ABA Corporate Tax Committee - Pillsbury Winthrop … · ABA Corporate Tax Committee Boot Distributions in ... 35% for corporations 10.5%/7% for corporations after ... – Complete

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ABA Corporate Tax CommitteeABA Corporate Tax Committee

Boot Distributions in ReorganizationsBoot Distributions in Reorganizations

October 2, 2004October 2, 2004

William Alexander William Alexander –– Internal Revenue ServiceInternal Revenue ServiceJulie Divola Julie Divola –– Pillsbury Winthrop LLPPillsbury Winthrop LLP

Irwin Panitch Irwin Panitch –– Deloitte Tax LLPDeloitte Tax LLPLewis Steinberg Lewis Steinberg –– Cravath, Swaine & Moore LLPCravath, Swaine & Moore LLP

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Boot and ReorganizationsBoot and Reorganizations

WhatWhat’’s at stake?s at stake?Possible grounds for distinctionPossible grounds for distinctionOverview of the rulesOverview of the rulesBoot and continuity of interestBoot and continuity of interestBoot in D, E, and F reorganizationsBoot in D, E, and F reorganizationsReorganization/Section 351 overlapsReorganization/Section 351 overlapsWhat rules should apply?What rules should apply?

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Boot and ReorganizationsBoot and ReorganizationsWhy Characterization MattersWhy Characterization Matters

PrePre--reorganization Continuity of Interestreorganization Continuity of Interest

Treas. reg. Treas. reg. §§ 1.3681.368--1(e)(1)(ii)1(e)(1)(ii) -- COI is violated if a target COI is violated if a target shareholder is treated as receiving boot in a preshareholder is treated as receiving boot in a pre--reorganization distribution or redemption under reorganization distribution or redemption under §§ 356.356.

The regs. do not say when section 356 should apply.The regs. do not say when section 356 should apply.

PostPost--reorganization Continuity of Interestreorganization Continuity of Interest

Treas. reg. Treas. reg. §§ 1.3681.368--1(e)(1)(i)1(e)(1)(i) -- COI is generally violated by COI is generally violated by distributions distributions in connection with in connection with the reorganization.the reorganization.

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Boot and ReorganizationsBoot and ReorganizationsWhy Characterization MattersWhy Characterization Matters

Other reorganization requirementsOther reorganization requirements

Solely for voting stock requirementSolely for voting stock requirementFor B reorgs., CFor B reorgs., C’’s reorgs. and their subsidiary formss reorgs. and their subsidiary forms

Acquisition of ControlAcquisition of ControlFor reverse subsidiary mergersFor reverse subsidiary mergers

Substantially all of the assets requirement Substantially all of the assets requirement For reverse subsidiary mergers, forward subsidiary mergers, C For reverse subsidiary mergers, forward subsidiary mergers, C reorgs. subsidiary Creorgs. subsidiary C’’s, D reorgs. and G reorgs.s, D reorgs. and G reorgs.

Continuity of Business EnterpriseContinuity of Business EnterpriseRarely of practical concernRarely of practical concern

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WhatWhat’’s at stake in determining whether s at stake in determining whether distribution is boot, dividend, or a redemption?distribution is boot, dividend, or a redemption?

Generally not requiredGenerally not requiredRequiredRequiredGenerally not requiredGenerally not requiredWithholdingWithholding

Ordinarily determined by Ordinarily determined by residence of recipientresidence of recipient

Determined by place of incorporation of Determined by place of incorporation of payorpayor

Ordinarily determined by residence of Ordinarily determined by residence of recipientrecipient

Sourcing Sourcing RulesRules

Basis in redeemed shares offset Basis in redeemed shares offset by proceeds receivedby proceeds receivedNo basis recoveryNo basis recoveryBasis recovered lastBasis recovered last

Basis Basis RecoveryRecovery

Corporations Corporations -- 45 days for DRD45 days for DRD

LTCG LTCG -- more than 1 yearmore than 1 yearIndividuals Individuals -- 60 days for 15% rate60 days for 15% rateLTCG LTCG -- more than 1 yearmore than 1 yearHolding Holding PeriodPeriod

CapitalCapitalOrdinaryOrdinaryOrdinarily capital (after Clark)Ordinarily capital (after Clark)CharacterCharacter

(Assuming LTCG)(Assuming LTCG)(Assuming LTCG)(Assuming LTCG)

35% for corporations35% for corporations10.5%/7% for corporations after DRD10.5%/7% for corporations after DRD35% for corporations35% for corporations

15% for individuals15% for individuals15% for individuals15% for individuals15% for individuals15% for individualsRateRate

Full amount of gain or loss Full amount of gain or loss taxabletaxableFull amount taxable to extent of E&PFull amount taxable to extent of E&P

Gain limited to cash or other property Gain limited to cash or other property received; no losses allowedreceived; no losses allowedAmountAmount

Redemption Treated as ExchangeRedemption Treated as ExchangeDividendDividendBootBoot

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Possible Distinctions in Distinguishing Boot Possible Distinctions in Distinguishing Boot from Nonfrom Non--BootBoot

Stock (e.g., BStock (e.g., B’’s and (a)(2)(E)s and (a)(2)(E)’’s) vs. Asset (e.g., As) vs. Asset (e.g., A’’s) s) ReorgsReorgs

““Parent to ParentParent to Parent”” AA’’s vs. s vs. DRE ADRE A’’s vs. s vs. (a)(2)(D)(a)(2)(D)’’ss

D's/E's/F's versus othersD's/E's/F's versus others

§§368 vs. 368 vs. §§351 Transaction351 Transaction

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Distributions and ReorganizationsDistributions and Reorganizations

Treas. Reg. Sec. 1.301Treas. Reg. Sec. 1.301--1(l)1(l) –– ““A distribution to shareholders A distribution to shareholders with respect to their stock is within the terms of Sec. 301 with respect to their stock is within the terms of Sec. 301 although it takes place at the same time as another transaction although it takes place at the same time as another transaction if the distribution is in substance a separate transaction if the distribution is in substance a separate transaction whether or not connected in a formal sense. This is most likelywhether or not connected in a formal sense. This is most likelyto occur in the case of a recapitalization, a reincorporation, oto occur in the case of a recapitalization, a reincorporation, or r a merger of a corporation with a newly organized corporation a merger of a corporation with a newly organized corporation having substantially no property.having substantially no property.””

D reorganizations with substantially overlapping shareholdersD reorganizations with substantially overlapping shareholders

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Rev. Rul. 61Rev. Rul. 61--156156 –– Shareholders of Oldco adopted a plan of Shareholders of Oldco adopted a plan of liquidation and liquidation and ““soldsold”” assets to Newco in exchange for cash, assets to Newco in exchange for cash, notes, and a 45% stock interest in Newco. The IRS recast the notes, and a 45% stock interest in Newco. The IRS recast the transaction as an E and F, the issuance of Newco stock to new transaction as an E and F, the issuance of Newco stock to new investors in a public offering as a transaction separate from thinvestors in a public offering as a transaction separate from the e reorganization, and the distribution of cash and notes to Oldco reorganization, and the distribution of cash and notes to Oldco shareholders as a distribution under Section 301 (rather than shareholders as a distribution under Section 301 (rather than as boot).as boot).

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Davant v. CommissionerDavant v. Commissioner, 366 F.2d 874 (5, 366 F.2d 874 (5thth Cir. 1965) Cir. 1965) ––Court found that distributions from identically owned transfereeCourt found that distributions from identically owned transfereeand transferor corporations made simultaneously with a D and and transferor corporations made simultaneously with a D and F were taxable as dividends under Sec. 301 since they had no F were taxable as dividends under Sec. 301 since they had no rational connection with the reorganization.rational connection with the reorganization.

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American Manufacturing Inc. v. CommissionerAmerican Manufacturing Inc. v. Commissioner, 55 T.C. 204 , 55 T.C. 204 (1970) (1970) –– Court held that Sec. 301 may not be applied when a Court held that Sec. 301 may not be applied when a reorganization has taken place, and where the distribution is reorganization has taken place, and where the distribution is made in connection with made in connection with ““an overall scheme of eventsan overall scheme of events””constituting that reorganization. The particular case involved constituting that reorganization. The particular case involved a a D where both the transferor and the transferee were owned by D where both the transferor and the transferee were owned by the same sole shareholder. Without mentioning Treas. Reg. the same sole shareholder. Without mentioning Treas. Reg. Sec. 1.301Sec. 1.301--1(l), the Court squarely rejected the analysis and 1(l), the Court squarely rejected the analysis and holding of Davant.holding of Davant.

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PLR 9743001PLR 9743001 –– Distribution of Newco notes to Oldco Distribution of Newco notes to Oldco shareholders simultaneously with an F was taxable under Sec. shareholders simultaneously with an F was taxable under Sec. 301. Newco301. Newco’’s issuance of debt was not consideration s issuance of debt was not consideration received in exchange for Oldcoreceived in exchange for Oldco’’s assets, but was instead a s assets, but was instead a distribution separate and apart from the reorganization distribution separate and apart from the reorganization because it was undertaken simply to refinance Oldco. The because it was undertaken simply to refinance Oldco. The IRS cited Rev. Rul. 61IRS cited Rev. Rul. 61--156, Treas. Reg. Sec. 1.301156, Treas. Reg. Sec. 1.301--1(l), and 1(l), and DavantDavant in reaching its conclusion.in reaching its conclusion.

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PLR 200335032PLR 200335032 –– Corporate taxpayer received a dividend Corporate taxpayer received a dividend distribution from a corporation that underwent a recapitalizatiodistribution from a corporation that underwent a recapitalization n a few months later. The IRS rejected the Examining Agenta few months later. The IRS rejected the Examining Agent’’s s attempt to apply the step transaction doctrine so that the attempt to apply the step transaction doctrine so that the distribution would be taxable as boot (rather than as a dividenddistribution would be taxable as boot (rather than as a dividend). ). The distribution functioned to decrease the taxpayerThe distribution functioned to decrease the taxpayer’’s interest in s interest in the corporation while increasing the other shareholderthe corporation while increasing the other shareholder’’s interest. s interest. The recapitalization converted the taxpayerThe recapitalization converted the taxpayer’’s remaining s remaining common shares into preferred. Citing Treas. Reg. Sec. 1.301common shares into preferred. Citing Treas. Reg. Sec. 1.301--1(l) and Rev. Rul. 611(l) and Rev. Rul. 61--156, the IRS held that, even if the 156, the IRS held that, even if the distribution and exchange took place at the same time, the distribution and exchange took place at the same time, the distribution represented separately bargained for consideration,distribution represented separately bargained for consideration,so that the distribution was in substance a transaction separateso that the distribution was in substance a transaction separateand apart from the recapitalization.and apart from the recapitalization.

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Rev. Rul. 84Rev. Rul. 84--114114 ––Taxpayer had some of its shares of Taxpayer had some of its shares of common stock redeemed for cash and later had its remaining common stock redeemed for cash and later had its remaining common stock recapitalized into preferred stock. The IRS held common stock recapitalized into preferred stock. The IRS held that the cash redemption and the recapitalization were part of that the cash redemption and the recapitalization were part of a single integrated transaction and, accordingly, treated the a single integrated transaction and, accordingly, treated the cash as boot (unlike the case in PLR 200335032). The IRS cash as boot (unlike the case in PLR 200335032). The IRS noted that the redemption and recapitalization were pursuant noted that the redemption and recapitalization were pursuant to a single plan of reorganization that had been formally to a single plan of reorganization that had been formally adopted by the taxpayer prior to the redemption.adopted by the taxpayer prior to the redemption.

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PLR 200415004PLR 200415004 –– Target policyholders received distributions at the time of an ATarget policyholders received distributions at the time of an A merger of merger of Target into Acquirer. Acquirer argued that distributions were dTarget into Acquirer. Acquirer argued that distributions were deductible to Target as eductible to Target as policyholder dividends under Sec. 832(c)(11), while the Examininpolicyholder dividends under Sec. 832(c)(11), while the Examining Agent argued that the g Agent argued that the distributions were boot paid to former Target policyholders. Thdistributions were boot paid to former Target policyholders. The IRS agreed with the e IRS agreed with the Examining Agent.Examining Agent.

Under the Merger Agreement, an extraordinary cash dividend was tUnder the Merger Agreement, an extraordinary cash dividend was to be declared prior to closing, o be declared prior to closing, payable on or about the closing date, and paid payable on or about the closing date, and paid ““in connection within connection with”” the merger.the merger.TargetTarget’’s petition to the insurance commissioner noted that payment of ts petition to the insurance commissioner noted that payment of the dividend would have a he dividend would have a de minimis effect on the surplus of the Acquirer.de minimis effect on the surplus of the Acquirer.Target did not have sufficient excess capital to support the extTarget did not have sufficient excess capital to support the extraordinary dividend.raordinary dividend.Acquirer stated that the dividend payment was a negotiated term Acquirer stated that the dividend payment was a negotiated term of the merger agreement that of the merger agreement that was a condition of the merger.was a condition of the merger.TargetTarget’’s financial advisors financial advisor’’s fairness opinion stated that the dividend constituted part of s fairness opinion stated that the dividend constituted part of the the ““Aggregate ConsiderationAggregate Consideration”” to the Target policyholders.to the Target policyholders.

Under these facts the IRS found PLR 200335032 distinguishable baUnder these facts the IRS found PLR 200335032 distinguishable based on the close sed on the close connection between the distribution and the merger, and held thaconnection between the distribution and the merger, and held that t Waterman SteamshipWaterman Steamship, , 430 F.2d 1185 (5430 F.2d 1185 (5thth Cir. 1970), was more relevant because the acquirer furnished thCir. 1970), was more relevant because the acquirer furnished the cash e cash with which to pay the dividend. However, the IRS remarked in a with which to pay the dividend. However, the IRS remarked in a footnote that, footnote that, ““even even assuming Target had sufficient capital to make the paymentassuming Target had sufficient capital to make the payment……, the facts still indicate[d] that , the facts still indicate[d] that the cash distribution was part of the consideration in the mergethe cash distribution was part of the consideration in the merger transaction (and not a r transaction (and not a deductible policyholder dividend).deductible policyholder dividend).””

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Distributions and Section 351Distributions and Section 351

Rev. Rul. 80Rev. Rul. 80--239239 –– Individual transferred stock of wholly owned Oldco to Individual transferred stock of wholly owned Oldco to newly formed Newco in exchange for Newco stock and cash that Newnewly formed Newco in exchange for Newco stock and cash that Newco co borrowed from the bank. The IRS applied borrowed from the bank. The IRS applied Waterman SteamshipWaterman Steamship to determine to determine that Newco was a mere conduit for a disguised dividend from Oldcthat Newco was a mere conduit for a disguised dividend from Oldco. The IRS o. The IRS held that Sec. 304(a)(1) was not applicable because, in substancheld that Sec. 304(a)(1) was not applicable because, in substance, there was e, there was no receipt of cash by the Individual from Newco.no receipt of cash by the Individual from Newco.

Rev. Rul. 80Rev. Rul. 80--240240 –– Individual wished to acquire Bank but could not do so Individual wished to acquire Bank but could not do so directly. He therefore borrowed money, bought the Bank stock, adirectly. He therefore borrowed money, bought the Bank stock, and nd immediately transferred it to a newly formed Holding Company aloimmediately transferred it to a newly formed Holding Company along with the ng with the indebtedness in exchange for Holding Companyindebtedness in exchange for Holding Company’’s stock. The IRS found that s stock. The IRS found that Holding CompanyHolding Company’’s assumption of the liability did not trigger Sec. 357(a) or s assumption of the liability did not trigger Sec. 357(a) or 304(a)(1) because the Individual served as a mere intermediary e304(a)(1) because the Individual served as a mere intermediary employed mployed solely to satisfy nonsolely to satisfy non--tax related issues. (Note that the problem of transferring tax related issues. (Note that the problem of transferring liabilities incurred by a Sec. 304 transferor to purchase transfliabilities incurred by a Sec. 304 transferor to purchase transferred stock has erred stock has now been solved by Sec. 304(b)(3)(B)).now been solved by Sec. 304(b)(3)(B)).

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Boot and ReorganizationsBoot and Reorganizations

Section 356(a)Section 356(a)

Section 356(a)(1) Section 356(a)(1) –– Gain in stock (if any) is recognized to Gain in stock (if any) is recognized to the extent boot is received in a reorganization.the extent boot is received in a reorganization.

Section 356(a)(2) Section 356(a)(2) –– If the exchange has the If the exchange has the ““effect of the effect of the distribution of a dividend,distribution of a dividend,”” then the gain determined under then the gain determined under section 356(a)(1) is treated as a dividend to each section 356(a)(1) is treated as a dividend to each distributee (to the extent of his or its ratable share of the distributee (to the extent of his or its ratable share of the corporationcorporation’’s E&P).s E&P).

SSection 356(c) ection 356(c) –– Loss in stock is not recognized upon the Loss in stock is not recognized upon the receipt of boot in a reorganization.receipt of boot in a reorganization.

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Dividend Equivalence vs. GainDividend Equivalence vs. Gain

Commissioner v. ClarkCommissioner v. Clark, 489 U.S. 726 (1989), 489 U.S. 726 (1989)

The Supreme Court determined that in testing for dividend The Supreme Court determined that in testing for dividend equivalence, exchanging shareholders are treated as equivalence, exchanging shareholders are treated as receiving solely stock in the exchange, and then having a receiving solely stock in the exchange, and then having a portion of that stock redeemed with the boot received.portion of that stock redeemed with the boot received.

The deemed redemption is tested under section 302 for The deemed redemption is tested under section 302 for dividend equivalence.dividend equivalence.

The Court rejected testing the receipt of the boot as though The Court rejected testing the receipt of the boot as though it were received in a hypothetical redemption by the target it were received in a hypothetical redemption by the target corporation immediately prior to the reorganization. corporation immediately prior to the reorganization.

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Section 302Section 302

A distribution by a corporation in redemption of its stock is trA distribution by a corporation in redemption of its stock is treated as part eated as part or full payment in exchange for the stock if one of the tests inor full payment in exchange for the stock if one of the tests in section section 302(b) applies302(b) applies..

Section 302(b)(1)Section 302(b)(1) –– Redemption is not Redemption is not ““essentially equivalentessentially equivalent”” to a dividend.to a dividend.

SSection 302(b)(2)ection 302(b)(2) –– Substantially disproportionate redemption of stock.Substantially disproportionate redemption of stock.

Section 302(b)(3)Section 302(b)(3) –– Complete termination of shareholderComplete termination of shareholder’’s interest in the s interest in the corporation.corporation.

SSection 302(d)ection 302(d)

If a redemption does not meet any of the requirements of sectionIf a redemption does not meet any of the requirements of section 302(b), then 302(b), then it is treated as a distribution of property to which section 301it is treated as a distribution of property to which section 301 applies.applies.

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Section 302 AuthoritiesSection 302 Authorities

United States v. DavisUnited States v. Davis, 397 U.S. 301 (1970), 397 U.S. 301 (1970)

Attribution rules of section Attribution rules of section 318 apply to all of section 302, including for the 318 apply to all of section 302, including for the purpose of deciding whether a distribution is purpose of deciding whether a distribution is ““not essentially equivalent to a not essentially equivalent to a dividenddividend”” under section 302(b)(1).under section 302(b)(1).

Redemptions of stock of a sole shareholder (including a sole shaRedemptions of stock of a sole shareholder (including a sole shareholder via reholder via section 318 attribution) are always section 318 attribution) are always ““essentially equivalent to a dividendessentially equivalent to a dividend”” under under section 302(b)(1), and are thus subject to the rules of section section 302(b)(1), and are thus subject to the rules of section 301 and section 301 and section 316.316.

Redemption must result in a Redemption must result in a ““meaningful reduction of the shareholdermeaningful reduction of the shareholder’’s s proportionate interest in the corporationproportionate interest in the corporation”” to avoid dividend equivalence.to avoid dividend equivalence.

Any reduction in the interest of a common shareholder owning a mAny reduction in the interest of a common shareholder owning a minimal inimal interest in a public company is a interest in a public company is a ““meaningful reductionmeaningful reduction”” (Rev. Rul. 76(Rev. Rul. 76--385).385).

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Section 302 AuthoritiesSection 302 Authorities

Zenz v. QuinlivanZenz v. Quinlivan, 213 F.2d 914 (6, 213 F.2d 914 (6thth Cir. 1954)Cir. 1954)

CComplete termination of a sole stockholderomplete termination of a sole stockholder’’s interest can s interest can occur through a partial stock sale followed by redemption occur through a partial stock sale followed by redemption of remaining shares if part of one overall plan, providing of remaining shares if part of one overall plan, providing exchange treatment for the entire transaction.exchange treatment for the entire transaction.

IRS has applied IRS has applied ZenzZenz to redemptions under section to redemptions under section 302(b)(2) (Rev. Rul. 75302(b)(2) (Rev. Rul. 75--447).447).

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Boot in Section 351 TransactionsBoot in Section 351 Transactions

Section 351(a)Section 351(a)No gain or loss is recognized if property is transferred to a No gain or loss is recognized if property is transferred to a corporation by one or more persons corporation by one or more persons solelysolely in exchange in exchange for stock and immediately after the exchange, such person for stock and immediately after the exchange, such person or persons are in control of the corporation.or persons are in control of the corporation.

Section 351(b)Section 351(b)If a person receives boot in a transaction otherwise If a person receives boot in a transaction otherwise qualifying under section 351(a), gain on the exchange is qualifying under section 351(a), gain on the exchange is recognized, but not in excess of the amount of money plus recognized, but not in excess of the amount of money plus the fair market value of other property received.the fair market value of other property received.

No loss is recognized upon the receipt of boot in a section No loss is recognized upon the receipt of boot in a section 351 transaction.351 transaction.

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Boot and Continuity of InterestBoot and Continuity of Interest

PrePre--reorganization Continuity of Interestreorganization Continuity of Interest

Treas. reg. Treas. reg. §§ 1.3681.368--1(e)(1)(ii)1(e)(1)(ii) -- COI is violated if a target COI is violated if a target shareholder is treated as receiving boot in a preshareholder is treated as receiving boot in a pre--reorganization distribution or redemption under reorganization distribution or redemption under §§ 356.356.

The regs. do not say when section 356 should apply.The regs. do not say when section 356 should apply.

Compare 1998 temporary and proposed regs. (withdrawn) Compare 1998 temporary and proposed regs. (withdrawn) where prewhere pre--reorganization redemptions and extraordinary reorganization redemptions and extraordinary distributions generally count against COI.distributions generally count against COI.

Also see Rev. Proc.77Also see Rev. Proc.77--3737

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Boot and Continuity of InterestBoot and Continuity of Interest

Determining whether section 356 applies:Determining whether section 356 applies:

Regs. provide that each Target shareholder is deemed to Regs. provide that each Target shareholder is deemed to have received some stock of acquirer.have received some stock of acquirer.

Section 356 applies if (i) section 354 (or 355) apply to the Section 356 applies if (i) section 354 (or 355) apply to the exchange and (ii) boot is received.exchange and (ii) boot is received.

356 can apply to A, C and D reorganizations.356 can apply to A, C and D reorganizations.

356 does not apply to B reorganizations.356 does not apply to B reorganizations.

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Boot and COI in B ReorganizationsBoot and COI in B Reorganizations

Application of 356 to B Reorgs.Application of 356 to B Reorgs.

Example 9Example 9: Redemption prior to a B reorg. is not : Redemption prior to a B reorg. is not governed by 356 where acquirer does not provide funds.governed by 356 where acquirer does not provide funds.

In Example 9, distribution appears to be before, but In Example 9, distribution appears to be before, but in in connection withconnection with, the reorg., the reorg.

Reference to 356 is misleading, but B reorg. would have Reference to 356 is misleading, but B reorg. would have failed if cash paid in redemption had been treated as failed if cash paid in redemption had been treated as transferred by acquirer.transferred by acquirer.

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Boot and COI in B ReorganizationsBoot and COI in B Reorganizations

PrePre--Reorg.Reorg.

($$)

XX

TT

YY

TT

AAA Stock

T Stock

XXT Stock

•Treas. Reg. § 1.368-1(e)(6), Example 9•Compare Rev. Rul. 75-360 and Arthur D. McDonald, 52 T.C. 82 (1969)

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Boot and B ReorganizationsBoot and B Reorganizations

Published rulings find dividend treatment (not Published rulings find dividend treatment (not boot) where funds are provided by target: boot) where funds are provided by target:

Rev. Rul. 70Rev. Rul. 70--172 (section 301 applies to property 172 (section 301 applies to property distribution prior to B reorg.) distribution prior to B reorg.)

Rev. Rul. 69Rev. Rul. 69--443, Rev. Rul. 68443, Rev. Rul. 68--435 and Rev. Rul. 56435 and Rev. Rul. 56--184 184 (section 301 applies to cash distribution prior to B reorg.)(section 301 applies to cash distribution prior to B reorg.)

Rev. Rul. 68Rev. Rul. 68--285 (redemption of dissenting shareholders 285 (redemption of dissenting shareholders prior to B reorg.)prior to B reorg.)

Does the same rule apply to reverse subsidiary Does the same rule apply to reverse subsidiary mergers? Asset mergers?mergers? Asset mergers?

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Boot and B ReorganizationsBoot and B Reorganizations

Compare results where the distribution is funded Compare results where the distribution is funded by the acquirer by the acquirer

Rev. Rul. 56Rev. Rul. 56--184184 (dividend prior to B reorg.) (dividend prior to B reorg.)

Rev. Rul. 75Rev. Rul. 75--360360 and and Arthur D. McDonaldArthur D. McDonald, 52 T.C. 82 , 52 T.C. 82 (1969) (redemption of preferred stock prior to reorg. with (1969) (redemption of preferred stock prior to reorg. with redemption funded by shortredemption funded by short--term bank loan; common term bank loan; common retained and exchanged in reorg. one week later; acquirer retained and exchanged in reorg. one week later; acquirer transfers funds used to repay loan to target on closing transfers funds used to repay loan to target on closing date).date).

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Boot and Stock ReorganizationsBoot and Stock Reorganizations

Source of funds rule is consistent with cases Source of funds rule is consistent with cases applying applying §§ 301 to dividends prior to stock sales.301 to dividends prior to stock sales.

TSN Liquidating Corp. v. United StatesTSN Liquidating Corp. v. United States, 624 F.2d 1328 (5, 624 F.2d 1328 (5thth

Cir. 1980) (unwanted assets distributed to parent shortly Cir. 1980) (unwanted assets distributed to parent shortly before sale of target treated as dividend)before sale of target treated as dividend)

Also see, Also see, Gilmore v. CommissionerGilmore v. Commissioner, 25 T.C. 1321 (1956) , 25 T.C. 1321 (1956) and Coffey v. Commissioner, 14 T.C. 1410 (1950)and Coffey v. Commissioner, 14 T.C. 1410 (1950)

Cf. Cf. Litton Industries, Inc. v. CommissionerLitton Industries, Inc. v. Commissioner, 89 T.C. 1086 , 89 T.C. 1086 (1987) (acq. in result)(1987) (acq. in result)

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Source of funds approach is consistent with Source of funds approach is consistent with cases finding that precases finding that pre--reorg. spinreorg. spin--offs do not offs do not violate COIviolate COI

Rev. Rul. 75Rev. Rul. 75--406 (spin406 (spin--off prior to reorg.) off prior to reorg.)

Also see, Rev. Rul. 70Also see, Rev. Rul. 70--434 (spin434 (spin--off prior to B reorg. off prior to B reorg. does not violate B reorg. does not violate B reorg. ‘‘solely for voting stocksolely for voting stock’’requirement)requirement)

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Compare results where distribution prior to Compare results where distribution prior to stock purchase was funded by the acquirerstock purchase was funded by the acquirer

Waterman Steamship v. CommissionerWaterman Steamship v. Commissioner, 430 F.2d 1185 , 430 F.2d 1185 (5(5thth Cir. 1970) (Target note distributed to S/H prior to sale; Cir. 1970) (Target note distributed to S/H prior to sale; note paid shortly after sale with funds lent by acquirer; note paid shortly after sale with funds lent by acquirer; distribution was purchase price rather than dividend) distribution was purchase price rather than dividend)

Also see Also see Casner v. CommissionerCasner v. Commissioner, 450 F.2d 379 (5, 450 F.2d 379 (5thth

Cir. 1971) (distribution of cash prior to binding agreement Cir. 1971) (distribution of cash prior to binding agreement held to be dividend to buyer held to be dividend to buyer ---- not seller).not seller).

But see Rev. Rul. 75But see Rev. Rul. 75--493 (Service will not follow 493 (Service will not follow Casner; Casner; Waterman Waterman distinguished based upon source of funds). distinguished based upon source of funds).

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Boot and COI and Asset Reorgs.Boot and COI and Asset Reorgs.

For preFor pre--reorg. distributions, section 356 should not apply reorg. distributions, section 356 should not apply to C reorgs. where the funds are provided by target.to C reorgs. where the funds are provided by target.

Rev. Rul. 71Rev. Rul. 71--266266 (section 356 and section 301 do not apply to (section 356 and section 301 do not apply to distribution of S corp.distribution of S corp.’’s AAA account prior to C reorg.)s AAA account prior to C reorg.)

G.C.M. 32868G.C.M. 32868 (June 26, 1964) (redemption of preferred stock (June 26, 1964) (redemption of preferred stock prior to C reorg. is governed by section 302 rather than sectionprior to C reorg. is governed by section 302 rather than section356 where funds were provided by target)356 where funds were provided by target)

““It is the position of [the Office of Chief Counsel] that a prefeIt is the position of [the Office of Chief Counsel] that a preferred rred stock redemption which precedes a reorganization exchange shouldstock redemption which precedes a reorganization exchange shouldgenerally be treated separately from the reorganization, even generally be treated separately from the reorganization, even though it may have been motivated by it.though it may have been motivated by it.””

G.C.M. 32868 also provides that such a redemption should not be G.C.M. 32868 also provides that such a redemption should not be treated as a related step for purposes of the treated as a related step for purposes of the ““substantially allsubstantially all”” test. test. However, the impact of a distribution on COBE was left open.However, the impact of a distribution on COBE was left open.

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Boot and COI and Asset Reorgs.Boot and COI and Asset Reorgs.

For preFor pre--reorg. distributions, section 356 should reorg. distributions, section 356 should not apply to C reorgs. where funds provided by not apply to C reorgs. where funds provided by targettarget

However, see ominous footnote in PLR 200415004 However, see ominous footnote in PLR 200415004 (Target(Target’’s ability to pay dividend should not change result s ability to pay dividend should not change result that distribution prior to but in connection with A that distribution prior to but in connection with A reorganization is boot).reorganization is boot).

Would result change if Target actually paid the dividend?Would result change if Target actually paid the dividend?

Would the result change if the distribution were made prior to Would the result change if the distribution were made prior to the reorganization?the reorganization?

Any basis for distinguishing A reorgs. and C reorgs. ? Any basis for distinguishing A reorgs. and C reorgs. ?

33

Boot and COI in C Reorgs. Boot and COI in C Reorgs.

PrePre--Reorg.Reorg.

($$)AAA AAA

T S/HsT S/Hs

TT TT AAA Stock

T Assets

•Rev. Rul. 71-266•See also G.C.M. 32868 (June 26, 1964)

T S/HsT S/Hs

(2)

A Stock

(1)

34

Boot and Asset ReorganizationsBoot and Asset Reorganizations

Application of 356 to C reorgs.Application of 356 to C reorgs.

Compare results where distribution occurs after Compare results where distribution occurs after the reorganization.the reorganization.

Rev. Rul. 71Rev. Rul. 71--364364 (target transfers 90% of its assets to (target transfers 90% of its assets to acquirer in exchange for acquireracquirer in exchange for acquirer’’s stock in a C reorg.; s stock in a C reorg.; target liquidates and transfers acquirertarget liquidates and transfers acquirer’’s stock and s stock and targettarget’’s remaining assets to its shareholders; assets s remaining assets to its shareholders; assets received by shareholders treated as boot under received by shareholders treated as boot under section 356)section 356)

35

COI and PostCOI and Post--C Reorg. DistributionC Reorg. Distribution

TT

•Rev. Rul. 71-364•In this case, analysis does not look to source of funds

T S/HsT S/Hs

10 % T AssetsA Stock

TT AAA Stock

90% T Assets

T S/HsT S/Hs

36

Boot and PostBoot and Post--Reorg. COIReorg. COI

Regs. also provide a different standard Regs. also provide a different standard for postfor post--reorganization distributionsreorganization distributions

COI is not preserved to the extent Target stock COI is not preserved to the extent Target stock is acquired for boot or acquireris acquired for boot or acquirer’’s stock is s stock is redeemed redeemed in connection within connection with the reorganization. the reorganization. Treas. Regs. Treas. Regs. §§1.3681.368--1(e)(1)(i).1(e)(1)(i).

PostPost--reorg. treatment is consistent with reorg. treatment is consistent with Clark.Clark.

37

COI and Simultaneous DistributionsCOI and Simultaneous Distributions

What standard applies to simultaneous What standard applies to simultaneous distributions?distributions?

PrePre--Reorg. standard in the regulations is limited to Reorg. standard in the regulations is limited to distributions distributions ““prior toprior to”” reorg.reorg.

Cf. Cf. TAM 9123002TAM 9123002 (February 14, 1991) (section 302 applies (February 14, 1991) (section 302 applies in taxable reverse cash merger where purchase price is in taxable reverse cash merger where purchase price is funded by acquisition sub debt assumed by target)funded by acquisition sub debt assumed by target)

Cf. Cf. PLR 9003003PLR 9003003 (purchase price funded by target is (purchase price funded by target is treated as dividend to acquirer)treated as dividend to acquirer)

38

Distributions and Other Reorg. Distributions and Other Reorg. RequirementsRequirements

Boot determination can affect other reorg. Boot determination can affect other reorg. requirementsrequirements

Depending upon the form of the reorg, other requirements Depending upon the form of the reorg, other requirements could be implicated including the solely for voting stock could be implicated including the solely for voting stock requirement, the acquisition of control requirement and the requirement, the acquisition of control requirement and the substantially all of the assets requirement.substantially all of the assets requirement.

For all reorgs., distribution could also impact the continuity For all reorgs., distribution could also impact the continuity of business enterprise requirement.of business enterprise requirement.

Should the test be the same for all reorg. requirements?Should the test be the same for all reorg. requirements?

39

PrePre--Reorg. COI Reorg. COI –– A Reorg.A Reorg.

66 % T Assets

TT

T S/HsT S/Hs

TT AA

A Stock

Merger

T S/HsT S/Hs

•What if T distributes cash funded by borrowing? What is A guarantees the loan?•What if T only distributes unwanted assets (unique to T)?•Should different standards apply for asset-based reorganizations?

40

PrePre--Reorg. COI Reorg. COI ––Forward Subsidiary Reorg.Forward Subsidiary Reorg.

66 % T Assets

TT

T S/HsT S/Hs

TT MergerMerger

SubSub

A Stock

Merger

T S/HsT S/HsPP

•Is this case better than a parent-to-parent merger?•Is this case worse than a reverse subsidiary merger? A B reorganization?

41

PrePre--Reorg. COI Reorg. COI ––DE MergerDE Merger

66 % T Assets

TT

T S/HsT S/Hs

TT

A Stock

Merger

T S/HsT S/HsPP

DEDE

•Is this case better than a parent-to-parent merger?•Is this case worse than a forward subsidiary merger? A reverse subsidiary merger?•Does it matter how P accounts for DE after the merger?

42

Boot in D, E, and F ReorganizationsBoot in D, E, and F ReorganizationsOverviewOverview

Section 356(a) limits dividend/gain on boot received Section 356(a) limits dividend/gain on boot received to gain in stock.to gain in stock.

BazleyBazley and Treas. Reg. and Treas. Reg. §§ 1.3011.301--1(1(ll) treat boot as a ) treat boot as a separate distribution such that dividend/gain not separate distribution such that dividend/gain not limited to gain in stock.limited to gain in stock.

Historically, IRS has viewed Historically, IRS has viewed BazleyBazley and and Treas. Reg. Treas. Reg. §§ 1.3011.301--1(1(ll) as applying in abusive transactions ) as applying in abusive transactions (e.g., bailouts). (e.g., bailouts). See See Rev. Rul. 86Rev. Rul. 86--25, G.C.M. 25, G.C.M. 39,088.39,088.

43

Boot in D, E, and F ReorganizationsBoot in D, E, and F ReorganizationsOverviewOverview

Prop. Treas. Reg. Prop. Treas. Reg. §§ 1.3681.368--2(m)(4) treats boot received in an F 2(m)(4) treats boot received in an F Reorganization as a separate distribution immediately before Reorganization as a separate distribution immediately before the transaction. Section 356(a) would not apply.the transaction. Section 356(a) would not apply.

Preamble to proposed regulations states that IRS/Treasury Preamble to proposed regulations states that IRS/Treasury believe same rule should apply to E Reorganizations. believe same rule should apply to E Reorganizations. Comments are requested on whether there are some E Comments are requested on whether there are some E Reorganizations to which this treatment should not apply.Reorganizations to which this treatment should not apply.

Rev. Rul. 70Rev. Rul. 70--240 applies section 356(a), and not section 301, 240 applies section 356(a), and not section 301, to boot received in a D Reorganization with identical to boot received in a D Reorganization with identical shareholders.shareholders.

44

Boot in D, E, and F ReorganizationsBoot in D, E, and F ReorganizationsD vs. F ReorganizationsD vs. F Reorganizations

1.1. P transfers FSP transfers FS1 1 to to Newco for stock Newco for stock and cash. S and cash. S transfers FStransfers FS2 2 to to Newco for stock.Newco for stock.

2.2. FSFS1 1 checks the box.checks the box.

What result if FSWhat result if FS1 1 is is transferred first?transferred first?

What result if FSWhat result if FS22 is is transferred first?transferred first?

Cash and Stock

FS1FS1

FS2FS2

SS

PP

F F NewcoNewco

FS2FS2 FS1FS1

45

Boot in D, E, and F ReorganizationsBoot in D, E, and F ReorganizationsIPOIPO

VC has not held P for 1 year and wants to take P public. P mergVC has not held P for 1 year and wants to take P public. P merges into es into Newco for stock and a note.Newco for stock and a note.

Newco does an IPO.Newco does an IPO.

Newco uses the cash to pay off the note.Newco uses the cash to pay off the note.

Does VC get the 15% dividend rate on its receipt of the note?Does VC get the 15% dividend rate on its receipt of the note?

VC VC FundFund Public

1

3

2stock

cash

cashStock and note

NewcoNewcoPP

46

Section 368(a)(2)(E) and Section 351 OverlapSection 368(a)(2)(E) and Section 351 Overlap

Does it matter if the cash comes from TDoes it matter if the cash comes from T--2 or HC?2 or HC?

Does it matter if HC takes a net inside asset basis in the Does it matter if HC takes a net inside asset basis in the stock of Tstock of T--2?2?

HCHC

SS--22SS--11

TT--11 TT--22

Pub Pub AA

Pub Pub BB

HC Stock and Cash

mergemerge

HC Stock

47

Boot and Continuity of InterestBoot and Continuity of InterestWhat rules should apply?What rules should apply?

Alternatives for preAlternatives for pre--reorganization distributionsreorganization distributionsTarget dividend or redemption depending upon source of fundsTarget dividend or redemption depending upon source of funds

Consistent with B rulings and Consistent with B rulings and Waterman SteamshipWaterman SteamshipHow should the rule apply to A reorgs.? Would tracing be requirHow should the rule apply to A reorgs.? Would tracing be required when ed when fungible property is distributed in an asset reorg.?fungible property is distributed in an asset reorg.?

Dividend equivalency determined by ability to payDividend equivalency determined by ability to payMore administrable rule More administrable rule ---- would not require tracingwould not require tracingRule could apply equally to all forms of reorganizationRule could apply equally to all forms of reorganization

Boot whenever distribution is Boot whenever distribution is in connection within connection with the reorg.the reorg.How does this sync with B reorg. authorities? How does this sync with B reorg. authorities?

Should the same rules apply for preShould the same rules apply for pre-- and postand post--reorg. COI?reorg. COI?If yes, how would If yes, how would ‘‘source of fundssource of funds’’ or or ‘‘ability to payability to pay’’ rule sync with rule sync with ClarkClark? ? With With Zenz?Zenz?

Should the same rules apply for simultaneous distributions and Should the same rules apply for simultaneous distributions and postpost--reorg. distributions?reorg. distributions?

48

Boot and Continuity of InterestBoot and Continuity of InterestWhat rules should apply?What rules should apply?

Factors to considerFactors to consider

AdministrationAdministrationTo what extent should form control in economically equivalent trTo what extent should form control in economically equivalent transactions (e.g., ansactions (e.g., prepre--reorg. and postreorg. and post--reorg. dividends)? reorg. dividends)? How burdensome is a tracing rule? Would it create arbitrary disHow burdensome is a tracing rule? Would it create arbitrary distinctions?tinctions?Should the same rules apply regardless of the form of the reorgaShould the same rules apply regardless of the form of the reorganization (e.g., nization (e.g., stock rerogs. vs. asset reorgs.)?stock rerogs. vs. asset reorgs.)?Would an election regime be appropriate? CheckWould an election regime be appropriate? Check--thethe--box for dividends?box for dividends?

Should the rules be the same for taxable and taxShould the rules be the same for taxable and tax--free transactions?free transactions?In taxable transactions, Seller dividends, Seller redemptions anIn taxable transactions, Seller dividends, Seller redemptions and Buyer dividends d Buyer dividends may be economically equivalent. In taxmay be economically equivalent. In tax--free transactions, Seller redemption free transactions, Seller redemption treatment is arguably not appropriate.treatment is arguably not appropriate.

Should the rules be the same for dividends and redemptions?Should the rules be the same for dividends and redemptions?

Should the rules be the same for all reorg. requirements?Should the rules be the same for all reorg. requirements?

49

Boot in D, E, and F ReorganizationsBoot in D, E, and F ReorganizationsAlternative TreatmentsAlternative Treatments

Section 356Section 356

Gain in stock recognized to extent of boot Gain in stock recognized to extent of boot -- §§356(a)(1).356(a)(1).

Dividend equivalence under Dividend equivalence under §§356(a)(2) as determined under 356(a)(2) as determined under ClarkClark, , DavisDavis, , Zenz.Zenz.

BazleyBazley, Treas. Reg. , Treas. Reg. §§ 1.3011.301--1(1(ll) provide ) provide ““antianti--abuse backstop.abuse backstop.””

Treat as a Separate, PreTreat as a Separate, Pre--Reorganization Distribution/RedemptionReorganization Distribution/Redemption

Apply Treas. Reg. Apply Treas. Reg. §§ 1.3011.301--1(1(ll) and section 302.) and section 302.

Authority?Authority?

Represents position taken by Prop. Treas. Reg. Represents position taken by Prop. Treas. Reg. §§ 1.3681.368--2(m)(4) for F (and possibly 2(m)(4) for F (and possibly E) Reorganizations.E) Reorganizations.

Impact on Estate Freezes and isolated recapitalizations under seImpact on Estate Freezes and isolated recapitalizations under section 305?ction 305?

Application to D Reorganizations?Application to D Reorganizations?

Documents

ABA Corporate Tax Committee - Pillsbury Winthrop … · ABA Corporate Tax Committee Boot Distributions in ... 35% for corporations 10.5%/7% for corporations after ... – Complete