Expansion of Merger and Consolidation Provisions
Schwartzman, Randy A., The CPA Journal
In IRC section 368(a)(1)(A), the term "reorganization" includes a "statutory merger or consolidation." No restrictions are placed on the type of consideration used, even permitting money to be exchanged, as long as the continuity-ofinterest requirement is satisfied. A taxfree merger is considered a type A reorganization, which is a combination of two companies for at least 40% stock consideration. The A reorganization is the most flexible of the reorganization techniques. There is no "substantially all" (of the assets) rule and no "solely for" (voting stock) rule in order to have a valid A reorganization. A statutory merger or consolidation had been limited since 1935 to transactions structured in conformity with the corporation laws of the United States (i.e., a state, a territory, or the District of Columbia). This restriction has been relaxed in recent years.
In January 2003, the 1RS issued regulations to expand the scope of the term statutory merger or consolidation to allow limited liability companies (LLC) to be party to an A reorganization. Consequently, the word "corporation" was removed from the regulatory definition of statutory merger or consolidation.
In January 2005, the 1RS issued proposed regulations to expand the meaning of a statutory merger or consolidation by eliminating the requirement that such transactions conform only to domestic laws. Because many foreign jurisdictions now have merger statutes that operate like those of the states, whereby all assets and liabilities move by operation of law, this change in the definition of an A reorganization allows such foreign transactions to qualify, for purposes of IRC section 368(a)(1)(A), as a statutory merger or consolidation if they satisfy the functional criteria applicable to transactions under domestic statutes.
Analysis of Merger Transactions
In the past, foreign mergers between unrelated parties needed to qualify as type C reorganizations if they did not meet the requirements for type A reorganizations. In a type C reorganization, a target company must transfer "substantially all" of its assets to the acquiring corporation solely for voting stock and, in some instances, a limited amount of new stock consideration.
The applicability of the "substantially all" and the "solely for" requirements adversely affected otherwise good foreign mergers. The new regulations contain an example that illustrates a transaction in which Corporation Z and Corporation Y, each incorporated under the laws of Country Q, combine in a transaction in conformity with Q's statutes in which all of the assets of Z become assets of Y and Z ceases its separate legal existence. Even though the merger participants are foreign entities, it qualifies under the new 1RS regulations as an A reorganization because the transaction is a statutory merger under Q's statutes, Z and Y are qualified participants, and the transaction is not divisive.
In addition, a legally valid merger of two domestic corporations can still be an A reorganization even if the merger was preceded by a sale by the acquired corporation of one of its two, equally sized, historical businesses. In this case, the net proceeds of such a sale could be distributed to the shareholders of the acquired corporation immediately before the merger. Although half of the assets were sold before the reorganization, this transaction qualifies as an A reorganization because it did not have to meet the "substantially all" requirement in a type C reorganization.
Before foreign entities fell under the A reorganization provisions, the transaction would have needed to qualify as a C reorganization (for unrelated parties, as discussed above) or a D reorganization (for related parties). In the example above, which involved a sale of half of the target's assets immediately before the transaction, if a subsidiary corporation was used, this combination could not have qualified as a C reorganization, a forward triangular merger [by reason of IRC section 368(a)(2)(D)], or a reverse triangular merger [by reason of section 368(a)(2)(E)J, because in each case the "substantially all" (of the assets) requirement would apply to the preliminary distribution. …