1. 7-1 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

2. 7-2 CORP ACQUISITIONS & REORGANIZATIONS (1 of 2)  Taxable acquisition transactions  Taxable vs. nontaxable acquisitions  Tax consequences of reorganizations  Acquisitive reorganizations  Divisive reorganizations  Other reorganization transactions ©2011 Pearson Education, Inc. Publishing as Prentice Hall

3. 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

4. 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

5. 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

6. 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/hs recognize gain/loss  Payment to a s/h for a noncompete agreement is ordinary income to s/h ©2011 Pearson Education, Inc. Publishing as Prentice Hall

7. 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8. 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

9. 7-9 Stock Acquisitions with §338 Deemed Sale Election (1 of 5)  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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

10. 7-10 Stock Acquisitions with §338 Deemed Sale Election (2 of 5)  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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

11. 7-11 Stock Acquisitions with §338 Deemed Sale Election (3 of 5)  Target’s old tax attributes wiped out  New elections are made  See Topic Review 1 for summary ©2011 Pearson Education, Inc. Publishing as Prentice Hall

12. 7-12 Stock Acquisitions with §338 Deemed Sale Election (4 of 5) 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

13. 7-13 Stock Acquisitions with §338 Deemed Sale Election (5 of 5)  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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

14. 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

15. 7-15 Taxable vs. Nontaxable Acquisitions (2 of 2)  Only purchase method allowed for GAAP for business combinations  ASC 805 (FAS No. 141)  Goodwill not amortized for GAAP  Assets recorded at FMV  Tested for impairment  ASC 350 (FAS No. 142) ©2011 Pearson Education, Inc. Publishing as Prentice Hall

16. 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

17. 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

18. 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

19. 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

20. 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

21. 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

22. 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

23. 7-23 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

24. 7-24 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

25. 7-25 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

26. 7-26 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  New Reg. allows acquiring corp to use as much as 60% other consideration ©2011 Pearson Education, Inc. Publishing as Prentice Hall

27. 7-27 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

28. 7-28 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

29. 7-29 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

30. 7-30 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

31. 7-31 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

32. 7-32 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

33. 7-33 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

34. 7-34 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

35. 7-35 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

36. 7-36 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

37. 7-37 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

38. 7-38 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

39. 7-39 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

40. 7-40 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

41. 7-41 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). ©2011 Pearson Education, Inc. Publishing as Prentice Hall

42. 7-42 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

43. 7-43 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

44. 7-44 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

45. 7-45 Example (4 of 4)  What if Thomas’ basis had been $750K?  Recognized loss: $ 0  Basis (carryover):$750K  Distribution gain or loss: $ 0 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

46. 7-46 Tax Planning Considerations  Why use a reorganization instead of a taxable transaction?  Target corp s/h defer gain recognition  Target corp exchanges assets w/out gain recognition or depreciation recapture  Avoiding reorganization provisions  Allows acquiring corp to make §338 election ©2011 Pearson Education, Inc. Publishing as Prentice Hall

47. 7-47 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

48. 7-48 Financial Statement Implications (1 of 2)  ASC 805 (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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

49. 7-49 Financial Statement Implications (2 of 2)  Taxable asset acquisition  Nontaxable asset acquisition  Stock acquisition  Pricing the acquisition  Net operating losses ©2011 Pearson Education, Inc. Publishing as Prentice Hall

50. 7-50 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

51. 7-51 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

52. 7-52 Stock Acquisition  Target corp remains intact as a subsidiary of acquiring corp  Adjustments under ASC 850 & 740 (SFAS 141 & 109) occur when preparing consolidated financial statements ©2011 Pearson Education, Inc. Publishing as Prentice Hall

53. Comments or questions about PowerPoint Slides? Contact Dr. Richard Newmark at University of Northern Colorado’s Kenneth W. Monfort College of Business richard.newmark@PhDuh.com 7-53 ©2011 Pearson Education, Inc. Publishing as Prentice Hall