In general, gain or loss must be recognized upon the exchange of property by a taxpayer if the new property differs materially, in kind or extent, from the old property.
The purpose of the so-called “reorganization” provisions of the Code is to except from this general rule certain specifically described corporate exchanges that are required by business exigencies and that effect only a readjustment of a taxpayer’s continuing interests in property under modified corporate forms.
The Code describes several types of corporate transactions that constitute “tax-free” reorganizations. One of these, described in section 368(a)(1)(F) of the Code, is “a mere change in identity, form, or place of organization of one corporation, however effected” (a “Mere Change”) – or an “F” reorganization.
Although the statutory description of an F reorganization is short, and some courts have described F reorganizations as “simple,” questions have arisen regarding the requirements of F reorganizations.
In particular, when a corporation changes its identity, form, or place of incorporation, what other changes (if any) may occur, either before, during, or after the Mere Change, without affecting the tax-free status of the Mere Change ? In other words, what other changes are compatible with the Mere Change?
These questions can become more pronounced if the transaction that is intended to qualify as an F reorganization is composed of a series of steps. Moreover, changes in identity, form, or place of organization are often undertaken to facilitate other changes that may be difficult to effect in the corporation’s current form or place of organization.
The IRS recently issued Final Regulations in which it addressed many of these questions.
Like other types of corporate reorganizations, an F reorganization generally involves, in form, two corporations, one (a Transferor Corporation) that transfers (or is deemed to transfer) assets to the other (a Resulting Corporation). However, the statute describes an F reorganization as being undertaken with respect to “one corporation” and provides for treatment that differs from that accorded other types of reorganizations in which assets are transferred from one corporation to another (Asset Reorganizations).
An F reorganization is treated for most purposes of the Code as if the reorganized corporation were the same entity as the corporation in existence before the reorganization. Thus, the tax treatment accorded an F reorganization is more consistent with that of a single continuing corporation in that
(1) the taxable year of the Transferor Corporation does not close and includes the operations of the Resulting Corporation for the remainder (post-reorganization portion) of the taxable year, and
(2) the Resulting Corporation’s losses may be carried back to taxable years of the Transferor Corporation.
Because an F reorganization must involve “one corporation,” and continuation of the taxable year and loss carrybacks from the Resulting Corporation to the Transferor Corporation are allowed, the statute cannot accommodate transactions in which the Resulting Corporation has pre-existing activities or tax attributes.
Similarly, the requirement that there be “one corporation” means that the status of the Resulting Corporation as the successor to the Transferor Corporation must be unambiguous.
The Final Regulations
Based on the above principles, the Final Regulations provide that a transaction (a “Potential F Reorganization”) that involves an actual or deemed transfer of property by a Transferor Corporation to a Resulting Corporation is a Mere Change that qualifies as an F reorganization if six requirements are satisfied (with certain exceptions).
In the context of determining whether a Potential F Reorganization qualifies as a Mere Change, deemed asset transfers include, but are not limited to, the deemed asset transfer by the Transferor Corporation to the Resulting Corporation resulting from a so-called “liquidation- reincorporation” transaction; and the deemed transfer of the Transferor Corporation’s assets to the Resulting Corporation in a so-called “drop-and-check” transaction in which a newly formed Resulting Corporation acquires the stock of a Transferor Corporation from its shareholders and, as part of the plan, the Transferor Corporation liquidates into the Resulting Corporation.
Viewed together, the following six requirements ensure that an F reorganization involves only one continuing corporation and is neither an acquisitive transaction nor a divisive transaction.
Resulting Corporation Stock Issuances and Identity of Stock Ownership
A transaction that shifts the ownership of the equity interests in a corporation cannot qualify as a Mere Change. Thus, the Final Regulations provide that a transaction that involves the introduction of a new shareholder or new equity capital into the corporation does not qualify as an F reorganization.
In accordance with this principle, the first requirement in the Final Regulations is that immediately after the Potential F Reorganization, all the stock of the Resulting Corporation must have been distributed (or deemed distributed) in exchange for stock of the Transferor Corporation in the Potential F Reorganization.
The second requirement is that, subject to certain exceptions, the same person or persons own all the stock of the Transferor Corporation at the beginning of the Potential F Reorganization and all of the stock of the Resulting Corporation at the end of the Potential F Reorganization, in identical proportions.
Notwithstanding these requirements, the Final Regulations allow the Resulting Corporation to issue a de minimis amount of stock (not in respect of stock of the Transferor Corporation) to facilitate the organization or maintenance of the Resulting Corporation. This rule is designed to allow, for example, reincorporation in a jurisdiction that requires minimum capitalization, two or more shareholders, or ownership of shares by directors. It is also intended to allow a transfer of assets to certain pre-existing entities.
In addition, the Final Regulations allow changes of ownership that result from either (i) a holder of stock in the Transferor Corporation exchanging that stock for stock of equivalent value in the Resulting Corporation but having terms different from those of the stock in the Transferor Corporation or (ii) receiving a distribution of money or other property from either the Transferor Corporation or the Resulting Corporation, whether or not in redemption of stock of the Transferor Corporation or the Resulting Corporation.
In other words, the corporation involved in a Mere Change may also recapitalize, redeem its stock, or make distributions to its shareholders, without causing the Potential F Reorganization to fail to qualify as an F reorganization.
These exceptions reflect the determination of the IRS that allowing certain transactions to occur contemporaneously with an F reorganization is appropriate so long as one corporation could otherwise effect the transaction without undergoing an F reorganization.
Resulting Corporation’s Assets or Attributes and Liquidation of Transferor Corporation
In general, and consistent with the statutory mandate that an F reorganization involve only one corporation, the third requirement under the Final Regulations is that the Resulting Corporation not hold any property or have any tax attributes immediately before the Potential F Reorganization.
However, the Resulting Corporation may hold a de minimis amount of assets to facilitate its organization or to preserve its existence (and to have tax attributes related to these assets), and the Resulting Corporation may hold proceeds of borrowings undertaken in connection with the Potential F Reorganization.
Under the fourth requirement in the Final Regulations, the Transferor Corporation must completely liquidate in the Potential F Reorganization for federal income tax purposes. Nevertheless, the Transferor Corporation is not required to legally dissolve, and may retain a de minimis amount of assets for the sole purpose of preserving its legal existence.
One Acquiring Corporation, One Transferor Corporation
A Mere Change involves only one Transferor Corporation and one Resulting Corporation. Thus, the Final Regulations provide that only one Transferor Corporation can transfer property to the Resulting Corporation in the Potential F Reorganization.
Thus, the fifth requirement under the Final Regulations is that immediately after the Potential F Reorganization, no corporation other than the Resulting Corporation may hold property that was held by the Transferor Corporation immediately before the Potential F Reorganization if such other corporation would, as a result, succeed to and take into account the tax attributes of the Transferor Corporation.
A transaction that divides the property or tax attributes of a Transferor Corporation between or among acquiring corporations, or that leads to potential competing claims to such tax attributes, will not qualify as a Mere Change.
The sixth requirement under the Final Regulations is that immediately after the Potential F Reorganization, the Resulting Corporation may not hold property acquired from a corporation other than the Transferor Corporation if the Resulting Corporation would, as a result, succeed to and take into account the tax attributes of such other corporation. Thus, a transaction that involves simultaneous acquisitions of property and tax attributes from multiple transferor corporations will not qualify as a Mere Change.
Similarly, the Final Regulations provide that a Mere Change cannot accommodate transactions that occur at the same time as the Potential F Reorganization if those other transactions could result in a corporation other than the Resulting Corporation acquiring the tax attributes of the Transferor Corporation.
Series of Transactions
In some cases, business or legal considerations may require extra steps to complete a transaction that is intended to qualify as a Mere Change. The Final Regulations provide that a Potential F Reorganization consisting of a series of related transactions that together result in a Mere Change may qualify as an F reorganization, whether or not certain steps in the series, viewed in isolation, might, for example, be treated as a redemption of stock, a complete corporate liquidation, or as a contribution of property to a corporation . For example, the first step in an F reorganization of a corporation owned by individual shareholders could be a dissolution of the Transferor Corporation, so long as this step is followed by a transfer of all the assets of the Transferor Corporation to a Resulting Corporation.
Mere Change within Larger Transaction
An F reorganization may be a step, or a series of steps, before, within, or after other transactions that effect more than a Mere Change, even if the Resulting Corporation has only a transitory existence following the Mere Change. In some cases an F reorganization sets the stage for later transactions by alleviating nontax impediments to a transfer of assets. In other cases, prior transactions may tailor the assets and shareholders of the Transferor Corporation before the commencement of the F reorganization.
Although an F reorganization may facilitate another transaction that is part of the same plan, the IRS has concluded that step transaction principles generally should not re-characterize F reorganizations because F reorganizations involve only one corporation.
Thus, the Final Regulations provide that related events preceding or following the Potential F Reorganization that constitutes a Mere Change generally will not cause that Potential F Reorganization to fail to qualify as an F reorganization.
The Final Regulations also provide that the qualification of a Potential F Reorganization as an F reorganization would not alter the treatment of other related transactions. For example, if an F reorganization is part of a plan that includes a subsequent merger involving the Resulting Corporation, the qualification of a Potential F Reorganization as an F reorganization will not alter the tax consequences of the subsequent merger.
Transactions Qualifying under Other Reorganization Provisions
In some cases, an asset transfer that would constitute a step in an F reorganization is also a necessary step for characterizing a larger transaction as a non-recognition transaction that would not constitute an F reorganization.
In general, the Final Regulations provide that if a Transferor Corporation’s transfer of property qualifies as a step in both an F reorganization and another type of reorganization in which the Resulting Corporation is the acquiring corporation, the transaction qualifies for the benefits accorded to an F reorganization. (There is an exception for specifically described acquisitive asset reorganizations.)
The Final Regulations provide that, if a shareholder receives money or other property (including in exchange for its shares) from the Transferor Corporation or the Resulting Corporation in a transaction that constitutes an F reorganization, the money or other property will be treated as having been distributed by the Transferor Corporation in a transaction separate from the F reorganization. In substance, such a distribution is functionally separate from the Mere Change, and should not be treated the same as an exchange of money or other property for stock of a target corporation in an acquisitive reorganization.
Employer Identification Numbers
It should be noted that the IRS is studying the very practical issue of how to assign (or reassign) employer identification numbers (“EIN”) to corporate taxpayers following an F reorganization. After all, although an F reorganization generally involves, in form, two corporations, the Transferor Corporation (with an existing EIN) and the Resulting Corporation (with a new EIN) are treated as the same taxpayer. In some cases, it will be important to the Transferor Corporation that the Resulting Corporation continue to use the Transferor Corporation’s EIN.
An “F” Can Be Good
Although you wouldn’t want to receive it as a grade in school, an “F,” as it relates to a reorganization, can prove to be a very useful tool in the restructuring of a close corporation. The key is to recognize the opportunities for its application, whether it be to effect a change in corporate form or in state of organization, or to defend against the characterization of a transaction as a taxable liquidation-reincorporation. You never know when you may need an “F.”