1. 13-1 Corporate Acquisitions  Acquisition form  Asset Acquisition  Direct acquisition of selected assets of target corporation  Merger with target corporation dissolved into acquiring corporation  Stock Acquisition

2. 13-2 Acquisitions Decision Model

3. 13-3 Five Major Tax Issues  Will the transaction result in a taxable gain or loss to the target firm’s shareholders?  Will the transaction result in a taxable gain or loss to the target firm?  How will the transaction affect the target firm’s tax attributes (NOLs, credit carryovers)?  Will the transaction affect the tax basis of the target firm’s assets?  Will the use of leverage generate tax savings?

4. 13-4 Taxable Asset Acquisitions  If direct asset acquisition  Target recognizes gain or loss on sale of assets  No tax consequences to target shareholders, unless target liquidates (then shareholders recognize gain or loss on disposition of their stock)  If structured as a merger  Target recognizes gain or loss as if assets were sold at FMV  Target shareholders recognize gain or loss on the disposition of their target stock

5. 13-5 Taxable Asset Acquisitions continued  If merger, or target liquidates after acquisition, target firm’s tax attributes, including NOL and credit carryovers, are lost  Cannot ‘buy’ tax attributes  Acquiring corporation takes a cost basis (FMV) in assets acquired  Debt financing is common in taxable asset acquisitions, often resulting in increased leverage

6. 13-6 Example: Taxable Asset Acquisition  ABC Inc. wishes to acquire the business of Target Corporation, whose stock is owned by Mr. Smith. ABC is willing to pay $2 million for all of Target’s assets.  If Target’s assets have a tax basis of $800,000, what are the tax consequences of the sale?  Mr. Smith’s tax basis in his target stock is $500,000. If Target liquidates and distributes the after-tax proceeds of the asset sale to Mr. Smith, what are the tax consequences of the liquidation?

7. 13-7 Taxable Stock Acquisitions  Target shareholders recognize gain or loss on disposition of their target stock  Target does not recognize gain or loss (unless Sec. 338 election)  Tax attributes survive the acquisition, but their future use is subject to limitations  Acquiring corporation takes a cost (FMV) basis in the target stock acquired  No impact on basis of target’s assets (unless Sec. 338 election)

8. 13-8 Taxable Stock Acquisitions continued  Debt financing is common in taxable stock acquisitions, often resulting in increased leverage  If 80% control acquired, acquiring corporation and target may file a consolidated tax return

9. 13-9 Example: Taxable Stock Acquisition  Refer to previous example.  Suppose that ABC is willing to pay Mr. Smith $2 million for his Target stock. What are the tax consequences of this sale?  Why might ABC not be willing to pay $2 million for the stock?  At what stock purchase price would Mr. Smith be indifferent between a stock sale and an asset sale followed by a liquidation of Target?

10. 13-10 Special Issues in Taxable Stock Acquisitions  Section 338 Election  Election to treat a stock purchase as an asset purchase for tax purposes  Advantage: Acquiring corporation gets to adjust the tax basis of target’s assets to FMV  Cost: Target must recognize gain or loss as though assets were sold for FMV

11. 13-11 Nontaxable Acquisitions (Reorganizations)  Qualified reorganizations are treated as nontaxable exchanges  Judicial requirements for acquisitive reorgs:  Original owners of target must maintain continuity of proprietary interest in target’s business - satisfied if at least 50% of consideration is acquiring corporation stock  Continuity of business enterprise - acquirer must continue target’s business or use target’s assets in an existing business  Business purpose, beyond tax avoidance

12. 13-12 Tax Consequences of Nontaxable Acquisitions  Most basic case: No boot (all consideration is acquiring corporation stock)  No gain or loss recognized by target corporation, or target’s shareholders  Target tax attributes survive  Acquiring corporation takes a carryover basis in the assets or stock acquired  If asset acquisition, target distributes stock received to its shareholders and (usually) liquidates

13. 13-13 Nontaxable Acquisitions continued  Target shareholders take a carryover basis in the acquiring corporation stock received  Debt financing cannot occur directly in this case (since it would be considered boot), so increased leverage not possible as part of the acquisition transaction  Acquirer corporation debt can be issued to replace target corporation debt. No gain or loss will occur if principal amounts are equal

14. 13-14 Boot in Acquisitive Reorganizations  Any property transferred by the acquiring corporation other than its own stock or securities is considered boot  Gain (but not loss) recognized by the acquirer if FMV of boot transferred > adjusted tax basis  No gain or loss if the boot is cash  Target corporation recognizes gain (but not loss) if boot not distributed to shareholders, or if target distributes its own assets (not acquired in the reorganization) to its shareholders

15. 13-15 Boot in Acquisitive Reorganizations continued  Target shareholders receiving boot and stock or securities recognize gain (but not loss) equal to the lesser of the gain realized or the FMV of the boot received  Target shareholders receiving only boot recognize any gain or loss realized  Gain recognized by target shareholders is treated as a dividend (ordinary income) to the extent of each shareholder’s proportionate share of target’s AEP. Any remaining gain is capital gain.

16. 13-16 Boot in Acquisitive Reorganizations continued  Target security holders recognize gain if the principal value of the securities received is greater than the principal value of the securities given up  The basis of assets transferred to the acquirer is increased by any gain recognized by the target  The basis of stock or securities received by target shareholders is increased by any gain recognized and decreased by the FMV of boot received

17. 13-17 GAAP Treatment of Mergers and Acquisitions  Purchase accounting  All assets and liabilities of acquired target recorded at FMV, including goodwill  SEC-preferred method of accounting for acquisitions  Pooling-of-interests accounting  Assets and liabilities of combined firms recorded at historical book cost  Typically results in little or no recorded goodwill  No longer allowed under GAAP

18. 13-18 Tax versus Financial Statement Goodwill  For tax purposes, goodwill is recorded only when the tax basis of target assets is stepped up to FMV  Taxable asset acquisitions  Taxable stock acquisitions with Sec. 338 election  Purchased goodwill amortizable over 15 years for tax purposes  Many nontaxable acquisitions are recorded using the purchase method for GAAP purposes, resulting in GAAP goodwill that is not amortizable for tax purposes

19. 13-19 Corporate Divisions  Spin-off: Parent corporation distributes controlling interest in stock of a subsidiary corporation to parent’s shareholders  Split-off: Parent corporation distributes controlling interest in stock of a subsidiary to a group of shareholders in exchange for their parent stock  Split-up: Parent corporation distributes stock of two (or more) subsidiaries to its shareholders in complete liquidation of the parent

20. 13-20 Corporate Divisions continued  Such transactions are nontaxable to the parent and participating shareholders if undertaken for a corporate business purpose and requirements of Sec. 355 are met  Parent must distribute at least 80% of subsidiary stock  Subsidiary and parent (spin-off or split-off) must continue to engage in a business that had been conducted for at least 5 years before the distribution  Parent must have held the stock of the subsidiary for at least 5 years before the distribution (unless acquired in a nontaxable transaction)