Chapter 7 Corporations: Reorganizations Corporations: Reorganizations Copyright ©2008 South-Western/Thomson Learning Corporations, Partnerships, Estates

Chapter 7Chapter 7

Corporations: Reorganizations

Corporations: Reorganizations

Copyright ©2008 South-Western/Thomson LearningCopyright ©2008 South-Western/Thomson LearningCopyright ©2008 South-Western/Thomson LearningCopyright ©2008 South-Western/Thomson Learning

Corporations, Partnerships,Corporations, Partnerships,Estates & TrustsEstates & Trusts

Corporations, Partnerships,Corporations, Partnerships,Estates & TrustsEstates & Trusts

C7 - 2Corporations, Partnerships, Estates & TrustsCorporations, Partnerships, Estates & Trusts

Reorganizations—In GeneralReorganizations—In General

• Refers to any corporate restructuring that may be tax-free under §368– To qualify, must meet certain general

requirements:• Must be a plan of reorganization• Must meet continuity of interest and continuity of

business enterprise tests• Must have a sound business purpose• Tax-free status can be denied under step transaction

doctrine

• Refers to any corporate restructuring that may be tax-free under §368– To qualify, must meet certain general

requirements:• Must be a plan of reorganization• Must meet continuity of interest and continuity of

business enterprise tests• Must have a sound business purpose• Tax-free status can be denied under step transaction

doctrine


Summary of Different Types of Reorganizations

Summary of Different Types of Reorganizations

• The term reorganization includes:– Statutory merger or consolidation

– Stock for stock exchange

– Stock for assets exchange

– Divisive exchange

– Recapitalization

– Change in identity, form, or place of organization

– Transfers in bankruptcy or receivership

• The term reorganization includes:– Statutory merger or consolidation

– Stock for stock exchange

– Stock for assets exchange

– Divisive exchange

– Recapitalization

– Change in identity, form, or place of organization

– Transfers in bankruptcy or receivership


Tax Free Reorganization Consequences, in General (slide 1 of 3)


• Consequences to Acquiring Corporation– No gain or loss recognized unless it transfers

property to the Target corporation as part of the transaction

• Then gain, but not loss, may be recognized

– Basis of property received retains basis it had in hands of Target corp plus any gain recognized by the target

• Consequences to Acquiring Corporation– No gain or loss recognized unless it transfers

property to the Target corporation as part of the transaction

• Then gain, but not loss, may be recognized

– Basis of property received retains basis it had in hands of Target corp plus any gain recognized by the target




• Consequences to Target Corporation– No gain or loss unless it retains “other

property” received in the exchange or it distributes its own property to shareholders

• Other property is defined as anything received other than stock or securities

– Treated as boot

• Gain, but not loss, may be recognized

• Consequences to Target Corporation– No gain or loss unless it retains “other

property” received in the exchange or it distributes its own property to shareholders

• Other property is defined as anything received other than stock or securities

– Treated as boot

• Gain, but not loss, may be recognized




• Consequences to Target or Acquiring Co. Shareholders– No gain or loss unless shareholders receive

cash or other property in addition to stock• Cash or other property is considered boot

– Gain recognized by the stockholder is the lesser of the boot received or the realized gain

– Basis of shares received is same as basis of those surrendered, decreased by boot received, increased by gain and dividend income, if any, recognized in the transaction

• Consequences to Target or Acquiring Co. Shareholders– No gain or loss unless shareholders receive

cash or other property in addition to stock• Cash or other property is considered boot

– Gain recognized by the stockholder is the lesser of the boot received or the realized gain

– Basis of shares received is same as basis of those surrendered, decreased by boot received, increased by gain and dividend income, if any, recognized in the transaction


Type A ReorganizationType A Reorganization

• Includes mergers and consolidations– Merger is union of two or more corporations

• One corporation retains it existence and absorbs the others

– Consolidation occurs when a new corporation is created to take the place of two or more corporations

• Includes mergers and consolidations– Merger is union of two or more corporations

• One corporation retains it existence and absorbs the others

– Consolidation occurs when a new corporation is created to take the place of two or more corporations


Type A Reorganization (slide 1 of 2)Type A Reorganization (slide 1 of 2)


Type A Reorganization (slide 2 of 2)Type A Reorganization (slide 2 of 2)


Type A Reorganization Issues(slide 1 of 2)

Type A Reorganization Issues(slide 1 of 2)

• Advantages:– Type A reorganization is flexible– Consideration need not be voting stock– Money or other property can be transferred

without disqualifying the transaction, as long as “continuity of interest” is met (at least 50% of consideration used in reorganization must be stock)

• Advantages:– Type A reorganization is flexible– Consideration need not be voting stock– Money or other property can be transferred

without disqualifying the transaction, as long as “continuity of interest” is met (at least 50% of consideration used in reorganization must be stock)


Type A Reorganization Issues (slide 2 of 2)

Type A Reorganization Issues (slide 2 of 2)

• Disadvantages:– Money or other property transferred is “boot”

so some gain may be required to be recognized– Shareholders of either entity may dissent; in

most states their shares must be redeemed– Acquiring entity must assume all liabilities of

Target

• Disadvantages:– Money or other property transferred is “boot”

so some gain may be required to be recognized– Shareholders of either entity may dissent; in

most states their shares must be redeemed– Acquiring entity must assume all liabilities of

Target


Type B Reorganization (Stock-for-Stock Reorganization)

Type B Reorganization (Stock-for-Stock Reorganization)


Type B Reorganization Requirements (slide 1 of 4)


• Corporation acquires stock of Target solely in exchange for its own voting stock (stock for stock)– Acquiring corporation must acquire “control”

of Target• Control is ownership of at least 80% of all classes of

stock of target

• Acquirer may add shares owned previously with shares acquired in reorganization

• Corporation acquires stock of Target solely in exchange for its own voting stock (stock for stock)– Acquiring corporation must acquire “control”

of Target• Control is ownership of at least 80% of all classes of

stock of target

• Acquirer may add shares owned previously with shares acquired in reorganization




• Acquiring corporation may acquire shares from either:(1) Shareholders of Target, or(2) Directly from Target

• Exception to the “solely for voting stock” requirement when shareholders must receive fractional shares– May receive cash rather than fractional shares

in the acquiring corporation

• Acquiring corporation may acquire shares from either:(1) Shareholders of Target, or(2) Directly from Target

• Exception to the “solely for voting stock” requirement when shareholders must receive fractional shares– May receive cash rather than fractional shares

in the acquiring corporation




• Example: Assume Target has 100 shares outstanding:– Acquirer may obtain 80 shares from current

Target shareholders in exchange for Acquirer’s voting stock

– Target may also issue 400 new shares to Acquirer in exchange for Acquirer’s voting stock (500 shares would be outstanding)

• Example: Assume Target has 100 shares outstanding:– Acquirer may obtain 80 shares from current

Target shareholders in exchange for Acquirer’s voting stock

– Target may also issue 400 new shares to Acquirer in exchange for Acquirer’s voting stock (500 shares would be outstanding)




• Consideration paid by Acquirer can only include Acquirer’s voting stock or transaction does not qualify

• Consideration paid by Acquirer can only include Acquirer’s voting stock or transaction does not qualify


Type C Reorganization (Stock-for-Assets Reorganization)

Type C Reorganization (Stock-for-Assets Reorganization)


Type C Reorganization Requirements (slide 1 of 3)


• A ‘‘Type C’’ reorganization is essentially an exchange of voting stock for assets followed by liquidation of the target corporation– Called a “Stock-for-Assets” reorganization– Transfer is generally between the entities, not

the shareholders

• A ‘‘Type C’’ reorganization is essentially an exchange of voting stock for assets followed by liquidation of the target corporation– Called a “Stock-for-Assets” reorganization– Transfer is generally between the entities, not

the shareholders




• Consideration paid by Acquirer normally consists only of voting stock– However, if at least 80% of FMV of Target is

acquired with voting stock, cash or other property can be used for remainder

– Limitation: liabilities assumed by Acquirer are considered “other property” if any additional “other property” is used

• Consideration paid by Acquirer normally consists only of voting stock– However, if at least 80% of FMV of Target is

acquired with voting stock, cash or other property can be used for remainder

– Limitation: liabilities assumed by Acquirer are considered “other property” if any additional “other property” is used




• “Substantially all” of Target’s assets must be transferred to Acquirer

• There is no statutory definition of ‘‘substantially all’’– To receive a favorable ruling from the IRS, the

target must transfer at least 90% of net asset value or 70% of the gross asset value to the acquiring corporation

• “Substantially all” of Target’s assets must be transferred to Acquirer

• There is no statutory definition of ‘‘substantially all’’– To receive a favorable ruling from the IRS, the

target must transfer at least 90% of net asset value or 70% of the gross asset value to the acquiring corporation


Type D Reorganization (slide 1 of 4)


• Generally a mechanism for corporate division– Called a “divisive reorganization” but can be

used to carry out a corporate combination– In a Type D acquisitive reorganization

• Entity transferring assets is considered the acquiring corporation

• Corporation receiving the property is the target

• Generally a mechanism for corporate division– Called a “divisive reorganization” but can be

used to carry out a corporate combination– In a Type D acquisitive reorganization

• Entity transferring assets is considered the acquiring corporation

• Corporation receiving the property is the target




• In an acquisitive Type D reorganization– Substantially all of acquiring corp’s property

must be transferred to target corporation– The acquiring corp must be in control (at least

50%) of the target– Target stock received by the acquiring corp and

any remaining assets of acquiring corp must be distributed to its shareholders

– Acquiring corporation must liquidate

• In an acquisitive Type D reorganization– Substantially all of acquiring corp’s property

must be transferred to target corporation– The acquiring corp must be in control (at least

50%) of the target– Target stock received by the acquiring corp and

any remaining assets of acquiring corp must be distributed to its shareholders

– Acquiring corporation must liquidate




• In a divisive Type D reorganization– A corporation is divided– One or more new corps are formed to receive

assets of original corp– Original corp must receive stock representing

control (80%) of new corps– Stock of new corps is then distributed to

shareholders of original corp

• In a divisive Type D reorganization– A corporation is divided– One or more new corps are formed to receive

assets of original corp– Original corp must receive stock representing

control (80%) of new corps– Stock of new corps is then distributed to

shareholders of original corp




• Three types of divisive “Type D” reorganizations– Spin-Off and Split-Off

• A new corporation is formed to receive some of the assets of the original corporation in exchange for the new corporation's stock

– Split-Up• Two or more corporations are formed to receive

substantially all of the assets of the original corporation

• Three types of divisive “Type D” reorganizations– Spin-Off and Split-Off

• A new corporation is formed to receive some of the assets of the original corporation in exchange for the new corporation's stock

– Split-Up• Two or more corporations are formed to receive

substantially all of the assets of the original corporation


Type D ReorganizationSpin-Off (slide 1 of 2)






Type D Reorganization Split-Off (slide 1 of 2)






Type D Reorganization Split-Up (slide 1 of 2)






Type E Reorganization (slide 1 of 2)


• Type E reorganization is a recapitalization– Involves a major change in character and

amount of outstanding stock, securities, or paid-in-capital

• The following exchanges qualify: – Bonds for stock– Stock for stock– Bonds for bonds

• Type E reorganization is a recapitalization– Involves a major change in character and

amount of outstanding stock, securities, or paid-in-capital

• The following exchanges qualify: – Bonds for stock– Stock for stock– Bonds for bonds




• Corporation can exchange its common stock for preferred stock or its preferred stock for common stock tax-free– The exchange of bonds for other bonds is tax-

free when the debt received has a principal amount that is not more than the surrendered debt’s principal amount

• Corporation can exchange its common stock for preferred stock or its preferred stock for common stock tax-free– The exchange of bonds for other bonds is tax-

free when the debt received has a principal amount that is not more than the surrendered debt’s principal amount


Type F ReorganizationType F Reorganization

• A mere change in identity, form, or place of organization, however effected– Restricted to a single operating corporation– Tax characteristics of predecessor corp carry

over to successor corp– Does not jeopardize status of §1244 stock or

terminate a valid S corp election

• A mere change in identity, form, or place of organization, however effected– Restricted to a single operating corporation– Tax characteristics of predecessor corp carry

over to successor corp– Does not jeopardize status of §1244 stock or

terminate a valid S corp election


Type G ReorganizationType G Reorganization

• All or part of assets of debtor corp are transferred to an acquiring corp in bankruptcy – Debtor corp’s creditors must receive voting

stock of the acquiring corp in exchange for debt representing 80% or more of total FMV of debt of debtor corp

• All or part of assets of debtor corp are transferred to an acquiring corp in bankruptcy – Debtor corp’s creditors must receive voting

stock of the acquiring corp in exchange for debt representing 80% or more of total FMV of debt of debtor corp


Judicial Doctrines (slide 1 of 2)Judicial Doctrines (slide 1 of 2)

• Besides meeting specific requirements of reorganization, several judicially created doctrines must be met – Reorganization must exhibit a sound business purpose

• Not a well defined test

– Continuity of interest test• IRS deems this test met if shareholders of Target receive stock

in Acquirer equal to at least 50% of their prior stock ownership in Target stock

• Besides meeting specific requirements of reorganization, several judicially created doctrines must be met – Reorganization must exhibit a sound business purpose

• Not a well defined test

– Continuity of interest test• IRS deems this test met if shareholders of Target receive stock

in Acquirer equal to at least 50% of their prior stock ownership in Target stock


Judicial Doctrines (slide 2 of 2)Judicial Doctrines (slide 2 of 2)

– Continuity of business enterprise test• Requires the acquiring corp to either:

– Continue the Target’s historic business, or

– Use a significant portion of Target’s assets in business

– Step transaction doctrine• Ensures that a series of transactions are not used to obtain tax

benefits that would be unavailable if the transaction were accomplished in a single step

• IRS generally views any transactions occurring within one year of reorganization as part of the restructuring

– Continuity of business enterprise test• Requires the acquiring corp to either:

– Continue the Target’s historic business, or

– Use a significant portion of Target’s assets in business

– Step transaction doctrine• Ensures that a series of transactions are not used to obtain tax

benefits that would be unavailable if the transaction were accomplished in a single step

• IRS generally views any transactions occurring within one year of reorganization as part of the restructuring


Carryover of Corporate Tax Attributes (slide 1 of 4)


• Assumption of liabilities– Acquiring corp either assumes liabilities of

Target or takes property subject to liabilities

• Allowance of Carryovers– In Type A, C, acquisitive D, and G

reorganizations, the Target’s tax attributes are acquired

– In Type B reorganizations, Target retains its assets and tax attributes

• Assumption of liabilities– Acquiring corp either assumes liabilities of

Target or takes property subject to liabilities

• Allowance of Carryovers– In Type A, C, acquisitive D, and G

reorganizations, the Target’s tax attributes are acquired

– In Type B reorganizations, Target retains its assets and tax attributes




• NOL Carryovers– Amount of NOL that can be used in year

ownership change occurs is limited to a percentage representing the remaining days in the tax year over the total number of days in the year

• NOL Carryovers– Amount of NOL that can be used in year

ownership change occurs is limited to a percentage representing the remaining days in the tax year over the total number of days in the year




• NOL Carryovers (cont’d)– NOL can be further limited in first and succeeding

years when there is a more than 50-percentage-point ownership change

• An ownership change takes place on the day (change date) that either an equity structure shift or an owner shift occurs

– An equity structure shift occurs when a tax-free reorganization causes an owner shift

– An owner shift is any change in the common stock ownership of shareholders owning at least 5%

– NOL can be used to the extent of the value of the loss corp’s stock on the date of the ownership change multiplied by the long-term tax-exempt rate

• NOL Carryovers (cont’d)– NOL can be further limited in first and succeeding

years when there is a more than 50-percentage-point ownership change

• An ownership change takes place on the day (change date) that either an equity structure shift or an owner shift occurs

– An equity structure shift occurs when a tax-free reorganization causes an owner shift

– An owner shift is any change in the common stock ownership of shareholders owning at least 5%

– NOL can be used to the extent of the value of the loss corp’s stock on the date of the ownership change multiplied by the long-term tax-exempt rate




• Earnings and Profits– Positive E & P of acquired corp carries over– E & P of a deficit corp are deemed received by

acquiring corp as of change date • Deficit may only be used to offset E & P

accumulated by successor corporation after the change date

• Earnings and Profits– Positive E & P of acquired corp carries over– E & P of a deficit corp are deemed received by

acquiring corp as of change date • Deficit may only be used to offset E & P

accumulated by successor corporation after the change date


Type Advantages Disadvantages

A. Merger/ Consolidation

Consideration need not be voting stock

State law may give dissenters rights or require s/holder mtgs.

Up to 50% of consideration can be in cash

All liabilities of Target are assumed by Acquirer


A. Merger/ Consolidation

Consideration need not be voting stock

State law may give dissenters rights or require s/holder mtgs.

Up to 50% of consideration can be in cash

All liabilities of Target are assumed by Acquirer

Comparison of Reorganization Types (slide 1 of 5)






B. Stock-for- Stock

Stock can be acq’d from shareholders

Only voting stock of Acquirer can be used

Procedures are not complex

Must have 80% control of Target -May have minority after reorg.


B. Stock-for- Stock

Stock can be acq’d from shareholders

Only voting stock of Acquirer can be used

Procedures are not complex

Must have 80% control of Target -May have minority after reorg.





C. Stock-for-Assets

Less complex as to state law than “A”

“Substantially all” assets of Target must be transferred

Cash or property are OK consideration if 20% or less of FMV of property transferred

Liabilities count as “other property” for 20% test if any other consideration used. Target must distribute assets rec’d to s/holders


C. Stock-for-Assets

Less complex as to state law than “A”

“Substantially all” assets of Target must be transferred

Cash or property are OK consideration if 20% or less of FMV of property transferred

Liabilities count as “other property” for 20% test if any other consideration used. Target must distribute assets rec’d to s/holders




Type Advantages

D. Division (generally)

Permits corporate division without tax consequences if no boot is involved

E. Recapitalization Allows for major change in makeup of shareholders’ equity without gain recognition requirement

Type Advantages

D. Division (generally)

Permits corporate division without tax consequences if no boot is involved

E. Recapitalization Allows for major change in makeup of shareholders’ equity without gain recognition requirement




Type Advantages

F. Change in form, identity, or place of organization

Survivor is treated as same entity as predecessor; tax attributes of predecessor can be carried back or forward

G. Court approved reorganization

Creditors can exchange notes for stock tax-free and state merger laws need not be followed

Type Advantages

F. Change in form, identity, or place of organization

Survivor is treated as same entity as predecessor; tax attributes of predecessor can be carried back or forward

G. Court approved reorganization

Creditors can exchange notes for stock tax-free and state merger laws need not be followed

Documents

Chapter 7 Corporations: Reorganizations Corporations: Reorganizations Copyright ©2008 South-Western/Thomson Learning Corporations, Partnerships, Estates