Chapter 7: Corporate Reorganizations Research Problem 1 Essays

____ 26. When a taxpayer transfers property subject to a mortgage to a controlled corporation in an exchange

Section 368(a)(1) of the tax code provides several options for corporate reorganizations. Section 368(a)(1)(d), also known as a “divisive D reorganization”, is the best choice for this particular situation. In a divisive “D” reorganization, the controlling corporation (in this case, BackBone) will distribute assets (the Willow office) to a newly formed subsidiary corporation, in exchange for the stock of the new subsidiary corporation, in a transaction that qualifies under section 355 (Sec. 368(a)(1)(d)). After the transaction is complete, the Willow office will be its own corporation which is wholly (or at least mostly) owned by BackBone. BackBone will also still own and control the Troy, Union and Vista offices after the reorganization.

The case of H.K. Porter Co., Inc. 87 T.C. 689 (1986) also had a subsidiary liquidate assets and the distribute failed to cover the preferred stock’s liquidation preference. On its 1978 and 1979 Federal income tax returns, petitioner claimed losses with respect to its Porter Australia stock. In his notice of deficiency, respondent disallowed said losses because "under I.R.C. Sec. 332, no gain or loss is recognized on the receipt of property distributed in complete liquidation of a subsidiary corporation." The court ruled in favor of H.K. Porter. “Finally, because we have held that section 332 does not bar the recognition of petitioner's losses, we hold that, based on the record, petitioner is entitled to an ordinary loss of $249,981 in 1978 with respect to the worthlessness of its common stock and a long-term capital loss of $1,957,770 in 1979 with respect to its preferred stock. See sec. 165(a) and (g).”

Section 351(c)(2) allows shareholders to dispose of all or part of the transfers stock without preventing the corporations Section 351 transaction from satisfying the “ control immediate after” requirement (4). Section 351(d) states that there are times when services, certain indebtedness, and accrued interest not treated as property as per James v. Commissioner, 53 T.C. 63 (1969); cf. Hospital Corporation of America v. Commissioner, 81 T.C. 520

c. A parent transfers its controlling interest in several partially owned subsidiaries to a new wholly owned subsidiary. That also is a change in legal organization but not in the reporting entity.

Off course, if we think about only these numbers it seemed that TKC is receiving more than it pays but this not exactly true since TKC paid for the bonds more than it is going to get after the 38 years (premium bond = coupon>YTM plus TKC’ initial investment of $21 million.

When the debt instrument and the option to acquire common stock are inseparable, as in the case of convertible bonds, the entire proceeds of the bond issue are allocated to the debt and the related premium or discount accounts.

o Cost of debt in this case is 12.5% though MCI can raise $ 100 million more with this option in comparison to option (a) above. Servicing this debt would be a significant drain on the cash flow. o Please see Exhibit 3. (c) $600 million Convertible offering @ 7.625% 20 year with conversion at 54 per share o Using this option MCI can raise $ 100 million more than option (b) at 4.88% lower rate of interest. It also gives MCI an option to convert it to equity once the stock price reaches 54 (it is currently 47). Based on previous convertible offerings (As per exhibit 6 of case, 1978, 1979, 1980, 1981 and 1982), MCI has been converting it to equity within 18 months because of its high growth. As higher growth is projected for the next few years (Exhibit 9 of case), MCI is expected to convert this $600 million offering to equity, thereby reducing its leverage. o This option allows to finance its current activities and match capital inflows with expected investment outlays in the near future. It also allows MCI the option to eliminate the cash flow drain from servicing the debt once the stock price increases. o As per Exhibit 3 attached here, this offering will provide capital to meet the external financing needs for 1983.

As for the combination of cash and new shares, shareholders can take part of their money

2. Evaluate the two offers in Exhibit 7. What explains the two structures? In each case, what is the value to MCI shareholders?

Under liquidation, the term sheet stipulates that the Series E investors is entitled to claim its initial investment of $10.75 million plus any accrued but unpaid dividend. Any proceeds after this claim will then be distributed to all common and Series E Preferred shareholders on an as-converted pro-rata basis. This double dipping means that RSC will not only recover its initial investment of $5 millions, but also enjoys the convertible benefits.

It demonstrated that deductions for capital expenditures are possible. In Chief Industries, Inc., TC Memo 2004-45, the tax court held that the settlement payment and the redemption payment should be considered as separate. In 1993, the tax payer, a corporation, and its board of directors voted a new CEO to replace the principle founder. The taxpayer and the founder reached an employment agreement that the founder could continue the title “chairman of the board of directors” without any managerial authority. Then, a litigation of controlling the taxpayer occurred between the board and the founder. To avoid unnecesary risks, time and expenses, the board pursed settlement negotiations. In 1996, the taxpayer, the new chairman and CEO agreed to purchase all of the founder’s stocks in the taxpayer for $37,223,114. Additionally, the taxpayer transferred a $3,082,710 settlement payment to the founder to relinquish his rights under the employment agreement. IRS argued, the settlement payments were used for purchasing stocks, which belong to capital assets. Furthermore, the settlement payments increased company’s value, because the payments were to prevent the founder re-controlling the taxpayer. According to Reg. 1.263(a)-1(b), expenditures that substantially increase values should not be deductible. However, the taxpayer argued that the payments were “to defend against attacks on business practices and partially in

Reorganization is the process of extending the life of a company that is facing liquidation by restructuring it in order to carry out activities which minimizes reoccurrence of past situations. Type A reorganization involves consolidation and merging and it gives greater flexibility since there is no restrictions of voting stock. Nontaxable status is not affected by removal of unnecessary assets. Additionally, this type of reorganization saves on time as approval from shareholders, which often brings complexity can be avoided. In a type B, assets and contracts which cannot be transferred are not lost, there is no substantially all requisite and liabilities of target’s corporation are isolated in a subsidiary.

An acquisition happens when a purchasing organization acquires over half possession in an objective organization. As a component of the trade, the procuring organization frequently buys the objective organization's stock and different resources, which permits the getting organization to settle on choices in regards to the recently gained resources without the endorsement of the objective organization's investors. Acquisitions can be paid for in real money, in the obtaining organization's stock or a combination of both.

Acquisition: In a simple acquisition, the acquiring firm will hold the majority of stake in the acquired company that does not change their name or any legal structure.