Academic journal article Northwestern University Law Review

Tax-Free Reorganizations: The Evolution and Revolution of Triangular Mergers

Academic journal article Northwestern University Law Review

Tax-Free Reorganizations: The Evolution and Revolution of Triangular Mergers

Article excerpt

ABSTRACT-Tax laws applicable to triangular mergers lack neutrality, are complex, and overlap substantially with other tax-preferred forms of corporate acquisition. Their current status is a result of both path dependency and Congress's attempt to create consistency within a framework founded upon inconsistent conceptualizations of the corporation. This Article highlights problems arising under current rules, including a notable lack of tax neutrality among merger forms. It proposes pragmatic revisions made within the constraint of double taxation of corporate profits and then revisits the question through a more normative framework. The Article concludes that the tax treatment of target shareholders and the target corporation in corporate acquisitions should be disaggregated. Finally, it observes that both pragmatic and normative solutions proposed within the reorganization statute are unsatisfying in light of larger structural problems in the Internal Revenue Code.

INTRODUCTION

Federal tax law unduly limits nonrecognition treatment of triangular mergers, the most important acquisition form used in the United States.1 The law is internally inconsistent and difficult to understand. The poor state of the rules has real costs to parties involved in corporate acquisitions, who must sacrifice business gains to account for federal tax constraints. This Article explains the genesis of the problem over the one-hundred-year history of our income tax as a byproduct of reciprocal state-federal responsiveness to changes in law and business climate, and offers corrections based on pragmatic and normative views of corporate acquisitions.2 It argues that difficulties in the taxation of triangular mergers are a microcosm of larger structural problems in corporate tax law- namely, difficulties created by conflicting conceptualizations of corporate personhood and Congress's inability to nimbly respond to changes in business.

Subchapter C of the Internal Revenue Code focuses heavily on the form of corporate transactions rather than on their substance, thus enabling businesses to lodge novel substance within existing forms. This occurs when federal law gives high regard to state law characterizations of business forms, their governance, and their life cycle, or when it leaves terms integral to the operation of the Internal Revenue Code-such as "merger"-open for interpretation by the states. Additionally, ossified features of federal tax law, like the dichotomy between taxation of partnerships and corporations, leave gaps in the statutory structure that create opportunities for state innovation.3 Since Congress cannot respond to such changes nimbly, the Treasury and the IRS are left to employ guidance, regulatory and otherwise, in unanticipated ways.4 Over time, and particularly in the area of corporate acquisitions, events such as these have filled federal tax law with complexity and hidden meaning.

Triangular merger provisions perfectly encapsulate the problem. Section 368 of the Internal Revenue Code is the quintessential form-driven tax statute, but Congress cannot predict every new form. Triangular mergers were not included in § 368. Yet, the transaction's many state law benefits, such as the isolation of debt and the preservation of target attributes like state licensures and contracts in place, made it both useful and popular, putting pressure on the existing statute.5 The IRS's initial refusal to grant nonrecognition to triangular forms, combined with relevant Supreme Court precedent, eventually led to additional complexity in the law.6 As the Treasury and the IRS, through rulings and regulations, responded to taxpayers' attempts to circumvent the prohibition, the law became a thicket.7 At the same time, triangular acquisitions became an increasingly large part of acquisition practice. Because it acted ex post rather than ex ante to address the evolution of corporate practice, Congress's new legislation was path dependent. …

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