©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston Chapter Tax Planning Options

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 2 Taxable vs. Nontaxable or Tax-Deferred Acquisitions Basic rules –Nontaxable transaction — merger or tender offer involves stock-for-stock transaction –Taxable transaction — transaction involves cash or debt

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 3 "Acquisition tax-free reorganizations" Section 368 of Internal Revenue Code –Type A Statutory merger — target firm shareholders exchange their target stock for shares in the acquiring company Consolidation — shareholders of both firms receive stock of new company

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 4 Three-party forward triangular merger –Parent creates shell subsidiary –Shell issues stock, all of which is bought by parent with cash or own stock –Target is bought with cash or parent stock held by subsidiary –Target merged into subsidiary in a statutory merger –Parent avoids incurring liability for debt of target

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 5 –Type B Stock-for-stock exchanges Target may be liquidated into acquiring firm or maintained as an independent entity Reverse triangular three-party merger –Acquirer forms a shell subsidiary funded by parent stock –Subsidiary is merged into target –Parent stock held by subsidiary is distributed to target’s shareholders in exchange for their target stock –End result: parent owns the stock of the merged subsidiary - target

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 6 –Type C Stock-for-asset transaction; at least 80% of the fair market value of target's property must be acquired Typical transaction –Target firm sells assets in exchange for acquiring firm’s voting stock –Target firm dissolves –Target distributes acquiring firm stock in exchange for old canceled target stock

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 7 Main implications –Nontaxable reorganization Acquiring firm –Net Operating Loss (NOL) carryover –Tax-credit carryover –No write-up or step-up of depreciable assets Target firm –Deferred taxable gains for shareholders

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 8 –Taxable acquisitions Acquiring firm –Stepped-up asset basis –Loss of NOLs and tax credits Target firm –Immediate gain recognition by target shareholders –Recapture of tax credits and excess depreciation

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 9 Tax Reform Act of 1986 — less favorable to M&A activity Limits on Net Operating Loss (NOL) carryovers Master limited partnerships and S corporations avoid double taxation Minimum 20% tax on corporate profits

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 10 General Utilities doctrine –General Utilities provision on tax-free asset liquidation repealed –Exemption only for small and closely held corporations Greenmail — limit extent to which greenmail payments could be tax deductible

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 11 Stock vs. Asset Purchase Acquisitions by stock purchases –Avoid double taxation –Higher net proceeds to seller stockholders

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 12 Acquisitions by asset purchases –Lower net proceeds because of double taxation –Buyer may prefer acquisitions of assets Avoid unknown liabilities of seller In purchase accounting, buyer is able to step- up tax basis of assets acquired –Closely held small corporations should be formed as limited liability corporations or S corporations

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 13 Do Tax Gains Cause Acquisitions? Increased leverage — firm can leverage itself without acquisition Net operating loss carryforwards (NOLs) — could be utilized by issuing equity and buying taxable debt Basis increase on acquired assets — could achieve by selling assets and then buying them back

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 14 Empirical studies –Tax factors significant in less than 10% of merger transactions –Tax effects are not the main motivation for merger transactions

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 15 Roles of taxes in going private transactions (LBOs and MBOs) –Initial financial structures as high as 90% debt –Tax savings are not the dominant factor Debt paid down as rapidly as possible Main objective is to achieve value increases in order to take company public within 3-5 years Proceeds from public offerings used to pay down debt

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 16 –Increased taxes from LBOs Capital gains taxes on realized capital gains to shareholders Taxable capital gains from asset sales Taxable interest income from debt payments Increase taxable operating income Efficient capital use generates additional taxable revenues in the economy –Lost taxes from LBOs Increased tax deductions from the additional debt Lower personal tax revenue because LBOs pay little or no dividends

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 17 –On average, LBOs generated tax increases that were almost 200% of the tax losses they created –RJR-Nabisco tax payments were more than eight times pre-LBO taxes