The Internal Revenue Code (the “Code”) recognizes very few transactions that do not somehow result in a recognition of gain and assessment of tax, especially transactions that result in some form of corporate restructuring. A restructuring is generally involved in mergers, acquisitions or dispositions, and often results in recognition of taxes by an acquirer, a target, or their respective shareholders, as well as adjustments to asset or share tax bases, net operating losses, or other tax attributes.
A restructuring also may result in the termination of a business or entity, impacting a variety of contractual arrangements including, but not limited to, leases, licenses, financing commitments and employee welfare and benefit plan obligations. Although such arrangements may require consents, approvals or other actions regardless of the applicable tax considerations, the tax impact may be minimized or eliminated when a transaction is structured to qualify as a tax-free reorganization. One form of tax-free reorganization is recognized under Code Section 368(a)(1)(F), commonly referred to as an “F” reorganization.
An F reorganization is “a mere change in identity, form or place of organization of one corporation, however effected.” Qualification as an F reorganization is often sought where a corporation changes its name, state of incorporation, or form, such as a change from a Massachusetts business trust to a corporation, or vice versa, conversion of a mutual savings and loan association into a stock savings and loan association, or conversion of a for-profit into a not-for-profit corporation. In addition, the IRS has recognized F reorganizations that included a change from a public to a private or limited liability company, accompanied by shareholder exchanges of stock certificates for registered shares or quotas.
F reorganizations that transform operating companies with valuable assets into operating subsidiaries without such valuable assets have been perhaps the most controversial. A typical scenario might be as follows: A corporation provides services and holds valuable assets, including the building from which the services are provided, and related furniture and equipment. The shareholders desire to shield the corporation’s assets from potential claims that might arise from their provision of services. They create a new corporate shell in which they own all of the shares, and then transfer their shares in the existing corporation to the shell, which becomes the parent through an F reorganization, including a transfer of the building, furniture, equipment and other assets to the parent. The reorganization creates a firewall between the assets and the liabilities that would be associated with any claims made in connection with services provided.
The transfer of assets from one entity to another solely to protect assets from claims of creditors may reflect a valid business purpose for the reorganization, a condition required to qualify for any type of tax free reorganization; however, it may also give rise to fraudulent transfer claims, particularly if there is any hint of a potential customer or client claim at the time of the reorganization. In the absence of customer or client concerns, an F reorganization may be a good way to protect business assets. If you desire any further information regarding F reorganizations, please contact us.