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Lawyers, accountants and bankers have a long history of creating
restructuring transactions that are both complex, such as mergers,
acquisitions and recapitalization and relatively
straightforward such as changes in the state jurisdiction of incorporation.
Predating significant tax consequences,
these transactions were designed to
increase firm value through efficiency and operations,
while of course generating professional fees in the process.
However, with the arrival of corporate income tax,
the courts were tasked with determining whether and to what extent
such fundamental changes in corporate structure were taxable events.
In a series of cases spanning the 1920s,
the US Supreme Court destined to protect
the tax base held that even slight modifications to corporate operations,
such as changing the state of incorporation from Illinois to Florida,
were taxable events requiring gain or loss recognition.
However, while these cases were pending Congress intervened by
enacting one of the first non-recognition statutes in the code,
preceding even section 351.
Specifically, Section 202 B of the Revenue Act of
1918 provided that no gain or loss shall be recognized on the re-organization,
merger or consolidation of a corporation,
where a person received in place of stock or securities owned by him,
new stock or securities of no greater value.
In other words, if a shareholder received
nothing else but new shares with the same value,
there was no realization event to tax.
The basic premise was that unless the shareholders receive
some wherewithal to pay tax like cash, why bother with it.
The ultimate goal of providing non-recognition tax treatment was
to nurture the development and expansion of the corporate tax base.
From a conceptual perspective,
Congress reasoned that taxes should not impede
these transactions as they are simply modifications to continuing interest in
property albeit in modified form and the new property
received is substantially a continuation of the old investment still unliquidated.
But, in so far as a shareholder liquidates an interest in a corporation,
gain or loss recognition is then appropriate, as you have learned.
A later version of these rules provided that shareholders must
recognize realized gains to the extent of any boot received.
That is some wherewithal to pay tax.
Congress then refine these rules to make it clear that non-recognition
meant gain deferral and not complete forgiveness indefinitely.
As such, the revenue act of 1928 included rules governing carry over exchange basis and
re-organisations to preserve unrecognized gain or loss for
later recognition whenever the shareholder liquidated the investment.
Since the 1920s, this tax favorable means
of encouraging business development has evolved into
a vast body of law that governs some of
the most financially significant and notoriously complex business transactions.
Consequently, experts note that it is important to recognize at the outset that
the system of tax rules for re-organisations
is not necessarily sensible for at least four reasons.
First, incredibly different transactions such as
corporate acquisitions and divisions are grouped together and labeled re-organisations.
Similarly, economically equivalent methods of acquisition are tested for
re-organization status using different criteria that place
a premium on the transactional form chosen by the parties.
Third, determining the tax consequences of a re-organization requires application of
both precise statutory language and judicially created
common law doctrines of uncertain scope such as the step transaction doctrine.
Finally, the re-organization rules routinely overlap with
other parts of subchapter C further complicating the analysis.
Overall experts describe the tax rules of
re-organisations as extraordinarily complex even for the code.
For these reasons our coverage of this topic will be necessarily broad.
Michael P Donohoe, PhD, CPAAssociate Professor of Accountancy and PwC Faculty Fellow
