Mergers, Acquisitions, & Divestitures

1. Mergers, Acquisitions, & Divestitures • Reasons • Types • Tax Issues • Non-Tax Issues • Methods • Tax Deductibility of Goodwill

2. Reasons for Mergers/Acquisitions • 1) To improve economic efficiency • 2) To extend the power base of management • 3) To effect transfers of wealth between classes of stakeholders

3. Reasons for Divestitures • 1) To focus on core competencies • 2) To free managers of the divested business to focus on the divested firm • 3) To solve market mispricing • 4) To gain greater access to capital markets

4. Types of Mergers/Acquisitions • Freestanding companies can acquire: • 1) Other freestanding companies • 2) Subsidiaries of other companies • Acquisitions can be structured to be: • 1) Taxable (when the acquirer uses cash) • 2) Tax-free (when the acquirer uses mostly stock)

5. Types of Divestitures • Tax-Free Spin-off: Involves the division of the parent corporation into two or more distinct corporations. • Equity Carve-out: Involves the sale of a portion of a subsidiary’s equity for cash.

6. Major Tax Issues • 1) Shareholder tax liabilities • 2) Effect on tax attributes • 3) Corporate-level tax effect of the merger, acquisition, or divestiture • 4) Change in the tax basis of the assets of the target or divested subsidiary • 5) Effect of leverage on mergers and acquisitions

7. Shareholder Tax Liabilities--Mergers/Acquisitions • If taxable: Purchase price - Basis in stock = Gain recognized by target shareholders • Requirement for a tax-free acquisition: • Target shareholders must maintain a continuity of interest--50% of total consideration paid is acquiring-firm stock • Note: “Tax-free” transactions can result in a taxable gain for target shareholders to the extent they receive cash!

8. Shareholder Tax Liabilities--Divestitures • Spin-off: No taxable gain or loss recognized by the divesting corporation’s shareholders • Equity Carve-out: No taxable gain or loss recognized by shareholders • Sale of Division or Subsidiary for Cash: No taxable gain or loss recognized by the divesting corporation’s shareholders unless proceeds are distributed to them by the divesting corporation

9. Effect on Tax Attributes

10. Corporate-Level Tax Effect--Mergers/Acquisitions • If acquisition is accomplished through the purchase of assets in a taxable transaction, a taxable gain or loss is recognized by the target corporation • If acquisition is accomplished through the purchase of stock in either a taxable or tax-free transaction, no gain or loss is recognized at the corporation level

11. Corporate-Level Tax Effect--Divestitures • Subsidiary Sale: Purchase price of stock or assets - Seller’s basis in stock or assets = Taxable gain (loss) recognized by seller • Equity Carve-out: Generally does not result in a taxable gain or loss for the divesting corporation • Spin-off: Since a spin-off is usually tax-free, no taxable gain is recognized under typical circumstances

12. Change in Tax Basis of Assets of the Target or Divested Subsidiary • A step-up in the tax basis of assets of an acquired business to the purchase price creates increased future depreciation deductions, which provide valuable tax savings. • This is common in subsidiary sales, but acquisitions of freestanding C corporations are limited in this practice by the Tax Reform Act of 1986.

13. Non-Tax Issues in Mergers, Acquisitions, and Divestitures • Financial Reporting Costs • Purchase Accounting • Pooling of Interests Accounting* • Transaction Costs • Contingent or Unrecorded Liabilities • Managerial and/or Control Issues • * FASB eliminated this method after 2001

14. Five Basic Methods to Acquire a Freestanding C Corporation • A’s taxable purchase of C’s (for C Corp) assets • A’s taxable purchase of C’s stock followed by an I.R.C. § 338 election • A’s taxable purchase of C’s stock notfollowed by an I.R.C. § 338 election • A’s acquisition of C’s stock in a tax-free exchange • A’s acquisition of C’s assets in a tax-free exchange

15. Four Methods to Divest a Subsidiary or Line of Business • Subsidiary Stock Sale • Subsidiary Asset Sale • Spin-off • Equity Carve-out

16. Tax Deductibility of Goodwill Under I.R.C. § 197 • I.R.C. § 197 makes goodwill tax-deductible. • However, goodwill is only tax-deductible when the tax basis of the acquired firm’s assets is stepped up. • This occurs frequently in subsidiary sales and in acquisitions of conduits but not in acquisitions of freestanding C corporations.

17. Structures Employed in Acquisitionsof Freestanding C Corpsand Tax Implications

18. Divestiture Methods and Tax Implications