Transcript Corporate Acquisitions

Corporate Acquisitions
 Acquisition
form
 Asset Acquisition
 Direct acquisition of selected assets of target
corporation
 Merger with target corporation dissolved into
acquiring corporation
 Stock Acquisition
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Acquisitions Decision Model
Taxable Asset
Taxable Stock
Acquisition
Acquisition
Nontaxable Asset
Nontaxable Stock
Acquisition (Type A or Acquisition (Type B
C reorganization)
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reorganization)
Five Major Tax Issues
 Will
the transaction result in a taxable gain or
loss to the target firm’s shareholders?
 Will the transaction result in a taxable gain or
loss to the target firm?
 How will the transaction affect the target firm’s
tax attributes (NOLs, credit carryovers)?
 Will the transaction affect the tax basis of the
target firm’s assets?
 Will the use of leverage generate tax savings?
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Taxable Asset Acquisitions
 If
direct asset acquisition
 Target recognizes gain or loss on sale of assets
 No tax consequences to target shareholders,
unless target liquidates (then shareholders
recognize gain or loss on disposition of their stock)
 If
structured as a merger
 Target recognizes gain or loss as if assets were
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sold at FMV
 Target shareholders recognize gain or loss on the
disposition of their target stock
Taxable Asset Acquisitions
continued
 If
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merger, or target liquidates after
acquisition, target firm’s tax attributes,
including NOL and credit carryovers, are
lost
 Cannot ‘buy’ tax attributes
 Acquiring corporation takes a cost basis
(FMV) in assets acquired
 Debt financing is common in taxable asset
acquisitions, often resulting in increased
leverage
Example: Taxable Asset
Acquisition
 ABC
Inc. wishes to acquire the business of
Target Corporation, whose stock is owned by
Mr. Smith. ABC is willing to pay $2 million for
all of Target’s assets.
 If Target’s assets have a tax basis of $800,000,
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what are the tax consequences of the sale?
 Mr. Smith’s tax basis in his target stock is
$500,000. If Target liquidates and distributes the
after-tax proceeds of the asset sale to Mr. Smith,
what are the tax consequences of the
liquidation?
Taxable Stock Acquisitions
 Target
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shareholders recognize gain or
loss on disposition of their target stock
 Target does not recognize gain or loss
(unless Sec. 338 election)
 Tax attributes survive the acquisition, but
their future use is subject to limitations
 Acquiring corporation takes a cost (FMV)
basis in the target stock acquired
 No impact on basis of target’s assets
(unless Sec. 338 election)
Taxable Stock Acquisitions
continued
 Debt
financing is common in taxable stock
acquisitions, often resulting in increased
leverage
 If 80% control acquired, acquiring
corporation and target may file a
consolidated tax return
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Example: Taxable Stock
Acquisition
 Refer
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to previous example.
 Suppose that ABC is willing to pay Mr. Smith
$2 million for his Target stock. What are the
tax consequences of this sale?
 Why might ABC not be willing to pay $2
million for the stock?
 At what stock purchase price would Mr.
Smith be indifferent between a stock sale
and an asset sale followed by a liquidation of
Target?
Special Issues in Taxable
Stock Acquisitions
 Section
338 Election
 Election to treat a stock purchase as an asset
purchase for tax purposes
 Advantage: Acquiring corporation gets to
adjust the tax basis of target’s assets to FMV
 Cost: Target must recognize gain or loss as
though assets were sold for FMV
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Nontaxable Acquisitions
(Reorganizations)

Qualified reorganizations are treated as nontaxable
exchanges
 Judicial requirements for acquisitive reorgs:
 Original owners of target must maintain continuity of
proprietary interest in target’s business - satisfied if at
least 50% of consideration is acquiring corporation stock
 Continuity of business enterprise - acquirer must
continue target’s business or use target’s assets in an
existing business
 Business purpose, beyond tax avoidance
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Tax Consequences of
Nontaxable Acquisitions
 Most
basic case: No boot (all consideration
is acquiring corporation stock)
 No gain or loss recognized by target
corporation, or target’s shareholders
 Target tax attributes survive
 Acquiring corporation takes a carryover basis in
the assets or stock acquired
 If asset acquisition, target distributes stock received
to its shareholders and (usually) liquidates
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Nontaxable Acquisitions
continued
 Target shareholders take a carryover basis in
the acquiring corporation stock received
 Debt financing cannot occur directly in this
case (since it would be considered boot), so
increased leverage not possible as part of the
acquisition transaction
 Acquirer corporation debt can be issued to replace
target corporation debt. No gain or loss will occur
if principal amounts are equal
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Boot in Acquisitive
Reorganizations
 Any
property transferred by the acquiring
corporation other than its own stock or
securities is considered boot
 Gain (but not loss) recognized by the acquirer if
FMV of boot transferred > adjusted tax basis
 No gain or loss if the boot is cash
 Target corporation recognizes gain (but not
loss) if boot not distributed to shareholders, or if
target distributes its own assets (not acquired in
the reorganization) to its shareholders
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Boot in Acquisitive
Reorganizations continued

Target shareholders receiving boot and stock or
securities recognize gain (but not loss) equal to
the lesser of the gain realized or the FMV of the
boot received
 Target shareholders receiving only boot
recognize any gain or loss realized
 Gain recognized by target shareholders is
treated as a dividend (ordinary income) to the
extent of each shareholder’s proportionate
share of target’s AEP. Any remaining gain is
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capital gain.
Boot in Acquisitive
Reorganizations continued

Target security holders recognize gain if the
principal value of the securities received is
greater than the principal value of the securities
given up
 The basis of assets transferred to the acquirer is
increased by any gain recognized by the target
 The basis of stock or securities received by
target shareholders is increased by any gain
recognized and decreased by the FMV of boot
received
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GAAP Treatment of Mergers
and Acquisitions
 Purchase
accounting
 All assets and liabilities of acquired target
recorded at FMV, including goodwill
 SEC-preferred method of accounting for
acquisitions
 Pooling-of-interests
accounting
 Assets and liabilities of combined firms recorded
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at historical book cost
 Typically results in little or no recorded goodwill
 No longer allowed under GAAP
Tax versus Financial
Statement Goodwill

For tax purposes, goodwill is recorded only when
the tax basis of target assets is stepped up to FMV
 Taxable asset acquisitions
 Taxable stock acquisitions with Sec. 338 election
 Purchased goodwill amortizable over 15 years for tax
purposes

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Many nontaxable acquisitions are recorded using
the purchase method for GAAP purposes, resulting
in GAAP goodwill that is not amortizable for tax
purposes
Corporate Divisions

Spin-off: Parent corporation distributes controlling
interest in stock of a subsidiary corporation to
parent’s shareholders
 Split-off: Parent corporation distributes controlling
interest in stock of a subsidiary to a group of
shareholders in exchange for their parent stock
 Split-up: Parent corporation distributes stock of two
(or more) subsidiaries to its shareholders in
complete liquidation of the parent
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Corporate Divisions
continued

Such transactions are nontaxable to the parent and
participating shareholders if undertaken for a
corporate business purpose and requirements of
Sec. 355 are met
 Parent must distribute at least 80% of subsidiary stock
 Subsidiary and parent (spin-off or split-off) must continue
to engage in a business that had been conducted for at
least 5 years before the distribution
 Parent must have held the stock of the subsidiary for at
least 5 years before the distribution (unless acquired in a
nontaxable transaction)
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