C reorgs. with preexisting ownership of target stock.
Generally, a C reorganization is defined as the acquisition of substantially all the assets of a target solely for voting stock of an acquirer. Under the so-called "boot relaxation rules," the use of money or other property does not prevent an exchange from qualifying if at least 80% of the target's property is acquired for voting stock. For transactions subject to the boot relaxation rule, liabilities assumed by the acquirer are treated as money received by the transferor and, thus, must be considered for the 80% test.
If the acquiring company already owns a portion of the target's stock, the IRS has historically treated such portion as consideration paid for the assets acquired. As a result, the acquisition is not solely for voting stock, and must be tested under the boot relaxation rule. Consequently, it has been extremely difficult to effect a C reorganization for acquiring companies that previously held a portion of the target's stock. The Service's position was initially articulated in Rev. Rul. 54-396 and upheld by the courts in Bausch & Lomb Optical Co., 267 F2d 75 (2d Cir. 1959).
The IRS recently issued proposed regulations withdrawing its position in Rev. Rul. 54-396. Under Prop. Regs. Sec. 1.368-2(d)(4), an acquiring corporation's preexisting ownership of target stock will not be treated as cash or other property and will not trigger the boot relaxation rule. In addition, when the acquirer transfers cash or other property to the target, the previously owned stock will not be counted for purposes of determining whether at least 80% of the assets were acquired for voting stock. Thus, if the boot relaxation rule applies, it will be satisfied if (1) the sum of money and other consideration distributed to target shareholders and to target creditors under Sec. 361(b)(3) and (2) the assumption of target's liabilities do not exceed 20% of the value of all the target's properties. The following example is provided in the regulations:
Example 1: Corporation P owns 60% of Corporation T stock. T has 100 shares of stock outstanding. The other 40% of T stock is owned by Corporation X, an unrelated corporation. T has properties with a fair market value of $110 and liabilities of $10. T transfers all of its properties to P; P assumes the $10 of liabilities and transfers to T $30 of P voting stock and $10 of cash. T distributes the P voting stock and $10 of cash to X and liquidates. The transaction satisfies the solely-for-voting-stock requirement, because the sum of the $10 of cash paid to X and the assumption by P of $10 of liabilities does not exceed 20% of the value of T's properties.
Preexisting ownership is treated differently if it is purchased for cash or property other than voting stock of the acquirer, as part of a prearranged plan that culminates in a C reorganization. In such a situation, the two transactions are considered together and the amounts paid for the preexisting ownership will count against the taxpayer in determining whether (1)the acquisition was solely for voting stock and (2) the transaction is within the limits of the boot relaxation rule.
Example 2: The facts are the same as in Example 1, except that P purchased the 60% of T for $60 in cash in connection with the acquisition of T's assets. The transaction does not satisfy the solely-for-voting-stock requirement: P is treated as having acquired all of the T assets for consideration, consisting of $70 of cash, $10 of liability assumption and $30 of P voting stock; the total of $70 of cash and the assumption by P of $10 of liabilities exceeds 20% of the value of T's properties.
The regulations will apply to transactions occurring after the date these rules are finalized and published in the Federal Register, but will not apply to transactions occurring pursuant to a written agreement binding on that date.
FROM LOUIS A. PANOUTSOS, CPA, OAK BROOK, IL
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|Title Annotation:||IRC Subchapter C corporate reorganizations|
|Author:||Panoutsos, Louis A.|
|Publication:||The Tax Adviser|
|Date:||Sep 1, 1999|
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