- - - - - - - - Chapter 4 - - - - - - - -

1. - - - - - - - - Chapter 4- - - - - - - - Tax Planning Options ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 1

2. Taxable vs. Nontaxable or Tax-Deferred Acquisitions • Basic rules • Nontaxable transaction — merger or tender offer involves stock-for-stock transaction • Taxable transaction — transaction involves cash or debt ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 2

3. "Acquisition tax-free reorganizations" Section 368 of Internal Revenue Code • Type A • Statutory merger — target firm shareholders exchange their target stock for shares in the acquiring company • Consolidation — shareholders of both firms receive stock of new company ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 3

4. Three-party forward triangular merger • Parent creates shell subsidiary • Shell issues stock, all of which is bought by parent with cash or own stock • Target is bought with cash or parent stock held by subsidiary • Target merged into subsidiary in a statutory merger • Parent avoids incurring liability for debt of target ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 4

5. Type B • Stock-for-stock exchanges • Target may be liquidated into acquiring firm or maintained as an independent entity • Reverse triangular three-party merger • Acquirer forms a shell subsidiary funded by parent stock • Subsidiary is merged into target • Parent stock held by subsidiary is distributed to target’s shareholders in exchange for their target stock • End result: parent owns the stock of the merged subsidiary - target ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 5

6. Type C • Stock-for-asset transaction; at least 80% of the fair market value of target's property must be acquired • Typical transaction • Target firm sells assets in exchange for acquiring firm’s voting stock • Target firm dissolves • Target distributes acquiring firm stock in exchange for old canceled target stock ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 6

7. Main implications • Nontaxable reorganization • Acquiring firm • Net Operating Loss (NOL) carryover • Tax-credit carryover • No write-up or step-up of depreciable assets • Target firm • Deferred taxable gains for shareholders ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 7

8. Taxable acquisitions • Acquiring firm • Stepped-up asset basis • Loss of NOLs and tax credits • Target firm • Immediate gain recognition by target shareholders • Recapture of tax credits and excess depreciation ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 8

9. Tax Reform Act of 1986 — less favorable to M&A activity • Limits on Net Operating Loss (NOL) carryovers • Master limited partnerships and S corporations avoid double taxation • Minimum 20% tax on corporate profits ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 9

10. General Utilities doctrine • General Utilities provision on tax-free asset liquidation repealed • Exemption only for small and closely held corporations • Greenmail — limit extent to which greenmail payments could be tax deductible ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 10

11. Stock vs. Asset Purchase • Acquisitions by stock purchases • Avoid double taxation • Higher net proceeds to seller stockholders ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 11

12. Acquisitions by asset purchases • Lower net proceeds because of double taxation • Buyer may prefer acquisitions of assets • Avoid unknown liabilities of seller • In purchase accounting, buyer is able to step-up tax basis of assets acquired • Closely held small corporations should be formed as limited liability corporations or S corporations ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 12

13. Do Tax Gains Cause Acquisitions? • Increased leverage — firm can leverage itself without acquisition • Net operating loss carryforwards (NOLs) — could be utilized by issuing equity and buying taxable debt • Basis increase on acquired assets — could achieve by selling assets and then buying them back ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 13

14. Empirical studies • Tax factors significant in less than 10% of merger transactions • Tax effects are not the main motivation for merger transactions ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 14

15. Roles of taxes in going private transactions (LBOs and MBOs) • Initial financial structures as high as 90% debt • Tax savings are not the dominant factor • Debt paid down as rapidly as possible • Main objective is to achieve value increases in order to take company public within 3-5 years • Proceeds from public offerings used to pay down debt ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 15

16. Increased taxes from LBOs • Capital gains taxes on realized capital gains to shareholders • Taxable capital gains from asset sales • Taxable interest income from debt payments • Increase taxable operating income • Efficient capital use generates additional taxable revenues in the economy • Lost taxes from LBOs • Increased tax deductions from the additional debt • Lower personal tax revenue because LBOs pay little or no dividends ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 16

17. On average, LBOs generated tax increases that were almost 200% of the tax losses they created • RJR-Nabisco tax payments were more than eight times pre-LBO taxes ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 17