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International Tax Free Reorganizations

Feb 10, 2008
In the world of international business, corporations that operate in different countries sometimes pursue reorganizations. They may do this to streamline operations to maintain a competitive advantage. They may also do it to change their corporate 'persona' with a new management and operating structure. When a multinational corporation reorganizes, it takes into consideration the tax implications.

What is an international tax-free reorganization?

It's a transaction whereby one corporation acquires the stock or assets of another corporation. They may acquire part, or all, of the stock or assets of the target company. These two companies are 'commonly controlled companies'. This 'common control' occurs when two or more businesses have the same entity controlling them.

In reorganizations, one company is the target. The target liquidates into the common parent after the reorganization. If the parties to the reorganization meet U.S. Internal Revenue Code (IRC) stipulations then the transaction is not taxable.

When one corporation acquires the assets of another corporation it must give 'consideration'. In the tax-free reorganization, this involves transactions between commonly controlled corporations as previously stated. The acquiring company must give some of its stock as part of the 'consideration'. The targeted company must distribute this consideration to its shareholders when it liquidates completely.

The name for the above transaction is an Acquisitive or Non-Divisive D Reorganization. The target company is obligated to transfer all or 'substantially all' of its assets to the acquiring company. The distribution element of the transaction ('consideration' to the targeted company's shareholders) must meet IRC 354 regulations.

In an international tax-free reorganization, the acquiring company receives the target's operating assets. However, there are qualifying requirements to receive the designation as a Non-Divisive D Reorganization according to the IRC.

The basic qualifying requirements are:

1. The target company transfers most or all of its assets to the acquiring company. The acquiring company receives at least 90% of the Fair Market Value (FMV) of net assets of the target company. The 'net value' of assets is Total Assets minus Total Liabilities of the company. Another measurement is that the acquiring company receives 70% of the FMV of gross assets. These are assets without any of the company's liabilities taken into consideration.

2. The company targeted in the reorganization, distributes the stock or securities received from the acquirer as consideration. With a 'plan of reorganization', the targeted company gives to its shareholders the stocks, securities and other properties received. It also distributes to its shareholders any of its remaining properties to complete the liquidation process.

There may be other property, other than that allowed by IRC stipulations that the target receives. The target company has to record a 'gain' according to the FMV of this property. This gain is taxable.

3. The target company shareholders must retain substantial continuing proprietary interest in the business that transferred to the acquiring company. At least 50% of the consideration paid to the target company shareholders must be the acquiring company's stock.

4. The acquiring company must continue operating a major portion of the target company's historic business. At the very least, it must use a significant portion of the target company's historic assets in the operation of the business.

5. There must be a business purpose for the reorganization. It cannot be tax-motivated or conducted to avoid or evade taxation.

6. There must be a 'plan of reorganization', preferably written. The transfer of assets must occur according to this plan. The plan must consider the requirements necessary for the reorganization to qualify as a 'non-recognition of gain' or tax-free transaction. If 100% of the plan is not in writing, there must be evidence of the companies' discussions and negotiations.

Some of the general tax consequences of an international tax-free reorganization are:

* The acquiring company recognizes no gain or loss if it receives money or any other property from the target company. This is as long as it transfers stock, as consideration, to the targeted company.

* The target company shareholders who exchange their stock for acquiring company's stock recognize no gain or loss. However, they may receive property or money that doesn't qualify under a Non-Divisive D transaction.

* The targeted company does not record a gain or loss when they are part of a tax-free reorganization. If they exchange property solely for stock or securities, they don't pay tax. Of course, they have to follow the 'plan of reorganization' with all its adherents to the IRC stipulations.

If the target receives something other than stock or securities, they still record no gain or loss. This is only if they distribute this 'other' to their shareholders according to the plan of reorganization.

Again, this other property must meet IRC definitions to qualify for a Non-Divisive D transaction. If it doesn't, there may be tax implications.

There are many elements for a multinational corporation to consider when reorganizing. In today's regulated business environment, financial acumen, and wise planning will ensure a smooth reorganization process.
About the Author
Mr. Stransky is a partner in the Boston law firm of Sullivan & Worcester LLP. He specializes in international tax planning for U.S. companies with foreign investments. Mr. Stransky can be reached at dstransky@sandw.com or you can find further information at Sullivan & Worcester
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