Post on 27-Jul-2018
Corporate Taxation Chapter Eleven: Nonacquisitive &
Nondivisive Reorganizations Professors Wells
Presentation:
April 13, 2015
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§368(a)(1)(D) – Liquidation – Reincorporations §368 (a)(1)(E) – Recapitalizations §368(a)(1)(F) – Change in Form or Place of Incorporation §368(a)(1)(G) – Insolvency Reorganizations
Nonacquisitive & Nondivisive Reorgs. p.518
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Recapitalizations §368(a)(1)(E) p.519
Rearrangement of a single corp’s capital structure. Business objectives for a recapitalization: 1) Improve the debt/equity ratio by shifting from debt into equity
ownership – i.e., a downstream recapitalization.
2) Change the shareholder ownership relationships between the preferred and common shareholders – e.g., an upstream recapitalization (some shareholders acquiring preferred stock).
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COBE & COI Not Relevant p.518
“Continuity of business enterprise” (COBE) is not a requirement to have “E” corporate reorganization treatment. Similar treatment to Rev. Rul. 77-415 that “continuity of shareholder interest” (COI) is also not required in an “E” reorganization. But, a business purpose is required. This result is not impacted by the 1998 COI and COBE regulations.
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Types of Corporate “Recapitalizations” p.519
1) A shift from debt into equity is tax-free. But, recognition is required of the accrued interest element. See §354 (bondholder) & §1032 (corp), but also §108 (re COD income).
2) An exchange of bonds for new bonds. No gain recognition occurs to the bondholder except (a) for bonds received for accrued interest, or (b) if the principal amount of the bonds is increased. §354(a)(2)(A) & (B). The corporate issuer may have COD income (subject to §108(e)(10) and needs to resolve OID issues. See §163(e) and §1272 through §1275.
3) Stock for stock exchanges: (a) exchange preferred and receive common; or, (b) exchange common and receive preferred.
§§354, 356 & 358 (shareholder) §1032 & §1036 (stock issuances/exchanges) §305(c) (increase in proportionate share interest) & §306 stock (bailout effect?).
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Rev. Rul. 84-114 p.521 Preferred and Cash Received
Nonvoting preferred stock and cash are received in an integrated transaction in exchange for common shares (in an “E” reorganization). Is the cash “boot” received a “dividend equivalent” for §356(a)(2) purposes? Held: Not a dividend since the requirements of §301(b)(1) (no dividend equivalency) are satisfied here (and, therefore, no §356(a)(2) dividend distribution effect). See Davis case. A’s interest reduced from 28.57% (120/420) to 23.08% (90/390). This was a meaningful reduction of interest.
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Bonds Received & Stock Transferred – Bazley v. Commissioner p.524
For old shares, shareholders received new shares and also callable debenture bonds. Significant “earned surplus” (e&p) existed. IRS asserts income to the extent of bonds. Taxpayer asserts the securities were received in a tax-free corporate reorganization. Held: Receipt of the (callable) debenture bonds was equivalent to the receipt of a cash dividend (i.e., an accumulated earnings distribution).
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Problem 1(a) p.528 Exchange Transaction
Results to shareholders on this exchange: 1) “E” reorganization treatment. 2) No gain recognition to the
shareholders on the exchange. §354(a)(1).
3) Substituted basis - §358(a)(1) – 1/3 for preferred and 2/3 for common stock.
4) Tacked holding period. §1223(1). 5) Preferred stock received is §306
stock.
Recap
Shareholders
E&P=100,000
C.S.=20x Pfd S.=10x
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Problem 1(b) p.528 Preferred Stock is Called
Question: What is the result if Recap calls the preferred stock? Answer:
1) §306(a)(2) redemption. 2) $10,000 §301 distribution to each shareholder (assuming e&p
is at the $100,000 level). 3) Reduction of the corp’s e&p to zero. §312(a)(1). 4) Tax basis previously allocated from the common to the
preferred stock is allocated back to the common stock.
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Problem 1(c) p.528 Sale of the Preferred Shares
Question: What is the result if a shareholder sells preferred stock? Answer:
1. A Code §306(a)(1) “ordinary income” transaction occurs, as measured by reference to the allocable e&p at the time of the preferred stock issuance. No DRD is available to a corporate recipient. 20% taxation on the amount received.
2. Any excess over $10,000 is treated as: (i) tax basis recovery, and after basis recovery then thereafter as (ii) capital gain.
3. No e&p reduction occurs (even though deemed “dividend” treatment for §1(h)(11)).
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Problem 1(d) p.528 E&P Deficit Upon Issuance
Question: What is the result if Recap had a deficit in its E&P at the time of the distribution but it foresaw future profits? Answer: An e&p deficit existed at the time of the distribution of the shares by the corporation would cause the preferred stock would not to be §306 stock. i) Treatment of the stock redemption when occurring would be
determined under §302. ii) The share sale would produce capital gain (after tax basis
recovery).
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Problem 2 p.528 Stock & Debt Issuance
FACTS: Each of 10 shareholders exchanges common stock (FMV=$50,000 B=$10,000) for common stock (FMV=$25,000) and bonds (FMV=$25,000). Shuffle has E&P=$250,000.
Shuffle
Shareholders
E&P=250,000
C.S.=250x Security.=25x
C.S. (B=100x FMV=500x)
RESULT: An “E” reorganization. The securities are “boot”. §354(a)(2) & §356(d)(1). Each shareholder must recognize $25,000 of the $40,000 of gain realized in the exchange. The pro-rata distribution is classified as a dividend distribution.
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Problem 3(a) p.529 Debt Principal is Reduced
FACTS: Exchange bonds with Face=$1,000,000 and FMV of $800,000 for bonds with Face=$800,000; FMV=$800,000.
RESULT: “E” Reorganization. Leverage
Bondholders Bonds (Face=800x FMV=800x) Bonds
(Face=1,000x FMV=800x)
1. Because the principal amount of the securities received ($800,000) does not exceed the principal amount of the securities surrendered ($1,000,000) and there is no indication of any accrued interest, the bondholders have no gain or loss. See §354(a)(1) & (2)(B); §354(a)(2); §356(d)(2). The security holders take an exchange basis per §358(a)(1) and tacked holding period per §1223(1).
2. Leverage has $200,000 of debt discharge income and has income unless insolvent. See §108(e)(10)(A); §108(a)(a)(B).
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Problem 3(b) p.529 Debt Principal Increased
1. §356(d)(2)(B) says the fair market value of the excess principal amount is treated as taxable “boot” under §356(a)(1) if the securities have realized gain. So, 80% of $200,000 or $160,000 is boot. If security holder is a stockholder, then need to test for dividend treatment per §356(a)(2). If not a stockholder, then gain is likely a capital gain and not a dividend.
2. To the extent that the excess face amount ($200,000) exceeds the FMV of this excess face amount ($160,000), the bonds have original issue discount ($40,000) under §1272.
Leverage
Bondholders
Bonds (Face=800x FMV=800x)
Bonds (Face=1,000x FMV=800x)
FACTS: Exchange bonds with Face=$800,000 and FMV of $800,000 for bonds with Face=$1,000,000; FMV=$800,000.
RESULT: “E” Reorganization.
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Problem 4 p.529 Receipt of Stock for Bonds
FACTS: Exchange of bonds transferred for the receipt of stock by shareholder is treated as an “E” reorganization. This is a “downstream” recapitalization. RESULT:
Leverage
Bondholders
Bonds Stock
1. Bondholders: A nonrecognition event occurs to the old security holders/new shareholders assuming a business purpose. Reg. §1.368-2(e), Ex. 1. Business objective of this transaction: A business purpose could be to improve the corporation’s debt/equity ratio.
2. Corporation: The corporation would have COD income to the extent that the principle amount of the bonds exceed the fair market value of its stock. See §108(e)(8).
“D” Reorganization “Liquidation Reincorporation” p. 529
1) Operating assets are transferred to the acquiring corp. for cash; the selling corporation then liquidates with a cash distribution to its shareholders.
2) All assets are distributed to the shareholders, then the shareholders infuse only operating assets into a new corporation.
D
D Op Assets
Cash
P Liquidate
Cas
h D
D
P Liquidate
Op
Ass
ets
Op Assets
Two alternative structures (involving two corporations & similar shareholder groups):
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Smothers v. United States p.530 Transfer of Operating Assets?
IUS liquidated and then the operating assets (15 percent of the FMV) were inserted into TIL.
Taxpayer position: Distirbution was a liquidation entitled to capital gain treatment under §331(a)(1).
IUS
TIL Op Assets $22,637
Cash
Smothers Liquidate
$149
,162
IRS position: the transaction was a “D” reorganization with §356(a)(2) boot being received.
Held: The “substantially all” test was satisfied since all the operating assets were transferred and so this transaction qualified as a “D” reorganization. The Smothers received boot that was characterized as a dividend distribution under §356(a)(2).
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Nondivisive Reorganizations All Cash D Reorganizations p.540
D
C All Assets
Cash
Shareholder Liquidate
Cas
h
Objective: To extract cash with basis offset. Boot is taxed to the extent of gain realized (boot within gain rule). Counter-Characterization: A straight dividend would be taxable under §301(c)(1) to the extent of E&P with no basis offset.
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Problem 1 p.541 Common Ownership – 2 Corps.
FACTS: Shareholders have $200,000 basis in Brother. Brother has operating assets (FMV=$500,000 B=$150,000) and $200,000 cash (total FMV $700,000) and $250,000 of E&P. Sister has $300,000 of E&P. Sister purchases Brother’s operating assets for $500,000 cash and Brother liquidates.
Brother
Sister Op Assets
B=150 FMV=500
$500 Cash
Shareholders B=200
Liquidate
$700
cas
h
RESULT: Boot of $700,000 to Shareholders and must recognize dividend per §356(a)(2) to the extent of their gain ($500). Under Davant, E&P of both companies are used to support the dividend characterization
E&P= 250 E&P=
300
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Problem 2 p.541 All Cash D Reorganization Transactions
FACTS: T sells all assets to S for cash and liquidates. RESULT: Dividend to A. Reg. §1.368-2T(1)(3), Ex. 2. Control of S exists through the family attribution rules. See Code §368(a)(2)(H)(i)
T
S All Assets
B=100,000 FMV=1,000,000
$1,000,000 Cash
A B=200
Liquidate
Cas
h
and §304(c). §368(a)(1)(D) & §354(b)(1)(B) are satisfied even though no S stock is actually issued. The $1 million cash of distributed to A is a dividend effect to the extent of E&P and thereafter is return of basis and then §301(c)(3) gain.
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“F” Reorganization p.541
Mere change in identity, form or the place of corporate organization of one corporation. Often used to change the place of corporate organization (e.g., to Delaware). Why to Delaware? Prior attempt to blend multiple corporations together in an “F” reorganization – The potential use of §381(b) in this context has been eliminated. F reorganization treatment is limited to one corp.
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Rev. Rul. 96-29 p.543 Part of Step Transaction OK
Two transactions involving stock offering or acquisition – place of organization changed. Situation One: Change place of incorporation by merging Q into a new corporation (R) formed in another state (probably Delaware). R issued significant additional stock in a public offering. So two steps were involved: merger and stock sale. Situation Two: Forward triangular merger and the selling shareholder received new preferred stock of Corp. which then changed its place of organization by merger into corporation in another state.
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Problem p.545 Change State of Organization
Change of corporate status from California to Arizona by an asset transfer in exchange for stock and then the liquidation of the old corporation. RESULT: This is an“F” reorganization. It could also be a “D” reorganization but probably best viewed as an F reorganization. Under these facts, the § 351 (incorporation) and § 331 (liquidation) transactions are telescoped to result in full nonrecognition to all parties. See Whittell & Co., Inc. v. Commissioner, 34 B.T.A. 1070 (1936).
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Insolvency Reorganizations §368(a)(1)(G) p.546
Transfer of assets to another corporation in a bankruptcy restructuring. Liquidations are not bankruptcy reorganizations.
The “substantially all” test is not precluded when assets are used to pay creditors.
The “continuity of interest” test must be satisfied, but creditors may be counted for purposes of satisfying COI.
Shareholder or debtholders who receives an increased amount of debt securities are taxable.
Creditor have interest income to the extent securities are received for unpaid interest on the securities surrendered.
Possible NOL shifting to the corporation acquiring the assets.
No recognition to the transferring corporation on asset transfers; carryover tax basis for assets.
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Problem p.551 Acquirer’s Stock to Creditors
Debtor in bankruptcy with assets (B=$75,000 FMV=$100,000), NOL ($200,000). Debts include (1) bonds outstanding (with no accrued unpaid interest) of $100,000 and trade debts of $100,000. Debtor transfers all of its assets to Relief Corporation in return for $100,000 of Relief stock which will pass half to the security holders and half to trade creditors. Debtor’s shareholders will receive nothing. RESULT: 1. Valid G reorganization since the debtor transfers all assets and
then distributes the stock of Relief. Creditors are treated as equity owners COI.
2. Shareholders receive nothing – a §165(g) LTCL on their stock (equal to their tax basis).
3. Security holders exchange $100,000 of securities for $50,000 stock. No loss recognized and $100,000 basis.
4. Trade creditors - $50,000 bad debt loss (no §354). 5. Debtor corp has $100,000 of COD income that may be eligible
for §108(a)(1)(B) relief with the consequence that tax attributes are reduced (i.e., the NOLs).