In the world of international business, corporations operating in different countries sometimes seek reorganizations. They can do this to streamline operations and maintain a competitive advantage. They can also do it to change their corporate ‘personality’ with a new administrative and operational structure. When a multinational corporation reorganizes, it takes into consideration the tax implications.
What is a tax-free international reorganization?
It is a transaction by which a corporation acquires shares or assets of another corporation. They can acquire part or all of the shares 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 controlling entity.
In reorganizations, one company is the target. The target is settled on the common parent after the reorganization. If the parties to the reorganization comply with the provisions of the US Internal Revenue Code (IRC), the transaction is not taxable.
When a corporation acquires the assets of another corporation, it must give “consideration.” In tax-free reorganization, this involves transactions between commonly controlled corporations as noted above. The acquiring company must assign part of its shares as part of the “consideration”. The target company must distribute this consideration to its shareholders when it is fully liquidated.
The name of the above transaction is Reorganization D Acquisitive or Non-Divisive. The target company is required to transfer all or “substantially all” of its assets to the acquiring company. The distribution element of the transaction (‘consideration’ to the shareholders of the target company) must comply with IRC 354 regulations.
In a tax-free international reorganization, the acquiring company receives the target’s operating assets. However, there are qualification requirements to receive a Non-Divisive D Reorganization D designation under the IRC.
The basic qualification 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 the net assets of the target company. The ‘net worth’ of assets is the total assets minus the total liabilities of the company. Another measure is that the acquiring company receives 70% of the fair market value of the gross assets. These are assets without taking into account any of the company’s liabilities.
2. The company object of the reorganization, distributes the shares or securities received from the acquirer as consideration. With a ‘reorganization plan’, the target company hands over the shares, securities and other properties received to its shareholders. It also distributes any of its remaining properties to its shareholders to complete the liquidation process.
There may be another property, other than that allowed by IRC stipulations, that the target receives. The target company has to record a “profit” according to the fair market value of this property. This gain is taxable.
3. The shareholders of the target company must retain a substantial continuing equity interest in the business that was transferred to the acquiring company. At least 50% of the consideration paid to the shareholders of the target company must be shares of the acquiring company.
4. The acquiring company must continue to operate a significant part of the historical business of the target company. At a minimum, you should use a significant portion of the target company’s historical assets in operating the business.
5. There must be a business purpose for the reorganization. It cannot be tax-motivated or done to avoid or evade taxes.
6. There should be a ‘reorganization plan’, preferably written. The transfer of assets must occur in accordance with this plan. The plan must consider the requirements for the reorganization to qualify as a ‘non-recognition of earnings’ 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 a tax-free international reorganization are:
* The acquiring company does not recognize any profit or loss if it receives money or any other property from the target company. This is whenever you transfer shares, as consideration, to the target company.
* Shareholders of the target company who exchange their shares to acquire shares of the company do not recognize gains or losses. However, they may receive non-qualifying money or goods in a non-divisive D transaction.
* The target company does not record a profit or loss when they are part of a tax-free reorganization. If they exchange property solely for stocks or securities, they pay no taxes. Of course, they have to follow the ‘reorganization plan’ with all their adherents to the IRC stipulations.
If the target receives more than just stocks or stocks, they still don’t post a profit or loss. This is only if they distribute this ‘other’ to their shareholders in accordance with the reorganization plan.
Again, this other property must meet IRC definitions to qualify for a non-divisive D transaction. If not, there may be tax implications.
There are many elements that a multinational corporation must consider when reorganizing. In today’s regulated business environment, financial acumen and smart planning will ensure a smooth reorganization process.
DISCLAIMER: This article does not constitute or is intended to constitute legal, tax or accounting advice. You should consult an attorney, tax advisor, or accountant for individual advice on your own situation. Also, this article is not designed or written to be used, and cannot be used, to avoid tax-related penalties under the Internal Revenue Code.