Chap.11 - Nonacquisitive & Nondivisive Reorgs. p.562
§368(a)(1)(D) - Liquidation- reincorporations
§368(a)(1)(E) - Recapitalizations
§368(a)(1)(F) - Change in Form or Place of Incorporation
§368(a)(1)(G) - Insolvency Reorganizations
Recapitalizations
§368(a)(1)(E) p.562
Rearrangement of a single corp’s capital structure. Business objectives for a recapitalization:
1) improve the debt/equity ratio by shifting from debt into equity ownership - i.e., a downstream recapitalization.
2) change the shareholder ownership relationships between the preferred and common shareholders - e.g., an upstream recapitalization (some shareholders acquiring preferred stock).
Rev. Rul. 82-34 p.562
COBE & COI Not Relevant
"Continuity of business enterprise" (COBE) is not a requirement to have “E” corporate reorganization treatment.
Similar treatment to Rev. Rul. 77-415 that "continuity of shareholder interest" (COI) is also not required in an “E” reorganization.
But, a business purpose is required.
This result is not impacted by the 1998 COI and COBE regulations.
Types of Corporate “Recapitalizations” p.563
1) A shift from debt into equity is tax-free. But, recognition is required of the accrued interest element. See §354 (bondholder) & §1032 (corp), but also §108 (re COD income).
2) An exchange of bonds for new bonds. No gain recognition occurs except (a) for bonds received for accrued interest, or (b) if the principal amount of the bonds is increased. §354(a)(2)(A) & (B).
Continued - Corporate “Recapitalizations” p.565
3) Stock for stock exchanges: (a) exchange preferred and receive common; or,
(b) exchange common and receive preferred.
Applicable additional Code provisions:
§§354, 356 & 358 (shareholder)
§1032 & §1036 (stock issuances/exchanges)
§305(c) (increase in proportionate share interest) & §306 stock (bailout effect?).
Rev. Rul. 84-114 p.567
Preferred and cash received
Nonvoting preferred stock and cash are received in an integrated transaction in exchange for common shares (in an “E” reorganization).
Is the cash “boot” received a "dividend equivalent" for §356(a)(2) purposes?
Held: Not a dividend since the requirements of §301(b)(1) (no dividend equivalency) are satisfied here (and, therefore, no §356(a)(2) dividend distribution effect). See Davis case.
Bonds Received & Stock Transferred - Bazley case
For old shares shareholders received new shares and also callable debenture bonds.
Significant "earned surplus" (e&p) existed.
IRS asserts income to the extent of bonds.
Taxpayer asserts the securities were received in a tax-free corporate reorganization.
Held: Receipt of the (callable) debenture bonds was equivalent to the receipt of a cash dividend (i.e., an accumulated earnings distribution).
Problem 1(a) p.573
Exchange transaction.
Results to shareholders on this exchange:
1) "E" reorganization treatment.
2) No gain recognition to the shareholders on the exchange. §354(a)(1).
3) Substituted basis - §358(a)(1) - 1/3 for preferred and 2/3 for common stock
4) Tacked holding period. §1223(1).
5) Preferred stock received is §306 stock.
Problem 1(b) p.573
Preferred stock is called
Tax results when the preferred stock is called:
1) §306(a)(2) redemption.
2) $10,000 §301 distribution to each shareholder (assuming e&p is at the $100,000 level).
3) Reduction of the corp’s e&p to zero. §312(a)(1).
4) Tax basis previously allocated from the common to the preferred stock is allocated back to the common stock.
Problem 1(c) p.573
Sale of the Preferred Shares
A Code §306(a)(1) "ordinary income" transaction occurs, as measured by reference to the allocable e&p at the time of the preferred stock issuance.
No DRD is available to a corporate recipient.
15% taxation on the amount received.
Any excess over $10,000 is treated as:
i) tax basis recovery, and ii) capital gain.
No e&p reduction occurs (even though deemed “dividend” treatment for §1(h)(11)).
Problem 1(d) p.574
E&P Deficit Upon Issuance
An e&p deficit existed at the time of the distribution of the shares by the corporation.
The preferred stock would not be §306 stock.
i) Treatment of the stock redemption when occurring would be determined under §302.
ii) The share sale would produce capital gain (after tax basis recovery).
Problem 2 p.574
Stock & Debt Issuance
Each shareholder exchanges $50,000 of fmv common ($10,000 basis) for (1) $25,000 common and (2) $25,000 bonds. Corp has $250,000 E&P.
An “E” reorganization presumably occurs.
The securities are “boot.” §356(a)(1)&(d)(1).
Each shareholder must recognize $25,000 of the $40,000 of gain realized in the exchange.
The pro-rata distribution is classified as a dividend distribution.
Problem 3(a) p.574
Debt Principal Is Reduced
Leverage issued 8% bonds: $1 million face value and $800,000 current FMV. Leverage redeems for new 12% $800,000 (face value and FMV) bonds.
“E” Reorganization? Yes; OK for a bond-for-bond exchange since the principal amount does not exceed the $1million principal amount for the securities surrendered (and no accrued interest?).
COD income to Leverage Corp.? Yes ($200,000, unless insolvent - §108).
Problem 3(b) p.574
Debt Principal Increased
12% bonds with $800,000 face value are redeemed for 8% bonds (lesser rate) with face amount of $1 million; both bond packages have same FMV.
§356(d)(2)(B) says the fair market value of the excess principal amount is treated as taxable "boot" under §356(a)(1) if the securities have realized gain. If held by the shareholders then §356(a)(2) dividend?
Excess is $200,000; The FMV of this excess is $160,000. Therefore, $40,000 of OID. §1272.
Problem 4 p.574
Receipt of stock for bonds
Exchange of bonds transferred for the receipt of stock by shareholder is treated as an “E” reorg.
This is a "downstream" recapitalization.
A nonrecognition event occurs to the old security holders/new shareholders. Reg. §1.368-2(e), Ex. 1.
Business objective of this transaction: To improve the corporation’s debt/equity ratio.
Does the corporation have COD income? See §108(e)(8) (is the stock value less than the principal amount of debt?).
“D” Reorg. “Liquidation-Reincorporation” p.574
Two alternative structures (involving two corporations & similar shareholder groups):
1) Operating assets are transferred to the acquiring corp. for cash; the selling corporation then liquidates with a cash distribution to its shareholders.
2) All assets are distributed to the shareholders - then the shareholders infuse only operating assets into a new corporation.
Smothers case p.574
Transfer of Operating Assets?
IUS liquidated and then the operating assets (15 percent of the FMV) were inserted into TIL.
§331(a)(1) cap gain liquidation to the shareholders?
IRS characterized the transaction as a "D" reorganization with §356(a)(2) boot being received.
Held: The ”substantially all" test was satisfied and (1) characterization of the transaction as a “D” reorg. resulted, & (2) dividend distribution treatment under §356(a)(2) for non-business assets.
Nondivisive Reorganizations - Summary p.583
Objective: Extract cash from corp. on capital gains basis and retain the business operations in another corporation format.
Structures: 1) Liquidate and then reincorporate the operating assets; or,
2) Transfer assets to a new sub, and distribute the new stock sub and other assets to shareholders.
Now: use 1) and infuse business assets into an LLC?
Note re: “all cash D reorganizations” at p. 584.
Problem 1 p.586
Common Ownership - 2 Corps
Shareholders have $200,000 basis in Brother stock.
Brother corporation has operating assets with a $500,000 value ($200,000 basis) and $200,000 of cash (total FMV $700,000) and $200,000 of earnings and profits. Sister corporation has $300,000 of E&P.
Sister purchases Brother’s operating assets for $500,000 cash and Brother then liquidates.
Boot of $700,000 to the Brother shareholders? And income to extent of $500,000 gain? & dividend treatment? (and how measured – both corps E&P?)
Problem 2 p.586
All Cash D Reorg Transactions
Dividend effect to A?
Yes, unless a waiver of the attribution of ownership rules occurs? Reg. §1.368-2T(l)(3), Ex. 2.
Control of S through the family attribution rules.
See Code §368(a)(2)(H)(i) and §304(c).
Are §§368(a)(1)(D) and 354(b)(1)(B) satisfied even through no S stock is actually issued?
$1 million cash distributed to A & dividend effect (but 15% dividends tax rate presently)?
§356(a)(2) boot distribution is deemed to occur.
“F” Reorganization
p.586
Mere change in identity, form or the place of corporate organization of one corporation.
Often used to change the place of corporate organization (e.g., to Delaware). Why to Delaware?
Prior attempt to blend multiple corporations together in an "F" reorganization - the potential use of §381(b) in this context has been eliminated.
F reorg. treatment is limited to one corp.
Rev. Rul. 96-29 p.588
Part of Step Transaction - OK
Two transactions involving stock offering or acquisition - place of organization changed.
Situation One: Change to Delaware (?) and then issuance of significant additional stock in a public offering. Merger into new corp. & then stock sale.
Situation Two: Forward triangular merger and the selling shareholder received new preferred stock of Corp which then changed its place of organization by merger into corporation in an other state.
Problem p.590
Change State of Organization
Change of corporate status from California to Arizona by an asset transfer in exchange for stock and then the liquidation of the old corporation.
"F" reorganization status.
Also "D" reorganization qualification?
Mechanically accomplished as (1) a §351 drop down and (2) a §331 liquidation.
Why not a merger for achieving more efficient property transfers?
Insolvency Reorganizations
§368(a)(1)(G) p.590
Transfer of assets to another corporation in a bankruptcy restructuring. Liquidations are not bankruptcy reorganizations.
What relevance of the “substantially all" test for purposes of transferring assets? OK here to transfer assets to pay creditors.
The “continuity of interest” test must be satisfied.
Short-term creditors may be counted for purposes of satisfying the “continuity of interest” rule.
Insolvency Reorganizations
§368(a)(1)(G), continued
Taxation to the shareholder or debt holder who receives an increased amount of debt securities.
Creditor receives interest income to the extent securities received are for unpaid interest on the securities surrendered.
Possible shifting of the NOL carryover to the corporation acquiring the assets.
No recognition to the transferring corporation on asset transfers; carryover tax basis for assets.
Problem p.596
Acquirer’s Stock to Creditors
Valid G reorganization since the debtor transfers all assets and then distributes the stock of Relief.
Lenient standards for “continuity of interest.” Creditors are treated as equity owners.
Debtor’s shareholders receive nothing - a §165(g) LTCL on their stock (equal to their tax basis).
Security holders exchange $100,000 of securities for $50,000 stock. No loss recognized & $100,000 basis.
Trade creditors - $50,000 bad debt loss (no §354).
Debtor corp: Unrecognized COD income. NOLs?