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Wednesday, March 21, 2007

Conway on The Inconsistent Tax Treatment of Security Holders in Tax-Free Reorganizations

Conway_2Meredith R. Conway (Texas Wesleyan) has published "Clowns to the Left of Me, Jokers to the Right, Here I Am, Stuck in the Middle With You": The Inconsistent Tax Treatment of Security Holders in Tax-Free Reorganizations, 56 Cath. U. L. Rev. 99 (2006).  Here is part of the Introduction:

Part II of this Article will provide a hypothetical that illustrates the inconsistent tax treatment of security holders in a tax-free reorganization as compared to holders of stock and holders of non-security debt instruments. Following the hypothetical, Part III of this Article will discuss the tax consequences of an exchange of security instruments and non-security instruments in a tax-free reorganization, the policy reasons or justifications behind the reorganization provisions, and the possible justifications for the disparate treatment of security holders. This discussion will include an examination of whether or not an interest that a taxpayer holds is a security instrument, what the tax consequences are of the underlying exchange to the holders of security instruments, and the tax consequences to the corporation of the tax-free exchange. Once the tax consequences of an exchange of security instruments in a tax-free reorganization have been evaluated, Part IV of this Article will then discuss the tax consequences of a fully taxable exchange. Then, Part V of this Article will examine the policy justifications and the legislative history behind these provisions as well as current public policy and will suggest solutions that are consistent with current public policy motivations. Finally, Part VI of this Article will raise and then refute arguments in favor of retaining the current tax provisions regarding security instruments.

The tax treatment of security instruments in tax-free reorganizations is puzzling and inconsistent. A security instrument has been defined as a long-term debt instrument, an interest that represents a continuing ownership interest in the corporation. Non-security debt instruments enerally represent a mere creditor's interest. Yet, when compared to the tax consequences of an exchange of non-security debt instruments in a corporation in connection with a tax-free reorganization an exchange of security instruments has less favorable tax consequences.

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