Chapter 9 - Acquisitive Corporate Reorganizations

Transcription

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 1

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 2

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 3

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 4

5 Tax Code Provisions re Tax-free Reorgs p no gain or loss is to be recognized upon an exchange of shares by shareholders who are parties to a reorganization. Cf., 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 carryover of tax attributes. 11/14/2011 (c) William P. Streng 5

6 How Assure Tax-free Reorganization Treatment? Options: 1) IRS Private Letter Ruling but, limited availability, unless a significant issue. - See Rev. Proc See Rev. Proc (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 6

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 7

8 Divisive Mergers p.418 (i.e., not acquisitive ) Rev. Rul 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 8

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 9

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 10

11 Rev. Rul p % 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 11

12 What Stock % is Required? P ) Nelson case (Sup. Ct 1935) 38% nonvoting preferred stock was OK. 2 To obtain an IRS PLR Rev. Proc requires a 50% stock value issuance. 3) Reg T(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 12

13 Other Continuity of Interest Issues: p ) 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 13

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 14

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 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 15

16 Continuity of Interest (COI) Regulations Reg (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 16

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 17

18 Rev. Rul 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 18

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 19

20 Rev. Rul 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 (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 20

21 Continuity of Business Enterprise Regulations COBE regulations - Reg (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 (d)(4). 11/14/2011 (c) William P. Streng 21

22 Problem 1(a) p.438 All Cash Merger-Rev. Rul "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 22

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 23

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 postacquisition stock disposition? None (on the other 25% shareholder(s)). See Reg (e)(7), Example 1(i). 11/14/2011 (c) William P. Streng 24

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 (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 25

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 ). 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 26

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 T(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 27

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 % 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 28

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 29

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 prorata values of the consideration received and not to the shareholder numbers. See Rev. Rul (p.422). 11/14/2011 (c) William P. Streng 30

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 31

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 32

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 33

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 34

35 Rev. Rul 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 35

36 Rev. Rul 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 36

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 redemption by Target corp. 11/14/2011 (c) William P. Streng 37

38 B Reorganizations- Contingent Stock p 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 38

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 39

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 40

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 41

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 , p. 452). 11/14/2011 (c) William P. Streng 42

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 43

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 44

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 45

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 46

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 47

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 48

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 49

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 (c). 11/14/2011 (c) William P. Streng 50

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 51

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 52

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 53

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 (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 54

55 Liquidation of the Target Corporation p (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 55

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 (d)(4)(i) & (ii). 11/14/2011 (c) William P. Streng 56

57 Problem 1(a) p % 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 ) 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 57

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 58

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 59

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 60

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 61

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 62

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 re testing as a C reorganization. The solely for voting stock requirement is then not satisfied. But, cf. Reg (d)(4), Ex. 1 11/14/2011 (c) William P. Streng 63

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 64

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 65

66 Structures of Triangular Reorganizations p 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 66

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 67

68 Multi-Step Transactions Rev. Rul p (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 68

69 Multi-Step Transactions Rev. Rul 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 69

70 Multi-Step Transactions Rev. Rul , 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 70

71 Multi-Step Transactions Rev. Rul 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 71

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 72

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 73

74 Shareholder Consequences in a Reorganization p no gain or loss to be recognized on the share exchange 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 74

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 75

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 76

77 Basis and Holding Period for Target Shareholders p 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 (g) regulations (effective in 2011). 11/14/2011 (c) William P. Streng 77

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 stock. 306(c)(1)(B). Even though received in a merger? Yes. 11/14/2011 (c) William P. Streng 78

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 79

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 80

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 81

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 82

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 83

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 84

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 85

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 86

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 87

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 , as amplified by Rev. Proc re statistical analysis. 11/14/2011 (c) William P. Streng 88

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 89

90 Rev. Rul 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 90

91 Rev. Rul 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 91

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 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 92

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 /14/2011 (c) William P. Streng 93

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 94

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) ) 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 95

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 ) 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 96

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 97

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 98

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 99

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 (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 100

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 101

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 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 102

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 /14/2011 (c) William P. Streng 103

104 End of Chapter 9 information 11/14/2011 (c) William P. Streng 104