Excerpts: New Tax Law Proposals Target Merger and Acquisition Transactions
- Congress is considering several tax changes that could adversely affect merger and acquisition transactions. Some of these proposals are outlined below.
- Spin-Off Rules Tightened: Buyers and sellers frequently consider spin-off transactions in connection with mergers and acquisitions. In a typical tax-free spin-off, a parent corporation would distribute all of the stock of its subsidiary to the shareholders of the parent.
- One variation of the traditional spin-off involves the use of a spin-off to “sell” a subsidiary in a tax-efficient manner. The entity that wishes to acquire the subsidiary purchases an amount of parent stock equal to the value of the subsidiary stock. After a reasonable period of time (perhaps two years), the parent spins off the stock of the subsidiary to the new shareholder in exchange for the shareholder’s parent stock.
- The proposed change to the tax law would cause the distributing corporation to be subject to tax on any spin-off that resembles a sale. A transaction would resemble a sale if a shareholder who purchased stock within the last five years owns at least 50 percent of either the distributed or distributing corporation after the spin-off. In order words, for a spin-off to be fully tax-free, only shareholders who have held their stock for a substantial period can end up with control of either the parent or the subsidiary.
- Taxation of Debt Swaps Clarified: The current law that covers the taxation of certain debt-for-debt exchanges is unclear. For example, assume a corporation originally issued a $1,000 10-year debt security at par. The issuing corporation, now facing financial difficulty, convinces its debt holders to exchange their original $1,000 obligation for a new obligation with a face amount and a fair market value of $800. The current tax law is unclear whether the $200 of economic gain that the issuing corporation realizes in the debt swap should be treated as debt discharge income (generally subject to immediate taxation), or whether it should be treated as a reduction in the yield of the new obligation (generally resulting in $200 of reduced interest deductions over the life of the new obligation).
- The proposed law would clarify the tax treatment (but only prospectively) by providing that the transaction illustrated above results in immediate debt discharge income. Debt discharge income would also result if the face amount of the debt was not changed, but the yield was substantially reduced. The new rules would apply to exchanges taking place on or after October 10, 1990.
- Preferred Stock Exchanges in Bankruptcy Workouts: Under current law, a corporation in a bankruptcy proceeding can extinguish debt by issuing stock (including preferred stock) and escape taxation on the debt discharge income that would normally result. In addition, the current tax law does not require the debtor corporation to reduce its tax attributes (such as net operating loss carryforwards, tax basis of assets, etc.)
- The IRS recently held that the redemption price (not the fair market value) of the preferred stock is used to determine whether the corporation loses any tax attributes in a bankruptcy supervised swap. Thus, high face value, low yield preferred issues can help preserve a corporation’s tax attributes.
Source: Steve Baronoff of The Lodestar Group