“All Cash” D Reorganizations & Selected Issues under Section 108(i) Donald W. Bakke Mark R. Hoffenberg Office of the Tax Legislative Counsel KPMG LLP U.S. Department of Treasury Bruce A. Decker Scott M. Levine Office of Associate Chief Counsel (Corporate) Jones Day Internal Revenue Service Washington, DC November 3, 2009
D Reorganizations
“D” Reorganization Requirements • The Distribution Requirement • The stock , securities , and other properties received by the target corporation (“T”), as well as T’s other properties, must be distributed to the T shareholders in pursuance of the plan of reorganization. I.R.C. §§ 354(b)(1)(B), 368(a)(1)(D). • The “Substantially All” Requirement • The acquiring corporation (“Acq”) must acquire “substantially all” of T’s assets. I.R.C. § 354(b)(1)(A). • The Control Requirement • T must transfer all or a part of its assets to Acq and, immediately after the transfer, T or T’s shareholders, must be in “control” of Acq. • “Control” as defined in section 368(a)(2)(H)(i) (referencing section 304(c)). • The Continuity of Shareholder Interest (“COI”) Requirement • Not clear whether there is a COI requirement in an acquisitive “D” reorganization. See Treas. Reg. § 1.368-1(b) (“[r]equisite to a reorganization… [is] (except as provided in section 368(a)(1)(D)) a continuity of interest as described in [Treas. Reg. section 1.368-1(e)].”). • The Continuity of Business Enterprise Requirement 3
Topics to be Discussed • “All Cash” D Reorganizations • Inaccessible basis in nominal share • Applicability of Treas. Reg. section 1.368-2T( l ) to sections 354, 356, and 361 • The nominal share when target has multiple classes of stock • Treatment of the nominal share in consolidation • Continuity of Shareholder Interest • Does it apply to a D reorganization? • If so, how? • Liquidation-Reincorporation • Status of “alter ego” doctrine in light of Treas. Reg. section 1.368-2(k) 4
“All Cash” D Reorganizations
Rev. Rul. 70-240, 1970-1 C.B. 81 B Y Stock 2 Assets 1 X Y $ • X transferred all of its operating assets to Y for cash in a value-for-value exchange and then liquidated. • IRS concluded that actual issuance and distribution of Y stock is not necessary to satisfy the distribution requirement where the same person owns all of the stock of X and Y in identical proportions. Such an issuance would constitute a “meaningless gesture.” • IRS also concluded that B’s receipt of the sale proceeds upon X’s liquidation was determined pursuant to section 356(a)(2). See also American Manufacturing Co. v. Comm’r , 55 T.C. 204 (1970); Atlas Tool Co. v. Comm’r , 614 F.2d 860 6 (3d Cir.1980); Wilson v. Comm’r , 46 T.C. 334 (1966); James Armour, Inc. v. Comm’r , 43 T.C. 295 (1964).
P.L.R. 200551018 (Sept. 15, 2005) Newco Notes A B C 2 50% 50% 90% 10% TP Assets TP Newco 1 Newco Notes • TP represented that Newco Notes were indebtedness for federal income tax purposes. • IRS ruled that Newco may amortize TP goodwill acquired from “purchase” of TP’s business under section 197. • IRS implicitly determined that the transaction did not qualify as a D reorganization presumably because the distribution requirement was not satisfied. • Issuance of Newco stock would not have been a “meaningless gesture” because proportionate ownership of TP and Newco were not identical. 7
Temp. Treas. Reg. Section 1.368-2T( l ) • If the same person or persons own, directly or indirectly, all of the stock of T and Acq in identical proportions then a transaction otherwise described in section 368(a)(1)(D) will be treated as satisfying the distribution requirements of sections 368(a)(1)(D) and 354(b)(1)(B) notwithstanding that there is no actual issuance of stock and/or securities of Acq. • In such cases, Acq will be deemed to issue a nominal share (“NS”) of its stock to T in addition to the actual consideration exchanged for T’s assets. • The NS of Acq stock will then be deemed distributed by T to T’s shareholders and, where appropriate, further transferred through chains of ownership to the extent necessary to reflect the actual ownership of T and Acq. • Treas. Reg. section 1.368-2T( l ) sunsets on December 18, 2009. 8
Example 1: Treas. Reg. Section 1.368-2T( l ) Mechanics • Acq acquires T’s assets in exchange for cash equal to the fair market value of T’s assets followed by the P liquidation of T whereby T distributes the cash to S1. • Pursuant to Treas. Reg. section 3 NS 1.368-2T( l )(2) (second sentence): Acq is deemed to transfer a NS of Acq stock (in addition to the cash actually transferred) in Step 1. S Acq • NS deemed distributed to S in Step 2. • Pursuant to Treas. Reg. section 1.368-2T( l )(2) (last sentence): NS deemed distributed to P in Step 3 in $100 + NS 2 1 order to reflect the actual ownership of Acq stock. T T’s assets worth $100 in exchange for $100 in cash + NS 9
Example 2: Inaccessible Basis in Nominal Share • Acq acquires T’s assets in exchange for $100 followed by T distributing the $100 to C in complete liquidation. • C’s basis in the NS is $50. I.R.C. § 358(a). Can C ever access the $50 basis in the NS? • $100 + NS C • If C is permitted to later access the $50 basis in the NS, when is the appropriate time? • Upon C’s disposition of all of its Acq 2 Basis = $150 stock? FMV = $100 Upon C’s disposition of a “specifically • identified” Acq share that contains a T Assets “nominal segment” with a $50 basis under Treas. Reg. § 1.358-2? Proportionately as C disposes of T Acq • 1 shares of Acq stock? If so, should C be treated as allocating its remaining $100 + NS $50 of basis proportionately among its existing Acq shares? • With respect to C’s ability to recognize his built-in loss in his T stock, should there be a different result if instead T received $99 in cash and one Acq share worth $1? 10
Applicability of Treas. Reg. Section 1.368-2T( l )(2)(i) to Sections 354, 356, and 361 • Although Treas. Reg. section 1.368-2T( l )(2)(i) provides that a NS is deemed issued in an “all cash D reorganization,” the deemed NS issuance is for purposes of the distribution requirements under sections 368(a)(1)(D) and 354(b)(1)(B). • Treas. Reg. section 1.368-2T( l )(2)(i) does not explicitly provide that the issuance of a nominal share should be deemed to occur for all purposes of sections 354, 356 and 361 (as well as Treas. Reg. section 1.1502- 13(f)(3)). • Section 368 is merely a definitional provision and does not address the tax consequences to Acq, T or the T shareholders in a reorganization. • Shareholder tax consequences determined under sections 354 and 356. • Corporate level tax consequences determined under section 361. 11
Example 3: Treas. Reg. Section 1.368-2T( l ) and Multiple Classes of Stock Neither Treas. Reg. section 1.368-2T( l ) nor Rev. Rul. 70-240 • $1,000 addresses the consequences if T has multiple classes of stock outstanding. + NS • Under current law, C would recognize $400 of dividend income under section 356(a)(2). See Rev. Rul. 74-515. • Under Prop. Reg. section 1.354-1(d), is the Acq NS only issued in exchange for the Class A stock or the Class B stock? If so, C which one? Class A Class B If issued only in exchange for the Class A stock, C • 100 shares 100 shares would: (1) with respect to the Class A stock, recognize Basis = $1/share Basis = $5/share $400 of dividend income under section 356(a)(2); and (2) FMV = $500 FMV = $500 with respect to the Class B stock, either recognize (a) no gain or loss under sections 302(a) and 302(b)(3) (T goes 2 out of existence), or (b) $500 of dividend income under T Assets* sections 302(d) and 301(c)(1) (if a successor concept is appropriate under these circumstances). T Acq 1 If issued only in exchange for the Class B stock, C would: • (1) with respect to the Class A stock, either recognize (a) $1,000 + NS a $400 capital gain under sections 302(a) and 302(b)(3) E&P > $1,000 (T goes out of existence), or (b) $500 of dividend income under sections 302(d) and 301(c)(1) (if a successor concept is appropriate under these circumstances); and (2) with respect to the Class B stock, recognize no gain or loss under section 356(a)(1). Alternatively, should NS be split into “segments”? If yes, the • result should be the same as under current law. * T assets are worth $1,000. 12
“All Cash” D Reorganizations Treatment of the Nominal Share in Consolidation
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