The first four sections of this article discuss the tax consequences of domestic and cross-border tax-free acquisitions and spinoffs. The balance of the article applies these rules to the types of intra-group transactions that multinational groups typically employ before and after acquisitions and dispositions.
TAX-FREE ACQUISITIONS UNDER SECTION 368
Acquisitive reorganizations include mergers, consolidations, acquisitions by one corporation of the stock or assets of another corporation, and changes in form or place of organization. As a general matter, reorganizations described in section 3681 have the following tax consequences: (i) the target corporation generally recognizes no gain or loss on any transfer of its property in exchange for stock or securities of another corporation that is "a party to the reorganization under section 361"; (ii) the target shareholders and creditors may exchange their stock and securities for such new stock and securities without recognizing gain or loss under section 354 (although holders would recognize gain, but not loss, equal to the lesser of the amount of "boot" received, and the holder's gain realized, in the reorganization); and (iii) if a target corporation's assets are acquired in a reorganization, its tax attributes carry over to the acquiring corporation under section 381.2
To qualify for tax-free treatment under section 368, all transactions other than 368(a)(1)(E) reorganizations ("E reorganization") and 368(a)(1)(F) reorganizations ("F reorganization")3 must satisfy the judicial requirements of a valid business purpose, continuity of interest ("COI"), continuity of business enterprise ("COBE") and a plan of reorganization, and also must satisfy the requisite statutory requirements, which differ for each specific form of reorganization.4 The Code also limits the consideration that may be used in certain types of reorganizations.5
The business purpose requirement is designed to ensure that the parties to the reorganization engage in the transaction for a legitimate business purpose, rather than to avoid tax.6 Either a corporate or shareholder business purpose will suffice for this purpose, and the business purpose requirement for a reorganization is much less rigorous than the corresponding requirement for a tax free spinoff.7 However, the IRS will seek to tax transactions that satisfy the technical requirements of a reorganization if the business purpose for the transaction is to avoid tax on what, in substance, amounts to a sale.8
The COI doctrine once required that target shareholders indirectly retain their interest in the target's assets by both receiving and retaining ownership of acquirer stock for some period of time after the transaction. Although IRS ruling guidelines have historically adopted a 50% threshold for such continuing target shareholder ownership of acquirer stock, practitioners generally advise that 40% continuity is adequate for purposes of section 3689 and the IRS now seems to have adopted 40% as the COI threshold as well.10 Other COI regulations, which are discussed in Section I.B. below, have significantly altered the contours of the COI requirement, including, in particular, largely eliminating the requirement that acquirer stock be retained.
The continuity of business enterprise doctrine, which historically required that the acquirer itself continue a significant business of the target, has also been expanded to permit attribution of the activities of certain group members, including partnerships, to an acquirer for purposes of satisfying the COBE requirement. The section 368 regulations also require a "plan of reorganization." It is advisable, although not strictly required,11 to prepare a written plan that includes a general description of the reorganization and the parties thereto, the specific transaction steps, the acquisition consideration and the business purpose for the transaction.12
Continuity of Business Enterprise and Continuity of Interest
All reorganizations other than E or F reorganizations must satisfy COBE and COI.13 Five sets of COBE and COI regulations issued in the past decade have dramatically altered the contours of the COI and COBE requirements for corporate reorganizations.14 The IRS ruling guidelines set forth in Revenue Procedures 77-37 and 86-42 for blessing tax-free reorganizations will have to be modified in several respects, including to conform the guidelines to the current COI and COBE regulations.15 The American Bar Association ("ABA") has submitted a helpful report suggesting changes to Revenue Procedures 77-37 and 86-42 to reflect subsequent amendments to reorganization law, including the enactment of...