Tax 4022/5022 Tax 4022/5022 Federal Income Tax II Federal Income Tax II Corporate Acquisitions Corporate Acquisitions

Chapter: NoneChapter: NoneDr. Robert R. OlivaDr. Robert R. Oliva

Professor and ChairpersonProfessor and Chairperson

Department of AccountingDepartment of Accounting

University of Arkansas at Little RockUniversity of Arkansas at Little Rock

Corporate AcquisitionsCorporate Acquisitions

• I. Taxable AcquisitionsI. Taxable Acquisitions

• II. Non-Taxable Acquisitions: II. Non-Taxable Acquisitions: ReorganizationsReorganizations

Taxable AcquisitionsTaxable Acquisitions

IntroductionIntroduction

• I. I. ASSETASSET ACQUISITION ACQUISITION

• II.II. STOCKSTOCK ACQUISITION ACQUISITION

ASSETASSET ACQUISITION (not a ACQUISITION (not a reorganization):reorganization):

• Two possibilities: Two possibilities: – (1) (1)

• A. Purchasing Corporation (A. Purchasing Corporation (PP) ) buys assets buys assets from Target Corporation (T)from Target Corporation (T)

• B. T liquidates cash from sale of assets to T’s B. T liquidates cash from sale of assets to T’s shareholdersshareholders

– (2) (2) • A. T liquidates assets to its shareholders and A. T liquidates assets to its shareholders and

• B. B. PP buys assets from T’s shareholdersbuys assets from T’s shareholders

Tax effectTax effect

• Two levels of taxation: corporate Two levels of taxation: corporate and shareholderand shareholder– If so, P takes a cost ABIf so, P takes a cost AB

– P could avoid the corporate-level tax P could avoid the corporate-level tax on a stock purchase, but AB will be c/o.on a stock purchase, but AB will be c/o.

Allocation Allocation

• Sale of assets of a going business Sale of assets of a going business requires allocationrequires allocation

• Buyers and sellers have conflicting Buyers and sellers have conflicting interests.interests.

SellerSeller

• Seller’s gain or loss and character Seller’s gain or loss and character may depend on how the sales price may depend on how the sales price is allocated.is allocated.– Favor allocation to assets yielding Favor allocation to assets yielding

capital gains.capital gains.

BuyerBuyer

• Buyer’s AB and depreciation Buyer’s AB and depreciation depends on how sales price is depends on how sales price is allocated. allocated. – Favor allocation of sales price to Favor allocation of sales price to

depreciable assets depreciable assets

Price allocations may be Price allocations may be contractually specified, or contractually specified, or may be imposed by IRC.may be imposed by IRC.

• IRC 1060: Review it and its IRC 1060: Review it and its regulationsregulations

IRC 1060IRC 1060

• Where there is no agreement between the Where there is no agreement between the parties, or if there is one, IRS finds allocation parties, or if there is one, IRS finds allocation not appropriate.not appropriate.

• Outlines specific allocation method for Outlines specific allocation method for applicable assets acquisitions.applicable assets acquisitions.

• Applicable asset acquisitions: Direct or indirect Applicable asset acquisitions: Direct or indirect transfers of trade or business assets, where transfers of trade or business assets, where buyer’s (transferre) AB is determined by price buyer’s (transferre) AB is determined by price paid for assets.paid for assets.

Treas. Reg. 1.1060-1: Treas. Reg. 1.1060-1:

• Allocate as in Treas. Reg. 1.338-6: Allocate as in Treas. Reg. 1.338-6: 77 classes of assetsclasses of assets– 1.338-6(a)(1): Adjusted grossed-up 1.338-6(a)(1): Adjusted grossed-up

basis (AGUB) is allocated among basis (AGUB) is allocated among target's “acquisition date assets.”target's “acquisition date assets.”• Target’s assets held at the beginning of Target’s assets held at the beginning of

the day after the acquisition date. Reg the day after the acquisition date. Reg §1.338-2(c)(2) . §1.338-2(c)(2) .

77 classes of assets classes of assets

• Class I: cash, savings accounts, Class I: cash, savings accounts, checking accounts, but not CDs.checking accounts, but not CDs.

– If Class I assets exceed AGUB, new If Class I assets exceed AGUB, new target immediately realizes ordinary target immediately realizes ordinary income in the amount of the excess.income in the amount of the excess.

• Classes II through VII: Classes II through VII:

– In proportion to, and not in excess of, In proportion to, and not in excess of, their fair market value: their fair market value:

Class II - VII: Class II - VII: In proportion In proportion to, and not in excess of, to, and not in excess of, their fair market value: their fair market value:

– Class II: CDs, foreign currency; US gov secs; publicly traded Class II: CDs, foreign currency; US gov secs; publicly traded stock (not of target’s affiliate); stock (not of target’s affiliate); actively traded personal actively traded personal property property

– Class III: Class III: mark-to-market assets and some debt mark-to-market assets and some debt instruments instruments • Exceptions: debt instruments issued by related parties; Exceptions: debt instruments issued by related parties;

contingent debt; convertible debt contingent debt; convertible debt

– Class IV: InventoryClass IV: Inventory

– Class V: Not in any of the classes Class V: Not in any of the classes above or belowabove or below: furniture, : furniture, buildings, land, actively traded T’s affiliate stock buildings, land, actively traded T’s affiliate stock

– Class VI: IRC 197 intangibles Class VI: IRC 197 intangibles o/to/t goodwill and going concern goodwill and going concern valuevalue

– Class VII: goodwill and going concern value. Class VII: goodwill and going concern value.

Method of allocationMethod of allocation

• Asset by asset, starting first with I Asset by asset, starting first with I and down.and down.

• On the basis of FMV.On the basis of FMV.

• See Treas. Reg. 1.1060-1(d): See Treas. Reg. 1.1060-1(d): Example 2.Example 2.

STOCKSTOCK ACQUISITION ACQUISITION

Stock AcquisitionStock Acquisition

• P buys stock of T from T’s P buys stock of T from T’s shareholders.shareholders.

• If T is closely held, negotiation may If T is closely held, negotiation may be face to face.be face to face.

• But likely to be different if T is But likely to be different if T is publicly or widely held. publicly or widely held.

Either way: Either way:

• T’s shareholders recognize T’s shareholders recognize gain(loss)gain(loss)

• P takes a P takes a cost ABcost AB

Kimbell-Diamond’Kimbell-Diamond’’s ’s transitory ownershiptransitory ownership doctrinedoctrine• Some Some stock purchasesstock purchases had been had been treated treated

as asset acquisitionsas asset acquisitions when the stock when the stock purchase was followed by a liquidation of purchase was followed by a liquidation of Target into Parent.Target into Parent.

– Codified into IRC 334(b)(2): Asset’s AB = c/s Codified into IRC 334(b)(2): Asset’s AB = c/s AB if 80% acquired by purchase w/i 12 month AB if 80% acquired by purchase w/i 12 month and plan of liquidation adopted w/i 2 years and plan of liquidation adopted w/i 2 years after acquiring control after acquiring control

– However, in 1982: IRC 334(b)(2) was repealedHowever, in 1982: IRC 334(b)(2) was repealed

IRC 338: “Qualified stock IRC 338: “Qualified stock purchase” (QSP) purchase” (QSP)

• Replaced IRC 334(b)(2) Replaced IRC 334(b)(2)

• Qualified purchase (control) Qualified purchase (control) requirementrequirement

• Time requirementTime requirement

• Timely election requirementTimely election requirement

The IRC 338 electionThe IRC 338 election

• ActualActual election: IRC 338(a) election: IRC 338(a)– “… “… if a purchasing corporation makes an if a purchasing corporation makes an

election … in the case of a election … in the case of a qualified qualified stockstock purchasepurchase…. ”…. ”

• DeemedDeemed election: IRC 338(e) election: IRC 338(e)– “… “… a purchasing corporation … treated as a purchasing corporation … treated as

having made an election (the deemed election) having made an election (the deemed election) … if … during the consistency period… … if … during the consistency period… acquires any assetacquires any asset of the target…. ” of the target…. ”

““purchasing corporation”: purchasing corporation”: IRC 338(d)(1)IRC 338(d)(1)

• one which makes a QSP of another one which makes a QSP of another corporation.corporation.

““target corporation”: IRC target corporation”: IRC 338(d)(2)338(d)(2)

• one whose stock is acquired through one whose stock is acquired through a QSPa QSP

QSPQSP: IRC 338(d)(3): IRC 338(d)(3)

• One or a series of transactions, One or a series of transactions, where the purchasing where the purchasing corporationcorporation (not an individual) acquires by (not an individual) acquires by purchasepurchase

• ““sufficientsufficient target stock” target stock”

• during a “during a “12-month acquisition 12-month acquisition periodperiod” ”

How to “How to “purchasepurchase” ” stock:IRC 338(h)(3)(a), (b)stock:IRC 338(h)(3)(a), (b)

• TaxableTaxable stock “ stock “purchasepurchase” from an ” from an unrelatedunrelated party. party.

– Not by gift, inheritances, or tax-free/carry-Not by gift, inheritances, or tax-free/carry-over basis transactions. over basis transactions.

– Purchases by affiliates of purchaser are Purchases by affiliates of purchaser are includedincluded

– Effect of redemptions are included, e.g., Effect of redemptions are included, e.g., redeeming of minority shareholders to bring redeeming of minority shareholders to bring purchasing corporation to 80%.purchasing corporation to 80%.

““Purchase” does NOT Purchase” does NOT include stock acquisition include stock acquisition from from

• personspersons whose stock will be whose stock will be attributed to purchasing attributed to purchasing corporation: IRC 338(h)(3)(A)(iii)corporation: IRC 338(h)(3)(A)(iii)– e.g., cant buy from yourselfe.g., cant buy from yourself

• Apply IRC 318(a) ignoring option Apply IRC 318(a) ignoring option attribution.attribution.

Exception: Acquisitions Exception: Acquisitions from persons that are from persons that are “related corporations”“related corporations”

• DO consider acquisitions from a DO consider acquisitions from a related related corporationcorporation if 50% or more of stock of if 50% or more of stock of related corporation was acquired by related corporation was acquired by “purchase”. “purchase”.

• ““related corporation”: IRC 338(h)(3)(C)related corporation”: IRC 338(h)(3)(C)(iii): if stock owned by a related (iii): if stock owned by a related corporation corporation treated as ownedtreated as owned by the by the acquiring corporation. acquiring corporation.

Second element: Second element: ““sufficient sufficient target stock”target stock”

• >> 80% of the voting power and 80% of the voting power and

• >> 80% of the value of all classes of 80% of the value of all classes of stockstock– except nonvoting, nonparticipating except nonvoting, nonparticipating

preferred stock, that is not counted for preferred stock, that is not counted for the the >> 80% test. 80% test.

Third element: “Third element: “12-month 12-month acquisition periodacquisition period”: IRC ”: IRC 338(h)1)338(h)1)

• ““12 month” is a 12 month” is a moving moving parameterparameter, ending on “acquisition , ending on “acquisition date”. date”.

Acquisition date/First dayAcquisition date/First day

• ““acquisition date”: the first day of the acquisition date”: the first day of the acquisition period that took P into an acquisition period that took P into an 80% ownership by purchase. It is not 80% ownership by purchase. It is not necessarily the last day of the 12-necessarily the last day of the 12-month period. month period.

• First day of 12 month period: Look First day of 12 month period: Look back 12 month from acquisition date.back 12 month from acquisition date.

The electionThe election

• Who makes it?Who makes it?

• When is it made?When is it made?

• How is it made?How is it made?

• What is the effect of the election?What is the effect of the election?

Who makes it? Who makes it?

• By PBy P

• But there is a special case where T But there is a special case where T joins in the election.joins in the election.

When is it made?When is it made?

• Must be made on or before the 15th Must be made on or before the 15th day of the 9th month beginning day of the 9th month beginning after the month during which the after the month during which the 80% control is satisfied.80% control is satisfied.

How is it made? How is it made?

• File Form 8023 (Corporate Qualified File Form 8023 (Corporate Qualified Stock Purchase Election) with P’s Stock Purchase Election) with P’s IRS Service CenterIRS Service Center

What is the effect of the What is the effect of the election? election?

• IrrevocableIrrevocable

• Effect on Target Effect on Target

• Effect on PurchaserEffect on Purchaser

Effect on Target Effect on Target

• the “target” is treated as two:the “target” is treated as two:– the the Old TargetOld Target

– the the New TargetNew Target

Effect on Old TargetEffect on Old Target: IRC : IRC 338(a)(1)338(a)(1)

• Old Target treated as having sold ALL of its Old Target treated as having sold ALL of its assets at FMV at the end of the day assets at FMV at the end of the day considered as the “acquisition date”.considered as the “acquisition date”.– Recognize gain or loss on the deemed saleRecognize gain or loss on the deemed sale

• Use any tax attributes to offset gains; unused Use any tax attributes to offset gains; unused attributes are extinguished.attributes are extinguished.

• Recognize income earned to acquisition Recognize income earned to acquisition date-if not included in consolidated return. date-if not included in consolidated return.

Thus, a disadvantage:Thus, a disadvantage:

• there could be significant up-front there could be significant up-front tax costs tax costs

But there may not be up-But there may not be up-front tax costsfront tax costs

• Old Target may be able to use Old Target may be able to use NOLs, which otherwise may be NOLs, which otherwise may be wasted, to offset recognized gains wasted, to offset recognized gains on the deemed sale.on the deemed sale.– In turn provided stepped-up AB to New In turn provided stepped-up AB to New

Target.Target.

At what price did the Old At what price did the Old Target Target sellsell its assets? its assets?

• IRC 338(a)(1): At FMVIRC 338(a)(1): At FMV

• But: Treas. Reg. 1.338-4(a): At the But: Treas. Reg. 1.338-4(a): At the “aggregate deemed sales price” “aggregate deemed sales price” (ADSP)(ADSP)

““aggregate deemed sales aggregate deemed sales price” (ADSP): 1.338-4(b)price” (ADSP): 1.338-4(b)

• ADSP: determined at the beginning of ADSP: determined at the beginning of the day after the “acquisition date” the day after the “acquisition date” – grossed up amount realized on the sale grossed up amount realized on the sale

to the purchasing corporation of the to the purchasing corporation of the purchasing corporation’s recently purchasing corporation’s recently purchased stock (RPS), andpurchased stock (RPS), and

– liabilities (including taxes from gain liabilities (including taxes from gain recognition in 338 election)recognition in 338 election)

““Grossed up amount Grossed up amount realized”: 1.338-4(c)(1)realized”: 1.338-4(c)(1)

• Amount realized on the sale to P of Amount realized on the sale to P of the RPS / % of T stock, by value, the RPS / % of T stock, by value, attributable to the RPS stockattributable to the RPS stock

• Less selling costs Less selling costs

Example: 1.338-4(c)(2)Example: 1.338-4(c)(2)

• Voting c/s; Pfd stock (not taken into Voting c/s; Pfd stock (not taken into account for account for >> 80% test) 80% test)

• P buys c/s from 3 different parties when P buys c/s from 3 different parties when 100% FMV is $1250, and pfd FMV = $750:100% FMV is $1250, and pfd FMV = $750:– From S1: 40% for $500; selling costs = $40 From S1: 40% for $500; selling costs = $40

– From S2: 20% for $225; selling costs = $35 From S2: 20% for $225; selling costs = $35

– From S3: 20% for $275; selling costs = $25 From S3: 20% for $275; selling costs = $25

What is the “grossed up What is the “grossed up amount realized”?amount realized”?

• Amount realized on the sale to P of the Amount realized on the sale to P of the RPS = $1000RPS = $1000

• % of T stock, by value, attributable to the % of T stock, by value, attributable to the RPS stock = $1000/(FMV c/s $1250 + FMV RPS stock = $1000/(FMV c/s $1250 + FMV pfd $750) = 50%pfd $750) = 50%

• Selling costs = $100Selling costs = $100

• Hence: GUAR: $1000/.50 - $100 = $1900 Hence: GUAR: $1000/.50 - $100 = $1900

Note: About liabilitiesNote: About liabilities

• In previous example there were no In previous example there were no liabilities other any tax liability to be liabilities other any tax liability to be incurred by the deemed sale.incurred by the deemed sale.

Example (1) in Treas. Reg. Example (1) in Treas. Reg. 1.338-4(g)(1): 1 of 41.338-4(g)(1): 1 of 4

• One asset (IRC 1245 property), One asset (IRC 1245 property), bought for $80K (recomputed AB), bought for $80K (recomputed AB), AB = $50,400, FMV = $100,000. P AB = $50,400, FMV = $100,000. P purchases all 100% of the stock for purchases all 100% of the stock for $75,000$75,000

• ADSP = GUAR + L + MTR (ADSP-AB) ADSP = GUAR + L + MTR (ADSP-AB)

Example (1) continues: (2 Example (1) continues: (2 of 4): GUAR of 4): GUAR

• Amount realized on the sale to P of Amount realized on the sale to P of the RPS / % of T stock, by value, the RPS / % of T stock, by value, attributable to the RPS stock = attributable to the RPS stock = $75,000/1.00$75,000/1.00

• Selling costs = $0Selling costs = $0

• Hence: GUAR: $75,000/1.0 - 0 = Hence: GUAR: $75,000/1.0 - 0 = $75,000 $75,000

Example (1) continues: (3 Example (1) continues: (3 of 4): Solving for ADSP in of 4): Solving for ADSP in ADSP = GUAR + L + MTR ADSP = GUAR + L + MTR (ADSP-AB) (ADSP-AB) • ADSP = $75,000 + 0 + 0.34 (ADSP - ADSP = $75,000 + 0 + 0.34 (ADSP -

$50,400)$50,400)

• ADSP = 75,000 + 0.34 ADSP - 17,136ADSP = 75,000 + 0.34 ADSP - 17,136

• ADSP -0.34 ADSP = $57,864ADSP -0.34 ADSP = $57,864

• ADSP = 57,864/0.66 = $87,672.73ADSP = 57,864/0.66 = $87,672.73

• As ADSP < FMV of asset, then entire ADSP is As ADSP < FMV of asset, then entire ADSP is allocated to the 1245 propertyallocated to the 1245 property

End result in example (1): End result in example (1): (4 of 4)(4 of 4)

• Thus: Gain = 87,672.73 - 50,400 = Thus: Gain = 87,672.73 - 50,400 = 37,272.7337,272.73

• But since 1245 property:But since 1245 property:– $80,000 - $50,400 = $29,600 ordinary $80,000 - $50,400 = $29,600 ordinary

incomeincome

– 37,272.73 - 29,600 = $7,673.73 capital 37,272.73 - 29,600 = $7,673.73 capital gain gain

Example (2) in Treas. Reg. Example (2) in Treas. Reg. 1.338-4(g)(1): 1 of 51.338-4(g)(1): 1 of 5

• P buys all stock for $140,000P buys all stock for $140,000

• Other:Other:– T’s Liabilities (other than the tax for deemed T’s Liabilities (other than the tax for deemed

sale gain) = $50Ksale gain) = $50K

– Cash (Class I) = $10KCash (Class I) = $10K

– Marketable securities (Class II) = FMV $10K, Marketable securities (Class II) = FMV $10K, AB $4KAB $4K

– Goodwill (Class VII) = AB $3KGoodwill (Class VII) = AB $3K

EXAMPLE (2) continues: 2 EXAMPLE (2) continues: 2 of 5of 5

• Class V assets: Total FMV = $250,000Class V assets: Total FMV = $250,000– Land: FMV $35K, AB $5K, 14% of Class V Land: FMV $35K, AB $5K, 14% of Class V

FMVFMV

– Building: FMV $50K, AB $10K, 20% of Class V Building: FMV $50K, AB $10K, 20% of Class V

– Equipment A: FMV $90K, AB 5K, recomputed Equipment A: FMV $90K, AB 5K, recomputed AB $80K, 36% of Class VAB $80K, 36% of Class V

– Equipment B: FMV $75K, AB $10K, Equipment B: FMV $75K, AB $10K, recomputed AB $20K, 30%of Class Vrecomputed AB $20K, 30%of Class V

EXAMPLE (2) continues: 3 EXAMPLE (2) continues: 3 of 5of 5

• Issue is the allocation to Class V; allocate Issue is the allocation to Class V; allocate Class I and II their FMV or $10 K +$10K Class I and II their FMV or $10 K +$10K

• ADSP (V) = [G - (I + II)] + L + MTR [(Class ADSP (V) = [G - (I + II)] + L + MTR [(Class I gain) + ADSP (V) - (5K+10K+5K+10K)]I gain) + ADSP (V) - (5K+10K+5K+10K)]

• ADSP (V) = 140 - 10 -10 + 50 + 0.34 ADSP (V) = 140 - 10 -10 + 50 + 0.34 [(Class I: $10K FMV - $4K AB) +(ADSP (V) [(Class I: $10K FMV - $4K AB) +(ADSP (V) -30K)]-30K)]

EXAMPLE (2) continues: 4 EXAMPLE (2) continues: 4 of 5of 5

• ADSP (V) = 170 + 0.34[(6K) + (ADSP(V) - ADSP (V) = 170 + 0.34[(6K) + (ADSP(V) - 30K)] = 170,000 + 2,040 +0.34 ADSP - 10,20030K)] = 170,000 + 2,040 +0.34 ADSP - 10,200

• ADSP (V) - 0.34 ADSP (V) =161,840; ADSP = ADSP (V) - 0.34 ADSP (V) =161,840; ADSP = $161,840/0.66 = $161,840/0.66 = $245,212.12$245,212.12

• As $245,212 does not exceed total Class V’s As $245,212 does not exceed total Class V’s FMV of $250K, there is no ADSP balance to be FMV of $250K, there is no ADSP balance to be allocated to goodwill, resulting in a capital loss allocated to goodwill, resulting in a capital loss of $3K. of $3K.

EXAMPLE (2) continues: 5 EXAMPLE (2) continues: 5 of 5: Final allocation of of 5: Final allocation of Class VClass V• ADSP(V)= [G - (I +II)] + L + MTR {(II-AB) +ADSP(V)= [G - (I +II)] + L + MTR {(II-AB) +

[ADSP(V)-AB] + [ADSP(VII)-AB]}[ADSP(V)-AB] + [ADSP(VII)-AB]}

• ADSP(V) = (140-10-10) + 50 + 0.34{[10-4] +ADSP(V) = (140-10-10) + 50 + 0.34{[10-4] +[ADSP(V) -30] +[0-3]}[ADSP(V) -30] +[0-3]}

• ADSP(V) = 170 +0.34ADSP(V) +0.34(6-30-3) ADSP(V) = 170 +0.34ADSP(V) +0.34(6-30-3) = 160820 +0.34 ADSP(V)= 160820 +0.34 ADSP(V)

• ADSP(V) - 0.34 ADSP(V) = $160, 820; ADSP(V) - 0.34 ADSP(V) = $160, 820; ADSP(V)= $160, 820/.66 = ADSP(V)= $160, 820/.66 = $243,667$243,667

Tax effect:Tax effect:

– Land: 0.14(243667) - 5K AB = 34,113.33 -5K Land: 0.14(243667) - 5K AB = 34,113.33 -5K =$29,113.33 capital gain =$29,113.33 capital gain

– Building: 0.20(243667)-$10KAB = 48,733.34 - Building: 0.20(243667)-$10KAB = 48,733.34 - 10K = $38,733.34 capital gain10K = $38,733.34 capital gain

– Equipment A: 0.36(243667)-$5k = 87720-5k Equipment A: 0.36(243667)-$5k = 87720-5k = $82,720 gain: $75K OI; $7,720 capital= $82,720 gain: $75K OI; $7,720 capital

– Equipment B: 0.30(243667)-$10K= 73,100K -Equipment B: 0.30(243667)-$10K= 73,100K -10K = 63,100K gain: $10K OI; $53,100 capital 10K = 63,100K gain: $10K OI; $53,100 capital gaingain

Other advantages or Other advantages or planning opportunities:planning opportunities:

• The IRC 338(h)(10) electionThe IRC 338(h)(10) election

IRC 338(h)(10) election: IRC 338(h)(10) election:

• If Target is a subsidiary in a consolidated If Target is a subsidiary in a consolidated group and Target’s group and Target’s stockstock is sold by the group is sold by the group to P,to P,

• an election will treat the transaction as if an election will treat the transaction as if seller (consolidated group) seller (consolidated group) – had a taxable sale of the Target’s had a taxable sale of the Target’s assetsassets and and

thenthen

– liquidated sales’ proceeds into parent in an IRC liquidated sales’ proceeds into parent in an IRC 332 liquidation 332 liquidation

Good idea when Good idea when

• Target’s assets have declined in value, Target’s assets have declined in value, and/or and/or

• seller has a low basis in target’s stock seller has a low basis in target’s stock (requiring recognition of large amount of (requiring recognition of large amount of gains), or gains), or

• seller has tax attributes to offset gain seller has tax attributes to offset gain recognized on the deemed sale of assets.recognized on the deemed sale of assets.

End result of IRC 338(h)End result of IRC 338(h)(10) election to (10) election to consolidated groupconsolidated group

• Gain recognition?Gain recognition?

• Target’s tax attributes?Target’s tax attributes?

Gain recognition?Gain recognition?

• Consolidated group Consolidated group recognizes gainrecognizes gain on the deemed on the deemed sale of assetssale of assets, to the , to the extent not sheltered by any extent not sheltered by any consolidated tax attributes. consolidated tax attributes.

• Consolidated group Consolidated group does does notnot recognize gainrecognize gain on the on the sale of T’s sale of T’s stockstock. .

Target’s tax attributes?Target’s tax attributes?

• Because it is treated as a IRC 332 Because it is treated as a IRC 332 liquidation Target’s tax attributes liquidation Target’s tax attributes survive to the consolidated group.survive to the consolidated group.

• T must electT must elect

Election by T?Election by T?

• Actually a joint election in Form Actually a joint election in Form 8023.8023.

• First, P has to decide to make the First, P has to decide to make the IRC 338 election.IRC 338 election.

Effect on New TargetEffect on New Target: IRC : IRC 338(a)(2)338(a)(2)

• New Target treated as having purchased New Target treated as having purchased ALL of the Old Target’s assets at FMV at the ALL of the Old Target’s assets at FMV at the beginning of the day after “acquisition beginning of the day after “acquisition date”.date”.

• Main effect: Old Target recognizes gain, Main effect: Old Target recognizes gain, New Target gets higher AB.New Target gets higher AB.– New Target treated as if it bought the assets of New Target treated as if it bought the assets of

the Old Target for the “the Old Target for the “adjusted grossed-up adjusted grossed-up basisbasis”.”.

““adjusted grossed-up adjusted grossed-up basisbasis”(AGUB): 338(b)(1); ”(AGUB): 338(b)(1); 1.338-51.338-5

• Grossed-up basisGrossed-up basis of “ of “recently recently purchased stockpurchased stock”, ”, plusplus

• actual (historical) basis of the actual (historical) basis of the “nonrecently purchased stock”,“nonrecently purchased stock”, plus plus

• liabilities (including tax liability from liabilities (including tax liability from gain recognition due to election)gain recognition due to election)

““non-recently purchased non-recently purchased stock” (N-RPS)stock” (N-RPS)

• Target’s stock held by puchaser on Target’s stock held by puchaser on acquisition date that is not “recently acquisition date that is not “recently purchased stock”, e.g., was purchased stock”, e.g., was purchased during purchased during other thanother than the “12 the “12 month acquisition period” month acquisition period”

• Thus, the actual historical AB of the Thus, the actual historical AB of the stock in the hands of P.stock in the hands of P.

Election to step up AB of Election to step up AB of N-RPS to FMV N-RPS to FMV

• P may elect to increase AB of N-RPS P may elect to increase AB of N-RPS to FMV by treating the N-RPS as if it to FMV by treating the N-RPS as if it were sold on “acquisition date” and were sold on “acquisition date” and recognize gain accordingly. recognize gain accordingly.

““recently purchased recently purchased stock” (RPS): IRC 338(b)stock” (RPS): IRC 338(b)(6)(6)

• Target’s stock held by puchaser on Target’s stock held by puchaser on acquisition date that was purchased acquisition date that was purchased during “12 month acquisition during “12 month acquisition period” period”

““grossed-up basis” of RPS: grossed-up basis” of RPS: IRC 338(b)(4)IRC 338(b)(4)

• Formula in textbookFormula in textbook

• AB of RPS [ (100% - %N-RPS)/% AB of RPS [ (100% - %N-RPS)/% RPS ]RPS ]

Allocation of Allocation of AGUB:Allocation under AGUB:Allocation under IRC 338 pursuant to IRC 338 pursuant to Treas. Reg. 1.338-6: Treas. Reg. 1.338-6: • 77 classes of assets classes of assets

77 classes of assets classes of assets

• Class I: cash, savings accounts, Class I: cash, savings accounts, checking accounts, but not CDs.checking accounts, but not CDs.

– If Class I assets exceed AGUB, new If Class I assets exceed AGUB, new target immediately realizes ordinary target immediately realizes ordinary income in the amount of the excess.income in the amount of the excess.

• Classes II through VII: Classes II through VII:

– In proportion to, and not in excess of, In proportion to, and not in excess of, their fair market value: their fair market value:

Class II - VII: Class II - VII: In proportion In proportion to, and not in excess of, to, and not in excess of, their fair market value: their fair market value:

– Class II: CDs, foreign currency; US gov secs; publicly traded Class II: CDs, foreign currency; US gov secs; publicly traded stock (not of target’s affiliate); stock (not of target’s affiliate); actively traded personal actively traded personal property property

– Class III: Class III: mark-to-market assets and some debt mark-to-market assets and some debt instruments instruments • Exceptions: debt instruments issued by related parties; Exceptions: debt instruments issued by related parties;

contingent debt; convertible debt contingent debt; convertible debt

– Class IV: InventoryClass IV: Inventory

– Class V: Not in any of the classes Class V: Not in any of the classes above or belowabove or below: furniture, : furniture, buildings, land, actively traded T’s affiliate stock buildings, land, actively traded T’s affiliate stock

– Class VI: IRC 197 intangibles Class VI: IRC 197 intangibles o/to/t goodwill and going concern goodwill and going concern valuevalue

– Class VII: goodwill and going concern value. Class VII: goodwill and going concern value.

Failure to make electionFailure to make election

• P’s AB of T’s stock= purchase price P’s AB of T’s stock= purchase price of T’s stockof T’s stock

• AB of T’s assets remain unchangedAB of T’s assets remain unchanged

• T’s tax attributes survive (as T’s tax attributes survive (as limited) limited)

If T is liquidated under IRC If T is liquidated under IRC 332 w/o IRC 338 election332 w/o IRC 338 election

• no gain or loss to P or Tno gain or loss to P or T

• c/o AB of all T’s assetsc/o AB of all T’s assets

• c/o of tax attributesc/o of tax attributes

• Note: IRC 269: T’s liquidation w/i 2 Note: IRC 269: T’s liquidation w/i 2 years, any deductions denied.years, any deductions denied.

II. Non-Taxable II. Non-Taxable Acquisitions: Acquisitions: ReorganizationsReorganizations

• Some in Chapter 20Some in Chapter 20

Agenda Agenda

• I. Type of reorganizationsI. Type of reorganizations

• II. Definitions and rationaleII. Definitions and rationale

• III. Legal requirementsIII. Legal requirements– Common LawCommon Law

– StatutoryStatutory

I. Types of reorganizationI. Types of reorganization

• Acquisitive reorganizations: A, B, C Acquisitive reorganizations: A, B, C types and variations types and variations

• Divisive reorganizations: IRC 355 Divisive reorganizations: IRC 355 and D type.and D type.

• Nonacquisitive, non-divisive Nonacquisitive, non-divisive reorganizations: E, F and Greorganizations: E, F and G

II. Definitions and II. Definitions and Rationale Rationale

DefinitionsDefinitions

• Narrow: IRC 368 reorganizationNarrow: IRC 368 reorganization

• Broad; Corporate rearrangement Broad; Corporate rearrangement where Target’s (T) assets are where Target’s (T) assets are transferred to Acquiring (A) transferred to Acquiring (A) corporation through acquisition of corporation through acquisition of assets and stock and/or creation of assets and stock and/or creation of a new or a surviving corporation. a new or a surviving corporation.

Tax rationale for a tax-Tax rationale for a tax-free transactionfree transaction

• Assets remain in a corporate solutionAssets remain in a corporate solution

• Substantial continuation of the Substantial continuation of the traditional business (if S/S; not if traditional business (if S/S; not if boot)boot)

• Ability to pay tax on transaction Ability to pay tax on transaction (cashing in) (cashing in)

Business rationale for Business rationale for reorganizationsreorganizations

• Growth: vertically or horizontallyGrowth: vertically or horizontally

• Economies of scaleEconomies of scale

• DiversificationDiversification

• Divesture: Voluntary or InvoluntaryDivesture: Voluntary or Involuntary

III. Legal requirementsIII. Legal requirements

IIIA. Common law IIIA. Common law requirementsrequirements

• 1. Continuity of Propietary Interest1. Continuity of Propietary Interest

• 2. Continuity of Business Enterprise2. Continuity of Business Enterprise

• 3. Business Purpose3. Business Purpose

IIIA1. Continuing IIIA1. Continuing Propietary Interest (CPI): Propietary Interest (CPI): RationaleRationale

• DevelopmentDevelopment

Rationale for CPIRationale for CPI

• No statutory (IRC) requirement.No statutory (IRC) requirement.

• Recognize gain when investor liquidates Recognize gain when investor liquidates interest, not before.interest, not before.– If Target’s shareholders receive cash and notes If Target’s shareholders receive cash and notes

only, they cashed out (sold) their interest.only, they cashed out (sold) their interest.

– Treas. Reg. 1.368-1(b): bottom of Treas. Reg. 1.368-1(b): bottom of

• Permissible: voting stock; nonvoting stock. Permissible: voting stock; nonvoting stock.

However,However,

• as in IRC 351, a mere change of as in IRC 351, a mere change of form of holding the equity interest form of holding the equity interest in the Target is not a sufficient in the Target is not a sufficient change in investment interest. change in investment interest.

When is CPI at issue?When is CPI at issue?

• Not in B and C reorganizations. Not in B and C reorganizations. BecauseBecause– B: voting stock for voting stockB: voting stock for voting stock

– C: At least 80% is voting stock. C: At least 80% is voting stock.

• Thus, only at issue in an “A” type Thus, only at issue in an “A” type and its derivations.and its derivations.

DevelopmentDevelopment

• Courts have required an undefined Courts have required an undefined minimum of equity interest, based minimum of equity interest, based on facts and circumstances.on facts and circumstances.

• IRS: To request a PLR, Target’s IRS: To request a PLR, Target’s shareholders must receive shareholders must receive >> 50% 50% of the stock of Acquiring of the stock of Acquiring corporation. corporation. – However, IRS no longer issuing PLR’s. However, IRS no longer issuing PLR’s.

So how much stock should So how much stock should be kept to satisfy CPI?be kept to satisfy CPI?

• >> 50% of the stock of Acquiring 50% of the stock of Acquiring corporationcorporation

Post-Merger Sales: How Post-Merger Sales: How long must CPI exist?long must CPI exist?

• Step transaction issue?Step transaction issue?

Step Transaction doctrineStep Transaction doctrine

• A “first” transaction intrinsically A “first” transaction intrinsically tied, through a commitment, to a tied, through a commitment, to a “second” transaction”. “second” transaction”.

• Transactions are dependent on each Transactions are dependent on each other.other.

Examples: Examples:

• RR 66-23: To be “cold”: at least 5 RR 66-23: To be “cold”: at least 5 yearsyears

• But see Treas. Reg. 1.368-1(e)(1)(i); But see Treas. Reg. 1.368-1(e)(1)(i); (e)(6) Example 1.(e)(6) Example 1.

IIIA2. Continuity of IIIA2. Continuity of Business Enterprise (CBE)Business Enterprise (CBE)

• Defined by Treasury Regulation: Defined by Treasury Regulation: 1.368-1(d)1.368-1(d)

• Judicial responseJudicial response

• IRS positionIRS position

• Mostly important in divisive type Mostly important in divisive type (IRC 355 spin-offs or split-ups).(IRC 355 spin-offs or split-ups).

Defined by Treasury Defined by Treasury Regulation: 1.368-1(d)Regulation: 1.368-1(d)

• A (issuing corporation) must A (issuing corporation) must – continue T’s historic business, continue T’s historic business, oror

– use a significant portion of T’s historic use a significant portion of T’s historic business assets in a business business assets in a business

• 1. 368-1(d)(2); (3)1. 368-1(d)(2); (3)

Examples: 1.368-1(d)(5)Examples: 1.368-1(d)(5)

IRS position: IRS position:

• CBE Failure: RR 87-76: Prior to CBE Failure: RR 87-76: Prior to merger T was required to divest merger T was required to divest itself of historical assets and invests itself of historical assets and invests proceeds in munis.proceeds in munis.

So how much of the So how much of the historic business assets historic business assets should be used?should be used?

• At least 33% At least 33%

IIIA3. Business PurposeIIIA3. Business Purpose

• DefinitionDefinition– There must be a direct and substantial There must be a direct and substantial

business or corporate purpose for the business or corporate purpose for the reorganization; personal purpose is reorganization; personal purpose is irrelevant. irrelevant.

• Gregory v Helvering (1935)Gregory v Helvering (1935)

Identity of partiesIdentity of parties

• A = TPA = TP

• B = UMCB = UMC

• X stock = 10000 shares of MSCX stock = 10000 shares of MSC

• C = Averil Corp.; created on 9/18; received C = Averil Corp.; created on 9/18; received 1000 shares of MSC on 9/21; 9/24 spinned 1000 shares of MSC on 9/21; 9/24 spinned off on 9/24 pursuant to recently enacted off on 9/24 pursuant to recently enacted reorganization provision; liquidated on 9/25reorganization provision; liquidated on 9/25

Gregory v Helvering Gregory v Helvering (1935)(1935)

• Facts: A owned B which held X stock. A Facts: A owned B which held X stock. A wanted the X stock and in one week: wanted the X stock and in one week: – B created C and transferred X stock. B created C and transferred X stock.

– B spinned off all of C to B’s shareholder, e.g, A. B spinned off all of C to B’s shareholder, e.g, A.

– C liquidated and A received X stock. C liquidated and A received X stock.

– A argued strict compliance with statute and A argued strict compliance with statute and that personal motivation was irrelevant.that personal motivation was irrelevant.

HoldingHolding

• COA and USSC agreed with IRS: a COA and USSC agreed with IRS: a reorg is for the benefit of a reorg is for the benefit of a corporation, requiring a business corporation, requiring a business purpose and not a personal purpose and not a personal purpose. purpose.

IRS attacksIRS attacks

• Liquidation/ReincorporationLiquidation/Reincorporation

• Avoidance/Evasion: IRC 269Avoidance/Evasion: IRC 269

IIIB. Statutory IIIB. Statutory requirementsrequirements

• 1. Acquisitive reorganizations: 1. Acquisitive reorganizations: – (a) A reorga. (a) A reorga.

– (b) B reorg.(b) B reorg.

– (c) C reorg.(c) C reorg.

• 2. Divisive reorganizations: 2. Divisive reorganizations: – (a) IRC 355(a) IRC 355

– (b) D reorg.(b) D reorg.

• 3. Nonacquisitive, non-divisive reorganizations: 3. Nonacquisitive, non-divisive reorganizations: E, F and GE, F and G

IIIB1a. Acquisitive IIIB1a. Acquisitive reorganizations: reorganizations: A TypeA Type: :

• DefinitionDefinition

• Merger vs consolidationMerger vs consolidation

• AdvantagesAdvantages

• DisadvantagesDisadvantages

• VariationsVariations– Triangular MergersTriangular Mergers

– Reverse Triangular MergersReverse Triangular Mergers

DefinitionDefinition

• Two or more corporation combine Two or more corporation combine into oneinto one corporation. corporation. – Survivor: Statutory Merger: approval of Survivor: Statutory Merger: approval of

majority of T and Amajority of T and A

– New corporation: ConsolidationNew corporation: Consolidation

Note: Acquiring Note: Acquiring corporation acquires corporation acquires

• 100% of the Target’s assets and 100% of the Target’s assets and

• 100% of the Target’s liabilities100% of the Target’s liabilities– including contingent liabilities and including contingent liabilities and

– unknown liabilitiesunknown liabilities

AdvantagesAdvantages

• Flexibility of consideration: anything as long as Flexibility of consideration: anything as long as CPI satisfied.CPI satisfied.– B requires voting stockB requires voting stock

– C requires voting but permits limited amount of C requires voting but permits limited amount of other considerationother consideration

• Flexibility as to amount of T’s assets to be Flexibility as to amount of T’s assets to be acquiredacquired

• Flexibility to have a subsequent transfer to A’s Flexibility to have a subsequent transfer to A’s controlled subsidiarycontrolled subsidiary

DisadvantagesDisadvantages

• State and federal law complianceState and federal law compliance

• Dissenters’ appraisal rightsDissenters’ appraisal rights

• Assumption of T’s liabilitiesAssumption of T’s liabilities– may need to have a variation (reverse triangular) if may need to have a variation (reverse triangular) if

assets cant be transferred to A. assets cant be transferred to A.

• Getting majority approval Getting majority approval

• Target’s contractual rights or privileges may not Target’s contractual rights or privileges may not be transferable, and expire.be transferable, and expire.

Variations: Getting around Variations: Getting around disadvantagesdisadvantages

• Forward triangular/forward Forward triangular/forward subsidiary mergersubsidiary merger

• Reverse Triangular Reverse Triangular – Using subsidiariesUsing subsidiaries

Forward Triangular or Forward Triangular or Forward Subsidiary Forward Subsidiary Merger: IRC 368(a)(2)(D)Merger: IRC 368(a)(2)(D)

– T merged into A’s subsidiaryT merged into A’s subsidiary

– A’s subsidiary uses A’s voting or non-voting A’s subsidiary uses A’s voting or non-voting stock (stock (>> 50%) to acquire 50%) to acquire SUBSTANTIALLY SUBSTANTIALLY ALL of T’s ASSETSALL of T’s ASSETS- no liabilities.- no liabilities.• 70%70% of FMV of T’s of FMV of T’s gross assetsgross assets

• 90%90% of FMV of T’s of FMV of T’s net assetsnet assets

– No need to have majority of A approve, only No need to have majority of A approve, only majority of A’s subsidiary, e.g., A’s BOD, and majority of A’s subsidiary, e.g., A’s BOD, and majority of T’s shareholders. majority of T’s shareholders.

Thus large latitude in Thus large latitude in “boot”“boot”gain to be recognized by gain to be recognized by those who receive bootthose who receive boot

Problems avoided:Problems avoided:

• T’s liabilities may or may not be T’s liabilities may or may not be assumed.assumed.

• Majority vote of A shareholders is Majority vote of A shareholders is not required.not required.

• Liberal rules for consideration to be Liberal rules for consideration to be paid paid

Reverse Triangular: IRC Reverse Triangular: IRC 368(a)(2)(E)368(a)(2)(E)

– A’s sub merged into TA’s sub merged into T

– Variety of B reorg: A must use A’s Variety of B reorg: A must use A’s voting stock voting stock to acquire a controlling interestto acquire a controlling interest in T from T’s in T from T’s shareholdersshareholders

– A does not have to acquire T’s liabilities.A does not have to acquire T’s liabilities.

– T survives under A’s control: holding its and T survives under A’s control: holding its and A’s sub properties.A’s sub properties.

– Rationale: Retain T’s identity or public image; Rationale: Retain T’s identity or public image; T may have nontransferable rights. T may have nontransferable rights.

Note: Note:

• B varietyB variety b/c A must use A’s b/c A must use A’s voting voting stock to acquire 80%stock to acquire 80% of T from T’s of T from T’s shareholdersshareholders

• A does not have to assume Target’s A does not have to assume Target’s liabilities liabilities

Problems avoidedProblems avoided

• T remains aliveT remains alive

• A does not want to pay solely voting A does not want to pay solely voting stockstock

• T’s liabilities may or may not be T’s liabilities may or may not be assumed.assumed.

• no need to transfer target’s assets that no need to transfer target’s assets that were desirable but not transferable.were desirable but not transferable.

Acquisitive Acquisitive Reorganizations: B and C Reorganizations: B and C reorganizations:reorganizations:

IIIB. Statutory IIIB. Statutory requirementsrequirements

• 1. Acquisitive reorganizations: 1. Acquisitive reorganizations: – (a) A reorga. (a) A reorga.

– (b) B reorg.(b) B reorg.

– (c) C reorg.(c) C reorg.

• 2. Divisive reorganizations: 2. Divisive reorganizations: – (a) IRC 355(a) IRC 355

– (b) D reorg.(b) D reorg.

• 3. Nonacquisitive, non-divisive reorganizations: 3. Nonacquisitive, non-divisive reorganizations: E, F and GE, F and G

Agenda Agenda

• IIIB1(b): Acquisitive reorganizations: IIIB1(b): Acquisitive reorganizations: B B

• IIIB1(c): Acquisitive reorganizations: IIIB1(c): Acquisitive reorganizations: C C

IIIB1(b). Acquisitive IIIB1(b). Acquisitive reorganizations: reorganizations: B TypeB Type: :

• Summary: Acquiring Corp wants Summary: Acquiring Corp wants Target’s stock (not the assets)Target’s stock (not the assets)

• (1) The elements(1) The elements

• (2) Advantages and disadvantages(2) Advantages and disadvantages

IIIB1(b)(1) The B IIIB1(b)(1) The B reorganization: reorganization:

• (I) Nature of the transaction (I) Nature of the transaction – Acquiring corporation must use “Acquiring corporation must use “solely solely

voting stockvoting stock” to acquire “control” of ” to acquire “control” of Target.Target.

• (II) “Solely voting stock”: Acquiring’s (II) “Solely voting stock”: Acquiring’s voting stock for the Target’s stock voting stock for the Target’s stock necessary to control Tnecessary to control T

• (III) “Control” (III) “Control”

IIIB1(b)(1)(I) Nature of the IIIB1(b)(1)(I) Nature of the transaction transaction

• Transaction is between Transaction is between Acquiring Acquiring Corporation and Target’s shareholdersCorporation and Target’s shareholders..– Acquiring makes a “tender offer” to Target’s Acquiring makes a “tender offer” to Target’s

shareholders to acquire the Target’s voting shareholders to acquire the Target’s voting stock in exchange for Acquiring’s voting stockstock in exchange for Acquiring’s voting stock• Thus, after the transaction Acquiring and Target Thus, after the transaction Acquiring and Target

shareholders own Acquiring Corporation, which shareholders own Acquiring Corporation, which in turn is “in control” of Target Corporation. in turn is “in control” of Target Corporation.

IIIB1(b)(1)(II) Voting stockIIIB1(b)(1)(II) Voting stock

Issues regarding “voting Issues regarding “voting stock” stock”

• Acquisition must be with “voting stock”Acquisition must be with “voting stock”– Defining “voting stock”Defining “voting stock”

• ClassClass

– ExceptionsExceptions• Exceptions to exceptionsExceptions to exceptions

– # of acquiring transactions # of acquiring transactions

• Note that Acquiring may use other Note that Acquiring may use other consideration to acquire Target’s debt consideration to acquire Target’s debt securities.securities.

If there was an acquisition If there was an acquisition of stock, was the Target of stock, was the Target stock acquired with stock acquired with “voting stock”?“voting stock”?• ““class” (common or preferred) is class” (common or preferred) is

immaterial as long as it is “immaterial as long as it is “votingvoting” ” stock. stock. – ““voting”: unconditional right to vote on voting”: unconditional right to vote on

regular corporate decisionsregular corporate decisions

What is not Acquiring’s What is not Acquiring’s “voting stock”?“voting stock”?

• Convertible bonds, even if convertible Convertible bonds, even if convertible into voting stockinto voting stock

• Options to purchase “voting stock”Options to purchase “voting stock”

• Stock rights and warrantsStock rights and warrants– b/c they are like options to purchaseb/c they are like options to purchase

– But contractual rights to receive (not to But contractual rights to receive (not to purchase) may qualify. purchase) may qualify.

Exceptions to “voting Exceptions to “voting stock” rulestock” rule

• Cash in lieu of fractional sharesCash in lieu of fractional shares

• Cash to pay for Cash to pay for target corporation’starget corporation’s legal, accounting, appraisal, and other legal, accounting, appraisal, and other reorganization expenses.reorganization expenses.– But not the target’s shareholders’ But not the target’s shareholders’

expensesexpenses

• Pre-reorg redemptions of dissenting Pre-reorg redemptions of dissenting minorityminority

Redemptions of Redemptions of dissenting minoritydissenting minority

• OK OK if beforeif before B reorg: Target (not Acquiring B reorg: Target (not Acquiring Corp) may redeem minority dissenters’ Corp) may redeem minority dissenters’ stock for cash or other property prior to B stock for cash or other property prior to B reorg.reorg.

• Not as clear Not as clear if afterif after B reorg: If the B reorg: If the redemption is performed by the Acquiring redemption is performed by the Acquiring Corp, it is OK if there was NO Corp, it is OK if there was NO predetermined agreement about the predetermined agreement about the redemption prior to the B reorg. redemption prior to the B reorg.

How many transactions How many transactions involved in the acquisition involved in the acquisition of T’s stock?of T’s stock?

• It does not matter how many It does not matter how many transactions as long as transactions as long as – stock was acquired solely for voting stock was acquired solely for voting

stockstock

– the “control” element is satisfied. the “control” element is satisfied.

If > one transaction, and If > one transaction, and one of them was not one of them was not “solely for stock” of “solely for stock” of Acquiring corporation?Acquiring corporation?• Are the acquisitions “related” or are they Are the acquisitions “related” or are they

separate transactions?separate transactions?

• Facts and circumstances.Facts and circumstances.

– Time is a factorTime is a factor

• Simplest solution: Acquiring Simplest solution: Acquiring unconditionally sells purchased stock to unconditionally sells purchased stock to 3rd party before entering into B reorg. 3rd party before entering into B reorg.

IIIB1(b)(III) The “control” IIIB1(b)(III) The “control” elementelement

• ““Control” is to be determined at the Control” is to be determined at the end of the acquisition.end of the acquisition.– immediately after the transactionimmediately after the transaction

• It permits previous acquisitions to It permits previous acquisitions to be considered.be considered.

• But all must be “solely for voting stock” But all must be “solely for voting stock”

But how much before?But how much before?

• Regs: Regs: 12 months is OK12 months is OK

• But judicially: The issue is whether But judicially: The issue is whether the transactions are “related”.the transactions are “related”.– Facts and circumstances.Facts and circumstances.

– The longer the period between the The longer the period between the transactions, the greater they are transactions, the greater they are found “unrelated”. found “unrelated”.

The meaning of 80% The meaning of 80% control: IRC 351 controlcontrol: IRC 351 control

• ownership of 80% of total combined ownership of 80% of total combined voting powervoting power

• 80% of each class of nonvoting 80% of each class of nonvoting stockstock

IIIB1(b)(2) Advantages IIIB1(b)(2) Advantages and Disadvantages of B and Disadvantages of B reorganizations reorganizations

AdvantagesAdvantages

• Target survivesTarget survives– Immediate liquidation will make it a C Immediate liquidation will make it a C

reorganization reorganization

– Acquiring Corp’s assets are shielded from Acquiring Corp’s assets are shielded from the target’s liabilitiesthe target’s liabilities

• Nonassignable rights remain with Nonassignable rights remain with TargetTarget

• Tax attributes remain with TargetTax attributes remain with Target

Advantages of B Advantages of B reorganizations (2 of 3)reorganizations (2 of 3)

• No asset acquisition problems: No asset acquisition problems: – transfer feestransfer fees

– state and local income taxesstate and local income taxes

– recordkeeping recordkeeping

Advantages of B Advantages of B reorganizations (3 of 3)reorganizations (3 of 3)

• Unlike C: Acquiring Corp is not required Unlike C: Acquiring Corp is not required to keep substantially all of its assetsto keep substantially all of its assets

• Unlike A: Not dependent on local lawUnlike A: Not dependent on local law

– No need for a shareholder’s voteNo need for a shareholder’s vote

– Tender offer to target shareholders does not Tender offer to target shareholders does not require approval of Target’s management require approval of Target’s management

Disadvantages of B Disadvantages of B reorganizations (1)reorganizations (1)

• Only voting stock: dilutes control of Only voting stock: dilutes control of Acquiring’s original shareholdersAcquiring’s original shareholders

• Potential for dissenters’ problems at Potential for dissenters’ problems at shareholders’ meetingshareholders’ meeting

• Tax attributes remain in Target Tax attributes remain in Target

IIIB1(c) Acquisitive IIIB1(c) Acquisitive reorganizations: Creorganizations: C

Acquisitive Acquisitive reorganizations: Creorganizations: C

• (1) Summary(1) Summary

• (2) The elements(2) The elements

• (3) Advantages and disadvantages(3) Advantages and disadvantages

IIIB1(c)(1)IIIB1(c)(1)SummarySummary

• Substantially allSubstantially all of of TargetTarget Corp’s Corp’s assets forassets for Acquiring Corp’s “ Acquiring Corp’s “voting voting stockstock” ”

• Target must distribute to its Target must distribute to its shareholders property received form shareholders property received form Acquiring Corp and property not Acquiring Corp and property not transferred to Acquiring Corp. transferred to Acquiring Corp. – TargetTarget is effectively is effectively liquidated liquidated

• Similar to a “statutory merger” or Similar to a “statutory merger” or “practical merger”“practical merger”– In C reorg: In C reorg: substantially allsubstantially all assets are assets are

transferredtransferred

– In merger: In merger: AllAll assets are transferred. assets are transferred.

• Ends with Acquiring corp being Ends with Acquiring corp being owned by its original shareholders owned by its original shareholders and the Target’s original and the Target’s original shareholders. shareholders.

IIIB1(c)(2) ElementsIIIB1(c)(2) Elements

• Substantially all the Target’s assetsSubstantially all the Target’s assets

• Consideration to be paid: solely Consideration to be paid: solely voting stockvoting stock

• Distribution requirementDistribution requirement

Substantially all the Substantially all the Target’s assetsTarget’s assets

• Not defined in the IRCNot defined in the IRC

• For advanced ruling:For advanced ruling:– Higher of Higher of 70% of gross assets70% of gross assets and and 90% of 90% of

net assetsnet assets must be acquired must be acquired

• But other interpretations permit it if all But other interpretations permit it if all significant operating assets have been significant operating assets have been transferred to the Acquiring Corp.transferred to the Acquiring Corp.

ConsiderationConsideration

• ““Solely” voting stockSolely” voting stock

• Unlike an A type where anything is almost Unlike an A type where anything is almost OK.OK.

• But here it is But here it is “solely” with a twist“solely” with a twist (boot (boot relaxation rule)relaxation rule)– Must use solely voting stock to pay Must use solely voting stock to pay up to 80%up to 80% of of

FMV of Target’s assets.FMV of Target’s assets.

– Thus Thus 20% boot20% boot is OK. is OK.

The 20% boot and The 20% boot and liabilities assumedliabilities assumed

• As assets are being transferred that As assets are being transferred that may have debt attached to them, may have debt attached to them, disregard Acquiring Corp’s disregard Acquiring Corp’s assumption of Target’s liability. assumption of Target’s liability.

• However, assumed liabilities are However, assumed liabilities are considered “boot” for purposes of considered “boot” for purposes of the 20%.the 20%.

Example: Assume that the Example: Assume that the FMV of Target assets is FMV of Target assets is $100 and you want to $100 and you want to have a C reorg: have a C reorg: • If liabilities assumed = $18; may use up to If liabilities assumed = $18; may use up to

$2 in real boot.$2 in real boot.

• If liabilities assumed = $19; may use up to If liabilities assumed = $19; may use up to $1 in real boot.$1 in real boot.

• If liabilities assumed = $20; may not use any If liabilities assumed = $20; may not use any boot. boot.

• If liabilities assumed = $21; may not use any If liabilities assumed = $21; may not use any boot.boot.

• The point is that substantial liabilities The point is that substantial liabilities may be assumed as long as there is a may be assumed as long as there is a CPI.CPI.

• But little “real boot” can be used when But little “real boot” can be used when liabilities are being assumed. liabilities are being assumed.

• It is like the “basis” rules in IRC 351 It is like the “basis” rules in IRC 351 where liability is considered “money where liability is considered “money received ” for received ” for basis only but not bootbasis only but not boot..

However, depending on However, depending on the reason for the the reason for the liabilities, assumption may liabilities, assumption may be considered “real boot” be considered “real boot” • If the liability assumed is a payment If the liability assumed is a payment

to be made to dissenting to be made to dissenting shareholders, the payment of the shareholders, the payment of the liability is considered a transfer of liability is considered a transfer of cash to the Target, e.g., “real boot”. cash to the Target, e.g., “real boot”.

Distribution requirementDistribution requirement

• Target must Target must distributedistribute promptly to its promptly to its shareholders all the shareholders all the voting stock and bootvoting stock and boot received from Acquiring Corp.received from Acquiring Corp.

• Target must also Target must also distribute any assets not distribute any assets not transferredtransferred to the Acquiring Corp to the Acquiring Corp– All Acquring needs to acquire is “substantially All Acquring needs to acquire is “substantially

all” the assets, the other assets must be all” the assets, the other assets must be distributed.distributed.

– Target must not engage in an active T/B Target must not engage in an active T/B

Exception to distribution Exception to distribution requerement; IRC 368(a)requerement; IRC 368(a)(2)(G)(ii)(2)(G)(ii)

• IRS may waive it if IRS may waive it if – (1) it would result in a substantial (1) it would result in a substantial

hardship and hardship and

– (2) the Target and shareholders agree (2) the Target and shareholders agree to be treated as if the Target had made to be treated as if the Target had made the distribution of the undistributed the distribution of the undistributed assets and the shareholders assets and the shareholders contributed back to the Target.contributed back to the Target.

IIIb1(c)(3) Advantages of IIIb1(c)(3) Advantages of C reorgC reorg

• No need to assume all the Target’s No need to assume all the Target’s liabilities (A and B does).liabilities (A and B does).

• No need to acquire all the assets.No need to acquire all the assets.

• No need to have Acquiring shareholders No need to have Acquiring shareholders agree to the transaction. Only the Target agree to the transaction. Only the Target and its shareholders have to approve the and its shareholders have to approve the acquisition and likely liquidation.acquisition and likely liquidation.

The B reorganization The B reorganization followed by liquidationfollowed by liquidation

• Treated as a C reorganizationTreated as a C reorganization

• Issue: Were substantially all of the Issue: Were substantially all of the target’s assets acquired in the target’s assets acquired in the reorg?reorg?– Were there any spin offs immediately Were there any spin offs immediately

before the attempted B reorg? before the attempted B reorg?

Forward Triangulars; Forward Triangulars; Reverse TriangularsReverse Triangulars

• Already discussedAlready discussed

Disadvantages of C reorgDisadvantages of C reorg

• Substantial transfer costs associated with the Substantial transfer costs associated with the transfer of assets.transfer of assets.– likely to sustain a tax at the state level.likely to sustain a tax at the state level.

• Substantially all of the target’s assets must Substantially all of the target’s assets must be acquired. be acquired. – Precludes a spin-off of unwanted business or Precludes a spin-off of unwanted business or

assets before/immediately after reorgassets before/immediately after reorg

• Boot ignored by assumption of liabilities Boot ignored by assumption of liabilities

Aquisitive Aquisitive Reorganizations: Tax Reorganizations: Tax implicationsimplications

IntroductionIntroduction

• A TypeA Type

• B TypeB Type

• C typeC type

A TypeA Type: Acquiring Target’s : Acquiring Target’s assetsassets

• Tax consequences to Tax consequences to Target Target shareholdersshareholders

• Tax consequences to Tax consequences to Acquiring Acquiring corporationcorporation

• Tax consequences to Tax consequences to Target corporationTarget corporation

• Tax consequences to Tax consequences to Acquiring Acquiring corporation shareholderscorporation shareholders

Tax consequences to Tax consequences to Target shareholdersTarget shareholders

• IRC 354: nonrecognitionIRC 354: nonrecognition

• IRC 356: recognitionIRC 356: recognition

• IRC 358: basisIRC 358: basis

IRC 354(a)(1): IRC 354(a)(1): No gain or No gain or loss recognizedloss recognized shall be shall be recognized if recognized if • stocks or securitiesstocks or securities in a corporation a party in a corporation a party

to a reorganizationto a reorganization

• are, in pursuance of the plan of are, in pursuance of the plan of reorganization,reorganization,

• exchanged solely exchanged solely for stock or securitiesfor stock or securities – in such corporation or in such corporation or

– in another corporation a party to the in another corporation a party to the reorganization reorganization

Exceptions: IRC 354(a)(2) Exceptions: IRC 354(a)(2)

• Principal amount of Principal amount of securities securities receivedreceived > principal amount of > principal amount of securities surrenderedsecurities surrendered

IRC 356(a)(1): Gain on IRC 356(a)(1): Gain on exchange exchange

• If 354 would apply but for the fact that If 354 would apply but for the fact that the property received also included the property received also included cash and other property (“boot”), then cash and other property (“boot”), then

• recognize gain up to the cash and the recognize gain up to the cash and the FMV of the other property, e.g, the FMV of the other property, e.g, the boot.boot.

• But no loss is recognized.But no loss is recognized.

Character of the Character of the recognized gainrecognized gain

• capital capital

• dividenddividend

IRC 356(a)(2): DividendIRC 356(a)(2): Dividend

• If the exchange has If the exchange has the effect of a the effect of a dividend distributiondividend distribution, pursuant to , pursuant to IRC 318(a), then recognize as IRC 318(a), then recognize as dividend income the ratable share dividend income the ratable share of EP. of EP.

““Effect of a dividend Effect of a dividend distribution”?distribution”?

• IRC 302 analysisIRC 302 analysis

• Constructive rulesConstructive rules

• If 302(b)(1) [NEED] or 302(b)(2) [Sub. If 302(b)(1) [NEED] or 302(b)(2) [Sub. Disprop. Red.]: Then no dividend effect.Disprop. Red.]: Then no dividend effect.

• Typical end result: < 50% shareholder Typical end result: < 50% shareholder getting boot will get capital gain.getting boot will get capital gain.

IRC 302 analysis requiresIRC 302 analysis requires

• Make believeMake believe merger was a 100% merger was a 100% stock for stock followed by a stock for stock followed by a postmerger redemption of an postmerger redemption of an amount of stock equal to the boot amount of stock equal to the boot received. received.

Therefore, realized gain is Therefore, realized gain is recognized ifrecognized if

• Other than stock and securities is Other than stock and securities is received, e.g, cash, boot received, e.g, cash, boot

• Principal received > Principal Principal received > Principal surrenderedsurrendered

• Securities were received and no Securities were received and no securities surrenderedsecurities surrendered

IRC 358(a)(1): IRC 358(a)(1): BasisBasis of of nonrecognition property nonrecognition property to distributees: to distributees: Carry-overCarry-over basisbasis• Less: Less:

– other property received (boot)other property received (boot)

– cash received (boot)cash received (boot)

– loss recognizedloss recognized

• Plus:Plus:– dividend received (recognized as income)dividend received (recognized as income)

– gain recognized gain recognized

IRC 358(a)(2): Basis of IRC 358(a)(2): Basis of “other property” received:“other property” received:

• FMVFMV

Holding period: Holding period:

• Nonrecognition property: tackedNonrecognition property: tacked

• Other property: new holding periodOther property: new holding period

See Example 17.3 (p. 838)See Example 17.3 (p. 838)

Tax consequences to Tax consequences to AcquiringAcquiring corporation corporation

Gain (loss) Gain (loss) not recognizednot recognized

• IRC 1032(a): No gain(loss) on IRC 1032(a): No gain(loss) on issuance of stock.issuance of stock.

Basis: IRC 362(b)Basis: IRC 362(b)

• Carryover basisCarryover basis for transferor’s for transferor’s assets, increase by gain recognized assets, increase by gain recognized by transferor.by transferor.

• As usually no gain or loss As usually no gain or loss recognized recognized by Target recognized recognized by Target transferor, acquired assets move to transferor, acquired assets move to Acquiring corporation at c/o basis.Acquiring corporation at c/o basis.

NOTE who is the NOTE who is the “Transferor”: The Target “Transferor”: The Target corporation corporation

• Target Target shareholders ARE NOT the shareholders ARE NOT the “transferors”“transferors” of assets. of assets.

• Target shareholders may recognize Target shareholders may recognize gain b/c “boot” received but that gain b/c “boot” received but that does not increase AB of Acquiring does not increase AB of Acquiring Corporation.Corporation.

Other:Other:

• HP: carryover to Acquiring HP: carryover to Acquiring Corporation (tacked)Corporation (tacked)

• Target’s tax attributes: carryover to Target’s tax attributes: carryover to Acquiring Corporation Acquiring Corporation

Tax consequences to Tax consequences to Target corporationTarget corporation

• IRC 361(a): No gain(loss) to a party IRC 361(a): No gain(loss) to a party of the reorganization when it of the reorganization when it – exchanges property pursuant to a plan, exchanges property pursuant to a plan,

– solely for stock and securities solely for stock and securities

– in another corporation party to the in another corporation party to the reorganization.reorganization.

Target does not recognize Target does not recognize

• Receipt of “boot” Receipt of “boot”

• Assumption of target’s liabilities Assumption of target’s liabilities

Distributions by Target:Distributions by Target:

IRC 361( c)(1): IRC 361( c)(1):

• No gain (loss) recognized) to a party No gain (loss) recognized) to a party of reorganization on distribution of of reorganization on distribution of property pursuant to a plan. property pursuant to a plan.

IRC 361( c)(4): IRC 361( c)(4):

• IRC 311 does not apply to Target’s IRC 311 does not apply to Target’s distributionsdistributions

IRC 361( c)(2): Exceptions IRC 361( c)(2): Exceptions

• Appreciated property distributions: Appreciated property distributions: recognize gain (no loss) as if sold recognize gain (no loss) as if sold property.property.

• FMV: higher of FMV or liability FMV: higher of FMV or liability attached to property attached to property

Exception to exception: Exception to exception: “qualified property” “qualified property”

• stock, stock rights, or obligation of stock, stock rights, or obligation of distributing corporation distributing corporation

• stock, stock rights, or obligation of stock, stock rights, or obligation of another party to the reorganization another party to the reorganization when received by distributing when received by distributing corporation in exchange for its corporation in exchange for its assets.assets.

Typical end result for Typical end result for Target:Target:

• No gain (loss) on distribution of No gain (loss) on distribution of Acquiring Corp’s stock and Acquiring Corp’s stock and securitiessecurities

• Little or no gain (loss) on Little or no gain (loss) on distribution of boot received from distribution of boot received from Acquiring Corp b/c AB is picked up Acquiring Corp b/c AB is picked up at FMV. at FMV.

Acquiring Corporation Acquiring Corporation ShareholdersShareholders

• Tax effect: None, where Acquiring Tax effect: None, where Acquiring survives, there is no change in the survives, there is no change in the tax status of its shareholders.tax status of its shareholders.

• Non-tax effect: They own smaller Non-tax effect: They own smaller share of company because some of share of company because some of it is owned by Target’s it is owned by Target’s shareholders. shareholders.

B TypeB Type

• Tax consequences to Target Tax consequences to Target shareholdersshareholders

• Tax consequences to Acquiring Tax consequences to Acquiring corporationcorporation

• Tax consequences to Target corporationTax consequences to Target corporation

• Tax consequences to Acquiring Tax consequences to Acquiring corporation shareholders corporation shareholders

Tax consequences to Tax consequences to Target shareholdersTarget shareholders

• IRC 354(a)(1): No gain or loss recognizedIRC 354(a)(1): No gain or loss recognized

• Carryover AB and HPCarryover AB and HP

• If boot received, then recognize realized If boot received, then recognize realized gain up to the boot.gain up to the boot.– AB of stock = c/o - FMV boot + gain AB of stock = c/o - FMV boot + gain

recognizedrecognized

– AB of boot = FMV of bootAB of boot = FMV of boot

Tax consequences to Tax consequences to Acquiring corporationAcquiring corporation

• IRC 1032: No gain (loss) for issuance of IRC 1032: No gain (loss) for issuance of voting stock.voting stock.

• AB; HP: carryoverAB; HP: carryover

• AB when target is publicly held: OK to use AB when target is publicly held: OK to use sampling and estimating statistical sampling and estimating statistical techniques. techniques.

• Target’s tax attributes c/o to Acquiring Corp; Target’s tax attributes c/o to Acquiring Corp; limitationslimitations: later: later

Tax consequences to Tax consequences to Target corporationTarget corporation

• Remains in existence; tax attributes intactRemains in existence; tax attributes intact

• No gain (loss) recognized on exchange of assets No gain (loss) recognized on exchange of assets for S/S of Acquiring, nor on the distribution of for S/S of Acquiring, nor on the distribution of that S/S to target’s shareholders.that S/S to target’s shareholders.

• Gain is recognized for distribution of Gain is recognized for distribution of appreciated property that is not “qualified”. appreciated property that is not “qualified”.

• Target year ends on the date of the asset Target year ends on the date of the asset transfer: IRC 381(b)transfer: IRC 381(b)

Tax consequences to Tax consequences to Acquiring corporation Acquiring corporation shareholders shareholders

• IRC 1032: No gain (loss) for IRC 1032: No gain (loss) for issuance of voting stock.issuance of voting stock.

C Type: C Type: Same as a B Same as a B Type Type