California Tax Bar and Tax Policy Conference 2004 CURRENT CORPORATE DEVELOPMENTS

Transcription

1 California Tax Bar and Tax Policy Conference 2004 CURRENT CORPORATE DEVELOPMENTS William Alexander, Internal Revenue Service Julie Divola, Pillsbury Winthrop LLP David Gerson, Wilson Sonsini Goodrich & Rosati, PC Eric Solomon, Department of the Treasury 1

2 Legislative Developments AMERICAN JOBS CREATION ACT OF 2004 Selected Provisions Impacting U.S. Corporations 2

3 JOBS Act Act Section 101: Repeal of Exclusion for Extraterritorial Income Code Section 114 repealed: ETI benefit phased out: 100% allowed in 2004, 80% in 2005; 60% in i 2006 and 0% thereafter Act Section 801: Tax Treatment of Expatriated Entities and Foreign Parents Effective for Inversion Transactions completed after March 4, 2003 Foreign Corporation treated as a domestic corporation for ALL purposes of the IRC if: 3

4 JOBS Act Pursuant to a plan (or series of related transactions) a U.S. corporation or partnership becomes a subsidiary of, or transfers substantially all of its properties (whether held directly or indirectly) or substantially all the properties constituting a trade t or business of a U.S. partnership to a foreign corporation. As a result of the transaction and by reason of holding stock in the U.S. corporation or capital or profits interest in the partnership, as the case may be, at least 80% of the stock (by vote or value) of the foreign corporation is held by former stockholders or partners of the domestic corporation or partnership. The expanded affiliated group of the foreign corporation does not have substantial business activity in the foreign country of the parent s s incorporation compared to the group s s overall business activity. 4

5 JOBS Act If the continuing ownership is less than 80% but greater than 60%, then expatriated entity will NOT be treated as a domestic corporation for all purposes, BUT the taxable income of an expatriated entity for any taxable year which includes any portion of the applicable period shall in no event be less than the inversion gain. Applicable period is the 10 year period beginning with the date of the first transfer of property. Inversion gain means the income or gain recognized by reason of the transfer during the applicable period of stock or properties by an expatriated entity, or any income received or accrued during the applicable period by reason of a license of any property as part of the inversion transaction or, if afterwards, to a foreign related person. 5

6 JOBS Act Related provisions including expanded reporting of the taxable acquisitions. IRS given broad authority to issue regulations to prevent avoidance. Foreign corporate stock sold in public offering disregarded when testing for 80 or 60 percent; so cannot avoid provisions by going public. Provision has broad application. 100% BEFORE Non U.S. Citizens OR Residents Dutch Holdco 100% U.S. OPCO AFTER Non U.S. Citizens or Residents Dutch Holdco 100% French OPCO French OPCO U.S. OPCO 6

7 JOBS Act WHAT IS NOT COVERED? Initial formation off-shore: U.S. Founders & Investors 100% cash Cash 100 U.S. OPCO Cayman Irish OPCO Cash India R & D Non U.S. operating subs U.S. and Irish subs cost share development of technology in India. U.S. OPCO has U.S. rights and Irish OPCO has all non U.S. rights. 7

8 JOBS Act WHAT IS NOT COVERED? U.S. companies with foreign affiliates can still reduce U.S. taxable income by using debt leverage to increase U.S. interest expense, subject to existing limitations. (E.g., 163(j) (earning stripping limitations)). 8

9 JOBS Act Act Section 422: : Reinvestment of Foreign Earnings Provides a temporary DRD: allows a one-time deduction of 85% of cash dividends received by U.S. corporation from its controlled foreign corporations. result is effective tax rate of 5.25% election required to apply one of two possible taxable years: either (i) last taxable year which begins before October 22, 2004 or (ii) first taxable year that begins on or after October 22,

10 JOBS Act CFC status required and U.S. corporation must own 10% or more of the combined voting power of CFC s s stock. Dividend capped at greater of (i) $500 million and (ii) the amount permanently invested outside U.S. as reflected on the CFC s s financial statements. (Audited GAAP financials prepared prior to June 30, 2003 and used for substantial non- tax purpose or used to report to creditors or shareholders.) * disadvantages corporations that were conservative in booking reinvested foreign earnings. Note: if financial statements do not reflect amount permanently reinvested outside U.S. but do reflect specific amount of foreign tax liability attributable to such earnings, the amount equal to such tax liability divided by.35 is substituted for (ii) i) above. 10

11 JOBS Act Amount of dividends is reduced by any increase in related party borrowings since October 3, Dividend must be extraordinary, extraordinary, which means the applicable dividend must exceed the three year average of the CFC s s dividends using three out of the last five years but excluding the highest and lowest years of the five. * Corporations that did not repatriate cash during the last five years will be advantaged 11

12 JOBS Act Cash must be used in a domestic reinvestment plan Approved by CEO and Board Used to: Hire workers Training Infrastructure R & D Capital investments Financial stabilization re job creation or retention Can it be used to redeem stock, pay off debt, or do acquisitions? 12

13 JOBS Act Act Section 102: Deduction Relating To Income Attributable to Domestic Production Activities Domestic manufacturers permitted to claim a deduction of up to 9 percent of the lesser of their qualified production activities income or taxable income for each taxable year. Phase in: 3% for 2005 and 2006 : tax rate 33.95% 6% for 2007 through 2009 : tax rate 32.90% 9% thereafter : tax rate 31.85% (assuming highest marginal rate of 35%) 13

14 JOBS Act Deduction permitted in determining AMTI by applying the applicable percentage to the lesser of qualified production activities income or AMTI. Eligible Taxpayers: Applies broadly to all business entities: C Corporations, S Corporations, partnerships, sole proprietorships, Co-ops, ops, estates and trusts. Affiliated Group redefined by substituting 50% for 80% and group treated as a single taxpayer with deduction allocated among members in proportion to each member s qualified production activities income. Deduction for any taxable year shall not exceed 50 percent of W-2 2 wages of employer for the taxable year. Measured as of December 31 for that calendar year which ends within the taxpayer s s taxable year. 14

15 JOBS Act Qualified Production Activities Income equals the Domestic Production Gross Receipts less the sum of: (i) cost of goods sold allocable to such receipts; (ii) other deductions, expenses or losses that are directly allocable to such receipts; and (iii) a share of other deductions, expenses and losses not directly allocable to such receipts or another class of income. Domestic Production Gross Receipts means those gross receipts derived from (A) any lease, rental, license, sale, exchange or other o disposition of: (i) qualifying production property, that was manufactured, produced, grown or extracted in whole or significant nt part by the taxpayer in the U.S., or (ii) qualified film, electricity, natural gas or potable water produced by the taxpayer in the U.S.; or (B) construction, engineering or architectural services performed in the U.S. for construction projects in the U.S. (continued) 15

16 JOBS Act * qualified production property generally is tangible personal property, computer software and sound recordings. * qualified film property means if 50% of services for production were incurred in U.S. * does not include gross receipts from sale or preparation of food or beverage prepared at a retail establishment or transmission of electricity, natural gas or potable water. Effective for taxable years beginning after December 31,

17 JOBS Act Act Section 898: Modification of Treatment of Transfers to Creditors in Divisive Reorganization Prior Law: In connection with tax-free spin-offs, split- offs, and split-ups ( 355( Restructurings ) ) under Code Section 355 if, distributing corporation transfers property to the corporation being spun-off, thus invoking the rules of Section 368(a)(1)(D) and certain related rules, then the distributing corporation could receive boot and not recognize gain thereon if such boot was distributed to its stockholders or creditors in connection with the 355 Restructuring. 17

18 JOBS Act These corporations were able to avoid the application of Section 357(c) otherwise applicable to a Section 368(a)(1)(D) reorganization by invoking Section 361(b). BEFORE AFTER SPIN-OFF SHS Lender A $100 debt SHS Lender B $100 debt property D C $100 Cash to Lender $100 cash + stock Lender B $100 debt D C * C incurs debt and distributes cash to D. D repays Lender A without recognizing gain. 18

19 JOBS Act New Provision limits the amount of boot the distributing can distribute to its creditors without recognizing gain to the amount of basis of assets contributed to the controlled corporation. Limits amount of boot/cash that can be distributed by the controlled corporation in a 355 Restructuring. In addition, the Act provides that Section 368(a)(1)(D) reorganizations are no longer subject to Section 357(c). 19

20 JOBS Act Act Section 845 Expanded Disallowance of Deduction For Interest on Debt Current Law: In general, Code Section 163(l) disallows interest est deductions with respect to debt under certain circumstances if a substantial portion of the principal or interest is payable in equity of the issuer or a related party. The Act amends Code Section 163(l) so that its interest disallowance rule applies when the issuer uses equity of any corporation, whether or not related. Will significantly impact use of certain convertible debt structures commonly known as DECs debt exchange into common stock. 20

21 JOBS Act Act Section 231: S Corporation Reform and Simplification. Up to six generations of family members can be treated as one shareholder. Increases number of shareholders from 75 to 100. Permits bank that is an S Corporation to include IRAs as eligible shareholders. S Corporation suspended losses due to basis limitations to be transferred to divorced spouse. Expands IRS ability to provide relief for inadvertent S Corporation terminations. Allow beneficiaries of qualified subchapter S trust to use suspended losses under passive activity limitations and at-risk rules following disposition of S Corporation stock. 21

22 JOBS Act Act Section 885: Nonqualified Deferred Compensation Plans Section 885 imposes significant restrictions on nonqualified deferred compensation plans (which is defined broadly). Generally, compensation is includable in income at time of deferral or when a lapse of substantial risk of forfeiture, unless nonqualified deferred compensation plan complies with codified requirements relating to elections, distributions and acceleration provisions. 22

23 JOBS Act More arrangements covered than under prior law: Account based plans that allow employees to elect to defer compensation; Supplement Executive Retirement Plans (SERPs), that provide additional benefits based on the qualified retirement plan formulas; Restricted stock units or phantom stock unit plans (deferred compensation designated in employer stock); Stock options, unless exercise price is not less than fair market value; Stock appreciation rights; and Bonus plans where payment is made after bonus earned or vested. 23

24 JOBS Act Plan can be an arrangement for one person or all employees. Elections must be made in taxable year ending before year service is provided, which is consistent with existing IRS ruling guidelines. Exception for performance-based compensation, election must be made 6 months before the end of the year in which services performed. (If multi-year plan, then applies to last year of measurement period). Election must designate timing and form of distribution. Redeferrals allowed if made 12 months prior to planned distribution and additional deferral is for at least 5 years. 24

25 JOBS Act Act adds new restrictions to employee s s ability to control distributions, which are limited to: death or disability; separation from service; pursuant to fixed schedule identified at time of election; change of control of corporation; or certain emergencies. Distributions to key employees of public companies are subject to additional limitations: must wait 6 months in case of separation. Key employees are officers with compensation greater than $130,000, 5% owners or 1% owners with compensation greater than $150,

26 JOBS Act Distributions on change of control to be more restrictive than similar provisions in the Code (e.g., 280G). Regulations due within 90 days. Unforeseeable emergency limited to severe financial hardship and amount of distribution limit to amount needed to satisfy emergency. Disability means employee unable to be gainfully employed due to mental or physical illness that is expected to last at least 12 months or is receiving benefits under employer disability plan for 3 months with respect to a long-term disability. 26

27 JOBS Act Acceleration prohibited except as allowed under regulations. Currently, plans allow acceleration without risk of failing to be considered a deferred compensation plan if penalty imposed on early distribution, however, Act prohibits the use of such a forfeiture clause as the basis of obtaining deferred compensation status. Funding certain deferred compensation plans also limited under the Act: off-shore rabbi trusts trusts that receive creditor protection upon a change in financial condition of employer generally will not satisfy the new requirements 27

28 JOBS Act The Act provides penalties for failure to comply: current taxation of amount deferred 20% additional tax or amount deferred interest underpayment rate plus 1 percent Effective Date: changes regarding election and funding are effective for amounts deferred in taxable years beginning after December 31, Existing plans not affected unless modified after October 3, Guidance expected for grandfathering existing plans. 28

29 JOBS Act Reporting The Act provides that amounts deferred be reflected on Forms W-2 W 2 or 1099 as appropriate. Reporting for nonaccount plans awaits guidance as to when amount will be reasonably ascertainable. Act also codifies current IRS position on payroll taxes on income from exercise of ISO, ESPP or dispositions of stock acquired under such plans: no payroll tax assessed. Also, no withholding required on disqualifying disposition and compensation related to a discount under an ESPP. 29

30 JOBS Act Act Sections : 822: tax shelter provisions expand current trend in exposing aggressive tax structures: requires greater disclosure and increased penalties; targets specific transactions; and strengthens IRS administrative processes. Act imposes strict liability penalty on taxpayers who do not disclose required information re: reportable transactions. Natural person - $10,000 or $100,000 if listed transaction Others - $50,000 and $200,000 if listed transaction 30

31 JOBS Act Accuracy Related Penalties re: Reportable and Listed Transactions: 30 percent of tax understatement if fail to disclose and tax avoidance purpose, if disclosed, then penalty reduced to 20 percent. 20 percent penalty waived if reasonable cause: - taxpayer made adequate disclosure; - position supported by substantial authority; and - taxpayer reasonably believed that position was more likely than not correct. 31

32 JOBS Act A substantial understatement for corporations is now defined as the lesser of (i) 10 percent of the correct liability (or, if greater, $10,000) or (ii) $10 million. Public companies must disclose the imposition of penalties in SEC filings re: nondisclosure for listed transaction and understatement penalties and gross valuation misstatement penalties re: listed transactions or undisclosed reportable transactions with a significant tax avoidance purpose. 32

33 JOBS Act In addition, the Act: Extends statute of limitations to one year after government is provided with information re: a listed transaction. Eliminates interest deduction on underpayment re: listed transaction or reportable transaction with tax avoidance purpose. Promoter penalty for false or fraudulent statements re: marketing increase from $1,000 to 50 percent income derived from the transaction. Material Advisor definition expanded to include anyone who provides material aid, assistance or advice with respect to a reportable transaction and directly or indirectly derived $250,000 of gross income from such transaction. 33

34 Non-statutory Developments Business Plan Update Proposed Regulations Continuity of Interest Valuation Regs. Asset Transfer Regs. E and F Reorganization Regs. Two-Step Acquisitions with Disregarded Entities All Cash D Reorganization Ruling 34

35 Business Plan Update Guidance regarding: redemptions of corporate stock transactions involving the transfer or receipt of no equity value selected issues under section 336(e) taxable asset acquisition and dispositions of insurance companies (final regulations) section 355 plan issues under section 355(e) (final regulations) 35

36 Business Plan Update (Corporate) Guidance regarding: predecessor and successors under section 355(e) assumption of liabilities allocation of basis (final regulations under section 358) estimating stock basis in reorganizations under section 368(a)(1)(B) (revision of guidelines) the effect of pre-closing changes of acquiror stock value on continuity of interest 36

37 Business Plan Update (Corporate) Guidance regarding: transfers of assets after putative reorganizations statutory mergers section 368(a)(1)(F) section 382 section

38 Business Plan Update (Consolidated) Guidance under section 1502 regarding: transactions involving obligations of consolidated group members indebtedness to nonmembers that is traceable to intercompany obligations rate or discount subsidy payments treatment of member stock application of section 108 to members of a consolidated group liquidations under section 332 to multiple members 38

39 Business Plan Update (International - Outbound) Regulations regarding: the application of section 304 in transactions involving foreign corporations the carryover of tax attributes in certain international reorganizations mergers involving foreign corporations Other guidance on international restructurings 39

40 Proposed Regulations Continuity of Interest Valuation Regs. Prop. Regs (e)(2) 1(e)(2) Asset Transfer Regs. Prop. Regs (d) 1(d) and 2(k) E and F Reorganization Regs. Prop. Regs (b) 1(b) and -2(m) 40

41 COI Valuation Prop. Reg (e)(2) 1(e)(2) Prop. Regs (e) 1(e) Provides a rule of administrative convenience for measuring value for COI purposes Consideration is valued as of the end of the last business day before a binding contract is executed 41

42 COI Valuation Prop. Reg (e)(2) 1(e)(2) Rule only applies to transactions if consideration is fixed consideration is limited to issuer s s stock and cash e.g., transaction involving issuer s s debt, put options, CVRs or other property will not qualify 42

43 COI Valuation Prop. Reg (e)(2) 1(e)(2) Fixed Consideration General Rule: Consideration is fixed if the contract states the exact number of issuer s s shares and cash Placing part of issuer s s shares or cash in escrow to secure customary target reps. and warranties does not prevent consideration from being fixed Cash election merger will be treated as fixed consideration if the minimum amount of stock and the maximum amount of cash is specified COI is measured assuming issuance of minimum amount of stock and maximum amount of cash 43

44 COI Valuation Prop. Reg (e)(2) 1(e)(2) Binding Contract General Rule: Contract is binding if it is enforceable against the parties under applicable law Presence of a condition outside of the control of the parties does not prevent an instrument from being a binding contract e.g., transactions involving regulatory approval can qualify e.g., tender offers requiring shareholder vote or requiring tender of a sufficient amount of target stock can qualify 44

45 COI Valuation Prop. Reg (e)(2) 1(e)(2) Binding Contract Contract can be binding even though insubstantial terms remain to be negotiated or customary conditions remain to be satisfied If contract is binding but a subsequent modification (made prior to closing) relates to the amount or type of consideration then modification date if treated as the first date that contract is binding 45

46 COI Valuation Prop. Reg (e)(2) 1(e)(2) Binding Contract Tender offer will be treated as a binding contract on the date of announcement even though it may be modified by offeror or is not enforceable against offerees If modification of a tender offer relates to amount or type of consideration, then modification date is treated as the first date that the contract is binding 46

47 COI Valuation Prop. Reg (e)(7)(i), 1(e)(7)(i), Exs Jan 3, Yr. 1: T and P sign binding contract Pursuant to contract T S/Hs will receive 40 in P shares and $60 10 P shares will be placed in escrow to secure customary T reps. and warranties T S/Hs $30 P Stock $10 Escrowed P Stock & $60 Jan 2, Yr. 1: P stock trades for $1/SH T Merger P Merger Date (June 1, Yr. 1), P stock trades for $ 0.25/SH What if contract is modified on March 31, Yr. 1 (when P stock trades for $0.80/SH to provide that T S/Hs will receive 50 P shares and $60? What if P stock had been trading at $0.51/SH on March 31, Yr 1? 47

48 COI Valuation: Contingent Earn-out Jan 3, Yr. 1: T and P sign binding contract Pursuant to contract T S/Hs will receive 50 P shares and $50 at closing 50 P shares and $50 cash placed in escrow to be paid within two years based upon earnings milestones Jan 2, Yr. 1: P stock trades for $1/SH T S/Hs T Merger $30 P Stock $10 Escrowed P Stock & $60 P Merger Date (June 1, Yr. 1), P stock trades for $ 1 share Is Prop. Reg (e)(2) 1(e)(2) relevant to this transaction? Is it covered by Rev. Proc ? 42? 48

49 COI Valuation Prop. Reg (e)(7)(i), 1(e)(7)(i), Exs Notable Issues Addressed in the Example 40% continuity is blessed Any significance to escrow? Presume compliance with Rev. Proc ? 42? 49

50 COI Valuation Prop. Reg (e)(2) 1(e)(2) Unresolved Issues What valuation method is used when regs. do not apply? Example 10 could be read to suggest that value on the day prior to closing is relevant (see reference to June 1; closing date is June 20 If contract provides for consideration to be set based on a formula prior to closing, is closing date value used or should value be measured on date prior to date that the consideration becomes fixed? What if consideration is variable but it is also a cash election merger and minimum amount of stock and maximum amount of cash is stated? 50

51 Post-Reorg. Transfers: Prop. Regs (d) 1(d) & -2(k) In March 2004, proposed regulations were issued to amend: Regs (k) to provide that a section 368(a) reorg. will not be disqualified as a result of a transfer (or successive transfers) to one or more corporation controlled in each transfer by the transferor corporation of part or all of (i) the assets of any party to the reorg.; and (ii) the stock of any party to the reorg. other than the issuer Continuity of business enterprise (COBE) rules Regs. under (d) 1(d) Definition of a party to a reorg. under (f) 51

52 Prop. Regs. on Post-Reorg. Transfers August 2004 prop. regs. expand the March 2004 prop. regs. by addressing asset push-ups: ups: Section 368(a) reorg. will not be disqualified as a result of a subsequent distribution of the acquired assets or stock if (i) no transferee receives substantially all of the acquired assets, substantially all of the assets of the acquired or surviving corporation in a transaction otherwise qualifying as a stock reorg, (i.e., B reorg. or reverse triangular), or stock constituting control of the acquired corporation (ii) the transferee is either a member of the qualified group (as defined for COBE purposes) or a partnership the business of which is treated as conducted by a member of the qualified group; and (iii) the COBE requirement is satisfied Preamble to new prop. regs. also says that IRS is studying post-reorg. drop-downs downs to a partnership in which transferor owns an interest 52

53 Prop. Regs. on Post-Reorg. Transfers For purposes of the prop. regs. on asset push- ups: Substantially all has the same meaning as in section 368(a)(1)(C) Qualified group means one or more chains of corporations connected through stock ownership with the issuer, but only if the issuer owns directly stock meeting the requirements of section 368(c) in at least one other corporation, and stock meeting the requirements of section 368(c) in each of the corporations (except the issuer) is owned directly by one of the other corporations 53

54 Prop. Regs. on Post-Reorg. Transfers Rev. Rul Step 1 Step 2 A A S liquidates into A S Merger of T into S T S (T) Step 1: Forward subsidiary merger of T into S. S survives. Step 2: S liquidates into A. Transaction collapsed and tested as a C reorganization What if Step 2 is an upstream merger of S into A? 54

55 Prop. Regs. on Post-Reorg. Transfers Rev. Rul Step 1 Step 2 A A Stock T Stock T S/Hs A T liquidates into A T T Step 1: Stock-for for-stock exchange Step 2: T liquidates into A Tested as a C reorganization 55

56 Prop. Regs. on Post-Reorg. Transfers Rev. Rul Step 1 Step 2 A A Stock T Stock T S/Hs A 30% T Assets T T Step 1: Stock-for for-stock exchange Step 2: T distributes investment assets equal to 30% of its value to A No recast. Qualifies as a B reorg. followed by a dividend (since e Target does not distribute substantially all of its assets to Acquiring) 56

57 Prop. Regs. on Post-Reorg. Transfers Rev. Rul Step 1 Step 2 A A S Merger T T 50% T Assets $$ X Step 1: Reverse subsidiary merger of S into T Step 2: T sells 50% of its assets to unrelated X; T retains proceeds See Rev. Rul (sale of 50% assets did not disqualify subsequent C reorg. where proceeds transferred to Acquiring) 57

58 Prop. Regs. on Post-Reorg. Transfers Step 1 Step 2 A A S distributes 50% T assets to A S Merger of T into S T S Step 1: Forward subsidiary merger of T into S Step 2: S distributes 50% T assets to A OK. Less than sub all transferred to qualified group; COBE satisfied sfied Prop. Reg (k)(iii)(3), Example 2 58

59 Prop. Regs. on Post-Reorg. Transfers Step 1 Steps 2 & 3 A A (3) 50% T Assets (2) 50% T Assets S Merger of T into S T S1 S Step 1: Forward subsidiary merger of T into S Step 2: S distributes 50% T assets to A Step 3: A contributes 50% T assets to S1 Reg (f) and (k); Prop. Reg (f) and (k) 59

60 Prop. Regs. on Post-Reorg. Transfers P 80% Step 1 50% P Stock & 50% $$ P 80% Step 2 80% P/S T S/Hs 80% P/S 20% 20% (2) 50% T Assets S-1 T Merger of T into S-1S S-1 Step 1: Forward subsidiary merger of T into S-1; S otherwise qualifies. Step 2: S distributes 50% T assets to P/S in redemption of 5% S-1 S 1 stock Prop. Reg (k)(iii)(3), Example 6 60

61 Prop. Regs. on Post-Reorg. Transfers Step 1 Step 2 A A S distributes 90% T assets to A S Merger of T into S T S Step 1: Forward subsidiary merger of T into S Step 2: S distributes 90% T assets to A Prop. Reg (f) and (k) Alternative 1: S liquidates into P Alternative 2: Transaction is a reverse triangular merger (where e T survives) and T distributes 90% of its assets to A? 61

62 Prop. Regs. on Post-Reorg. Transfers Step 1 Step 2 A T S/Hs A S Stock S distributes 50% T assets to A S Merger T S Step 1: Merger of T into S for S shares Step 2: S distributes 50% T assets to A Prop. Reg (f) and (k) 62

63 Prop. Regs. on Post-Reorg. Transfers: Substantially All Standard Step 1 Step 2 A A S (S Assets) Merger of T into S T S (S assets) S distributes T assets to A Step 1: Forward subsidiary merger of T into S (with historic assets) a Step 2: S distributes all T assets to A No actual or defacto liquidation. See Rev. Rul What if Step 2 is an upstream merger of S into A? 63

64 Prop. Regs. on Post-Reorg. Transfers Step 1 Step 2 A S/Hs A/T S/Hs A/T S/Hs T S/Hs A Stock A A A distributes T1 Stock T Merger S S S distributes T1 Stock T1 T1 Assume distributions of T1 (by S and A) both qualify under section 355 What if distribution is pro-rata rata to A shareholders? What if distribution is a split-off to A shareholders (but not former T shareholders)? 64

65 Prop. Regs. on Post-Reorg. Transfers 50% T Assets A 50% T Assets T Merger A S-1 S-2 50% 50% 50% T Assets S-3 50% T Assets P owns more than 80% of S-1 S 1 and S-2. S T mergers into A in a C reorg, P contributes 50% of T assets to each of S-1 S 1 and S-2. S S-1 1 and S-2 S 2 each contribute 50% T assets to S-3 S 3 in exchange for 50% S-3 S 3 stock Is COBE satisfied? Is Reg (k) satisfied? Prop. Reg (k)? 65

66 Prop. Regs. on Post-Reorg. Transfers T S/Hs A Stock A A T T Stock (1) (2) 50% T Stock (3) 50% T Stock S1 S2 S3 50% S1 S2 S3 T 50% Reg (d) 1(d) and -2(k); Prop. Reg (k) T Assets T1 66

67 Prop. Regs. on Post-Reorg. Transfers Step 1 Step 2 P 50% P Stock & 50% $$ T S/Hs P S-1 Merger of T into S-1S T S-1 33⅓% T Assets P/S Step 1: Forward subsidiary merger of T into S-1S Step 2: S-1 S 1 contributes all T assets to P/S, which is owned 33⅓% % by S-1S Does transfer disqualify reorg.? Prop. Reg (k)(iii)(3), Example 5 67

68 E and F Reorganizations Prop. Regs (b) 1(b) & -2(m) E reorganizations involve a recapitalization or reshuffling of a capital structure within a framework of an existing corporation F reorganizations involve a mere change in identity, form or place of organization of one corporation, however effected 68

69 E and F Reorganizations Prop. Regs (b) 1(b) & -2(m) Proposed regulations provide: COI and COBE do not apply to E or F reorgs. Four characteristics of qualifying F reorgs. Limited application of the step transaction doctrine in connection with F reorgs. Distributions of money or other property to a shareholder in connection with an F reorg. will be treated as a distribution immediately before the F reorg. (in a distribution governed by 301 or 302 rather than 356) 69

70 E and F Reorganizations Prop. Regs (b) 1(b) & -2(m) Four characteristics of qualifying F reorgs. All stock of resulting corp. (including stock issued prior to transfer) must be issued in respect of stock of the transferring corporation There must be no change in ownership of the corporation in the transaction (other than a change that has no effect other than that of a redemption of less than all of the shares of the corporation The transferring corporation must completely liquidate in the transaction The resulting corporation must not hold any property or have any tax attributes (including under 381(c)) immediately before the transfer 70

71 E and F Reorganizations Prop. Regs (5)(m), Ex. 1 V (State B) W Stock C A $$ $$ U Merger W (State A) U U stock is not issued in respect of W stock (-2(m)(1)(i)(A))( and transaction results in a change in ownership that is more than a mere redemption (-2(m)(1)(i)(B))( Fails to qualify as an F reorg. 71

72 E and F Reorganizations Prop. Regs (m)(5), Ex. 2 A $$ for X Stock 75% 25% X B X Stock for Y Stock B (State A) Merger Y Y (State B) (State B) X reorganized in State B through merger of X into Y. A redeemed for cash Mere redemption of less than all of the shares of X (see -2(m)(1)(i)(B)) Qualifies as an F reorg. What if A owned 90% of X? 99% of X?? 72

73 E and F Reorganizations Prop. Regs (m)(5), Ex. 3 D S Stock 990 SHs T Stock $$ E D E 10 SHs T Stock 99% 10% S Merger T T (Country A) (Country B) (Country B) S reorganizes in Country B. To enjoy limited liability status, corps. in Country B must have 2 or more shareholders. Shares issued to E are nominal and used to facilitate organization on of T Qualifies as an F reorg. 73

74 E and F Reorganizations Prop. Regs (m)(5), Ex. 4 A Merger H HoldCo S OpCo A S (State B) H (holding co.) merges into S (operating co), which it has owned for many years. S has historic tax attributes (see -2(m)(1)(i)(D)) Does not qualify as an F reorg. Same result if S merged into H 74

75 E and F Reorganizations Prop. Regs (m)(5), Ex. 5 P (1) S1 Stock P S1 (State X) (2) Merger S2 (State Y) S1 (State X) S2 (State Y) P forms new S2. P contributes S1 to S2. S1 is merged into S2. Series of transactions, but result is mere change of one corp. (see( -2(m)(3)(i)) Qualifies as an F reorg. S1 is treated as transferring assets to S2 in exchange for S2 stock and distributing S2 stock to P in exchange for P s P s S1 stock 75

76 E and F Reorganizations Prop. Regs (m)(5), Ex. 6 P (3) Sale Unrelated Party Unrelated Party (1) S (State X) (2) Merger New S (State Y) New S (State Y) P forms New S. S is merged into New S. P sells New S stock to unrelated party. Sale is not taken into account in determining whether initial transactions qualifies as an F reorg. (see -2(m)(3)(ii)) Merger of S into New S qualifies as an F reorg. 76

77 E and F Reorganizations Prop. Regs (m)(5), Ex. 7 A B A B P $$ P Stock A (State M) (2) Merger A B New P (State N) T (State M) (1) Merger S New P (State N) S (State M) Step One: T acquired in a forward subsidiary merger. Step Two: P (issuer) merges into New P in a qualified F reorg. Step Three: New P redeems all A stock in exchange for cash F reorg. remains valid. However, redemption of A causes forward subsidiary merger to be taxable. F in the middle does not change this result. (see -2(m)(3)(ii)) 77

78 E and F Reorganizations Prop. Regs (m)(5), Ex. 8 P (1) P 1% S Stock S (State A) LLC (State A) 99% LP S (State A) 1% GP LLC (State A) (2) S converts to LP under state law (3) S makes tax election to be treated as a corp. Step One: T forms new LLC and transfers 1% of S to LLC. Step Two: Under statute, S converts to a limited partnership. Step Three: S makes tax election to be treated as a corporation for tax purposes Valid F reorg. since S s S s conversion to an LP and tax election are a mere change. 78

79 E and F Reorganizations Prop. Regs (b) 1(b) & -2(m) $$ X (1) T Stock X A Stock & $$ Y Y X T (State D) (2) Merger New T (State E) (3) Merger A (State E) A (State E) Step One: T redeems part of X s X s T shares for cash Step Two: T merges into New T in a valid F reorg. Step Three: New T merges into A in a purported A reorg. F reorg. remains valid. How is initial cash to X treated? Section 301? 302? 356? See -2(m)(4) 79

80 Mergers Involving Disregarded Entities Temporary Regulations (Treas. Regs T(b)) provides that for purposes of section 368(a)(1)(A), a statutory merger or consolidation includes a transaction involving domestic entities effected pursuant to the laws of the United States, a State, or the District of Columbia in which, as a result of the operation of such laws, the following events occur SIMULTANEOUSLY at the effective time of the transaction: all non-distributed assets and non-discharged liabilities of each member of one or more of the combining units (transferor unit) become the assets and liabilities of one or more members of the other combining unit (transferee unit), the combining entity of the transferor unit ceases its separate legal existence (except for limited purposes such as defending or bringing pre-closing lawsuits) 80

81 DE Merger: Basic A Reorg. A SHs T SHs A SHs T SHs A Stock & $$ Acquiring Acquiring Target Merger into DE DE DE (Target Assets) Merger of Target into DE. DE survives. T shareholders receive 50% A stock and 50% cash Temp. Regs T(b)(1)(iv), Ex. 2 Tested as an A reorganization 81

82 Disregarded Entity Liquidation Parent P DE DE Merger of Sub into DE Sub Sub Assets Merger of Sub into DE Treated as liquidation of Sub into Parent 82

83 Two-Step Acquisitions: Rev. Rul Step 1 Step 2 A A Upstream Merger S Merger of S into T T T Step 1: Reverse subsidiary merger of S into T. T survives. Step 2: Upstream merger of T into A. A survives. Situation 1: T shareholders receive 70% A stock and 30% cash Situation 2: T shareholders receive 100% A voting stock Tested first as an A reorganization 83

84 Two-Step Acquisitions: Sideways Merger Step 1 Step 2 P S P Y T X T Merger of Y into T Merger of T into X Step 1: Reverse subsidiary merger of Y into T. T survives. Step 2: Sideways merger T into X, X survives. Tested as a forward subsidiary merger ( 368(a)(2)(D)) (assuming no 338(h)(10) election If a 338(h)(10) election is made, then P s P s acquisition of T stock is treated as a QSP. See Treas. Regs (h)(10)-1T(e), 1T(e), Example 14 84

85 Two-Step Acquisitions With DE Step 1 Step 2 A A S T DE T Merger of S into T Merger of T into DE Step 1: Reverse subsidiary merger of S into T. T survives. Step 2: Merger of T into DE (disregarded entity of A). DE survives. Tested first as an A reorganization. See Rev. Rul and Temp. Treas. Regs. sec T Does it matter that acquisition of T stock does not occur simultaneously with the merger of T into DE? 85

86 Revenue Ruling All Cash D Reorganizations Step 1 Step 2 P P P sales T stock to S for $$ S T S T Liquidation Step 1: T and S wholly-owned owned by P. S purchases all of the T stock from P for cash. Step 2: T liquidates into S. Sale by T of all of its assets to S followed by liquidation of T into P would have qualified as a D reorg. Transaction is treated as a D reorg. (rather than a section 304 stock sale followed by a section 332 liquidation) Result is the same even if P, S & T do not consolidate 86