Pretransaction restructuring

CASE STUDY | September 13, 2023

Authored by RSM US LLP

Frequently, when buyers and sellers are negotiating transactions, the parties to the transaction want to structure the deal in a manner that suits their business needs. This makes perfect sense. But, sometimes, these negotiations can cause a tax problem to arise– perhaps a tax problem that is not at all obvious.


In a recent transaction, a RSM client (HC) was in negotiations to sell the stock of its two domestic operating subsidiaries, X and Y, to a foreign corporation (FP). As part of these negotiations, FP realized that if it purchased the stocks of X and Y separately, these two domestic corporations would not be able to file a consolidated U.S. tax return. To eliminate the need to file separately for the businesses of X and Y, FP requested that HC merge X into Y in a tax-free reorganization as permitted under section 368. This request seemed benign and was certainly understandable from a business viewpoint.


However, as a result of FP’s merger request, a question arose: Will the merger of X into Y be tax-free under the rules that apply under section 368? One such rule relates to the continuity of interest (COI) requirement. Under this rule, when X merges into Y, the shareholder of X (HC) must receive, as a significant portion of the total consideration for the merger, stock in the acquiring corporation (Y). In this case, HC would own 100 percent of both X and Y, and when this unity of ownership exists, the rule states that Y will be deemed to have issued its stock to HC as consideration for the merger. Thus, it appeared that all would be well.

But also warranting consideration was the fact that HC would sell the stock of Y immediately after the merger and, in fact, would have a contract with FP to do just that. To satisfy the COI requirement, it was necessary to address the question of whether a sale of the Y stock immediately after the merger was permissible. The answer is generally yes. In fact, the COI rules are rather liberal, stating that sales of the Y stock, even if pursuant to a binding contract entered into before the merger, are permissible. Thus, it continued to appear that all would be well.

But there is a trap for the unwary that RSM discovered through continued due diligence. It is true that the COI rules generally allow all or any portion of the stock received by HC to be sold, but there is an exception. HC may not sell the Y stock to any corporation related to Y. On the face of things, it certainly did seem that FP was unrelated to Y. Yet, herein lies the trap for the unwary that RSM discovered. Due diligence established that the rules underlying COI instruct that in determining which parties are related to Y, any corporation that was related to Y before the transaction and any corporation that becomes related to Y as a result of the transaction must be taken into account. Because RSM pointed out this exception to the general COI rule, FP was able to avoid a very real and significant issue.


In this case, the merger of X into Y would have been done at the request of FP and done solely to facilitate the closing of the sale to FP. Had FP bought 100 percent of the stock of Y post-merger, it is clear that Y would have become related to FP. A conclusion that FP became related to Y as a result of the merger would mean that the COI rule was failed. If the COI rule was failed, then the merger of X into Y would have become a taxable sale of all the assets of X to Y, and X would have owed tax on this sale. In this case, that tax would have been several million dollars. Because X was to be merged into Y, by law Y would assume all liabilities of X, including its tax liabilities. This meant that, in this case, FP might be purchasing a corporation with millions of dollars in tax liabilities, completely altering the economics of the deal it thought it had made.

The solution was simple to implement. RSM advised that FP must purchase the stock of X and Y separately (i.e., no pre-purchase merger). Once this was done, FP would be free to either (1) transfer 100 percent of the X stock to Y, which would allow X and Y to file a consolidated return, or (2) merge X into Y, making moot the filing of a consolidated return. RSM determined that if the merger took place after the purchase of X and Y as two separate corporations, no problem would exist under the COI rules. In negotiating a deal to fit the business needs of the parties, one must make certain that no tax issues are created that cannot be properly addressed. Small changes in facts can mean large changes in tax consequences.

Let's Talk!

Call us at +1 213.873.1700, email us at or fill out the form below and we'll contact you to discuss your specific situation.

  • Topic Name:
  • Should be Empty:

This article was written by RSM US LLP and originally appeared on 2023-09-13.
2022 RSM US LLP. All rights reserved.

The information contained herein is general in nature and based on authorities that are subject to change. RSM US LLP guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. RSM US LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer.

RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each is separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit us for more information regarding RSM US LLP and RSM International. The RSM logo is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.

​Vasquez & Company LLP is a proud member of the RSM US Alliance, a premier affiliation of independent accounting and consulting firms in the United States. RSM US Alliance provides our firm with access to resources of RSM US LLP, the leading provider of audit, tax and consulting services focused on the middle market. RSM US LLP is a licensed CPA firm and the U.S. member of RSM International, a global network of independent audit, tax and consulting firms with more than 43,000 people in over 120 countries.

Our membership in RSM US Alliance has elevated our capabilities in the marketplace, helping to differentiate our firm from the competition while allowing us to maintain our independence and entrepreneurial culture. We have access to a valuable peer network of like-sized firms as well as a broad range of tools, expertise and technical resources.

For more information on how ​Vasquez & Company LLP can assist you, please call +1 213.873.1700.

Subscribe to receive important updates from our Insights and Resources.

  • Should be Empty: