2009 Pearson Education Inc Publishing as Prentice Hall

CORP ACQUISITIONS & REORGANIZATIONS (1 of 2) ® Taxable acquisition transactions ® Taxable vs. nontaxable acquisitions ® Tax consequences of reorganizations ® Acquisitive reorganizations ® Divisive reorganizations ® Other reorganization transactions © 2009 Pearson Education, Inc. Publishing as Prentice 7 -2

CORP ACQUISITIONS & REORGANIZATIONS (2 of 2) ® Judicial restrictions on reorganizations ® Tax attributes ® Limitation on use of tax attributes ® Example ® Tax planning considerations ® Compliance & procedural considerations ® Financial statement implications © 2009 Pearson Education, Inc. Publishing as Prentice 7 -3

Taxable Acquisition Transactions ® Asset acquisitions ® Stock acquisitions w/ no liquidation ® Stock acquisitions w/ § 338 deemed sale election ® See Table C 7 -1 for a summary © 2009 Pearson Education, Inc. Publishing as Prentice 7 -4

Asset Acquisitions ® Direct purchase of assets ® Target corporation Gain or loss and depreciation recapture are computed by selling (target) corporation on each asset ® Acquiring Basis corporation in assets is acquisition cost © 2009 Pearson Education, Inc. Publishing as Prentice 7 -5

Stock Acquisitions with No Liquidation (1 of 2) ® How acquisition is accomplished Shareholders of target corp sell their shares directly to purchaser corp ® Target corp recognizes NO gain/loss ® Target corp s/hs recognize gain/loss Payment to a s/h for a noncompete agreement is ordinary income to s/h © 2009 Pearson Education, Inc. Publishing as Prentice 7 -6

Stock Acquisitions with No Liquidation (2 of 2) ® Purchaser corp consequences Purchaser has a new subsidiary Basis in target stock is acquisition cost ¬Purchaser’s basis in target’s stock (outside basis) may be > target’s basis in its assets No adjustment to basis of target’s assets ® Tax attributes of target transfer to purchaser © 2009 Pearson Education, Inc. Publishing as Prentice 7 -7

Stock Acquisitions with Liquidation ® If parent owns at least 80% of new subsidiary, liquidation is tax-free as described in Chapter 6 ® Premium paid (amount above target corp’s basis in its assets) is lost upon liquidation of the subsidiary © 2009 Pearson Education, Inc. Publishing as Prentice 7 -8

Stock Acquisitions with § 338 Deemed Sale Election (1 of 5) ® How acquisition is accomplished Shareholders of target corp sell their shares directly to purchaser corp ¬Within a 12 -month period Purchaser files § 338 election pretending that target has been liquidated and a new subsidiary created in its place © 2009 Pearson Education, Inc. Publishing as Prentice 7 -9

Stock Acquisitions with § 338 Deemed Sale Election (2 of 5) ® Target corp recognizes gains & losses on “pretend” sale of assets to itself Subject to depreciation recapture ® Target corp’s basis in its assets are stepped up (or down) Sales price calculated on slide 7 -12 © 2009 Pearson Education, Inc. Publishing as Prentice 7 -10

Stock Acquisitions with § 338 Deemed Sale Election (3 of 5) ® Target’s New ® See old tax attributes wiped out elections are made Topic Review C 7 -1 for summary © 2009 Pearson Education, Inc. Publishing as Prentice 7 -11

Stock Acquisitions with § 338 Deemed Sale Election (4 of 5) ADSP = G + L - (TR x B) (1 – TR) ADSP: Adjusted deemed sale price G: Acquiring’s grossed-up basis in the target corporation’s recently purchased stock L: Target’s liabilities other tax liab for sale TR: Applicable federal income tax rate B: Adjusted basis of asset(s) deemed sold © 2009 Pearson Education, Inc. Publishing as Prentice 7 -12

Stock Acquisitions with § 338 Deemed Sale Election (5 of 5) ® Tax basis in assets after deemed sale Adjusted ¬ grossed-up basis Sum of ªRecently purchased stock ªTarget corp’s nontax liabilities ªTarget corp’s tax liability Allocate to 7 classes using residual method © 2009 Pearson Education, Inc. Publishing as Prentice 7 -13

Taxable vs. Nontaxable Acquisitions (1 of 2) ® Use of cash and debt for acquisition produce taxable acquisition ® Use of stock and limited cash or debt likely produce nontaxable acquisition ® Primary tax impact is on the target (corporation being acquired) ® See Topic Reviews C 7 -2 & C 7 -3 © 2009 Pearson Education, Inc. Publishing as Prentice 7 -14

Taxable vs. Nontaxable Acquisitions (2 of 2) ® Only purchase method allowed for GAAP for business combinations initiated after June 30, 2001 FAS No. 141 ® Goodwill not amortized ¬Assets recorded at FMV ¬Tested for impairment ¬FAS No. 142 for GAAP © 2009 Pearson Education, Inc. Publishing as Prentice 7 -15

Tax Consequences of Reorganizations ® Target Also corporation referred to as “transferor” corp ® Acquiring Also corporation referred to as “transferee” corp ® Shareholders & security holders © 2009 Pearson Education, Inc. Publishing as Prentice 7 -16

Target (Transferor) Corporation ® No gain/loss on asset transfer ® Assets retain depr recap potential ® Assumption of liabilities generally does not trigger gain recognition Possible exception for divisive Type D ® No gain/loss on distribution of stock and securities as part of reorg plan © 2009 Pearson Education, Inc. Publishing as Prentice 7 -17

Acquiring (Transferee) Corporation ® No gain/loss recognized when it receives assets in tax-free reorg ® Carryover basis of qualifying property Gain recognized lesser of gain realized or FMV of nonqualified property received ® Carryover holding period © 2009 Pearson Education, Inc. Publishing as Prentice 7 -18

Shareholders & Security Holders (1 of 2) ® No gain/loss on stock or securities received if exchanged solely for stock or securities as part of reorg plan Gain recognized lesser of gain realized or cash plus FMV of other property received ¬Dividend or capital gain depending on § 302 test ªDividend vs. redemption © 2009 Pearson Education, Inc. Publishing as Prentice 7 -19

Shareholders & Security Holders (2 of 2) ® Basis of stocks & securities received Adjusted basis in stocks & securities given up + Gain recognized on the exchange - Money & FMV of other property received = Basis of nonrecognition property received © 2009 Pearson Education, Inc. Publishing as Prentice 7 -20

Acquisitive Reorganizations ® Acquiring corp obtains part or all of assets or stock of a target corp ªSee topic Review C 7 -5 ® Tax consequences ® Type A: Merger or consolidation ® Type C: Assets for stock ® Type B: Stock for stock exchange ® Type D: Asset for stock ® Type G: Bankruptcy © 2009 Pearson Education, Inc. Publishing as Prentice 7 -21

Tax Consequences ® Acquiring corporation Does not recognize gain/loss when it receives property as part of a tax-free exchange Acquired property has a carryover basis ® Shareholders & security holders May have gain to extent “nonqualifying” property received as part of exchange © 2009 Pearson Education, Inc. Publishing as Prentice 7 -22

Type A: Merger or Consolidation (1 of 2) ® Merger One company liquidates ® Consolidation Both companies liquidate and a new third company emerges ® Triangular merger Acquiring corp uses a controlled subsidiary to acquire target © 2009 Pearson Education, Inc. Publishing as Prentice 7 -23

Type A: Merger or Consolidation (2 of 2) ® Reverse triangular merger Acquiring corp uses a controlled subsidiary to acquire target Controlled subsidiary merged into the target corporation Target corporation becomes a subsidiary of the parent corporation © 2009 Pearson Education, Inc. Publishing as Prentice 7 -24

Type C: Assets for Stock ® Acquiring corp obtains substantially all of target corp’s assets in exchange for acquiring corp’s voting stock and a limited amount of other consideration Substantially all means 70% of FMV of gross assets & 90% of FMV of net assets ® Target liquidates itself © 2009 Pearson Education, Inc. Publishing as Prentice 7 -25

Type D: Asset for Stock Acquisitive D (1 of 2) ® Acquiring corp obtains substantially all of target corp’s assets in exchange for acquiring corp’s voting stock & other consideration Substantially all means 70% of FMV of gross assets & 90% of FMV of net assets © 2009 Pearson Education, Inc. Publishing as Prentice 7 -26

Type D: Asset for Stock Acquisitive D (2 of 2) ® Target or target s/hs must control acquiring corp immediately after asset transfer defined as either 50% of voting power of voting stock or 50% of total value of all stock Control ® Target liquidates itself © 2009 Pearson Education, Inc. Publishing as Prentice 7 -27

Type B: Stock for Stock ® Acquiring corp issues voting stock directly to target s/hs in exchange for shares of target ® Target continues under new ownership ® No other consideration can be used Except for acquiring fractional shares and payment of certain expenses of target © 2009 Pearson Education, Inc. Publishing as Prentice 7 -28

Type G: Bankruptcy ® Part or all of target’s assets transferred to a new corp as part of a court-approved plan in a bankruptcy, receivership, or similar situation ® Securities of new corporation are distributed in accordance with courtapproved plan © 2009 Pearson Education, Inc. Publishing as Prentice 7 -29

Divisive Reorganizations ® Part of corp’s assets transferred to a second corp which is owned by either the original corp or its s/hs ® Divisive D reorganizations Split-off Spin-off Split-up ® Divisive G reorganization © 2009 Pearson Education, Inc. Publishing as Prentice 7 -30

Split-off ® Corp transfers assets to a controlled subsidiary in exchange for sub’s stock ® Sub’s stock then transferred to one or more s/hs in exchange for parent corp stock © 2009 Pearson Education, Inc. Publishing as Prentice 7 -31

Spin-off ® Corp transfers assets to subsidiary in exchange for sub’s stock ® Parent distributes sub stock to all parent s/hs on a pro rata basis ® Parent receives nothing in exchange for distribution of sub’s stock © 2009 Pearson Education, Inc. Publishing as Prentice 7 -32

Split-up ® Existing corp transfers all assets to two or more new controlled subs in exchange for sub stock ® Parent distributes all stock of each sub to existing s/hs in exchange for all outstanding parent stock and liquidates © 2009 Pearson Education, Inc. Publishing as Prentice 7 -33

Divisive G Reorganization ® Existing corp transfers part of assets to a second corporation according to a court-approved plan ® Transferor distributes all stock and securities to second corp to s/hs, security holders, and creditors ® Transferor corp may continue business or be liquidated by the court © 2009 Pearson Education, Inc. Publishing as Prentice 7 -34

Other Reorganization Transactions (1 of 2) ® Type E: Recapitalization Reshuffling of corporate structure w/in framework of existing corp” (1942 S. C. ) Must have a bona fide business purpose for reorganization Stock for stock, bonds for stock, or bonds for bonds exchanged as part of a plan © 2009 Pearson Education, Inc. Publishing as Prentice 7 -35

Other Reorganization Transactions (2 of 2) ® Type F: Administrative change A mere change in identity, form, or state of incorporation Assets and liabilities of old corporation are transferred to new corporation All old securities are exchanged for identical new securities © 2009 Pearson Education, Inc. Publishing as Prentice 7 -36

Judicial Restrictions on Reorganizations (1 of 2) ® If judicial restrictions are not met, reorganization loses its tax-free status Continuity ¬Old owners must continue ownership Continuity ¬Old of proprietary interest of business enterprise assets must be used in new business © 2009 Pearson Education, Inc. Publishing as Prentice 7 -37

Judicial Restrictions on Reorganizations (2 of 2) Business ¬Valid Step purpose business purpose for transaction doctrine ¬IRS may collapse series of independent transactions if all part of a plan © 2009 Pearson Education, Inc. Publishing as Prentice 7 -38

Tax Attributes ® Tax attributes follow assets NOLs, capital losses, E&P, gen. bus. credit, inventory methods ® Acquiring corp obtains control of both assets & attributes in A, C, acquisitive D & G, and F reorgs ® Asset ownership does not change in B or E reorgs © 2009 Pearson Education, Inc. Publishing as Prentice 7 -39

Limitation on Use of Tax Attributes (1 of 2) ® §§ 382 & 269 prevent assets or stock purchases if primary purpose is obtaining loss carryovers ® §§ 382 & 269 also prevent a loss corp from purchasing a profitable corp if primary purpose is using its existing losses © 2009 Pearson Education, Inc. Publishing as Prentice 7 -40

Limitation on Use of Tax Attributes (2 of 2) ® § 383 restricts tax credit and capital loss carryovers if § 382 applies Restrictions similar to NOLs ® § 384 prevents pre-acquisition losses of either acquiring or target corp (loss corp) from offsetting BIG recognized during 5 yrs after acq. by another corp (gain corp). © 2009 Pearson Education, Inc. Publishing as Prentice 7 -41

Example (1 of 4) ® Thomas Corp transfers all assets and part of its liabilities to Andrews Corp. for $600 K of Andrews Common stock. Following the merger, Thomas is liquidated Thomas’ basis in assets Liabilities transferred $475 K $100 K © 2009 Pearson Education, Inc. Publishing as Prentice 7 -42

Example (2 of 4) ® What is Thomas’ recognized gain or loss? Gain realized: $700 K* - $475 K = $225 K Boot received: $0 Recognized Gain: $0 * $700 K = $600 K stock + $100 K relief of liabilities © 2009 Pearson Education, Inc. Publishing as Prentice 7 -43

Example (3 of 4) ® What is Andrews’ basis in the assets? $475 K (carryover) ® How much gain/loss does Thomas recognize upon distribution of Andrews stock to Thomas’ shareholders? No gain or loss © 2009 Pearson Education, Inc. Publishing as Prentice 7 -44

Example (4 of 4) ® What if Thomas’ basis had been $750 K? Recognized

Tax Planning Considerations ® Why use a reorganization instead of a taxable transaction? Target corp s/h defer gain recognition Target corp exchanges assets w/out gain recognition or depreciation recapture ® Avoiding reorganization provisions Allows acquiring corp to make § 338 election © 2009 Pearson Education, Inc. Publishing as Prentice 7 -46

Compliance and Procedural Considerations ® § 338 election Acquiring ® Plan corp files Form 8023 of reorganization Written ® Ruling plan not required, but prudent requests May request advanced ruling from IRS on tax consequences of reorganization © 2009 Pearson Education, Inc. Publishing as Prentice 7 -47

Financial Statement Implications (1 of 2) ® SAFS No. 141 Acquiring corp may only use purchase method for financial statement purposes Deferred tax accounts and treatment of goodwill depend on whether acquisition was taxable or nontaxable © 2009 Pearson Education, Inc. Publishing as Prentice 7 -48

Financial Statement Implications (2 of 2) ® Taxable asset acquisition ® Nontaxable asset acquisition ® Stock acquisition ® Pricing the acquisition ® Net operating losses © 2009 Pearson Education, Inc. Publishing as Prentice 7 -49

Taxable Asset Acquisition ® Tax basis likely same as book basis No deferred tax liabilities or assets If tax and book goodwill are equal, ¬§ 197 amortization of goodwill creates temporary difference © 2009 Pearson Education, Inc. Publishing as Prentice 7 -50

Nontaxable Asset Acquisition ® Book bases differ from carryover tax bases of acquired assets SFAS No. 109 prescribes that acquiring corp recognize def tax liability/asset for book/tax bases differences of transferred assets and liabilities ® Goodwill No not amortizable for tax temporary difference © 2009 Pearson Education, Inc. Publishing as Prentice 7 -51

Stock Acquisition ® Target corp remains intact as a subsidiary of acquiring corp ® Adjustments under SFAS No. 141 & 109 occur when preparing consolidated financial statements © 2009 Pearson Education, Inc. Publishing as Prentice 7 -52

Comments or questions about Power. Point Slides? Contact Dr. Richard Newmark at University of Northern Colorado’s Kenneth W. Monfort College of Business richard. newmark@Ph. Duh. com © 2009 Pearson Education, Inc. Publishing as Prentice Hall 7 -53