

D and C must each engage in the Active Conduct of a FiveYear Trade or Business immediately after the distribution
Section 355(e) – D will recognize gain on the distribution if there is
a 50% or greater change in the ownership of either D or C that is
treated as part of a plan (or series of related transactions) that
includes the distribution
32
Section 355
•
As a result of the significant tax exposure to D and its
shareholders, taxpayers frequently seek private letter rulings from
the IRS regarding the qualification of the distribution under section
355
•
Rev. Proc. 96-30
•

Contains the checklist questionnaire of information that must
be included in a request for ruling under Section 355

Appendix A – Business purposes guidelines, e.g., “fit and
focus”
Rev. Proc. 2003-3

IRS will not rule on issues that are primarily factual

Active Trade or Business – Where FMV of active trade or
business assets is less than 5% of total FMV of gross assets of
corporation, IRS will ordinarily not rule that active business
requirement of section 355 is met
33
Rev. Proc. 2003-48
•
IRS will not rule on business purpose, device, or acquisition “pursuant to a
plan” (section 355(e))
•
Taxpayers requesting rulings will have to make representations regarding
the satisfaction of the business purpose, device and section 355(e) issues.
•
IRS views these issues as “primarily factual”; best left for audit
•
Deletes Appendix A of Rev. Proc. 96-30, and Section 4.01(30) of Rev. Proc.
2003-3 (the less than 5% FMV active trade or business assets no rule area)
•
IRS will focus on increasing published guidance regarding business purpose
and other section 355 legal questions
•
One year pilot program
34
Recent Section 355 Rulings
•
Revenue Ruling 2004-23 – Business Purpose – Increase in
Aggregate Value of Stock of Distributing and Controlled
•
Revenue Ruling 2003-74 – “Fit and Focus” – Management
Problems
•
Revenue Ruling 2003-75 – “Fit and Focus” – Capital Allocation
Problems
•
Revenue Ruling 2003-79 – “C” Reorg Following Spin
35
Rev. Rul. 2004-23 – Increase in Stock Value
•
Corporate Business Purpose satisfied even though the Distribution is
expected to confer a benefit to existing shareholders
•
Stock of Distributing and Controlled likely would, in the aggregate, have
a higher trading price than the stock of Distributing if it continued to own
Controlled
•
The benefit of the increased aggregate value is a real and substantial
benefit to Distributing, Controlled or both (enhanced equity based
compensation or facilitates future acquisitions in a manner that
preserves capital with less dilution of existing shareholders’ interests)
•
Distributing’s directors do not effect the Distribution to facilitate any
particular shareholder’s disposition of the stock of Distributing or
Controlled
36
Rev. Rul. 2003-74 - “Fit & Focus” - Management
•
Distributing engaged in high-growth software technology
business
•
Controlled engaged in slow-growth paper products business
•
One 8% shareholder not involved in management
•
Senior management wants to concentrate solely on software
•
2 shared directors – 1 with unlimited term – not officers
37
Rev. Rul. 2003-75 - “Fit & Focus” - Capital
•
Distributing in pharmaceuticals and Controlled in cosmetics
•
One 6% non-management shareholder
•
Businesses compete for capital
•
Controlled will have direct access to capital if spun off
•
Continuing relationships – administrative, tax – for 2 years
with limited extension
38
Rev. Rul. 2003-79 – “C” Reorg Following Spin
•
D conducts Businesses X and Y of equal value
•
Unrelated A wants to acquire Business X but not Business Y
•
D transfers Business X to newco C
•
D spins off C to its shareholders
•
A acquires C assets in exchange for A voting stock (not a
merger) and C liquidates
39
Revenue Ruling 2003-79
Shldrs
Shldrs
D
A voting
stock
A
D
Bus Y
C
A
Bus X
“C” reorg
C
Bus X
40
Revenue Ruling 2003-79
•
Issue Addressed: Is the “substantially all of the properties
requirement” of a “C” reorganization met on C’s transfer of
Business X to A?
•
Issue Assumed: D distributed “stock of a controlled
corporation” – so a good spin-off
•
Apparent violation of doctrine that transitory existence of a
corporation formed solely to effect an acquisition should be
disregarded
41