Thursday, September 29, 2005
Joshua D. Blank (Wachtell, Lipton, Rosen & Katz) has posted Confronting Continuity: A Tradition of Fiction in Corporate Reorganizations (forthcoming, 2006 Columbia Business Review) on SSRN. Here is the abstract:
The venerable “continuity of interest” doctrine has determined the tax treatment of corporate mergers for over seventy years. Under the doctrine, a corporate merger may qualify as a tax-free reorganization if an acquiror corporation pays shareholders of the target corporation aggregate consideration that consists of at least a minimum amount of acquiror corporation stock. The continuity of interest doctrine has endured an abundance of criticism on both policy and legal grounds. Over the last ten years, the administrative agencies of the federal government have steadily chipped away at the continuity of interest requirement in an attempt to make it workable in modern business transactions. Such an approach to remedying the doctrine, however, ignores a fundamental question. Congress, and the tax community at large, should confront the end that the continuity of interest doctrine currently serves, and question whether this end justifies the hardship that the doctrine causes. This article argues that the end that the continuity of interest requirement is intended to achieve – an aggregate group of former target corporation shareholders maintaining a “continuity of interest” in the acquiror corporation following a merger – is fiction. Today corporate mergers may technically satisfy the continuity of interest requirement even though target corporation shareholders ultimately may receive or retain little or even no meaningful proprietary interest in the acquiror corporation. By highlighting the fictional premise upon which the continuity of interest doctrine has come to rest, this article offers a new and different justification for the repeal of the doctrine.
Vic Fleischer (UCLA) offers his views on the paper:
Joshua Blank (Wachtell) has an interesting paper arguing that we do away with the continuity of interest doctrine for corporate tax reorganizations. His argument that the continuity of interest doctrine has no teeth is fairly persuasive, but I am less sure that making nonrecognition treatment explicitly elective is such a great idea. In the alternative, we could make the continuity of interest test an economic test rather than a formal test (which would make it harder to evade the test through hedging or through taking securities like redeemable preferred stock.)
The hard question, which I don't really have a good handle on, is exactly when, from a policy perspective, it is important to call something a sale (and thus a realization event) versus a reorg (merely shifting money from one pocket to another). There is some sort of subsidy at work here, but it may just be a subsidy for legal and investment banking fees.