IRS applies reverse acquisition regulations: a substance-over-form approach.

• Author: Smith, Annette B.

Determining whether a transaction is characterized as a reverse acquisition under the consolidated return regulations can be challenging. The IRS has recently interpreted the reverse acquisition rules broadly and has issued private letter rulings applying a substance-over-form approach to transactions that may not fit within the literal definition of a reverse acquisition in Regs. Sec. 1.1502-75(d) (3), This item focuses on tax implications of reverse acquisitions and reviews recent private letter rulings in which the IRS applied substance-over-form principles.

Reverse Acquisition Rules

Generally, a reverse acquisition occurs when a larger corporate group or corporation (by reference to fair market value) is acquired by a member of a smaller group or corporation. The IRS developed the reverse acquisition rules in 1966 to prevent taxpayers from manipulating the effects of the consolidated return regulations. Prior to these rules, a taxpayer could choose which consolidated group terminated by having that group be the target in the acquisition.

The reverse acquisition rules generally look to the substance of the transaction and recharacterize the transaction so that the larger group is treated as continuing to exist. The reverse acquisition rules provide guidance on identifying the group that continues to exist for purposes of filing a consolidated return (Regs. Sec. 1.1502-75(d)(3)(i)), carrying over a loss (Regs. Sec. 1.1502-75(d)(3)(v)(b)), determining the group's accounting period (Regs. Sec. 1.1502-75(d)(3)(v)), and indicating the losses and other tax attributes that may be subject to the separate return limitation year rules (Regs. Sec. 1.1502-l(f)(3)).

Under Regs. Sec. 1.1502-75(d)(3)(i), a reverse acquisition occurs if:

* One corporation acquires the stock or substantially all the assets of another corporation (the target);

* As a result of the acquisition, the target becomes a member of the consolidated group of which the acquirer is the common parent; and

* Immediately after the acquisition, the target's shareholders have a controlling interest (i.e., more than 50% of the fair market value) of the outstanding stock (including preferred stock) of the acquirer as a result of owning the target's stock.

If a transaction qualifies as a reverse acquisition, the acquirer's group terminates its existence as of the close of the date of the acquisition, and the target's group continues to exist and files a consolidated return with the acquirer...