With or without You: Debt and Equity and Continuity of Interest

By Conway, Meredith R. | Stanford Journal of Law, Business & Finance, Spring 2010 | Go to article overview
Save to active project

With or without You: Debt and Equity and Continuity of Interest


Conway, Meredith R., Stanford Journal of Law, Business & Finance


Abstract

Continuity of interest is a judicially created doctrine designed to ensure that when holders of corporate interests in tax-free reorganizations exchange those interests merely on paper, the exchange is tax-free. The doctrine was intended to ensure that a holder who "continued" his interest in a corporation would not be taxed. Unfortunately, the continuity of interest doctrine throughout the years became distorted as a result of misinterpretations of both legislative history and judicial decisions.

The doctrine was intended to provide that as long as an exchange is purely on paper and takes place in a tax-free reorganization, the exchange will be tax-free. Instead, it has become a mechanical hurdle where a certain percentage of shareholder participation in an exchange (ranging from 40% to 80%) meets the continuity of interest doctrine. The doctrine itself does little to ensure a continuing interest because shareholders are free to sell their interest immediately after the exchange. Furthermore, the doctrine has been interpreted from judicial decisions to apply only to stock and equity and not to debt. Therefore, even when a reorganization meets the tax-free reorganization provisions, if a debt holder exchanges his interest for a similar debt instrument in the new corporation, he is not included within the continuity of interest doctrine.

The doctrine must be revisited and revised. The types of instruments that can be exchanged on a tax-free basis should be narrowed and limited to only instruments that are economically equivalent, excluding exchanges that are not economically equivalent but result in the ownership of instruments labeled as stock. First, the quantitative measure, an ineffective mechanical hurdle that can be used by stockholders to deliberately avoid the tax-free reorganization provisions, should be removed. The current level of required participation is simply too low to be meaningful. In addition, the participation of other shareholders bears little on whether a particular holder intends to continue and maintain his interest in the corporation (the behavior Congress wanted to encourage). This will allow more reorganizations to qualify for tax-free treatment, particularly Type A reorganizations, but because the other reorganization requirements must still be met, it will only serve to defer taxes, not eliminate them. This will also result in putting significantly more pressure on the continuity of business enterprise requirement.

Second, the qualitative measure of continuity of interest that determines what counts as an interest in the corporation must be revisited. Specifically, the issue of how the continuity of interest doctrine applies to debt must be revisited. The distinction between debt and equity has become an arbitrary assessment. A label is attached to an instrument created by a tax attorney or investment banker often because of desired tax attributes. However, the label often bears little resemblance to whether the instrument is debt or equity. In reality, making such a determination is often impossible because the corporate instruments created today often carry attributes of both debt and equity. Therefore, the emphasis on equity and stock in the continuity of interest doctrine should be removed.

Ultimately the continuity of interest requirement should be evaluated on a holder-by-holder basis, and an exchange should meet the continuity of interest requirement as long as the interests received are economically equivalent to, and mirror, the interests given up. Furthermore, any reorganization would still have to meet all the other requirements under state and federal law for tax-free reorganizations. Any interest holder, irrespective of the label attached to the instrument, should be afforded tax-free treatment provided that the instrument received is economically equivalent to the instrument given up in the exchange.

Introduction

"[T]he reorganization definition is an unduly complicated amalgam of varied and often conflicting statutory and extra statutory requirements.

The rest of this article is only available to active members of Questia

Sign up now for a free, 1-day trial and receive full access to:

  • Questia's entire collection
  • Automatic bibliography creation
  • More helpful research tools like notes, citations, and highlights
  • Ad-free environment

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
Loading One moment ...
Project items
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

Cited article

With or without You: Debt and Equity and Continuity of Interest
Settings

Settings

Typeface
Text size Smaller Larger
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

While we understand printed pages are helpful to our users, this limitation is necessary to help protect our publishers' copyrighted material and prevent its unlawful distribution. We are sorry for any inconvenience.
Full screen

matching results for page

Cited passage

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

Cited passage

Welcome to the new Questia Reader

The Questia Reader has been updated to provide you with an even better online reading experience.  It is now 100% Responsive, which means you can read our books and articles on any sized device you wish.  All of your favorite tools like notes, highlights, and citations are still here, but the way you select text has been updated to be easier to use, especially on touchscreen devices.  Here's how:

1. Click or tap the first word you want to select.
2. Click or tap the last word you want to select.

OK, got it!

Thanks for trying Questia!

Please continue trying out our research tools, but please note, full functionality is available only to our active members.

Your work will be lost once you leave this Web page.

For full access in an ad-free environment, sign up now for a FREE, 1-day trial.

Already a member? Log in now.

Are you sure you want to delete this highlight?