When stock consideration is involved in a merger or acquisition, the type A reorganization is a popular way to structure the transaction for income tax planning and compliance purposes. Relative to the other reorganization choices described in the Internal Revenue Code, the type A provides flexibility that is not found in the other types of reorganizations. The principal benefit of having a transaction meet the requirements of a type A reorganization is the deferral of income taxes. If the transaction is properly structured, to the extent that stock of the acquiring company is received, there is a deferral of income taxes (i.e., cash or other “boot” received will be subject to tax). Just like the other exchange provisions of the Internal Revenue Code, there is a tax basis being carried over to the stock received.
Under section 368(a)(1)(A), the Internal Revenue Code defines a type A reorganization as a “statutory merger or consolidation.” Besides meeting the definition of a statutory merger or consolidation, there is a continuity of interest requirement. As provided by the treasury regulations, this requirement will be met if at least 50% of the consideration received is stock (under case law, 40% stock consideration will meet this requirement).
Up until just a few years ago, a statutory merger or consolidation was limited to domestic transactions that are subject to the corporation laws of a state, a territory, or the District of Columbia, which are part of the United States. In 2005, proposed regulations were released that expand upon the statutory merger or consolidation requirement. The proposed regulations disposed of the requirement that only domestic transactions will qualify. As long as the statutory merger or consolidation satisfies the criteria that are often found in domestic statutes, then a foreign transaction will qualify. Since many foreign jurisdictions do have merger statutes in place, this change in the federal tax law opened the door to favorable tax treatment for cross border transactions.
In 2003, regulations were issued that expanded upon the type of entity included in the definition of a statutory merger or consolidation. Before 2003, an entity had to be a corporation. Under the regulations, subject to various restrictions, a limited liability company can be a party to a merger transaction in a type A reorganization.
As with any material transaction involving tax consequences, it is wise to seek counsel from a competent tax professional before entering into a merger or acquisition transaction.