Distinctions between state law mergers and tax-free reorganizations.

Rev. Rul. 2000-5 highlights the distinctions between what can be considered a state law "merger" and the Code's definition of that term. The ruling addresses two situations that were both initially purported to qualify as statutory mergers under Sec. 368(a)(1)(A).

Situation One

In a reorganization qualifying as a merger under state law, a target transferred some, but not all, of its assets and liabilities to an acquiring corporation. The target's shareholders surrendered part of their stock and received the acquiring corporation's stock in exchange.

Although the state in which this transaction occurred is not specified, it is common that state merger statutes allow more flexibility in their definition of the term "merger" than is allowed under the Code. Regs. Sec. 1.368-2(a) provides that the application of the term is to be strictly limited to the specific transactions set forth in Sec. 368(a). Thus, this term is restrictive when used for tax-free reorganizations. In contrast, state laws may allow reorganizations other than those described in Sec. 368(a)(1).

The reference to the term "statutory" in Sec. 368 (a) (1)(A) is amplified by Regs. Sec. 1.368-2(b)(1), which provides that a reorganization must be a merger or consolidation effected under the corporation laws of the U.S., a state, territory or the District of Columbia, to qualify as an A reorganization.

Rev. Rul. 2000-5 cites several cases for the premise that a target must cease to exist as a result of a merger; see, for example, Cortland Specialty Co., 60 F2d 937 (2d Cir. 1932), cert. denied, 288 US 599 (1933). Thus, to qualify as an A reorganization, in addition to meeting state law merger requirements, a reorganization must end a target's existence. Because a target did not cease to exist, Rev. Rul. 2000-5 holds that the reorganization did not qualify as an A reorganization.

Situation Two

In another reorganization qualifying as a merger under state law, a target that transferred some of its assets and liabilities to each of two acquiring companies liquidated. The target's shareholders received stock in each of the acquiring companies in exchange for their target's stock.

Rev. Rul. 2000-5 holds that an A reorganization must result in a single acquiring company acquiring a target's assets under state merger law, and the target ceasing to exist. Therefore, this reorganization did not qualify as an A reorganization, because the target's assets were not acquired by only one acquiring company.

Divisive Transactions

Rev. Rul. 2000-5 points out that, in contrast to corporate merger statutes, a divisive transaction is one in which a corporation's assets are divided among two or more corporations. Sec. 355 provides tax-free treatment for certain divisive transactions, but only if a number of specific requirements are satisfied.

This ruling further states that Congress intended Sec. 355 to be the sole means under which a tax-free divisive D reorganization could be accomplished. Thus, Congress specifically required a target's liquidation in a D (and C) reorganization to prevent it from being used in divisive transactions that did not satisfy Sec. 355. However, since corporate merger statutes historically contemplated that only one corporation survived a merger, no specific liquidation requirement is necessary for statutory mergers under Sec. 368(a)(1)(A). Nevertheless, a target must cease to exist in an A reorganization.

Rev. Rul. 2000-5 then determines that:

* In the first situation above, the transaction is divisive; after that transaction, the target's assets and liabilities are held by both the target and the acquiring company, and the target's shareholders hold both the target's and the acquiring company's stock.

* In the second situation above, the transaction is divisive because, after that transaction, the target's assets and liabilities are held by both acquiring companies, and the target's shareholders hold each of the acquiring company's stock.

Consequently, this ruling holds that, in both situations, the transactions do not qualify as A reorganizations, but "possibly" may qualify for tax-free treatment under other Code provisions.

Accordingly, tax-free treatment for these two transactions will depend on their ability to meet Sec. 355's conditions.

FROM ERICH C. HARRISON, CPA, MST, GRAND RAPIDS, MI