Chapter 13
Corporate Acquisitions, Mergers and Divisions
Two basic questions when one corporation decides to purchase another corporation.
Should the transaction be structured as a purchase of assets or a purchase of stock?
Should the transaction be structured as taxable or tax deferred?
Asset Acquisitions
All or some of the target’s assets can be purchased
Some, all or none of target’s liabilities can be assumed
May be done indirectly through a merger in which the acquiring corporation absorbs target receiving all its assets and all its liabilities.
What does it look like?
Stock Acquisitions
Acquiring corporation purchases controlling interest in stock of target
Target is either operated as a subsidiary or liquidated
What does it look like?
Advantages and Disadvantages
From seller’s perspective, stock sale might be preferable to insure capital gain treatment
From buyer’s perspective, asset purchase might be preferable to generate increase in basis in assets and to allow buyer to pick and choose assets and to avoid liabilities.
Contingent and unknown liabilities are a risk to new owners.
However, buyer might want to purchase stock due to name recognition of target corporation, experienced management team, favorable contracts, etc.
Should transaction be structured to be taxable or tax deferred to seller?
Both asset and stock acquisitions can be structured as taxable or tax deferred transactions.
Seller might accept a lower price if transaction is structured to be tax deferred
However, to be tax deferred, the majority to the purchase price has generally has to be in stock of the acquiring corporation. If seller wants cash, it may require transaction to be taxable.
Taxable Asset Purchases
Acquiring Corporation (buyer) has cost basis in assets purchased
However, a lump sum purchase price must be allocated to specific assets. This can result in tension between the buyer and seller:
The purchaser wants to allocate as much as possible to inventory items and depreciable items with a short useful life
The seller wants to allocate as much as possible to capital assets
I.R.C. Section 1060 says the allocation must be consistent between buyer and seller, and that the amount allocated can not exceed each asset’s fair market value. However, what is fair market value?
Any excess of purchase price over aggregate fair market value is allocated to goodwill
Acquired goodwill can be amortized for tax purposes over 15 years
Target corporation (Seller) has gain on assets sold. Target may stay in existence or liquidate. If the corporation is liquidated, shareholders must recognize a gain or loss equal to the difference between the proceeds and their basis in stock.
This can result in a double tax.
Cash Mergers
Asset acquisitions can be structured so that the target corporation merges into acquiring corporation.
Target recognizes gain or loss on sale of assets
The shareholders of target corporation receive cash and must recognize gain or loss as well.
Acquirer’s basis in target’s assets is stepped up to FMV
What does it look like?
A reverse cash merger can be structured to avoid the second level of taxation. Original target shareholders get cash and recognize gain or loss but there is no tax at the corporate level.
The acquiring corporation forms a subsidiary. The subsidiary is merged into the target corporation. The target corporation survives and the subsidiary can be liquidated at no tax cost.
However, the tax basis of the target’s assets don’t change
What does it look like?
HW # 1 and HW # 2
Tax-deferred asset acquisitions
Type A and Type C reorganizations
Acquiring corporation issues stock to target shareholders
Targets assets and liabilities are transferred to acquiring corporation
Target ceases to exist
What does it look like?
Target Corporation does not recognize gain or loss
Target shareholders do not recognize gain or loss
Shareholders own acquiring corp stock instead of target corp stock
Shareholder’s basis in target stock becomes his or her basis in acquiring corp stock
Acquiring corporation’s bases in assets acquired from target is the same as target’s bases in those assets
Type “A” Reorganization
The A refers to the subparagraph of Code Section 368 describing this type of reorganization
Must be structured as a merger or consolidation of two corporations.
What is the difference?
Must satisfy a continuity of interest requirement (target shareholders must continue their interest in the target’s business)
At least 50% of the total consideration paid must be acquiring corporation stock.
Other consideration can be cash, debt etc.
However, to the extent you receive other consideration, it is considered boot and shareholders must recognize gain to the extent of the boot received.
HW # 5
Type “C” Reorganization
Acquiring corporation buys substantially all of target’s assets for acquiring corporation voting stock.
Target corporation’s liabilities may be assumed
Target corporation must liquidate
In a Type A reorg, the acquirer becomes responsible for all the target’s liabilities- even undisclosed liabilities.
In a Type C reorg, the acquirer can select the specific liabilities that it will assume (if any)
HW # 7
Tax-Deferred Stock Acquisitions
Type B reorganizations
Shareholders of target corporation exchange their target stock for stock in the acquiring corporation. Acquiring corporation must use voting stock
After the transaction, acquiring corporation must own 80% of the voting power and 80% of each class of nonvoting stock
Acquiring corporation must continue target corporation’s historic business or use a significant portion of target’s assets in a new business
Shareholders do not recognize gain or loss
Shareholder’s basis for target corp. becomes basis of stock in acquiring corporation
Target corporation does not participate in the transaction
Acquiring corporation has a carryover basis equal to the stock basis in the hands of the target shareholders.
As a practical matter, with a large publicly held corp, this can be difficult to figure out.
HW #9
Corporate Divisions
Spin off
Corporation distributes stock of a subsidiary proportionately to its shareholders
After the spin off, shareholders own stock of both the parent and the subsidiary
Treated as a dividend to shareholders
What does it look like?
Split Off
Corporation distributes stock in a subsidiary to a group of shareholders in exchange for their stock in the parent corporation
After the split off shareholders own stock in subsidiary but not parent
Treated as a stock redemption to shareholders
What does it look like?
Split up
Corporation distributes stock of subsidiary to shareholders who own subsidiary directly.
Treated like a liquidating distribution to shareholders (we will talk about impact in chapter 13)
What does it look like?
Section 355
If the requirements of Section 355 are met, a corporate division is not taxable to either the parent corporation of to the participating shareholders
Section 355 requirements discussed in book (page 370)
HW # 16
1