Reorganizations provide ways for corporate entities to restructure without triggering substantial tax consequences. It is important to remember with any reorganization that the strategy is rooted in tax deferral rather than tax elimination. The consideration used by the acquiring corporation, or subsidiary of an acquiring corporation, can also have a significant impact on whether or not a transaction even qualifies as a reorganization under §368. This article has been prepared by a Denver business attorney and tax attorney to discuss a B Reorganization.
What is a B reorganization?
One technique is known as a stock for stock acquisition, or in other words, a “B reorganization” under § 368(a)(1)(B) of the Internal Revenue Code. In this type of reorganization, the acquiring company is transferring its own stock in exchange for stock held by the shareholders of the target corporation. Rather than dealing with the target corporation itself, the transaction is conducted between the acquiring corporation and target’s shareholders. This is important for basis purposes because the acquiring corporation takes over the basis that the target shareholders held in the stock, according to §362(b). In other words, the basis is calculated from the hands of the transferor. Generally, this is a corporation, but in a B reorganization, the transferor is considered the individual shareholder.
While B reorganizations may seem like a simple transaction, they have strict requirements when it comes to control and consideration.
What is the control requirement for a B reorganization?
First, consider control requirements. In a “B Reorganization”, the control requirement is satisfied under §368(c) of the tax code. This requires that the acquiring corporation possess 80% of the value of all of the voting stock in the target along with 80% of all other classes of stock that are not considered voting stock. For instance, consider five classes of stock – Class A, Class B, Class C, Class D, and Class E, where Class A and Class B are the only ones with voting stock. The acquiring corporation would need to acquire 80% of A and B since they contain voting stock, and 80% of each Class C, Class D, and Class E because these are the nonvoting stock classes.
What type of consideration may be used in a B reorganization?
For the consideration required, B reorganizations are difficult to satisfy since only voting stock may be used. B reorganizations may not be accomplished by using other property, such as nonvoting stock or cash. Therefore, the acquiring company cannot acquire a target’s stock valued at $200,000 for $160,000 worth of voting stock, $20,000 of cash and $20,000 of nonvoting stock. The cash and nonvoting stock components of the consideration will ruin the transaction by violating the requirements of a B reorganization and immediate tax consequences will follow.
Can B reorganizations occur over a series of transactions?
B reorganizations can also be achieved through several transactions rather than just one. However, one must consider if in the past, the stock acquired was done so by using cash or other property aside from voting stock. This is commonly known as “boot”. If boot was used in the past, then you will need to consider the length of time that has passed from the initial transaction to the subsequent transaction for purposes of satisfying the consideration requirements.
Will there still be minority shareholders?
If the objective of the reorganization is to eliminate minority shareholders, then a B reorganization is likely not the right fit. B reorganizations only require 80% control to be effective. This leaves 20% of the shareholders that may or may not release control. For some transactions, retaining minority shareholders may not be an issue in terms of accomplishing the tax deferral through a reorganization, but it may create other corporate issues outside of tax consequences.
You can contact The McGuire Law Firm to speak with a Denver Business Attorney and learn if your transaction qualifies as a B reorganization for tax deferral purposes.