The following article is adapted and reprinted from the M&A Tax Report, Vol. 8, No. 9, April 2000, Panel Publishers, New York, NY.


By Robert W. Wood

It may come as a surprise to many tax practitioners (and frankly most businesspeople, too), that much can go wrong with the tax aspects of a statutory merger (a good old "A" reorganization). It has long been true that the easiest tax-free reorganization to accomplish was the statutory merger, complying with the normally rather simple procedures of applicable state law.

With the issuance of Revenue Ruling 2000-5, 2000-5 I.R.B. 1, however, the IRS has stated flatly that some mergers don't qualify as an "A" reorganization. This may not exactly send shockwaves through the community, but perhaps it ought to.

The question examined is whether a transaction can qualify as an "A" reorganization in which the following occurs:

(1) a target corporation merges under state law with and into the acquiring corporation, and the target corporation does not go out of existence; or

(2) a target corporation merges under state law with and into two or more acquiring corporations and the target corporation does go out of existence.

In the first situation the ruling examines, a target merges under state law into the acquiring corporation but the target does not go out of existence. The facts indicate that the target does transfer some of its assets and liabilities to the acquiring corporation, but retains the remainder, and remains in existence. The target shareholders receive stock in the acquiring company in exchange for a part of their target corporation stock, but they retain their remaining target corporation stock. This transaction qualifies, we are told, as a merger under state corporate law.

The problem, says the Service, is that this can be viewed as a divisive transaction. The Service quotes some extremely old case law and some legislative history suggesting that a merger occurs where one corporation acquires substantially all of the properties of another. Plus, says the Service in Revenue Ruling 2000-5, compliance with corporate merger statutes does not by itself mean that the transaction is a reorganization (even an "A" merger, says the IRS). The Service does point out that the judicial doctrines of business purpose, continuity of business enterprise and continuity of interest, must also be met.

In the second case described in the ruling and you can almost see the result coming now the Service considers a target corporation which transfers some of its assets and liabilities to each of two acquiring corporations. Here, though, the target corporation liquidates and the target's shareholders receive stock in each of the two acquiring corporations in exchange for their target corporation stock. Once again, we are told that the transaction qualifies as a merger under state law. Unlike the first situation, though, here the target corporation does go out of existence.

Again, the Service sees this situation as one in which the transaction may be viewed as divisive, although it seems to me this is a much harder case to make than the first situation. Referring to old legislative history and case law, the Service is concerned here that it is not one corporation that acquires substantially all of the assets and properties of the target, but two. A divisive transaction like this, says the Service, should be governed by Section 355, which the IRS asserts was intended by Congress to be the sole means under which divisive transactions could be afforded tax-free status.

The IRS concludes that the first transaction described in the ruling is divisive because, afterwards, the target corporation's assets and liabilities are held by both the target corporation and the acquiring corporation, and the target corporation's shareholders hold stock in both companies. The transaction described in the second situation in the ruling is also divisive, says the Service, because afterwards the target corporation's assets and liabilities are held by each of the two acquiring corporations. The target's shareholders, likewise, hold stock in each of the two acquiring corporations.

Who's On First?

It does seem a little troubling, however inconsequential this may seem, that the Service did not cite its own regulations which make it eminently clear that satisfying state law is all that is required for a statutory "A" merger. See Reg. §1.368-2(b)(1). Plus, the IRS cites no authority for its theory that in order to qualify as a merger, the target corporation must go out of existence. If state law does not so require, why should the IRS require it? And on what basis?

And, if one wants to go back to ancient history (which the Service at least tries to do in the ruling), one should know that the term "statutory" which was added to the predecessor of Section 368(a)(1)(A) in 1934. Congress then made the decision to incorporate state law into the Tax Code requirement in order to clarify what a "merger" was for federal income tax purposes. The Service may be belatedly trying to change what Congress did in 1934 something that one would assume Congress should do rather than the IRS.

Finally, it should also be noted that there does not appear to be any authority for the notion that Section 355 is the only avenue for a divisive transaction. True, Congress has amended statutes (for example, to eliminate non-liquidating "C" reorganizations), to curtail other divisive transactions. Here, the Service seems to be making the attempt to prevent "non-liquidating A" all by itself. Query whether it has the authority to do so?


Maybe most practitioners will not worry too much about Revenue Ruling 2000-5. After all, in the vast majority of transactions one of the constituent corporations in the merger does go out of existence. At the same time, since this requirement has not been imposed on us before, the Service may be overstepping its authority. If the Treasury is serious about the policies it is trying to advocate in Revenue Ruling 2000-5, it would be better served by proposing legislation to amend the statute.

Revenue Rulings Questions Statutory Mergers, Vol. 8, No. 9, M&A Tax Report (April 2000), p. 1.