REV. RUL 67274

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REV. RUL 67-274

• Acquiring corp exchanges its stock for stock of
  Target in a B reorganization, and then
  liquidates the Target which is now a subsidiary
  the liquidation is tax free because of 332.
• In substance, this is both a B and a C since
  Acquiring ultimately received Targets assets.
• IRS rules that the exchange will be treated as a
  C, not a B. If large liabilities were
  assumed, the deal could fail the the
  assumption of too much debt problem. What a
  trap this is! How can Acquiring avoid the trap?
  Dont liquidate the target! Just file
  consolidated returns.

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WEST COAST MARKETING V CIR

• Cohen and West Coast owned land they meant to
  sell to Universal, a publicly traded corporation.
• To cause the deal to be tax deferred, Cohen and
  West Coast deeded the land to a corporation,
  Manatee Land Company, Inc., which then did a B
  reorg with Universal. Manatee never did any
  business its sole function was to hold title to
  the land.
• The court holds that this scheme fails as no
  business purpose existed other than a tax break.
  This is one of the few business purpose cases
  in the reorganization area.

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West Coast Marketing Trivia

• While there is not much substance to this case,
  the name Louis E. Wolfson appears as the major
  stockholder of the Acquiring corporation.
• Wolfson was famous for three things he was just
  about the first corporate raider, and he acquired
  Montgomery Ward and its huge cash hoard in a bold
  stock play, and,
• He paid Abe Fortas a consulting fee of 20,000
  when he was serving as a justice on the U.S.
  Supreme Court leading to Fortas resignation from
  the court.

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CONTINUITY IN A MERGER, I.E., AN A

• Roebling is a historical case, where the target
  shareholders got zero equity in exchange for
  their stock they received 8 100 year bonds in
  exchange for their stock in South jersey, Inc. so
  for that reason it was a taxable transaction.
• Had Roebling taken enough stock of Acquiring it
  would be a tax free merger, an A. How much
  stock is enough. Nelson, p.500, held that 38
  would do.
• Securities can be exchanged in a merger, but the
  face amount of the securities received must equal
  the face value of those surrendered or the
  excess is boot and hence taxable income.

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PAULSON V CIR

• The players here are Citizens, a mutual SL, and
  Commerce, a stock SL they merge, and Citizens
  is the survivor. The stockholders of Commerce get
  bank accounts as Citizens has no stock it is a
  non-stock mutual savings and loan organization.
• The court analyzes the rights of a depositor in a
  mutual SL and concludes they are creditors,
  although they have the only equity the SL has
  hence this is a taxable merger.

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MISCELLANEOUS THOUGHTS ON PAULSON

• The Citizen owners may have had only bank
  accounts, but they could vote and were entitled
  to the proceeds from tangible assets and goodwill
  in the event of a liquidation. Those facts caused
  the tax court to approve the reorg.
• If Commerce were the survivor and the Citizen
  depositors received stock, the merger would
  qualify. But, would you give up your savings
  account for stock of Commerce?
• Rehnquist thinks that Treasury Regulations are
  statutes. He says, p. 557 that the continuity
  of interest doctrine has been codified by Treas.
  Reg. 1.368-1(b).

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CAN THIS TRANSACTION BE SAVED?

• What if Citizens gave up their status as a mutual
  SL and incorporated. Then Citizens, Inc. merges
  with Commerce SL, whose shareholders get
  Citizens SL stock. This arrangement would work
  under North Dakota and federal SL law and
  regulations of the Federal Home Loan Bank board
  .FHLBB.
• The same result would occur if Commerce
  converted into a mutual SL. See 3d paragraph,
  p. 559.
• There is really no advantage in being a mutual
  SL as compared to a stock SL. Indeed,
  management would much prefer a stock SL. Witness
  Norman Jones and Metropolitan SL.

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KASS V COMMISSIONER

• A celebrated case and universally thought to be
  incorrectly decided.
• Kass was a shareholder in ACRA, Inc. Levy
  wanted control of ACRA, so he first formed Track
  which offered to buy all ACRAs stock. Over 80
  of the stockholders sold their stock to Track,
  but Kass did not. ACRA was then merged into
  Track, and Kass got Track stock IRS claims the
  merger is a taxable transaction and a failed A
  reorg.

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KASS CONTINUED

• Continuity was the problem over 80 of the Acra
  stock was originally obtained for cash, not
  stock. However, by the time of the merger, over
  80 of the remaining ACRA, Inc. stockholders got
  stock of Track.
• Kass claims that there was continuity because
  when she got Track stock at the time of the
  merger she, the and other former shareholders of
  Acra, and Track together owned 100 of Track, the
  surviving corporation.
• The court says that Tracks stock doesnt count
  unless its ownership is old and cold. So,
  less than 20 of owners got stock remember,
  Nelson (p.500) held that 38 continuity was OK in
  a merger.

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WHY IS KASS WRONG?

• Why should Mrs. Kass suffer because most of the
  other stockholders got cash? Again, there is no
  loophole here to be closed, no harm to the
  treasury.
• Is this the proper time to tax Kass? Remember,
  her share of the business is still in the lobster
  trap, also known as the corporate flux.
• Judge Dawson shows his lack of simple
  comprehension by saying Kass is no worse off than
  those shareholders that sold. Well, sure, except
  the others have pockets full of cash with which
  to pay the tax and all Kass has is Track stock.

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HOW MRS. KASS COULD AVOID THE TAX

• After Track acquired 84 of ACRA stock it had a
  choice if it liquidated ACRA some of the assets
  would go to the minority shareholders, a result
  it didnt want. So it merged the two
  corporations and kept all the assets.
• But what if Track didnt merge the corporations
  and simply moved assets back and forth between
  the parent and subsidiary to modernize the
  racetrack, which can be done tax free, and also
  filed consolidated returns. In that case there
  is no doubt that Mrs. Kass would have no income
  to tax and Track would be in substantially the
  same position as it was after the merger.

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McDonalds RESTAURANT V CIR, 688 F.2d 520 (7th
Cir. 1981)

• This is not in casebook but is the leading case
  on the step transaction theory.
• Garb owned 27 McDonalds hamburger joints.
  McDonald International wanted them. The price
  was agreed at 29 million. Garb insisted on
  cash, but McDonalds wanted to pay in stock. The
  parties agreed that Garb would take McDonalds
  stock for now, but piggy back that stock on a
  public stock offering that McDonalds was
  contemplating soon .

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McDonalds CONTINUED

• Garb took the stock, but sold it at the time of
  McDonalds first offering a few months later.
  There is no doubt that Garb had capital gain
  then.
• McDonald wants to step-up the basis of the assets
  it acquired to the purchase price 29 million
  as though McDonalds had paid cash for the stock.
  In these years this step-up was tax free to the
  Garb corporations. That is not true today,
  unless a 338 election is made, and that requires
  an immediate tax.
• IRS claims the acquisition was not a purchase,
  but a stock for stock swap, a B reorg.

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McDonalds CONTINUED

• The crucial fact was should the sale by Garb of
  McDonald stock for cash at the public offering be
  stepped together with the B stock swap some
  months earlier?
• The tax court said no, and held that the sale for
  cash was not required by the B reorganization .
• The 7th circuit reversed, noting that Garb
  insisted on selling for cash from the outset, and
  the B stock swap would not have occurred if the
  piggy back stock offering was not agreed to.

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STEP TRANSACTION THEORIES

• There are three step transaction theories
• The end result test that is, were the steps
  that were taken component parts of a single deal?
• The interdependence test that is, would the
  subsequent steps be taken if the first step was
  not? It is difficult to distinguish test one
  from test two.
• The binding commitment test was there a binding
  obligation to take the subsequent steps.
• On 1 2, timing is everything a long time
  between steps usually means the steps are not
  combined this is not true on the binding
  commitment test.

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SEAGRAM CORP V CIR

• Seagram got in a bidding war over Conoco with
  DuPont Seagram lost.
• Seagram bought 32 and Dupont 46 of Conoco
  stock, all for cash Dupont announced it had won
  the battle and offered to swap Dupont stock for
  the remaining Conoco stock Seagram and all the
  others accepted the swap so Dupont acquired 54
  of Conoco for its stock..
• Seagram claims this was not a good reorg, as 78
  Seagrams 32 Duponts 46 of the stock was
  bought for cash Seagram wants to claim a loss
  it paid 2.6 billion for its Conoco stock and
  only got 2 billion in Dupont stock in return..

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SEAGRAM CONT

• Seagram lost 600 million on the deal and claimed
  a capital loss of that sum.
• IRS and this court say that this is a good
  merger even though Seagrams stock is young
  hot.
• DuPont got 54 of the Conoco stock for Dupont
  stock and 46 for cash. IRS will approve a merger
  with 50 continuity.
• Trivia question. Where did the Bronfman family
  (the major owners of Seagram) get their start?

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SAM BRONFMAN
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PROBLEM 12-5 P. 571

• a Taxable only 25 continuity 75 of target
  was acquired for by ABC for cash.
• b Tax free 90 continuity only 10 of the
  stock was acquired by DEF for cash.
• c Taxable 15 continuity 10 of the stock
  acquired by DEF and 75 acquired by Target85
  acquired for cash.
• d Taxable only 15 continuity again if the
  steps are related.
• e Tax free but the sale by ABC is, of course,
  taxed 90 continuity exists.
• Do these rules on continuity make sense where
  there must be 100 continuity in a B and 80
  continuity in a C?

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SOMETIMES THE DOUBLE TAX ON THE SALE OF A
CORPORATION CAN BE AVOIDED

• If your client is lucky enough to find a buyer
  for his C corporation whose stock is publicly
  traded the double tax can be avoided with a B
  reorganization.
• The Acquiring corporation normally would not buy
  the Targets stock, but since the price is just
  shares of the Acquiring corporations stock, they
  will be happy to do so. A problem exists with
  letter stock which cant be sold for a year.

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HORNBARRIER V CIR

• Hornbarrier owned two corporations, Colonial and
  Central. Colonial had been in the trucking
  business, but was inactive after 1988, and only
  owned tax exempt bonds. It had a value of 7.442
  million.
• Central was very profitable, and was an S
  corporation with over 10 million in AAA.
• Central could not pay dividends as it needed its
  cash to remain competitive.
• Hornbarrier arranged for the two corporations to
  merge. This was step one.

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MORE HORNBARRIER

• Within days of the merger Central paid dividends
  of 7 million, and it is claimed that they are
  tax free as less than Centrals AAA.
• IRS successfully contended that the merger was
  not tax free as there was no continuity of
  business assets, i.e., Colonials assets the
  tax-free bonds were not used in Centrals
  business.
• The result is that this was treated as an
  exchange sale of stock and capital gain to
  Hornbarriers shareholders.
• What if Colonial cashed the bonds and used the
  proceeds to upgrade Centrals fleet of trucks and
  two years later the dividend was declared? It is
  another step transaction issue.

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KING ENTERPRISES INC V U.S.

• King a corporation was a shareholder of Tenco,
  Inc. Minute Maid wanted Tenco, and paid King,
  Inc. cash, promissory notes and Minute Maid
  stock in exchange for his Tenco shares King,
  Inc. agrees the cash and notes are taxable, as
  dividends, but claims the stock was received in
  an A merger and is tax free, since Tenco and
  Minute Maid merged within 9 months of the
  acquisition of Tenco stock.
• Minute Maid treated this as a purchase so as to
  step up the basis of the acquired assets which
  could be done tax free at that time it is not
  possible today.

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King,Inc. continued

• King, Inc. alleges that this is a tax free merger
  since over 50 of the equity interest was
  acquired for stock and the court agrees this is
  a step transaction case the government argued
  that the payment of cash and notes was not
  related to the later merger. The court found
  otherwise.
• It seems that Minute Maid intended to merge from
  the beginning. If a merger had not been planned
  from the start the value of the Minute Maid
  stock would be taxed to King, Inc. as a dividend
  at that time, but not today.

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KING, CONCLUDED

• King claimed the cash and notes were dividends
  at that time govt contended that such a payment
  must be tested under the 302 safe haven rules,
  that is, did the taxpayer have less than 50
  control and a 20 reduction in ownership
  immediately after the transfer?
• King won its argument , but today the cash and
  notes would be taxed as capital gain which gives
  no tax break to a C Corporation CIR v Clark,
  489 U.S. 726 1989 an 85 dividend received
  deduction applied then now a 70 or 80
  dividend received deduction is available to a
  corporate recipient.
• What if the merger occurred 5 years later? What
  if the two corporations never merged? There
  probably is no compelling reason to merge Tenco
  and Minute Maid.