In a stock for assets acquisition, Corporation 1 would provide common stock (as opposed to cash consideration) for the assets of Corporation 2.  Furthermore, Corporation 1 would assume all of Corporation 2’s liabilities.  Thus, the post transaction view of a stock for asset acquisition is similar to that of a stock swap merger.  After the transaction, Corporation 1 will not hold all Corporation 2 shares and Corporation 2 liabilities.

Depending upon the states that the corporations incorporated in, there may be general powers in the state corporate code that allows Corporation 1 to buy assets and for Corporation 2 to sell assets.  Additionally, other general powers may authorize Corporation 1’s assumption of Corporation 2’s liabilities.  However, the sale of all or substantially all of Corporation 2’s assets require specific authorization or steps and may require that the shareholders of Corporation 2 ratify the sale to Corporation 1.   What constitutes “substantially all” of a corporation’s assets may need to be determined based upon case law.  A Delaware case once determined the sale of substantially all corporate assets to be the sale of assets that is quantitatively vital to the operations of the corporation and would be out of the ordinary and substantially effects the existence and purpose of the corporation.  See Gimbel v. Signal Companies, Inc. (Del. Ch. 1974).  In terms of a Delaware law, another case once held that the sale of stock in a subsidiary was 68% of parent’s assets and primary income generating asset required a stockholder vote.  See Thorpe v. Serbco, Inc. (Del.1996). Certain codes or acts may replace the “all or substantially all of the corporate assets” with “a disposition that would leave the corporation without a significant continuing business purpose.  See MCBA Section 12.02.  This section also states a safe harbor where a significant continuing business purpose exists if the continuing business activity represents at least 25% of the total assets and 25% of either income (pre-tax) or revenue from pre transaction operations.

If your business is considering a transaction or acquisition, you can discuss your questions with a Denver business attorney and tax attorney from The McGuire Law Firm.  The McGuire Law Firm provides a free consultation to all potential clients to discuss your current business, tax and other legal matters.

Under Internal Revenue Code Section 368(a)(1), the term reorganization includes consolidations, mergers, recapitalizations, divisions, acquisitions by one corporation of another corporation’s stock or assets or other changes within an organization.  Many of these forms of reorganizations will involve the exchange of old interests in a corporation for new interests and a disposition of certain corporate assets.  The commonality amongst these changes and reorganizations is, that if the changes or adjustments qualify as a reorganization under the Internal Revenue Code, neither gain nor loss will be recognized by the corporation on the transfer of property for stock or securities in another corporation that is a party to the reorganization, and shareholders and/or creditors may exchange their stock or securities for “new” stock or securities without gain or loss recognition as well.  Additionally, the tax attributes of the target corporation that is acquired by another corporation in the reorganization, are generally carried over to the acquiring corporation.  For example, earnings and profit, loss carryovers and accounting method to name a few are generally carried over to the acquiring corporation.

The general theory behind tax free reorganizations is that neither gain nor loss shall be recognized on changes of form when a taxpayer’s investment, such as stock or securities remains in a corporate foundation and no change to the substance in these rights has occurred.  As an example, consider the situation where Corporation A merges into Corporation C.  The former shareholders of Corporation A will exchange all of their stock in Corporation A for stock in Corporation C.  The Corporation C stock received by the former shareholders of Corporation A is a continuation of their investment in Corporation A that has yet to be liquidated and thus create a taxable event of which gain or loss would be realized and/or recognized.

There are multiple types of tax free organizations under the Internal Revenue Code.  If your corporation has been targeted by another corporation for a tax free reorganization or is considering some form of reorganization, please feel free to contact a Denver tax attorney or Denver business attorney at The McGuire Law Firm to analyze your circumstances, options and the applicable federal tax consequences.

John McGuire from The McGuire Law Firm prepared this article.  John is a business attorney and tax attorney working with individuals and businesses regarding their taxation issues and business matters.

You can reach a Denver tax attorney or business attorney at The McGuire Law Firm by calling 720-833-7705 or email John@jmtaxlaw.com