Cumulative nonvoting preferred stock

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Reference no: EM1378637

Problems:

T Co. is a closely held corporation incorporated under the laws of the State of Delaware with 100 shares of voting common stock outstanding, owned 50 shares by A (basis $200), 30 by B (basis $400), and 20 by C (basis $150).  T Co. has the following assets:

                                                                               Basis                Value

            Nonoperating Assets                                       $200                $  300

            Operating Assets                                              700                    900

                   Totals                                                    $900                $1200

T Co. has outstanding liabilities of $200 (in the form of 20-year registered bonds), and accumulated earnings of $400.  The aggregate value of T's outstanding stock is $1,000.

P Co. is a publicly held corporation incorporated under the laws of the State of Delaware, the stock of which is listed in the New York Stock Exchange.

What are the tax consequences to T. Co., A, B, C and P Co. of the following transactions (assume throughout that all debt instruments of P Co. are not publicly traded and bear interest payable annually at ¾ of 1% above the federal rate [see § 1274(d)] applicable to the maturity in question):

Question (1).  Statutory merger ("A" reorganization).  In a statutory merger under the laws of the State of Delaware, T. Co. merges into P Co.  As a result of the merger, the following events occur by operation of law:  the transfer of all T assets to P Co.; the assumption by P of all of T's liabilities; the dissolution of T.  As consideration, P Co. issues the following to A, B, and C, the former T shareholders, proportionate to their interests in T:

(a) $1,000 in cash.

(b) $1,000 in P Co.'s notes (not publicly traded), payable over 5 years and bearing interest at 8%.  Cortland Specialty Co.

(c) $1,000 of  P Co.'s 8% registered bonds, payable after 20 years, and convertible into P Co. voting common stock at the election of the bondholder after 5 years.

(d) $1,000 worth of P Co.'s 8% cumulative nonvoting preferred stock.

(e) Same as (1) (d) except that the preferred stock is entitled to one vote per share, but such stock constitutes 1% of P Co.'s outstanding stock.

(f) $100 of P Co.'s 8% short-term notes, $500 of P Co.'s 8% 20-year registered bonds, and $400 worth of P Co.'s voting common stock. 

(g) Treatment of the holder of T's outstanding bonds.  Same as (f) above.  T has outstanding 20-year bonds in the face amount of $200 (worth $200).  Assume that the covenants in the bonds prohibit assumption without the holder's consent upon a change in control of T.  The plan of merger therefore provides for the consent of T's bondholders as well as T's shareholders and the substitution of P bonds (rather than the assumption of the liability evidenced by the T bonds by operation of law).  L owns all the T bonds with a basis of $199.

(i) In addition to the $500 20-year P bonds (Bond #1) and other consideration that A, B and C receive for their T stock, L receives $200 principal amount of P's newly issued 25-year bonds (Bond #2) bearing an adequate rate of interest and worth $200.

(ii) What are the results to L if, because of an above-market rate of interest, T's bonds are worth $220, whereas P's newly issued 25-year bonds are worth par, and P therefore must issue $220 face amount of bond #2 in order to even up the value in the substitution of bond #2 for the T bonds

(iii) What if, in (ii), L receives $200 face amount of bond #2 and warrants worth $20 to purchase P stock within 5 years?

(iv) What if in (ii) L receives $220 worth of P non-voting preferred stock (rather than P bonds) in exchange for his T bonds?

(h) $350 of P Co.'s 8% 20-year registered bonds, $400 worth of P Co.'s voting common stock and warrants worth $250 to purchase P stock within 5 years.  A, B and C receive this consideration as follows:

                                                                                         A                     B                     C

              20-year bonds                                                      $   50                $300                 $ --

              P common stock                                                      400

              Warrants to buy P stock                                            50                                            200

                        Total                                                            $500                $300                  $200

Question (2).  Statutory merger ("A" reorganization) - Miscellaneous continuity issues.  In a statutory merger under the laws of the State of Delaware, T Co. merges into P Co. solely in exchange for P Co. voting stock.  What is the effect of the following alternative fact patterns:

(a) B exercises dissenter's rights under Delaware law and is paid in cash for her shares.

(b) A, B and C agree to the merger transaction only on the condition that P Co. give its binding promise to assist them in selling their P Co. shares at a future date if they request its help.  Immediately after the merger, as they had planned all along, A, B and C sell all of their P Co. stock to unrelated parties with P's help.

(c) T was in the business of manufacturing widgets under a patented process and selling them at retail in the United States under the T brand name.  In the alternative:

(i) Immediately after the merger, P sells T's manufacturing plants and retain stores and continues to manufacture widgets on its own plants under T's patented process, selling them under the T brand name in P's own retail outlets.  Rev. Rul. 81-25.

(ii) Prior to the merger, P signed an agreement with Z Corp, a publicly traded corporation, to form a joint venture after consummation of the T/P merger.  The agreement requires P to contribute the assets of T; Z is to contribute title to a network of retail stores in Europe.  The partnership will sell T's former U.S. retail stores and will manufacture widgets in T's former plants, selling the widgets at retain in Z's former European outlets.  The partnership interest of P and Z, alternative are:

                                                Variation                     Variation                     Variation

                                                 #1                                    #2                                #3

                                                P           Z                    P          Z                     P            Z

              Percentage

              interest                  40%         60%                 3%       97%                 15%     85%

 

              Management

              Responsibility     None          All                   All       None               Most    Some

Question (3).  "C" reorganization.  In a transaction not structured as a statutory merger, T Co. transfers all its assets to P Co. for the following alternative types of consideration, after which T Co. promptly liquidates:

(a) $1,200 in cash.

(b) $1,200 of P Co.'s notes, payable over 5 years and bearing interest at 8%.

(c) $1,200 of P Co.'s 8% registered bonds, payable after 20 years, and convertible into P Co. voting common stock at the election of the bondholder after 5 years.

(d) $1,200 worth of P Co.'s 8% cumulative nonvoting preferred stock.

(e) $1,200 worth of P's 8% cumulative preferred stock that is entitled to one vote per share and that constitutes 1% of P's outstanding stock.

(f)  $1,000 worth of P's 8% cumulative preferred stock that is entitled to one vote per share.  P assumes T's liabilities of $200.

(g) $100 of P Co.'s 8% short term notes, $300 of P Co.'s 8% 20-year registered bonds, and $600 worth of P Co.'s voting common stock.  P assumes T's liabilities of $200.

Question (4).  "C" reorganization -- "Substantially All".

(a) T Co. transfers all of its operating assets to P Co. solely in exchange for $900 of P Co. voting stock.  T holds back its $300 of non-operating assets, a portion of which it uses to pay its liabilities.  T then liquidates and distributes all of its property (including the P shares that T received in the exchange) to its shareholders.

(b) Same as part (a) except that P Co. assumes T Co.'s liabilities of $200 and issues only $700 of P Co. voting stock.

(c) Same as part (a), except that, in addition to holding back its non-operating assets, T Co. also holds back (does not transfer to P) $100 of its operating assets and P issues $800 of P Co. voting stock.  No liabilities are assumed.

Question (5).  "C" reorganization -- "solely" relaxation rule.  T Co. transfers all of its assets to P Co. for the following alternative consideration, and T Co. immediately liquidates after the asset transfer.

(a) $200 worth of P Co.'s 8% cumulative nonvoting preferred stock, and $1,000 worth of P Co.'s voting common stock.  To satisfy its bondholder's claims, T alternatively sells $200 of P common stock and uses the cash proceeds to pay off its bonds, or transfers $200 of P common stock to its bondholders.

(i) In the liquidation of T, A receives $400 of P common stock and $100 of P nonvoting        preferred stock.  Does A recognize gain or loss?  What is A's basis in the P stock?

(b) $200 worth of P Co.'s 8% cumulative nonvoting preferred stock, and $950 worth of P Co.'s voting common stock.  P also assumes $50 of T's liabilities.

(c)  $90 of  P Co.'s short-term notes and P Co. voting common stock worth $960.  P assumes $150 of T's liabilities.   In the li      quidation of T, assume that T's $50 of retained liabilities are satisfied, alternatively through:

(i) A transfer of $50 of P voting common (all of the P notes, along with the balance of the P voting common, are distributed to the T shareholders).

(ii) A transfer of $50 of P notes (the balance of the notes, along with the P voting common, is distributed t o the T shareholders).

Question (6).  "C" reorganization -- dissenting shareholders; miscellaneous boot and "substantially all" issues.

(a) B dissents from the transaction.  T transfers all of its assets to P.  P transfers $300 in cash (which T uses to retire B's shares), assumes all $200 of T's liabilities and issues $700 voting common shares that T distributes pro-rata to A and C in liquidation of T.

(b) Shortly before the contemplated transfer, T Co. borrows $300, which it uses to redeem B's T Co.  P then assumes all $500 of T's liabilities and issues $700 worth of P Co. voting common stock (that T distributes pro-rata to A and C in liquidation of T) in exchange for T's assets.  Southwest Consolidated. 

(c) B dissents from the transaction, and shortly before the transfer, T uses its $300 of non-operating assets to retire B's stock.  Alternatively,

(i) P issues $700 voting common shares in exchange for T's $900 of operating assets.  See Rev. Proc. 77-37, § 3.01.

(ii) P issues $900 voting common shares in exchange for T's $900 of operating assets and assumes none of T's liabilities.

(d) P Co. assumes the legal fees, accounting fees, printing costs and filing fees incurred by T as a result of the acquisition.  See Rev. Rul. 73-54.

Reference no: EM1378637

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