Question

Aqua Corporation is a retail operation specializing in pool equipment and outdoor furniture. It is very interested in merging with Icterine Corporation, a lamp manufacturer; Aqua is very profitable and Icterine has large business credits that it has not been able to utilize.

Aqua proposes to exchange about 40% of its stock and $200,000 for most of Icterine’s assets. The assets not acquired by Aqua will be distributed to Icterine’s shareholders. Aqua stock will be distributed to most of Icterine’s shareholders, while dissenting Icterine shareholders will receive the cash.

Aqua is not interested in the lamp business except for the possibility of making pool lights. It therefore will sell off Icterine’s assets except those that can be retooled to manufacture pool lights. What are the tax issues to be considered in these transactions?

Answer 1

Tax issues are considered very important when an action plan is being laid down for any merger/acquisition transaction. Since there is no mention about any cross border transaction, so the consideration for changes in taxes in different countries is ruled out.

Now we will examine tax issues in each action/step taken by Aqua corporation and Icterine corporation.

1. Exchanging 40% of Aqua's stock and $200,000 for most of Icterine’s assets- This is a cash and share-based merger. In this type of combination, a shareholder must report in the tax return the smaller of the cash received or gain on the stock based on the value of the merger. So the shareholder of Icterine will only pay if they realize any capital gain by selling the stock post-merger or during the merger. Icterine corporation will pay the corporate tax on the amount in excess to the fair market value of the assets. This step brings maximum profitability for Aqua corporation since after acquiring the assets, the company can increase the depreciable assets which will affect the bottom line of the company.

2. The dissenting shareholders will receive the cash- This move will impact the Icterine shareholders who dissent to exchange their stock with Aqua's share because when they will be paid in cash, they will be liable to pay individual capital gain taxes as per the income tax category they fall in.

3.Aqua selling of the assets- This will make Aqua corporation liable to pay corporate taxes on the amount gained in excess to the price at which they bought the assets from Icterine corporation.