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- - - - - - - - Chapter 4 - - - - - - - -. Tax Planning Options. Taxable vs. Nontaxable or Tax-Deferred Acquisitions. Basic rules Nontaxable transaction — merger or tender offer involves stock-for-stock transaction Taxable transaction — transaction involves cash or debt.

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chapter 4
- - - - - - - - Chapter 4- - - - - - - -

Tax Planning Options

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 1

taxable vs nontaxable or tax deferred acquisitions
Taxable vs. Nontaxable or Tax-Deferred Acquisitions
  • Basic rules
    • Nontaxable transaction — merger or tender offer involves stock-for-stock transaction
    • Taxable transaction — transaction involves cash or debt

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 2

slide3
"Acquisition tax-free reorganizations" Section 368 of Internal Revenue Code
    • Type A
      • Statutory merger — target firm shareholders exchange their target stock for shares in the acquiring company
      • Consolidation — shareholders of both firms receive stock of new company

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 3

slide4
Three-party forward triangular merger
    • Parent creates shell subsidiary
    • Shell issues stock, all of which is bought by parent with cash or own stock
    • Target is bought with cash or parent stock held by subsidiary
    • Target merged into subsidiary in a statutory merger
    • Parent avoids incurring liability for debt of target

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 4

slide5
Type B
    • Stock-for-stock exchanges
    • Target may be liquidated into acquiring firm or maintained as an independent entity
    • Reverse triangular three-party merger
      • Acquirer forms a shell subsidiary funded by parent stock
      • Subsidiary is merged into target
      • Parent stock held by subsidiary is distributed to target’s shareholders in exchange for their target stock
      • End result: parent owns the stock of the merged subsidiary - target

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 5

slide6
Type C
    • Stock-for-asset transaction; at least 80% of the fair market value of target\'s property must be acquired
    • Typical transaction
      • Target firm sells assets in exchange for acquiring firm’s voting stock
      • Target firm dissolves
      • Target distributes acquiring firm stock in exchange for old canceled target stock

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 6

slide7
Main implications
    • Nontaxable reorganization
      • Acquiring firm
        • Net Operating Loss (NOL) carryover
        • Tax-credit carryover
        • No write-up or step-up of depreciable assets
      • Target firm
        • Deferred taxable gains for shareholders

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 7

slide8
Taxable acquisitions
    • Acquiring firm
      • Stepped-up asset basis
      • Loss of NOLs and tax credits
    • Target firm
      • Immediate gain recognition by target shareholders
      • Recapture of tax credits and excess depreciation

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 8

tax reform act of 1986 less favorable to m a activity
Tax Reform Act of 1986 — less favorable to M&A activity
  • Limits on Net Operating Loss (NOL) carryovers
  • Master limited partnerships and S corporations avoid double taxation
  • Minimum 20% tax on corporate profits

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 9

slide10
General Utilities doctrine
    • General Utilities provision on tax-free asset liquidation repealed
    • Exemption only for small and closely held corporations
  • Greenmail — limit extent to which greenmail payments could be tax deductible

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 10

stock vs asset purchase
Stock vs. Asset Purchase
  • Acquisitions by stock purchases
    • Avoid double taxation
    • Higher net proceeds to seller stockholders

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 11

slide12
Acquisitions by asset purchases
    • Lower net proceeds because of double taxation
    • Buyer may prefer acquisitions of assets
      • Avoid unknown liabilities of seller
      • In purchase accounting, buyer is able to step-up tax basis of assets acquired
    • Closely held small corporations should be formed as limited liability corporations or S corporations

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 12

do tax gains cause acquisitions
Do Tax Gains Cause Acquisitions?
  • Increased leverage — firm can leverage itself without acquisition
  • Net operating loss carryforwards (NOLs) — could be utilized by issuing equity and buying taxable debt
  • Basis increase on acquired assets — could achieve by selling assets and then buying them back

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 13

slide14
Empirical studies
    • Tax factors significant in less than 10% of merger transactions
    • Tax effects are not the main motivation for merger transactions

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 14

slide15
Roles of taxes in going private transactions (LBOs and MBOs)
    • Initial financial structures as high as 90% debt
    • Tax savings are not the dominant factor
      • Debt paid down as rapidly as possible
      • Main objective is to achieve value increases in order to take company public within 3-5 years
      • Proceeds from public offerings used to pay down debt

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 15

slide16
Increased taxes from LBOs
    • Capital gains taxes on realized capital gains to shareholders
    • Taxable capital gains from asset sales
    • Taxable interest income from debt payments
    • Increase taxable operating income
    • Efficient capital use generates additional taxable revenues in the economy
  • Lost taxes from LBOs
    • Increased tax deductions from the additional debt
    • Lower personal tax revenue because LBOs pay little or no dividends

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 16

slide17
On average, LBOs generated tax increases that were almost 200% of the tax losses they created
  • RJR-Nabisco tax payments were more than eight times pre-LBO taxes

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 17

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