Disposing of a valuable corporate charter is not as simple as a straight sale of the asset and can have unintended tax consequences if not properly structured. Corporations in certain regulated industries such as insurance or banking may have to jump through some regulatory hoops in transferring a charter. The requirements for such a transfer vary by state, but government agencies usually do not permit the charter to be transferred as a stand-alone asset. Therefore, the seller of a charter needs to go through certain steps and follow the requisite legal format to comply with the government agency requirements in order to properly effect the transfer.
The IRS has previously provided guidance on how a charter sale may be treated as a reorganization if certain conditions are met. The approved structures depend on the laws of the state and whether the state permits the sale of a single bank charter, but they have generally followed the structure in Rev. Proc. 89-50, with some acceptable deviations to comply with government agency requirements.
In May 2008, the Service issued Letter Ruling 200822022, which discusses the combination of bank subsidiaries’ operations and a subsequent sale of a bank charter. The letter ruling recasts the events leading up to the sale of the bank charter into transaction steps constituting a tax-free reorganization and discusses the tax implications of each step of the reorganization.
Letter Ruling 200822022Letter Ruling 200822022 provides guidance on a specific factual situation for the sale of a bank charter when state law will not permit a bank charter to be sold by itself. The key issues addressed were: (1) the steps of the reorganization needed to complete the sale of the charter; (2) the representations made by parties to the reorganization; and (3) the tax implications for the reorganization.
In the ruling, Acquirer and Target, both State A chartered banks and subsidiaries of Parent, a bank holding company, desired to combine their operations. Parent also wanted to sell Target’s State A bank charter to Third-Party Holding Company, a State B corporation and bank holding company unrelated to Parent, which owns all the stock of Third-Party Bank. Government Agency would not permit a State A bank charter to be transferred by itself. Rather, it would approve the proposed sale of the bank charter only if a certain transaction form was utilized.
The form required by Government Agency to effect the transaction is as follows:
- Target will transfer to Acquirer all its assets and liabilities, except for Target’s bank charter and the minimum capital required by Government Agency to maintain Target’s corporate existence.
- Parent will sell Target’s stock to Third-Party Holding Company for a payment of $X plus the value of the minimum capital.
- Parent will transfer to Acquirer the fair market value of the minimum capital. Third-Party Holding Company will merge Target with and into Third-Party Bank, with Third-Party Bank surviving.
The steps required above by Government Agency to effect the transaction are in accordance with the form approved in Rev. Proc. 89-50.
Recast as D Reorg.When applying this particular factual situation and the representations outlined in the ruling, the Service recast the steps of the transaction as follows:
1.The acquisition by Acquirer of all Target’s assets (including the bank charter and the minimum capital) solely in exchange for constructive Acquirer common stock and the assumption by Acquirer of Target’s liabilities;
2.The distribution to Parent by Target of the Acquirer stock in exchange for all of Parent’s Target stock in complete liquidation of Target;
3.The distribution to Parent by Acquirer of the bank charter and minimum capital of Target in redemption of a portion of Parent’s Acquirer stock constructively received in (2) above;
4.The contribution by Parent of the bank charter and the minimum capital of Target received in (3) above to the capital of New Target (the Deemed Contribution) in exchange for the issuance of New Target stock to Parent; and
5.The sale of all New Target’s stock to Third-Party Holding Company (the Deemed Sale) for $X plus the minimum capital.
The IRS ruled, among other things, that the recast steps (1) and (2) above would constitute a tax-free reorganization within the meaning of Sec. 368(a)(1)(D) and that Acquirer would recognize gain or loss under Sec. 311(b) or Regs. Sec. 1.1502-13(f)(2)(iii) from the recast step (3) above. Such gain or loss would be taken into account under the timing rules of Regs. Sec. 1.1502-13 upon the deemed sale of New Target in the recast step (5) above. The favorable conclusions in the ruling are consistent with other letter rulings as well as Rev. Proc. 89-50.
Rev. Proc. 89-50 and Earlier Letter RulingsIn Rev. Proc. 89-50, the IRS addressed situations in which the target did not dissolve under state law so that the value of its corporate charter could be realized. Rev. Proc. 89-50 established certain conditions under which the Service will normally rule that the distribution requirement applicable to reorganizations under Secs. 368(a)(1)(C) and 368(a)(1)(D) has been met. Under Rev. Proc. 89-50, as long as the additional representations for retention of corporate charters in Secs. 368(a)(1)(C) and 368(a)(1)(D) reorganizations were made, the IRS agreed to recast the transaction to qualify as a C or D reorganization. However, the Service has allowed similar but varied transaction structures to qualify for tax-free reorganization treatment.
For example, in Letter Ruling 200645006, in step 1 of the proposed transaction, the minimal capital and the charter of Target were contributed to a newly formed company, which was subsequently merged into an unrelated bank. The Parent of Target received cash for the value of the Target bank charter and any required minimum capital as well as the book value of the assets of Target. Subsequently, Parent transferred the cash to Acquiring, its bank subsidiary. Acquiring retained the cash for the charter and minimal capital and used the cash for the book value of the assets to acquire the assets previously held by Target from the unrelated bank.
While the transaction described in Letter Ruling 200645006 differed slightly in structure to comply with government agency requirements, the tax implications are similar to those outlined in Letter Ruling 200822022. The same holds true for Letter Ruling 200128051, in which the transaction structure again varied to comply with government agency requirements, and the IRS ruled favorably that the transaction would be recast and treated as a D reorganization.
ConclusionThe transaction described in Letter Ruling 200822022 is another structure the IRS has permitted for a bank to consummate a charter sale while complying with certain state law requirements and still receive favorable tax-free reorganization treatment. The ruling exemplifies the Service’s willingness to allow a corporation to dispose of a valuable corporate charter without incurring unfavorable tax consequences for complying with government agency structuring requirements.
Frank J. O’Connell Jr. is a partner in Crowe Chizek in Oak Brook, IL.
Unless otherwise noted, contributors are members of or associated with Crowe Chizek.
For additional information about these items, contact Mr. O’Connell at (630) 574-1619 or firstname.lastname@example.org.