Statutory mergers.

• Author: Schwartzman, Randy A.

The IRS recently finalized regulations under Kegs. Sec. 1.368-2, defining the term statutory merger or consolidation for purposes of applying Sec. 368(a)(1)(A)'s tax-flee reorganization provisions.

Background

While there are many different types of tax-flee reorganization or restructuring provisions, a statutory merger (also known as a Sec. 368(a)(1)(A) reorganization or type A reorganization) is the most flexible for the following reasons:

1. There are few restrictions on the type of consideration (even if money is exchanged), as long as the continuity-of-interest requirement is satisfied (i.e., courts generally require at least 40% stock consideration);

2. There is no "substantially all" (of the assets) rule; and

3. There is no "solely for" (voting stock) rule.

   Definition

   On Jan. 24, 2003, the IRS issued temporary and proposed regulations defining a statutory merger or consolidation as:

1. A transaction effected under the laws of the U.S., a state or the District of Columbia,

2. In which all of the assets and liabilities of the target are acquired by the acquiring corporation, and

3. The target ceases its separate legal existence for all purposes.

   A statutory merger or consolidation was historically limited to transactions effected pursuant to the corporate laws of the U.S. (i.e., a state, a territory or the District of Columbia), and until the recent changes (as discussed below), the definition had not changed much since 1935.

   Disregarded Entity Mergers

   The 2003 regulations expanded the applicability of the statutory merger or consolidation provisions, by expressly permitting a merger of a target into a limited liability company (LLC) that is disregarded as a separate entity from the acquiring corporation for Federal income tax purposes. Examples of disregarded entities include a domestic single-member LLC that does not elect to be classified as a corporation for Federal income tax purposes, a corporation that is a qualified real estate investment trust subsidiary and a corporation that is a qualified subchapter S subsidiary (QSub).

   In analyzing the effect of these rules on various transactions, the new regulations have examples that refer to combining entities, combining units and transferor units. By definition a combining entity is a business entity that is a corporation and is not a disregarded entity. A combining unit is composed solely of a combining entity and all disregarded entities (if any), the assets of which are treated as owned by such combining entity for Federal income tax purposes.

   For Sec. 368(a)(1)(A) purposes, a statutory merger or consolidation is a transaction effected pursuant to the statute, and all of the assets (other than those distributed in the transaction) and liabilities of each member of one or more combining units (each a transferor unit) become the assets and liabilities of one or more members of one other combining unit (the transferee unit), and the combining entity of each transferor unit ceases its separate legal existence for all purposes.

   Foreign Mergers

   In January 2005, the IRS further expanded the meaning of a statutory merger or consolidation by issuing proposed regulations eliminating the necessity for a transaction to be effected pursuant to domestic laws. Thus, the definition of statutory mergers or consolidations allowed transactions effected pursuant to the statutes of foreign jurisdictions or U.S. possessions to qualify as statutory mergers or consolidations. In January 2006, the Service adopted the proposed regulations as final (with certain minor technical changes), thus permitting practitioners to plan for...