Question

Scamander Corporation is the parent of Credence Corporation and owns 100% of Credence. Scamander is interested in acquiring either the assets or the stock of Lestrange Corporation. Lestrange Corporation holds a valuable license to produce QPS equipment that Scamander is interested in obtaining. Lestrange Corporation has assets with FMV of $4,000,000 but with an adjusted basis of $1,000,000. Lestrange has liabilities of $600,000 and AE&P of $3,000.000. The majority of Lestrange shareholders are in favor of a takeover by Scamander but insist that it be tax-free. However, a few shareholders owning, in total, 15% of the Lestrange stock, are opposed to the takeover. They are willing to claim a dissenter’s right to be paid the value of their stock in cash. Some of the Scamander shareholders are concerned about assuming the liabilities of Lestrange.

a) Discuss four types of reorganizations that would provide a tax-free outcome for the shareholders. Explain the rules of these reorganizations, whether Scamander or Lestrange will recognize any gain or loss, and whether the shareholders will recognize any gain or loss. For this part of the problem, ignore the dissenting shareholders.

b) How would you answers in a) change if, as part of the takeover, the dissenting Lestrange shareholders will have to have their stock purchased for cash?

Answer 1

Tax-free reorganizations can be divided into the following four types:

Acquisitive reorganizations
Divisive reorganizations
Corporate restructuring reorganizations
Bankruptcy reorganizations

Tax rules

Managing a tax-free reorganization is entirely dependent on the tax jurisdiction a company is in. A tax-free reorganization is done not necessarily to grant a tax exemption, and thereby put the company at a better position. It is done to reduce any tax consequences of an already impending reorganization. In other words, a business reorganization is not triggered by the need to conduct a tax-free reorganization. Rather, the tax-free reorganization is triggered when a business reorganization is expected. With the incoming restructuring, the business hopes to neither incur a tax advantage nor a disadvantage.

In essence, the term “tax-free” is misleading because the expense is not entirely mitigated, but may be deferred, transferred or minimized.