Mergers, Acquisitions,

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Mergers, Acquisitions, Divestitures

• Reasons
• Types
• Tax Issues
• Non-Tax Issues
• Methods
• Tax Deductibility of Goodwill

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Reasons for Mergers/Acquisitions

• 1) To improve economic efficiency
• 2) To extend the power base of
  
  
  
  management
• 3) To effect transfers of wealth between
  classes of stakeholders

3
Reasons for Divestitures

• 1) To focus on core competencies
• 2) To free managers of the divested business
  to focus on the divested firm
• 3) To solve market mispricing
• 4) To gain greater access to capital markets

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Types of Mergers/Acquisitions

• Freestanding companies can acquire
• 1) Other freestanding companies
• 2) Subsidiaries of other companies
• Acquisitions can be structured to be
• 1) Taxable (when the acquirer uses cash)
• 2) Tax-free (when the acquirer uses mostly
  stock)

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Types of Divestitures

• Tax-Free Spin-off Involves the division of the
  parent corporation into two or more distinct
  corporations.
• Equity Carve-out Involves the sale of a portion
  of a subsidiarys equity for cash.

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Major Tax Issues

• 1) Shareholder tax liabilities
• 2) Effect on tax attributes
• 3) Corporate-level tax effect of the merger,
  acquisition, or divestiture
• 4) Change in the tax basis of the assets of the
  target or divested subsidiary
• 5) Effect of leverage on mergers and
  acquisitions

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Shareholder Tax Liabilities--Mergers/Acquisitions

• If taxable Purchase price - Basis
  in stock Gain recognized by target
  shareholders
• Requirement for a tax-free acquisition
• Target shareholders must maintain a continuity of
  interest--50 of total consideration paid is
  acquiring-firm stock
• Note Tax-free transactions can result in a
  taxable gain for target shareholders to the
  extent they receive cash!

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Shareholder Tax Liabilities--Divestitures

• Spin-off No taxable gain or loss recognized by
  the divesting corporations shareholders
• Equity Carve-out No taxable gain or loss
  recognized by shareholders
• Sale of Division or Subsidiary for Cash No
  taxable gain or loss recognized by the divesting
  corporations shareholders unless proceeds are
  distributed to them by the divesting corporation

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Effect on Tax Attributes
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Corporate-Level Tax Effect--Mergers/Acquisitions

• If acquisition is accomplished through the
  purchase of assets in a taxable transaction, a
  taxable gain or loss is recognized by the target
  corporation
• If acquisition is accomplished through the
  purchase of stock in either a taxable or tax-free
  transaction, no gain or loss is recognized at the
  corporation level

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Corporate-Level Tax Effect--Divestitures

• Subsidiary Sale Purchase price of
  stock or assets - Sellers basis in stock
  or assets Taxable gain (loss) recognized
  by seller
• Equity Carve-out Generally does not result in a
  taxable gain or loss for the divesting
  corporation
• Spin-off Since a spin-off is usually tax-free,
  no taxable gain is recognized under typical
  circumstances

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Change in Tax Basis of Assets of the Target or
Divested Subsidiary

• A step-up in the tax basis of assets of an
  acquired business to the purchase price creates
  increased future depreciation deductions, which
  provide valuable tax savings.
• This is common in subsidiary sales, but
  acquisitions of freestanding C corporations are
  limited in this practice by the Tax Reform Act of
  1986.

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Non-Tax Issues in Mergers, Acquisitions, and
Divestitures

• Financial Reporting Costs
• Purchase Accounting
• Pooling of Interests Accounting
• Transaction Costs
• Contingent or Unrecorded Liabilities
• Managerial and/or Control Issues
• FASB eliminated this method after 2001

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Five Basic Methods to Acquire a Freestanding C
Corporation

• As taxable purchase of Cs (for C Corp) assets
• As taxable purchase of Cs stock followed by an
  I.R.C. 338 election
• As taxable purchase of Cs stock not followed by
  an I.R.C. 338 election
• As acquisition of Cs stock in a tax-free
  exchange
• As acquisition of Cs assets in a tax-free
  exchange

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Four Methods to Divest a Subsidiary or Line of
Business

• Subsidiary Stock Sale
• Subsidiary Asset Sale
• Spin-off
• Equity Carve-out

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Tax Deductibility of Goodwill Under I.R.C. 197

• I.R.C. 197 makes goodwill tax-deductible.
• However, goodwill is only tax-deductible when the
  tax basis of the acquired firms assets is
  stepped up.
• This occurs frequently in subsidiary sales and in
  acquisitions of conduits but not in acquisitions
  of freestanding C corporations.

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Structures Employed in Acquisitionsof
Freestanding C Corpsand Tax Implications
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Divestiture Methods and Tax Implications