CORPORATE REORGANIZATIONS Unless otherwise indicated notes are from the 2010 CCH Federal Tax Study Manual by Edward Frot

1. CORPORATE REORGANIZATIONSUnless otherwise indicated notes are from the 2010 CCH Federal Tax Study Manual by Edward Froth. pg263 et. al.CHAPTER 17 RUTGERS UNIVERSITY SCHOOL OF BUSINESS CAMDEN David E. Vance, MBA, CPA, JD 1

2. This chapter discusses different forms of reorganization in great detail. What�s the point of all these different forms? Why worry about how the reorganization is constructed? It would be nice to believe the law, tax law in particular, is a seemless web. The reality is that the law is a series of little boxes with lots of space in between. When the court, or the IRS, finds a transaction in a particular box, it knows what rules to apply. When it finds a transaction that falls between the boxes, courts and the IRS don�t know what specific rules to apply. In that case they may make up rules on an ad hoc basis. Such ad hoc rules rarely favor the tax payer. So, uncertainty can be greatly reduced by following the rules of each type of reorganization very carefully. 2

3. 1. Corporate reorganizations are non-taxable events on the assumption that the new company or companies is or are substantially a continuation of the old company or companies. There are several types of reorganizations. � 2. Type A � A statutory merger or consolidation Merger � one corporation absorbs another Consolidation � one or more corporations combine and the old corporations dissolve Advantages: Boot can be 50% of the consideration Non-voting stock can be used There is no �substantially all� requirement Disadvantages: Liabilities of the acquired corporation are acquired including contingent liabilities. Shareholders must approve the plan The corporation may have non-transferable contract rights (A common clause in bank loans and bonds is that a substantial change of ownership accelerates the debt.) 3

4. 3. Type B � the acquisition of stock solely for voting The acquiring corporation must acquire at least 80% of each class of stock whether or not it is voting stock. The acquiring company can only use stock. No boot is allowed. The acquiring company can use cash in lieu of fractional shares. 4. Type B Reorganization Advantages The acquired corporation remains in existence The acquiring corporation is protected from liabilities of its subsidiary Disadvantage Only voting stock can be used in the acquisition 4

5. 5. If a company wanted to squeeze out small shareholders in a target company, might it 1) do a 100:1 reverse split on its own stock to make each share more valuable than say 100 shares of the target stock. 2) pay cash to those with target stock less than the new share stock value. � Example: Acquiring Corporation (AC) has 10 million shares of stock outstanding at a market value of $20 each giving it a market cap of $200 million. Suppose the target company (TC) has 1 million of shares outstanding at a market price of $15 each. � AC does a 100:1 reverse stock split so that it now has 100,000 shares outstanding at a value of $2,000 each. Its market cap is still $200 million. Anyone who had 100 shares of TC would have $1,500 of stock. This is less than a single share of AC. AC could buy out what would be a fractional share of AC for cash eliminating shareholders with only 100 shares of stock. TC shareholders with 1,000 shares of stock would have $15,000 of stock value. This would translate to 7 shares of AC plus a cash payout of $1,000 further reducing the shares in AC held by the prior owners of TC. � This might be a way to assure that AC retains control and that control does not inadvertently slip into the hands of TC shareholders. Another reason to reduce the number of shareholders is to take a public company private. If the number of shareholders slips below some threshold, like 500 shareholders, a company can take itself private. 5

6. 6. Type C Reorganization Substantially all of the assets of one corporation is exchanged for substantially all the voting stock of the other corporation. If money or property is paid in addition to voting stock then the voting stock must be equal to 80% of the FMV of the deal. Substantially all means at least 90% of the FMV of the net assets and at least 70% of the FMV of the gross assets. The acquired corporation must distribute the assets received to its shareholders. 7. A Type B reorganization followed by a liquidation of the subsidiary is treated like a Type C reorganization. Advantages: Not all assets and liabilities need be acquired Shareholders of the acquiring corporation need not approve the transaction. Disadvantages: Substantial transfer costs may be incurred acquiring assets Generally only voting stock can be used in the acquisition 6

7. 8. Type D Reorganization The transfer of substantially all of the assets of a corporation to another in exchange for stock in the other company if the transferor has sufficient stock to control the transferee after the exchange. The acquired stock must be distributed to the transferor�s shareholders 9. A reorganization that is both Type C and D is treated as a Type D. The transfer is treated as non-taxable if the five year pre-distribution active trade or business test is met and it is one of the following: a) Spin-off: the distribution of shares of a subsidiary b) Split-off: Shareholder in the parent surrender some or all of their shares in the parent to get shares in the subsidiary c) Split-up: Shares in two subsidiaries are distributed to shareholder and the parent is dissolved. 10. A liquidation followed by a reincorporation may be treated as a Type D if the same shareholders own at least 50% of the stock. 11. A Type D reorganization may be used to resolve shareholder disputes. 7

8. 11. Type E Reorganization Change in the capital structure of a company (generally not taxable). 12. Type F Reorganization Change in the identity, form or place of incorporation (generally not taxable.) � 13. Type G Regorganization Reorganization in bankruptcy or insolvency (generally not taxable) � Gain is generally recognized by the distributing parent, but no gain is recognized by shareholders if the transaction qualifies as a spin-off, split-off or split-up. 8

9. ------------Outline & Expand on These Topics Yourself----------- Drop down assets IV-B. Parent carries liabilities of acquired corp in A or C reorganization. p.267. Carry over of tax attributes. P.267-268. Treatment of shareholders p.268 Treatment of parties to Reorganization p.268. Judicial Requirements p.268-269. 9

10. THE ENDCORPORATE REORGANIZATIONSCHAPTER 17 David E. Vance 10