Measuring COI under the binding contract rules.

• Author: Thornton, David A.
• Position: Continuity of interest

Final Regs. Sec. 1.368-1(e) (TD 9225, 9/15/05) allows taxpayers some flexibility in measuring continuity of interest (COI) for transactions entered into under a binding contract after Sept. 16, 2005. Under the "binding contract" rule, taxpayers are permitted to measure COI in a tax-free reorganization by reference to the value of the acquirer's stock as of the day immediately preceding the day the parties enter

into a binding contract to proceed with the transaction, as opposed to immediately before the closing date. This alternative is beneficial for preserving the COI requirement in situations in which the value of acquirer stock falls between the definitive agreement date and the closing date. While the requirements to use the binding contract rule are rigid, the resulting benefit is the assurance that the COI requirement will be met.

Background

The COI requirement for tax-free reorganizations is set forth in Regs. Sec. 1.368-1(e)(1); it provides that a substantial part of the value of the proprietary interests in the target corporation must be preserved in the reorganization. COI is generally measured by reference to the portion of the acquirer stock used as consideration in the transaction, as this represents a continued proprietary interest on the part of the target shareholders in the reorganized corporation. While different forms of tax-free reorganizations require varying levels of COI, satisfying the appropriate level is imperative if the transaction is to qualify as a tax-free reorganization.

Normally, COI is measured as of the date the reorganization transaction is closed. On that date, the portion of the total consideration paid to the target by the acquirer is measured to determine whether the COI requirements are met. The value of the target stock used as consideration is measured immediately before the transaction is dosed.

This rule can present a problem, if the overall value of the consideration to be paid to the target shareholders is fixed in the definitive agreement, and the value of the acquirer stock falls between the date of the definitive agreement and the dosing date. In this scenario, the acquirer must contribute additional consideration to make up for the decline in its stock value. This additional consideration would consist of additional acquirer stock or additional nonstock consideration (i.e., cash or other property). If nonstock consideration is used, the COI requirement could be jeopardized if the new mix...