Corporate Tax Law Rules Essay

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Reorg and Tax Returns

There are a seven types of reorganizations, and each type has different consequences. The client is considering a Type B reorganization, which is an acquisition. Two of its subsidiaries have been acquired this way. The client is considering type A, which is a merger or consolidation; Type C, which is an acquisition, with liquidation, and Type D, which is a transfer. This paper will outline the differences between these in terms of structure, and in terms of their tax consequences. Now, the client should be aware that tax reasons are a terrible reason to do things like mergers and acquisitions because of the profound impact those activities can have on corporate strategy, but it is always good to know the tax consequences of the different types of corporate reorganization before engaging in them.

Type A The Type A reorg is merger and consolidation. In this, the acquiring company (the client) would acquire another company. As part of the acquisition it would acquire the assets of the target company and assume ownership over the target and all of its assets (Kibilko, 2016). For an acquisition to be considered Type A, it needs to meet the following requirements:

50% of the payment must be in the stock of the acquirer

The selling entity is liquidated

Acquirer acquires all assets and liabilities of the seller

The main benefits of Type A are that it can have multiple payment types. Some cash can be used, as long as 50% of the payment is in stock. The sellers acquire stock in the acquiring company, which means that they can defer realizing the gain or loss on the sale until such time as they sell the share of the acquiring company. They would only pay on whatever cash was paid. The acquirer takes on the assets and liabilities of the acquired firm. The acquired firm is liquidated, however, which means that the acquirer only takes on the revenues and losses of the target firm from the data of acquisition (Accounting Tools, 2016). The tax burden therefore is mainly in the cash that was paid to the shareholders of the target firm.

To the extent that the acquirer has paid above market value for the acquired firm -- which is normal, in order to entice the shareholders to sell -- the amount paid that goes above the market value is recorded on the balance sheet as goodwill. If the company does not realize gains in the amount of the goodwill, it may be required to write that down at a later date, though it is likely to choose a year in which to do so that would deliver the best tax consequences for shareholders, within the limits of the rules regarding writing down impaired assets.

Type B

A Type B reorganization is similar to a Type A, but in the Type B, the target organization becomes a subsidiary of the acquiring company, rather than being absorbed into the acquiring company (Kibilko, 2016). In this situation, the acquiring company need not buy all the stock, but merely controlling interest. It can buy the remaining stock at a later date, again as part of a Type B reorg. Three are certain constraints for a reorg to meet the criteria of a Type B reorg:

No more than 20% of the value in cash

At least 80% of voting stock acquired with voting stock

At least 80% of acquiree's outstanding stock acquired

Selling entity becomes a subsidiary of the acquirer

One of the main advantages of this type of acquisition is strategic, in that the acquiree is still an ongoing business, versus in Type A where it is liquidated. The liquidation under Type A results in the termination of all contracts that the acquired firm held, which could be detrimental to the business of the acquiring company. Type B resolves that -- because the acquired business is not dissolved, all of the contracts that it had remain intact. For taxation, the acquired firm's taxation flows through to the corporate owner from the data of acquisition, same as in Type A. For the sellers, they again pay tax on the cash they receive in the transaction, but do not realize a gain or less until they sell their shares of the acquiring firm.

Type C

A Type C reorg is similar to a Type A. In the Type C, the threshold for the use of stock in the purchase is 80%, same as in Type B, and higher than the 50% in Type A. The seller will be liquidated, same as in Type A. This type is more commonly associated with an asset purchase.

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An example would be a company that is seeking mainly to acquire the patents or land holdings of the acquired company and not run that company. In this situation, the sellers would receive at least 80% of their return in shares of the acquirer, which allows the seller to defer tax liability. The buyer will incur taxes on profits and losses beginning at the date of acquisition.

The tax implications of Type C are basically the same as with the other types. Whatever value the assets of the acquired company generate after the acquisition are the primarily tax consequences. As usual, for the acquired company the implications are significant if there is cash, but the equity portion of the purchase cost does not realize a gain or loss until that equity is specifically liquidated.

Type D

This is a transfer, and contains a variety of different forms. The transfer can be a spin-off, a split-off, or another form of transfer reorg. Kibilko (2016) uses the example of a parent company A that contains the assets of former corporation B and of A. If B goes out of business, the former B shareholders would still have their shares in A at that point. A full split-up would also be considered a Type D, where a company splits into numerous sub-entities, each of which receives some assets and liabilities, and then the original company is liquidated. Type D is the only form of the four that does not involve an outside business, just a restructuring of the existence internal business (Accounting Tools, 2016).

The tax implications of Type D are different, because the transaction type is substantially different. Typically, the tax attributes of a corporation are passed to the new corporation, and no gain or loss is recognized on the transfer. Only in circumstances where the shareholder of one element has been paid out at a level higher than the level of the book value of the holding would there be a tax consequence, for that shareholder, but not for the corporation itself (Skinner & Nugent, 2014).

Recommendation for the Client

The first and most important recommendation is that nothing should be done on the basis of tax consequences. As much as tax professionals love to think this is the only thing that matters, the reality is that there are significant strategic and operational factors that need to drive reorganization decisions.

From there, there are some things to consider with respect to the case at hand. The client has targeted ABC for a takeover. ABC is running substantial losses, which implies that it will continue to do so for the foreseeable future. Net operating losses reduce the tax burden on the acquiring corporation in a Type A or Type B takeover. Under Type B, ABC would be maintained as an ongoing business, and would likely deliver these losses for a while. Under Type A, ABC would be liquidated. Operationally, it is probably better to liquidate as in Type A or Type C in order to remove those losses from the books and retain whatever assets are desirable in the company. This points to Type C as the means of acquisition, and that will leave some ABC shareholders holding stock in the client's company. Leaving ABC in the consolidated return will reduce the tax burden on the parent company, but it will also reduce the money available to shareholders for dividends, lower the company's returns and otherwise give the impression that the parent company's financial performance has declined. It is better to have a taxable acquisition structure, as this will allow the acquisition cost to be paid up front, and then allow the parent company to write off those losses going forward from the consolidated return.

Thus, it is recommended that ABC be purchased as a Type C acquisition, taking a loss on the initial transaction but only acquiring the assets of ABC before ABC is liquidated. The ongoing business clearly has little value, and it is specific assets that have interested the parent company.

The other two companies, XYZ and BB, are to be acquired as subsidiaries in the next six months. We know little about them. The form for a subsidiary acquisition is Type B. Thus, the parent company will be absorbing ABC, and end up with four Type B subsidiaries. These new subsidiaries….....

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