COBE in Statutory Mergers.

• Author: Joseph, Shibu M.
• Position: Continuity of business enterprise

Last September, the Tax Court ruled that a statutory merger of a trucking company was not a tax-free A reorganization, as originally treated by the company, because the acquiring company had not continued the target's business enterprise.

Honbarrier, 115 TC No. 23, involved the sole shareholder of Colonial, Inc., predominantly a freight trucking company. Colonial reported consecutive yearly losses up to 1988. The entity's trucking operations then ceased and Honbarrier liquidated the company. The earnings from the sale were invested in tax-exempt bonds and a municipal bond fund worth over $7 million.

Central Transport, Inc., an S corporation of which Honbarrier was the majority shareholder, was a separate trucking company that transported bulk chemicals. In December 1993, Central acquired Colonial in a merger. The parties treated the merger as a tax-free A reorganization. Central stated several business purposes for the merger, including obtaining Colonial's ICC operating rights for the expansion of Central's operations, reducing operating and administrative expenses and using Colonial's cash for Central's immediate expansion.

Prior to the merger, Central (the surviving entity) declared a $7 million distribution payable to its shareholders--$2.4 million in cash and approximately $4.5 million in tax-exempt bonds, to be acquired from Colonial. Central claimed the $7 million distribution as a payment of previously taxed income (PTI) reflected in its accumulated adjustments account.

According to the Tax Court, to qualify as a tax-free reorganization, a merger must meet three additional requirements: (1) business purpose, (2) continuity of business enterprise (COBE) and (3) continuity of interest (COI). Mergers between corporations in similar lines of business generally comply with the business-purpose requirement.

COBE required the issuing corporation (Central) to continue the target's historical business or use a significant portion of the target's business assets during daily operations. The business enterprise is the target's actual function; whether a manufacturer, distributor or holding company, an entity's historical business is that in...