Tax free exchange of assets for stock
However, many taxpayers are challenged by the Bureau of Internal Revenue BIR when availing of exemption on these tax-free exchanges. Revenue Regulations RR No. From the foregoing, it can be interpreted that a BIR ruling must be secured first before a transaction can be considered a tax-free exchange. Commissioner of Internal Revenue , wherein the court in division ruled that exchanges of real properties for shares of stocks are tax-free pursuant to Section 40 C 2 of the Tax Code.
Imposition of value-added tax on tax-free exchanges
Reorganizations, while not generally taxable at the entity level, are not completely tax-free to the selling shareholders. A reorganization is immediately taxable to the target's shareholders to the extent they receive non-qualifying consideration, or "boot". Also, tax on acquirer stock received by target shareholders as consideration is deferred rather than avoided altogether. Any consideration received by target shareholders other than acquirer stock e.
Let's examine how each stakeholder in a non-taxable acquisition is affected from a tax perspective:. Section of the Internal Revenue Code recognizes three types of corporate acquisition structures that qualify as tax-free or tax-deferred reorganizations:. Boot is immediately taxable to target shareholders, while payment in acquirer stock is tax-deferred.
Stock consideration may be paid in voting and non-voting common or qualified preferred shares of the acquirer. The target is liquidated, and all of the target's assets and liabilities are assumed by the acquirer. Approval of the merger plan is subject to acquirer and target shareholder vote in most states. Also, dissenting shareholders may have their independently appraised and purchase for cash.
In a statutory consolidation , two or more corporations contribute all of their assets and liabilities to a new corporation formed to effect the transaction, and the preexisting corporations are dissolved. This structure is appropriate for mergers of equals. Acquirer and target shareholders have the same voting and appraisal rights as in a statutory merger. In a forward triangular merger, the target is merged into a subsidiary of the acquiring corporation, leaving the subsidiary as the surviving entity.
Because the target is eliminated, non-transferrable assets and contracts, such as patents or licenses, may be lost. Sales of assets not wanted by the acquirer just prior to the merger may jeopardize favorable tax treatment. As in a statutory merger, the form of consideration must meet the continuity of interest requirement and payment in acquirer stock is flexible as to the type of securities used as consideration payment in subsidiary stock is disallowed.
However, this structure has two advantages over a statutory merger: 1 the acquirer is shielded from the target's liabilities because they are isolated in a separate legal entity the subsidiary and 2 the acquirer's shareholders need not approve the merger, unless the acquisition is material or more acquirer shares must be authorized to complete the transaction. In a reverse triangular merger, a subsidiary of the acquirer is merged into the target, leaving the target as the surviving entity and a subsidiary of the acquirer and eliminating any minority shareholders in the target.
This structure allows the acquirer to shield itself from the target's liabilities, as in the forward triangular merger, but with the added benefit that non-transferrable assets and contracts are not lost. For this reason, the reverse triangular merger is a commonly used structure. Other characteristics of this structure are similar to those found in forward triangular mergers, including the "substantially all" and shareholder approval requirements.
The target survives as a subsidiary of the acquirer, shielding the acquirer from the target's liabilities. This allows the buyer to acquire the target's shares gradually in what is known as a "creeping" acquisition. The "B" reorganization is similar to the reverse triangular merger, except that the latter allows boot, eliminates minority shareholders, and requires the buyer to acquire "substantially all" of the target's assets.
This structure may be useful when the target's shareholders are willing to accept acquirer stock as consideration because, for example, they might have built-in capital gains that would be triggered upon a stock sale for cash. The buyer may also prefer this structure if it does not want to part with a substantial amount of cash to fund the acquisition or seeks to shield itself from the target's liabilities. The target liquidates and transfers the acquirer shares and any remaining assets to its shareholders.
As in taxable asset acquisitions, the buyer can be selective in choosing which, if any, of the target's assets it will assume. Rejecting the certain liabilities altogether affords the acquirer even greater protection than does isolating those liabilities in a subsidiary.
However, the acquirer is highly exposed to any assumed liabilities unless a subsidiary is used to shield that exposure as in other structures. Moreover, like taxable asset acquisitions, the "C" reorganization can be mechanically complex, costly, and time consuming.
Hence, "C" reorganizations are rare. IRC Section provides a means to effect a tax-free business combination when the tax-free structures recognized under Section are impractical. The most notable advantage of Section over Section is that the former does not require continuity of ownership interest, which restricts the amount of non-taxable consideration acquirer stock that the target's shareholders may receive.
Thus, a Section merger may include an unrestricted amount of tax-free consideration, benefiting selling shareholders who value tax deferment over current income.
Founding shareholders in a newly formed corporation generally transfer property e. The conditions required by Section for tax-free treatment do not apply. The following illustration shows one way in which a Section merger might be structured:. Transferors may receive boot e. While the receipt by transferors of NewCo stock is not taxable, transferors who receive boot recognize a taxable gain equal to the lesser of the boot received and the gain realized on the transfer of property.
Transferors who receive NewCo stock assume a basis in such stock equal to the basis in the property transferred. However, if the transferors also receive boot in the exchange, their basis in their NewCo stock is reduced by FV of the boot and any loss they recognize on the exchange. Conversely, the transferors' basis is increased by the amount of any gain recognized on the exchange. NewCo assumes a carryover basis in the property received, increased by the amount of any gain recognized by transferors recall that when taxes are paid, a step-up is allowed by the IRS.
Section mergers are flexible in that they can be tailored to meet the objectives of the target's shareholders. Delta and Foxtrot are publicly traded corporations. Much of Delta's business consists of supplying raw materials to a manufacturing division of Foxtrot. In this case, Delta acquires a new division and Foxtrot acquires tax control of the combined company Delta as required by Section Of course, this equivalent series of transactions would be far more complex, potentially tax-inefficient, and impractical.
Continuity of business enterprise — The acquirer must either continue the target's historical business or use a significant portion of the target's assets in an existing business for 2 years after the transaction.
Valid business purpose — The transaction must serve a valid business purpose beyond tax avoidance. Step-transaction doctrine — The transaction cannot be part of a larger plan that, taken in its entirety, would constitute a taxable acquisition. Boot Any consideration received by target shareholders other than acquirer stock e.
Example 3. Exhibit 3. All rights reserved. Build models 5x faster with Macabacus for Excel. All target's liabilities assumed Acquirer and target shareholders may be entitled to voting and appraisal rights Transfer of titles, leases, and contracts may be necessary Neither company can be a foreign corporation. Flexibility in the form of consideration Target's liabilities isolated in a subsidiary.
May lose non-transferrable assets and contracts "Substantially all" requirement Target shareholder vote. Acquirer must exchange its voting stock for target stock "Substantially all" requirement Target shareholder vote. Target's liabilities isolated in a subsidiary Non-transferrable assets and contracts are not lost No "substantially all" requirement. Acquirer must exchange its voting stock for target stock Inflexible with respect to the form of consideration Minority shareholders not eliminated.
Acquirer can be selective in choosing the liabilities it assumes. Acquirer must exchange its voting stock for target stock Inflexible with respect to the form of consideration "Substantially all" requirement Mechanically complex and costly.
Tax-free exchanges, which are also referred to as tax-deferred transfer of assets in exchange for shares qualifies as a tax-free exchange and. Type C reorganization: A stock-for-asset deal, where the target company “sells” all of its targets to the parent company, in exchange for voting stock. Included in this.
We all know what Benjamin Franklin said: "Nothing is certain but death and taxes. Taxes are generally an obligation most people prefer to pay on a minimal basis. Taxpayers will give their best effort to reduce the portion of their income payable to Uncle Sam. While it is possible to discover loopholes that will reduce your total tax owed, maximizing after-tax income can take a considerable amount of time, expense, and creativity. And that rings just as true if you own property.
Generally, transferring property into a corporation in exchange for its stock is a taxable event. The transaction is treated as if you sold property to the corporation in return for cash.
Reorganizations, while not generally taxable at the entity level, are not completely tax-free to the selling shareholders. A reorganization is immediately taxable to the target's shareholders to the extent they receive non-qualifying consideration, or "boot".
When A “Tax Free” Exchange May Not Be Free of Tax
A tax-free acquisition is the purchase of a target company in which the recognition of a gain can be deferred. The deferral of gain recognition is of considerable importance, since it delays the payment of income taxes. A proposed transaction must incorporate all three of the following concepts into an IRS -approved acquisition structure before gain deferral will be allowed:. Bona fide purpose. The proposed transaction must have a genuine business purpose other than the deferral or complete avoidance of taxes.
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In recent years, corporate acquisitions, business reorganizations, combinations and mergers have become more common in the Philippines. Corporate acquisitions can be effected through a variety of methods and techniques, and the structure of a deal can have material tax consequences. Although reorganizations are generally taxable transactions, tax-efficient strategies and structures are available to the acquiring entity. On 19 December , Republic Act No. Republic Act No. It provides for the creation of an independent, quasi- judicial body called the Philippine Competition Commission. The law also provides that the commission shall promulgate other criteria, such as increased market share in the relevant market in excess of minimum thresholds, which may be applied specifically to a sector or across some or all sectors in determining whether parties to a merger or acquisition should notify the commission. If the commission determines that such agreement is prohibited and does not qualify for exemption, the commission may:. RMO No.
Mergers and acquisitions have become popular business strategies for companies looking to expand into new markets or territories, to achieve economies of scale, to attain increased synergy, or to gain a competitive edge.
However, such a transfer is not really free of tax in the sense of never being taxed; rather, it defers the recognition, and taxation, of the gain inherent in the asset being transferred. It is important that the business owner recognize the distinction. Allow me to illustrate this concept.
How Does a Tax-Free Exchange Work?
With tagged as among the Top 10 emerging markets, many domestic companies are acquiring, merging or consolidating their businesses to expand their operations, increase market share, and maintain competitiveness, among others. Under the Philippine Tax Code, gains or losses from the sale, exchange or transfer of properties are generally subject to tax. However, no gain or loss shall be recognized in case of a tax free exchange pursuant to Section 40 C 2 of the Tax Code. To qualify as a tax-free exchange, a person transfers property to a corporation in exchange for stocks issued by that corporation, and as a result of such exchange, said person, alone or together with others, not exceeding four 4 persons, gains control of said corporation. In essence, however, the tax free exchange is mere deferral of tax. Hence, any gains shall be recognized when the properties or shares are subsequently transferred. In determining the gain or loss from a subsequent sale of properties involved in the exchange, the Tax Code as implemented by Revenue Regulation No. Consequently, the number of shares to be issued will be computed based on the fair market value of the property transferred, without considering any additional paid in capital APIC. In one of the illustrations provided, the incorporator transferred property i. As such, the incorporator should receive 50, XYZ shares, which is equivalent to the P5-million property transferred. No APIC shall be considered. Under the Civil Code of the Philippines, donation is defined as an act of liberality whereby a person i.
Tax-free it is!
No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock in such corporation and immediately after the exchange such person or persons are in control as defined in section c of the corporation. In determining control for purposes of this section, the fact that any corporate transferor distributes part or all of the stock in the corporation which it receives in the exchange to its shareholders shall not be taken into account. If the requirements of section or so much of section as relates to section are met with respect to a distribution described in paragraph 1 , then, solely for purposes of determining the tax treatment of the transfers of property to the controlled corporation by the distributing corporation, the fact that the shareholders of the distributing corporation dispose of part or all of the distributed stock, or the fact that the corporation whose stock was distributed issues additional stock, shall not be taken into account in determining control for purposes of this section. A transfer of property of a debtor pursuant to a plan while the debtor is under the jurisdiction of a court in a title 11 or similar case within the meaning of section a 3 A , to the extent that the stock received in the exchange is used to satisfy the indebtedness of such debtor. Clauses i , ii , and iii of subparagraph A shall apply only if the right or obligation referred to therein may be exercised within the year period beginning on the issue date of such stock and such right or obligation is not subject to a contingency which, as of the issue date, makes remote the likelihood of the redemption or purchase.
