Chapter 4
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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- - - - - - - -

Tax Planning Options

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


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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


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  • "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


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  • Three-party forward triangular merger Internal Revenue Code

    • 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


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  • Type B Internal Revenue Code

    • 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


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  • Type C Internal Revenue Code

    • 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


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  • Main implications Internal Revenue Code

    • 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


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  • Taxable acquisitions Internal Revenue Code

    • 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


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Tax Reform Act of 1986 — less favorable to M&A activity Internal Revenue Code

  • 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


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  • General Utilities doctrine Internal Revenue Code

    • 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


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Stock vs. Asset Purchase Internal Revenue Code

  • 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


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  • Acquisitions by asset purchases Internal Revenue Code

    • 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


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Do Tax Gains Cause Acquisitions? Internal Revenue Code

  • 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


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  • Empirical studies Internal Revenue Code

    • 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


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  • Roles of taxes in going private transactions (LBOs and MBOs) Internal Revenue Code

    • 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


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  • Increased taxes from LBOs Internal Revenue Code

    • 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


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


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