Chapter 9

Question 1

What section deals with corporate reorganizations, and what is the challenge?

Answer 1

Corporate Reorganizations - §368(a)
Challenge:

1. When should a given transaction be taxable and when should it be afforded “tax free” treatment?
2. In general, Congress has held that any mere “change in form” should be afforded “tax free” treatment
   
   1. §351 “tax free” treatment is a good example
   2. §368(a)(1) provides “tax free” treatment for 7 (8 depending on how you count) types of mergers, acquisitions, divisions, recapitalizations, etc.

Question 2

Under 368(a), what are the 4 types of acquisitive reorgs?

Answer 2

Acquisitive Reorgs:

1. A reorgs – statutory mergers (§368(a)(1)(A))
2. B reorgs – stock-for-stock (§368(a)(1)(B))
3. C reorgs – stock-for-assets (§368(a)(1)(C))
4. Non-divisive D reorgs (§368(a)(1)(D))

Question 3

Under 368(a), what does it say about corporate divisions?

Answer 3

Corporate Divisions:

1. Divisive D reorgs – spin-offs, split-ups, split-offs (§368(a)(1)(D))
   
   1. Technically, a D reorg is only one step in a division. §355 is the controlling section as it relates to corporate divisions.

Question 4

Under 368(a), what are the 3 types of Single Corp Reorgs?

Answer 4

Single Corporation Reorgs:

1. E reorgs – recapitalization (§368(a)(1)(E))
2. F reorgs – reincorporation (§368(a)(1)(F))
3. G reorgs – bankruptcy restructuring (§368(a)(1)(G)

Question 5

What are the two types of triangular reorgs?

Answer 5

Triangular Reorgs:

1. Forward triangular (§368(a)(2)(D))
2. Reverse triangular (§368(a)(2)(E))

Question 6

How does a statutory, or Type A reorg work?

Answer 6

You start with two corps, A(acquiror) and T(target). The two corps have unrelated shareholders.

First, A transfers its stock to T for all of T’s assets and liabilities.

T then only has one asset: the A stock. T then liquidates by transferring its A stock to the T shareholders.

So in the end you have the original A shareholders owning A along with the T shareholders.

Question 7

How does a forward triangular merger work?

Answer 7

A transfers all of its stock to S, in exchange for all the S stock.

S then transfers the A stock to T, in exchange for all the assets and liabilties of T.

T then liquidates by giving the A stock to the T shareholders.

You end up with 2 groups of shareholders who own A, and T goes out of existence.

Question 8

How does a reverse triangular merger work?

Answer 8

This is the same as a forward triangular merger, except S goes out of business instead of T.

This happens by S transferring its assets and liabilities AND the A stock to T, and then S going out of existence.

Question 9

How does a B reorg, or a stock-for-stock reorg work?

Answer 9

A transfers its stock to the T shareholders, in exchange for T stock.

The end result is that A owns T, and the A &T shareholders both own A.

Question 10

How does a stock-for-assets, or a C reorg work?

Answer 10

This is like a statutory merger, except that A is not required to take all of T’s assets and liabilities.

Question 11

How does a divisive D reorg spinoff work?

Answer 11

P has to have at least 2 trades or businesses, and it starts by transferring one of the businesses into S, a sub.

In exhange it takes the stock of S.

P then owns the S stock, and it then distributes that stock to its shareholders on a pro-rata basis.

At the end of the day the P shareholders own P, but they also own S as well.

Question 12

How does a divisive D reorg split-off work?

Answer 12

This is the same as a spinoff deal, but the shares of S or only distributed to some of the P shareholders, in other words on a non-pro rata basis.

Question 13

How does a divisive D reorg split up work?

Answer 13

P has to have two businesses, and they put one business in S1 and one in S2.

P then has the stock of both S1 and S2. It distributes the stock to the P shareholders, and it can be done on pro-rata basis or a non-pro rata basis.

Question 14

How does an E reorg recapitalization work?

Answer 14

1. A recapitalization involves restructuring the equity and debt structure of the corporation.
2. The corp remains intact. Only the ownership structure changes.
3. Example: Voting common shareholders exchange their voting common for non-voting common.

Question 15

How does a F reorg reincorporation work?

Answer 15

F Reorg - Reincorporation:

1. All corporations are formed under the laws of one of the 50 states or the District of Columbia
2. Occasionally, a corporation wishes to be incorporated in a state other than its incorporating state
3. The corporation will be re-incorporated in another state
4. For income tax purposes, this is a non-event
5. New corporation (in new state) treated as though it were the old corporation for income tax purposes – no new EIN issued, only one return filed for corporation during year of reincorporation (as opposed to two stub period returns)

Question 16

How does a G reorg bankruptcy work?

Answer 16

G Reorg - Bankruptcy:
A G Reorganization allows the creditors to take over the assets of the bankrupt entity on a tax-free basis

Question 17

What are the basic elements of corporate reorganizations, and what section are they?

Answer 17

§368(a)

1. Tax free reorganizations are really tax-deferred reorganizations
2. In general, corps, party to the reorganization, and shareholders do not pay tax currently
3. Price paid- substituted/carryover basis
   
   1. Substituted basis for shareholders
   2. Carryover basis for the corporation
4. Disposition of stock by the shareholders and disposition of the assets by the acquirer will trigger the deferred tax

Question 18

What are some deeper issues of reorganizations? (9)

Answer 18

1. Corporate Reorganizations - §368(a)
2. Other Issues:
3. Extremely important to dot the “i”s and cross the “t”s
4. But, it’s not enough to simply comply with the form of the transaction. One must comply with the substance of the transaction. Judicial doctrines must also be met for tax-free treatment to be achieved
5. As mentioned above, shareholders do not pay tax in a tax-free reorganization. However, if “boot” is received the boot will be taxable. Sound familiar?
6. Stock vs. securities (bonds, debentures, long-term debt)
7. In general, securities are treated as boot unless the asset given up is also a security. To the extent a security holder transfers his/her/its security for another security with a principal amount in excess of the principal amount of the security surrendered, the excess principal will be taxable as boot
8. Nonqualified preferred stock (§351(g)) received in exchange for common stock or qualified preferred stock will be treated as boot
9. Corporations which received boot as part of the reorganization are NOT taxed on the boot as long as the boot is distributed to the corporation’s shareholders
10. Corporations issuing their own stock as part of a reorganization are not taxable on the issuance of such stock (§1032)
11. Corporations transferring boot in the form of appreciated property will be taxed on the built-in gain

Question 19

The 5 parts of basis in a reorganization:

Answer 19

Corporate Reorganizations - §368(a)
Basis in Reorganizations:

1. The price paid for “tax deferral” is basis
2. Shareholder takes a substituted basis in the stock received under §358
3. When a corporation acquires the assets of another corporation (as in an “A” or “C” reorg), the corporation takes a carryover basis in the assets under §362
4. In a “B” reorg, the target holds onto its assets and such assets continue with the same basis. The acquirer takes the target stock with a basis equal to the basis the target’s shareholders had in such stock immediately before the acquisition
5. To the extent boot is permitted to be received by the shareholders, such boot will be taxable. The boot in the hands of the shareholder will have a basis equal to its FMV

Question 20

What are the holding period issues for nonrecognition property?

Answer 20

Holding Period for Nonrecognition Property:

1. Assuming the shareholder holds stock as a capital asset, the shareholder’s holding period in the stock given up will tack to the stock received in the reorganization
2. As it relates to the acquiring corporation, the holding period of the assets received from the target will include the holding period of the assets in the hands of the target corporation

Question 21

What are some tax accounting attributes for reorganizations?

Answer 21

Tax Accounting:

1. In a “B”, “E”, “F” reorganization, the tax accounting attributes (taxable year, NOLs, capital loss carryovers, tax elections, etc.) carryover to the “new” corporation (since there is no “new” corporation other than in an “F” which for tax purposes is not treated as a “new” corporation)
2. In an acquisitive reorganization where assets are transferred (“A” or “C”), the tax year of the corporation transferring the assets is terminated, the tax attributes carryover to the corporation acquiring the assets to the extent permitted by §381
3. §§ 382 and 383 will effectively minimize the benefit of NOL, capital loss and credit carryovers

Question 22

What are the facts and issues of the Gregory vs Helvering case?

Answer 22

Gregory v. Helvering

• Facts:
• In 1928, Mrs. Gregory was the owner of 100% of the United Mortgage Corporation (United) stock
• The corporation held (among other assets) 1,000 shares of Monitor Securities Corporation (Monitor)
• Mrs. Gregory desired to hold the Monitor stock individually with the ultimate desire to sell such stock for her personal benefit
• Note that if United had simply distributed the stock to her, the distribution would have triggered a dividend taxable at ordinary rates – she wanted LTCG treatment
• She chose to engage in a tax free reorganization in order to accomplish her goal
• She incorporated a new corporation in which she owned 100% of the stock – the Averill Corporation (Averill). Such corporation was formed on 09/18/28
• Three days later, United transferred the Monitor stock to Averill in a tax-free reorganization
• On 09/24/28, Averill was liquidated transferring the Monitor stock to Mrs. Gregory
• Mrs. Gregory immediately sold the Monitor shares received in the liquidation
• Mrs. Gregory filed her return claiming a $76k capital gain associated with the sale of the Monitor stock
• IRS audited the return and claimed the transfer to Averill followed by the liquidation of such corporation should be disregarded – thus converting the $76k of capital gain to $133k of dividend
• All parties agree that Mrs. Gregory met the form of the transaction – reorganization/liquidation – and that tax avoidance was the only purpose for engaging in the transactions (reorganization/liquidation)

Issue:

• Does the taxpayer have to have a business purpose (aside from tax avoidance) to have a valid reorganization?

Holding:

• Yes. The Supreme Court concluded that Mrs. Gregory met the required “form” of the transactions but did not meet the “substance” since there was no business purpose other than tax avoidance

This case created perhaps the most important judicial doctrine – “business purpose”. This case has had enormous impact on the tax law as it we know it today! Though the “business purpose” origin as a requirement was this case, today it is statutory in that it is included as a requirement for many transactions in the regulations.

Question 23

What are the 3 elements behind the idea of ‘form and substance’?

Answer 23

Form and Substance

• If abused, the form will ultimately attempt to disguise the substance of the transaction
• Substance should control
• Bottom line – taxpayer must meet the “form” and the “substance” of the law

Question 24

What is the step transaction doctrine?

Answer 24

Step Transaction Doctrine

• Binding commitment test – the taxpayer is obligated to take not just the first step but also the second step (think of the Intermountain Lumber case)
• Interdependence test – the steps are so interdependent that the first step would have been meaningless without the second step (think of Gregory v. Helvering – reorganization followed by liquidation)
• “End Result” test – all steps were taken in order to achieve an “end result” (think of Kimbell-Diamond)

Question 25

What are the facts and issues of the King Enterprises case?

Answer 25

King Enterprises, Inc. v. United States
Facts:

• King Enterprises, Inc. (King) is a corporation engaged in holding and managing various investments
• King was one of 11 investors in Tenco – a company that manufactured instant coffee. The investors owned Tenco in order to have a reliable source of instant coffee for them to market in their own brand names
• By 1959, Tenco was the country’s second largest producer of “soluble coffee”
• Despite its success, the Tenco shareholders were discontent
• In the late 1950s, Minute Maid was highly successful and was looking to acquire other businesses – one of which was Tenco
• On 09/03/59, King and the other Tenco shareholders signed an agreement with Minute Maid entitled “Purchase and Sale Agreement”
• Under the agreement, Tenco shareholders received cash, notes and Minute Maid stock as consideration for the sale. King received $282k of cash, $239k in notes and 29,282 shares of Minute Maid stock – the stock amounted to more than 50% of the total consideration paid
• On 12/10/59, the Minute Maid directors approved the decision to merge Tenco into Minute Maid
• Minute Maid requested a PLR to the effect that the purchase and liquidation of Tenco would be treated as an asset purchase under §334(b)(2). The IRS agreed that it would be so treated.
• On 04/30/60, Tenco was merged (liquidated) into Minute Maid
• King filed its return claiming dividend treatment on the cash and notes received (subject to an 85% dividend received deduction) and no gain on the receipt of the Minute Maid stock since it was received as consideration in a tax-free reorganization.
• The IRS audited King’s return and claimed that the entire consideration was taxable as proceeds from the taxable sale of the Tenco stock

Issue:
Is the transaction a:
Reorganization (statutory merger – “A” reorg) with boot consisting of cash and notes, or
A taxable sale
Note that for the court to agree that the transaction was a reorganization, it must treat the purchase by Minute Maid and the liquidation of Tenco into Minute Maid as two steps in one transaction (i.e., the step transaction doctrine). If not, the transfer of the Tenco stock to Minute Maid would not qualify as a “B” reorg due to the boot.

Holding:
A reorganization!!

Other Points:
In this case the taxpayer, King, was arguing the step transaction doctrine. Usually, it is the government that is arguing the inappropriate use of related steps.
Minute Maid received a PLR stating that the transaction would be recognized as an asset purchase under §334(b)(2) (today §338(b)). Thus, Minute Maid received a step-up in the basis of the Tenco assets received in the purchase. That position is inconsistent with the holding of the court which provides carryover basis treatment to Minute Maid of the Tenco assets. What ultimately happened to Minute Maid?

Question 26

What are the two issues of continuity of shareholder interest?

Answer 26

Continuity of Shareholder Interest

• Tax-free treatment is afforded reorganizations, in part, because the target’s shareholders are simply changing the form in which they hold their investment (meaning that they are no longer holding target stock but rather acquirer’s stock). Implicit in this concept is the requirement that the target shareholders continue to own at least some interest in the target’s business no matter how indirect.
• Three requirements:
  
  • Qualitative – consideration must consist of stock (as opposed to securities)
  • Quantitative – substantial part of consideration must be in stock
  • Temporal – target shareholder must hold stock for appropriate period of time (in most cases, this requirement no longer exists!)

Question 27

What are the two issues of continuity of business enterprise?

Answer 27

Continuity of Business Enterprise

• This judicial doctrine looks to target’s business (rather than its owners)
• The doctrine requires that one of two scenarios continue post reorganization:
• Acquirer must continue to operate target’s business post reorganization or
• Acquirer must continue to use target’s assets in acquirer’s business