Reorganizations

• Pages: 275-366
• Author: Howard E. Abrams,Don A. Leatherman,Thomas J. Brennan

275

Chapter 10

REORGANIZATIONS

10.01 Introduction

The subject of corporate reorganizations is hard to define. In its

narrowest sense, corporate reorganizations include only those tax-

free transactions described in § 368(a)(1), i.e., the so-called A

(described in § 368(a)(1)(A)) through G (described in § 368(a)(1)(G))

reorganizations. More broadly, however, the term encompasses all

corporate rearrangements by which the assets of a corporation are

transferred to a new corporate entity or are retained by the

corporation but controlled by new shareholders.

We adopt the broader interpretation of the term

“reorganization” here not only because most tax lawyers use it that

way (allowing them to speak of tax-free reorganizations without

redundancy as well as of taxable reorganizations without

contradiction), but also because it is pedagogically better: the

statutory reorganizations constitute some but not nearly all the ways

of rearranging corporate structures. Sometimes meeting the

requirements of § 368(a)(1) will be easily accomplished and will

provide the most favorable results. In such cases, the corporate

rearrangement will be accomplished by means of a “corporate

reorganization” in its narrowest sense. Often, though, meeting the

dictates of § 368(a)(1) will be difficult, expensive, or impossible, and

in those cases other methods will have to be adopted. In addi tion, it

may well be the case that the tax treatment provided by the

reorganization provisions (once again in the narrow sense) may not

be what the taxpayer desires, and then a plan must be adopted which

deliberately runs afoul of the § 368(a)(1) definitions.

You are already familiar with a numb er of corporate

rearrangements. The bulk sale of a corporation’s assets followed by a

liquidating distribution of the proceeds is a corporate rearrangement,

generally taxable at both the shareholder and corporate levels.

1

The

sale of all the stock of a corporation accomplishes much the same

result but is only partially taxable: a shareholder-level tax is imposed

on the sale but corporate-level tax may be avoided. Indeed, you are

also familiar with a fully tax-free corporate rearrangement: the

liquidation by a parent of its wholly owned subsidiary.

The reorganizations defined in § 368(a)(1) are, in tax effect, most

similar to the liquidation of a wholly owned subsidiary because the

1

See Chapters 8 and 9 supra.

276

REORGANIZATIONS

Ch. 10

§ 368(a)(1) reorganizations can be tax-free at both the corporate and

shareholder levels. The operative shareholder-level provision is

§ 354(a)(1), providing (with some limitations) for the tax-free

exchange of stock or securities of one corporation for stock or

securities of another corporation if both corporations are “parties” to

a reorganization. The operative corporate-level provision is in § 361,

providing in a complicated way (and with some exceptions) for tax-

free treatment to the transferor corporation in a statutory

reorganization. The transactions covered by these sections, the

statutory reorganizations, are set out in § 368(a)(1) (though modified

by other parts of § 368). Note that § 368 is a definitional section only:

nowhere in § 368 are the tax implications of a reorganization

mentioned. The importance of § 368 is that many other sections (e.g.,

§§ 354 and 361) are triggered by transactions meeting the definitions

contained in § 368.

Most broadly, reorganizations can be divided into four groups:

(1) amalgamating reorganizations in which two or more corporations

are combined into a single corporate structure; (2) divisive

reorganizations in which a single corporation is divided into two or

more companies; (3) single-party reorganizations in which one

corporation undergoes a substantial change in financial structure or

modifies its place of incorporation or other similar corporate

characteristic; and (4) bankruptcy reorganizations in which a

distressed corporation seeks to improve its financial position. In

terms of § 368, the amalgamating reorganizations consist of the types

A through C as well as some D’s; the divisive reorganizations include

the remainder of the D’s as well as transactions described in § 355

though not falling within the definitions of § 368(a)(1); the single-

party reorganizations are the types E and F; and the bankruptcy

reorganization is the type G.

2

The one unifying aspect of the statutory reorganizations is that

of continuity of interest. The various definitions in § 368 seek to

provide tax-free treatment to corporate rearrangements in which the

shareholders continue their investment in modified form. The

rationale for tax-free treatment of such reorganizations is the same

as that for § 351 incorporations: not eno ugh is changed by the

transaction to warrant an immediate imposition of tax. You will have

to decide for yourself whether you think the lines drawn in § 368

properly distinguish mere changes in form not warranting taxation

from sales and other rearrangements that are fully taxable.

With few exceptions, the Code provisions specially applicable to

the statutory reorganizations do not distinguish among the various

2

We consider only the tax (and not bankruptcy) aspects of bankruptcy

reorganizations.

Sec. 10.02

AMALGAMATING REORGANIZATIONS:

DEFINITIONS

277

types described in § 368(a)(1). Accordingly, it is customary to

investigate the various definitions as a group and then consider the

tax implications common to all. Before beginning that investigation,

recall what we have already learned about the statutory

reorganizations: if the detailed provisions of § 368(a)(1) are met,

taxation may be avoided at both corporate and shareholder levels.

10.02 Amalgamating Reorganizations:

Definitions

For a transaction to be treated as an amalgamating

reorganization (or, as it is generally referred to, an acquisitive

reorganization), it must meet not only the statutory definition of a

reorganization under § 368(a) but generally also certain judicial

requirements: A reorganization must have a continuity of interest,

continuity of business enterprise, and valid business purpose.

3

Those judicial requirements help assure that a reorganization

meets both the express language and the spirit of the statutory

provisions. This willingness to look beyond the confines of the Code

for the definition of a reorganization remains with us today, in both

the case law and the regulations, as is clearly stated in Regs. § 1.368–

1(b):

In order to exclude transactions not intended to be included,

the specifications of the reorganization provisions of the law

are precise. Both the terms of the specifications and their

underlying assumptions and purposes must be satisfied in

order to entitle the taxpayer to the benefit of the exception

from the general rule. Accordingly, . . . an ordinary dividend

is to be treated as an ordinary dividend, and a sale is

nevertheless to be treated as a sale even though the

mechanics of a reorganization have been set up.

In this section, we first consider the judicial requirements for

amalgamating reorganizations and then their statutory

requirements.

(a) Judicial Requirements

(i) Continuity of interest. A merger or other corporate

combination qualifies as a § 368(a) reorganization only if it has

continuity of interest. This standard is met if “a substantial part of

the value of the proprietary interest in the target corporation [is]

preserved in the reorganization.” § 1.368–1(e)(1). Thus, the target

3

Courts have felt free to engraft their conception of what a reorganization

should be onto the statute, a statute already complex and detailed. Judicial activism

in tax is hardly limited to the reorganization arena, but it does seem to be the case

that reorganizations have sparked more than their share of judicial creativity.