The following article is adapted and reprinted from the M&A Tax Report, Vol. 10, No. 1, August 2001, Panel Publishers, New York, NY.


By Robert W. Wood

In a sense, the flip side of step transaction concerns arises where a series of acquisitions occur that need to be integrated in order for the control requirements of Section 368 to be met. Recently, the IRS issued guidance that will help taxpayers affecting tender offers to achieve tax-free treatment.

The Service ruled in Revenue Ruling 2001-26 that the control-for- voting-stock requirement for a reverse triangular merger will be satisfied when the parent of the merger sub receives 51 percent of the target stock in a tender offer, and the subsidiary then merges into the target, with remaining target shareholders receiving cash and parent stock for their target shares. The Service also determined that Section 354 or 356 applies to each exchanging shareholder, and that the transaction qualifies as a tax-free reorganization.

Two Cases

Two situations are considered in the ruling. In the first, a parent corporation tenders for a target's voting stock and acquires 51 percent of the target's stock for the parent's voting stock. Both the acquiring parent and the target are manufacturing companies. The parent then forms a subsidiary which merges into the target under state law.

In the merger, parent's subsidiary stock is converted to target stock, and the target's other shareholders exchange the remaining 49 percent of the target voting stock for the parent's voting stock and cash. The tender offer and the statutory merger are treated as an integrated acquisition by the parent of all of the target's stock.

In the second scenario, the facts are the same as in the first situation. However, here the subsidiary initiates the tender offer for the target stock, and in the offer, the subsidiary acquires 51 percent of the target's stock for parent stock (provided to the subsidiary by its parent).

Integrated Transaction

The Service determined that in both situations, the control-for- voting-stock requirement would be satisfied. In each case, the target shareholders exchange more than 80 percent of the target's voting stock for the parent's voting stock.

The ruling relies upon Section 368(a)(1)(A) and Section 368(a)(2)(E). The latter provides that a transaction otherwise qualifying under Section 368(a)(1)(A) will not be disqualified by reason of the fact that stock of a corporation that before the merger was in control of the merged corporation is used in the transaction, if (1) after the transaction, the corporation surviving the merger holds substantially all of its properties and of the properties of the merged corporation (other than stock of the controlling corporation distributed in the transaction), and (2) in the transaction, former shareholders of the surviving corporation exchanged, for an amount of voting stock of the controlling corporation, an amount of stock in the surviving corporation that constitutes control of such corporation (the "control-for-voting-stock requirement"). Control is defined in Section 368(c).

A well-known case in this field, one mentioned in the ruling, is King Enterprises, Inc. v. United States, 418 F.2d 511 (Ct. Cl. 1969). In that case, as part of an integrated plan, a corporation acquired all of the stock of a target corporation from the target corporation's shareholders for consideration, in excess of 50 percent of which was the acquiring corporation stock. It subsequently merged the target corporation into the acquiring corporation. Because the merger was the intended result of the stock acquisition, the court held that the acquiring corporation's acquisition of the target qualified as a reorganization under Section 368(a)(1)(A).

What's a Plan?

It is important to define the concept of a plan of reorganization. As used in Section 1.368-1(c) of the Regulations, a plan of reorganization must contemplate the bona fide execution of one of the transactions specifically described as a reorganization in Section 368(a), and the bona fide consummation of each of the requisite acts under which nonrecognition of gain is claimed.

Under general principles of tax law, including the step transaction doctrine, the tender offer and the statutory merger in both of the situations described in the ruling are treated as an integrated acquisition by the parent of all of the target stock. The principles of King Enterprises support this conclusion. The tender offer exchange is treated as part of the statutory merger for purposes of the reorganization provisions. Compare J.E. Seagram Corp. v. Commissioner, 104 T.C. 75 (1995) (treating a tender offer that was an integrated step in a plan that included a forward triangular merger as part of the merger transaction).

Consequently, the integrated steps must be examined together to determine whether the requirements of Section 368(a)(2)(E) are satisfied. In both situations, the shareholders of the target exchange for parent voting stock an amount of target stock constituting in excess of 80 percent of the voting stock of the target. The control-for-voting-stock requirement was therefore satisfied.

Tender Offer and Merger Equals Control for Voting Stock, Vol. 10, No. 1, The M&A Tax Report (August 2001), p. 1.