Transcript TAXABLE CORPORATE ACQUSIITIONS

Tax 4022/5022
Federal Income Tax II
Corporate Acquisitions
Chapter: None
Dr. Robert R. Oliva
Professor and Chairperson
Department of Accounting
University of Arkansas at Little Rock
Corporate Acquisitions
• I. Taxable Acquisitions
• II. Non-Taxable Acquisitions:
Reorganizations
Taxable Acquisitions
Introduction
• I. ASSET ACQUISITION
• II. STOCK ACQUISITION
ASSET ACQUISITION (not a
reorganization):
• Two possibilities:
– (1)
• A. Purchasing Corporation (P) buys assets from
Target Corporation (T)
• B. T liquidates cash from sale of assets to T’s
shareholders
– (2)
• A. T liquidates assets to its shareholders and
• B. P buys assets from T’s shareholders
Tax effect
• Two levels of taxation: corporate and
shareholder
– If so, P takes a cost AB
– P could avoid the corporate-level tax on a
stock purchase, but AB will be c/o.
Allocation
• Sale of assets of a going business
requires allocation
• Buyers and sellers have conflicting
interests.
Seller
• Seller’s gain or loss and character may
depend on how the sales price is
allocated.
– Favor allocation to assets yielding capital
gains.
Buyer
• Buyer’s AB and depreciation depends on
how sales price is allocated.
– Favor allocation of sales price to depreciable
assets
Price allocations may be
contractually specified, or
may be imposed by IRC.
• IRC 1060: Review it and its regulations
IRC 1060
• Where there is no agreement between
the parties, or if there is one, IRS finds
allocation not appropriate.
• Outlines specific allocation method for
applicable assets acquisitions.
• Applicable asset acquisitions: Direct or
indirect transfers of trade or business
assets, where buyer’s (transferre) AB is
Treas. Reg. 1.1060-1:
• Allocate as in Treas. Reg. 1.338-6: 7
classes of assets
– 1.338-6(a)(1): Adjusted grossed-up basis
(AGUB) is allocated among target's
“acquisition date assets.”
• Target’s assets held at the beginning of the
day after the acquisition date. Reg §1.3382(c)(2) .
7 classes of assets
• Class I: cash, savings accounts, checking
accounts, but not CDs.
– If Class I assets exceed AGUB, new target
immediately realizes ordinary income in the
amount of the excess.
• Classes II through VII:
– In proportion to, and not in excess of, their
fair market value:
Class II - VII: In proportion to,
and not in excess of, their fair
market value:
– Class II: CDs, foreign currency; US gov secs; publicly
traded stock (not of target’s affiliate); actively traded
personal property
– Class III: mark-to-market assets and some debt
instruments
• Exceptions: debt instruments issued by related parties;
contingent debt; convertible debt
– Class IV: Inventory
– Class V: Not in any of the classes above or below:
furniture, buildings, land, actively traded T’s affiliate stock
– Class VI: IRC 197 intangibles o/t goodwill and going
concern value
– Class VII: goodwill and going concern value.
Method of allocation
• Asset by asset, starting first with I and
down.
• On the basis of FMV.
• See Treas. Reg. 1.1060-1(d): Example 2.
STOCK ACQUISITION
Stock Acquisition
• P buys stock of T from T’s shareholders.
• If T is closely held, negotiation may be
face to face.
• But likely to be different if T is publicly or
widely held.
Either way:
• T’s shareholders recognize gain(loss)
• P takes a cost AB
Kimbell-Diamond’’s transitory
ownership doctrine
• Some stock purchases had been treated
as asset acquisitions when the stock
purchase was followed by a liquidation of
Target into Parent.
– Codified into IRC 334(b)(2): Asset’s AB = c/s
AB if 80% acquired by purchase w/i 12
month and plan of liquidation adopted w/i 2
years after acquiring control
– However, in 1982: IRC 334(b)(2) was
repealed
IRC 338: “Qualified stock
purchase” (QSP)
• Replaced IRC 334(b)(2)
• Qualified purchase (control) requirement
• Time requirement
• Timely election requirement
The IRC 338 election
• Actual election: IRC 338(a)
– “… if a purchasing corporation makes an
election … in the case of a qualified stock
purchase…. ”
• Deemed election: IRC 338(e)
– “… a purchasing corporation … treated as
having made an election (the deemed
election) … if … during the consistency
period… acquires any asset of the
“purchasing corporation”: IRC
338(d)(1)
• one which makes a QSP of another
corporation.
“target corporation”: IRC
338(d)(2)
• one whose stock is acquired through a
QSP
QSP: IRC 338(d)(3)
• One or a series of transactions, where
the purchasing corporation (not an
individual) acquires by purchase
• “sufficient target stock”
• during a “12-month acquisition period”
How to “purchase” stock:IRC
338(h)(3)(a), (b)
• Taxable stock “purchase” from an
unrelated party.
– Not by gift, inheritances, or tax-free/carryover basis transactions.
– Purchases by affiliates of purchaser are
included
– Effect of redemptions are included, e.g.,
redeeming of minority shareholders to bring
purchasing corporation to 80%.
“Purchase” does NOT include
stock acquisition from
• persons whose stock will be attributed
to purchasing corporation: IRC
338(h)(3)(A)(iii)
– e.g., cant buy from yourself
• Apply IRC 318(a) ignoring option
attribution.
Exception: Acquisitions from
persons that are “related
corporations”
• DO consider acquisitions from a related
corporation if 50% or more of stock of
related corporation was acquired by
“purchase”.
• “related corporation”: IRC
338(h)(3)(C)(iii): if stock owned by a
related corporation treated as owned
by the acquiring corporation.
Second element: “sufficient
target stock”
• > 80% of the voting power and
• > 80% of the value of all classes of stock
– except nonvoting, nonparticipating preferred
stock, that is not counted for the > 80%
test.
Third element: “12-month
acquisition period”: IRC
338(h)1)
• “12 month” is a moving parameter,
ending on “acquisition date”.
Acquisition date/First day
• “acquisition date”: the first day of the
acquisition period that took P into an
80% ownership by purchase. It is not
necessarily the last day of the 12-month
period.
• First day of 12 month period: Look back
12 month from acquisition date.
The election
• Who makes it?
• When is it made?
• How is it made?
• What is the effect of the election?
Who makes it?
• By P
• But there is a special case where T joins
in the election.
When is it made?
• Must be made on or before the 15th day
of the 9th month beginning after the
month during which the 80% control is
satisfied.
How is it made?
• File Form 8023 (Corporate Qualified
Stock Purchase Election) with P’s IRS
Service Center
What is the effect of the
election?
• Irrevocable
• Effect on Target
• Effect on Purchaser
Effect on Target
• the “target” is treated as two:
– the Old Target
– the New Target
Effect on Old Target: IRC
338(a)(1)
• Old Target treated as having sold ALL of its
assets at FMV at the end of the day considered
as the “acquisition date”.
– Recognize gain or loss on the deemed sale
• Use any tax attributes to offset gains; unused
attributes are extinguished.
• Recognize income earned to acquisition date-if
not included in consolidated return.
Thus, a disadvantage:
• there could be significant up-front tax
costs
But there may not be up-front
tax costs
• Old Target may be able to use NOLs,
which otherwise may be wasted, to offset
recognized gains on the deemed sale.
– In turn provided stepped-up AB to New
Target.
At what price did the Old
Target sell its assets?
• IRC 338(a)(1): At FMV
• But: Treas. Reg. 1.338-4(a): At the
“aggregate deemed sales price” (ADSP)
“aggregate deemed sales
price” (ADSP): 1.338-4(b)
• ADSP: determined at the beginning of
the day after the “acquisition date”
– grossed up amount realized on the sale to
the purchasing corporation of the purchasing
corporation’s recently purchased stock (RPS),
and
– liabilities (including taxes from gain
recognition in 338 election)
“Grossed up amount
realized”: 1.338-4(c)(1)
• Amount realized on the sale to P of the
RPS / % of T stock, by value, attributable
to the RPS stock
• Less selling costs
Example: 1.338-4(c)(2)
• Voting c/s; Pfd stock (not taken into account for
> 80% test)
• P buys c/s from 3 different parties when 100%
FMV is $1250, and pfd FMV = $750:
– From S1: 40% for $500; selling costs = $40
– From S2: 20% for $225; selling costs = $35
– From S3: 20% for $275; selling costs = $25
What is the “grossed up
amount realized”?
• Amount realized on the sale to P of the
RPS = $1000
• % of T stock, by value, attributable to
the RPS stock = $1000/(FMV c/s $1250
+ FMV pfd $750) = 50%
• Selling costs = $100
• Hence: GUAR: $1000/.50 - $100 = $1900
Note: About liabilities
• In previous example there were no
liabilities other any tax liability to be
incurred by the deemed sale.
Example (1) in Treas. Reg.
1.338-4(g)(1): 1 of 4
• One asset (IRC 1245 property), bought
for $80K (recomputed AB), AB =
$50,400, FMV = $100,000. P purchases
all 100% of the stock for $75,000
• ADSP = GUAR + L + MTR (ADSP-AB)
Example (1) continues: (2 of
4): GUAR
• Amount realized on the sale to P of the
RPS / % of T stock, by value, attributable
to the RPS stock = $75,000/1.00
• Selling costs = $0
• Hence: GUAR: $75,000/1.0 - 0 =
$75,000
Example (1) continues: (3 of
4): Solving for ADSP in ADSP
= GUAR + L + MTR (ADSPAB)
• ADSP = $75,000 + 0 + 0.34 (ADSP $50,400)
• ADSP = 75,000 + 0.34 ADSP - 17,136
• ADSP -0.34 ADSP = $57,864
• ADSP = 57,864/0.66 = $87,672.73
• As ADSP < FMV of asset, then entire
ADSP is allocated to the 1245 property
End result in example (1): (4
of 4)
• Thus: Gain = 87,672.73 - 50,400 =
37,272.73
• But since 1245 property:
– $80,000 - $50,400 = $29,600 ordinary
income
– 37,272.73 - 29,600 = $7,673.73 capital gain
Example (2) in Treas. Reg.
1.338-4(g)(1): 1 of 5
• P buys all stock for $140,000
• Other:
– T’s Liabilities (other than the tax for deemed
sale gain) = $50K
– Cash (Class I) = $10K
– Marketable securities (Class II) = FMV
$10K, AB $4K
– Goodwill (Class VII) = AB $3K
EXAMPLE (2) continues: 2 of
5
• Class V assets: Total FMV = $250,000
– Land: FMV $35K, AB $5K, 14% of Class V
FMV
– Building: FMV $50K, AB $10K, 20% of Class
V
– Equipment A: FMV $90K, AB 5K, recomputed
AB $80K, 36% of Class V
– Equipment B: FMV $75K, AB $10K,
recomputed AB $20K, 30%of Class V
EXAMPLE (2) continues: 3 of
5
• Issue is the allocation to Class V; allocate
Class I and II their FMV or $10 K +$10K
• ADSP (V) = [G - (I + II)] + L + MTR
[(Class I gain) + ADSP (V) (5K+10K+5K+10K)]
• ADSP (V) = 140 - 10 -10 + 50 + 0.34
[(Class I: $10K FMV - $4K AB) +(ADSP
(V) -30K)]
EXAMPLE (2) continues: 4 of
5
• ADSP (V) = 170 + 0.34[(6K) + (ADSP(V)
- 30K)] = 170,000 + 2,040 +0.34 ADSP 10,200
• ADSP (V) - 0.34 ADSP (V) =161,840;
ADSP = $161,840/0.66 = $245,212.12
• As $245,212 does not exceed total Class
V’s FMV of $250K, there is no ADSP
balance to be allocated to goodwill,
EXAMPLE (2) continues: 5 of
5: Final allocation of Class V
• ADSP(V)= [G - (I +II)] + L + MTR {(IIAB) +[ADSP(V)-AB] + [ADSP(VII)-AB]}
• ADSP(V) = (140-10-10) + 50 +
0.34{[10-4] +[ADSP(V) -30] +[0-3]}
• ADSP(V) = 170 +0.34ADSP(V) +0.34(630-3) = 160820 +0.34 ADSP(V)
• ADSP(V) - 0.34 ADSP(V) = $160, 820;
ADSP(V)= $160, 820/.66 = $243,667
Tax effect:
– Land: 0.14(243667) - 5K AB = 34,113.33 -5K
=$29,113.33 capital gain
– Building: 0.20(243667)-$10KAB = 48,733.34
- 10K = $38,733.34 capital gain
– Equipment A: 0.36(243667)-$5k = 87720-5k
= $82,720 gain: $75K OI; $7,720 capital
– Equipment B: 0.30(243667)-$10K= 73,100K
-10K = 63,100K gain: $10K OI; $53,100
capital gain
Other advantages or planning
opportunities:
• The IRC 338(h)(10) election
IRC 338(h)(10) election:
• If Target is a subsidiary in a consolidated
group and Target’s stock is sold by the
group to P,
• an election will treat the transaction as if
seller (consolidated group)
– had a taxable sale of the Target’s assets and
then
– liquidated sales’ proceeds into parent in an
IRC 332 liquidation
Good idea when
• Target’s assets have declined in value,
and/or
• seller has a low basis in target’s stock
(requiring recognition of large amount of
gains), or
• seller has tax attributes to offset gain
recognized on the deemed sale of assets.
End result of IRC 338(h)(10)
election to consolidated group
• Gain recognition?
• Target’s tax attributes?
Gain recognition?
• Consolidated group recognizes gain on
the deemed sale of assets, to the extent
not sheltered by any consolidated tax
attributes.
• Consolidated group does not recognize
gain on the sale of T’s stock.
Target’s tax attributes?
• Because it is treated as a IRC 332
liquidation Target’s tax attributes survive
to the consolidated group.
• T must elect
Election by T?
• Actually a joint election in Form 8023.
• First, P has to decide to make the IRC
338 election.
Effect on New Target: IRC
338(a)(2)
• New Target treated as having purchased
ALL of the Old Target’s assets at FMV at
the beginning of the day after
“acquisition date”.
• Main effect: Old Target recognizes gain,
New Target gets higher AB.
– New Target treated as if it bought the assets
of the Old Target for the “adjusted grossedup basis”.
“adjusted grossed-up
basis”(AGUB): 338(b)(1);
1.338-5
• Grossed-up basis of “recently purchased
stock”, plus
• actual (historical) basis of the
“nonrecently purchased stock”, plus
• liabilities (including tax liability from gain
recognition due to election)
“non-recently purchased
stock” (N-RPS)
• Target’s stock held by puchaser on
acquisition date that is not “recently
purchased stock”, e.g., was purchased
during other than the “12 month
acquisition period”
• Thus, the actual historical AB of the stock
in the hands of P.
Election to step up AB of NRPS to FMV
• P may elect to increase AB of N-RPS to
FMV by treating the N-RPS as if it were
sold on “acquisition date” and recognize
gain accordingly.
“recently purchased stock”
(RPS): IRC 338(b)(6)
• Target’s stock held by puchaser on
acquisition date that was purchased
during “12 month acquisition period”
“grossed-up basis” of RPS:
IRC 338(b)(4)
• Formula in textbook
• AB of RPS [ (100% - %N-RPS)/% RPS ]
Allocation of AGUB:Allocation
under IRC 338 pursuant to
Treas. Reg. 1.338-6:
• 7 classes of assets
7 classes of assets
• Class I: cash, savings accounts, checking
accounts, but not CDs.
– If Class I assets exceed AGUB, new target
immediately realizes ordinary income in the
amount of the excess.
• Classes II through VII:
– In proportion to, and not in excess of, their
fair market value:
Class II - VII: In proportion to,
and not in excess of, their fair
market value:
– Class II: CDs, foreign currency; US gov secs; publicly
traded stock (not of target’s affiliate); actively traded
personal property
– Class III: mark-to-market assets and some debt
instruments
• Exceptions: debt instruments issued by related parties;
contingent debt; convertible debt
– Class IV: Inventory
– Class V: Not in any of the classes above or below:
furniture, buildings, land, actively traded T’s affiliate stock
– Class VI: IRC 197 intangibles o/t goodwill and going
concern value
– Class VII: goodwill and going concern value.
Failure to make election
• P’s AB of T’s stock= purchase price of T’s
stock
• AB of T’s assets remain unchanged
• T’s tax attributes survive (as limited)
If T is liquidated under IRC
332 w/o IRC 338 election
• no gain or loss to P or T
• c/o AB of all T’s assets
• c/o of tax attributes
• Note: IRC 269: T’s liquidation w/i 2
years, any deductions denied.
II. Non-Taxable Acquisitions:
Reorganizations
• Some in Chapter 20
Agenda
• I. Type of reorganizations
• II. Definitions and rationale
• III. Legal requirements
– Common Law
– Statutory
I. Types of reorganization
• Acquisitive reorganizations: A, B, C types
and variations
• Divisive reorganizations: IRC 355 and D
type.
• Nonacquisitive,
reorganizations: E, F and G
non-divisive
II. Definitions and Rationale
Definitions
• Narrow: IRC 368 reorganization
• Broad; Corporate rearrangement where
Target’s (T) assets are transferred to
Acquiring (A) corporation through
acquisition of assets and stock and/or
creation of a new or a surviving
corporation.
Tax rationale for a tax-free
transaction
• Assets remain in a corporate solution
• Substantial continuation of the traditional
business (if S/S; not if boot)
• Ability to pay tax on transaction (cashing
in)
Business rationale for
reorganizations
• Growth: vertically or horizontally
• Economies of scale
• Diversification
• Divesture: Voluntary or Involuntary
III. Legal requirements
IIIA. Common law
requirements
• 1. Continuity of Propietary Interest
• 2. Continuity of Business Enterprise
• 3. Business Purpose
IIIA1. Continuing Propietary
Interest (CPI): Rationale
• Development
Rationale for CPI
• No statutory (IRC) requirement.
• Recognize gain when investor liquidates
interest, not before.
– If Target’s shareholders receive cash and notes only,
they cashed out (sold) their interest.
– Treas. Reg. 1.368-1(b): bottom of
• Permissible: voting stock; nonvoting stock.
However,
• as in IRC 351, a mere change of form of
holding the equity interest in the Target
is not a sufficient change in investment
interest.
When is CPI at issue?
• Not in B and C reorganizations. Because
– B: voting stock for voting stock
– C: At least 80% is voting stock.
• Thus, only at issue in an “A” type and its
derivations.
Development
• Courts have required an undefined
minimum of equity interest, based on
facts and circumstances.
• IRS: To request a PLR, Target’s
shareholders must receive > 50% of the
stock of Acquiring corporation.
– However, IRS no longer issuing PLR’s.
So how much stock should be
kept to satisfy CPI?
• > 50% of the stock of Acquiring
corporation
Post-Merger Sales: How long
must CPI exist?
• Step transaction issue?
Step Transaction doctrine
• A “first” transaction intrinsically tied,
through a commitment, to a “second”
transaction”.
• Transactions are dependent on each
other.
Examples:
• RR 66-23: To be “cold”: at least 5 years
• But see Treas. Reg. 1.368-1(e)(1)(i);
(e)(6) Example 1.
IIIA2. Continuity of Business
Enterprise (CBE)
• Defined by Treasury Regulation: 1.3681(d)
• Judicial response
• IRS position
• Mostly important in divisive type (IRC
355 spin-offs or split-ups).
Defined by Treasury
Regulation: 1.368-1(d)
• A (issuing corporation) must
– continue T’s historic business, or
– use a significant portion of T’s historic
business assets in a business
• 1. 368-1(d)(2); (3)
Examples: 1.368-1(d)(5)
IRS position:
• CBE Failure: RR 87-76: Prior to merger T
was required to divest itself of historical
assets and invests proceeds in munis.
So how much of the historic
business assets should be
used?
• At least 33%
IIIA3. Business Purpose
• Definition
– There must be a direct and substantial
business or corporate purpose for the
reorganization;
personal
purpose
is
irrelevant.
• Gregory v Helvering (1935)
Identity of parties
• A = TP
• B = UMC
• X stock = 10000 shares of MSC
• C = Averil Corp.; created on 9/18; received
1000 shares of MSC on 9/21; 9/24 spinned off
on 9/24 pursuant to recently enacted
reorganization provision; liquidated on 9/25
Gregory v Helvering (1935)
• Facts: A owned B which held X stock. A wanted
the X stock and in one week:
– B created C and transferred X stock.
– B spinned off all of C to B’s shareholder, e.g, A.
– C liquidated and A received X stock.
– A argued strict compliance with statute and that
personal motivation was irrelevant.
Holding
• COA and USSC agreed with IRS: a reorg
is for the benefit of a corporation,
requiring a business purpose and not a
personal purpose.
IRS attacks
• Liquidation/Reincorporation
• Avoidance/Evasion: IRC 269
IIIB. Statutory requirements
• 1. Acquisitive reorganizations:
– (a) A reorga.
– (b) B reorg.
– (c) C reorg.
• 2. Divisive reorganizations:
– (a) IRC 355
– (b) D reorg.
• 3. Nonacquisitive, non-divisive reorganizations:
E, F and G
IIIB1a. Acquisitive
reorganizations: A Type:
• Definition
• Merger vs consolidation
• Advantages
• Disadvantages
• Variations
– Triangular Mergers
– Reverse Triangular Mergers
Definition
• Two or more corporation combine into
one corporation.
– Survivor: Statutory Merger: approval of
majority of T and A
– New corporation: Consolidation
Note: Acquiring corporation
acquires
• 100% of the Target’s assets and
• 100% of the Target’s liabilities
– including contingent liabilities and
– unknown liabilities
Advantages
• Flexibility of consideration: anything as
long as CPI satisfied.
– B requires voting stock
– C requires voting but permits limited amount
of other consideration
• Flexibility as to amount of T’s assets to
be acquired
• Flexibility to have a subsequent transfer
Disadvantages
• State and federal law compliance
• Dissenters’ appraisal rights
• Assumption of T’s liabilities
– may need to have a variation (reverse
triangular) if assets cant be transferred to A.
• Getting majority approval
• Target’s contractual rights or privileges
Variations: Getting around
disadvantages
• Forward triangular/forward subsidiary
merger
• Reverse Triangular
– Using subsidiaries
Forward Triangular or Forward
Subsidiary Merger: IRC
368(a)(2)(D)
– T merged into A’s subsidiary
– A’s subsidiary uses A’s voting or non-voting
stock (> 50%) to acquire SUBSTANTIALLY
ALL of T’s ASSETS- no liabilities.
• 70% of FMV of T’s gross assets
• 90% of FMV of T’s net assets
– No need to have majority of A approve, only
majority of A’s subsidiary, e.g., A’s BOD, and
majority of T’s shareholders.
Thus large latitude in “boot”
gain to be recognized by
those who receive boot
Problems avoided:
• T’s liabilities may or may not be
assumed.
• Majority vote of A shareholders is not
required.
• Liberal rules for consideration to be paid
Reverse Triangular: IRC
368(a)(2)(E)
– A’s sub merged into T
– Variety of B reorg: A must use A’s voting stock to
acquire a controlling interest in T from T’s
shareholders
– A does not have to acquire T’s liabilities.
– T survives under A’s control: holding its and A’s sub
properties.
– Rationale: Retain T’s identity or public image; T may
have nontransferable rights.
Note:
• B variety b/c A must use A’s voting stock
to acquire 80% of T from T’s
shareholders
• A does not have to assume Target’s
liabilities
Problems avoided
• T remains alive
• A does not want to pay solely voting
stock
• T’s liabilities may or may not be
assumed.
• no need to transfer target’s assets that
were desirable but not transferable.
Acquisitive Reorganizations: B
and C reorganizations:
IIIB. Statutory requirements
• 1. Acquisitive reorganizations:
– (a) A reorga.
– (b) B reorg.
– (c) C reorg.
• 2. Divisive reorganizations:
– (a) IRC 355
– (b) D reorg.
• 3. Nonacquisitive, non-divisive reorganizations:
E, F and G
Agenda
• IIIB1(b): Acquisitive reorganizations: B
• IIIB1(c): Acquisitive reorganizations: C
IIIB1(b). Acquisitive
reorganizations: B Type:
• Summary: Acquiring Corp wants Target’s
stock (not the assets)
• (1) The elements
• (2) Advantages and disadvantages
IIIB1(b)(1) The B
reorganization:
• (I) Nature of the transaction
– Acquiring corporation must use “solely voting
stock” to acquire “control” of Target.
• (II) “Solely voting stock”: Acquiring’s
voting stock for the Target’s stock
necessary to control T
• (III) “Control”
IIIB1(b)(1)(I) Nature of the
transaction
• Transaction is between Acquiring Corporation
and Target’s shareholders.
– Acquiring makes a “tender offer” to Target’s
shareholders to acquire the Target’s voting stock in
exchange for Acquiring’s voting stock
• Thus, after the transaction Acquiring and Target
shareholders own Acquiring Corporation, which in turn
is “in control” of Target Corporation.
IIIB1(b)(1)(II) Voting stock
Issues regarding “voting
stock”
• Acquisition must be with “voting stock”
– Defining “voting stock”
• Class
– Exceptions
• Exceptions to exceptions
– # of acquiring transactions
• Note that Acquiring may use other
consideration to acquire Target’s debt
securities.
If there was an acquisition of
stock, was the Target stock
acquired with “voting stock”?
• “class” (common or preferred) is
immaterial as long as it is “voting” stock.
– “voting”: unconditional right to vote on
regular corporate decisions
What is not Acquiring’s
“voting stock”?
• Convertible bonds, even if convertible into
voting stock
• Options to purchase “voting stock”
• Stock rights and warrants
– b/c they are like options to purchase
– But contractual rights to receive (not to purchase)
may qualify.
Exceptions to “voting stock”
rule
• Cash in lieu of fractional shares
• Cash to pay for target corporation’s legal,
accounting, appraisal, and other
reorganization expenses.
– But not the target’s shareholders’ expenses
• Pre-reorg redemptions of dissenting
minority
Redemptions of dissenting
minority
• OK if before B reorg: Target (not Acquiring
Corp) may redeem minority dissenters’ stock for
cash or other property prior to B reorg.
• Not as clear if after B reorg: If the redemption
is performed by the Acquiring Corp, it is OK if
there was NO predetermined agreement about
the redemption prior to the B reorg.
How many transactions
involved in the acquisition of
T’s stock?
• It does not matter how many
transactions as long as
– stock was acquired solely for voting stock
– the “control” element is satisfied.
If > one transaction, and one
of them was not “solely for
stock” of Acquiring
corporation?
• Are the acquisitions “related” or are they
separate transactions?
• Facts and circumstances.
– Time is a factor
• Simplest solution: Acquiring
unconditionally sells purchased stock to
3rd party before entering into B reorg.
IIIB1(b)(III) The “control”
element
• “Control” is to be determined at the end
of the acquisition.
– immediately after the transaction
• It permits previous acquisitions to be
considered.
• But all must be “solely for voting stock”
But how much before?
• Regs: 12 months is OK
• But judicially: The issue is whether the
transactions are “related”.
– Facts and circumstances.
– The longer the period between the
transactions, the greater they are found
“unrelated”.
The meaning of 80% control:
IRC 351 control
• ownership of 80% of total combined
voting power
• 80% of each class of nonvoting stock
IIIB1(b)(2) Advantages and
Disadvantages of B
reorganizations
Advantages
• Target survives
– Immediate liquidation will make it a C
reorganization
– Acquiring Corp’s assets are shielded from the
target’s liabilities
• Nonassignable rights remain with Target
• Tax attributes remain with Target
Advantages of B
reorganizations (2 of 3)
• No asset acquisition problems:
– transfer fees
– state and local income taxes
– recordkeeping
Advantages of B
reorganizations (3 of 3)
• Unlike C: Acquiring Corp is not required
to keep substantially all of its assets
• Unlike A: Not dependent on local law
– No need for a shareholder’s vote
– Tender offer to target shareholders does not
require approval of Target’s management
Disadvantages of B
reorganizations (1)
• Only voting stock: dilutes control of
Acquiring’s original shareholders
• Potential for dissenters’ problems at
shareholders’ meeting
• Tax attributes remain in Target
IIIB1(c) Acquisitive
reorganizations: C
Acquisitive reorganizations: C
• (1) Summary
• (2) The elements
• (3) Advantages and disadvantages
IIIB1(c)(1)Summary
• Substantially all of Target Corp’s assets
for Acquiring Corp’s “voting stock”
• Target must distribute to its shareholders
property received form Acquiring Corp
and property not transferred to Acquiring
Corp.
– Target is effectively liquidated
• Similar to a “statutory merger” or
“practical merger”
– In C reorg: substantially all assets are
transferred
– In merger: All assets are transferred.
• Ends with Acquiring corp being owned by
its original shareholders and the Target’s
original shareholders.
IIIB1(c)(2) Elements
• Substantially all the Target’s assets
• Consideration to be paid: solely voting
stock
• Distribution requirement
Substantially all the Target’s
assets
• Not defined in the IRC
• For advanced ruling:
– Higher of 70% of gross assets and 90% of
net assets must be acquired
• But other interpretations permit it if all
significant operating assets have been
transferred to the Acquiring Corp.
Consideration
• “Solely” voting stock
• Unlike an A type where anything is
almost OK.
• But here it is “solely” with a twist (boot
relaxation rule)
– Must use solely voting stock to pay up to
80% of FMV of Target’s assets.
– Thus 20% boot is OK.
The 20% boot and liabilities
assumed
• As assets are being transferred that may
have debt attached to them, disregard
Acquiring Corp’s assumption of Target’s
liability.
• However, assumed liabilities are
considered “boot” for purposes of the
20%.
Example: Assume that the
FMV of Target assets is $100
and you want to have a C
reorg:
• If liabilities assumed = $18; may use up
to $2 in real boot.
• If liabilities assumed = $19; may use up
to $1 in real boot.
• If liabilities assumed = $20; may not use
any boot.
• If liabilities assumed = $21; may not use
any boot.
• The point is that substantial liabilities
may be assumed as long as there is a
CPI.
• But little “real boot” can be used when
liabilities are being assumed.
• It is like the “basis” rules in IRC 351
where liability is considered “money
received ” for basis only but not boot.
However, depending on the
reason for the liabilities,
assumption may be
considered “real boot”
• If the liability assumed is a payment to
be made to dissenting shareholders, the
payment of the liability is considered a
transfer of cash to the Target, e.g., “real
boot”.
Distribution requirement
• Target must distribute promptly to its
shareholders all the voting stock and boot
received from Acquiring Corp.
• Target must also distribute any assets not
transferred to the Acquiring Corp
– All Acquring needs to acquire is “substantially all” the
assets, the other assets must be distributed.
– Target must not engage in an active T/B
Exception to distribution
requerement; IRC
368(a)(2)(G)(ii)
• IRS may waive it if
– (1) it would result in a substantial hardship
and
– (2) the Target and shareholders agree to be
treated as if the Target had made the
distribution of the undistributed assets and
the shareholders contributed back to the
Target.
IIIb1(c)(3) Advantages of C
reorg
• No need to assume all the Target’s
liabilities (A and B does).
• No need to acquire all the assets.
• No need to have Acquiring shareholders
agree to the transaction. Only the Target
and its shareholders have to approve the
acquisition and likely liquidation.
The B reorganization followed
by liquidation
• Treated as a C reorganization
• Issue: Were substantially all of the
target’s assets acquired in the reorg?
– Were there any spin offs immediately before
the attempted B reorg?
Forward Triangulars; Reverse
Triangulars
• Already discussed
Disadvantages of C reorg
• Substantial transfer costs associated with
the transfer of assets.
– likely to sustain a tax at the state level.
• Substantially all of the target’s assets
must be acquired.
– Precludes a spin-off of unwanted business or
assets before/immediately after reorg
• Boot ignored by assumption of liabilities
Aquisitive Reorganizations:
Tax implications
Introduction
• A Type
• B Type
• C type
A Type: Acquiring Target’s
assets
• Tax consequences to Target shareholders
• Tax consequences to Acquiring
corporation
• Tax consequences to Target corporation
• Tax consequences to Acquiring
corporation shareholders
Tax consequences to
Target shareholders
• IRC 354: nonrecognition
• IRC 356: recognition
• IRC 358: basis
IRC 354(a)(1): No gain or
loss recognized shall be
recognized if
• stocks or securities in a corporation a
party to a reorganization
• are, in pursuance of the plan of
reorganization,
• exchanged solely for stock or securities
– in such corporation or
– in another corporation a party to the
reorganization
Exceptions: IRC 354(a)(2)
• Principal amount of securities received >
principal amount of securities
surrendered
IRC 356(a)(1): Gain on
exchange
• If 354 would apply but for the fact that
the property received also included cash
and other property (“boot”), then
• recognize gain up to the cash and the
FMV of the other property, e.g, the boot.
• But no loss is recognized.
Character of the recognized
gain
• capital
• dividend
IRC 356(a)(2): Dividend
• If the exchange has the effect of a
dividend distribution, pursuant to IRC
318(a), then recognize as dividend
income the ratable share of EP.
“Effect of a dividend
distribution”?
• IRC 302 analysis
• Constructive rules
• If 302(b)(1) [NEED] or 302(b)(2) [Sub.
Disprop. Red.]: Then no dividend effect.
• Typical end result: < 50% shareholder
getting boot will get capital gain.
IRC 302 analysis requires
• Make believe merger was a 100% stock
for stock followed by a postmerger
redemption of an amount of stock equal
to the boot received.
Therefore, realized gain is
recognized if
• Other than stock and securities is
received, e.g, cash, boot
• Principal received > Principal surrendered
• Securities were received and no
securities surrendered
IRC 358(a)(1): Basis of
nonrecognition property to
distributees: Carry-over basis
• Less:
– other property received (boot)
– cash received (boot)
– loss recognized
• Plus:
– dividend received (recognized as income)
– gain recognized
IRC 358(a)(2): Basis of
“other property” received:
• FMV
Holding period:
• Nonrecognition property: tacked
• Other property: new holding period
See Example 17.3 (p. 838)
Tax consequences to
Acquiring corporation
Gain (loss) not recognized
• IRC 1032(a): No gain(loss) on issuance
of stock.
Basis: IRC 362(b)
• Carryover basis for transferor’s assets,
increase by gain recognized by transferor.
• As usually no gain or loss recognized
recognized by Target transferor, acquired
assets move to Acquiring corporation at
c/o basis.
NOTE who is the “Transferor”:
The Target corporation
• Target shareholders ARE NOT the
“transferors” of assets.
• Target shareholders may recognize gain
b/c “boot” received but that does not
increase AB of Acquiring Corporation.
Other:
• HP: carryover to Acquiring Corporation
(tacked)
• Target’s tax attributes: carryover to
Acquiring Corporation
Tax consequences to
Target corporation
• IRC 361(a): No gain(loss) to a party of
the reorganization when it
– exchanges property pursuant to a plan,
– solely for stock and securities
– in another corporation party to the
reorganization.
Target does not recognize
• Receipt of “boot”
• Assumption of target’s liabilities
Distributions by Target:
IRC 361( c)(1):
• No gain (loss) recognized) to a party of
reorganization on distribution of property
pursuant to a plan.
IRC 361( c)(4):
• IRC 311 does not apply to Target’s
distributions
IRC 361( c)(2): Exceptions
• Appreciated property distributions:
recognize gain (no loss) as if sold
property.
• FMV: higher of FMV or liability attached
to property
Exception to exception:
“qualified property”
• stock, stock rights, or obligation of
distributing corporation
• stock, stock rights, or obligation of
another party to the reorganization when
received by distributing corporation in
exchange for its assets.
Typical end result for Target:
• No gain (loss) on distribution of Acquiring
Corp’s stock and securities
• Little or no gain (loss) on distribution of
boot received from Acquiring Corp b/c AB
is picked up at FMV.
Acquiring Corporation
Shareholders
• Tax effect: None, where Acquiring
survives, there is no change in the tax
status of its shareholders.
• Non-tax effect: They own smaller share
of company because some of it is owned
by Target’s shareholders.
B Type
• Tax consequences to Target shareholders
• Tax consequences to Acquiring
corporation
• Tax consequences to Target corporation
• Tax consequences to Acquiring
corporation shareholders
Tax consequences to Target
shareholders
• IRC 354(a)(1): No gain or loss
recognized
• Carryover AB and HP
• If boot received, then recognize realized
gain up to the boot.
– AB of stock = c/o - FMV boot + gain
recognized
– AB of boot = FMV of boot
Tax consequences to
Acquiring corporation
• IRC 1032: No gain (loss) for issuance of
voting stock.
• AB; HP: carryover
• AB when target is publicly held: OK to
use sampling and estimating statistical
techniques.
• Target’s tax attributes c/o to Acquiring
Corp; limitations: later
Tax consequences to Target
corporation
• Remains in existence; tax attributes
intact
• No gain (loss) recognized on exchange of
assets for S/S of Acquiring, nor on the
distribution of that S/S to target’s
shareholders.
• Gain is recognized for distribution of
appreciated property that is not
Tax consequences to
Acquiring corporation
shareholders
• IRC 1032: No gain (loss) for issuance of
voting stock.
C Type: Same as a B Type