Chapter 9 - Acquisitive
Concept of a “corporate
reorganization” - the exchange of an equity interest in the old corporation for
shares in the new corporation;
Effects of tax-free corporate
1) Corporate parties to
the transaction - no gain or loss on transfers of properties.
2) Exchanging shareholders
- no gain or loss.
3) Tax attributes
transferred to the acquirer.
(cf., Divisive Reorgs), p.415
One corporation acquires the
stock or assets of another corporation in exchange for stock of the acquiring
1) "A" reorganization
- statutory merger
2) "B" reorganization
- stock/stock exchange
3) "C" stock for
assets exchange, and
4) certain “triangular”
variants (e.g., using acquisition subsidiaries).
Judicial Limitations -
Tax “Common Law” p.415
1) “Business purpose”
2) Continuity of
interest (COI) (or ownership) requirement.
3) Continuity of
Note: a “step” or
“integrated” transaction rule or an “old and cold” rule also often applies.
Concepts of Tax-free Corporate
1) Limit on the character of
the consideration received - a proprietary interest in the acquirer. Must
be stock in the acquirer (cf., nonqualified preferred).
2) Substantially all the
transferor's properties must be acquired, i.e., the operating
“business” must be acquired.
3) A business purpose
(i.e., non-tax objective) for the transaction must exist.
Tax Code Provisions re Tax-free
§354 - no gain or loss is to be
recognized upon an exchange of shares by shareholders who are parties to
a reorganization. Cf., §351.
§361 - no gain or loss to the acquired
corporation. Also, §1032 for the stock issue.
§§356/357 - treatment of boot
received and liabilities assumed in the transaction.
§358/362(b) - substitute tax
§381 - carryover of tax
How Assure Tax-free
1) IRS Private Letter
Ruling – but, limited availability, unless a “significant issue.”
Rev. Proc. 2010-3.
Rev. Proc. 77-37 re guidelines for issuing corporate reorganization tax
Is this Rev. Proc.
2) Law firm tax opinion
Statutory Merger or
Shareholders of the target corporation receive shares of the acquiring
corporation as a result of a “statutory merger” of target into purchaser, i.e.,
under local law merger statute.
mergers of two existing corporations into a third (often new) corporation.
(i.e., not “acquisitive”)
Rev. Rul. 2000-5 – for
tax-free corporate reorganization treatment the merger must be acquisitive,
rather than divisive (i.e., subject to the §355 rules).
Mere compliance with the
local corporate law merger statute (i.e., calling the transaction a “merger”)
does not constitute a merger transaction as a tax-free corporate reorganization.
Mergers involving Disregarded
between a corporation and a disregarded entity.
A. Merger of a target
corporation into a disregarded entity (e.g., LLC) is treated as a
“merger” into another corporation.
B. Merger of an LLC
into a corporation does not qualify (since only divisional assets are
transferred, presumably not all of the assets of the transferor corp.,
owner of the LLC).
Continuity of Proprietary
Interest – Quantity Test
Southwest Natural Gas Co.
Merger of Peoples Gas into
Less than 1% of the
consideration received was paid in acquirer’s common stock. The remaining
portion was paid in bonds or cash.
Held: No “continuity of
The stock received was not
a substantial part of the value of the property transferred.
Rev. Rul. 66-224
50% of Consideration as Stock
Four 25 percent shareholders -
A & B received cash for their 25% interests;
C & D received stock for
their 25% interests.
Held: COI requirement was
requirement is satisfied if each shareholder received 1/2 cash and 1/2 stock
(total 50% in the form of stock as the consideration for the acquisition).
What Stock % is
1) Nelson case (Sup. Ct
– 1935) – 38% nonvoting preferred stock OK.
2 To obtain an IRS PLR
– Rev. Proc. 77-37 requires a 50% stock value issuance.
§1.368-1T(e)(2)(v), Example 1.
What is large firm
practice re a merger opinion?
What is “stock”? Cf., “nonqualified
preferred stock” (as “boot”?).
Other COI Issues:
1) Remote Continuity –
can assets be dropped down into subsidiaries by Acquirer and not violate COI
2) When to
measure COI text compliance?
- Day before the binding
contract if fixed number of shares.
- Alternative if
variable consideration, i.e., shares are increased if Acquirer’s share value
J.E. Seagram Corp.
case Reorg. Treatment p.425
Competing tender offers for
Conoco between Seagram and DuPont. Neither gets 50%.
DuPont then acquires the
remaining Conoco shares for DuPont stock (including Seagram shares – purchased
previously for cash).
Seagram claims a loss - but IRS
is successful in asserting that this was a reorganization (i.e.,
continuity of interest did exist).
Pre-deal trading not negating
the tax-free status.
Continuity by Historic Target
Kass v. Commissioner
p. 428, note 1
Squeeze-out upstream merger
after a cash stock acquisition in a tender offer and a prior 80% plus purchase
of Target’s stock.
5.82 percent of the outstanding
stock was not tendered but then subjected to a squeeze-out. This enabled
acquisition of the entire business.
Held: Not a merger -
even though the shareholder received exclusively shares of Acquirer.
Continuity of Interest (COI)
Reg. § 1.368-1(e)(1)(i).
Disposition of stock prior to a
reorganization to unrelated persons will be disregarded and will not affect
continuity of interest into the acquirer by exchanging party.
Requirement: exchange Target
stock for Purchaser stock to have at least 50 percent of the entire
consideration received being equity.
How long must the target
shareholders hold their stock in the acquiring corporation after their
What is the impact of a
pre-arranged stock sale commitment by majority shareholders?
The COI regulations focus on
exchanges between target shareholders and the purchaser corp.
Sales of stock by the former
target shareholders generally are disregarded (unless made to P).
Rev. Rul. 99-58 p. 431
Open Market Repurchase
(50/50 stock & cash) followed by open market reacquisitions of the
Purchaser’s stock (redemptions? § 302(b)(2)).
The purpose of the
reacquisition was to prevent stock ownership dilution for Purchaser.
No understanding that the P
share ownership by T shareholders would be transitory.
No impact on the COI status.
Continuity of Business
Enterprise (COBE) p.433
Bentsen v. Phinney
Corporation was engaged in land development business and transferred property
to a life insurance company.
Shareholders received stock of
Type of business carried on by
the survivor entity was the insurance business (acquirer).
No IRS private letter ruling re
Held: COBE requirement was
satisfied - need not engage in the same business – only some
business activity. Appropriate result in tax refund suit?
Rev. Rul. 81-25
Transferor Business Important
COBE requirement – per IRS:
Look to the business assets of
the transferor corporation (not the transferee
corporation) to determine whether the continuity of business enterprise (COBE)
test is satisfied in the acquisition transaction.
Reg. § 1.368-1(d)(1980).
Must look to the transferor's
historic business; no relevance to business of the Acquirer.
Continuity of Business
COBE regulations - Reg.
COBE requires that the issuing
corporation either continue the Target's historic business or use a
significant portion of the Target's historic business assets.
COBE requirement is not
violated if P transfers acquired T assets or stock to (1) controlled
subsidiaries or (2) a controlled partnership.
All Cash Merger
"All cash" merger -
valid under state law.
Lacks continuity of interest
(but does satisfy the §368(a)(1)(A) mechanical rules).
No continuing proprietary
interest exists (see Southwest Natural Gas).
Therefore, the transaction is
(i) Target (i.e., a cash asset
sale), and (ii) its shareholders (a §331 taxable liquidation).
the liability for the corporate tax?
Non-Voting Preferred Stock
T shareholders receive P non-voting
preferred stock in exchange for their T stock.
The “continuity of interest”
rule is satisfied.
This stock is a “proprietary
the nature of the equity
interest is not considered in an “A” reorganization.
But, cf., what result if “nonqualified
preferred stock” is received?
Commitment to Sell Stock
Shareholders holding 75% of
Target have a binding commitment to sell one week after the merger transaction
The only consideration received
is stock and, therefore, a tax-free merger has occurred.
But, what is the adverse impact
(if any) of the post-acquisition stock disposition? None (on other 25%). See
Reg. §1.368-1(e)(7), Example 1(i).
Target Assets Sold
P sells T’s assets
(after the merger and as part of the plan) to an unrelated party and uses
proceeds to expand another P business.
The COBE requirements are not
A significant line of T’s
business must be continued after the merger, and T’s business is not continued
Stock & Notes Received
Nonvoting preferred stock
($120,000) and notes ($180,000) are received in the merger.
40% of the
consideration received by T shareholders is P stock.
Is the continuity of interest
rule satisfied? (see Regs. - 40% test; 50% test under Rev. Proc. 77-37).
Nonrecognition to the
shareholders - except to the extent that they receive "boot” -
again assuming no nonqualified preferred stock.
P Stock Value Declines
As in (e) –stock (120,000) and
notes (180,000) but stock declines to 60,000 prior to closing. At closing stock
of 60,000 and notes of 180,000 equals 25% for stock. Invalidate tax-free
merger treatment (for the 60,000 stock)?
Reg. §1.368-1T(e)(2)(i) says value
deal measured on the last day before the binding contract – here 40% &
acceptable for continuity of interest test.
More Non-Stock Consideration
Nonvoting preferred worth
$100,000 is received and bonds worth $200,000 are received. Less than 50% of
the consideration received in the merger consists of P stock.
Does 331/3% stock consideration
represent an adequate continuity of proprietary interest? Kass - 5.82% not
sufficient to satisfy test.
Will the boot cause taxable
gain for all? Yes.
Convertible Debt (not Stock)
Facts: Bonds issued in the
exchange transaction are convertible into P nonvoting preferred stock.
feature of debt is to be disregarded for purposes of applying the
“continuity of interest” rule (unless the bonds are recharacterized as
Similarly, warrants will
not be treated as stock for this purpose.
Larger $ Stock Consideration
75% of shareholders owning 1/3
of the stock receive the notes worth $100,000 and 25% of the shareholders
owning 2/3rds of the stock receive P stock worth $200,000.
The “continuity of interest”
rule is satisfied.
Continuity measurement is by
reference to the pro-rata values of the consideration received and not
to the shareholder numbers.
See Rev. Rul. 66-224 (p.422).
“Old & Cold” Cash Purchase?
70% of T stock was acquired by
P for cash five years ago. T merges into P and the 30 percent minority
shareholders of T receive 20 percent stock and 80 percent cash.
Is this a “creeping A”
70 percent of the T stock is
“old and cold”.
holdings are counted - 70% continuity, plus a small percentage for the minority
(6%) and a qualifying “A” reorg. does occur.
Step Transaction & Cash?
A acquired 80 percent of T
stock six months ago in a tender offer for $240,000 cash. T merges into A and
the remaining shareholders receive $60,000 of P stock in exchange for
their T stock.
The 80% stock interest (for
cash) is not "old and cold”.
Only a 20% “continuity of
interest” results and, therefore, gain or loss recognition occurs to the minority
The “B” Reorganization -
Stock-for stock exchange
(completed at the Target shareholder level):
Step 1. A
stock exchange occurs between the Target shareholders and the Purchaser
Corporation (for P Shares).
Step 2. The
acquired Target Corporation becomes a subsidiary of the Purchaser as a result
of the stock acquisition transaction.
ITT/Hartford “No boot in a B”
Motion for Summary Judgment:
ITT as the Purchaser of
Hartford acquires 8% for cash and then an 80% exchange of “stock for stock”
Held: Cannot exclude the prior
acquisition for cash - if linkage exists. The 8% is not
essentially irrelevant. The entire payment must not contain any
On remand: are the two
Rev. Rul. 67-274
“C”, not a “B” Reorganization
1) Y corporation acquired X
corporation shares from X corporation shareholders.
2) Y corporation then
liquidated X corporation into Y Corp. & Y then conducted the X business.
Held: A step transaction - not
a "B" reorganization, but a "C" reorganization -i.e., a
“stock for assets” exchange.
Why differentiate between the
“B” and “C”?
Rev. Rul. 55-440
p.450 Preferred Previously Called
X corporation acquired Y
corp. common stock in exchange solely for X corp. common.
Y corp. voting preferred
was outstanding and the voting control test would not be satisfied.
But, preferred previously
called for redemption.
Held: Rights of the preferred
terminated upon the redemption call and shareholder rights transformed into a
claim for payment. Therefore, the preferred was not outstanding at the
time of exchange.
“B” Reorganization Limitations
No "boot" in a B
What if preferred only
votes in the event of dividend arrearages?
Is a fractional share cash-out
OK? Yes. Why?
Payment of target’s expenses by
acquirer (yes, but not expenses of the shareholders).
How to deal with the problem of
“B” Reorganizations- Contingent
Contingent stock arrangements
are acceptable (for B reorg. treatment) if:
1) Only additional stock can be
2) Five year limit is
3) Valid business reason, e.g.,
4) Maximum 50% of the deal
5) Contingent rights are not
6) No control by seller of
Cf., escrow arrangement –
Voting Preferred Received
Target shareholders receive
voting preferred with value of $1,000 per share (ten times the value of common
stock) & 1:1 voting rights.
Treated as solely “voting
Need not be common stock; can
receive voting preferred stock in the B reorganization.
What if substantially diluted
voting rights compared to common stock?
“Solely” Requirement Not Met
Transfer of 85% voting stock
and 15% warrants to Target shareholders.
Warrants are not voting
The “solely" for voting
stock requirement is violated and the transaction is not a
No "boot" is
permitted in a "B" reorganization.
Fractional Share Cash-out
Voting shares are received with
payment for the fractional
Assuming "not separately
bargained for" consideration, the “solely for voting stock” requirement is
The fractional share cash
received is treated as received from a separate §302 redemption distribution
(not under §356).
P pays T’s Expenses
P pays Target's legal and
related transaction fees in addition to issuing P voting common stock.
If related to the
reorganization: the solely for voting stock requirement is not
Why? Payment must be made
directly to the creditors, rather than to Target (per Rev. Rul. 73-54, p.
Problem 1(e) p.455
B Reorg Status Not Available
P pays attorney's fees incurred
by T's majority shareholders for legal and tax advice relating to the
This payment would constitute
"boot", i.e., consideration which is other than solely "voting
stock“ to the shareholders.
The amount is paid to the
shareholders (as shareholders), not on behalf of the Target corporation.
Dee Minimis is unwilling to
participate in transaction. Disregard Dee (a 5% minority shareholder) in the
acquisition transaction since Dee does not want to participate?
Yes, but then Dee is a minority
in Target & fiduciary
obligations are imposed on the majority towards the minority (under state
5% Shareholder Redeemed
1) T redeems Dee prior
to exchange with P.
The prior redemption does not
violate the “solely for voting stock” requirement.
2) Loan situation - is the P
loan bona fide?
a) if so, the arrangement
should be OK;
b) if not, the loan proceeds
constitute additional consideration, disqualifying the attempted “B”
P redeems Dee's P shares one
month after the exchange - pursuant to an oral understanding with Dee.
IRS would argue step
transaction treatment and that this transaction with Dee constitutes a
violation of the “solely for voting stock” B reorganization requirement.
Third Party Share Purchase
Majority shareholders of T buy
Dee's stock and then enter into an exchange with P.
This qualifies as a “solely for
voting stock” exchange.
Assuming: The cash did not come
from P but from the shareholders’ own funds.
And, no indirect funding from P
to the purchasing shareholders.
Creeping “B”? “Old & Cold”?
(1) P acquired 30% of T for
cash 5 years ago.
(2) Now P acquires the remaining
70% of T stock for P voting common stock in a single transaction (going above
Step transaction doctrine is not
The statute does permit
“creeping control,” i.e., the entire 80% voting stock interest need not be
acquired in one transaction.
P acquired 85% of T in a cash
tender offer one year ago. P acquires the remaining 15% from T
shareholders in exchange for P voting common shares.
A valid "B"
reorganization exists for the 15% T shareholders if that
acquisition is unrelated to the acquisition of the 85 percent for cash.
Prior 30% ownership. Staggered
acquisition of the remaining 70% occurs: 40% (for stock) in year one and 30%
(for stock) in year two.
1) The final 30%
acquisition (70 to 100%) should be a "B" reorganization transaction.
2) An issue exists whether the
earlier 40% transaction is integrally related to the later 30% stock
transaction (or is it a separate, ineligible transaction?). Reg. §1.368-2(c).
Intermediate Cash Purchase
Facts: An additional 40% is
acquired (for cash) and later the remaining 30% (from 70% to 100% ownership) is
acquired for stock.
Issue: Are (i) the cash
acquisition and (ii) the subsequent acquisition for stock (a) related or (b)
unrelated transactions? If unrelated, the 30% acquisition qualifies for “B”
reorg. treatment. But, not the 40% for cash transaction. If related - what
impact on 30%?
Purchase & Sale of T Stock
P bought 10% of T stock for
cash 1 year ago.
Then P sold the 10% interest to
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 the reacquisition from Friendly Bank.
The “C” Reorganization -The
Criteria for a valid
1) Voting stock of the
acquirer is received.
2) A transfer of “substantially
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).
The “Substantially All” Requirement p.457
IRS ruling position: 70% of
gross & 90% of net assets (for ruling purposes) are 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 (p.457) permitting the sale of 50%
of the historic assets if the cash proceeds are also transferred by Target
corporation to Purchaser.
Liquidation of the Target
§368(a)(2)(G) requires the
Target to distribute all its assets (including the shares of purchaser) in
Possible waiver of the
liquidation requirement can be obtained from the Service. Then treated as if
(1) the distribution to Target shareholders had occurred, and
(2) the assets were
then contributed to the capital of a new corporation.
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 the
prior Bausch & Lomb history.
Under the boot relation rule
the non-qualifying consideration cannot exceed 20% of the value of all of the
Reg. § 1.368-2(d)(4)(i) &
Problem 1(a) p.459
70% Operating Assets
T has $70,000 of operating
assets and $30,000 of cash and securities & A issues voting stock worth
$70,000. T liquidates (stock & cash).
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) has not been satisfied.
But, only non-operating
properties are retained and all assets transferred to shareholders in
Operating Assets Retained
A acquires (1) $40,000 (of a
total of $70,000) of the operating assets and (2) $30,000 of the investment
assets of Target in exchange for A voting stock.
T then liquidates, distributing
$70,000 of A stock and $30,000 of T’s operating assets.
Here, operating assets
have been retained by Target shareholders in the exchange and a failure
occurs to satisfy the "C" reorganization “substantially all”
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) re liability assumption.
What if $90,000 of liabilities?
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
Assumed liabilities are treated
as additional cash.
60% of assets are acquired for
stock and 40% for cash. The boot relaxation rule is not satisfied and
no “C” reorganization occurs.
“B” or “C” Reorg?
T owns (1) $70,000 of operating
assets and (2) $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
If no step
transaction: a valid "B” reorg?
If a step transaction:
a "C" reorganization? Yes?
T redeems 30% shareholders by
distributing operating assets rather than cash and investment
1) If the redemption is separate:
a "C" reorganization occurs (since then all assets are acquired in
2) If the redemption is not
separate: not a valid "C" reorganization, since
substantially all the assets are not transferred to P.
“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 re testing as a “C” reorganization.
The “solely for voting stock”
requirement is not satisfied. But, cf. Reg. §1.368-2(d)(4), Ex. 1
(see supp. charts)
1. “A” Reorg. (§368(a)(1)(A))
& then an asset drop down to a subsidiary. §368(a)(2)(C).
2. Forward Triangular Merger.
"B" Reorg. §368(a)(1)(B).
"C" Reorg. §368(a)(1)(C).
5. Reverse Triangular Merger.
Objectives of Triangular
To satisfy business (i.e.,
E.g., Parent avoids hidden
liabilities in the transferred assets (through the isolation of the
liabilities of Target into a separate sub).
E.g., to facilitate the
acquisition of non-transferable assets (through maintaining the Target
corporation’s separate existence).
E.g., to avoid shareholder
Structures of Triangular
See the separate charts
concerning the structuring of these triangular reorganization transactions.
(Charts available on W. Streng
UH Law Center/faculty website: corporate tax slides).
Objectives in multi-step
1) Achieve business
plan –including regulatory and financial accounting issues
2) Tax result based on
overall transaction basis
3) Relevance of Section
338/cash asset purchase transaction treatment.
Overall objective: (1)
get assets acquired; (2) then restructure to rationalize operations.
Rev. Rul. 2001-26 p.463
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)).
Rev. Rul. 2001-46 p.466
(1) Purchaser’s wholly owned
transaction sub merges into Target and then (2) Target merges into acquiring corporation.
Holding: Step transaction
treatment and therefore a statutory merger into Purchaser and §368(a)(1)(A)
Situation one: if not
a step-transaction, would be a qualified stock purchase for §338 purposes and
asset basis step-up would be applicable. continued
Rev. Rul. 2001-46, cont.
Situation two: In
an acquisition merger (1) the Target shareholders receive solely acquiring
corporation stock, and then (2) an upstream merger of the acquired corporation
into the parent occurs.
This transaction qualifies as a
§368(a)(2)(E) reorg. However, the transaction is still treated as a single
statutory merger qualifying under §368(a)(1)(A).
Rev. Rul. 2008-25 Supp.
1) P forms merger sub which
merges into T.
Consideration paid to T
shareholder is 10x cash and 90X P voting stock.
2) T then liquidates into P
(not a merger) & then P conducts the T business.
If separate: § 368(a)(2)(E) and
then §332 .
If integrated: Not an (a)(2)(E)
reorg since T does not hold substantially all properties.
Holding: not reorg &
purchase of stock under 338.
See the separate charts
concerning the elements of the transactions identified in these problems.
Treatment of the Parties
Consider the income tax
treatment from a tax-free corporate reorganization for the following parties:
1) The shareholders of
the Target Corporation
2) The Acquiring
Corporation & any Acquisition Subsidiary
3) The Target
Shareholder Consequences in a
§354 - no gain or loss to be
recognized on the share exchange.
§358 - carryover/substituted
§1223(1) - tacked holding
What if "boot"?
securities" treated as boot.
§356(a)(1) & §356(d)
Tax basis for any “boot”
received - FMV.
of boot? §356(a)(2).
Commissioner v. Clark
p. 474 (n. 10) Code §356(a)(2)
Received 300,000 P shares and
$3.25 mil. cash. Could have received 425,000 P shares.
What is the Code §356(a)(2)
1) deemed pre-reorganization
redemption of Target acquired shares (Shimberg case); or,
2) deemed post-reorganization
redemption of acquiring corp. (P) shares (Wright case)?
Characterization of Boot as
Dividend or Capital Gain
Boot dividend is limited
to the gain amount. §356(a)(2) - (dividend within gain)
Tax rate of 15% on both
dividend and capital gain reduces tax significance, but:
1) Prefer dividends
received deduction (DRD) – for a corporate shareholder?
2) Boot gain is
received as installment notes –
not if dividend
Basis and Holding Period for
Target Shareholders p.475
§358 – basis in the
property received is derived from the basis of the property transferred.
Boot takes a fair market
What about multiple “tax
lots”? – tracing or pro rata allocation? Allocation to each block of stock is
required. Average basis method not available – Cf., basis reporting by brokers
- §6045(g) regulations (effective in 2011).
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 total;
3) Tacked holding period.
4) Preferred stock - §306
p.477 Note & Not Stock Received
Shareholder receives voting
common stock plus a 20 year $10,000 interest bearing note (rather than the
Necessitates a Clark case
analysis re §302(b)(2) redemption status.
Treatment as if (1) each
shareholder received 1,000 shares and (2) subsequently transformed those shares
into the $10,000 note. continued
Problem (b) continued
Note & Stock Received
1) Each shareholder before
= $50,000 (1,000 shares are boot).
550,000 shares equals .909
2) After redemption:
(actual shares retained by each)
540,000 equals .741 percent.
3) 80% times .909% equals
§302(b)(2) is not
satisfied. But, is §302(b)(1) (“not essentially equivalent”) applicable?
p.477 High Tax Basis Limits Gain
Each shareholder has $45,000
basis in her T stock. Only a $5,000 amount of realized gain.
The recognized gain is limited
Tax character of gain – see the
Clark case analysis.
Notes have a $10,000 FMV
Stock has an exchanged basis.
less $10,000 equals $35,000, plus
- the $5,000 gain recognized
equals a $40,000 basis.
Problem (d) p.477
Notes Paid for Redemption
Two shareholders receive notes
The remaining shareholders
receive voting common stock worth $400,000.
1) Shareholders receiving
solely voting stock:
$20,000 substituted basis under
2) Shareholders receiving
Not boot, since no
received. Treated as §302 redemptions to each.
Boot & T has limited E&P
T had $50,000 E&P, not
is received as a dividend. §356(a)(2).
What is the amount of the
1) only $50,000 of T's
2) also the E&P of the acquiring
Cf., the §304(b)(2) result.
Assuming only T’s E&P to be relevant: $5,000 dividend and $5,000 gain from
stock sale or exchange.
Target Corporation p.478
Consequences - Issues
Income tax realization events:
1) Reorganization exchange
of its property for stock (and boot) (e.g., “A”, “C” or forward triangular
2) Distribution in
corporate liquidation of stock received (or boot) (or sale of stock prior to
the corporate liquidation).
Tax recognition on these events
Target Level Treatment
§361(a) - no gain or loss
recognized on the transfer of assets in the reorganization transaction.
§357(a) - assumption of the
target's liabilities is not treated as boot.
These rules apply to (1)
"A“ & "C" reorganizations, and (2) forward triangular
mergers; but, not for "B" reorganizations, or reverse triangular
mergers, since stock, not assets, acquired in those transactions.
- Tax Effects to the Target
No gain or loss is recognized
to Target when it distributes qualified property - §361(c).
requirement under §361(c) - stock of the other party in the reorganization.
Distribution of other than
“qualified property” - e.g., boot - gain recognition on the distribution is
required. §§361(c)(1) & (2) (but prior step-up when transferred by P)?
Corporation Consequences - Asset Deal
§1032(a) - issuance of its
shares by the acquiring corporation is not a taxable event.
Same result if issuance of debt
securities by the acquirer. But, other assets as “boot”?
Tax basis for assets received
§362(b) carryover from the
This relevant in acquisition of
“A” or “C” & forward
Corporation Consequences - Stock Deal
What tax basis result to a
Acquirer when receiving stock from the “seller” shareholders in exchange
for Acquirer stock?
If a "B"
reorganization (or reverse triangular?) - take shareholders’ tax bases.
Sampling is acceptable to
determine stock basis of the shareholders if multiple shareholders of the
Rev. Proc. 81-70 is under
What if issuance by sub of
parent's stock – constitute a transfer of appreciated property by the sub to
the target shareholders? No.
What tax basis to parent for
the target stock received in a triangular reorganization (i.e., merger of (i)
target into sub, or (ii) sub into target)?
Not basis of the stock of
subsidiary (often zero). Rather - treat as (i) an asset acquisition and (ii) an
asset drop down transaction into the sub.
Rev. Rul. 72-327 p.482
1) Recipient corporate
shareholder receiving dividend boot can obtain dividends received
deduction (under §243(a)).
2) FMV basis for the asset
received by shareholder as dividend boot.
3) Acquiring corporation using
appreciated property for acquisition recognizes gain on use of that appreciated
property (40x less 10 x equals 30x gain). Davis case. continued
Rev. Rul. 72-327
4) Acquirer’s E&P is
increased by the gain recognized.
5) Acquirer succeeds to
the Target’s E&P.
6) Corporate shareholder
receiving realized gain is required to recognize that gain to extent of boot
and to include that boot amount in its E&P.
P transfers voting stock worth
$80,000 in exchange for T's assets (fmv $100,000) subject to $20,000
liabilities, and T distributes shares. P - no gain on issuance of its stock -
§1032. P takes T’s E&P.
P takes assets with $60,000
basis - §362(b).
T has no gain recognition for
the $40,000 realized gain - §361(a). No gain recognition to T on the
liquidation distribution - §361(c).
Nonrecognition to T’s
shareholders & exchanged basis ($20,000) under §358(a)(1).
Cash Used for Liabilities
P transfers $80,000 of voting
stock and $20,000 of cash to T used to pay liabilities. C reorg & boot.
Stock is distributed in
Target - recognizes no gain on
transfer of its assets to P - §361(a) & (b)(1)(A). “C” Reorg.
T received $20,000 boot from P
but no recognition to P. §1032. Boot is distributed.
Distribution: No T gain on
distribution of P stock - all is qualified property - §361(c)(1).
Securities as “boot.”
1) P transfers (a) voting
stock worth $80,000 and (b) investment securities with a basis of $10,000 and a
value of $20,000 for all T's assets not subject to any liabilities. Gain of
$10,000 is recognized to P.
2) T immediately distributes
the consideration received. T recognizes no gain on receipt of boot
(§361(b)(1)(A)) but on the distribution of boot (if any gain,
probably not here).
3) Shareholders realize $80,000
gain & recognize $20,000 boot gain.
C Reorg & No Liquidation
1) P transfers $80,000 of its
voting stock, $10,000 of its bonds and $10,000 of cash to T in exchange for its
assets. T receives permission not to liquidate and retains the cash, bonds and
stock. P - no gain recognition for stock or securities.
2) T - waiver for
distribution? Treated as a constructive liquidation. T has no gain
recognition on the deemed distribution.
3) Shareholders receive boot
Two Types of Stock
P transfers $80,000 of voting
stock and $20,000 of nonvoting preferred stock to T in exchange for all of T's
assets. No debt.
T liquidates and distributes
the voting and nonvoting preferred (§306) stock to its shareholders prorata
& tax basis allocation.
P – no gain – under §1032.
No T gain on either its asset
transfers or the distribution of P stock. §361(a), (c)(1).
No gain recognition to the
Valid “C” reorganization?
P - no
gain on the distribution of P’s stock, but $8,000 gain on the transfer of the
Bell stock (& E&P increase by the $8,000).
T - no
gain on transfer of its operating assets.
T’s basis for the P stock is
Sale by T of $40,000 P stock -
gain to be recognized.
Target distribution to shareholders
– recognition ($22,000) for the Bell stock & the land (but not the P
Transfer of stock by T to
creditors as part of reorganization plan.
Code §361(c)(3) permits non-recognition of gain (i.e., $36,000 gain not
The transfer is treated as a
distribution to the shareholders, entitling T to nonrecognition under
E&P does not reflect the
Problem 3(a) p.485
Forward Triangular Merger
Formation of S - no gain.
P’s basis in its S stock -
equal to T’s basis in assets - $100,000.
S - no gain on its issuance of
its own stock.
S has no gain on its transfer
of P stock.
S takes T’s assets - $100,000
T’s shareholders - no gain
Problem 3(b) p.485
Reverse Triangular Merger
Parent - non-recognition on
formation of S.
P’s basis in S stock - adjusted
as if T had merged into S in a forward triangular merger.
S - No gain on S issuing its
own stock (§1032) or when transferring P stock to T (§361).
T – nonrecognition (T stock for
Shareholders – nonrecognition
when receiving P stock for T stock. §354(a)(1) & substituted basis.
Problem 3(c) p.485
Forward Triangular Merger
§368(a)(2)(D) – forward triangular.
Parent - non-recognition on
formation of S.
S - No gain on issuing its own
S gain when transferring P
stock to T.
T gain recognition on transfer
of its assets.
S §1012 cost basis for T’s assets.
T’s shareholders recognize 150x
cap. Gain and have 200x fmv basis for P stock held.
Problem 3(d) p.485
Reverse Triangular Merger
Parent - non-recognition on
formation of S.
S - No gain on issuing its own
S gain when transferring P
stock to T.
T transfers T stock for P stock
and no gain recognition - §1032.
End of Chapter 9 information