What Is an Acquisitive D Reorganization?

An acquisitive “D” reorganization is a tax-advantaged method for one corporation to acquire the assets of a related corporation. It is often used to combine two commonly controlled companies or to change a corporation’s state of incorporation without an immediate tax liability. The primary function is to allow the transfer of a business from one corporate shell to another when ownership remains substantially the same. The process involves a target corporation transferring its assets to an acquirer, then distributing the compensation received to its shareholders before liquidating.

Core Qualification Requirements

For a transaction to be recognized as an acquisitive D reorganization, it must satisfy several strict requirements outlined in the tax code and related judicial doctrines to achieve a tax-neutral outcome.

Control Requirement

A condition is that the transferor corporation or its shareholders must have “control” of the acquiring corporation immediately after the asset transfer. For this reorganization, control is defined under Internal Revenue Code Section 304 as ownership of at least 50% of the total combined voting power or 50% of the total value of all stock. This is a lower threshold than the 80% control requirement found in other corporate transactions and ensures the original owners retain a significant interest in the new structure.

Transfer of “Substantially All” Assets

The transaction requires the target corporation to transfer “substantially all” of its assets to the acquiring corporation. For ruling purposes, the IRS considers this test met if the acquirer receives at least 70% of the fair market value of the target’s gross assets and 90% of its net assets. The principle is that the acquiring corporation must obtain the significant operating assets of the target’s business, not just non-operating or investment assets.

Distribution Requirement

The target corporation must distribute all of its properties, including the stock and securities it receives from the acquiring corporation, to its shareholders as part of the reorganization plan. This requirement means the target corporation must completely liquidate after transferring its assets.

Overarching Doctrines

Beyond the specific statutory rules, all corporate reorganizations must satisfy several judicial doctrines. The “business purpose” doctrine requires the transaction to have a legitimate non-tax reason, such as achieving operational efficiencies. The “continuity of business enterprise” (COBE) doctrine mandates that the acquiring corporation must either continue the target’s historical business or use a significant portion of the target’s historical business assets. The “continuity of interest” (COI) doctrine requires that the original shareholders of the target corporation retain a continuing equity stake in the acquiring corporation, which is satisfied for IRS ruling purposes if they receive acquirer stock equal to at least 50% of the value of their old target stock.

Tax Consequences for Involved Parties

When a transaction successfully qualifies as an acquisitive D reorganization, the tax consequences are favorable for all parties involved. The Internal Revenue Code provides specific non-recognition rules, meaning that gains “realized” from the exchange are not “recognized” for tax purposes at the time of the transaction.

Target (Transferor) Corporation

The target corporation recognizes no gain or loss on the transfer of its assets to the acquiring corporation, as governed by IRC Section 361. The target also recognizes no gain or loss when it distributes the acquiring corporation’s stock to its shareholders as part of its liquidation. This tax-free treatment prevents immediate taxation on any appreciation in the value of the target’s assets.

Acquiring (Transferee) Corporation

The acquiring corporation also receives non-recognition treatment. Under IRC Section 1032, the corporation does not recognize any gain or loss when it issues its own stock to acquire the target’s assets. This rule applies whether the corporation is issuing new shares or using existing treasury stock.

Target’s Shareholders

Shareholders of the target corporation who exchange their stock for stock in the acquiring corporation recognize no gain or loss on the exchange under IRC Section 354. A complication arises if shareholders receive property in addition to stock, such as cash, which is referred to as “boot.” If a shareholder receives boot, any realized gain must be recognized, but only up to the fair market value of the boot received.

Basis and Tax Attribute Rules

The tax-free nature of an acquisitive D reorganization extends to the tax accounting that follows the transaction. The rules for determining the tax basis of assets and stock are designed to preserve any deferred gain or loss for future recognition. The tax history of the target corporation is also inherited by the acquiring corporation.

Asset Basis for the Acquirer

The acquiring corporation takes a “carryover basis” in the assets it receives under IRC Section 362. This means the acquirer’s basis in the assets is the same as the target corporation’s basis was before the transfer. The gain not taxed during the reorganization is preserved in the low basis of the assets, so if the acquiring corporation later sells an asset, it will recognize the deferred gain.

Stock Basis for the Shareholders

Shareholders determine their basis in the new acquiring corporation stock using a “substituted basis” rule under IRC Section 358. Their basis in the new stock is the same as their basis was in the old target stock they surrendered. This substituted basis must be decreased by the fair market value of any boot received and increased by the amount of any gain recognized on the exchange.

Carryover of Tax Attributes

The acquiring corporation inherits the tax attributes of the target corporation under IRC Section 381. Attributes that carry over include net operating loss (NOL) carryforwards, corporate earnings and profits (E&P), and capital loss carryforwards. While these attributes carry over, other sections of the tax code, such as IRC Section 382, may impose limitations on the use of certain inherited attributes like NOLs if there has been a significant change in ownership.

Transaction Reporting Requirements

Corporate-Level Reporting

Both the target and acquiring corporations must attach a statement to their federal income tax returns for the year of the reorganization, per Treasury Regulation Section 1.368-3. This statement must include a description of the reorganization plan, the fair market value and tax basis of the transferred assets, and a detailed account of all property exchanged, including any boot.

Shareholder-Level Reporting

Each shareholder receiving property in the reorganization must also file a statement with their income tax return for the year of the exchange. The statement must detail the basis of the target stock they surrendered and the fair market value of all property they received, including the acquiring corporation’s stock and any boot.