11/14/2011 (c) William P. Streng 1
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 re possible gain recognition.
Effects of tax-free corporate reorganizations:
1) Corporate parties to the transaction - no gain or loss on transfers of corporate properties.
2) Exchanging shareholders - no gain or loss.
3) Tax attributes are transferred to the acquirer.
11/14/2011 (c) William P. Streng 2
AcquisitiveReorganizations
(cf., Divisive Reorgs), p.415
One corporation acquires the stock or assets of
another corporation in exchange for the 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 an
acquisition subsidiary of Acquirer ).
Cf., receipt of cash by shareholder.
11/14/2011 (c) William P. Streng 3
Judicial Limitations -
Tax “Common Law” 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.
11/14/2011 (c) William P. Streng 4
Concepts of Tax-free
Corporate Reorganizations
1) Limit is imposed 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.
11/14/2011 (c) William P. Streng 5
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. Cf., §351.
§361 - no gain or loss to the acquired corporation.
Also, §1032 for the stock issuance by acquirer.
§§356/357 - treatment of boot received and
liabilities assumed in the transaction.
§358/362(b) - substitute tax basis rules.
§381 - carryover of tax attributes.
11/14/2011 (c) William P. Streng 6
How Assure Tax-free
Reorganization Treatment?
Options:
1) IRS Private Letter Ruling – but, limited
availability, unless a “significant issue.”
- See Rev. Proc. 2011-3.
- See Rev. Proc. 77-37 (fn., p. 417) re guidelines
for issuing corporate reorganization tax private
letter rulings.
Is this Rev. Proc. “substantive law”?
2) Law firm/accounting firm tax opinion letter.
11/14/2011 (c) William P. Streng 7
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
(including foreign merger statutes).
2) Consolidation: mergers of two existing
corporations into a third (often new)
corporation.
11/14/2011 (c) William P. Streng 8
Divisive Mergers p.418
(i.e., not “acquisitive”)
Rev. Rul. 2000-5 – for tax-free corporate
reorganization treatment the merger must be
acquisitive, rather than divisive (i.e., subject 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.
11/14/2011 (c) William P. Streng 9
Mergers involving
Disregarded Entities p.419
Example: Mergers between a corporation and a
disregarded entity.
A. Merger of a target corporation into a
disregarded entity (e.g., LLC) is treated as a
“merger” into another corporation. Why?
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., the owner of the LLC).
11/14/2011 (c) William P. Streng 10
Continuity of Proprietary
Interest – A 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.
11/14/2011 (c) William P. Streng 11
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).
11/14/2011 (c) William P. Streng 12
What Stock % is Required?
P. 423
1) Nelson case (Sup. Ct – 1935) – 38% nonvoting
preferred stock was OK.
2 To obtain an IRS PLR – Rev. Proc. 77-37
requires a 50% stock value issuance.
3) Reg. §1.368-1T(e)(2)(v), Example 1 (40% ok).
What is large firm practice re a merger opinion?
What is “stock”? Cf., “nonqualified preferred
stock” (as “boot”?).
11/14/2011 (c) William P. Streng 13
Other Continuity of Interest
Issues: p. 424
1) Remote continuity – can assets be dropped down
into subsidiaries by Acquirer and not violate
COI test? If to controlled (80%) subsidiaries.
2) When to measure the COI test compliance (to
avoid possibly violating the COI threshold)?
- Day before the binding contract if a fixed number
of shares is to be delivered.
- Alternative if variable consideration, i.e., shares
are increased if Acquirer’s share value declines.
11/14/2011 (c) William P. Streng 14
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 the 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.
11/14/2011 (c) William P. Streng 15
Continuity by Historic
Target Shareholders
Kass v. Commissioner p. 428, note 1
Squeeze-out upstream merger after a cash stock
acquisition in a tender offer and a prior 80% plus
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.
11/14/2011 (c) William P. Streng 16
Continuity of Interest (COI)
Regulations
Reg. § 1.368-1(e)(1)(i).
Disposition of stock prior to a reorganization to
unrelated persons will be disregarded and will not
affect continuity of interest in the acquirer by the
exchanging party.
Requirement: Exchange Target stock for
Purchaser stock & have at least 50 percent of the
entire consideration received being equity.
11/14/2011 (c) William P. Streng 17
Post-Acquisition Continuity
p. 430
How long must the target shareholders hold their
stock in the acquiring corporation after their
acquisition?
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).
11/14/2011 (c) William P. Streng 18
Rev. Rul. 99-58 p.431
Open Market Repurchase
Reorganization acquisition (50/50 stock & cash)
followed by open market reacquisitions of the
Purchaser’s stock (redemptions? § 302(b)(2)).
The purpose of the reacquisition was to prevent
stock ownership dilution for the Purchaser.
No understanding that the P share ownership by
the T shareholders would be transitory.
No impact on the COI status resulted.
Disposition of stock to unrelated persons OK.
11/14/2011 (c) William P. Streng 19
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 this tax refund suit?
11/14/2011 (c) William P. Streng 20
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 the business of the Acquirer.
11/14/2011 (c) William P. Streng 21
Continuity of Business
Enterprise Regulations
COBE regulations - Reg. §1.368-1(d).
COBE requires that the issuing corporation either
continue the Target's 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).
11/14/2011 (c) William P. Streng 22
Problem 1(a) p.438
All Cash Merger-Rev. Rul. 69-6
"All cash" merger - valid under state law.
Lacks continuity of interest (but does satisfy the
§368(a)(1)(A) mechanical 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?
11/14/2011 (c) William P. Streng 23
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 of interest” rule is 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?
11/14/2011 (c) William P. Streng 24
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.
The only consideration received is stock and,
therefore, a tax-free merger has occurred.
But, what is the adverse impact (if any) of the post-
acquisition stock disposition? None (on the other
25% shareholder(s)). See Reg. §1.368-1(e)(7),
Example 1(i).
11/14/2011 (c) William P. Streng 25
Problem 1(d) p.438
Target Assets Sold
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 in this situation T’s business
is not continued.
11/14/2011 (c) William P. Streng 26
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.
11/14/2011 (c) William P. Streng 27
Problem 1(f) p.439
P Stock Value Declines
As in (e) –stock (120,000) and notes (180,000) but
the stock declines to 60,000 prior to the closing.
At the closing stock of 60,000 and notes of 180,000
equals 25% for stock. Invalidate tax-free merger
treatment (for the 60,000 stock)?
Reg. §1.368-1T(e)(2)(i) says the value of the deal is
measured on the last day before the binding
contract – here 40% & acceptable for the
continuity of interest test.
11/14/2011 (c) William P. Streng 28
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
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
shareholders in this situation? Yes.
11/14/2011 (c) William P. Streng 29
Problem 1(h) p.439
Convertible Debt (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.
11/14/2011 (c) William P. Streng 30
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 owning 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 pro-
rata values of the consideration received and not to
the shareholder numbers.
See Rev. Rul. 66-224 (p.422).
11/14/2011 (c) William P. Streng 31
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 reorg”?
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. Are they
counted?
11/14/2011 (c) William P. Streng 32
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) appears to be not
"old and cold”.
Therefore, only a 20% “continuity of interest”
results and gain or loss recognition occurs to the
minority shareholders.
Section 338 election? Available but unlikely.
11/14/2011 (c) William P. Streng 33
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.
11/14/2011 (c) William P. Streng 34
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 for
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?
11/14/2011 (c) William P. Streng 35
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”?
11/14/2011 (c) William P. Streng 36
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.
11/14/2011 (c) William P. Streng 37
“B” Reorganization
Limitations on Eligibility
No "boot" in a B reorganization.
Voting preferred is possible.
What if preferred only votes in the event of
dividend arrearages?
Is a fractional share cash-out OK? Yes. Why?
Payment of target’s expenses by the acquirer ok? -
yes, but not expenses of the shareholders.
How to deal with the problem of dissenters? P.453.
- redemption by Target corp.
11/14/2011 (c) William P. Streng 38
“B” Reorganizations-
Contingent Stock p.453-4
Contingent stock arrangements are acceptable (for
B reorg. eligible treatment) if:
1) Only additional stock can be issued.
2) Five year limit is applicable.
3) Valid business reason, e.g., a valuation issue.
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
11/14/2011 (c) William P. Streng 39
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 rights.
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 of the
preferred stock compared to common stock?
11/14/2011 (c) William P. Streng 40
Problem 1(b) p.455
“Solely” Requirement Not Met
Transfer of 85% voting stock and 15% warrants to
Target shareholders.
Warrants are not voting stock.
The “solely" for voting stock requirement is
violated and the transaction is not a "B"
reorganization.
No "boot" is permitted in a "B" reorganization.
11/14/2011 (c) William P. Streng 41
Problem 1(c) p.455
Fractional Share Cash-out
Voting shares are received with an additional
payment for the fractional share cash-out.
Assuming "not separately bargained for"
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 – the boot provision).
11/14/2011 (c) William P. Streng 42
Problem 1(d) p.455
P pays T’s Expenses
P pays Target's legal and related transaction fees in
addition to issuing P voting common stock.
If related to the reorganization: the solely for
voting stock requirement is not violated.
Why? Payment must be made directly to the
creditors, rather than to Target (per Rev. Rul. 73-
54, p. 452).
11/14/2011 (c) William P. Streng 43
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.
11/14/2011 (c) William P. Streng 44
Problem 2(a) p.455
Minority Shareholder
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).
11/14/2011 (c) William P. Streng 45
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
for voting stock” requirement.
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.
11/14/2011 (c) William P. Streng 46
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.
11/14/2011 (c) William P. Streng 47
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 for voting 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.
11/14/2011 (c) William P. Streng 48
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
P voting common stock in a single transaction (going
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.
11/14/2011 (c) William P. Streng 49
Problem 3(b) p.455
Step Transaction?
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.
11/14/2011 (c) William P. Streng 50
Problem 3(c) p.456
Multiple Acquisitions
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).
11/14/2011 (c) William P. Streng 51
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% final transaction?
11/14/2011 (c) William P. Streng 52
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 examine questions about the transfer
to and the reacquisition from Friendly Bank.
11/14/2011 (c) William P. Streng 53
The “C” Reorganization -
The “Practical Merger”
Criteria for a valid "C" reorganization:
1) Voting stock of the acquirer is received.
2) A transfer of “substantially all” properties.
3) Liquidation of Target with the distribution to the
shareholders of the Acquirer’s stock received.
4) Assumption of some liabilities is permitted.
5) Limited "boot" exception - but a 20% limitation
rule (including the liabilities assumed).
11/14/2011 (c) William P. Streng 54
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 the “operating 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.
11/14/2011 (c) William P. Streng 55
Liquidation of the Target
Corporation p.457
§368(a)(2)(G) requires the Target to distribute all
its assets (including the shares of the purchaser
corporation) 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
actually occurred, and
(2) the assets were thereafter contributed to the
capital of a new corporation.
11/14/2011 (c) William P. Streng 56
Creeping Acquisitions
p.458
Prior purchase of stock of the Target - is this
purchase transaction “old and cold”?
Purchaser’s prior holding of stock not invalidating
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).
11/14/2011 (c) William P. Streng 57
Problem 1(a) p.459
70% Operating Assets
T has $70,000 of operating assets and $30,000 of cash
and securities & A issues voting stock worth $70,000.
T liquidates (distributing both stock & cash).
The tax issue concerns whether "substantially all"
the properties have been transferred? Note: The
“70 percent of gross and 90 percent of net” test
(Rev. Proc. 77-37) has not been satisfied.
But, (1) only non-operating properties were retained,
and (2) all assets are transferred to the shareholders
in the liquidation.
11/14/2011 (c) William P. Streng 58
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 assets of Target in exchange for A voting stock.
T then liquidates, distributing $70,000 of A stock and $30,000 of T’s operating assets.
Here, operating assets have been (temporarily) retained by Target shareholders after the exchange. Therefore, a failure occurs to satisfy the "C" reorganization “substantially all” requirement.
11/14/2011 (c) William P. Streng 59
Problem 1(c) p.459
Assumption of Liabilities
T has (1) $100,000 of operating assets and (2) $30,000 of liabilities.
A issues $70,000 of voting stock in exchange 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 are assumed?
11/14/2011 (c) William P. Streng 60
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.
11/14/2011 (c) William P. Streng 61
Problem 2(a) p.459
“B” or “C” Reorg?
T owns (1) $70,000 of operating assets and (2)
$30,000 cash and investment securities.
T redeems 30% of the stock for cash & 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?
-but, acquisition of “substantially all” assets?
11/14/2011 (c) William P. Streng 62
Problem 2(b) p.459
Step Transaction?
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.
11/14/2011 (c) William P. Streng 63
Problem 2(c) p.459
“C” Reorg Status?
A has held 30 percent of T stock (old & cold).
A exchanges A voting stock for the remaining 70%
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 then not satisfied.
But, cf. Reg. §1.368-2(d)(4), Ex. 1
11/14/2011 (c) William P. Streng 64
Triangular Reorganizations
p.460
Alternative structures: (see supp. charts)
1. “A” Reorg. (§368(a)(1)(A)) & then an asset drop
down to a subsidiary. §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).
11/14/2011 (c) William P. Streng 65
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 (parent as sole
shareholder votes stock of the acquisition sub).
11/14/2011 (c) William P. Streng 66
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).
11/14/2011 (c) William P. Streng 67
Multi-Step Transactions
Objectives in multi-step transactions:
1) Achieve business plan – including regulatory
and financial accounting issues
2) Tax result based on overall transaction basis
3) Relevance of Section 338/cash asset purchase
transaction treatment.
Overall objective: (1) get assets & control position
acquired; (2) then, restructure to rationalize
operations.
11/14/2011 (c) William P. Streng 68
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
T’s stock, followed by (2) merger of P’s sub into T
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)).
11/14/2011 (c) William P. Streng 69
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
the acquiring corporation.
Holding: Step transaction treatment & statutory
merger into P & §368(a)(1)(A) reorg. treatment.
Situation One: if not a step-transaction, then not a
reorg., & would be a qualified stock purchase for
§338 purposes and asset basis step-up would be
applicable. continued
11/14/2011 (c) William P. Streng 70
Multi-Step Transactions
Rev. Rul. 2001-46, cont.
Situation two: In an acquisition merger (1) the
Target shareholders receive solely acquiring
corporation 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).
11/14/2011 (c) William P. Streng 71
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 a reorg & gain to shareholder; but not a stock purchase without a §338 election.
11/14/2011 (c) William P. Streng 72
Triangular Reorganizations
Problems p.471
See the separate charts concerning the
elements of the transactions identified in these
problems.
11/14/2011 (c) William P. Streng 73
Acquisitive Reorganization
Treatment of the Parties
Consider the income tax treatment resulting from a
tax-free corporate reorganization for the following
parties to that reorganization:
1) The shareholders of the Target Corporation
2) The Acquiring Corporation & any Acquisition
Subsidiary
3) The Target Corporation
11/14/2011 (c) William P. Streng 74
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 the boot? §356(a)(2).
11/14/2011 (c) William P. Streng 75
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 425,000 P shares.
What is the Code §356(a)(2) applicability?
1) A deemed pre-reorganization redemption of the
Target acquired shares (Shimberg case); or,
2) A deemed post-reorganization redemption of the
acquiring corp. (P) shares (Wright case)?
11/14/2011 (c) William P. Streng 76
Characterization of Boot as
Dividend or Capital Gain
Boot dividend is limited to the gain amount.
§356(a)(2) - (dividend within gain)
Tax rate of 15% on both dividend and capital gain
reduces tax significance, but:
1) Preferring dividends received deduction (DRD) –
for a corporate shareholder?
2) Boot gain is received in form of installment notes
– not if dividend characterization applies.
11/14/2011 (c) William P. Streng 77
Basis and Holding Period for
Target Shareholders p.475
§358 – basis in the stock received is derived from the
basis of the stock transferred.
However, boot takes a fair market value basis.
What about multiple “tax lots” for shares received?
– 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).
11/14/2011 (c) William P. Streng 78
Problem (a) p.477
Merger “A” Reorganization
Each shareholder receives (1) 4,000 shares ($40,000
FMV) of voting common stock and (2) nonvoting (not
nonqualified) preferred stock worth $10,000.
1) Nontaxable - solely “stock for stock.” §354(a).
2) Substituted basis. §358(a)(1) - $20,000 total basis;
common-16,000; preferred - 4,000
3) Tacked holding period. §1223(1).
4) Preferred stock - §306 stock. §306(c)(1)(B). Even
though received in a merger? Yes.
11/14/2011 (c) William P. Streng 79
Problem (b) p.477
Note & Not Stock Received
Shareholder receives (1) 4,000 voting common stock
plus (2) a 20 year $10,000 interest bearing note
(rather than the preferred stock).
Necessitates a Clark case analysis re §302(b)(2)
redemption status.
Treatment as if (1) each shareholder received 5,000
shares and (2) subsequently transformed 1,000
shares into the $10,000 note.
continued
11/14/2011 (c) William P. Streng 80
Problem (b) continued
Note & Stock Received
1) Each shareholder before the deemed redemption:
5,000 shares = $50,000 (1,000 shares are “boot”).
550,000 shares equals .909 shareholder %.
2) After redemption:
4,000 (actual shares retained by each shareholder)
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?
11/14/2011 (c) William P. Streng 81
Problem (c) p.477
High Tax Basis Limits Gain
Each shareholder has $45,000 basis in her T stock.
Only a $5,000 gain is realized.
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 basis less $10,000 equals $35,000, plus
$5,000 gain recognized equals $40,000 stock basis.
11/14/2011 (c) William P. Streng 82
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). Tacked holding.
$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.
11/14/2011 (c) William P. Streng 83
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.
11/14/2011 (c) William P. Streng 84
Target Corporation p.478
Consequences - Issues
Income tax realization events:
1) Reorganization exchange of its property for
stock (and boot) (e.g., “A”, “C” or forward
triangular reorganization).
2) Distribution in corporate liquidation of the
Purchaser’s stock received (or boot) (or sale of
hat stock prior to the corporate liquidation).
Any income tax recognition upon these events
occurring?
11/14/2011 (c) William P. Streng 85
Reorganization Exchange
Target Level Treatment
§361(a) - no gain or loss is recognized on the
transfer of assets in the reorganization transaction.
§357(a) - assumption of the target's 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, is
acquired in these transactions.
11/14/2011 (c) William P. Streng 86
Shareholder Distribution
- Tax Effects to the Target
No gain or loss is recognized to Target when it distributes “qualified property” See §361(c).
"Qualified property" requirement is 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 to Target)?
11/14/2011 (c) William P. Streng 87
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 occurs. 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.
11/14/2011 (c) William P. Streng 88
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 a reverse triangular?) -
take the shareholders’ tax bases.
Sampling is acceptable to determine stock basis of
the shareholders if multiple shareholders of the
Target. Rev. Proc. 81-70, as amplified by Rev. Proc.
2011-35 re statistical analysis.
11/14/2011 (c) William P. Streng 89
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.
11/14/2011 (c) William P. Streng 90
Rev. Rul. 72-327 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
11/14/2011 (c) William P. Streng 91
Rev. Rul. 72-327 p.482
continued
4) Acquirer’s E&P is increased by the gain
recognized.
5) Acquirer succeeds to the Target’s 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.
11/14/2011 (c) William P. Streng 92
Problem 1(a) p.484
“C” Reorganization
P transfers voting stock worth $80,000 in exchange for T's assets (fmv $100,000; basis 60,000) subject to $20,000 liabilities; T distributes shares.
P - no gain when issuing P stock - §1032. P takes T’s E&P. P - 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).
T’s shareholders - nonrecognition & exchanged basis ($20,000) under §358(a)(1).
11/14/2011 (c) William P. Streng 93
Problem 1(b) p.484
Cash Used for Liabilities
P transfers $80,000 of voting stock and $20,000 cash
to T; cash used to pay T 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 which is distributed.
Distribution: No T gain on distribution of P stock -
all is qualified property - §361(c)(1).
P - no recognition on cash & stock transfers. §1032.
11/14/2011 (c) William P. Streng 94
Problem 1(c) p.484
Securities as “boot.”
1) P transfers to T (a) voting stock worth $80,000 and (b) investment securities (basis $10,000 and value $20,000 ) for all T's assets not subject to any liabilities. Gain of $10,000 is recognized to P.
2) T – no gain on its asset transfers - §361(a).
T recognizes no gain on receipt of boot (§361(b)(1)(A)), but on the distribution of boot (if any gain - probably not here since basis is 20x).
3) Shareholders realize 100x value and 80x gain & recognize 20x boot gain. §356(a)(1). Character?
11/14/2011 (c) William P. Streng 95
Problem 1(d) p.484
C Reorg & No Liquidation
P transfers $80,000 voting stock, $10,000 bonds and $10,000 cash to T in exchange for T’s assets.
T receives permission not to liquidate and retains the cash, bonds and stock.
1) P - no gain recognition (stock/securities). §1032.
2) T - waiver for distribution? §368(a)(2)(G)(ii). No gain to T on asset transfers. §361(a). Treated as a constructive liquidation. T has no gain recognition on the deemed distribution. §361(c)(1).
3) Shareholders - 20x boot (dividend?). Character?
11/14/2011 (c) William P. Streng 96
Problem 1(e) p.484
Two Types of Stock
P transfers $80,000 of voting stock and $20,000 of nonvoting preferred stock to T in exchange for all T's assets. No debt.
T liquidates and distributes the voting and nonvoting preferred (§306) stock to its shareholders prorata & tax basis allocation.
1) P – no gain – under §1032.
2) T – no gain on either its asset transfers or the distribution of P stock. §361(a), (c)(1).
3) No gain recognition to shareholders. §354(a)(1).
11/14/2011 (c) William P. Streng 97
Problem 2(a) p.484
C Reorganization
Valid “C” reorganization? Not all assets acquired.
1) P - no gain on the distribution of P’s stock (§1032), but $8,000 gain on the transfer of the Bell stock (& E&P increase by the $8,000). 20x + 8x asset basis.
2) T - no gain on transfer of its operating assets.
T’s basis for P stock is $8,000 (18x less 10x boot).
Sale by T of $40,000 P stock - gain to be recognized.
Target distribution to shareholders – recognition to T for the Bell stock (2x) & the land (8x), but not the P stock gain. And, recognition of gain on stock sale? 40x less 4x (½ of 8x basis) = 36x. continued
11/14/2011 (c) William P. Streng 98
Problem 2(a) p.484
C Reorganization, cont.
3) Shareholders – receive property worth 62x (P stock – 40x; Bell stock – 12x; land – 10x) in exchange for stock with basis of 10x. Gain of 52x.
Gain recognized to extent of boot: land – 10x & Bell stock – 12x). Dividend under §356(a)(2)?
11/14/2011 (c) William P. Streng 99
Problem 2(b) p.484
C Reorganization
Transfer of stock by T to creditors as part of
reorganization plan.
Code §361(c)(3) permits non-recognition of gain
(i.e., $36,000 gain not recognized).
Stock 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 (cf., sale for
40x, Problem 2a).
11/14/2011 (c) William P. Streng 100
Problem 3(a) p.485
Forward Triangular Merger
Code §368(a)(2)(D).
Formation of S - no gain (§361(a)).
P’s basis in its S stock - equal to T’s basis in assets -
$100,000. Reg. §1.358-6(c)(1).
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.
11/14/2011 (c) William P. Streng 101
Problem 3(b) p.485
Reverse Triangular Merger
§368(a)(2)(E).
Parent - non-recognition on formation of S.
P’s basis in S stock - adjusted as if T had merged
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.
11/14/2011 (c) William P. Streng 102
Problem 3(c) p.485
Forward Triangular Merger
Failed §368(a)(2)(D) – forward triangular.
Parent - non-recognition on the formation of S.
S - No gain on issuing its own 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.
11/14/2011 (c) William P. Streng 103
Problem 3(d) p.485
Reverse Triangular Merger
Failed §368(a)(2)(E).
Parent - non-recognition on formation of S.
S - No gain on issuing its own stock.
S gain when transferring P stock to T.
T transfers T stock for P stock and no gain
recognition - §1032.
11/14/2011 (c) William P. Streng 104
End of Chapter 9
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