2. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Principles of Taxation: Advanced Strategies Chapter 12 Corporate Acquisitions, Mergers and Divisions Slide 12-1

3. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Corporate Acquisitions Asset acquisitions versus stock acquisitions Taxable acquisitions versus tax deferred acquisitions Slide 12-2

4. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Asset Acquisitions Slide 12-3 All or some of the target’s assets can be purchased Some, all, or none of target’s liabilities assumed May be done indirectly through a merger   Acquiring corporation “absorbs” target, receiving all its assets and assuming all its liabilities

5. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Stock Acquisitions Acquiring corporation purchases controlling interest in stock of target Target operated as a subsidiary or liquidated Slide 12-4

6. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Stock Acquisitions- Considerations Advantages:   Target may have nontransferable rights, management in place and name recognition Disadvantages:   Contingent liabilities   Minority shareholders Slide 12-5

7. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Taxable Versus Tax Deferred Acquisition Refers to whether seller is taxable on gain Tax deferred transactions generally result in a higher sales price since seller has no immediate tax liability Tax deferred acquisitions often done with purchaser’s stock, a very tax efficient way to make a purchase Slide 12-6

8. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Acquisition Matrix Slide 12-7 Taxable asset Acquisitions Taxable stock acquisitions Tax deferred asset acquisition (A or C reorganization) Tax deferred stock acquisition (B reorganization

9. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Other Considerations Friendly acquisition can result in lowest overall tax and acquisition costs Hostile acquisition can result in large professional and investment banking fees   Acquisition expenditures must generally be capitalized Slide 12-8

10. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Taxable Asset Purchases Purchaser takes cost basis in assets A lump-sum purchase price must be allocated to specific assets Purchaser wants to allocate as much as possible inventory items and depreciable assets with short useful lives Slide 12-9

11. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Section 1060 Price allocation must be consistent between buyer and seller Amount allocated to an asset can not exceed its fair market value Any excess of purchase price over aggregate fair market value of operating assets allocated to goodwill   Goodwill is amortizable over 15 years Slide 12-10

12. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Taxable Asset Sales- Target Target may stay in existence or liquidate If corporation liquidated, shareholders must recognize gain or loss equal to difference between proceeds and their basis in their stock Slide 12-11

13. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Cash Mergers Target corporation merges into acquiring corporation. Shareholders of target receive cash Treated as taxable sale of assets by target corporation. Gain and loss recognized by target Shareholders of target also recognize gain or loss Slide 12-12

14. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Reverse Cash Merger Slide 12-13 Acquiring corporation forms subsidiary. Subsidiary merged into target. Target shareholders receive cash No tax at corporate level Shareholders of target recognize gain or loss

15. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Purchase of Stock Acquirer takes cost basis in stock No change in bases of assets to acquired corporation Slide 12-14

16. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Tax Deferred Asset Acquisitions Acquiring issues stock to target shareholders. Target’s assets and liabilities transferred to acquiring. Target goes out of existence Slide 12-15

17. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Tax Deferred Assets Acquisitions-Effects No gain or loss to target No gain or loss to shareholders of target receiving acquiring corporation stock Shareholder’s basis in target stock become his or her basis for acquiring corporation stock Acquiring corporation’s bases in assets acquired from target is same as target’s bases in those same assets Slide 12-16

18. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Type A Reorganizations Merger or consolidation Must satisfy continuity of interest   To receive favorable ruling from IRS at least 50% of total consideration must be acquiring corporation stock Gain but not loss recognized on any boot received up to gain realized Slide 12-17

19. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Forward Triangular Merger Used as a way to avoid obtaining consent of acquiring corporation’s shareholders Acquiring corporation forms new subsidiary and contributes stock to subsidiary. Target merged into subsidiary. Target shareholders are distributed acquiring corporation stock Slide 12-18

20. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Type C Reorganizations Slide 12-19 Often referred to as a “practical merger” Acquiring corporation buys substantially all of target’s corporations assets for acquiring corporation voting stock Target corporation’s liabilities may be assumed Target corporation must liquidate

21. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Tax Deferred Stock Acquisitions Shareholders of target corporation exchange their target stock for stock of acquiring corporation Shareholders recognize no gain or loss Shareholder’s basis for target corporation becomes basis of stock in acquiring corporation Target corporation does not participate in or is affected by the transaction Slide 12-20

22. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Type B Reorganizations Tax deferred stock acquisition Acquiring corporation must use solely voting stock to acquire stock of target corporation After transaction, acquiring corporation must own 80% of voting power of target corporation and 80% of each class of nonvoting stock Slide 12-21

23. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Continuity of business enterprise Acquiring corporation must continue target corporation’s historic business or Use a significant portion of target’s assets in a new business Slide 12-22

24. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Book/Tax Differences Purchase method of accounting generally required under GAAP regardless of tax treatment Target’s assets generally recorded at fair market value Slide 12-23

25. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Survival of Target Corporation’s Tax Attributes Slide 12-24 Taxable asset acquisitions Acquirer cannot purchase target’s tax attributes Taxable stock acquisitions Target’s tax attributes remain in tact Tax deferred asset acquisition (A or C reorganization) Acquirer succeeds to target’s tax attributes Tax deferred stock acquisition (B reorganization Target’s tax attributes are in tact

26. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Net Operating Loss and Credit Carryovers May only be used against post-acquisition income of acquirer Use of acquired net operating loss carryovers and other favorable tax attributes subject to several limitations Slide 12-25

27. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Limitations on Use of Carryovers Section 269 gives IRS power to disallow use of net operating loss or credit carryforwards if principal purpose of acquisition is evasion or avoidance of tax Section 382 limits use of net operating loss carryforwards after a change in ownership Slide 12-26

28. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Section 382 Ownership change triggering statute can result from both taxable and tax deferred acquisitions If an ownership change takes place, net operating loss carryforward that may be used in any one year is subject to the section 382 limitation Slide 12-27

29. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Section 382 Limitation Represents largest amount of net operating loss that may be utilized in any one year Equal to long term tax-exempt federal rate multiplied by value of target corporation immediately before the ownership change Slide 12-28

30. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Corporate Divisions Three types:   Spin-off   Split off   Split up Slide 12-29

31. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Spin-off Corporation distributes stock of a subsidiary proportionately to its shareholders Shareholders own stock in both parent and subsidiary after the transaction Slide 12-30

32. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Spin-off Transaction Shareholders P S S Stock P owns S Slide 12-31

33. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Spin-off Post Transaction Shareholders p S Slide 12-32

34. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Split off Corporation distributes stock in a subsidiary to a group of shareholders in exchange for their stock in the parent corporation   Exchanging shareholders have no ownership in parent after transaction Slide 12-33

35. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Split off Transaction A B P S P owns S P distributes S stock to B B gives up his P stock Slide 12-34

36. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Split off Post Transaction A P B S A owns P B owns S Slide 12-35

37. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Split Up Corporation owns one or more subsidiaries Stock of subsidiaries distributed to shareholders who own subsidiaries directly Slide 12-36

38. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Split up Transaction Shareholders P S1 S2 P liquidates Slide 12-37

39. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Split up Post Transaction Shareholders S1S2 Shareholders own both S1 and S2 Slide 12-38

40. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Tax Consequences of Corporate Division Spin off   Dividend to shareholders Split off   Redemption Split up   Liquidation Slide 12-39

41. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Section 355 If provision applies no gain or loss to parent No gain or loss to shareholders Slide 12-40

42. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Section 355 Requirements Parent distributes stock representing at least 80% of subsidiary After transaction, subsidiary engaged in an active business After transaction, parent engaged in an active business Slide 12-41

43. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Section 355 Requirements Both business conducted for five years before transaction Not carried out as a device to distribute earnings and profits Slide 12-42

44. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Type D Reorganizations Process where assets transferred to various old or newly created subsidiaries followed by distribution Transaction must meet section 355 Slide 12-43