More Tax-Free Reorganizations

More tax-free reorganizations � §368(a)(1)(B) • acquisition of stock in exchange solely for voting stock of acquiring corporation or its parent � §368(a)(1)(C) • acquisition of substantially all of the properties of another corporation in exchange solely for voting stock of acquiring corporation or its parent Type B: Stock-for-Stock Exchange � Acquiring corporation exchanges its stock for stock of Target, Target becomes a subsidiary of the acquiring corporation • Keeps Target intact and avoids having to transfer title to Target's assets � Disadvantage is no consideration other than stock is allowed or the transaction will not qualify as a reorganization • In tax jargon, "no boot in a B" � Easy to inadvertently include some unintended compensation (such as the acquiring corporation paying some liability of Target) that causes the deal to become taxable. Normal “B” Reorganization � Example: • T has assets with a basis of $100 (inside basis) and FMV of $200. • A pays T’s shareholders with A shares. • T’s shareholders have a basis (outside basis) in T stock = $80. Normal “B” Reorganization - Results � T Corp • No gain or loss on the exchange • T’s basis in its assets remain the same ($100) • Tax attributes generally not affected (ability to use in the future may be limited) � A Corp • Basis in T stock = Basis which T’s old shareholders had in stock ($80) � T’s Shareholders • No gain or loss on the exchange of stock • Basis in A stock = Basis in old T stock ($80) Subsidiary “B” Reorganization � Only a first-tier subsidiary may act as the acquiring corporation � The subsidiary can subsequently “drop-down” the acquired target to lower level “controlled corporations” with no tax consequences • Note: drop-downs to partnerships (even if corporation is the majority owner) is not allowed � A’s basis in S is increased by the carryover basis of T shares in S’s hands “Solely for Voting Stock” Rule � Exceptions: • • Redemptions by T -- T may redeem up to 50% of its own stock (e.g., for cash) prior to the “B” without destroying reorganization # “50%” limitation is needed to preserve “continuity of shareholder interests” requirement # T must use its own resources -- debt which is later repaid by a cash infusion from A will destroy “B” Payments to dissenters -- In cases of forced “B”, state laws may provide for dissenters rights. # T payoffs will not destroy “B”. (treated like redemptions) “Solely for Voting Stock” Rule, continued � Exceptions: • Cash for fractional shares -- If A pays T shareholders cash instead of issuing fractional shares, it will not violate the “solely for stock” rules • A’s acquisition of T debentures -- If A acquires T’s debentures (bonds, etc.) this exchange will normally be viewed as a distinct transaction from the “B” -- A can use any form for payment without nullifying “B” Step-Transaction Doctrine � What if A had previously acquired T stock for cash or property -- can it acquire the remaining T stock in a “B” reorganization? • Key question: Is the second step a separate transaction from the first step? # Based on A’s intent (subjective) and partly on the passage of time # Periods of 12 months or less are generally not sufficient Type C: Stock-for-Assets � Acquiring corporation exchanges its stock for "substantially all" of the assets of Target • Target is liquidated • Stock of acquiring corporation is distributed to Target's shareholders � Up to 20% boot allowed as consideration Normal “C” Reorganization � “substantially all” of T’s assets must be acquired solely in exchange for A voting stock � An assumption of T’s liabilities will generally be disregarded � T’s liquidation as part of the plan of reorganization is a requirement Normal “C” Reorganization � Example: • T has assets with a basis of $100 (inside basis) and FMV of $200. • A pays T with A shares. • T’s shareholders have a basis (outside basis) in T stock = $80. Normal “C” Reorganization - Results � T Corp • No gain or loss on the exchange � A Corp • Carryover basis in T’s assets ($100) • Acquires T’s tax attributes (ability to use in the future may be limited) � T’s Shareholders • No gain or loss on the exchange of stock • Basis in A stock = Basis in old T stock ($80) Subsidiary “C” Reorganization � Only a first-tier subsidiary may act as the acquiring corporation � The subsidiary can subsequently “drop-down” the acquired target to lower level “controlled corporations” with no tax consequences • Note: drop-downs to partnerships (even if corporation is the majority owner) is not allowed � A’s basis in S is increased by the carryover basis of T’s assets in S’s hands The “Substantially All” Requirement � IRS’s position is that “substantially all” of T’s assets means: • 90% of the FMV of T’s net assets (gross assets less liabilities) and • 70% of the FMV of T’s gross assets � Redemptions or spin-offs by T shortly before A acquires T’s assets in a “C” reorganization are taken into account in determining whether A acquires substantially all of T’s assets The Liquidation Requirement � The general rule states that T must liquidate as part of a plan of reorganization qualifying as a “C” � Very limited exceptions exist which allow the company to distribute its assets but to retain its corporate charter and the minimum (state) required capital • T has a license to operate (bank or insurance company) which was not “sold” in the reorganization “Boot Permitted” � Limited use of “boot” is permitted in a “C” reorganization Boot plus T’s liabilities transferred plus the FMV of any of T’s assets not transferred to A must be less than or equal to 20% of the FMV of T’s total assets Treatment of goodwill and other intangibles � Since reorganizations are not "purchases" for tax purposes no goodwill (or other purchased intangibles) is recorded • No assets are stepped up in basis, therefore, there are no future tax deductions associated with the purchase price � Financial accounting treatment • Because tax basis is lower than book basis for acquired assets, deferred tax liabilities are also recorded for the tax effect of the book-tax difference • These DTLs reflect the fact that future depreciation will be higher for book than tax