corporation University of Arkansas at Little Rock

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					             Tax 4022/5022
          Federal Income Tax II
          Corporate Acquisitions
             Chapter: None
Dr. Robert R. Oliva
Professor and Chairperson
Department of Accounting
University of Arkansas at Little Rock
Corporate Acquisitions

• I. Taxable Acquisitions
• II. Non-Taxable Acquisitions:
  Reorganizations
Taxable Acquisitions
Introduction

• I. ASSET ACQUISITION
• II. STOCK ACQUISITION
ASSET ACQUISITION (not a
reorganization):
• Two possibilities:
   – (1)
      • A. Purchasing Corporation (P) buys assets from
        Target Corporation (T)
      • B. T liquidates cash from sale of assets to T’s
        shareholders
   – (2)
      • A. T liquidates assets to its shareholders and
      • B. P buys assets from T’s shareholders
Tax effect

• Two levels of taxation: corporate and
  shareholder
  – If so, P takes a cost AB
  – P could avoid the corporate-level tax on a
    stock purchase, but AB will be c/o.
Allocation

• Sale of assets of a going business
  requires allocation
• Buyers and sellers have conflicting
  interests.
Seller

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

• Buyer’s AB and depreciation depends on
  how sales price is allocated.
  – Favor allocation of sales price to depreciable
    assets
Price allocations may be
contractually specified, or
may be imposed by IRC.
• IRC 1060: Review it and its regulations
IRC 1060

• Where there is no agreement between
  the parties, or if there is one, IRS finds
  allocation not appropriate.
• Outlines specific allocation method for
  applicable assets acquisitions.
• Applicable asset acquisitions: Direct or
  indirect transfers of trade or business
  assets, where buyer’s (transferre) AB is
Treas. Reg. 1.1060-1:

• Allocate as in Treas. Reg. 1.338-6: 7
  classes of assets
  – 1.338-6(a)(1): Adjusted grossed-up basis
    (AGUB) is allocated among target's
    “acquisition date assets.”
     • Target’s assets held at the beginning of the
       day after the acquisition date. Reg §1.338-
       2(c)(2) .
7 classes of assets

• Class I: cash, savings accounts, checking
  accounts, but not CDs.
   – If Class I assets exceed AGUB, new target
     immediately realizes ordinary income in the
     amount of the excess.
• Classes II through VII:
   – In proportion to, and not in excess of, their
     fair market value:
Class II - VII: In proportion to,
and not in excess of, their fair
market value:
  – Class II: CDs, foreign currency; US gov secs; publicly
    traded stock (not of target’s affiliate); actively traded
    personal property
  – Class III: mark-to-market assets and some debt
    instruments
      • Exceptions: debt instruments issued by related parties;
        contingent debt; convertible debt
  – Class IV: Inventory
  – Class V: Not in any of the classes above or below:
    furniture, buildings, land, actively traded T’s affiliate stock
  – Class VI: IRC 197 intangibles o/t goodwill and going
    concern value
  – Class VII: goodwill and going concern value.
Method of allocation

• Asset by asset, starting first with I and
  down.
• On the basis of FMV.
• See Treas. Reg. 1.1060-1(d): Example 2.
STOCK ACQUISITION
Stock Acquisition

• P buys stock of T from T’s shareholders.
• If T is closely held, negotiation may be
  face to face.
• But likely to be different if T is publicly or
  widely held.
Either way:

• T’s shareholders recognize gain(loss)
• P takes a cost AB
Kimbell-Diamond’’s transitory
ownership doctrine

• Some stock purchases had been treated
  as asset acquisitions when the stock
  purchase was followed by a liquidation of
  Target into Parent.
  – Codified into IRC 334(b)(2): Asset’s AB = c/s
    AB if 80% acquired by purchase w/i 12
    month and plan of liquidation adopted w/i 2
    years after acquiring control
  – However, in 1982: IRC 334(b)(2) was
    repealed
IRC 338: “Qualified stock
purchase” (QSP)

• Replaced IRC 334(b)(2)
• Qualified purchase (control) requirement
• Time requirement
• Timely election requirement
The IRC 338 election

• Actual election: IRC 338(a)
  – “… if a purchasing corporation makes an
    election … in the case of a qualified stock
    purchase…. ”

• Deemed election: IRC 338(e)
  – “… a purchasing corporation … treated as
    having made an election (the deemed
    election) … if … during the consistency
    period… acquires any asset of the
“purchasing corporation”: IRC
338(d)(1)

• one which makes a QSP of another
  corporation.
“target corporation”: IRC
338(d)(2)

• one whose stock is acquired through a
  QSP
QSP: IRC 338(d)(3)

• One or a series of transactions, where
  the purchasing corporation (not an
  individual) acquires by purchase
• “sufficient target stock”
• during a “12-month acquisition period”
How to “purchase” stock:IRC
338(h)(3)(a), (b)

• Taxable stock “purchase” from an
  unrelated party.
  – Not by gift, inheritances, or tax-free/carry-
    over basis transactions.
  – Purchases by affiliates of purchaser are
    included
  – Effect of redemptions are included, e.g.,
    redeeming of minority shareholders to bring
    purchasing corporation to 80%.
“Purchase” does NOT include
stock acquisition from

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

• Apply IRC 318(a) ignoring option
  attribution.
Exception: Acquisitions from
persons that are “related
corporations”
• DO consider acquisitions from a related
  corporation if 50% or more of stock of
  related corporation was acquired by
  “purchase”.
• “related corporation”: IRC
  338(h)(3)(C)(iii): if stock owned by a
  related corporation treated as owned
  by the acquiring corporation.
Second element: “sufficient
target stock”

• > 80% of the voting power and
• > 80% of the value of all classes of stock
  – except nonvoting, nonparticipating preferred
    stock, that is not counted for the > 80%
    test.
Third element: “12-month
acquisition period”: IRC
338(h)1)
• “12 month” is a moving parameter,
  ending on “acquisition date”.
Acquisition date/First day

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

• Who makes it?
• When is it made?
• How is it made?
• What is the effect of the election?
Who makes it?

• By P
• But there is a special case where T joins
  in the election.
When is it made?

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

• File Form 8023 (Corporate Qualified
  Stock Purchase Election) with P’s IRS
  Service Center
What is the effect of the
election?

• Irrevocable
• Effect on Target
• Effect on Purchaser
Effect on Target

• the “target” is treated as two:
  – the Old Target
  – the New Target
Effect on Old Target: IRC
338(a)(1)
• Old Target treated as having sold ALL of its
  assets at FMV at the end of the day considered
  as the “acquisition date”.
   – Recognize gain or loss on the deemed sale
      • Use any tax attributes to offset gains; unused
        attributes are extinguished.

• Recognize income earned to acquisition date-if
  not included in consolidated return.
Thus, a disadvantage:

• there could be significant up-front tax
  costs
But there may not be up-front
tax costs

• Old Target may be able to use NOLs,
  which otherwise may be wasted, to offset
  recognized gains on the deemed sale.
  – In turn provided stepped-up AB to New
    Target.
At what price did the Old
Target sell its assets?

• IRC 338(a)(1): At FMV
• But: Treas. Reg. 1.338-4(a): At the
  “aggregate deemed sales price” (ADSP)
“aggregate deemed sales
price” (ADSP): 1.338-4(b)

• ADSP: determined at the beginning of
  the day after the “acquisition date”
  – grossed up amount realized on the sale to
    the purchasing corporation of the purchasing
    corporation’s recently purchased stock
    (RPS), and
  – liabilities (including taxes from gain
    recognition in 338 election)
“Grossed up amount
realized”: 1.338-4(c)(1)

• Amount realized on the sale to P of the
  RPS / % of T stock, by value, attributable
  to the RPS stock
• Less selling costs
Example: 1.338-4(c)(2)

• Voting c/s; Pfd stock (not taken into account
  for > 80% test)
• P buys c/s from 3 different parties when 100%
  FMV is $1250, and pfd FMV = $750:
   – From S1: 40% for $500; selling costs = $40
   – From S2: 20% for $225; selling costs = $35
   – From S3: 20% for $275; selling costs = $25
What is the “grossed up
amount realized”?

• Amount realized on the sale to P of the
  RPS = $1000
• % of T stock, by value, attributable to
  the RPS stock = $1000/(FMV c/s $1250
  + FMV pfd $750) = 50%
• Selling costs = $100
• Hence: GUAR: $1000/.50 - $100 = $1900
Note: About liabilities

• In previous example there were no
  liabilities other any tax liability to be
  incurred by the deemed sale.
Example (1) in Treas. Reg.
1.338-4(g)(1): 1 of 4

• One asset (IRC 1245 property), bought
  for $80K (recomputed AB), AB =
  $50,400, FMV = $100,000. P purchases
  all 100% of the stock for $75,000
• ADSP = GUAR + L + MTR (ADSP-AB)
Example (1) continues: (2 of
4): GUAR

• Amount realized on the sale to P of the
  RPS / % of T stock, by value, attributable
  to the RPS stock = $75,000/1.00
• Selling costs = $0
• Hence: GUAR: $75,000/1.0 - 0 =
  $75,000
Example (1) continues: (3 of
4): Solving for ADSP in ADSP
= GUAR + L + MTR (ADSP-
AB)
• ADSP = $75,000 + 0 + 0.34 (ADSP -
  $50,400)
• ADSP = 75,000 + 0.34 ADSP - 17,136
• ADSP -0.34 ADSP = $57,864
• ADSP = 57,864/0.66 = $87,672.73
• As ADSP < FMV of asset, then entire
  ADSP is allocated to the 1245 property
End result in example (1): (4
of 4)

• Thus: Gain = 87,672.73 - 50,400 =
  37,272.73
• But since 1245 property:
  – $80,000 - $50,400 = $29,600 ordinary
    income
  – 37,272.73 - 29,600 = $7,673.73 capital gain
Example (2) in Treas. Reg.
1.338-4(g)(1): 1 of 5

• P buys all stock for $140,000
• Other:
  – T’s Liabilities (other than the tax for deemed
    sale gain) = $50K
  – Cash (Class I) = $10K
  – Marketable securities (Class II) = FMV
    $10K, AB $4K
  – Goodwill (Class VII) = AB $3K
EXAMPLE (2) continues: 2 of
5

• Class V assets: Total FMV = $250,000
  – Land: FMV $35K, AB $5K, 14% of Class V
    FMV
  – Building: FMV $50K, AB $10K, 20% of Class
    V
  – Equipment A: FMV $90K, AB 5K, recomputed
    AB $80K, 36% of Class V
  – Equipment B: FMV $75K, AB $10K,
    recomputed AB $20K, 30%of Class V
EXAMPLE (2) continues: 3 of
5

• Issue is the allocation to Class V; allocate
  Class I and II their FMV or $10 K +$10K
• ADSP (V) = [G - (I + II)] + L + MTR
  [(Class I gain) + ADSP (V) -
  (5K+10K+5K+10K)]
• ADSP (V) = 140 - 10 -10 + 50 + 0.34
  [(Class I: $10K FMV - $4K AB) +(ADSP
  (V) -30K)]
EXAMPLE (2) continues: 4 of
5

• ADSP (V) = 170 + 0.34[(6K) + (ADSP(V)
  - 30K)] = 170,000 + 2,040 +0.34 ADSP -
  10,200
• ADSP (V) - 0.34 ADSP (V) =161,840;
  ADSP = $161,840/0.66 = $245,212.12
• As $245,212 does not exceed total Class
  V’s FMV of $250K, there is no ADSP
  balance to be allocated to goodwill,
EXAMPLE (2) continues: 5 of
5: Final allocation of Class V

• ADSP(V)= [G - (I +II)] + L + MTR {(II-
  AB) +[ADSP(V)-AB] + [ADSP(VII)-AB]}
• ADSP(V) = (140-10-10) + 50 +
  0.34{[10-4] +[ADSP(V) -30] +[0-3]}
• ADSP(V) = 170 +0.34ADSP(V) +0.34(6-
  30-3) = 160820 +0.34 ADSP(V)
• ADSP(V) - 0.34 ADSP(V) = $160, 820;
  ADSP(V)= $160, 820/.66 = $243,667
Tax effect:

 – Land: 0.14(243667) - 5K AB = 34,113.33 -5K
   =$29,113.33 capital gain
 – Building: 0.20(243667)-$10KAB = 48,733.34
   - 10K = $38,733.34 capital gain
 – Equipment A: 0.36(243667)-$5k = 87720-5k
   = $82,720 gain: $75K OI; $7,720 capital
 – Equipment B: 0.30(243667)-$10K= 73,100K
   -10K = 63,100K gain: $10K OI; $53,100
   capital gain
Other advantages or planning
opportunities:

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

• If Target is a subsidiary in a consolidated
  group and Target’s stock is sold by the
  group to P,
• an election will treat the transaction as if
  seller (consolidated group)
  – had a taxable sale of the Target’s assets and
    then
  – liquidated sales’ proceeds into parent in an
    IRC 332 liquidation
Good idea when

• Target’s assets have declined in value,
  and/or
• seller has a low basis in target’s stock
  (requiring recognition of large amount of
  gains), or
• seller has tax attributes to offset gain
  recognized on the deemed sale of assets.
End result of IRC 338(h)(10)
election to consolidated group

• Gain recognition?
• Target’s tax attributes?
Gain recognition?

• Consolidated group recognizes gain on
  the deemed sale of assets, to the extent
  not sheltered by any consolidated tax
  attributes.
• Consolidated group does not recognize
  gain on the sale of T’s stock.
Target’s tax attributes?

• Because it is treated as a IRC 332
  liquidation Target’s tax attributes survive
  to the consolidated group.
• T must elect
Election by T?

• Actually a joint election in Form 8023.
• First, P has to decide to make the IRC
  338 election.
Effect on New Target: IRC
338(a)(2)

• New Target treated as having purchased
  ALL of the Old Target’s assets at FMV at
  the beginning of the day after
  “acquisition date”.
• Main effect: Old Target recognizes gain,
  New Target gets higher AB.
  – New Target treated as if it bought the assets
    of the Old Target for the “adjusted grossed-
    up basis”.
“adjusted grossed-up
basis”(AGUB): 338(b)(1);
1.338-5
• Grossed-up basis of “recently purchased
  stock”, plus
• actual (historical) basis of the
  “nonrecently purchased stock”, plus
• liabilities (including tax liability from gain
  recognition due to election)
“non-recently purchased
stock” (N-RPS)

• Target’s stock held by puchaser on
  acquisition date that is not “recently
  purchased stock”, e.g., was purchased
  during other than the “12 month
  acquisition period”
• Thus, the actual historical AB of the stock
  in the hands of P.
Election to step up AB of N-
RPS to FMV

• P may elect to increase AB of N-RPS to
  FMV by treating the N-RPS as if it were
  sold on “acquisition date” and recognize
  gain accordingly.
“recently purchased stock”
(RPS): IRC 338(b)(6)

• Target’s stock held by puchaser on
  acquisition date that was purchased
  during “12 month acquisition period”
“grossed-up basis” of RPS:
IRC 338(b)(4)

• Formula in textbook
• AB of RPS [ (100% - %N-RPS)/% RPS ]
Allocation of AGUB:Allocation
under IRC 338 pursuant to
Treas. Reg. 1.338-6:
• 7 classes of assets
7 classes of assets

• Class I: cash, savings accounts, checking
  accounts, but not CDs.
   – If Class I assets exceed AGUB, new target
     immediately realizes ordinary income in the
     amount of the excess.
• Classes II through VII:
   – In proportion to, and not in excess of, their
     fair market value:
Class II - VII: In proportion to,
and not in excess of, their fair
market value:
  – Class II: CDs, foreign currency; US gov secs; publicly
    traded stock (not of target’s affiliate); actively traded
    personal property
  – Class III: mark-to-market assets and some debt
    instruments
      • Exceptions: debt instruments issued by related parties;
        contingent debt; convertible debt
  – Class IV: Inventory
  – Class V: Not in any of the classes above or below:
    furniture, buildings, land, actively traded T’s affiliate stock
  – Class VI: IRC 197 intangibles o/t goodwill and going
    concern value
  – Class VII: goodwill and going concern value.
Failure to make election

• P’s AB of T’s stock= purchase price of T’s
  stock
• AB of T’s assets remain unchanged
• T’s tax attributes survive (as limited)
If T is liquidated under IRC
332 w/o IRC 338 election

• no gain or loss to P or T
• c/o AB of all T’s assets
• c/o of tax attributes
• Note: IRC 269: T’s liquidation w/i 2
  years, any deductions denied.
II. Non-Taxable Acquisitions:
Reorganizations

• Some in Chapter 20
Agenda

• I. Type of reorganizations
• II. Definitions and rationale
• III. Legal requirements
  – Common Law
  – Statutory
I. Types of reorganization

• Acquisitive reorganizations: A, B, C types
  and variations
• Divisive reorganizations: IRC 355 and D
  type.
• Nonacquisitive,               non-divisive
  reorganizations: E, F and G
II. Definitions and Rationale
Definitions

• Narrow: IRC 368 reorganization
• Broad; Corporate rearrangement where
  Target’s (T) assets are transferred to
  Acquiring (A) corporation through
  acquisition of assets and stock and/or
  creation of a new or a surviving
  corporation.
Tax rationale for a tax-free
transaction

• Assets remain in a corporate solution
• Substantial continuation of the traditional
  business (if S/S; not if boot)
• Ability to pay tax on transaction (cashing
  in)
Business rationale for
reorganizations

• Growth: vertically or horizontally
• Economies of scale
• Diversification
• Divesture: Voluntary or Involuntary
III. Legal requirements
IIIA. Common law
requirements

• 1. Continuity of Propietary Interest
• 2. Continuity of Business Enterprise
• 3. Business Purpose
IIIA1. Continuing Propietary
Interest (CPI): Rationale

• Development
Rationale for CPI

• No statutory (IRC) requirement.
• Recognize gain when investor liquidates
  interest, not before.
   – If Target’s shareholders receive cash and notes only,
     they cashed out (sold) their interest.
   – Treas. Reg. 1.368-1(b): bottom of

• Permissible: voting stock; nonvoting stock.
However,

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

• Not in B and C reorganizations. Because
  – B: voting stock for voting stock
  – C: At least 80% is voting stock.

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

• Courts have required an undefined
  minimum of equity interest, based on
  facts and circumstances.
• IRS: To request a PLR, Target’s
  shareholders must receive > 50% of the
  stock of Acquiring corporation.
  – However, IRS no longer issuing PLR’s.
So how much stock should be
kept to satisfy CPI?

• > 50% of the stock of Acquiring
  corporation
Post-Merger Sales: How long
must CPI exist?

• Step transaction issue?
Step Transaction doctrine

• A “first” transaction intrinsically tied,
  through a commitment, to a “second”
  transaction”.
• Transactions are dependent on each
  other.
Examples:

• RR 66-23: To be “cold”: at least 5 years
• But see Treas. Reg. 1.368-1(e)(1)(i);
  (e)(6) Example 1.
IIIA2. Continuity of Business
Enterprise (CBE)

• Defined by Treasury Regulation: 1.368-
  1(d)
• Judicial response
• IRS position
• Mostly important in divisive type (IRC
  355 spin-offs or split-ups).
Defined by Treasury
Regulation: 1.368-1(d)

• A (issuing corporation) must
  – continue T’s historic business, or
  – use a significant portion of T’s historic
    business assets in a business

• 1. 368-1(d)(2); (3)
Examples: 1.368-1(d)(5)
IRS position:

• CBE Failure: RR 87-76: Prior to merger T
  was required to divest itself of historical
  assets and invests proceeds in munis.
So how much of the historic
business assets should be
used?
• At least 33%
IIIA3. Business Purpose

• Definition
  – There must be a direct and substantial
    business or corporate purpose for the
    reorganization; personal  purpose   is
    irrelevant.

• Gregory v Helvering (1935)
Identity of parties

• A = TP
• B = UMC
• X stock = 10000 shares of MSC
• C = Averil Corp.; created on 9/18; received
  1000 shares of MSC on 9/21; 9/24 spinned off
  on 9/24 pursuant to recently enacted
  reorganization provision; liquidated on 9/25
Gregory v Helvering (1935)

• Facts: A owned B which held X stock. A wanted
  the X stock and in one week:
  – B created C and transferred X stock.
  – B spinned off all of C to B’s shareholder, e.g, A.
  – C liquidated and A received X stock.
  – A argued strict compliance with statute and that
    personal motivation was irrelevant.
Holding

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

• Liquidation/Reincorporation
• Avoidance/Evasion: IRC 269
IIIB. Statutory requirements

• 1. Acquisitive reorganizations:
   – (a) A reorga.
   – (b) B reorg.
   – (c) C reorg.

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

• 3. Nonacquisitive, non-divisive reorganizations:
  E, F and G
IIIB1a. Acquisitive
reorganizations: A Type:
• Definition
• Merger vs consolidation
• Advantages
• Disadvantages
• Variations
   – Triangular Mergers
   – Reverse Triangular Mergers
Definition

• Two or more corporation combine into
  one corporation.
  – Survivor: Statutory Merger: approval of
    majority of T and A
  – New corporation: Consolidation
Note: Acquiring corporation
acquires

• 100% of the Target’s assets and
• 100% of the Target’s liabilities
  – including contingent liabilities and
  – unknown liabilities
Advantages

• Flexibility of consideration: anything as
  long as CPI satisfied.
  – B requires voting stock
  – C requires voting but permits limited amount
    of other consideration

• Flexibility as to amount of T’s assets to
  be acquired
• Flexibility to have a subsequent transfer
Disadvantages

• State and federal law compliance
• Dissenters’ appraisal rights
• Assumption of T’s liabilities
  – may need to have a variation (reverse
    triangular) if assets cant be transferred to A.

• Getting majority approval
• Target’s contractual rights or privileges
Variations: Getting around
disadvantages

• Forward triangular/forward subsidiary
  merger
• Reverse Triangular
  – Using subsidiaries
Forward Triangular or
Forward Subsidiary Merger:
IRC 368(a)(2)(D)
 – T merged into A’s subsidiary
 – A’s subsidiary uses A’s voting or non-voting
   stock (> 50%) to acquire SUBSTANTIALLY
   ALL of T’s ASSETS- no liabilities.
    • 70% of FMV of T’s gross assets
    • 90% of FMV of T’s net assets
 – No need to have majority of A approve, only
   majority of A’s subsidiary, e.g., A’s BOD, and
   majority of T’s shareholders.
Thus large latitude in “boot”
gain to be recognized by
those who receive boot
Problems avoided:

• T’s liabilities may or may not be
  assumed.
• Majority vote of A shareholders is not
  required.
• Liberal rules for consideration to be paid
Reverse Triangular: IRC
368(a)(2)(E)
 – A’s sub merged into T
 – Variety of B reorg: A must use A’s voting stock to
   acquire a controlling interest in T from T’s
   shareholders
 – A does not have to acquire T’s liabilities.
 – T survives under A’s control: holding its and A’s sub
   properties.
 – Rationale: Retain T’s identity or public image; T may
   have nontransferable rights.
Note:

• B variety b/c A must use A’s voting stock
  to acquire 80% of T from T’s
  shareholders
• A does not have to assume Target’s
  liabilities
Problems avoided

• T remains alive
• A does not want to pay solely voting
  stock
• T’s liabilities may or may not be
  assumed.
• no need to transfer target’s assets that
  were desirable but not transferable.
Acquisitive Reorganizations: B
and C reorganizations:
IIIB. Statutory requirements

• 1. Acquisitive reorganizations:
   – (a) A reorga.
   – (b) B reorg.
   – (c) C reorg.

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

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

• IIIB1(b): Acquisitive reorganizations: B
• IIIB1(c): Acquisitive reorganizations: C
IIIB1(b). Acquisitive
reorganizations: B Type:

• Summary: Acquiring Corp wants Target’s
  stock (not the assets)
• (1) The elements
• (2) Advantages and disadvantages
IIIB1(b)(1) The B
reorganization:
• (I) Nature of the transaction
  – Acquiring corporation must use “solely voting
    stock” to acquire “control” of Target.

• (II) “Solely voting stock”: Acquiring’s
  voting stock for the Target’s stock
  necessary to control T
• (III) “Control”
IIIB1(b)(1)(I) Nature of the
transaction
• Transaction is between Acquiring Corporation
  and Target’s shareholders.
   – Acquiring makes a “tender offer” to Target’s
     shareholders to acquire the Target’s voting stock in
     exchange for Acquiring’s voting stock
      • Thus, after the transaction Acquiring and Target
        shareholders own Acquiring Corporation, which in turn
        is “in control” of Target Corporation.
IIIB1(b)(1)(II) Voting stock
Issues regarding “voting
stock”
• Acquisition must be with “voting stock”
   – Defining “voting stock”
      • Class
   – Exceptions
      • Exceptions to exceptions
   – # of acquiring transactions

• Note that Acquiring may use other
  consideration to acquire Target’s debt
  securities.
If there was an acquisition of
stock, was the Target stock
acquired with “voting stock”?
• “class” (common or preferred) is
  immaterial as long as it is “voting” stock.
  – “voting”: unconditional right to vote on
    regular corporate decisions
What is not Acquiring’s
“voting stock”?
• Convertible bonds, even if convertible into
  voting stock
• Options to purchase “voting stock”
• Stock rights and warrants
   – b/c they are like options to purchase
   – But contractual rights to receive (not to purchase)
     may qualify.
Exceptions to “voting stock”
rule
• Cash in lieu of fractional shares
• Cash to pay for target corporation’s legal,
  accounting, appraisal, and other
  reorganization expenses.
  – But not the target’s shareholders’ expenses

• Pre-reorg redemptions of dissenting
  minority
Redemptions of dissenting
minority
• OK if before B reorg: Target (not Acquiring
  Corp) may redeem minority dissenters’ stock
  for cash or other property prior to B reorg.
• Not as clear if after B reorg: If the redemption
  is performed by the Acquiring Corp, it is OK if
  there was NO predetermined agreement about
  the redemption prior to the B reorg.
How many transactions
involved in the acquisition of
T’s stock?
• It does not matter how many
  transactions as long as
  – stock was acquired solely for voting stock
  – the “control” element is satisfied.
If > one transaction, and one
of them was not “solely for
stock” of Acquiring
corporation?
• Are the acquisitions “related” or are they
  separate transactions?
• Facts and circumstances.
  – Time is a factor

• Simplest solution: Acquiring
  unconditionally sells purchased stock to
  3rd party before entering into B reorg.
IIIB1(b)(III) The “control”
element

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

• It permits previous acquisitions to be
  considered.
     • But all must be “solely for voting stock”
But how much before?

• Regs: 12 months is OK
• But judicially: The issue is whether the
  transactions are “related”.
  – Facts and circumstances.
  – The longer the period between the
    transactions, the greater they are found
    “unrelated”.
The meaning of 80% control:
IRC 351 control

• ownership of 80% of total combined
  voting power
• 80% of each class of nonvoting stock
IIIB1(b)(2) Advantages and
Disadvantages of B
reorganizations
Advantages

• Target survives
  – Immediate liquidation will make it a C
    reorganization
  – Acquiring Corp’s assets are shielded from the
    target’s liabilities

• Nonassignable rights remain with Target
• Tax attributes remain with Target
Advantages of B
reorganizations (2 of 3)

• No asset acquisition problems:
  – transfer fees
  – state and local income taxes
  – recordkeeping
Advantages of B
reorganizations (3 of 3)

• Unlike C: Acquiring Corp is not required
  to keep substantially all of its assets
• Unlike A: Not dependent on local law
  – No need for a shareholder’s vote
  – Tender offer to target shareholders does not
    require approval of Target’s management
Disadvantages of B
reorganizations (1)

• Only voting stock: dilutes control of
  Acquiring’s original shareholders
• Potential for dissenters’ problems at
  shareholders’ meeting
• Tax attributes remain in Target
IIIB1(c) Acquisitive
reorganizations: C
Acquisitive reorganizations: C

• (1) Summary
• (2) The elements
• (3) Advantages and disadvantages
IIIB1(c)(1)Summary
• Substantially all of Target Corp’s assets
  for Acquiring Corp’s “voting stock”
• Target must distribute to its shareholders
  property received form Acquiring Corp
  and property not transferred to Acquiring
  Corp.
  – Target is effectively liquidated
• Similar to a “statutory merger” or
  “practical merger”
  – In C reorg: substantially all assets are
    transferred
  – In merger: All assets are transferred.
• Ends with Acquiring corp being owned by
  its original shareholders and the Target’s
  original shareholders.
IIIB1(c)(2) Elements

• Substantially all the Target’s assets
• Consideration to be paid: solely voting
  stock
• Distribution requirement
Substantially all the Target’s
assets

• Not defined in the IRC
• For advanced ruling:
  – Higher of 70% of gross assets and 90% of
    net assets must be acquired

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

• “Solely” voting stock
• Unlike an A type where anything is
  almost OK.
• But here it is “solely” with a twist (boot
  relaxation rule)
  – Must use solely voting stock to pay up to
    80% of FMV of Target’s assets.
  – Thus 20% boot is OK.
The 20% boot and liabilities
assumed

• As assets are being transferred that may
  have debt attached to them, disregard
  Acquiring Corp’s assumption of Target’s
  liability.
• However, assumed liabilities are
  considered “boot” for purposes of the
  20%.
Example: Assume that the
FMV of Target assets is $100
and you want to have a C
reorg:
• If liabilities assumed = $18; may use up
  to $2 in real boot.
• If liabilities assumed = $19; may use up
  to $1 in real boot.
• If liabilities assumed = $20; may not use
  any boot.
• If liabilities assumed = $21; may not use
  any boot.
• The point is that substantial liabilities
  may be assumed as long as there is a
  CPI.
• But little “real boot” can be used when
  liabilities are being assumed.
• It is like the “basis” rules in IRC 351
  where liability is considered “money
  received ” for basis only but not boot.
However, depending on the
reason for the liabilities,
assumption may be
considered “real boot”
• If the liability assumed is a payment to
  be made to dissenting shareholders, the
  payment of the liability is considered a
  transfer of cash to the Target, e.g., “real
  boot”.
Distribution requirement

• Target must distribute promptly to its
  shareholders all the voting stock and boot
  received from Acquiring Corp.
• Target must also distribute any assets not
  transferred to the Acquiring Corp
   – All Acquring needs to acquire is “substantially all” the
     assets, the other assets must be distributed.
   – Target must not engage in an active T/B
Exception to distribution
requerement; IRC
368(a)(2)(G)(ii)
• IRS may waive it if
  – (1) it would result in a substantial hardship
    and
  – (2) the Target and shareholders agree to be
    treated as if the Target had made the
    distribution of the undistributed assets and
    the shareholders contributed back to the
    Target.
IIIb1(c)(3) Advantages of C
reorg

• No need to assume all the Target’s
  liabilities (A and B does).
• No need to acquire all the assets.
• No need to have Acquiring shareholders
  agree to the transaction. Only the Target
  and its shareholders have to approve the
  acquisition and likely liquidation.
The B reorganization followed
by liquidation

• Treated as a C reorganization
• Issue: Were substantially all of the
  target’s assets acquired in the reorg?
  – Were there any spin offs immediately before
    the attempted B reorg?
Forward Triangulars; Reverse
Triangulars

• Already discussed
Disadvantages of C reorg

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

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

• Boot ignored by assumption of liabilities
Aquisitive Reorganizations:
Tax implications
Introduction

• A Type
• B Type
• C type
A Type: Acquiring Target’s
assets

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

• IRC 354: nonrecognition
• IRC 356: recognition
• IRC 358: basis
IRC 354(a)(1): No gain or
loss recognized shall be
recognized if
• stocks or securities in a corporation a
  party to a reorganization
• are, in pursuance of the plan of
  reorganization,
• exchanged solely for stock or securities
  – in such corporation or
  – in another corporation a party to the
    reorganization
Exceptions: IRC 354(a)(2)

• Principal amount of securities received >
  principal amount of securities
  surrendered
IRC 356(a)(1): Gain on
exchange

• If 354 would apply but for the fact that
  the property received also included cash
  and other property (“boot”), then
• recognize gain up to the cash and the
  FMV of the other property, e.g, the boot.
• But no loss is recognized.
Character of the recognized
gain

• capital
• dividend
IRC 356(a)(2): Dividend

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

• IRC 302 analysis
• Constructive rules
• If 302(b)(1) [NEED] or 302(b)(2) [Sub.
  Disprop. Red.]: Then no dividend effect.
• Typical end result: < 50% shareholder
  getting boot will get capital gain.
IRC 302 analysis requires

• Make believe merger was a 100% stock
  for stock followed by a postmerger
  redemption of an amount of stock equal
  to the boot received.
Therefore, realized gain is
recognized if

• Other than stock and securities is
  received, e.g, cash, boot
• Principal received > Principal surrendered
• Securities were received and no
  securities surrendered
IRC 358(a)(1): Basis of
nonrecognition property to
distributees: Carry-over basis
• Less:
  – other property received (boot)
  – cash received (boot)
  – loss recognized

• Plus:
  – dividend received (recognized as income)
  – gain recognized
 IRC 358(a)(2): Basis of
“other property” received:

• FMV
Holding period:

• Nonrecognition property: tacked
• Other property: new holding period
See Example 17.3 (p. 838)
Tax consequences to
Acquiring corporation
Gain (loss) not recognized

• IRC 1032(a): No gain(loss) on issuance
  of stock.
Basis: IRC 362(b)

• Carryover basis for transferor’s assets,
  increase by gain recognized by
  transferor.
• As usually no gain or loss recognized
  recognized by Target transferor, acquired
  assets move to Acquiring corporation at
  c/o basis.
NOTE who is the
“Transferor”: The Target
corporation
• Target shareholders ARE NOT the
  “transferors” of assets.
• Target shareholders may recognize gain
  b/c “boot” received but that does not
  increase AB of Acquiring Corporation.
Other:

• HP: carryover to Acquiring Corporation
  (tacked)
• Target’s tax attributes: carryover to
  Acquiring Corporation
Tax consequences to
Target corporation

• IRC 361(a): No gain(loss) to a party of
  the reorganization when it
  – exchanges property pursuant to a plan,
  – solely for stock and securities
  – in another corporation party to the
    reorganization.
Target does not recognize

• Receipt of “boot”
• Assumption of target’s liabilities
Distributions by Target:
IRC 361( c)(1):

• No gain (loss) recognized) to a party of
  reorganization on distribution of property
  pursuant to a plan.
IRC 361( c)(4):

• IRC 311 does not apply to Target’s
  distributions
IRC 361( c)(2): Exceptions

• Appreciated property distributions:
  recognize gain (no loss) as if sold
  property.
• FMV: higher of FMV or liability attached
  to property
Exception to exception:
“qualified property”

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

• No gain (loss) on distribution of Acquiring
  Corp’s stock and securities
• Little or no gain (loss) on distribution of
  boot received from Acquiring Corp b/c AB
  is picked up at FMV.
Acquiring Corporation
Shareholders

• Tax effect: None, where Acquiring
  survives, there is no change in the tax
  status of its shareholders.
• Non-tax effect: They own smaller share
  of company because some of it is owned
  by Target’s shareholders.
B Type

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

• IRC 354(a)(1): No gain or loss
  recognized
• Carryover AB and HP
• If boot received, then recognize realized
  gain up to the boot.
  – AB of stock = c/o - FMV boot + gain
    recognized
  – AB of boot = FMV of boot
Tax consequences to
Acquiring corporation

• IRC 1032: No gain (loss) for issuance of
  voting stock.
• AB; HP: carryover
• AB when target is publicly held: OK to
  use sampling and estimating statistical
  techniques.
• Target’s tax attributes c/o to Acquiring
  Corp; limitations: later
Tax consequences to Target
corporation

• Remains in existence; tax attributes
  intact
• No gain (loss) recognized on exchange of
  assets for S/S of Acquiring, nor on the
  distribution of that S/S to target’s
  shareholders.
• Gain is recognized for distribution of
  appreciated property that is not
Tax consequences to
Acquiring corporation
shareholders
• IRC 1032: No gain (loss) for issuance of
  voting stock.
C Type: Same as a B Type

				
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