Introduction
In general, corporate acquisitions involve a buyer and a seller. The buyer, referred to as the acquiring corporation or the acquiror, represents the company that chooses to buy one or more businesses that are currently operated and owned by another company. The seller, referred to as the target corporation or simply the target, either represents the acquired corporation itself or stands for its shareholders in the aggregate. The target has the desire to either combine its business with that of the acquiring corporation or to sell it to the acquiror in exchange for adequate consideration. Deals involving mergers and acquisitions need to be structured thoroughly. This deal-structuring process should not only determine the principle objectives of the parties engaged in the transaction, but it should also consider the risks inherent in reaching these goals and how these risks can be spread equally among the parties. As a result, part of this process focuses on the form of the acquisition, the type of consideration that is used to pay for the purchase as well as tax-related issues. Although all of these decisions are strongly interrelated, as described below, this chapter will mainly deal with the different forms of acquisition which specify the process of transferring ownership of stock, assets, and liabilities from the acquired corporation to the acquiring corporation. Subsequent chapters will then provide for a greater insight into the other aspects involved.
One of the most important decisions the shareholders of the target corporation need to make is whether they wish to preserve their equity interest in the corporation after the transaction has taken place or whether they would like to terminate their investment in the course of the transaction. The resolution of this matter will not only influence the type of consideration the target's shareholders receive but it will also determine the structure of the entire transaction. In addition, the decision will also affect the tax consequences the deal entails. Since corporate acquisitions are either treated as taxable a tax-free transactions depending on whether certain requirements are met, their characterization for tax purposes will generally influence the price that the target's shareholders demand and the price the acquiring corporation is willing to pay. This indicates that the structure of the acquisition, the type of consideration used, and pricing decisions are strongly interrelated and cannot be decided independently
Forms of Acquisition[1]
The acquisition of a target corporation can be executed by either purchasing the target's stock or by purchasing its assets. Generally, acquisitions are defined as transactions in which one entity gains control over another company, another company's legal subsidiary, or some of its assets. Acquisitions often provide for the continuing existence of the target company as a new subsidiary of the acquiring entity. However, this is not true for cases where the acquisition represents a merger since such transactions are characterized by a combination of the target and the acquiring firm in which one goes out of existence while the other survives
Several possibilities exist as to how both asset and stock acquisitions can be affected. The following figure illustrates the various forms of asset and stock acquisitions.
Figure | 1: Forms of Acquisition | |||||
Forms of Acquisition | ||||||
Acquisitions of Assets | Acquisitions of Stock | |||||
Direct Acquisition of Assets -Without Liquidation of Target Direct Acquisition of Assets -With Liquidation of Target Forward Triangular Merger Consolidation | Direct Acquisition of Stock Reverse Triangular Merger | |||||
Acquisitions of Assets
Direct Acquisition of Assets - Without Liquidation of Target
A direct asset purchase represents the simplest form of an asset acquisition: The acquiring corporation buys some or all of the assets and liabilities for cash, stock, or other consideration directly from the target corporation. The seller is able to remain in existence and is still owned by its shareholders after the transaction. The consideration received for the sale stays with the selling corporation and is not automatically distributed to its shareholders. The selling corporation can choose to either hold the proceeds received through the sale, or declare a dividend, or reinvest them The subsequent figure illustrates a direct asset acquisition in which the target is not liquidated.
Figure 2: Direct Acquisition of Assets - Without Liquidation of Target
Consideration | ||||||||
Acquiring Corporation | Target Corporation | |||||||
Assets H | ||||||||
After the Asset Acquisition: | ||||||||
Acquiring Corporation Holding Some or All of the Target's Assets | Target Corporation | |||||||
From the acquiring corporation's perspective, the main advantages of a direct asset acquisition are the following: The purchaser does not need to buy all of the seller's assets but he can select specific ones. The same applies to the liabilities he assumes. This in turn means that the buyer cannot ordinarily be held liable for liabilities of the seller, unless otherwise specified in the purchase agreement. This applies to disclosed, undisclosed and contingent liabilities. Yet, some liabilities, such as property taxes or claims relating to environmental issues are excluded from this general rule and can only be avoided if an indemnity clause in favor of the purchaser is included in the contract. Depending on the bylaws of the acquiring corporation, the buyer may not need to obtain the approval of its shareholders. The disadvantages of an asset purchase for the buyer comprise the following: Since the assets of the seller are transferred to the acquiring corporation, transfer taxes are imposed on the sale. Moreover, a transfer of assets requires an assignment and a bill of sale. If a large number of assets are transferred, the transaction will prove to be rather cumbersome and costly. In addition, the sale of assets serving as collateral for debt requires the approval of the respective creditor, and the transfer of certain rights, such as patents or licenses, needs to be approved by the particular agency which can turn out to be problematic. Last but not least, certain tax attributes of the seller cannot be transferred to the buyer, such as tax elections, loss carryovers, as well as tax credits.
The main advantages for the seller include the provision that the selling corporation does not go out of existence in the course of an asset acquisition and that it retains the assets that were not transferred. In addition, the above mentioned tax attributes remain with the seller. However, the remaining assets that the buyer decided not to purchase may also represent a disadvantage for the seller if it turns out to be troublesome to sell them separately later on or if they on their own are of no practical use to the seller.
Direct Acquisition of Assets - With Liquidation of Target
Sometimes direct asset purchases are followed by a liquidation of the target corporation, as illustrated below in Figure 3. In these cases it is the shareholders of the target who receive the proceeds of the asset sale since these proceeds are distributed to them in the course of the target's liquidation. In addition, any assets that were not acquired by the acquiring corporation are transferred to the shareholders as well. Occasionally, a liquidating trust is set up if not all of the target's assets can be distributed or not all of the disclosed or undisclosed liabilities are assumed. This means that these remaining assets and liabilities are assigned to the respective trustee, who is then responsible for settling any outstanding matters of the liquidated corporation and distributing any remaining proceeds as soon as possible.
Figure 3: Direct Acquisition of Assets - With Liquidation of Target
Acquiring Corporation | |||||||
Target's Assets and Liabilities | Consideration | ||||||
Target Corporation | Target Stock Is Cancelled | Target's Shareholders | |||||
Consideration Any Remaining Assets & |
|||||||
i i | Afterthe Asset Acquisition and Liquidation of Target: |
||||||
Acquiring Corporation-Holding Some or All of the Target's Assets | |||||||
Types of merger
Forward Merger[2]
Since mergers in the United States
Figure 4 illustrates a forward merger.
Figure | 4: Forward Merger | ||||||
Acquiring Corporation | |||||||
Target's Assets and Liabilities | Merger Consideration | ||||||
Target Corporation | Target Stock Is Cancelled — Merger Consideration --------- | Target's Shareholders | |||||
After the Merger: J L | |||||||
Acquiring Corporation | |||||||
As mentioned briefly above, the acquiring corporation conveys the agreed upon consideration to the target corporation which then transfers it to its own shareholders in exchange for their target stock. The target's stock is cancelled, while the acquiring corporation assumes the target's assets and liabilities. The acquired corporation is then dissolved. The only entity remaining in existence is the acquiring corporation whose stock is now held by its original shareholders and the former shareholders of the target corporation.
Forward Triangular Merger
The forward triangular merger, as shown in Figure 5, represents a modification of the forward merger: instead of the target being directly merged into the acquiring corporation, it is merged into a subsidiary of the purchaser. Such a subsidiary usually typifies a shell that is newly set up by the parent for the purpose of the merger and that is financed by its parent's stock or cash. It is sometimes referred to as "merger sub". In the course of the merger, the target's shareholders receive stock of the parent corporation or other consideration in return for their target stock. The merger sub assumes the assets and liabilities of the target. The target's stock is cancelled and the acquired corporation goes out of existence. Since the acquiring corporation owns the subsidiary's stock, it also is in possession of the target's assets and liabilities that were transferred to the subsidiary.
Figure | 5: Forward Triangular Merger | |||||||
Acquiring Corporation |
Target's Shareholders | |||||||
Merger Consideration given from Parent or Subsidiary ___ | ||||||||
Subs St | diary's ock |
Existing Target Stock Is Cancelled | ||||||
Subsidiary of the | Target Corporation | |||||||
Acquiring Corporation | Merger: Target's Assets and Liabilities | |||||||
After the Merger: |
||||||||
Acquiring Corporation | Subsidiary of the | |||||||
Acquiring Corporation | ||||||||
This subsidiary structure is advantageous whenever the liabilities of the target should be kept isolated from the acquiring corporation. In addition, the acquiring corporation may not need to obtain the vote of its own shareholders under certain circumstances since the assets of the target are merged into the subsidiary and not the parent itself. The only shareholders who would be required to approve the transaction would be those of the subsidiary. Since the parent company is the only shareholder of the subsidiary, the subsidiary's board of directors would need to vote in favor of the deal. Usually, this board comprises the same members as the board of the parent corporation, which in turn means that the approval could be obtained without further problems.
Acquisitions of Stock[3]
Direct Acquisition of Stock
In a direct stock acquisition, the acquiring corporation purchases the stock of the target corporation and all of the target's assets are automatically conveyed with the tar get's stock. Yet, the target's corporate identity is preserved. If the target corporation is a publicly held corporation, the purchaser can either buy the target's stock in the open market or he can offer the target's shareholders the option to buy their shares for cash or to exchange them for stock, or another type of consideration. Stock acquisitions generally result in less complexity and lower costs than asset acquisitions since less documentation is required and no transfer taxes need to be paid. However, it must be considered that just as all of a target's assets are absorbed by the acquiring corporation, all of its liabilities are as well, i.e. the purchaser is liable for any disclosed, undisclosed and contingent liabilities up to the value of the target's assets.
Figure 7: Direct Acquisition of Stock
Consideration | ||||||||
Acquiring Corporation | Target's Shareholders | |||||||
Target Stock | ||||||||
Target Corporation | ||||||||
After the Stock Acquisition: | ||||||||
Acquiring Corporation | Target is a 100 % Subsidiary of the Ac- | |||||||
quiring Corporation | ||||||||
As it is up to each shareholder of the target as to whether he sells his stock or not, stock acquisitions are mainly used in cases where only a small number of shareholders hold a large portion of the target's stock. Depending on the amount of stock the acquiring corporation is able to obtain, the target either turns into a partially or wholly owned subsidiary of the purchaser.
Tax related Issues in Connection with Acquisitions
This chapter will provide for a brief overview of the types of consideration that can be used to finance an acquisition, and the general rule for gain and loss recognition under U.S. Tax Law. In addition, the difference between ordinary income and capital gains is discussed as well as the significant effect the Tax Reform Act of 1986 had within the field of corporate acquisitions.
Type of Consideration
Besides determining the appropriate form of acquisition, as discussed earlier, the decision on what type of consideration will be used to finance the acquisition is also a very significant part of the deal structuring process. The resolution of this issue will mainly determine whether an acquisition will be taxable or tax-free.
Generally, a vast number of types of consideration can be involved in an acquisition, which can all be combined in such a way to best meet the desires of the parties involved in the transaction. However, since discussing all the existing types of consideration would go beyond the scope of this paper, only the most common ones will be mentioned below.
Cash represents the simplest type of consideration. To the extent that cash is involved in an acquisition, the seller terminates his investment in the corporation that is acquired. As a result, any tax consequences will affect the seller at the point in time when the acquisition is consummated. This is the main reason why acquisitions involving too high a percentage of cash can basically not qualify for tax-free treatment, as will be discussed later on.
A second form of consideration comprises assets, i.e. instead of receiving cash the selling shareholders might receive assets. Yet, this might not always prove to be very feasible, especially in cases where a corporation wants to distribute assets to a large number of minority shareholders. Moreover, the receipt of assets is usually treated the same way as the receipt of cash for tax purposes at the shareholder level.
In addition, debt instruments can be used to finance an acquisition. Depending on the underlying terms of such an instrument, the recipient could preserve a substantial interest in the corporation. Nevertheless, debt generally does not provide for the continuing interest that tax-free reorganizations require. The only type of consideration that does count towards continuity of interest in reorganizations is equity securities, i.e. stock. They represent another form of consideration that is used very frequently
Recognition of Gain and Loss - Overview
Under current tax law, the recognition of gain or loss is generally dependent on the occurrence of a realizable event. Such an event occurs whenever property is transferred to somebody else for cash or when property is exchanged "for other property differing materially either in kind or extent" (Reg. § 1.1001-1(a)). Section 1001 (a) regulates that in these cases, the gain and loss to be recognized is equal to the difference between the amount realized in the transaction and the adjusted basis in the property given up. The amount realized corresponds to the amount of cash the transferor receives, increased by the fair market value of any other consideration he receives (cf. § 1001(b)). In most cases this amount also comprises any potential "liabilities from which the transferor is discharged" (Reg. § 1.1001-2(a)) by selling or disposing of the property. Basically, the adjusted basis represents an asset's acquisition price reduced by accumulated depreciation and increased by capital improvements (cf. §§ 1011(a) and 1016).
In transactions governed by § 1001, the transferee's future basis in the assets acquired is the cost of these assets, i.e. the amount the acquiror paid for them. In case the compensation involved in the sale or exchange is not cash but property, the transferor's future basis in this property will correspond to its fair market value (cf. § 1012).
However, the Internal Revenue Code does regulate that certain transactions are excluded from this general recognition rule. Yet, unless such exceptions are explicitly mentioned in the statutes, a sale or an exchange will be a taxable event. The subsequent two chapters, chapters 5 and 6, will deal with taxable acquisitions, in which the statutory requirements for tax-free treatment are not satisfied.
Direct Acquisition of Assets - Without Liquidation of Target[4]
In General
A direct asset purchase without liquidation of the target is characterized by the fact that the corporation selling all or some its assets remains in existence. As a result, it is only the target corporation that receives the proceeds from the disposition of the assets and not the shareholders, unless the corporation decides to distribute them. If the target chooses to hold or reinvest the sales proceeds, the shareholders themselves are not involved in a taxable transaction.
Tax Issues related to Target
In a direct acquisition of assets, the target corporation itself will be required to recognize any gain or loss resulting from the sale. Generally, in cases where the target corporation sells its assets to another corporation, § 1001 (a) is applied. As a result, the target needs to recognize gain or loss on an asset-by-asset basis equal to the difference between the amount realized in the sale and its adjusted basis in the assets given up. The subsequent treatment of these gains or losses depends on the classification of the assets sold and their holding period: capital assets, Section 1231 property, or other assets generating ordinary income. Therefore, a sale of assets can generate different classes of income. Section 1060, which is dealt with in subchapter 5.4, provides detailed instructions on how to allocate a lump-sum purchase price among a number of assets in an "applicable asset acquisition" (§ 1060(a)) in order to determine the correct amount of gain or loss for each single asset. (cf. Scholes et al. 2002, 337).
If the target does not distribute the sales proceeds to its shareholders, it might be able to defer gain recognition in that the consideration it receives involves deferred payments. This means that it might not need to tax the gains related to such payments in the year the sale is executed but it can postpone their taxation to the point in time when the respective payments are received. Generally, a corporation is entitled to defer gain recognition if its disposition of the assets meets the definition of an installment sale and fulfills the requirements set forth in § 453. However, inventory sold can never qualify for installment treatment (cf. § 453(b)(2)). Moreover, any recapture income related to §§ 1245 and 1250, as described below, needs to be recognized in the year of the sale, and only the remaining amount will be treated according to the installment method
Reasons for Preferring Taxable Acquisitions to Tax-Free Reorganizations
Having analyzed the general tax consequences that taxable acquisitions and tax-free acquisitive reorganizations entail, this chapter will point out why certain parties to an acquisition might prefer a taxable transaction to a tax-free one. This is despite the fact that tax-free transactions are basically more desirable than ones that are taxed since they enable the parties receiving qualified property to defer gain and loss recognition.
Asset as well as stock acquisitions affect a number of parties, such as the acquiring corporation, the acquiror's shareholders and creditors, the target, and the target's shareholders and creditors. When structuring a deal, the interests of all these parties need to be taken into consideration. However, it is almost impossible to completely satisfy the wishes of all parties involved. Even when focusing only on the target's shareholders this task is impossible to attain. Every single shareholder will have his own preference since every shareholder holds his target stock with a different intention. For example, some shareholders might have held their target stock as a long-term investment, whereas others might have favored the target corporation itself because of its dividend policy. In addition, individual and corporate shareholders will have different interests. While noncorporate shareholders are generally required to recognize any gain on the receipt of boot, corporate shareholders will not necessarily be obliged to do so, provided that any gains they realize in the corporate acquisition will be treated as dividends qualifying for the dividends-received deduction under §243.
Yet, for an acquisition to qualify for reorganization treatment, a number of requirements must be met, and one of the most important ones comprises the continuity of interest requirement. If a sufficient percentage of equity interest cannot be preserved, an acquisition will not qualify for tax-free reorganization treatment, neither at the shareholder level, nor at the corporate level. However, the majority of a target's shareholders might prefer terminating their stock ownership in the course of an acquisition since they might consider any boot they receive to be less risky than holding stock in a "new” corporation.
In addition, financing a corporate acquisition with debt also has its advantages for the acquiring corporation due to the general deductibility of interest or discounts for tax purposes. This indicates that an acquiring corporation might prefer debt to equity to finance the transaction. While it generally will be entitled to deduct any interest that it pays to its creditors from taxable income, this is not the case in regard to dividends it distributes to shareholders. As a result, financing an acquisition with debt will provide for a leverage, i.e. provide an economic benefit to the owners of the acquiror. However, the more debt is used, the less the chance that the continuity of interest requirement will be satisfied.
Nevertheless, under certain circumstances taxable acquisitions may prove advantageous to the majority of the parties involved. For instance, this would be the case if a target corporation has sufficient net operating losses to offset any gains or at least a significant portion of the gains it would recognize on the sale of its assets in the course of an asset acquisition. If the acquiror's present value of future depreciation and amortization deductions exceeds the cost of structuring an acquisition as a taxable transaction, such a structure will prove beneficial. Moreover, an acquiror will need to opt for a taxable acquisition in instances where he wishes to step up the basis either in the target's assets or the target's stock he acquires, depending on whether the transaction is an asset or stock acquisition.
In addition, an acquiror might even be entitled to make a Section 338(h)(10) election, provided that the respective requirements are met to effect such a transaction, if the acquiror wishes to step up the basis in the target's assets, while invoking only a single level of tax for the selling corporation.
With regard to the target's shareholders, a taxable stock transfer will prove advantageous whenever these shareholders have net operating losses that they can use to offset against any gains resulting from the sale of their target stock. In cases where the consideration they receive for the exchange of their target stock is less than their basis in their target stock, target shareholders might also prefer a taxable sale of their stock to enable them to recognize the loss on this transaction.
Nevertheless, it is essential to bear in mind that even if transactions qualify for tax-free reorganization treatment, gain recognition is not eliminated, it is simply deferred.
The Australian Scenario[5]
This project describes the current merger control regime under Australia's competition law; outlines the framework for its administration; explores its legislative history and development; and examines the experience of its operation in Australia.Merger control is part of Australia's competition law, the Trade Practices Act 1974 ('the Act'). The Act prohibits a range of horizontal and vertical anti-competitive conduct and anti-competitive mergers; has extensive consumer protection provisions; and provides for the regulation of public utilities.
Section 50 of the Act prohibits mergers or acquisitions which substantially lessen competition in a substantial market for goods or services in Australia
An important feature of Australian competition law is that, if it can be demonstrated that a merger results in a sufficient benefit to the public, it can be authorised under a procedure which is quite separate from the competition assessment. It is a formal, transparent, reviewable, administrative procedure to allow an examination of public benefit as a basis for exemption of anti-competitive mergers on a case-by-case basis. This procedure is explained in greater detail further in the paper.
The paper focuses especially on the two changes to the competition test, namely, from substantial lessening of competition [SLC] to dominance, in 1977, and back to SLC, in 1993. It examines the arguments put forward by proponents of each view; and offers some insights of the competition agency from the experience of the operation of the two tests in the Australian market at various times over more than a quarter of a century.
The merger control regime in Australia[6]
This section describes the statutory provisions; the criteria used in assessing whether competition has been substantially lessened; the assessment process; a statutory method for accepting enforceable conditions to allow otherwise unacceptable mergers to proceed; and the procedure for enforcement of the prohibition.
The following section considers the process of authorisation.
The competition standard and the assessment criteria
In essence, section 50 prohibits the acquisition of shares or assets if it would have the effect, or be likely to have the effect, of substantially lessening competition in a substantial market in Australia.2
Section 4E provides that, for the purposes of the Act, unless a contrary intention appears, "market" means a market in Australia
services, includes a market for those goods and services and other goods or services that are substitutable for, or otherwise competitive with, them.3
Section 4G provides that references to the lessening of competition shall be read as including preventing or hindering competition.
Sub-section 50(3) lists a number of factors for assessing whether a merger contravenes the prohibition. These are:
a) the actual and potential level of import competition in the market;
b) the height of barriers to entry to the market;
c) the level of concentration in the market;
d) the degree of countervailing power in the market;
e) the likelihood that the merger would result in the merged entity being able to
significantly and sustainably increase prices or profit margins;
significantly and sustainably increase prices or profit margins;
f) the extent to which substitutes are available, or are likely to be available, in the
market;
market;
g) the dynamic characteristics of the market, including growth, innovation and
product differentiation;
product differentiation;
h) the likelihood that the acquisition would result in the removal from the market
of a vigorous and effective competitor; and i) the nature and extent of vertical integration in the market.
The Commission must consider all these factors but it may consider any other relevant factor.
There is no requirement to notify the Commission about proposed mergers to ensure that their competitive impact is assessed in advance. However, nearly all parties approach the Commission in advance and do not proceed with the merger until it has decided whether or not it will take action to oppose the merger.
2 The process of assessment of the effect of a merger on competition
In assessing mergers, the ACCC follows the criteria contained in the merger factors listed in sub-section 50(3), referred to earlier. However, the sequence of analysis of those factors in respect of a merger is not identical to the order in which they are set out in the Act. In fact, the Commission has organised the statutory factors into a five stage evaluation process.
The analytical sequence is designed to give clear signals of the Commission's likely attitude to merger proposals to the business community, at the earliest possible stage of the assessment process; and, thereby, to minimise the costs of compliance, data collection and analysis for the parties to the merger and the Commission.
The five-step process of assessment is as follows:
(1) The definition of the market in its product, geographic functional and time dimensions; and ascertaining whether it is a substantial one.
(2) Gauging concentration levels. The Commission has adopted twofold
concentration thresholds below which it is unlikely to intervene in a merger.
Generally speaking, if the merged entity would have a market share of more
than 40%, that would suggest the possibility of unilateral market power.
Alternatively, if it would have a share of more than 15% and the post-merger
combined market share of the four largest firms would be greater than 75%,
that would suggest the possibility of coordinated market power. In either of the
above two concentration situations, the Commission would want to give the
proposed merger further consideration. Concentration below the twofold
threshold has come to be known as the 'safe harbour' and the Commission is
normally unlikely to proceed further as the merger would usually be considered
to be unlikely to SLC.
concentration thresholds below which it is unlikely to intervene in a merger.
Generally speaking, if the merged entity would have a market share of more
than 40%, that would suggest the possibility of unilateral market power.
Alternatively, if it would have a share of more than 15% and the post-merger
combined market share of the four largest firms would be greater than 75%,
that would suggest the possibility of coordinated market power. In either of the
above two concentration situations, the Commission would want to give the
proposed merger further consideration. Concentration below the twofold
threshold has come to be known as the 'safe harbour' and the Commission is
normally unlikely to proceed further as the merger would usually be considered
to be unlikely to SLC.
(3) Where the merger crosses either of the concentration thresholds, the
Commission will seek to assess whether actual or potential imports would be
likely to constrain the merged entity. If they are, the merger is unlikely to be
considered to SLC.
Commission will seek to assess whether actual or potential imports would be
likely to constrain the merged entity. If they are, the merger is unlikely to be
considered to SLC.
(4) If the merger crosses either of the concentration thresholds and imports are not
seen to be an effective constraint, the Commission will examine whether there
are significant barriers to the entry of new competitors. If there are not, it will
not oppose the merger.
seen to be an effective constraint, the Commission will examine whether there
are significant barriers to the entry of new competitors. If there are not, it will
not oppose the merger.
(5) In a concentrated market, unconstrained by imports and characterised by
significant entry barriers, the Commission will examine whether any other
factor, such as:
significant entry barriers, the Commission will examine whether any other
factor, such as:
• countervailing bargaining power;
• the availability of substitute product from spare, expandable or convertible
capacity;
capacity;
• dynamic factors including growth, innovation or product differentiation in
the market; or
the market; or
• the elimination or creation of a vigorous and effective competitor
suggests that a substantial lessening of competition is, or is not, likely.
suggests that a substantial lessening of competition is, or is not, likely.
In practice, prospective parties to a proposed merger initially approach the Commission for informal, often confidential, discussions. They generally provide a submission seeking to make their case. Often expert economic analyses and opinion, together with legal argument, are provided. If the proposal is confidential, the Commission is unlikely to be in a position to provide the parties with its finalised view about the acquisition. The Commission normally requires the views of market participants before providing a final response whether it considers a proposed merger may or may not contravene the Act; hence it refrains from forming a view until after it has had an opportunity to test the submissions after the matter becomes public.
A key feature of the Commission's merger assessment work is its market inquiries. Besides seeking further details from the parties the Commission may consult customers, suppliers, competitors, industry associations, government agencies and departments, consumer groups, overseas agencies and trade unions, to seek their views about the likely effect on competition of the merger.
Such an approach conveys a market-oriented picture of the likely effect of a merger, rather than a theoretical construct, based on the parties' submissions, or the Commission's internal assessment thereof. While confidentiality of information has been a concern to parties, the Commission has sought to combine a sensitivity to confidentiality with obtaining relevant information.
If, after the merger has been made public, and the Commission has had an opportunity to make inquiries, it is considered unobjectionable in competition terms, the parties are informed accordingly. Where the Commission has formed the view that a merger is likely to SLC, the Commission will consider offers by the parties to modify the proposal, generally by structural changes, but occasionally by other means, to address the Commission's concerns, through section 87B undertakings (described below). The parties may choose to offer such undertakings or pursue their proposal without amendment. In the latter case, the Commission would have to institute legal proceedings to either prevent the merger or to unwind it in the rare case where it has been consummated. Private parties may not seek injunction. They may, however, seek other forms of relief outlined below, following discussion of section 87B undertakings.
Court enforceable undertakings to modify unacceptable components of
merger proposals
merger proposals
Section 87B, introduced in 1993, provides that the Commission may accept written undertakings from a person in connection with any matter relating to the Commission's functions under the Act. They can be withdrawn or varied with the consent of the Commission. Importantly, the Commission can take court action to compel observance of the undertaking.
The legislation recognises the practical benefits of the flexibility of such undertakings for merger control by explicitly providing for their acceptance and enforceability in the courts; they should be seen as a legitimate tool to allow modifications to permit mergers to proceed where they would, otherwise, not be allowed.
The enforcement of the competition prohibition
The Australian Competition and Consumer Commission has (and its predecessor, the Trade Practices Commission had) the responsibility of administration of the Act, including the merger provisions.
The Commission, however, is not the arbiter of unlawfulness of a merger (ie. whether it does, or does not, substantially lessen competition) - that is the prerogative of the judicial system. The Commission or interested private parties may bring action in the Federal Court of Australia for such relief as they are empowered to seek under the legislation - in the case of the Commission, injunction, pecuniary penalty and/or divestiture; in the case of private parties, for damages and/or divestiture. Appeals lie from a single judge at first instance to the Full Court of the Federal Court. Further appeals may be made to the High Court of Australia, the highest court in the land and the ultimate court of appeal under the Australian judicial system, but only by leave of that Court.
The competition test for mergers is the same as that for the main categories of anti competitive conduct and, as noted earlier, exemption, through an "authorisation" process, is available for mergers on the same basis as for those types of anticompetitive conduct - public benefit outweighing anti-competitive detriment.
The authorisation process is described below, followed by an account of the evolution of the merger test. The arguments for and against each of the merger tests - dominance and SLC; the experience of the Commission in the administration of the merger law under the different tests applying at various times; and the lessons emerging therefrom are then discussed.
The legislative history of merger regulation[7]
In the Trade Practices Act 1974, merger control provisions were introduced for the first time in Australia.25 It prohibited mergers which "were likely to have the effect of substantially lessening competition in a market for goods or services".
The debate, however, continued. The merger provision was examined by a Government-appointed Trade Practices Act Review Committee (the Swanson Committee) in 1976. While the terms of reference of that Committee allowed it to examine all aspects of the merger prohibition, it supported the retention of merger control provisions, in its prevailing form, with a minor change to exclude insignificant mergers from consideration.
Following the report, however, the Government decided to introduce a different test: the prohibition of mergers where, as a result, the merged entity would be, or be likely to be, in a position to control or dominate a market, or where such an existing position was substantially strengthened a, it.
The dominance threshold operated for sixteen years.
The issue resurfaced in 1983. A green paper, The Trade Practices Act - Proposals for Change, issued by then Attorney-General, the Honourable Gareth Evans, canvassed the issue of reverting to the previous SLC test. In the event, only the removal of control was legislated, largely on the grounds that the term was redundant, given that dominance, a lesser standard, was included in the prohibition.
The debate, however, continued, with two parliamentary committees inquiring and reporting on the merger test (among other issues relating to the Act) between 1989 and 1991. First, the House of Representatives Standing Committee on Legal and Constitutional Affairs (the Griffith
The Senate Standing Committee on Legal and Constitutional Affairs (the Cooney Committee) then considered the issue in its report in December 1991 and, by majority, recommended a reversion to the SLC test.
The recommendation was accepted by the Government which enacted amendments to re-instate the SLC test for mergers in 1993. Until this time, no criteria, for the determination of dominance or SLC, had been legislated, but the re-instatement of the SLC test was accompanied by the non-exhaustive statutory merger factors in subsection 50(3), referred to earlier, to facilitate certainty of interpretation. Furthermore, the non-exhaustive criteria of export enhancement, import substitution and international competitiveness, for the consideration of merger authorisation applications, were also included at this time, to ensure that globalisation issues were taken into account.
While the above changes were occurring, the interpretation of dominance began to change in Europe as well as in Australia New Zealand
What is the appropriate test?
The key arguments in support of each test, many of which were canvassed in the debate during the Cooney inquiry, form a useful context in which to examine the Australian experience under both dominance and SLC and they are discussed below.
Scale, international competitiveness and domestic market power[8]
The proponents of the dominance test essentially argued that, in smaller economies, such as Australia
Those in favour of the SLC test argued that the underlying principle of competition policy requires that mergers which substantially lessen competition should be prohibited.The economic evidence strongly suggested that concentrated markets led to the exercise of market power. It was argued that while dominance addressed single firm market power, it did not address coordinated conduct. They pointed to the significant costs imposed on consumers and intermediate businesses under the dominance test. The SLC test, on the other hand, addressed both single firm market power (including dominance) as well as coordinated market power.
During the period of the dominance test, a number of very prominent mergers had not been opposed and many argued that they had caused significant competitive harm.
Those would have been likely to have been scrutinised and probably opposed under an SLC test. The most prominent ones were:[9]
• Coles-Myer. This was a merger between two of the three largest competitors
in the department store and discount department store retailing sectors of
retailing. A merger in the supermarket sector, shortly thereafter, between
Woolworths and Safeways, combined two of the four largest integrated
supermarket chains. The overall impact of these two mergers appeared to
be a substantial increase in concentration in the retailing sector. In these major
areas of retailing, the Commission did not oppose mergers of leading firms,
under the dominance test, which led to substantial increases in concentration.
in the department store and discount department store retailing sectors of
retailing. A merger in the supermarket sector, shortly thereafter, between
Woolworths and Safeways, combined two of the four largest integrated
supermarket chains. The overall impact of these two mergers appeared to
be a substantial increase in concentration in the retailing sector. In these major
areas of retailing, the Commission did not oppose mergers of leading firms,
under the dominance test, which led to substantial increases in concentration.
• In the newspaper market, two of the three national newspaper publishing
groups, News Ltd and Herald & Weekly Times had merged, leavingFairfax
the only remaining significant competitor.
groups, News Ltd and Herald & Weekly Times had merged, leaving
the only remaining significant competitor.
• In the national domestic aviation market, a merger between Ansett Airlines
and East West Airlines reduced the number of interstate competitors from
three (Qantas, Ansett and East-West), to two. While Qantas and Ansett were
substantially larger than East West, it was a vigorous and effective competitor
on the trunk routes it competed on, with good prospects of growth.
and East West Airlines reduced the number of interstate competitors from
three (Qantas, Ansett and East-West), to two. While Qantas and Ansett were
substantially larger than East West, it was a vigorous and effective competitor
on the trunk routes it competed on, with good prospects of growth.
A number of other mergers that did not infringe the dominance standard, but would have required examination under an SLC test, and many of which might have been opposed, were identified by the Commission to the Cooney Committee.
The Commission also expressed concern about markets that had either been recently de-regulated or were candidates for imminent deregulation such as airlines and telecommunications where mergers short of dominance were likely to defeat the objectives of deregulation.
Experience showed that competitiveness at home bred efficiency and competitiveness abroad. The conclusions of Professor Michael Porter, of the Harvard Business School
A strong anti-trust policy - especially for horizontal mergers, alliances and collusive behaviour - is fundamental to innovation. While it is fashionable today to call for mergers and alliances in the name of globalization and the creation of national champions, these often undermine the creation of competitive advantage. Real national competitiveness requires governments to disallow mergers, acquisitions and alliances that involve industry leaders ... Companies should, however, be allowed to acquire small companies in related industries when the move promotes the transfer of skills that could ultimately create competitive advantage.
While there were concerns that a strong merger law could prevent firms achieving scale and scope economies to compete effectively on international markets, in the traded goods sector, where international competitiveness arguments were most relevant, the introduction of the SLC test did not prevent mergers. Not only does import competition feature prominently in the consideration of competitive constraints; authorisation is also possible, where international competitiveness on domestic and overseas markets, is mandated by the statute as a consideration, even where the merger leads to single firm dominance, as discussed under the topic of authorisation above.
In the non-tradeable sector, largely insulated from international competition, market power led to cost increases for downstream firms, whose international competitiveness was adversely affected. Competition reform of the "utility" sector (eg. electricity; water; railways; telecommunications; gas pipelines), which often involved vertical and horizontal separation of large suppliers, would be undermined by anti-competitive mergers, which the Commission would be unable to prevent under a dominance test.
The certainty from maintaining the status quo of the dominance test versus
the costs of adjustment to the SLC test
the costs of adjustment to the SLC test
The proponents of the dominance test also argued that there was no need to change to SLC since they considered that the dominance test worked well - it was simple to understand; SLC was much more complex; would require adjustment; assessment would require more time; and all these factors would lead to costly uncertainty.
The advocates for an SLC test argued that standard economic concepts, based on well accepted economic theory and experience, underpin the SLC test and provide clarity. As noted earlier, there were signs of a possible trend by the courts to a gradual lowering of the single firm dominance standard, thereby making the nature of the standard less clear. Recent European experience of a drift, from the concept of unilateral market power under a dominance test to coordinated market power based on the concept of collective dominance, suggests that had the 1993 change not occurred, Australian courts might well have also gradually drifted away from the clarity of single firm dominance to the less conceptually clear collective dominance standard on a case-by-case basis. In fact, during the Cooney Inquiry, there were informal discussions about various alternative options such as: measures to lower the test of dominance by broadening it to catch more anti-competitive situations, while retaining the existing substantive test; widening the test to include concepts such as joint, collective or shared dominance; to retain the dominance test but set criteria which were close to the SLC test; to adopt the SLC test but define it using criteria based on single firm dominance. It was decided that all such modifications to the test were conceptually unclear and would be likely to cause confusion, thereby making them difficult to administer. In addition, it was believed that, in principle, the SLC test was appropriate.
Consistency, value added by mergers and other issues
Proponents of the SLC test argued that there was a need for consistency between the merger test and that applying to the conduct provisions. Firms prohibited from price-fixing could achieve the same outcome through merger - a very strong incentive to merge. Arguments, based on "event studies" and "accounting studies" of the outcomes of mergers, that they led to substantial economic benefits, were put forward to the Cooney Committee; the former relating to value generated, as measured by stock-market capitalisation; the latter based on profitability. No firm conclusions could be drawn from such studies as their findings were contradictory.
The Committee also considered the results of a study by the Bureau of Industry Economics, into the effects of four mergers in three sectors of the manufacturing industry, one involving automotive batteries, two in the roof tiles sector and one in pastry products, over the period 1985 to 1989.Broadly, the study concluded that, both, the anti-competitive detriments and the rationalisation benefits, were small. Causal links between the mergers and the benefits were not demonstrable.The Cooney Committee concluded that, overall, quantitative studies about the benefits of mergers were inconclusive.
In considering the arguments, it is useful to remember that the two parliamentary inquiries were conducted against the backdrop of the 1980's which experienced the notorious excesses of big business.
Conclusion
This project analyzed the various tax consequences taxable acquisitions and tax-free reorganizations entail under the Tax Law System of the United States
However, despite the fact that transactions might qualify for non recognition of gain or loss treatment, this beneficial tax treatment does not necessarily apply to all parties involved in such a transaction.
Having described the provisions and effects of the various forms of acquisition, the author is of the opinion that there is no one structure that will best meet the desires of all parties to an acquisition. Therefore, it is essential to first determine the preferences of the parties involved, and then to identify which structure will best meet these desires. Moreover, the acquiror will have to determine whether he prefers accomplishing an asset or a stock acquisition, taking into consideration the various advantages and disadvantages the different forms of acquisition have.
Although deciding on the tax effects that a corporate acquisition will entail is an essential part of the entire deal structuring process, the consequences of which should not be underestimated, taxes are rarely the main motive for consummating a deal. In addition, any acquisitions that are solely effected with the intention of avoiding taxes will not satisfy the business purpose doctrine. Generally, the primary motives of a corporate acquisition are the basic economic effects that such a transaction will give rise to. Nevertheless, determining the appropriate tax structure that will best satisfy the needs of the parties involved in such a transaction can fortify the decision to effect the acquisition
Although tax-free acquisitive reorganizations are generally preferred to taxable acquisitions since they provide for gain recognition, they might not always prove to be the best choice. However, when deciding that a transaction should be effected by means of a tax-free reorganization, the parties involved need to take great care to ensure that the respective requirements are met. While the "A" Reorganization provides for the greatest flexibility in regard to statutory conditions that need to be satisfied, it can only be consummated if the acquisition represents a merger or consolidation that is effected pursuant to state or federal law. However, since there is no necessity to use voting stock of the acquiring corporation as merger consideration, this type of reorganization can be especially advantageous in cases where the acquiror is reluctant to dilute the number of outstanding shares with voting power. In addition, in an "A" Reorganization, the highest percentage of boot can be used, as compared to the other types of acquisitive reorganizations.
Forward triangular mergers qualifying for reorganization treatment have the additional advantage that the target's liabilities can be kept isolated from the parent corporation, and the parent might be able to avoid the necessity of obtaining a shareholder approval for the transaction. However, in tax-free forward triangular mergers, substantially all of the target's assets must be acquired.
On the contrary, "B" Reorganizations, representing stock acquisitions, generally provide for greater simplicity and lower transaction costs since there is no need to comply with state or federal merger laws, as is the case in "A" Reorganizations, and the target's assets are generally not transferred to the acquiror but remain with the acquired corporation. In addition, "B" Type acquisitions do not require that the target retain substantially all of its assets before or after the acquisition. Consequently, such transactions are advantageous if the target distributed any of its assets to its shareholders or if assets are to be transferred to, for instance, the acquiror following the acquisition. Moreover, since "B" Reorganizations are stock acquisitions, the acquiring corporation does not have to assume the target's liabilities, as is the case in "A" and possibly "C" Reorganizations. Nevertheless, the main drawback of "B" Reorganizations is the "solely for voting stock" requirement, prohibiting the use of any boot. In addition, the issuance of voting stock will lead to a dilution of the control that ac-quiror's shareholders have.
Despite the fact that "C" Reorganizations, being assets acquisitions, also entail the "solely for voting stock" requirement, the respective conditions, however, contain boot relaxation rules. As a result, the required percentage of voting stock that needs to be used as consideration amounts to 80%. Nevertheless, the conditions that substantially all of the target's assets need to be acquired and that the target is required to liquidate in the course of the transaction provide for additional drawbacks. Yet, "C" Reorganizations can prove useful in situations where an acquisition cannot be con summated pursuant to state or federal merger laws. Moreover, the acquiring corporation might be able to bypass the approval and appraisal rights of its own shareholders, which is generally not possible in a merger.
Reverse triangular mergers entail the advantage that the target remains in existence after the acquisition, providing that any non-transferable permits and contracts the target may have can be preserved. Moreover, the target's liabilities remain with the target itself, which means that they are kept isolated from the parent corporation. In addition, since such an acquisition represents a merger, the parent can be sure to obtain control of the target corporation. However, reverse triangular mergers qualifying for reorganization treatment need to satisfy the condition that the target must hold substantially all of its own assets as well those of the subsidiary after the transaction is consummated. Although the requirements regarding permitted consideration are less restrictive than in a "B" Reorganization, the acquiror is required to gain control of the target only by using his voting stock.
Since this paper focused on C Corporations, it would be very interesting to analyze the tax effects other types of entities entail. Moreover, despite the fact that this paper dealt with corporate acquisitions that are effected by corporations charted in the United States
Australian merger law has a number of significant features:
1. It has experimented with both a dominance test and an SLC test and appears
likely to remain permanently with the SLC test.
likely to remain permanently with the SLC test.
2. The SLC test generally covers a wider range of mergers particularly those likely
to give rise to enhanced possibilities of co-operative behaviour.
to give rise to enhanced possibilities of co-operative behaviour.
3. It takes account of possible significant anti-competitive effects in segments of
markets characterised by product differentiation.
markets characterised by product differentiation.
4. Benefit was seen in changing from dominance to the conceptually clear SLC
criterion rather than experiencing uncertainty through a gradual change in the
law through the judicial precedents of case law.
criterion rather than experiencing uncertainty through a gradual change in the
law through the judicial precedents of case law.
5. The changeover from the dominance test to the SLC test was accomplished
relatively smoothly in terms of certainty for business.
relatively smoothly in terms of certainty for business.
6. Australia
can occur if a sufficient public benefit can justify this. Although there are few
authorisation applications, it enables approvals of mergers in those instances
where a benefit to the public can be demonstrated.
can occur if a sufficient public benefit can justify this. Although there are few
authorisation applications, it enables approvals of mergers in those instances
where a benefit to the public can be demonstrated.
Moreover, in relation to claims that the merger law needs to take account of a case for mergers necessary in a global world, the Commission's acceptance of mergers in the traded goods sector and the existence of authorisation means that, even with the SLC test, there are few obstacles to genuinely justified mergers needed in a globalised world.
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