C reorgs. with preexisting ownership of target stock.

• Author: Panoutsos, Louis A.
• Position: IRC Subchapter C corporate reorganizations

When one corporation acquires the assets of another in a tax-free reorganization, the acquisition is often structured as a merger because of the relative simplicity and flexibility. However, a merger may not always be the appropriate form for the transaction. For instance, a C reorganization may be preferable if the acquirer does not want to assume the target's liabilities or acquire all of its assets. Further, a reorganization of another type may fall under the C reorganization rules under the overlap provisions. This would be the case, for example, in a B stock-for-stock reorganization followed by a prearranged liquidation of the target.

Generally, a C reorganization is defined as the acquisition of substantially all the assets of a target solely for voting stock of an acquirer. Under the so-called "boot relaxation rules," the use of money or other property does not prevent an exchange from qualifying if at least 80% of the target's property is acquired for voting stock. For transactions subject to the boot relaxation rule, liabilities assumed by the acquirer are treated as money received by the transferor and, thus, must be considered for the 80% test.

If the acquiring company already owns a portion of the target's stock, the IRS has historically treated such portion as consideration paid for the assets acquired. As a result, the acquisition is not solely for voting stock, and must be tested under the boot relaxation rule. Consequently, it has been extremely difficult to effect a C reorganization for acquiring companies that previously held a portion of the target's stock. The Service's position was initially articulated in Rev. Rul. 54-396 and upheld by the courts in Bausch & Lomb Optical Co., 267 F2d 75 (2d Cir. 1959).

The IRS recently issued proposed regulations withdrawing its position in Rev. Rul. 54-396. Under Prop. Regs. Sec. 1.368-2(d)(4), an acquiring corporation's preexisting ownership of target stock will not be treated as cash or other property and will not trigger the boot relaxation rule. In addition, when the acquirer transfers cash or other property to the target, the previously owned stock will not be counted for purposes of determining whether at least 80% of the assets were acquired for voting stock. Thus, if the boot relaxation rule applies, it will be satisfied if (1) the sum of money and other consideration distributed to target shareholders and to target creditors under Sec. 361(b)(3) and...