The term reorganization denotes any type of corporate restructuring, including company mergers, business acquisitions and corporate takeovers. Reorganizations often focus on reengineering and rejuvenation of financially distressed corporations.
The Internal Revenue Service (IRS) has its own set of rules and definitions for corporate reorganizations, to determine how far a particular reorganization is tax free M&A.
Certain reorganizations are tax free M&A, which permit the shareholders of the selling company to exchange their shares for the stock of the buying company without paying taxes. Under the tax law there are three basic types of M&A with varying tax implications.
In type ‘A’ reorganization, the buying company allots its voting or non voting stocks and also distributes cash consideration among the shareholders of the selling company. The shares of the selling company, which goes out of existence, are cancelled. Since at least 50% of such consideration to the shareholders of the selling company must be voting or equity stock of the buying company, cash component including debt or non equity security can be raised maximum up to 50%.
Those shareholders of the selling company, who receive non equity considerations including cash in exchange of their shares of the selling company, may be liable to capital gains tax. Capital gains tax is attracted where such consideration for the shares of the selling company cancelled exceeds the cost of acquisition of the same, in the hands of the shareholders of the selling company.
In type ‘B’ reorganization, the buying company mostly allots its voting or equity stocks among the shareholders of the selling company. The shares of the selling company, which go into liquidation, are also cancelled. Since at most 20% of such consideration to the shareholders of the selling company may be in cash including debt instruments or non equity security of the buying company, at least 80% of the same must be voting or equity stock in the buying company.
There is no tax on the allotment of such voting or equity stock of the buying company among the shareholders of the selling company. These are non taxable exchanges in the first instance. However, such recipients are liable to capital gains tax in the event of sale of those shares at a profit.
In a type “C” reorganization, the acquiring corporation purchases at least 80 percent of the target company’s assets at market value. In this type of reorganization, a tax liability results in the hands of the selling company when the acquiring corporation purchases its assets at a price higher than the cost, using consideration other than stock in the acquiring company.
