Chapter 10 Pt. 3 Flashcards
Characteristics of triangle mergers
Triangular Reorganizations
- “Triangular” refers to the use of acquirer’s parent stock to effect the merger rather than acquirer’s stock
- Parent stock can be used in a A, B or C reorganization
- Can’t mix stock – use some parent stock and some acquirer’s stock as consideration – “all or nothing rule”
- Most common triangular reorganizations are the:
- Forward triangular merger and
- Reverse triangular merger
Facts of Rev Ruling 67-448
Reverse Triangular Reorganizations
Revenue Ruling 67-448
Facts:
- P and Y are publicly owned corporations.
- P wanted to acquire the business of Y
- Apparently, it was essential that Y remained in existence owning and operating its historic business as a public utility – thus an A or C reorganization would not work
- P desired to eliminate the risk of minority shareholders of Y if some Y shareholders dissented
- P engaged in the following transaction:
- P transferred shares of its voting stock to its newly formed subsidiary S in exchange for S stock
- S (whose only asset consisted of the P stock) merged into Y in a transaction which qualified as a statutory merger under applicable state law
- Pursuant to the plan of reorganization, the S stock owned by P was converted into Y stock
- The Y stock held by the Y shareholders was converted into P stock
- Dissenting Y shareholders (5% of shareholders) had their shares redeemed by Y using Y’s assets
Issue:
Does this transaction (or transactions) qualify as a B reorganization?
Holding:
Yes.
Other issues of triangle mergers
Reverse Triangular Reorganizations
- Originally not permitted since the target was not transferring its assets (and, as such, was not going out of existence)
- Revenue Ruling 67-448 involves a permitted triangular B reorganization which generated the same end result as a reverse triangular merger
- In 1971, Congress permitted the reverse triangular merger by adding §368(a)(2)(E)
- Survivor (the target) must hold substantially all of its properties (the properties held prior to the merger)
- Boot is allowed but only to the extent of 20% of the total consideration (not the 60% permitted in a forward triangular merger)
Treatment of Boot Paid Incident to a Reorganization
Different types of boot:
- Cash
- Securities (debt)
- Nonqualified preferred stock (§351(g))
- Stock of a corporation other than a corporation party to the reorganization
- Other non-stock property
Target shareholder recognizes gain in an amount equal to the lesser of:
- The FMV of the boot received
- The realized (but otherwise not recognized) gain on the tax-free reorganization
No loss is recognized in connection with the distribution of boot
Issues for security holders
- Exchange of securities for other securities is tax-free assuming the principal amount of the security received is equal to or less than the principal amount of the security surrendered
- Excess principal treated as boot
- Exchange of security for nonqualified preferred stock is tax-free
- Exchange of security for common stock is tax-free
- Exchange of security for other types of boot taxable
- Any assets transferred to security holder in exchange for accrued interest are taxable
Issues for Holders of Non-qualified Preferred Stock (NQPS)
- Treated as boot just as securities are so treated
- Exchange of NQPS for NQPS of equal or lesser value is tax-free
- Exchange of NQPS for securities is tax-free
- Exchange of NQPS for common stock is tax-free
Is boot taxable as a dividend?
Is Boot Taxable as a Dividend?
- The receipt of boot in a tax-free reorganization is similar to a target shareholder receiving property in redemption of his/her/its stock
- §302(b) applies to determine if the boot will be treated as proceeds in a sale or exchange or as a dividend
- For purposes of determining whether or not any of the §302(b) tests are met, the redemption is tested based on the change in holdings of the acquirer stock from:
- What would have been held by the target shareholder if the only consideration offered was the acquirer’s stock vs.
- What the target shareholder actually holds in the acquirer’s stock following the reorganization
Issues of Debt Obligations as Securities
Debt Obligations as Securities
- Securities exchanged for securities in a tax-free reorganization are exchanged tax-free
- Securities exchanged for debt instruments that are NOT treated as securities is a taxable exchange
- Likewise, the exchange for a debt instrument that is NOT treated as a security for a security is a taxable exchange
- As such, it is important to understand when a debt is treated as a security and when it isn’t treated as a security
Rev ruling 59-98
Debt Obligations as Securities
Revenue Ruling 59-98
Facts:
- In 1957, the corporation exchanged newly issued common stock in exchange for outstanding bonds and accrued interest
- Following the E reorganization, the former bond holders owned 40% of the corporation
- The bonds were originally issued in 1946
- The original life of the bonds ranged from 3 to 10 years (at issuance, the average life to maturity being 6-1/2 years)
- The FMV of the stock issued for each bond was substantially below the principal balance on the bond
Issue:
Were the bonds securities?
Holding:
Yes, the bonds were securities. They (the bonds) were secured by a mortgage, the average life at issue was 6-1/2 years and the bonds were held by the owners as investments
Therefore, the restructuring of capital qualified as an E reorganization and the bond holders did not recognize gain on the exchange of their bonds for common stock. Today, the accrued interest would be taxable in the exchange.
What is a security?
What is a Security?
- The code does not provide a definition
- Based on tax cases and rulings, securities are:
- Debt instruments with a life at issuance of at least 5 years
- Type of instrument held as an investment in the debtor’s business
- Clearly, short-term notes, accounts payable, other short-term liabilities are not treated as securities
Issues of Nonrecognition of Gain or Loss by Corporate Parties to the Reorganization
Nonrecognition of Gain or Loss by Corporate Parties to the Reorganization
- Parties to the reorganization include acquirer, target and in a triangular reorganization, the corporation in control of the acquirer (the parent)
- In general, no gain or loss is recognized by these parties in a qualified reorganization
- Boot received by target is not taxable to target if such boot is distributed to the target’s shareholders as part of the reorganization (which almost always happens automatically) – rationale is that target corporation is simply a conduit for the boot
- Acquirer issuing appreciated assets as boot (other than stock or securities of acquirer or its parent (in a triangular reorganization)) will be subject to tax on the appreciation
Issues of Determination of Basis
Shareholder’s Basis (§358(a))
General rule – substituted basis
Boot will take a basis equal to FMV
Remaining deferred gain will be completely resident in the acquired stock
Corporation’s Basis in Property Received (§362(b))
General rule – carryover basis (same basis as target had in its assets)
Basis increased by any gain recognized by target (generally, the gain should be zero)
In a “B” reorganization, acquirer takes a basis equal to the basis the shareholders’ had in the target’s stock immediately prior to the reorganization. Given the impossibility of determining this basis number if the target is publicly traded, statistical sampling is acceptable in determining the basis the acquirer will take in the target’s stock
§362(e)(1) provides rules similar to §362(e)(2) (forcing the step-down of basis to FMV in aggregate on assets transferred to a corporation in a §351 transaction) when the target is a foreign entity not taxable in the U.S. and the aggregate assets have a built-in loss. However, in this case, each built-in loss asset’s basis is reduced to its FMV.
Issues of Assumption of Liabilities
Assumption of Liabilities
- Relief of debt in many cases (outside the world of reorganizations) is treated as though cash were paid to the party who experienced the relief of debt
- If this were the case, parties to the reorganization that experienced a relief of debt (for instance the target corporation which is relieved of its debts in the transfer of assets to the acquirer) would be treated as receiving cash – boot!!
- Fortunately, this is not the case. The relief of debt is not treated as boot
- Don’t forget the “boot relaxation rule” in connection with a “C” reorganization!!
