Corporate Tax-Free Reorganizations 2

Example 3(e) Purchase & Sale of T Stock P bought 10% of T stock for cash 1 year ago. Then P sold the 10% interest to Friendly. P then in a single transaction acquired 100% of the T stock solely for P stock. Issue: 1) Are the cash and the subsequent acquisition separate and unrelated? If yes, then 100% is a qualifying "B” reorg. 2) If not, then questions about the transfer and 4/30/2007 (c) WilliamFriendly P. Streng 49 the reacquisition from Bank. The “C” Reorganization The “Practical Merger” Criteria for a valid "C" reorganization: 1) Voting stock of the acquirer is received. 2) A transfer of “substantially all” properties. 3) Liquidation of Target with the distribution to the shareholders of the Acquirer’s stock. 4) Assumption of some liabilities is permitted. 5) Limited "boot" exception - but a 20% limitation rule (including liabilities assumed). 4/30/2007 (c) P. 50 25 The “Substantially All” Requirement IRS ruling position: 70% of gross & 90% of net assets (for ruling purposes) to be acquired. Emphasis on “operating assets” (even if the percentage tests are not met). Cannot be a divisive transaction, e.g., consider Rev. Rul. 88-48 permitting the sale of 50% of the historic assets if the cash proceeds are also transferred by Target corporation. 4/30/2007 (c) P. 51 Liquidation of the Target Corporation §368(a)(2)(G) requires the Target to distribute all its assets (including the shares of purchaser) in liquidation. Possible waiver of the liquidation requirement can be obtained from the Service. Then treated as if (1) distribution to Target shareholders had occurred and (2) assets contributed to capital of a new corporation. 4/30/2007 (c) P. 52 26 Creeping Acquisitions Prior purchase of stock of the Target - is this purchase transaction “old and cold”? Purchaser’s prior holding of stock not invalidating the “solely for voting stock” requirement. See Bausch & Lomb history. Under boot relation rule the non-qualifying consideration cannot exceed 20% of value of all of Target’s properties. Reg. § 1.368-2(d)(4)(i) & (ii). 4/30/2007 (c) P. 53 Example 1(a) 70% Operating Assets T has $70,000 of operating assets and $30,000 of cash and securities and A issues voting stock worth $70,000. The tax issue concerns whether "substantially all" the properties have been transferred? The “70 percent of gross and 90 percent of net” test (Rev. Proc. 77-37) is not satisfied. But, only non-operating properties retained and all 4/30/2007 54 27 Example 1(b) Operating Assets Retained A acquires $40,000 (of a total of $70,000) of the operating assets and $30,000 of the investment assets of Target for A voting stock. T then liquidates, distributing $70,000 of A stock and $30,000 of its operating assets. Here, operating assets are retained by Target shareholders and a failure occurs to satisfy the "C" reorganization “substantially all” requirement. 4/30/2007 (c) P. 55 Example 1(c) Assumption of Liabilities T has $100,000 of operating assets and $30,000 of liabilities. A issues $70,000 of voting stock in exchange for the T assets & liabilities. Substantially all the T assets are acquired. The assumption of liabilities is permitted in this situation without losing tax-free “C” reorganization treatment. See §368(a)(1)(C). 4/30/2007 (c) P. 56 28 Example 1(d) Cash & Liability Assumption A issues $60,000 of its voting stock and $10,000 cash in exchange for all of T's assets and the assumption of the $30,000 of liabilities. T liquidates, distributing A stock and cash. See the "boot relaxation rule"- §368(a)(2)(B). Assumed liabilities treated as additional cash. 60% of assets are acquired for stock and 40% for cash. The boot relaxation rule is not Example 2(a) “B” or “C” Reorg? T owns $70,000 of operating assets and $30,000 cash and investment securities. T redeems 30% of the stock for the cash and investment securities. Acquiring issues $70,000 worth of voting stock to the remaining T shareholders in exchange for T stock and T then liquidates. If no step transaction: a valid "B” reorg? 4/30/2007 58 29 Example 2(b) Step Transaction? T redeems 30% shareholders by distributing operating assets rather than cash and investment securities. 1) If the redemption is separate: a "C" reorganization occurs (since then all assets are acquired in the transaction). 2) If the redemption is not separate: not a valid "C" reorganization, since substantially all assets are not transferred to P. 4/30/2007 (c) William P. Streng 59 Example 2(c) “C” Reorg Status? A has held 30 percent of T stock (old & cold). A exchanges voting stock of A for the remaining 70 percent of T stock & liquidates. Under (now obsolete) Bausch & Lomb case A would be treated as obtaining 30% of T's assets for T stock, not A stock and not a "C" reorganization. See Rev. Rul. 67-274. The “solely for voting stock” requirement was not satisfied. But,(c)see Reg. § 1.368-2(d)(4). 4/30/2007 P. 60 30 Triangular Reorganizations Alternative structures: (see charts) 1. “A” Reorg. (§368(a)(1)(A)) & then an asset drop down to a subsidiary. §368(a)(2)(C). 2. Forward Triangular Merger. §368(a)(2)(D). 3. Parenthetical "B" Reorg. §368(a)(1)(B). 4. Parenthetical "C" Reorg. §368(a)(1)(C). 5. Reverse Triangular Merger. §368(a)(2)(E). 4/30/2007 (c) P. 61 Objectives of Triangular Reorganizations To satisfy business (i.e., non-tax) objectives. E.g., Parent avoids hidden liabilities in the transferred assets (through the isolation of the liabilities of Target into a separate subsidiary). E.g., to facilitate the acquisition of nontransferable assets (through maintaining the Target corporation’s separate existence). 4/30/2007 (c) P. 62 31 Structures of Triangular Reorganizations See the separate charts concerning the structuring of these triangular reorganization transactions. (Charts also available on W. UH Law Center/faculty website) 4/30/2007 63 Multi-Step Transactions Rev. Rul. 2001-26 §368(a)(2)(E) reverse triangular merger issue: Transaction: (1) tender offer of P stock for 51% of T’s stock, followed by (2) merger of P’s sub into T and remaining T shareholders receive P voting stock and cash combination (83%+ consideration is stock). (Alternative: Sub initiates the tender offer). Held: When segments are integrated at least 80% of the T stock was acquired for P stock & tax-free reorg. status is available (under §368(a)(2)(E)). 4/30/2007 (c) P. 64 32 Multi-Step Transactions Rev. Rul. 2001-46 (1) Purchaser’s wholly owned transaction sub merges into Target and then (2) Target merges into acquiring corporation. Holding: Step transaction treatment and therefore statutory merger into Purchaser and §368(a)(1)(A) reorg. treatment. Situation one: if not a step-transaction, would be qualified stock purchase for §338 purposes available. continued and asset basis step-up 4/30/2007 (c) P. 65 Multi-Step Transactions Rev. Rul. 2001-46, cont. Situation two: In an acquisition merger the Target shareholders receive solely acquiring corporation stock, and then an upstream merger of acquired corporation into the parent occurs. Qualifies as a §368(a)(2)(E) reorg. However, transaction is still treated as a single statutory merger qualifying under §368(a)(1)(A). 4/30/2007 (c) P. 66 33 Triangular Reorganizations Examples See the separate charts concerning the transactions in these problems. 4/30/2007 (c) P. 67 Acquisitive Reorganization Treatment of the Parties Consider tax treatment from tax-free corporate reorganization to: 1) Shareholders of Target Corporation 2) Acquiring Corporation & any Acquisition Subsidiary 3) Target Corporation 4/30/2007 (c) P. 68 34 Shareholder Consequences in a Reorganization §354 - no gain or loss on the share exchange. §358 - carryover/substituted stock basis. §1223(1) - tacked holding period. What if "boot"? §356(a) "excess securities" included as boot. §356(a)(1) & §356(d) Tax basis for any “boot” received - FMV. of boot? §356(a)(2).69 Tax "characterization” 4/30/2007 (c) P. Commissioner v. Clark Code §356(a)(2) Code §368(a)(2)(D) reorganization. Received 300,000 P shares and $3.25 mil. cash. Could have received 425,000 P shares. What is the Code §356(a)(2) applicability? 1) deemed pre-reorganization redemption of Target acquired shares (Shimberg case); or, 2) deemed post-reorganization redemption of acquiring corp. (P) shares (Wright case)? 4/30/2007 (c) P. 70 35 Characterization of Boot as Dividend or Capital Gain Boot dividend is limited to gain amount. Tax rate of 15% on both dividend and capital gain reduces tax significance, but: 1) Prefer dividends received deduction? 2) Boot gain received as installment notes – not if dividend characterization. 4/30/2007 (c) P. 71 Example (a) Merger “A” Reorganization Each shareholder receives 4,000 ($40,000) of voting common stock and nonvoting (not nonqualified) preferred stock worth $10,000. 1) Nontaxable - solely “stock for stock” §354(a) 2) Substituted basis. §358(a)(1) - $20,000 common-16,000; preferred - 4,000 3) Tacked holding period. §1223(1). 4) Preferred stock(c)- P.§306 stock. §306(c)(1)(B). 4/30/2007 72 36