Tax-Free Reverse Triangular Merger
Depending on how the deal is executed, a reverse triangular merger can be either taxable or nontaxable. If it is taxable, then it is treated as a stock purchase as described above. On the other hand, it can also be structured as a tax-free reorganization if it qualifies under Internal Revenue Code Section 368(a)(2)(E). A myriad of complex requirements must be met, including the following:
The acquirer must control (the subsidiary immediately prior to the merger;
After the merger the target company must hold substantially all of its assets and substantially all of the properties of the subsidiary; and
The target company’s shareholders must exchange stock of the target company constituting control of the target for voting stock of the acquiring company.
Very generally, “control” is defined as stock possessing 80% of the voting power of all voting stock classes and at least 80% of shares of all other classes of stock.
In addition, the transaction must satisfy the “continuity of business enterprise rule” (i.e., the entity must continue the target company’s business or use a substantial portion of the target’s business assets in its business) as well as the “continuity of interest rule” (meaning that the shareholders of the acquired company must hold an equity interest in the acquiring company).
In other words, in the tax-free version, the shareholders of the former target company receive voting stock of the acquiring company in the exchange. By contrast, the shareholders will receive cash in a taxable reverse cash merger.
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