Recently, the Internal Revenue Service issued final regulations addressing reorganizations, commonly referred to as “F reorganizations,” under Section 368(a)(1)(F) of the Internal Revenue Code (the Code). F reorganizations differ from other types of reorganizations because, as noted in the guidance, their tax treatment is more consistent with that of a single continuing corporation even though F reorganizations generally involve a transferor corporation transferring assets to a “resulting corporation.” The final regulations, which largely adopt proposed regulations issued more than 10 years ago, provide further guidance regarding the requirements to qualify as an F reorganization and clarify the treatment of F reorganizations undertaken in conjunction with other transactions. 

This IRS guidance is significant because F reorganizations have become a relatively common means of facilitating broader corporate transactions in a tax-efficient manner. In particular, under existing IRS guidance, which essentially is confirmed by the regulations, F reorganizations may be undertaken in connection with other transactions but considered entirely separate from those transactions. This treatment represents a significant exception to the judicial “step transaction” doctrine, under which a series of related transactions generally must be viewed together, rather than independently, for tax purposes. 

Some practitioners have described this phenomenon as the F reorganization occurring “in a bubble” or in the “eye of the hurricane.” Regardless of one’s metaphor of choice, the ability for a corporation to engage in an F reorganization in connection with a broader transaction, without impacting the tax treatment of the broader transaction, is the most significant aspect of F reorganizations and the reason that they have become a solution of choice in structuring corporate transactions.

Below is a summary of the final regulations as well as some practical guidance on how F reorganizations arise in connection with acquisitions and other corporate transactions.

General Requirements for an F Reorganization

The Code defines an F reorganization as “a mere change in identity, form, or place of organization of one corporation,” which the IRS refers to as a “mere change.” The final regulations set forth the following specific requirements that must be met in order for a transaction or series of transactions to qualify as a “mere change” and therefore an F reorganization:

• Subject to certain de minimis exceptions, the resulting corporation does not hold any property or have any tax attributes before the transaction or series of transactions, all stock of the resulting corporation is distributed in exchange for stock of the transferor corporation, and the transferor corporation completely liquidates;
• The same person or persons who own all the stock of the transferor corporation prior to the transaction or series of transactions own all of the stock of the resulting corporation after the transaction or series of transactions in identical proportions; and
• No corporation other than the resulting corporation succeeds to tax attributes (for example, net operating losses) of the transferor corporation, and the resulting corporation does not succeed to any tax attributes of any corporation other than the transferor corporation.

These requirements are designed to ensure that the transaction or series of transactions result in a “mere change” and that there are no acquisitive or divisive actions affecting the corporation that alter the status or ownership of the corporation.

F Reorganizations in the Context of Other Transactions

The final regulations also provide specific guidance with respect to the relationship between F reorganizations and other transactions. Specifically, the final regulations provide, among other things, that:

• A series of related transactions can together qualify as an F reorganization even if certain steps, viewed in isolation, could be subject to other provisions of the Code.
• The judicial “continuity of interest” and “continuity of business enterprise” requirements generally applicable to other types of reorganizations do not apply to an F reorganization.
• In determining whether a transaction or series of related transactions qualify as an F reorganization, the transaction is deemed to begin when the transferor corporation begins transferring its assets to the resulting corporation and ends when the transferor corporation has distributed to the shareholders the consideration it receives and has completely liquidated, whether actual or deemed.
• An F reorganization may occur before, within or after other transactions that effect more than a mere change of the corporation, even if the resulting corporation in the F reorganization has only transitory existence.
• A distribution of money or other property, including a redemption, from either the transferor corporation or the resulting corporation is treated as an unrelated, separate transaction from the reorganization, whether or not connected. 
• With limited exceptions, if a transaction or series of transactions qualifies as both an F reorganization and as another type of reorganization, the transaction generally will be treated as an F reorganization. 

The Practicality of F Reorganizations

As noted above, F reorganizations have become an extremely useful tool for facilitating broader corporate transactions. A common example arises in the context of a sale of a corporation (generally an “S” corporation), where the parties desire asset sale treatment for income tax purposes but prefer to sell the stock of the corporation for non-tax purposes in order to avoid any actual transfer of the corporation’s assets.

Although such a transaction may, in certain circumstances, be achieved by making an election under the Code (pursuant to Sections 336(e) or 338(h)(10)), these elections can be somewhat narrow in their application. For example, these elections generally do not apply if any of the consideration constitutes retained or “rollover” equity that is received by the selling shareholders on a tax deferred basis, which is particularly common in private equity acquisitions. The solution to the foregoing situation is that, immediately prior to the transaction, the shareholders of the target corporation contribute their stock to a new corporation, and the target corporation (now wholly-owned by the new corporation) is converted to a limited liability company that is disregarded as a separate entity for tax purposes. These transactions are collectively treated as an F reorganization, such that they do not have any meaningful tax consequences and are not “stepped” together with the acquisition. The purchaser then acquires the equity of the limited liability company, which allows for asset sale treatment for tax purposes (without any actual transfer of assets) and also permits a portion of the consideration to consist of rollover equity that is received on a tax deferred basis.

F reorganizations also may be used to, among other things, facilitate tax deferred mergers, maintain taxpayer identification numbers, shift corporate jurisdictions and allow a purchaser to limit its exposure to tax or other liabilities in an equity purchase transaction. Given their many potential uses, the guidance in the final regulations, in particular the confirmation that F reorganizations may in fact occur “in a bubble” without impacting the treatment of related transactions, is welcome. 

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