Reorganizations and Consolidated Tax Returns

Assignment 3: Reorganizations and Consolidated Tax Returns

ACC 565

Organizational Tax Research and Planning

Assignment 3: Reorganizations and Consolidated Tax Returns

Tax Benefits and Advantages

Reorganization refers to the acquisition of new entities in a way that results in the transactions being nontaxable. Section 368 addresses the concept of reorganization and its’ forms. There are currently four types of reorganization: A, B, C and D.

These types of reorganization are considered nontaxable transactions, meaning there is no tax liability of acquiring the new entity. While there is no taxation, it is important to ensure that the various sections of the Internal Revenue Service (IRS) are followed in order to avoid a breach of the law. There are benefits and advantages to each type of reorganization, which will be outlined below.

• Type A reorganization occurs in the form of consolidations and mergers.
• Type B reorganization occurs by utilizing the voting stock of the company undergoing the reorganization to acquire the stock of the company being attained.
• Type C reorganization occurs when the company being acquired is liquidated and the shareholders of the acquiring company buy the shares of the attained organization.
• Type D reorganization happens when division and acquisition are used as the method (Pope, 2016).

Type A

As stated above, Type A reorganization involves mergers. In the merger, the liabilities of the acquired entity is not transferred to the company acquiring the entity. This makes it somewhat safe for the acquirer to proceed with the merger. Approval from shareholders is not required with Type A reorganization, thus resulting in the avoidance of additional time and paperwork (Pope, 2016).

Type B

Type B reorganization has an important benefit. It allows 80% of possession of the stock of the acquired company. This allows the acquired entity to become a subsidiary of the acquirer. Again, a taxable transaction is avoided (Pope, 2016).

Type C

With a Type C reorganization the assets of the targeted entity are possessed by acquiring the company and the previous shareholders of the company hold its stock. With this type of reorganization, the benefit occurs as the acquiring company has the option of choosing which liabilities they wish to undertake and which ones they would like to ignore. The assets and liabilities are acquired within the likes of the acquiring organization (Pope, 2016).

Type D

Lastly, Type D reorganization provides benefits as well. With Type D reorganization, the company can divide itself into new corporation but maintain its control on them by having 80% of share in all of them. This not only will assist in forming new entities, but also keeps the former company in charge of the entire operation (Pope, 2016).

Further, Type Areorganization allows the tax to be avoided by deferring the taxable amount to the capital gains in the statement of financial position. This happens in accordance with section 368 of the IRS and enables the company to get rid of tax in a lawful manner. UnderType B, the voting rights get restricted while transferring them to or from the target company (Mergers, 2016). Here, the tax benefit arises in the form of deferring of the capital gain for taxation related issues. For Type C, the market value is recognized of the assets belonging to the target entity and if compliance is ensured with the required section then the tax is avoided by the company’s shareholders (Mergers, 2016). In Type D, the organization is merely divided and no tax liability arises in the first place from it.

For this client, Type B will be best suited over the other types of reorganization. This is because it is cash free type which makes it well-suited for avoiding taxes. Once this reorganization has taken place, two independent entities develop with no link between them and are charged independently for their taxes. It also gives the acquiring company the chance to get hold of the shares of the target company if its shareholders want those shares.

Reorganization Type That Should Be Used

The corporation is experiencing a loss in its operations and is subjected to being acquired under the reorganization type of nontaxable transactions. The company wants to capitalize the losses. With the taxes that are paid, the companies looking for reorganization methods. The method that will suit it the most is the type a method (Vanistendael, 1998). This method was chosen because the assets of the company will be merged with the target entity’s liabilities and this will result in consolidation of assets and liabilities. The assets will be written down on the financial statements if the acquiring company and the loss will be used to set off the taxes to be paid.

Acquisition Structure

It is proposed to utilize the step up method of acquisition. Although this structure is taxed, it will provide assets of market value to the acquiring company. The market value can be used for tax credit as its base and will also be depreciated. Consolidation will allow for both assets and liabilities of the acquired entity to be listed in the statements of the acquiring company. This method assists in reducing the tax liability.

Value and Limitations

Consolidated financial statements are a special category of financial statements that have legal support (Pope, 2016) before their implementation, it is necessary that the legal formalities must be fulfilled. There are ways that consolidation will benefit the company. These include the setting off of losses of one of the parties of the consolidation against the taxable income of the entire entity. In this case, the loss of subsidiary can be set off against the taxable income of the parent entity (Vanistendael, 1998). This helps in reducing tax payable for the ABC Corporation. Consolidation also saves the dividends of the parent company from taxation since consolidated companies carry out intercompany dividend system.

There are also disadvantages or limitations of this system as well. The first limitation is as follows: if the company decides to operate as a consolidated company and files for it, it will have to be a consolidated firm after that, no matter what happens. This means if ABC opts for consolidation, it will be bound to follow that method for the rest of its operating life. However, the advantages of this system are greater than the disadvantages. Therefore, ABC should go for consolidation and enjoy the tax benefits stemming out from it.

Reduction of Disadvantages

As mentioned above, the limitation is to continue operating as a consolidated firm for the life of the company. To create a scenario for reducing this limitation effect, it is suggested that ABC may quit its links with the consolidated firms when it wants to end the consolidation. In turn, this allows ABC to sell its share in its subsidiary, which in turn will eliminate its ownership and put an end to the consolidation. If there is any other valid reason for not getting consolidated then the company should present it to the authorities to get exemptions.

References

Pope, T. R., Rupert, T. J., & Anderson, K. E. (2016). Prentice Hall’s federal taxation 2015 corporations, partnerships, estates, and trusts. (29thed.). Upper Saddle River, NJ: Pearson Education, Inc.

• Mergers and Acquisitions. (2016). Retrieved December 14, 2016 from http://www.referenceforbusiness.com/small/Mail-Op/Mergers-and-Acquisitions.html.

Vanistendael, F. (1998). Taxation of Corporate Reorganizations. Retrieved December 14, 2016 from https://www.imf.org/external/pubs/nft/1998/tlaw/eng/ch20.pdf.