An Introduction to Type C Tax-Free Corporate Reorganizations

A Type C reorganization generally is a purchasing corporation’s (“P’s”) acquisition of substantially all of a target corporation (“T’s”) assets solely in exchange for P voting stock (or voting stock of P’s parent). In a Type C reorganization, the target must “substantially all” of its properties. Internal Revenue Service (“IRS”) ruling policy requires a transfer of “assets representing at least 90 percent of the fair market value of the net assets and at least 70 percent of the fair market value of the gross assets held by the target corporation immediately preceding the transfer.” Rev.Proc. 77-37, 1977-2 C.B. 568. Some authorities interpret this requirement more flexibly by stating that no particular percentage is controlling and by looking at the type of assets retained by T and the purpose for the retention. For example, it may be permissible for T to retain nonoperating liquid assets (e.g., cash) to pay liabilities. Rev.Rul. 57-518, 1957-2 C.B. 253. If T sells 50% of its historic assets to unrelated parties for cash and then transfers all its assets (including the sales proceeds) to P, the “substantially all” requirements are met because T transfers all its assets and the effect of the transaction was not divisive. Rev.Rul. 88-48, 1988-1 C.B. 117.

Perhaps the most significant statutory distinction between Type C and other reorganizations is the boot relation rules for purposes of asset acquisitions found in Section 368(a)(2)(B) of the Internal Revenue Code. Under this provision, a transaction that would otherwise qualify as a Type C reorganization will not be disqualified by the addition of money or other property (boot) so long as the purchasing corporation does acquire, solely for voting stock, target property with the fair market value of at least 80% of the fair market value of all of the target corporation’s stock. Treas. Reg. Section 1.368-2(d)(1). Thus, despite the “solely for voting stock” requirement stated in Section 368(a)(!)(C), the use of consideration other than voting stock for up to 20% of the acquisition will not disqualify a Type C reorganization. However, in computing the 20% “boot” in a Type C reorganization, the statute requires that all liabilities assumed or liabilities to which any property acquired is subject shall be considered as money (boot) paid for the property. Thus, if the assumption of liabilities is the only consideration other than voting stock, this limitation will generally not cause a problem for purposes of qualifying for Type C reorganization treatment. On the other hand, if P assumed debts and also paid cash or other boot in the reorganization transaction, the 20% boot rules must be closely considered.

Another issue involves “creeping acquisitions,” in which the acquiring corporation has previously acquired some of the target and now seeks to assume complete control by acquiring all of its assets. For example, in Bausch & Lomb Optical Co. v. Commissioner, 267 F.2d 75 (2d Cir. 1959), cert denied, 361 U.S. 835 (1959), Bausch & Lomb already owned 79% of the stock in Riggs corporation and wished to acquire complete control over Riggs’ assets. (This was just short of the 80% necessary to make Riggs a subsidiary for purposes of Section 332 of the Internal Revenue Code). Bausch & Lomb (Hereinafter “B&L”) acquired control in a two-step transaction, the first part of which was an acquisition of all of Riggs’ assets in return for B&L voting stock, followed by a liquidation whereby Riggs distributed its recently acquired B&L voting stock. This two-step transaction appeared to the IRS as part of a taxable liquidation transaction and thus the IRS claimed that the two steps were part of an integrated plan and that the Riggs stock surrendered by B&L was additional consideration paid by B&L in the acquisition in violation for the “solely for voting stock” requirement. The Tax Court and the Second Circuit Court of Appeals agreed. The Bausch & Lomb case created potential traps for purchasing corporations with a very small percentage of target stock prior to the acquisition.

Liquidation Requirement

Immediately after T’s sale of substantially all of its property to P, T must distribute stock, securities, and other properties pursuant to a plan or reorganization.

Tax Consequences of Type C Reorganization

In many Type C reorganizations, T transfers all of its assets to P solely in exchange for P’s voting stock. This exchange is not taxable pursuant to Section 361(a). T’s basis in the P voting stock will be the same basis it had in the transferred assets. When T transfers substantially all assets but retains some of its assets, T’s subsequent liquidation will involve a distribution of “qualified property” eligible for Section 361(c) nonrecognition.

Plan of Reorganization

A Type C reorganization must occur pursuant to a plan in order to qualify as a reorganization under Section 368. Treas. Reg. Section 1.368-1(c), 1.368-2(g). Prior to implementing a reorganization, a written plan should be entered into by all shareholders.

Conclusion

This article is intended to provide the reader with a basic understanding of basic tax-free corporate reorganization principles. It should be evident from this article that this is a complicated area of tax law that requires advance planning. If you are considering utilizing a tax-free corporate reorganization as a planning option, it is crucial that you consult with a qualified tax attorney to review your particular circumstances.

Anthony Diosdi is an international tax attorney at Diosdi & Liu, LLP. Anthony focuses his practice on domestic and international tax planning for multinational companies, closely held businesses, and individuals. Anthony has written numerous articles on international tax planning and frequently provides continuing educational programs to tax professionals.

He has assisted companies with a number of international tax issues, including Subpart F, GILTI, and FDII planning, foreign tax credit planning, and tax-efficient cash repatriation strategies. Anthony also regularly advises foreign individuals on tax efficient mechanisms for doing business in the United States, investing in U.S. real estate, and pre-immigration planning. Anthony is a member of the California and Florida bars. He can be reached at 415-318-3990 or adiosdi@sftaxcounsel.com.

This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.