Structuring Corporate Acquisitions — Tax Aspects (Portfolio 770)

Tax Management Portfolio, Structuring Corporate Acquisitions — Tax Aspects, No. 770-4th, discusses the principal tax planning considerations related to designing an appropriate transactional structure for a corporate acquisition.

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Tax Management Portfolio, Structuring Corporate Acquisitions — Tax Aspects, No. 770-4th, discusses the principal tax planning considerations related to designing an appropriate transactional structure for a corporate acquisition. It introduces the basic concepts of taxable transactions and tax-free reorganizations, as well as stock and asset acquisition structures, and discusses the consequences to various parties of each transactional form, with particular emphasis on the factors which point to the use of a particular acquisition structure. In addition, it explains more complex acquisition structures, as well as the critical aspects of financing techniques (including the tax consequences of various financial instruments which may be used to finance acquisitions), several special applications of §351 in the context of corporate acquisitions, matters relating to the preservation and usability of loss carryovers and other tax attributes, issues arising when a corporation is acquired out of an affiliated group, tax treatment of transaction costs, acquisition-related compensation issues, techniques for disposing of unwanted assets, allocation of tax risks between a buyer and seller of a corporate business, and selected non-tax issues.
This Portfolio generally does not discuss: (i) the use of partnerships, S corporations, and other entities which are subject to special taxing regimes, (ii) special considerations where a party to an acquisition is foreign, or (iii) special considerations relating to financially troubled businesses (including bankruptcy situations).
Many of the topics discussed herein are considered in greater detail in other Tax Management Portfolios. Of particular relevance are 780 T.M., Net Operating Losses and Other Tax Attributes — Sections 381, 382, 383, 384 and 269; 565 T.M., Installment Sales; 784 T.M., Corporate Liquidations; 765 T.M., Stock Rights and Stock Dividends — Sections 305 and 306; 776 T.M., Corporate Separations; 536 T.M., Interest Expense Deductions; 535 T.M., Time Value of Money: OID and Imputed Interest; 767 T.M., Redemptions; 758 T.M., Transfers to Controlled Corporations: In General; 384 T.M., Restricted Property — Section 83; 390 T.M., Reasonable Compensation; 772 T.M., Corporate Acquisitions — (D) Reorganizations; and 771 T.M., Corporate Acquisitions — (A), (B), and (C) Reorganizations.

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Barnet Phillips, IV, Retired Partner, Skadden, Arps, Slate, Meagher & Flom L.L.P., New York, New York; B.A., Yale University 1970; J.D., Fordham University 1973; LL.M., New York University 1977.


Detailed Analysis

I. Introduction

Introductory Material

A. Basic Considerations

B. Taxable Acquisitions, Tax-Free Reorganizations and Special Techniques

C. Asset Acquisitions vs. Stock Acquisitions

D. The Tax Reform Act of 1986 and the Repeal of General Utilities

E. Substance vs. Form

F. Integration and the Step Transaction Doctrine

II. Mechanics of Implementing an Acquisition

A. Stock Acquisitions

1. Direct Stock Purchase

2. Indirect Stock Purchase - Reverse Triangular Merger

a. General

b. Single-Step Structure

c. Two-Step Structure

d. Tax Treatment

e. Transitory Nature of the Merger Subsidiary

3. Redemptions and Other Bootstrap Acquisition Techniques

a. General

b. Transactions Treated as Redemptions

4. Stock Acquisition Followed by Deemed Asset Sale - § 338

a. Effect of Election

b. Requirements for § 338 to Apply

c. The Consistency Rules

(1) In General

(2) The § 338 Consistency Regulations

(a) Background

(b) Pre-1994 Temporary Consistency Regulations

(c) Final Consistency Regulations

5. Stock Purchase Followed by Liquidation

a. Taxable Transactions - Pre-1982 Law

b. The Kimbell-Diamond Doctrine After TEFRA

c. Section 269(b) - The Forbidden Purpose

B. Asset Acquisitions

1. Direct Asset Purchase/No Liquidation

2. Direct Asset Purchase/Liquidation

3. Forward Merger

4. Forward Triangular Merger

5. Section 336(e) Election

C. Holding Company Structures

D. Joint Venture Structures

III. Forms of Consideration

Introductory Material

A. Cash

B. Other Assets of the Target Corporation

C. Debt

1. Identity of the Debtor

2. Payment Schedule

3. Seniority and Subordination of Debt

D. Stock

1. Identity of the Issuer

2. Type of Stock

E. Convertible and Exchangeable Instruments

F. Warrants

G. Other Techniques

1. Contingent Purchase Price

2. “Tracking” Stock

IV. Taxable Acquisitions - Consequences to Selling Shareholders

A. Basic Principles

B. Characterization of Transactions and Character of Gain

1. Exchange Transactions

2. Liquidations

3. Redemptions

C. Timing and Amount of Gain Recognition

1. Cash

2. Deferred Payments

a. Prior Law

b. Coordination with the Original Issue Discount and Imputed Interest Rules

c. Installment Reporting of Gain - Fixed-Payment Transactions

d. Non-Installment Reporting - Fixed-Payment Transactions

e. Examples - Fixed-Payment Transactions

3. Stock and Other Property

4. Contingent Payments

a. Characterization of Contingent Payment Arrangements

b. Original Issue Discount and Imputed Interest

(1) Debt Subject to the OID Rules

(a) Instruments Issued for Cash or Publicly Traded Property

(b) Instruments Issued for Nonpublicly Traded Property

(c) Other Provisions

(2) Debt Subject to § 483

c. Basis and Timing of Gain Recognition

(1) Sales Subject to the Installment Sale Rules

(2) Sales Where the Seller Elects Out of Installment Treatment

(3) Sales Not Eligible for Installment Treatment

d. Examples - Contingent Payment Transactions

D. Other Issues

1. Escrows

2. Capital Gain vs. Dividend Treatment

3. Overlapping Share Ownership

E. Reporting Requirements

V. Taxable Acquisitions - Consequences to the Target Corporation

A. Stock Acquisitions

1. General Rule

2. Section 338 Election

3. Distributions of Appreciated Property

B. Asset Acquisitions

1. Overview of Pre-1986 TRA Law

a. General Principles

b. Exceptions - Types of Transactions

c. Exceptions - Types of Gain (The Recapture Rules)

d. Transactional Effect - Pre-1986 TRA

2. Post-1986 TRA Law

a. General Rule

b. Special Rule for Parent-Subsidiary Liquidations

c. Character of Gain or Loss

d. Amount and Timing of Gain or Loss

(1) General Principles

(2) Non-Liquidating Transactions

(3) Liquidating Transactions

e. “Unripe” Income and Deduction Items

f. Transactional Effect - Post-1986 TRA

C. Reporting Requirements

VI. Taxable Acquisitions - Consequences to the Acquiror

A. Stock Acquisitions

1. General Principles

2. Redemptions and Distributions

3. Post-acquisition Liquidation

B. Asset Acquisitions

1. Aggregate Basis in Acquired Assets

a. Actual Asset Acquisitions

b. Deemed Asset Sales Under § 338

(1) “Regular” § 338 Election

(2) Section 338(h)(10) Deemed Asset Sale

2. Allocation of Basis Among Acquired Assets

a. Significance of Basis Allocation

b. Historical Background

c. Effect of 1986 TRA

d. Section 197

e. Special Techniques

(1) Creating a Record

(2) Customer Lists and Similar Assets

(3) Franchises, Trademarks and Trade Names

(4) Covenants Not to Compete, Consulting Agreements, and Similar Techniques

C. Use of Parent Stock or Debt

1. Gain Recognition by the Acquiror - The Zero-Basis Problem

2. Basis of Property Acquired with Parent Debt

D. Reporting Requirements

VII. Tax-free Reorganizations - Definitions

A. General Principles

1. Continuity of Interest

a. In General

b. Character Issues

c. Requisite Amount of Consideration

d. Specific Reorganizations

e. Step Transaction Issues

f. Insolvency Issues

2. Business Purpose

3. Continuity of Business Enterprise (COBE)

B. Specific Forms of Reorganization

1. Mergers - The “A” Reorganization

2. Stock for Voting Stock - The “B” Reorganization

a. Solely for Voting Stock

b. Control

c. Narrow Definition of the Plan of Reorganization

3. Assets for Voting Stock - The “C” Reorganization

a. Substantially All the Assets

b. Solely for Voting Stock

c. Liquidation Requirement

d. Triangular “C” Reorganizations and “C” Reorganizations Followed by a Drop-down

4. Forward Triangular Merger - The “(a)(2)(D)” Reorganization

a. Substantially All

b. Permissible Consideration

c. Assumption of Liabilities

d. The “Would Have Qualified” Requirement

5. Reverse Triangular Merger - The “(a)(2)(E)” Reorganization

a. Substantially All

b. Permissible Consideration and Acquisition of Control

6. Post Reorganization Transfers of Assets and Stock

C. Special Problems and Issues in Reorganizations

1. Redemptions and Distributions in Connection with Reorganizations

2. Dissenters’ Rights

3. Contingent and Escrowed Consideration

a. Contingent Stock

b. Escrowed Stock

c. IRS Ruling Position

4. Investment Company Rules

VIII. Tax-free Reorganizations - Consequences

A. General Principles

1. “Party to a Reorganization”

2. Securities

B. Consequences to Target Shareholders

1. Exchanges of Stock

2. Exchanges of Securities

3. Stock or Securities Attributable to Accrued Interest

4. “Boot” - The Receipt of Nonqualifying Property

a. General

b. Character of Gain

5. Nonqualified Preferred Stock

6. Coordination with Original Issue Discount Rules

7. Basis and Holding Period of Acquired Property

8. Examples

C. Consequences to the Target Corporation

1. Stock Acquisitions

2. Asset Acquisitions

3. Basis and Holding Period

D. Consequences to the Acquiror

1. Gain Recognition

2. Basis and Holding Period of Property Acquired

3. Tax Attributes

IX. Financing the Acquisition

A. Basic Approaches

1. Cash on Hand

a. Cash on Hand of the Acquiror

b. Cash on Hand of the Target

2. Debt Financing

a. Advantages of Debt Over Cash on Hand

b. Advantages of Debt Over Equity Financing

c. Terms of Debt Financing

3. Equity Financing

a. Reasons for Equity Financing

b. Terms of Equity Financing

B. Consequences of Debt Issued in Connection with an Acquisition

1. Original Issue Discount - Overview

a. Applicability of Rules

b. Character of Payments - General Rules

c. Amount of Original Issue Discount

(1) Stated Redemption Price at Maturity

(2) Issue Price

d. Accounting for Interest and Original Issue Discount

e. Additional Issues

(1) Contingent Payments

(2) Investment Units

(3) Mandatory and Optional Redemptions and Options to Extend

(4) Baby Bonds

(5) Anti-Abuse Rule

2. Consequences to Holders

3. Consequences to Issuers

a. General

b. Distinguishing Between Debt and Equity

(1) The Factors Considered

(2) Planning Techniques

c. Section 279 - Limitation on Interest Deductions with Respect to Certain Acquisition Debt

(1) Purpose of Debt

(2) Subordination

(3) Convertibility

(4) Debt/Equity Ratio and Projected Earnings

(5) Dollar Limitation on Disallowance

d. Section 163(e)(5) - Limitation on Interest Deductions with Respect to Certain High-Yield Discount Obligations

e. Other Limitations on Interest Deduction - Section 163(j) and (l)

f. Use of Interest Deductions in Consolidation

C. Consequences of Equity Issued in Connection with an Acquisition

1. Treatment of Distributions to Holders

2. The Intercorporate Dividends-received Deduction

3. Constructive Dividends - Section 305

a. Preferred Stock Issued at a Discount

b. PIK Preferred Stock

c. Non-Level Dividend Schedules

4. Section 306 Stock

a. Background

b. Definition of § 306 Stock

(1) Stock Received as a Tax-free Distribution

(2) Stock Received in Certain Reorganizations and Divisions

(3) Stock Received in Certain § 351 Transactions

(4) Nonqualified Preferred Stock

(5) Certain Stock Received in Exchange for § 306 Stock

c. Treatment of Dispositions of § 306 Stock

D. Consequences of Convertible and Exchangeable Instruments

1. Convertible Instruments

2. Exchangeable Instruments

a. Consequences to Holder

b. Determination of Original Issue Discount and Consequences to Issuer

(1) Instruments Exchangeable Against the Issuer

(2) Instruments Exchangeable Against the Issuer's Parent

3. Changes in Conversion Ratio

E. Consequences of Warrants and Options

1. Consequences to Holder

2. Consequences to Issuer

X. Net Operating Losses and Related Issues

A. General Principles

B. Section 382

1. General Principles

2. Ownership Change

a. General

b. Special Rules Regarding Options

(1) Ownership Test

(2) Control Test

(3) Income Test

(4) Exemption and Safe Harbors

3. Losses to Which Limitations Apply

4. Amount of Limitation

5. Built-in Gains and Losses

a. Built-in Losses and Deductions Attributable to Prior Years

b. Built-in Gains

c. Identification of Built-in Items

(1) The 1374 Approach

(2) The 338 Approach

6. Limitations on Tax Credit and Capital Loss Carryovers

C. Section 269

D. Limitations on the Use of Net Operating Losses in Consolidation

1. Pre-January 1, 1997 Rules

2. The January 1, 1997 Temporary Regulations

3. Final Regulations

4. Transactional Effect

E. Section 384

F. Section 172(b)(1)(E)

XI. Special Problems When a Corporation Is Acquired Out of an Affiliated Group

Introductory Material

A. Seller's Basis in the Target Stock - The Investment Adjustment Rules

1. Basic Rules

2. Adjustments to Stock Basis

B. Excess Loss Accounts and Deferred Intercompany Gains and Losses

1. Excess Loss Accounts

2. Deferred Intercompany Gains and Losses

C. Several Liability for Taxes

D. Tax-Sharing Agreements

E. The Loss Disallowance Rules

1. Historical Background

2. The September 1991 Regulations

3. The 2002 and 2003 Temporary Regulations and the 2005 Final Regulations

4. The 2008 Regulations

a. Basis Redetermination Rule to Reduce Disparity in Bases of Subsidiary Stock

b. Basis Reduction Rule to Prevent Noneconomic Loss

c. Attribute Reduction Rule to Prevent Loss Duplication

d. Interaction of Loss Duplication Rules and § 362(e)(2)

5. Transactional Effect

F. Allocation of Tax Attributes

G. Taxable Years

H. Carrybacks of Post-Acquisition Items

XII. Treatment of Transaction Costs

Introductory Material

A. The Acquiror's Expenses

1. Taxable Acquisitions

2. Tax-Free Reorganizations

3. The § 263 Regulations

B. The Target's Expenses

1. The National Starch Case

2. The Hostile Acquisition Authorities

3. The § 263 Regulations

4. Applicability to Specific Transactional Forms

a. Taxable Stock Purchase

b. Tax-free Stock Acquisition

c. Taxable Asset Acquisition

d. Tax-Free Asset Acquisition

C. Special Issues

1. Costs of Financing

2. Organizational Expenses

3. Costs of Employee Compensation in Connection with Acquisitions

4. Costs of Reacquiring a Corporation's Own Stock - The “Greenmail” Rules

5. Abandoned Transactions

6. Other Expenses

7. Shareholder Litigation

8. Allocation of Expenses

XIII. Selected Compensation Issues

Introductory Material

A. The “Golden Parachute” Legislation

1. Basic Rules

2. Practical Application

B. Treatment of Outstanding Employee Stock Options

1. “Cash-Out” of Options

2. Substitution of Options

3. Employee Election to Cash Out or Substitute Options

4. Immediate Vesting of Options

5. Treatment of Options Under the Golden Parachute Rules

C. Participation of Management in the Acquisition

1. Basic Rules - Overview of § 83

a. Transfer of Property

b. Substantial Risk of Forfeiture

c. Special Rule for Stock Subject to § 16(b)

d. Deduction to Employer

2. Planning Techniques

a. Objectives

b. Valuation of Stock

c. Purchase of Stock with Notes

d. Junior Stock

e. Contribution of Existing Stock Under § 351

XIV. Disposition of Unwanted Assets

Introductory Material

A. Taxable Asset Sales

1. Selective Asset Sales to Multiple Buyers

2. Asset Sales and In-Kind Distributions to Shareholders

3. Single Asset Sale and Dispositions by Buyer

B. Taxable Stock Sales

C. Tax-free Reorganizations

1. Qualification as a Reorganization

2. Tax on Disposition of Assets

3. Treatment of Disposition Proceeds

D. Section 355

1. Basic Transactional Framework

2. Active Business Requirement

3. The “Device” Restriction

4. The Distribution Requirement

5. General Judicial Requirements

a. Continuity of Interest

b. Business Purpose

6. Additional Restrictions on Corporate-Level Nonrecognition

a. In General

b. The 2002 Temporary and Proposed Regulations

c. The 2005 Final Regulations

7. Disqualified Investment Corporations

XV. Other Special Problems and Planning Techniques

A. Taxable Acquisitions That Are Tax-free to Particular Shareholders - The National Starch Transaction

B. Holding Company Business Combinations - The “Merger of Equals”

1. Double-Winged Stock Acquisition

2. Asset Acquisition

C. Joint Venture Subsidiaries

D. Overlapping Share Ownership

1. Stock Acquisitions - § 304

2. Asset Acquisitions - § 368(a)(1)(D) and Other Potential Pitfalls

a. Control

b. Substantially All

c. Distribution

d. Liquidation

e. “D” Reorganizations Followed by a Drop-down

f. Other Attacks

E. Employee Stock Ownership Plans

F. Special Statutory Provisions for Specially-Taxed Entities and Particular Industries

XVI. Documentation; Allocation of Risks Between the Buyer and Seller

Introductory Material

A. General Documentation Issues

B. The Tax Representation

1. Definition of “Taxes”

2. Operative Provisions

3. Relationship of Representation to Indemnification

4. Limitations

5. Survival of Representations

6. Representations Related to the Tax Treatment of the Transaction

C. Tax-related Covenants

D. Tax Indemnification

E. Private Rulings and Tax Opinions

XVII. Selected Non-tax Considerations

Introductory Material

A. Federal Securities Law Considerations

1. General

2. Illustrations of Timing Issues

3. Illustrations of Disclosure Issues

B. State Corporate Law Fiduciary Duty Considerations

C. Financial Accounting Treatment

1. Purchase Accounting

a. In General

b. Application of Purchase Accounting Rules

(1) Determining the Acquiror

(2) Determining the Cost of the Acquired Company

(3) Recording the Assets Acquired and the Liabilities Assumed

c. Amortization of Goodwill and Other Intangibles Acquired

d. On-Going Accounting

2. Acquisition Method

D. Antitrust Law Considerations

1. General

2. The Jurisdictional Tests

3. Definitions

4. Value of the Acquisition

5. Acquisitions by Newly Formed Entities

6. Corporate Joint Ventures

7. The Waiting Period

8. Requests for Additional Information

9. Early Termination

10. Other Exemptions

11. Secondary Acquisitions

12. Confidentiality

13. The Notification and Report Form

14. Filing Fees

15. Acquisition Thresholds for Acquisitions of Voting Securities

16. Transactions for Avoidance

17. Penalty Provisions


Working Papers

Table of Worksheets

Worksheet 1 Table of Tax Consequences of Basic Acquisition Structures

Worksheet 2 Table of the Suitability of Different Forms of Consideration to Different Shareholder Objectives

Worksheet 3 Table of the Taxation of Various Forms of Consideration in Taxable and Tax-Free Structures1

Worksheet 4 Table of the Suitability of Different Structures to Different Shareholder Groups

Worksheet 5 Possible Forms of Consideration

Worksheet 6 Tax Issues Arising in Connection With Various Forms of Financing

Worksheet 7 Facts Needed to Structure an Acquisition

Worksheet 8 Requirements for Different Forms of Reorganization

Worksheet 9 Single-Step Reverse Triangular Merger

Worksheet 10 Two-Step Reverse Triangular Merger

Worksheet 11 Two-Step Reverse Triangular Merger - Variant

Worksheet 12 Direct Redemption/Sale

Worksheet 13 Forward Triangular Merger

Worksheet 14 Acquisitive Section 351 Transaction (National Starch Structure)

Worksheet 15 Holding Company Transaction - Double Reverse Merger

Worksheet 16 Holding Company Transaction - Forward and Reverse Triangular Mergers

Worksheet 17 Joint Venture Subsidiary

Worksheet 18 Sample Form of Agreement to Make a § 338(h)(10) Election

Worksheet 19 Sample Tax Representation (Long Version)

Worksheet 20 Sample Tax Representation (Short Version)

Worksheet 21 Sample Form of Contest Provision





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