Corporate Acquisitions

1
Corporate Acquisitions

• Acquisition form
• Asset Acquisition
• Direct acquisition of selected assets of target
  corporation
• Merger with target corporation dissolved into
  acquiring corporation
• Stock Acquisition

2
Acquisitions Decision Model
3
Five Major Tax Issues

• Will the transaction result in a taxable gain or
  loss to the target firms shareholders?
• Will the transaction result in a taxable gain or
  loss to the target firm?
• How will the transaction affect the target firms
  tax attributes (NOLs, credit carryovers)?
• Will the transaction affect the tax basis of the
  target firms assets?
• Will the use of leverage generate tax savings?

4
Taxable Asset Acquisitions

• If direct asset acquisition
• Target recognizes gain or loss on sale of assets
• No tax consequences to target shareholders,
  unless target liquidates (then shareholders
  recognize gain or loss on disposition of their
  stock)
• If structured as a merger
• Target recognizes gain or loss as if assets were
  sold at FMV
• Target shareholders recognize gain or loss on the
  disposition of their target stock

5
Taxable Asset Acquisitions continued

• If merger, or target liquidates after
  acquisition, target firms tax attributes,
  including NOL and credit carryovers, are lost
• Cannot buy tax attributes
• Acquiring corporation takes a cost basis (FMV) in
  assets acquired
• Debt financing is common in taxable asset
  acquisitions, often resulting in increased
  leverage

6
Example Taxable Asset Acquisition

• ABC Inc. wishes to acquire the business of Target
  Corporation, whose stock is owned by Mr. Smith.
  ABC is willing to pay 2 million for all of
  Targets assets.
• If Targets assets have a tax basis of 800,000,
  what are the tax consequences of the sale?
• Mr. Smiths tax basis in his target stock is
  500,000. If Target liquidates and distributes
  the after-tax proceeds of the asset sale to Mr.
  Smith, what are the tax consequences of the
  liquidation?

7
Taxable Stock Acquisitions

• Target shareholders recognize gain or loss on
  disposition of their target stock
• Target does not recognize gain or loss (unless
  Sec. 338 election)
• Tax attributes survive the acquisition, but their
  future use is subject to limitations
• Acquiring corporation takes a cost (FMV) basis in
  the target stock acquired
• No impact on basis of targets assets (unless
  Sec. 338 election)

8
Taxable Stock Acquisitions continued

• Debt financing is common in taxable stock
  acquisitions, often resulting in increased
  leverage
• If 80 control acquired, acquiring corporation
  and target may file a consolidated tax return

9
Example Taxable Stock Acquisition

• Refer to previous example.
• Suppose that ABC is willing to pay Mr. Smith 2
  million for his Target stock. What are the tax
  consequences of this sale?
• Why might ABC not be willing to pay 2 million
  for the stock?
• At what stock purchase price would Mr. Smith be
  indifferent between a stock sale and an asset
  sale followed by a liquidation of Target?

10
Special Issues in Taxable Stock Acquisitions

• Section 338 Election
• Election to treat a stock purchase as an asset
  purchase for tax purposes
• Advantage Acquiring corporation gets to adjust
  the tax basis of targets assets to FMV
• Cost Target must recognize gain or loss as
  though assets were sold for FMV

11
Nontaxable Acquisitions (Reorganizations)

• Qualified reorganizations are treated as
  nontaxable exchanges
• Judicial requirements for acquisitive reorgs
• Original owners of target must maintain
  continuity of proprietary interest in targets
  business - satisfied if at least 50 of
  consideration is acquiring corporation stock
• Continuity of business enterprise - acquirer must
  continue targets business or use targets assets
  in an existing business
• Business purpose, beyond tax avoidance

12
Tax Consequences of Nontaxable Acquisitions

• Most basic case No boot (all consideration is
  acquiring corporation stock)
• No gain or loss recognized by target corporation,
  or targets shareholders
• Target tax attributes survive
• Acquiring corporation takes a carryover basis in
  the assets or stock acquired
• If asset acquisition, target distributes stock
  received to its shareholders and (usually)
  liquidates

13
Nontaxable Acquisitions continued

• Target shareholders take a carryover basis in the
  acquiring corporation stock received
• Debt financing cannot occur directly in this case
  (since it would be considered boot), so increased
  leverage not possible as part of the acquisition
  transaction
• Acquirer corporation debt can be issued to
  replace target corporation debt. No gain or loss
  will occur if principal amounts are equal

14
Boot in Acquisitive Reorganizations

• Any property transferred by the acquiring
  corporation other than its own stock or
  securities is considered boot
• Gain (but not loss) recognized by the acquirer if
  FMV of boot transferred gt adjusted tax basis
• No gain or loss if the boot is cash
• Target corporation recognizes gain (but not loss)
  if boot not distributed to shareholders, or if
  target distributes its own assets (not acquired
  in the reorganization) to its shareholders

15
Boot in Acquisitive Reorganizations continued

• Target shareholders receiving boot and stock or
  securities recognize gain (but not loss) equal to
  the lesser of the gain realized or the FMV of the
  boot received
• Target shareholders receiving only boot recognize
  any gain or loss realized
• Gain recognized by target shareholders is treated
  as a dividend (ordinary income) to the extent of
  each shareholders proportionate share of
  targets AEP. Any remaining gain is capital gain.

16
Boot in Acquisitive Reorganizations continued

• Target security holders recognize gain if the
  principal value of the securities received is
  greater than the principal value of the
  securities given up
• The basis of assets transferred to the acquirer
  is increased by any gain recognized by the target
• The basis of stock or securities received by
  target shareholders is increased by any gain
  recognized and decreased by the FMV of boot
  received

17
GAAP Treatment of Mergers and Acquisitions

• Purchase accounting
• All assets and liabilities of acquired target
  recorded at FMV, including goodwill
• SEC-preferred method of accounting for
  acquisitions
• Pooling-of-interests accounting
• Assets and liabilities of combined firms recorded
  at historical book cost
• Typically results in little or no recorded
  goodwill
• No longer allowed under GAAP

18
Tax versus Financial Statement Goodwill

• For tax purposes, goodwill is recorded only when
  the tax basis of target assets is stepped up to
  FMV
• Taxable asset acquisitions
• Taxable stock acquisitions with Sec. 338 election
• Purchased goodwill amortizable over 15 years for
  tax purposes
• Many nontaxable acquisitions are recorded using
  the purchase method for GAAP purposes, resulting
  in GAAP goodwill that is not amortizable for tax
  purposes

19
Corporate Divisions

• Spin-off Parent corporation distributes
  controlling interest in stock of a subsidiary
  corporation to parents shareholders
• Split-off Parent corporation distributes
  controlling interest in stock of a subsidiary to
  a group of shareholders in exchange for their
  parent stock
• Split-up Parent corporation distributes stock of
  two (or more) subsidiaries to its shareholders in
  complete liquidation of the parent

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Corporate Divisions continued

• Such transactions are nontaxable to the parent
  and participating shareholders if undertaken for
  a corporate business purpose and requirements of
  Sec. 355 are met
• Parent must distribute at least 80 of subsidiary
  stock
• Subsidiary and parent (spin-off or split-off)
  must continue to engage in a business that had
  been conducted for at least 5 years before the
  distribution
• Parent must have held the stock of the subsidiary
  for at least 5 years before the distribution
  (unless acquired in a nontaxable transaction)