Types of Acquisitive Reorganizations

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Types of Acquisitive Reorganizations

• Type A reorganizations - statutory mergers and
  consolidations, forward and reverse triangular
  mergers
• Type B reorganizations - stock for stock
  exchanges
• Type C reorganizations - exchanges of stock for
  assets
• Section 351 transactions

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Type A Reorganizations

• Must meet requirements of state law
• Typically requires approval of shareholders of
  both target and acquirer
• Merger target is liquidated into the acquiring
  corporation target shareholders receive
  acquiring corporation stock
• Consolidation target and acquirer combine to
  form new legal entity whose stock is issued to
  both shareholder groups

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Type A Reorganizations continued

• Forward triangular merger Acquirer forms a new
  subsidiary into which target is merged, then sub
  may be liquidated into acquirer
• Reverse triangular merger Acquirer forms a new
  subsidiary which merges into target, with target
  as the surviving entity

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Type C Reorganization

• Asset acquisition based on contract
• To qualify for nontaxable treatment, acquirer
  must obtain substantially all of targets assets
  solely in exchange for voting stock of the
  acquiring corporation
• Substantially all means 70 of FMV of gross
  assets and 90 of net assets
• Solely for voting stock means at least 80 of
  value acquired using voting stock
• Requirements are less flexible than an A
  reorganization, but nontax advantages may exist

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Type B Reorganization

• Requirements for nontaxability
• Exchange of target stock solely for voting stock
  of the acquiring corporation
• Solely requirement is strict
• Immediately after the exchange, the acquiring
  corporation must have at least 80 control of
  target
• Control requires 80 of voting power and
  ownership of 80 of shares of each nonvoting
  class of stock
• Control need not be acquired in the exchange, but
  must exist subsequent to the exchange

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Section 351 Transactions

• Newco formed
• Acquirer and target shareholders exchange their
  stock for stock in Newco and other consideration
• Exchanging shareholders receiving both stock and
  boot recognize gain (not loss) equal to the
  lesser of gain realized or FMV of boot received
• Exchanging shareholders receiving only boot
  recognize gain or loss
• Following exchange, Acquirer and Target are
  subsidiaries of Newco

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Example Nontaxable Acquisitions

• Recall facts from Example on Taxable
  Acquisitions
• Acquiring corporation (A) is willing to purchase
  the stock of target corporation (T) for 364,000
• Ts assets have a tax basis of 100,000
• Ts shareholders have 150,000 of tax basis in
  their T stock and have owned it longer than 1
  year
• T has no liabilities and no NOL, capital loss, or
  tax credit carry forwards

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Example continued

• Determine the tax consequences of the following
  alternative nontaxable structures
• B reorg. with 100 stock consideration
• A reorg. with 70 stock, 30 cash
• C reorg. with 80 stock, 20 cash
• Sec. 351 transaction with 45 stock, 55 cash
• Assume that Ts shareholders will hold the A
  stock received for 3 years, during which time it
  appreciates at a before-tax rate of 12. The
  after-tax discount rate is 8.5.

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Preservation of Target Corporations Tax
Attributes

• Accounting methods, earnings and profits, credit
  and net operating loss carryforwards
• Stock acquisitions and nontaxable asset
  acquisitions (Type A and C reorganizations)
  generally preserve tax attributes, although use
  of loss carryforwards may be limited
• Tax attributes are lost in taxable asset
  acquisitions

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Limits on Use of Loss Carry-forwards after
Ownership Change

• Section 269 - Credit and loss carryforwards
  disallowed if principal purpose of acquisition
  was tax avoidance
• Section 382 - Annual limit on amount of loss
  carryforward deductible following significant
  change in ownership of a loss corporation
• Limit equals FMV of loss corporations stock on
  date of acquisition multiplied by long-term
  tax-exempt federal interest rate

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Sec. 382 Limitation continued

• Applies to any ownership change of more than 50
  ownership of the loss corporation
• Types of ownership changes
• Owner shift - any change in ownership of a 5 or
  greater shareholder during the shorter of 1) the
  prior 3 years or 2) the time since the last
  ownership change
• Equity structure shift - any nontaxable
  reorganization other than a divisive type D, type
  F, or type G

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Nontax Issues

• Nontaxable transactions require that a
  substantial portion of the consideration be
  acquirer stock
• Dilutes existing acquirer shareholders holdings
• Exposes target shareholders to undiversified risk
  of price fluctuations in acquirer stock
• Ability to issue nonvoting stock (A reorg) can
  avoid diluting of existing shareholders control,
  but target shareholders may demand a premium