Common Use for a Forward Triangular Merger

One standard method used is a forward triangular merger, or as some people refer to it, an indirect merger under Section 368(a)(2)(D) of the Internal Revenue Code. This type of merger is beneficial when a parent corporation is looking to purchase or acquire another entity, known as the target corporation, but is hesitant to inherit any liabilities or other negative aspects of the target. 

In a traditional A reorganization under Section 368(a)(1)(A), the target corporation merges directly with the acquirer. At this point, the acquirer is responsible for all liabilities associated with the target. Therefore, the purchasing corporation may often structure the transaction as a forward triangular merger rather than a traditional A merger by using a subsidiary to protect against any known or unknown liabilities the target may have. A Denver business attorney has prepared the article below to provide additional information on a forward triangular reorganization.

Where Forward Triangular Mergers are Prevalent

Forward triangular mergers are also prevalent where entities plan to use a significant amount of cash, or boot, in the deal.

Unlike reverse triangular mergers, forward triangular mergers have greater flexibility in the amount of boot that may be used in the transaction since the 80% voting requirement does not apply under Section 368(a)(2)(D) for purposes of consideration.

For example, consider Corporation P, which would like to acquire Corporation T. However, Corporation T has a massive liability on its books that Corporation P is hesitant to accept. Corporation P will first set up another entity called a subsidiary. The Corporation T is the target corporation and will then merge into a subsidiary, rather than Corporation P, for consideration provided by Corporation P. The target corporation ceases to exist and thereby liquidates. At this point, the only surviving corporation in the merger is the subsidiary. Thus, the shareholders of Corporation T will ultimately receive the consideration provided by Corporation P. This structuring allows the target’s liabilities to remain isolated within a subsidiary while simultaneously allowing the purchasing corporation to acquire the target, Corporation T. 

Note that even though this may be considered a tax-free reorganization, there may still be tax consequences to the target corporation’s shareholders upon liquidation, depending on the amount and type of consideration used in the transaction (See Internal Revenue Code Section 354).

Three Critical Things to Remember in a Forward Triangular Reorganization

 First, this transaction only qualifies for tax-free treatment if it would have satisfied the requirements of a traditional A reorganization under Section 368(a)(1)(A) had the merger been done directly between the purchasing corporation and the target corporation. This requires evaluating the transaction as if the subsidiary were not used. If the target merged into the purchasing corporation and still satisfied the A reorg requirements, then this would help Section 368(a)(2)(D)(ii). This requires a statutory merger and, even more importantly, continuity of interest requirements.

Second, in Section 368(a)(2)(D) reorganization, no stock of the wholly-owned subsidiary entity may be used as part of the consideration in the transaction. The only stock acquisition of the purchasing corporation, Corporation P in the above example, may be used. However, other reviews from the subsidiary may be provided, such as cash. Suppose the stock of the wholly-owned subsidiary corporation is used. In that case, it will fail the requirements of Section 368(a)(2)(D) and may result in a taxable transaction unless it satisfies another reorganization structure under Section 368.

Finally, according to the treasury regulations under 1.368-2, the purchasing corporation must substantially acquire all of the target’s assets by using the subsidiary.

Forward triangular reorganizations optimize restructuring without facing tax consequences while removing the transfer of a target’s liabilities to a parent corporation. Depending on the type and value of consideration available, a forward triangular reorganization may be the best restructuring tool for your merger.

Key Takeaways

• A forward triangular merger is a form of reorganization that provides a means to avoid the potential tax consequences of acquiring a company with substantial liabilities. It accomplishes this by merging the target with a subsidiary of the acquiring corporation. The target corporation ceases to exist and is liquidated. The sole remaining corporation is the subsidiary.
• The IRS considers a forward triangular merger to be a reorganization because it satisfies the definition of a reorganization found in Section 368(a).
• However, the IRS does not allow a forward triangular merger to qualify as a tax-free reorganizational event unless the following conditions are met:
  • The acquiring company must pay fair market value for the target company’s assets.
  • The target company continues to operate after the acquisition.
  • The acquired company ceases to exist and is liquidated.

You can contact The McGuire Law Firm to discuss your business or tax-related issues with a Denver business attorney or tax attorney.