7-1 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-2 CORP ACQUISITIONS & REORGANIZATIONS (1 of 2)  Taxable acquisition transactions  Taxable vs. nontaxable acquisitions  Tax consequences of reorganizations  Acquisitive reorganizations  Divisive reorganizations  Other reorganizations Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-3 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 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-4 Taxable Acquisition Transactions  Asset acquisitions  Stock acquisitions w/ no liquidation  Stock acquisitions w/ liquidation  Stock acquisitions w/ §338 deemed sale election  See Table 1 for a summary Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-5 Asset Acquisitions  Direct purchase of assets  Target corporation  Gain or loss and depreciation recapture are computed by selling (target) corporation on each asset  Acquiring corporation  Basis in assets is acquisition cost Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-6 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/h’s recognize gain/loss  Payment to a s/h for a noncompete agreement is ordinary income to s/h Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-7 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 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-8 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 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-9 Stock Acquisitions with §338 Deemed Sale Election In General  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 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-10 Stock Acquisitions with §338 Deemed Sale Election Target Corp (1 of 2)  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 12 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-11 Stock Acquisitions with §338 Deemed Sale Election Target Corp (2 of 2)  Target’s old tax attributes wiped out  New elections are made  See Topic Review 1 for summary Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-12 Stock Acquisitions with §338 Deemed Sale Election Deemed Sale Price ADSP = G + L - (T R x B) (1 – T R ) ADSP: Adjusted deemed sale price G: Acquiring’s grossed-up basis in the target corporation’s recently purchased stock L: Target’s liabilities other than tax liab for sale T R : Applicable federal income tax rate B: Adjusted basis of asset(s) deemed sold Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-13 Stock Acquisitions with §338 Deemed Sale Election New Tax Basis  Tax basis in assets after deemed sale  Adjusted grossed-up basis  Sum of  Recently purchased stock  Target corp’s nontax liabilities  Target corp’s tax liability  Allocate to 7 classes using residual method Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-14 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 2 & 3 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-15 Taxable vs. Nontaxable Acquisitions (2 of 2)  Only purchase method allowed for GAAP for business combinations  ASC 805  Goodwill not amortized for GAAP  Assets recorded at FMV  Tested for impairment  ASC 350 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-16 Tax Consequences of Reorganizations  Target corporation  Also referred to as “transferor” corp  Acquiring corporation  Also referred to as “transferee” corp  Shareholders & security holders Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-17 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 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-18 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  Does not include boot Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-19 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  Dividend vs. redemption Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-20 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 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-21 Acquisitive Reorganizations  Acquiring corp obtains part or all of assets or stock of a target corp  See Topic Review C7-5  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 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-22 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 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-23 Type A: Merger or Consolidation Types (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 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-24 Type A: Merger or Consolidation Types (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 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-25 Type A: Merger or Consolidation Type A Illustration – Merger Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-26 Type A: Merger or Consolidation Type A Illustration – Consolidation Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-27 Type A: Merger or Consolidation Illustration – Triangular Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-28 Type C: Assets for Stock Basic Concepts  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 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-29 Type C: Assets for Stock Illustration Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-30 Type D: Asset for Stock Acquisitive D - Acquiring Corporation  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  New Reg. allows acquiring corp to use as much as 60% other consideration Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-31 Type D: Asset for Stock Acquisitive D -Target  Target or target s/h’s must control acquiring corp immediately after asset transfer  Control defined as either  50% of voting power of voting stock or  50% of total value of all stock  Target liquidates itself Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-32 Type D: Asset for Stock Acquisitive D - Illustration Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-33 Type B: Stock for Stock Basic Concepts  Acquiring corp issues voting stock directly to target s/h’s 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 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-34 Type B: Stock for Stock Illustration Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-35 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 court- approved plan Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-36 Divisive Reorganizations  Part of corp’s assets transferred to a second corp which is owned by either the original corp or its s/h’s  Divisive D reorganizations  Split-off  Spin-off  Split-up  Divisive G reorganization Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-37 Divisive D: Split-Off Basic Concepts  Corp transfers assets to a controlled subsidiary in exchange for sub’s stock  Sub’s stock then transferred to one or more s/h’s in exchange for parent corp stock Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-38 Divisive D: Split-Off Illustration Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-39 Divisive D: Spin-Off  Corp transfers assets to subsidiary in exchange for sub’s stock  Parent distributes sub stock to all parent s/h’s on a pro rata basis  Parent receives nothing in exchange for distribution of sub’s stock Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-40 Divisive D: 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/h’s in exchange for all outstanding parent stock and liquidates Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-41 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/h’s, security holders, and creditors  Transferor corp may continue business or be liquidated by the court Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-42 Other Reorganizations 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 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-43 Other Reorganizations 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 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-44 Judicial Restrictions on Reorganizations (1 of 2)  If judicial restrictions are not met, reorganization loses its tax-free status  Continuity of proprietary interest  Old owners must continue ownership  New Reg now accepts 40% as the continuity of interest threshold  Continuity of business enterprise  Old assets must be used in new business Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-45 Judicial Restrictions on Reorganizations (2 of 2)  Business purpose  Valid business purpose for transaction  Step transaction doctrine  IRS may collapse series of independent transactions if all part of a plan Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-46 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 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-47 Limitation on Use of Tax Attributes §§382 & 269  Prevent assets or stock purchases if primary purpose is obtaining loss carryovers  Also prevent a loss corp from purchasing a profitable corp if primary purpose is using its existing losses Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-48 Limitation on Use of Tax Attributes §383 & § 384  §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). Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-49 Example (1 of 4)  Thomas Corp transfers all assets and part of its liabilities to Andrews Corp. for $600K of Andrews Common stock. Following the merger, Thomas is liquidated  Thomas’ basis in assets$475K  Liabilities transferred$100K Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-50 Example (2 of 4)  What is Thomas’ recognized gain or loss?  Gain realized: $700K* - $475K = $225K  Boot received: $0  Recognized Gain: $0 * $700K = $600K stock + $100K relief of liabilities Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-51 Example (3 of 4)  What is Andrews’ basis in the assets?  $475K (carryover)  How much gain/loss does Thomas recognize upon distribution of Andrews stock to Thomas’ shareholders?  No gain or loss Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-52 Example (4 of 4)  What if Thomas’ basis had been $750K?  Recognized loss: $ 0  Basis (carryover):$750K  Distribution gain or loss: $ 0 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-53 Tax Planning Considerations  Why use a reorganization instead of a taxable transaction?  Target corp s/h’s defer gain recognition  Target corp exchanges assets w/out gain recognition or depreciation recapture  Avoiding reorganization provisions  Allows acquiring corp to make §338 election Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-54 Compliance and Procedural Considerations  §338 election  Acquiring corp files Form 8023  Plan of reorganization  Written plan not required, but prudent  Ruling requests  May request advanced ruling from IRS on tax consequences of reorganization Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-55 Financial Statement Implications (1 of 2)  ASC 805  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 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-56 Financial Statement Implications (2 of 2)  Taxable asset acquisition  Nontaxable asset acquisition  Stock acquisition  Pricing the acquisition  Net operating losses Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-57 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 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-58 Nontaxable Asset Acquisition  Book bases differ from carryover tax bases of acquired assets  ASC 850 (SFAS 109) prescribes that acquiring corp recognize deferred tax liability/asset for book/tax differences in bases of transferred assets and liabilities  Goodwill not amortizable for tax  No temporary difference Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

7-59 Stock Acquisition  Target corp remains intact as a subsidiary of acquiring corp  Adjustments under ASC 850 & 740 occur when preparing consolidated financial statements Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

Comments or questions about PowerPoint Slides? Contact Dr. Richard Newmark at University of Northern Colorado’s Kenneth W. Monfort College of Business 7-60 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall