Corporate Taxation Chapter Eleven: Nonacquisitive & Nondivisive Reorganizations

Transcription

1 Presentation: Corporate Taxation Chapter Eleven: Nonacquisitive & Nondivisive Reorganizations Professors Wells April 9, 2018

2 Nonacquisitive & Nondivisive Reorgs. p (a)(1)(D) Liquidation Reincorporations 368 (a)(1)(e) Recapitalizations 368(a)(1)(F) Change in Form or Place of Incorporation 368(a)(1)(G) Insolvency Reorganizations 2

3 Recapitalizations 368(a)(1)(E) p.527 Rearrangement of a single corp s capital structure. Business objectives for a recapitalization: 1) Improve the debt/equity ratio by shifting from debt into equity ownership i.e., a downstream recapitalization. 2) Change the shareholder ownership relationships between the preferred and common shareholders e.g., an upstream recapitalization (some shareholders acquiring preferred stock). 3

4 COBE & COI Not Relevant p.527 Continuity of business enterprise (COBE) is not a requirement to have E corporate reorganization treatment. Similar treatment to Rev. Rul that continuity of shareholder interest (COI) is also not required in an E reorganization. But, a business purpose is required. This result is not impacted by the 1998 COI and COBE regulations. 4

5 Types of Corporate Recapitalizations p.528 1) A shift from debt into equity is tax-free. But, recognition is required of the accrued interest element. See 354 (bondholder) & 1032 (corp), but also 108 (re COD income). 2) An exchange of bonds for new bonds. No gain recognition occurs to the bondholder except (a) for bonds received for accrued interest, or (b) if the principal amount of the bonds is increased. 354(a)(2)(A) & (B). The corporate issuer may have COD income (subject to 108(e)(10) and needs to resolve OID issues. See 163(e) and 1272 through ) Stock for stock exchanges: (a) exchange preferred and receive common; or, (b) exchange common and receive preferred. 354, 356 & 358 (shareholder) 1032 & 1036 (stock issuances/exchanges) 305(c) (increase in proportionate share interest) & 306 stock (bailout effect?). 5

6 Rev. Rul p.530 Preferred and Cash Received Nonvoting preferred stock and cash are received in an integrated transaction in exchange for common shares (in an E reorganization). Is the cash boot received a dividend equivalent for 356(a)(2) purposes? Held: Not a dividend since the requirements of 301(b)(1) (no dividend equivalency) are satisfied here (and, therefore, no 356(a)(2) dividend distribution effect). See Davis case. A s interest reduced from 28.57% (120/420) to 23.08% (90/390). This was a meaningful reduction of interest. 6

7 Bonds Received & Stock Transferred Bazley v. Commissioner p.534 For old shares, shareholders received new shares and also callable debenture bonds. Significant earned surplus (e&p) existed. IRS asserts income to the extent of bonds. Taxpayer asserts the securities were received in a tax-free corporate reorganization. Held: Receipt of the (callable) debenture bonds was equivalent to the receipt of a cash dividend (i.e., an accumulated earnings distribution). 7

8 Problem 1(a) p.538 Exchange Transaction Results to shareholders on this exchange: Shareholders 1) E reorganization treatment. 2) No gain recognition to the shareholders on the exchange. 354(a)(1). 3) Substituted basis - 358(a)(1) 1/3 for preferred and 2/3 for common stock. 4) Tacked holding period. 1223(1). 5) Preferred stock received is 306 stock. C.S.=20x Pfd S.=10x Recap E&P=100,000 8

9 Problem 1(b) p.538 Preferred Stock is Called Question: What is the result if Recap calls the preferred stock? Answer: 1) 306(a)(2) redemption. 2) $10, distribution to each shareholder (assuming e&p is at the $100,000 level). 3) Reduction of the corp s e&p to zero. 312(a)(1). 4) Tax basis previously allocated from the common to the preferred stock is allocated back to the common stock. 9

10 Problem 1(c) p.538 Sale of the Preferred Shares Question: What is the result if a shareholder sells preferred stock? Answer: 1. A Code 306(a)(1) ordinary income transaction occurs, as measured by reference to the allocable e&p at the time of the preferred stock issuance. No DRD is available to a corporate recipient. 20% taxation on the amount received. 2. Any excess over $10,000 is treated as: (i) tax basis recovery, and after basis recovery then thereafter as (ii) capital gain. 3. No e&p reduction occurs (even though deemed dividend treatment for 1(h)(11)). 10

11 Problem 1(d) p.538 E&P Deficit Upon Issuance Question: What is the result if Recap had a deficit in its E&P at the time of the distribution but it foresaw future profits? Answer: An e&p deficit existed at the time of the distribution of the shares by the corporation would cause the preferred stock would not to be 306 stock. i) Treatment of the stock redemption when occurring would be determined under 302. ii) The share sale would produce capital gain (after tax basis recovery). 11

12 Problem 2 p.538 Stock & Debt Issuance FACTS: Each of 10 shareholders exchanges common stock (FMV=$50,000 B=$10,000) for common stock (FMV=$25,000) and bonds (FMV=$25,000). Shuffle has E&P=$250,000. C.S.=250x Security.=25x C.S. (B=100x FMV=500x) Shareholders Shuffle E&P=250,000 RESULT: An E reorganization. The securities are boot. 354(a)(2) & 356(d)(1). Each shareholder must recognize $25,000 of the $40,000 of gain realized in the exchange. The pro-rata distribution is classified as a dividend distribution. 12

13 Problem 3(a) p.538 Debt Principal is Reduced FACTS: Exchange bonds with Face=$1,000,000 and FMV of $800,000 for bonds with Face=$800,000; FMV=$800,000. RESULT: E Reorganization. Bondholders Bonds (Face=800x FMV=800x) Bonds (Face=1,000x FMV=800x) Leverage 1. Because the principal amount of the securities received ($800,000) does not exceed the principal amount of the securities surrendered ($1,000,000) and there is no indication of any accrued interest, the bondholders have no gain or loss. See 354(a)(1) & (2)(B); 354(a)(2); 356(d)(2). The security holders take an exchange basis per 358(a)(1) and tacked holding period per 1223(1). 2. Leverage has $200,000 of debt discharge income and has income unless insolvent. See 108(e)(10)(A); 108(a)(a)(B). 13

14 Problem 3(b) p.538 Debt Principal Increased FACTS: Exchange bonds with Face=$800,000 and FMV of $800,000 for bonds with Face=$1,000,000; FMV=$800,000. RESULT: E Reorganization. Bondholders Bonds (Face=1,000x FMV=800x) Leverage Bonds (Face=800x FMV=800x) (d)(2)(B) says the fair market value of the excess principal amount is treated as taxable boot under 356(a)(1) if the securities have realized gain. So, 80% of $200,000 or $160,000 is boot. If security holder is a stockholder, then need to test for dividend treatment per 356(a)(2). If not a stockholder, then gain is likely a capital gain and not a dividend. 2. To the extent that the excess face amount ($200,000) exceeds the FMV of this excess face amount ($160,000), the bonds have original issue discount ($40,000) under

15 Problem 4 p.538 Receipt of Stock for Bonds FACTS: Exchange of bonds transferred for the receipt of stock by shareholder is treated as an E reorganization. This is a downstream recapitalization. Stock Bondholders Leverage Bonds RESULT: 1. Bondholders: A nonrecognition event occurs to the old security holders/new shareholders assuming a business purpose. Reg (e), Ex. 1. Business objective of this transaction: A business purpose could be to improve the corporation s debt/equity ratio. 2. Corporation: The corporation would have COD income to the extent that the principle amount of the bonds exceed the fair market value of its stock. See 108(e)(8). 15

16 D Reorganization Liquidation Reincorporation p. 539 Two alternative structures (involving two corporations & similar shareholder groups): 1) Operating assets are transferred to the acquiring corp. for cash; the selling corporation then liquidates with a cash distribution to its shareholders. Cash Liquidate D P Op Assets Cash D 2) All assets are distributed to the shareholders, then the shareholders infuse only operating assets into a new corporation. Op Assets Liquidate D P Op Assets D 16

17 Smothers v. United States p.540 Transfer of Operating Assets? IUS liquidated and then the operating assets (15 percent of the FMV) were inserted into TIL. Taxpayer position: Distirbution was a liquidation entitled to capital gain treatment under 331(a)(1). Liquidate IUS Smothers Op Assets $22,637 Cash IRS position: the transaction was a D reorganization with 356(a)(2) boot being received. $149,162 TIL Held: The substantially all test was satisfied since all the operating assets were transferred and so this transaction qualified as a D reorganization. The Smothers received boot that was characterized as a dividend distribution under 356(a)(2). 17

18 Nondivisive Reorganizations All Cash D Reorganizations p.548 Objective: To extract cash with basis offset. Boot is taxed to the extent of gain realized (boot within gain rule). Cash Liquidate Shareholder Counter-Characterization: A straight dividend would be taxable under 301(c)(1) to the extent of E&P with no basis offset. D All Assets Cash C 18

19 Problem 1 p.550 Common Ownership 2 Corps. FACTS: Shareholders have $200,000 basis in Brother. Brother has operating assets (FMV=$500,000 B=$150,000) and $200,000 cash (total FMV $700,000) and $250,000 of E&P. Sister has $300,000 of E&P. Sister purchases Brother s operating assets for $500,000 cash and Brother liquidates. $700 cash Liquidate Brother E&P= 250 Shareholders B=200 Op Assets B=150 FMV=500 $500 Cash RESULT: Boot of $700,000 to Shareholders and must recognize dividend per 356(a)(2) to the extent of their gain ($500). Under Davant, E&P of both companies are used to support the dividend characterization Sister E&P=

20 Problem 2 p.550 All Cash D Reorganization Transactions FACTS: T sells all assets to S for cash and liquidates. RESULT: Dividend to A. Reg T(1)(3), Ex. 2. Control of S exists through the family attribution rules. See Code 368(a)(2)(H)(i) T Liquidate A B=200 All Assets B=100,000 FMV=1,000,000 $1,000,000 Cash and 304(c). 368(a)(1)(D) & 354(b)(1)(B) are satisfied even though no S stock is actually issued. The $1 million cash distributed to A creates $800,000 of gain. That gain has the effect of a dividend to the extent of T s E&P. Cash S 20

21 F Reorganization p.550 Mere change in identity, form or the place of corporate organization of one corporation. Often used to change the place of corporate organization (e.g., to Delaware). Why to Delaware? Prior attempt to blend multiple corporations together in an F reorganization The potential use of 381(b) in this context has been eliminated. F reorganization treatment is limited to one corp. 21

22 Rev. Rul p.553 Part of Step Transaction OK Two transactions involving stock offering or acquisition place of organization changed. Situation One: Change place of incorporation by merging Q into a new corporation (R) formed in another state (probably Delaware). R issued significant additional stock in a public offering. So two steps were involved: merger and stock sale. Situation Two: Forward triangular merger and the selling shareholder received new preferred stock of Corp. which then changed its place of organization by merger into corporation in another state. 22

23 Problem p.555 Change State of Organization Change of corporate status from California to Arizona by an asset transfer in exchange for stock and then the liquidation of the old corporation. RESULT: This is an F reorganization. It could also be a D reorganization but probably best viewed as an F reorganization. Under these facts, the 351 (incorporation) and 331 (liquidation) transactions are telescoped to result in full nonrecognition to all parties. See Whittell & Co., Inc. v. Commissioner, 34 B.T.A (1936). 23

24 Insolvency Reorganizations 368(a)(1)(G) p.556 Transfer of assets to another corporation in a bankruptcy restructuring. Liquidations are not bankruptcy reorganizations. The substantially all test is not precluded when assets are used to pay creditors. The continuity of interest test must be satisfied, but creditors may be counted for purposes of satisfying COI. Shareholder or debtholders who receives an increased amount of debt securities are taxable. Creditor have interest income to the extent securities are received for unpaid interest on the securities surrendered. Possible NOL shifting to the corporation acquiring the assets. No recognition to the transferring corporation on asset transfers; carryover tax basis for assets. 24

25 Problem p.561 Acquirer s Stock to Creditors Debtor in bankruptcy with assets (B=$75,000 FMV=$100,000), NOL ($200,000). Debts include (1) bonds outstanding (with no accrued unpaid interest) of $100,000 and trade debts of $100,000. Debtor transfers all of its assets to Relief Corporation in return for $100,000 of Relief stock which will pass half to the security holders and half to trade creditors. Debtor s shareholders will receive nothing. RESULT: 1. Valid G reorganization since the debtor transfers all assets and then distributes the stock of Relief. Creditors are treated as equity owners COI. 2. Shareholders receive nothing a 165(g) LTCL on their stock (equal to their tax basis). 3. Security holders exchange $100,000 of securities for $50,000 stock. No loss recognized and $100,000 basis. 4. Trade creditors - $50,000 bad debt loss (no 354). 5. Debtor corp has $100,000 of COD income that may be eligible for 108(a)(1)(B) relief with the consequence that tax attributes are reduced (i.e., the NOLs). 25