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7-1 ©2008 Prentice Hall, Inc.
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7-2 ©2008 Prentice Hall, Inc. CORP ACQUISITIONS & REORGANIZATIONS (1 of 2) Taxable acquisition transactions Taxable vs. nontaxable acquisitions Tax consequences of reorganizations Acquisitive reorganizations Divisive reorganizations
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7-3 ©2008 Prentice Hall, Inc. CORP ACQUISITIONS & REORGANIZATIONS (2 of 2) Other reorganization transactions Judicial restrictions on reorganizations Tax attributes Limitation on use of tax attributes Example Financial statement implications
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7-4 ©2008 Prentice Hall, Inc. Taxable Acquisition Transactions Asset acquisitions Stock acquisitions w/ no liquidation Stock acquisitions w/ liquidation Stock acquisitions w/ §338 deemed sale election See Table C7-1 for a summary
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7-5 ©2008 Prentice Hall, Inc. Asset Acquisitions Direct purchase of assets Target corporation Gain or loss and depreciation recapture are computed by selling (target) corporation on each asset Acquiring corporation Basis in assets is acquisition cost
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7-6 ©2008 Prentice Hall, Inc. Stock Acquisitions with No Liquidation (1 of 2) How acquisition is accomplished Shareholders of target corp sell their shares directly to purchaser corp Target corp recognizes NO gain/loss Target corp s/hs recognize gain/loss Payment to a s/h for a noncompete agreement is ordinary income to s/h
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7-7 ©2008 Prentice Hall, Inc. Stock Acquisitions with No Liquidation (2 of 2) Purchaser corp consequences Purchaser has a new subsidiary Basis in target stock is acquisition cost Purchaser’s basis in target’s stock (outside basis) may be > target’s basis in its assets No adjustment to basis of target’s assets Tax attributes of target transfer to purchaser
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7-8 ©2008 Prentice Hall, Inc. Stock Acquisitions with Liquidation If parent owns at least 80% of new subsidiary, liquidation is tax-free as described in Chapter 6 Premium paid (amount above target corp’s basis in its assets) is lost upon liquidation of the subsidiary
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7-9 ©2008 Prentice Hall, Inc. Stock Acquisitions with §338 Deemed Sale Election (1 of 4) How acquisition is accomplished Shareholders of target corp sell their shares directly to purchaser corp Purchaser files §338 election pretending that target has been liquidated and a new subsidiary created in its place
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7-10 ©2008 Prentice Hall, Inc. Stock Acquisitions with §338 Deemed Sale Election (2 of 4) Target corp recognizes gains & losses on “pretend” sale of assets to itself Subject to depreciation recapture Target corp’s basis in its assets are stepped up (or down) Sales price calculated on slide 7-12
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7-11 ©2008 Prentice Hall, Inc. Stock Acquisitions with §338 Deemed Sale Election (3 of 4) Target’s old tax attributes wiped out New elections are made See Topic Review C7-1 for summary
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7-12 ©2008 Prentice Hall, Inc. Stock Acquisitions with §338 Deemed Sale Election (4 of 4) ADSP = G + L - (T R x B) (1 – T R ) ADSP: Adjusted deemed sale price G: Acquiring’s grossed-up basis in the target corporation’s recently purchased stock L: Target’s liabilities other other tax liab for sale T R : Applicable federal income tax rate B: Adjusted basis of asset(s) deemed sold
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7-13 ©2008 Prentice Hall, Inc. Taxable vs. Nontaxable Acquisitions (1 of 2) Use of cash and debt for acquisition produce tax liability Use of stock and limited cash or debt likely produce nontaxable acquisition Primary tax impact is on the target (corporation being acquired) See Topic Reviews C7-2 & C7-3
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7-14 ©2008 Prentice Hall, Inc. Taxable vs. Nontaxable Acquisitions (2 of 2) Only purchase method allowed for GAAP for business combinations initiated after June 30, 2001. FAS No. 141 Goodwill not amortized for GAAP Assets recorded at FMV Tested for impairment FAS No. 142
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7-15 ©2008 Prentice Hall, Inc. Tax Consequences of Reorganizations Target corporation Also referred to as “transferor” corp Acquiring corporation Also referred to as “transferee” corp Shareholders & security holders
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7-16 ©2008 Prentice Hall, Inc. Target (Transferor) Corporation No gain/loss on asset transfer Assets retain depr recap potential Assumption of liabilities generally does not trigger gain recognition Possible exception for divisive Type D No gain/loss on distribution of stock and securities as part of reorg plan
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7-17 ©2008 Prentice Hall, Inc. Acquiring (Transferee) Corporation No gain/loss recognized when it receives assets in tax-free reorg Carryover basis of qualifying property Gain recognized lesser of gain realized or FMV of nonqualified property received Carryover holding period
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7-18 ©2008 Prentice Hall, Inc. Shareholders & Security Holders (1 of 2) No gain/loss on stock or securities received if exchanged solely for stock or securities as part of reorg plan Gain recognized lesser of gain realized or cash plus FMV of other property received Dividend or capital gain depending on §302 test Dividend vs. redemption
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7-19 ©2008 Prentice Hall, Inc. Shareholders & Security Holders (2 of 2) Basis of stocks & securities received Adjusted basis in stocks & securities given up + Gain recognized on the exchange - Money & FMV of other property received = Basis of nonrecognition property received
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7-20 ©2008 Prentice Hall, Inc. Acquisitive Reorganizations Acquiring corp obtains part or all of assets or stock of a target corp See topic Review C7-5 Tax consequences Type A: Merger or consolidation Type C: Assets for stock Type B: Stock for stock exchange Type D: Asset for stock Type G: Bankruptcy
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7-21 ©2008 Prentice Hall, Inc. Tax Consequences Acquiring corporation Does not recognize gain/loss when it receives property as part of a tax-free exchange Acquired property has a carryover basis Shareholders & security holders May have gain to extent “nonqualifying” property received as part of exchange
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7-22 ©2008 Prentice Hall, Inc. Type A: Merger or Consolidation (1 of 2) Merger One company liquidates Consolidation Both companies liquidate and a new third company emerges Triangular merger Acquiring corp uses a controlled subsidiary to acquire target
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7-23 ©2008 Prentice Hall, Inc. Type A: Merger or Consolidation (2 of 2) Reverse triangular merger Acquiring corp uses a controlled subsidiary to acquire target Controlled subsidiary merged into the target corporation Target corporation becomes a subsidiary of the parent corporation
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7-24 ©2008 Prentice Hall, Inc. Type C: Assets for Stock Acquiring corp obtains substantially all of target corp’s assets in exchange for acquiring corp’s voting stock and a limited amount of other consideration Substantially all means 70% of FMV of gross assets & 90% of FMV of net assets Target liquidates itself
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7-25 ©2008 Prentice Hall, Inc. Type D: Asset for Stock Acquisitive D (1 of 2) Acquiring corp obtains substantially all of target corp’s assets in exchange for acquiring corp’s voting stock & other consideration Substantially all means 70% of FMV of gross assets & 90% of FMV of net assets
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7-26 ©2008 Prentice Hall, Inc. Type D: Asset for Stock Acquisitive D (2 of 2) Target or target s/hs must control acquiring corp immediately after asset transfer Control defined as either 50% of voting power of voting stock or 50% of total value of all stock Target liquidates itself
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7-27 ©2008 Prentice Hall, Inc. Type B: Stock for Stock Acquiring corp issues voting stock directly to target s/hs in exchange for shares of target Target continues under new ownership No other consideration can be used Except for acquiring fractional shares and payment of certain expenses of target
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7-28 ©2008 Prentice Hall, Inc. Type G: Bankruptcy Part or all of target’s assets transferred to a new corp as part of a court-approved plan in a bankruptcy, receivership or similar situation Securities of new corporation are distributed in accordance with court- approved plan
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7-29 ©2008 Prentice Hall, Inc. Divisive Reorganizations Part of corp’s assets transferred to a second corp which is owned by either the original corp or its s/hs Divisive D reorganizations Split-off Spin-off Split-up Divisive G reorganization
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7-30 ©2008 Prentice Hall, Inc. Split-off Corp transfers assets to a controlled subsidiary in exchange for sub’s stock Sub’s stock then transferred to one or more s/hs in exchange for parent corp stock
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7-31 ©2008 Prentice Hall, Inc. Spin-off Corp transfers assets to subsidiary in exchange for sub’s stock Parent distributes sub stock to all parent s/hs on a pro rata basis Parent receives nothing in exchange for distribution of sub’s stock
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7-32 ©2008 Prentice Hall, Inc. Split-up Existing corp transfers all assets to two or more new controlled subs in exchange for sub stock Parent distributes all stock of each sub to existing s/hs in exchange for all outstanding parent stock and liquidates
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7-33 ©2008 Prentice Hall, Inc. Divisive G Reorganization Existing corp transfers part of assets to a second corporation according to a court-approved plan Transferor distributes all stock and securities to second corp to s/hs, security holders, and creditors Transferor corp may continue business or be liquidated by the court
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7-34 ©2008 Prentice Hall, Inc. Other Reorganization Transactions (1 of 2) Type E: Recapitalization Reshuffling of corporate structure w/in framework of existing corp” (1942 S.C.) Must have a bona fide business purpose for reorganization Stock for stock, bonds for stock or bonds for bonds exchanged as part of a plan
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7-35 ©2008 Prentice Hall, Inc. Other Reorganization Transactions (2 of 2) Type F: Administrative change A mere change in identity, form or state of incorporation Assets and liabilities of old corporation are transferred to new corporation All old securities are exchanged for identical new securities
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7-36 ©2008 Prentice Hall, Inc. Judicial Restrictions on Reorganizations (1 of 2) If judicial restrictions are not met, reorganization loses its tax-free status Continuity of proprietary interest Old owners must continue ownership Continuity of business enterprise Old assets must be used in new business
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7-37 ©2008 Prentice Hall, Inc. Judicial Restrictions on Reorganizations (2 of 2) Business purpose Valid business purpose for transaction Step transaction doctrine IRS may collapse series of independent transactions if all part of a plan
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7-38 ©2008 Prentice Hall, Inc. Tax Attributes Tax attributes follow assets NOLs, capital losses, E&P, gen. bus. credit, inventory methods Acquiring corp obtains control of both assets & attributes in A, C, acquisitive D & G, and F reorgs Asset ownership does not change in B or E reorgs
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7-39 ©2008 Prentice Hall, Inc. Limitation on Use of Tax Attributes (1 of 2) §§382 & 269 prevent assets or stock purchases if primary purpose is obtaining loss carryovers §§382 & 269 also prevent a loss corp from purchasing a profitable corp if primary purpose is using its existing losses
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7-40 ©2008 Prentice Hall, Inc. Limitation on Use of Tax Attributes (2 of 2) §383 restricts tax credit and capital loss carryovers if §382 applies Restrictions similar to NOLs §384 prevents pre-acquisition losses of either acquiring or target corp (loss corp) from offsetting BIG recognized during 5 yrs after acq. by another corp (gain corp).
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7-41 ©2008 Prentice Hall, Inc. Example (1 of 4) Thomas Corp transfers all assets and part of its liabilities to Andrews Corp. for $600K of Andrews Common stock. Following the merger, Thomas is liquidated Thomas’ basis in assets$475K Liabilities transferred$100K
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7-42 ©2008 Prentice Hall, Inc. Example (2 of 4) What is Thomas’ recognized gain or loss? Gain realized: $700K* - $475K = $225K Boot received: $0 Recognized Gain: $0 * $700K = $600K stock + $100K relief of liabilities
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7-43 ©2008 Prentice Hall, Inc. Example (3 of 4) What is Andrews’ basis in the assets? $475K (carryover) How much gain/loss does Thomas recognize upon distribution of Andrews stock to Thomas’ shareholders? No gain or loss
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7-44 ©2008 Prentice Hall, Inc. Example (4 of 4) What if Thomas’ basis had been $750K? Recognized loss: $ 0 Basis (carryover):$750K Distribution gain or loss: $ 0
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7-45 ©2008 Prentice Hall, Inc. Financial Statement Implications (1 of 2) SAFS No. 141 Acquiring corp may only use purchase method for financial statement purposes Deferred tax accounts and treatment of goodwill depend on whether acquisition was taxable or nontaxable
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7-46 ©2008 Prentice Hall, Inc. Financial Statement Implications (2 of 2) Taxable asset acquisition Nontaxable asset acquisition Stock acquisition Pricing the acquisition Net operating losses
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7-47 ©2008 Prentice Hall, Inc. Taxable Asset Acquisition Tax basis likely same as book basis No deferred tax liabilities or assets If tax and book goodwill are equal, §197 amortization of goodwill creates temporary difference
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7-48 ©2008 Prentice Hall, Inc. Nontaxable Asset Acquisition Book bases differ from carryover tax bases of acquired assets SFAS No. 109 prescribes that acquiring corp recognize def tax liability/asset for book/tax bases differences of transferred assets and liabilities Goodwill not amortizable for tax No temporary difference
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7-49 ©2008 Prentice Hall, Inc. Stock Acquisition Target corp remains intact as a subsidiary of acquiring corp Adjustments under SFAS No. 141 & 109 occur when preparing consolidated financial statements
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Comments or questions about PowerPoint Slides? Contact Dr. Richard Newmark at University of Northern Colorado’s Kenneth W. Monfort College of Business richard.newmark@PhDuh.com 7-50 ©2008 Prentice Hall, Inc.
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