In our previous post on corporate reorganizations under IRC Section 368, we mentioned that corporations can select between several variations of Sec. 368 reorganizations. Whether a corporation elects one variation over another depends on the specific circumstances involved. There can be many reasons as to why one variation may be more advantageous in a given situation, and an optimal decision requires a careful analysis of all relevant facts. The requirements for variations derive from both the subsections of 368 and our common law.
Section 368 Reorganizations
No matter what the variation, reorganizations under Section 368 are complex transactions, and they require expert counsel to ensure that everything be performed correctly. In this article, we will focus our attention on just three variations of 368 reorganizations. Specifically, we’ll concentrate on the “merger” variations; that is, we will examine statutory mergers under subsection 368(a)(1)(A), 368(a)(2)(D) and 368(a)(2)(E). In future articles we will cover the remaining, non-merger transactions covered by Section 368.
Subsection 368(a)(1)(A) – The Statutory Merger
The statutory merger under subsection 368(a)(1)(A) is the most commonly performed merger transaction. In this classic transaction, the acquiring corporation absorbs all of the target corporation’s stock, assets and liabilities, in exchange for acquirer stock and other consideration. The target corporation may only accept a maximum of 60% of non-stock consideration (i.e. cash or other property); if non-stock consideration exceeds 60% of total consideration, then the reorganization character of the transaction will be lost and Section 368 will not apply. The stock consideration given by the acquiring corporation may be non-voting, voting, or preferred shares.
Statutory mergers under subsection (A) are the simplest, most straightforward type of reorganization transactions. This is due in part to the fact that only two entities are involved; as we’ll see, the other merger variations are bit more complicated.
Subsection 368(a)(2)(D) – The Forward Triangular Merger
In a so-called “forward triangular merger,” the target company isn’t absorbed into the acquiring corporation directly, but instead is absorbed into a subsidiary. The target company is liquidated and passes its assets and liabilities to the subsidiary. In this variation, the acquiring corporation must obtain “substantially all” of the target company’s assets to qualify for the benefits under Section 368; this “substantially all” requirement is defined as at least 70 percent of the gross assets and 90 percent of the net assets of the target company. As with traditional statutory mergers under subsection (1)(A), acquirer stock must make up a substantial portion of the overall consideration.
This structure has the advantage of insulating the acquiring corporation from the liabilities of target company because they’re placed in the subsidiary. Plus, in this type of merger, the shareholders of the acquiring corporation typically do not have to provide express approval of the transaction, although there may be exceptions depending on the individual case.
Subsection 368(a)(2)(E) Reorganizations – The Reverse Triangular Merger
Finally, the third merger variation is the “reverse triangular merger” under subsection 368(a)(2)(E). In this variation, the acquiring corporation merges its own subsidiary with the target company, leaving the target company as the surviving entity. As with the forward merger, this variation also allows the acquiring corporation to be insulated from the target company’s liabilities, but it comes with the added benefit of preserving all non-transferable assets of the target company. By contrast, sometimes, in forward triangular mergers, certain non-transferable assets of the target company may be lost as it is absorbed by the subsidiary of the acquiring corporation.
Importantly, in a reverse merger, at least 80% of the total consideration paid to the target company must take the form of acquirer voting common or preferred stock.
Again, it’s not at all difficult to see why corporations must utilize the services of an experienced and qualify tax attorney to navigate through these transactions. Understanding and complying with all these rules and regulations are not easy tasks, so it’s in your best interest to hire experienced counsel to help you with Sec. 368 reorganizations. The New York City tax attorneys at Mackay, Caswell & Callahan, P.C., have a wealth of expertise with these and other types of transactions. Don’t hesitate to contact us if you need assistance!