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Chapter 7

Chapter 7. Corporations: Reorganizations. Reorganizations—In General. Refers to any corporate restructuring that may be tax-free under §368 To qualify, must meet certain general requirements: Must be a plan of reorganization

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Chapter 7

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  1. Chapter 7 Corporations: Reorganizations

  2. Reorganizations—In General • Refers to any corporate restructuring that may be tax-free under §368 • To qualify, must meet certain general requirements: • Must be a plan of reorganization • Must meet continuity of interest and continuity of business enterprise tests • Must have a sound business purpose • Tax-free status can be denied under step transaction doctrine

  3. Summary of Different Types of Reorganizations • The term reorganization includes: • Statutory merger or consolidation • Stock for stock exchange • Stock for assets exchange • Divisive exchange • Recapitalization • Change in identity, form, or place of organization • Transfers in bankruptcy or receivership

  4. Tax Free Reorganization Consequences, in General (slide 1 of 3) • Consequences to Acquiring Corporation • No gain or loss recognized unless it transfers property to the Target corporation as part of the transaction • Then gain, but not loss, may be recognized • Basis of property received retains basis it had in hands of Target corp plus any gain recognized by the target

  5. Tax Free Reorganization Consequences, in General (slide 2 of 3) • Consequences to Target Corporation • No gain or loss unless it retains “other property” received in the exchange or it distributes its own property to shareholders • Other property is defined as anything received other than stock or securities • Treated as boot • Gain, but not loss, may be recognized

  6. Tax Free Reorganization Consequences, in General (slide 3 of 3) • Consequences to Target or Acquiring Co. Shareholders • No gain or loss unless shareholders receive cash or other property in addition to stock • Cash or other property is considered boot • Gain recognized by the stockholder is the lesser of the boot received or the realized gain • Basis of shares received is same as basis of those surrendered, decreased by boot received, increased by gain and dividend income, if any, recognized in the transaction

  7. Type A Reorganization • Includes mergers and consolidations • Merger is union of two or more corporations • One corporation retains it existence and absorbs the others • Consolidation occurs when a new corporation is created to take the place of two or more corporations

  8. Type A Reorganization (slide 1 of 2)

  9. Type A Reorganization (slide 2 of 2)

  10. Type A Reorganization Issues(slide 1 of 2) • Advantages: • Type A reorganization is flexible • Consideration need not be voting stock • Money or other property can be transferred without disqualifying the transaction, as long as “continuity of interest” is met

  11. Type A Reorganization Issues (slide 2 of 2) • Disadvantages: • Money or other property transferred is “boot” so some gain may be required to be recognized • Shareholders of either entity may dissent; in most states their shares must be redeemed • Acquiring entity must assume all liabilities of Target

  12. Type B Reorganization (Stock-for-Stock Reorganization)

  13. Type B Reorganization Requirements (slide 1 of 4) • Corporation acquires stock of Target solely in exchange for its own voting stock (stock for stock) • Acquiring corporation must acquire “control” of Target • Control is ownership of at least 80% of all classes of stock of target • Acquirer may add shares owned previously with shares acquired in reorganization

  14. Type B Reorganization Requirements (slide 2 of 4) • Acquiring corporation may acquire shares from either: • (1) Shareholders of Target, or • (2) Directly from Target • Exception to the “solely for voting stock” requirement when shareholders must receive fractional shares • May receive cash rather than fractional shares in the acquiring corporation

  15. Type B Reorganization Requirements (slide 3 of 4) • Example: Assume Target has 100 shares outstanding: • Acquirer may obtain 80 shares from current Target shareholders in exchange for Acquirer’s voting stock • Target may also issue 400 new shares to Acquirer in exchange for Acquirer’s voting stock (500 shares would be outstanding)

  16. Type B Reorganization Requirements (slide 4 of 4) • Consideration paid by Acquirer can only include Acquirer’s voting stock or transaction does not qualify

  17. Type C Reorganization (Stock-for-Assets Reorganization)

  18. Type C Reorganization Requirements (slide 1 of 3) • A ‘‘Type C’’ reorganization is essentially an exchange of voting stock for assets followed by liquidation of the target corporation • Called a “Stock-for-Assets” reorganization • Transfer is generally between the entities, not the shareholders

  19. Type C Reorganization Requirements (slide 2 of 3) • Consideration paid by Acquirer normally consists only of voting stock • However, if at least 80% of FMV of Target is acquired with voting stock, cash or other property can be used for remainder • Limitation: liabilities assumed by Acquirer are considered “other property” if any additional “other property” is used

  20. Type C Reorganization Requirements (slide 3 of 3) • “Substantially all” of Target’s assets must be transferred to Acquirer • There is no statutory definition of ‘‘substantially all’’ • To receive a favorable ruling from the IRS, the target must transfer at least 90% of net asset value or 70% of the gross asset value to the acquiring corporation

  21. Type D Reorganization (slide 1 of 4) • Generally a mechanism for corporate division • Called a “divisive reorganization” but can be used to carry out a corporate combination • In a Type D acquisitive reorganization • Entity transferring assets is considered the acquiring corporation • Corporation receiving the property is the target

  22. Type D Reorganization (slide 2 of 4) • In an acquisitive Type D reorganization • Substantially all of acquiring corp’s property must be transferred to target corporation • The acquiring corp must be in control (at least 50%) of the target • Target stock received by the acquiring corp and any remaining assets of acquiring corp must be distributed to its shareholders • Acquiring corporation must liquidate

  23. Type D Reorganization (slide 3 of 4) • In a divisive Type D reorganization • A corporation is divided • One or more new corps are formed to receive assets of original corp • Original corp must receive stock representing control (80%) of new corps • Stock of new corps is then distributed to shareholders of original corp

  24. Type D Reorganization (slide 4 of 4) • Three types of divisive “Type D” reorganizations • Spin-Off and Split-Off • A new corporation is formed to receive some of the assets of the original corporation in exchange for the new corporation's stock • Split-Up • Two or more corporations are formed to receive substantially all of the assets of the original corporation

  25. Type D Reorganization Spin-Off (slide 1 of 2)

  26. Type D Reorganization Spin-Off(slide 2 of 2)

  27. Type D Reorganization Split-Off(slide 1 of 2)

  28. Type D Reorganization Split-Off (slide 2 of 2)

  29. Type D Reorganization Split-Up(slide 1 of 2)

  30. Type D Reorganization Split-Up(slide 2 of 2)

  31. Type E Reorganization (slide 1 of 2) • Type E reorganization is a recapitalization • Involves a major change in character and amount of outstanding stock, securities, or paid-in-capital • The following exchanges qualify: • Bonds for stock • Stock for stock • Bonds for bonds

  32. Type E Reorganization (slide 2 of 2) • Corporation can exchange its common stock for preferred stock or its preferred stock for common stock tax-free • The exchange of bonds for other bonds is tax-free when the debt received has a principal amount that is not more than the surrendered debt’s principal amount

  33. Type F Reorganization • A mere change in identity, form, or place of organization, however effected • Restricted to a single operating corporation • Tax characteristics of predecessor corp carry over to successor corp • Does not jeopardize status of §1244 stock or terminate a valid S corp election

  34. Type G Reorganization • Substantially all of the assets of debtor corp are transferred to an acquiring corp in exchange for its stock and securities • This stock and securities are distributed to the senior creditors in exchange for their claims against the debtor corporation

  35. Judicial Doctrines(slide 1 of 2) • Besides meeting specific requirements of reorganization, several judicially created doctrines must be met • Reorganization must exhibit a sound business purpose • Not a well defined test • Continuity of interest test • IRS deems this test met if shareholders of Target receive stock in Acquirer equal to at least 40% of their prior stock ownership in Target stock

  36. Judicial Doctrines (slide 2 of 2) • Continuity of business enterprise test • Requires the acquiring corp to either: • Continue the Target’s historic business, or • Use a significant portion of Target’s assets in business • Step transaction doctrine • Ensures that a series of transactions are not used to obtain tax benefits that would be unavailable if the transaction were accomplished in a single step • IRS generally views any transactions occurring within one year of reorganization as part of the restructuring

  37. Carryover of Corporate Tax Attributes (slide 1 of 4) • Assumption of liabilities • Acquiring corp either assumes liabilities of Target or takes property subject to liabilities • Allowance of Carryovers • In Type A, C, acquisitive D, and G reorganizations, the Target’s tax attributes are acquired • In Type B, E, and F reorganizations, Target corporation remains intact and retains its tax attributes

  38. Carryover of Corporate Tax Attributes (slide 2 of 4) • NOL Carryovers • Amount of NOL that can be used in year ownership change occurs is limited to a percentage representing the remaining days in the tax year over the total number of days in the year

  39. Carryover of Corporate Tax Attributes (slide 3 of 4) • NOL Carryovers (cont’d) • NOL can be further limited in first and succeeding years when there is a more than 50-percentage-point ownership change • An ownership change takes place on the day (change date) that either an equity structure shift or an owner shift occurs • An equity structure shift occurs when a tax-free reorganization causes an owner shift • An owner shift is any change in the common stock ownership of shareholders owning at least 5% • NOL can be used to the extent of the value of the loss corp’s stock on the date of the ownership change multiplied by the long-term tax-exempt rate

  40. Carryover of Corporate Tax Attributes (slide 4 of 4) • Earnings and Profits • Positive E & P of acquired corp carries over • E & P of a deficit corp is deemed received by acquiring corp as of change date • Deficit may only be used to offset E & P accumulated by successor corporation after the change date

  41. Comparison of Reorganization Types (slide 1 of 5)

  42. Comparison of Reorganization Types (slide 2 of 5)

  43. Comparison of Reorganization Types (slide 3 of 5)

  44. Comparison of Reorganization Types (slide 4 of 5)

  45. Comparison of Reorganization Types (slide 5 of 5)

  46. If you have any comments or suggestions concerning this PowerPoint Presentation for South-Western Federal Taxation, please contact: • Dr. Donald R. Trippeer, CPA • trippedr@oneonta.edu • SUNY Oneonta

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