7-1 ©2008 Prentice Hall, Inc.

7-2 ©2008 Prentice Hall, Inc. CORP ACQUISITIONS & REORGANIZATIONS (1 of 2)  Taxable acquisition transactions  Taxable vs. nontaxable acquisitions  Tax consequences of reorganizations  Acquisitive reorganizations  Divisive reorganizations

7-3 ©2008 Prentice Hall, Inc. CORP ACQUISITIONS & REORGANIZATIONS (2 of 2)  Other reorganization transactions  Judicial restrictions on reorganizations  Tax attributes  Limitation on use of tax attributes  Example  Financial statement implications

7-4 ©2008 Prentice Hall, Inc. Taxable Acquisition Transactions  Asset acquisitions  Stock acquisitions w/ no liquidation  Stock acquisitions w/ liquidation  Stock acquisitions w/ §338 deemed sale election  See Table C7-1 for a summary

7-5 ©2008 Prentice Hall, Inc. 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

7-6 ©2008 Prentice Hall, Inc. 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

7-7 ©2008 Prentice Hall, Inc. 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

7-8 ©2008 Prentice Hall, Inc. 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

7-9 ©2008 Prentice Hall, Inc. Stock Acquisitions with §338 Deemed Sale Election (1 of 4)  How acquisition is accomplished  Shareholders of target corp sell their shares directly to purchaser corp  Purchaser files §338 election pretending that target has been liquidated and a new subsidiary created in its place

7-10 ©2008 Prentice Hall, Inc. Stock Acquisitions with §338 Deemed Sale Election (2 of 4)  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

7-11 ©2008 Prentice Hall, Inc. Stock Acquisitions with §338 Deemed Sale Election (3 of 4)  Target’s old tax attributes wiped out  New elections are made  See Topic Review C7-1 for summary

7-12 ©2008 Prentice Hall, Inc. Stock Acquisitions with §338 Deemed Sale Election (4 of 4) 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 other tax liab for sale T R : Applicable federal income tax rate B: Adjusted basis of asset(s) deemed sold

7-13 ©2008 Prentice Hall, Inc. Taxable vs. Nontaxable Acquisitions (1 of 2)  Use of cash and debt for acquisition produce tax liability  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 C7-2 & C7-3

7-14 ©2008 Prentice Hall, Inc. Taxable vs. Nontaxable Acquisitions (2 of 2)  Only purchase method allowed for GAAP for business combinations initiated after June 30,  FAS No. 141  Goodwill not amortized for GAAP  Assets recorded at FMV  Tested for impairment  FAS No. 142

7-15 ©2008 Prentice Hall, Inc. Tax Consequences of Reorganizations  Target corporation  Also referred to as “transferor” corp  Acquiring corporation  Also referred to as “transferee” corp  Shareholders & security holders

7-16 ©2008 Prentice Hall, Inc. 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

7-17 ©2008 Prentice Hall, Inc. 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

7-18 ©2008 Prentice Hall, Inc. 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

7-19 ©2008 Prentice Hall, Inc. 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

7-20 ©2008 Prentice Hall, Inc. 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

7-21 ©2008 Prentice Hall, Inc. 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

7-22 ©2008 Prentice Hall, Inc. 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

7-23 ©2008 Prentice Hall, Inc. 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

7-24 ©2008 Prentice Hall, Inc. 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

7-25 ©2008 Prentice Hall, Inc. 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

7-26 ©2008 Prentice Hall, Inc. Type D: Asset for Stock Acquisitive D (2 of 2)  Target or target s/hs 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

7-27 ©2008 Prentice Hall, Inc. 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

7-28 ©2008 Prentice Hall, Inc. 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

7-29 ©2008 Prentice Hall, Inc. 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

7-30 ©2008 Prentice Hall, Inc. 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

7-31 ©2008 Prentice Hall, Inc. 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

7-32 ©2008 Prentice Hall, Inc. 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

7-33 ©2008 Prentice Hall, Inc. 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

7-34 ©2008 Prentice Hall, Inc. 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

7-35 ©2008 Prentice Hall, Inc. 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

7-36 ©2008 Prentice Hall, Inc. 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  Continuity of business enterprise  Old assets must be used in new business

7-37 ©2008 Prentice Hall, Inc. 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

7-38 ©2008 Prentice Hall, Inc. 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

7-39 ©2008 Prentice Hall, Inc. 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

7-40 ©2008 Prentice Hall, Inc. 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).

7-41 ©2008 Prentice Hall, Inc. 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

7-42 ©2008 Prentice Hall, Inc. 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

7-43 ©2008 Prentice Hall, Inc. 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

7-44 ©2008 Prentice Hall, Inc. Example (4 of 4)  What if Thomas’ basis had been $750K?  Recognized loss: $ 0  Basis (carryover):$750K  Distribution gain or loss: $ 0

7-45 ©2008 Prentice Hall, Inc. 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

7-46 ©2008 Prentice Hall, Inc. Financial Statement Implications (2 of 2)  Taxable asset acquisition  Nontaxable asset acquisition  Stock acquisition  Pricing the acquisition  Net operating losses

7-47 ©2008 Prentice Hall, Inc. 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

7-48 ©2008 Prentice Hall, Inc. 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 not amortizable for tax  No temporary difference

7-49 ©2008 Prentice Hall, Inc. Stock Acquisition  Target corp remains intact as a subsidiary of acquiring corp  Adjustments under SFAS No. 141 & 109 occur when preparing consolidated financial statements

Comments or questions about PowerPoint Slides? Contact Dr. Richard Newmark at University of Northern Colorado’s Kenneth W. Monfort College of Business 7-50 ©2008 Prentice Hall, Inc.