Tax 4022/5022 Federal Income Tax II Corporate Acquisitions Chapter: None

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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

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Corporate Acquisitions

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

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Taxable Acquisitions
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Introduction

• I. ASSET ACQUISITION
• II. STOCK ACQUISITION

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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 Ts
  shareholders
• (2)
• A. T liquidates assets to its shareholders and
• B. P buys assets from Ts shareholders

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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.

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Allocation

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

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Seller

• Sellers gain or loss and character may depend on
  how the sales price is allocated.
• Favor allocation to assets yielding capital gains.

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Buyer

• Buyers AB and depreciation depends on how sales
  price is allocated.
• Favor allocation of sales price to depreciable
  assets

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

• IRC 1060 Review it and its regulations

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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
  buyers (transferre) AB is determined by price
  paid for assets.

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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.
• Targets assets held at the beginning of the day
  after the acquisition date. Reg 1.338-2(c)(2) .

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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

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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 targets
  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 Ts affiliate stock
• Class VI IRC 197 intangibles o/t goodwill and
  going concern value
• Class VII goodwill and going concern value.

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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.

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STOCK ACQUISITION
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Stock Acquisition

• P buys stock of T from Ts shareholders.
• If T is closely held, negotiation may be face to
  face.
• But likely to be different if T is publicly or
  widely held.

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Either way

• Ts shareholders recognize gain(loss)
• P takes a cost AB

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Kimbell-Diamonds 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) Assets 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

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IRC 338 Qualified stock purchase (QSP)

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

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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 target.

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purchasing corporation IRC 338(d)(1)

• one which makes a QSP of another corporation.

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target corporation IRC 338(d)(2)

• one whose stock is acquired through a QSP

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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

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How to purchase stockIRC 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.

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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.

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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.

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Second element sufficient target stock

• gt 80 of the voting power and
• gt 80 of the value of all classes of stock
• except nonvoting, nonparticipating preferred
  stock, that is not counted for the gt 80 test.

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Third element 12-month acquisition period IRC
338(h)1)

• 12 month is a moving parameter, ending on
  acquisition date.

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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.

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The election

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

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Who makes it?

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

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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.

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How is it made?

• File Form 8023 (Corporate Qualified Stock
  Purchase Election) with Ps IRS Service Center

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What is the effect of the election?

• Irrevocable
• Effect on Target
• Effect on Purchaser

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Effect on Target

• the target is treated as two
• the Old Target
• the New Target

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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.

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Thus, a disadvantage

• there could be significant up-front tax costs

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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.

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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)

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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
  corporations recently purchased stock (RPS), and
• liabilities (including taxes from gain
  recognition in 338 election)

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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

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Example 1.338-4(c)(2)

• Voting c/s Pfd stock (not taken into account for
  gt 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

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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

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Note About liabilities

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

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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)

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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

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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 lt FMV of asset, then entire ADSP is
  allocated to the 1245 property

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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

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

• P buys all stock for 140,000
• Other
• Ts 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

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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, 30of Class V

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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) - (5K10K5K10K)
• ADSP (V) 140 - 10 -10 50 0.34 (Class I
  10K FMV - 4K AB) (ADSP (V) -30K)

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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 Vs FMV
  of 250K, there is no ADSP balance to be
  allocated to goodwill, resulting in a capital
  loss of 3K.

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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 0.3410-4
  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

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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

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Other advantages or planning opportunities

• The IRC 338(h)(10) election

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IRC 338(h)(10) election

• If Target is a subsidiary in a consolidated group
  and Targets 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 Targets assets and
  then
• liquidated sales proceeds into parent in an IRC
  332 liquidation

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Good idea when

• Targets assets have declined in value, and/or
• seller has a low basis in targets stock
  (requiring recognition of large amount of gains),
  or
• seller has tax attributes to offset gain
  recognized on the deemed sale of assets.

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

• Gain recognition?
• Targets tax attributes?

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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 Ts stock.

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Targets tax attributes?

• Because it is treated as a IRC 332 liquidation
  Targets tax attributes survive to the
  consolidated group.
• T must elect

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Election by T?

• Actually a joint election in Form 8023.
• First, P has to decide to make the IRC 338
  election.

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

• New Target treated as having purchased ALL of the
  Old Targets 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.

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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)

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non-recently purchased stock (N-RPS)

• Targets 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.

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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.

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recently purchased stock (RPS) IRC 338(b)(6)

• Targets stock held by puchaser on acquisition
  date that was purchased during 12 month
  acquisition period

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

• Formula in textbook
• AB of RPS (100 - N-RPS)/ RPS

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Allocation of AGUBAllocation under IRC 338
pursuant to Treas. Reg. 1.338-6

• 7 classes of assets

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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

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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 targets
  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 Ts affiliate stock
• Class VI IRC 197 intangibles o/t goodwill and
  going concern value
• Class VII goodwill and going concern value.

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Failure to make election

• Ps AB of Ts stock purchase price of Ts stock
• AB of Ts assets remain unchanged
• Ts tax attributes survive (as limited)

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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 Ts assets
• c/o of tax attributes
• Note IRC 269 Ts liquidation w/i 2 years, any
  deductions denied.

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II. Non-Taxable Acquisitions Reorganizations

• Some in Chapter 20

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Agenda

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

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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

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II. Definitions and Rationale
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Definitions

• Narrow IRC 368 reorganization
• Broad Corporate rearrangement where Targets (T)
  assets are transferred to Acquiring (A)
  corporation through acquisition of assets and
  stock and/or creation of a new or a surviving
  corporation.

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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)

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Business rationale for reorganizations

• Growth vertically or horizontally
• Economies of scale
• Diversification
• Divesture Voluntary or Involuntary

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III. Legal requirements
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IIIA. Common law requirements

• 1. Continuity of Propietary Interest
• 2. Continuity of Business Enterprise
• 3. Business Purpose

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IIIA1. Continuing Propietary Interest (CPI)
Rationale

• Development

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Rationale for CPI

• No statutory (IRC) requirement.
• Recognize gain when investor liquidates interest,
  not before.
• If Targets 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.

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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.

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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.

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Development

• Courts have required an undefined minimum of
  equity interest, based on facts and
  circumstances.
• IRS To request a PLR, Targets shareholders
  must receive gt 50 of the stock of Acquiring
  corporation.
• However, IRS no longer issuing PLRs.

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So how much stock should be kept to satisfy CPI?

• gt 50 of the stock of Acquiring corporation

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Post-Merger Sales How long must CPI exist?

• Step transaction issue?

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Step Transaction doctrine

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

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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.

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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).

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Defined by Treasury Regulation 1.368-1(d)

• A (issuing corporation) must
• continue Ts historic business, or
• use a significant portion of Ts historic
  business assets in a business
• 1. 368-1(d)(2) (3)

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Examples 1.368-1(d)(5)
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IRS position

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

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

• At least 33

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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)

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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

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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 Bs shareholder, e.g,
  A.
• C liquidated and A received X stock.
• A argued strict compliance with statute and that
  personal motivation was irrelevant.

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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.

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IRS attacks

• Liquidation/Reincorporation
• Avoidance/Evasion IRC 269

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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

103
IIIB1a. Acquisitive reorganizations A Type

• Definition
• Merger vs consolidation
• Advantages
• Disadvantages
• Variations
• Triangular Mergers
• Reverse Triangular Mergers

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Definition

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

105
Note Acquiring corporation acquires

• 100 of the Targets assets and
• 100 of the Targets liabilities
• including contingent liabilities and
• unknown liabilities

106
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 Ts assets to be
  acquired
• Flexibility to have a subsequent transfer to As
  controlled subsidiary

107
Disadvantages

• State and federal law compliance
• Dissenters appraisal rights
• Assumption of Ts liabilities
• may need to have a variation (reverse triangular)
  if assets cant be transferred to A.
• Getting majority approval
• Targets contractual rights or privileges may not
  be transferable, and expire.

108
Variations Getting around disadvantages

• Forward triangular/forward subsidiary merger
• Reverse Triangular
• Using subsidiaries

109
Forward Triangular or Forward Subsidiary Merger
IRC 368(a)(2)(D)

• T merged into As subsidiary
• As subsidiary uses As voting or non-voting
  stock (gt 50) to acquire SUBSTANTIALLY ALL of Ts
  ASSETS- no liabilities.
• 70 of FMV of Ts gross assets
• 90 of FMV of Ts net assets
• No need to have majority of A approve, only
  majority of As subsidiary, e.g., As BOD, and
  majority of Ts shareholders.

110
Thus large latitude in bootgain to be
recognized by those who receive boot
111
Problems avoided

• Ts liabilities may or may not be assumed.
• Majority vote of A shareholders is not required.
• Liberal rules for consideration to be paid

112
Reverse Triangular IRC 368(a)(2)(E)

• As sub merged into T
• Variety of B reorg A must use As voting stock
  to acquire a controlling interest in T from Ts
  shareholders
• A does not have to acquire Ts liabilities.
• T survives under As control holding its and As
  sub properties.
• Rationale Retain Ts identity or public image T
  may have nontransferable rights.

113
Note

• B variety b/c A must use As voting stock to
  acquire 80 of T from Ts shareholders
• A does not have to assume Targets liabilities

114
Problems avoided

• T remains alive
• A does not want to pay solely voting stock
• Ts liabilities may or may not be assumed.
• no need to transfer targets assets that were
  desirable but not transferable.

115
Acquisitive Reorganizations B and C
reorganizations
116
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

117
Agenda

• IIIB1(b) Acquisitive reorganizations B
• IIIB1(c) Acquisitive reorganizations C

118
IIIB1(b). Acquisitive reorganizations B Type

• Summary Acquiring Corp wants Targets stock (not
  the assets)
• (1) The elements
• (2) Advantages and disadvantages

119
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 Acquirings voting
  stock for the Targets stock necessary to control
  T
• (III) Control

120
IIIB1(b)(1)(I) Nature of the transaction

• Transaction is between Acquiring Corporation and
  Targets shareholders.
• Acquiring makes a tender offer to Targets
  shareholders to acquire the Targets voting stock
  in exchange for Acquirings voting stock
• Thus, after the transaction Acquiring and Target
  shareholders own Acquiring Corporation, which in
  turn is in control of Target Corporation.

121
IIIB1(b)(1)(II) Voting stock
122
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 Targets debt securities.

123
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

124
What is not Acquirings 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.

125
Exceptions to voting stock rule

• Cash in lieu of fractional shares
• Cash to pay for target corporations legal,
  accounting, appraisal, and other reorganization
  expenses.
• But not the targets shareholders expenses
• Pre-reorg redemptions of dissenting minority

126
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.

127
How many transactions involved in the acquisition
of Ts stock?

• It does not matter how many transactions as long
  as
• stock was acquired solely for voting stock
• the control element is satisfied.

128
If gt 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.

129
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

130
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.

131
The meaning of 80 control IRC 351 control

• ownership of 80 of total combined voting power
• 80 of each class of nonvoting stock

132
IIIB1(b)(2) Advantages and Disadvantages of B
reorganizations
133
Advantages

• Target survives
• Immediate liquidation will make it a C
  reorganization
• Acquiring Corps assets are shielded from the
  targets liabilities
• Nonassignable rights remain with Target
• Tax attributes remain with Target

134
Advantages of B reorganizations (2 of 3)

• No asset acquisition problems
• transfer fees
• state and local income taxes
• recordkeeping

135
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 shareholders vote
• Tender offer to target shareholders does not
  require approval of Targets management

136
Disadvantages of B reorganizations (1)

• Only voting stock dilutes control of Acquirings
  original shareholders
• Potential for dissenters problems at
  shareholders meeting
• Tax attributes remain in Target

137
IIIB1(c) Acquisitive reorganizations C
138
Acquisitive reorganizations C

• (1) Summary
• (2) The elements
• (3) Advantages and disadvantages

139
IIIB1(c)(1)Summary
140

• Substantially all of Target Corps assets for
  Acquiring Corps voting stock

141

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

142

• Similar to a statutory merger or practical
  merger
• In C reorg substantially all assets are
  transferred
• In merger All assets are transferred.

143

• Ends with Acquiring corp being owned by its
  original shareholders and the Targets original
  shareholders.

144
IIIB1(c)(2) Elements

• Substantially all the Targets assets
• Consideration to be paid solely voting stock
• Distribution requirement

145
Substantially all the Targets 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.

146
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 Targets assets.
• Thus 20 boot is OK.

147
The 20 boot and liabilities assumed

• As assets are being transferred that may have
  debt attached to them, disregard Acquiring Corps
  assumption of Targets liability.
• However, assumed liabilities are considered
  boot for purposes of the 20.

148
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.

149

• 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.

150
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.

151
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

152
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.

153
IIIb1(c)(3) Advantages of C reorg

• No need to assume all the Targets 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.

154
The B reorganization followed by liquidation

• Treated as a C reorganization
• Issue Were substantially all of the targets
  assets acquired in the reorg?
• Were there any spin offs immediately before the
  attempted B reorg?

155
Forward Triangulars Reverse Triangulars

• Already discussed

156
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 targets assets must be
  acquired.
• Precludes a spin-off of unwanted business or
  assets before/immediately after reorg
• Boot ignored by assumption of liabilities

157
Aquisitive Reorganizations Tax implications
158
Introduction

• A Type
• B Type
• C type

159
A Type Acquiring Targets assets

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

160
Tax consequences to Target shareholders

• IRC 354 nonrecognition
• IRC 356 recognition
• IRC 358 basis

161
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

162
Exceptions IRC 354(a)(2)

• Principal amount of securities received gt
  principal amount of securities surrendered

163
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.

164
Character of the recognized gain

• capital
• dividend

165
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.

166
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 lt 50 shareholder getting
  boot will get capital gain.

167
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.

168
Therefore, realized gain is recognized if

• Other than stock and securities is received, e.g,
  cash, boot
• Principal received gt Principal surrendered
• Securities were received and no securities
  surrendered

169
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

170
IRC 358(a)(2) Basis of other property
received

• FMV

171
Holding period

• Nonrecognition property tacked
• Other property new holding period

172
See Example 17.3 (p. 838)
173
Tax consequences to Acquiring corporation
174
Gain (loss) not recognized

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

175
Basis IRC 362(b)

• Carryover basis for transferors 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.

176
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.

177
Other

• HP carryover to Acquiring Corporation (tacked)
• Targets tax attributes carryover to Acquiring
  Corporation

178
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.

179
Target does not recognize

• Receipt of boot
• Assumption of targets liabilities

180
Distributions by Target
181
IRC 361( c)(1)

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

182
IRC 361( c)(4)

• IRC 311 does not apply to Targets distributions

183
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

184
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.

185
Typical end result for Target

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

186
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 Targets
  shareholders.

187
B Type

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

188
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

189
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.
• Targets tax attributes c/o to Acquiring Corp
  limitations later

190
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 targets shareholders.
• Gain is recognized for distribution of
  appreciated property that is not qualified.
• Target year ends on the date of the asset
  transfer IRC 381(b)

191
Tax consequences to Acquiring corporation
shareholders

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

192
C Type Same as a B Type
193