1. Mergers, Acquisitions, & Divestitures n Reasons n Types n Tax Issues n Non-Tax Issues n Methods n Tax Deductibility of Goodwill

2. Reasons for Mergers/Acquisitions n 1)To improve economic efficiency n 2)To extend the power base of management n 3)To effect transfers of wealth between classes of stakeholders

3. Reasons for Divestitures n 1)To focus on core competencies n 2)To free managers of the divested business to focus on the divested firm n 3)To solve market mispricing n 4)To gain greater access to capital markets

4. Types of Mergers/Acquisitions n Freestanding companies can acquire: – 1) Other freestanding companies – 2) Subsidiaries of other companies n Acquisitions can be structured to be: – 1) Taxable (when the acquirer uses cash) – 2) Tax-free (when the acquirer uses mostly stock)

5. Types of Divestitures n Tax-Free Spin-off: Involves the division of the parent corporation into two or more distinct corporations. n Equity Carve-out: Involves the sale of a portion of a subsidiary’s equity for cash.

6. Major Tax Issues n 1)Shareholder tax liabilities n 2)Effect on tax attributes n 3)Corporate-level tax effect of the merger, acquisition, or divestiture n 4)Change in the tax basis of the assets of the target or divested subsidiary n 5)Effect of leverage on mergers and acquisitions

7. Shareholder Tax Liabilities-- Mergers/Acquisitions n If taxable: Purchase price - Basis in stock = Gain recognized by target shareholders n Requirement for a tax-free acquisition: – Target shareholders must maintain a continuity of interest --50% of total consideration paid is acquiring-firm stock n Note: “Tax-free” transactions can result in a taxable gain for target shareholders to the extent they receive cash!

8. Shareholder Tax Liabilities-- Divestitures n Spin-off: No taxable gain or loss recognized by the divesting corporation’s shareholders n Equity Carve-out: No taxable gain or loss recognized by shareholders n Sale of Division or Subsidiary for Cash: No taxable gain or loss recognized by the divesting corporation’s shareholders unless proceeds are distributed to them by the divesting corporation

9. Effect on Tax Attributes

10. Corporate-Level Tax Effect-- Mergers/Acquisitions n If acquisition is accomplished through the purchase of assets in a taxable transaction, a taxable gain or loss is recognized by the target corporation n If acquisition is accomplished through the purchase of stock in either a taxable or tax- free transaction, no gain or loss is recognized at the corporation level

11. Corporate-Level Tax Effect-- Divestitures n Subsidiary Sale: Purchase price of stock or assets - Seller’s basis in stock or assets = Taxable gain (loss) recognized by seller n Equity Carve-out: Generally does not result in a taxable gain or loss for the divesting corporation n Spin-off: Since a spin-off is usually tax-free, no taxable gain is recognized under typical circumstances

12. Change in Tax Basis of Assets of the Target or Divested Subsidiary n A step-up in the tax basis of assets of an acquired business to the purchase price creates increased future depreciation deductions, which provide valuable tax savings. n This is common in subsidiary sales, but acquisitions of freestanding C corporations are limited in this practice by the Tax Reform Act of 1986.

13. Non-Tax Issues in Mergers, Acquisitions, and Divestitures n Financial Reporting Costs – Purchase Accounting – Pooling of Interests Accounting* n Transaction Costs n Contingent or Unrecorded Liabilities n Managerial and/or Control Issues * FASB eliminated this method after 2001

14. Five Basic Methods to Acquire a Freestanding C Corporation n A’s taxable purchase of C’s (for C Corp) assets n A’s taxable purchase of C’s stock followed by an I.R.C. § 338 election n A’s taxable purchase of C’s stock not followed by an I.R.C. § 338 election n A’s acquisition of C’s stock in a tax-free exchange n A’s acquisition of C’s assets in a tax-free exchange

15. Four Methods to Divest a Subsidiary or Line of Business n Subsidiary Stock Sale n Subsidiary Asset Sale n Spin-off n Equity Carve-out

16. Tax Deductibility of Goodwill Under I.R.C. § 197 I.R.C. § 197 makes goodwill tax-deductible. However, goodwill is only tax-deductible when the tax basis of the acquired firm’s assets is stepped up. This occurs frequently in subsidiary sales and in acquisitions of conduits but not in acquisitions of freestanding C corporations.

17. Structures Employed in Acquisitions of Freestanding C Corps and Tax Implications

18. Divestiture Methods and Tax Implications