On January 5, 2005, the IRS issued proposed regulations that allow certain mergers and consolidations effected pursuant to foreign law to qualify as tax-free “A” reorganizations, if they meet certain criteria in the US law and qualify as reorganizations under foreign law. The regs become effective when published as temporary or permanent regulations, and they will be welcome relief to practitioners.

Currently, certain transactions involving foreign corps qualify for tax-free treatment as “B,” “C,” or “D” reorganizations, but generally not as “A” reorganizations. This limitation adds complexity and restricts flexibility in structuring such transactions, because “A” reorg requirements are generally less stringent in matters such as the amount of non-stock consideration that can be given by the acquiror, the amount of unwanted assets of the target that can be retained or disposed of before the acquisition, and the treatment of option holders. For example, an “A” reorg generally does not restrict the use of cash (and other non-stock) consideration given by the acquiror, other than the general “continuity of proprietary interest” requirement, which generally permits at least 50 percent cash (most practitioners are comfortable with 60 percent); “B” and “C” reorgs generally impose lower thresholds or prohibit the use of cash altogether. Expanding the scope of “A” reorgs to embrace foreign corps will also ease internal restructurings in many cases, such as the merger of a US parent's two foreign subs.

At present, to qualify as an “A” (statutory merger) transaction, the merger must be effected pursuant to the laws of the United States, any state, or the District of Columbia. Mergers and consolidations arising under foreign law generally do not qualify, although some cross-border transactions may be structured to meet “A” requirements; for example, a foreign acquiror of a US company can form a US acquisition subsidiary to merge with the target. The proposals replace the US-law requirement with a requirement that the transfer of assets and liabilities be effected “pursuant to the statute or statutes necessary to effect the merger or consolidation.” If the transaction is effected under foreign law, it must also qualify as a reorganization under that foreign law and must meet certain criteria found in the US law: most notably, the assets and liabilities of the participating corporations must be transferred by operation of law--that is, by statutory rule rather than by contract.

The new regs remove certain existing restrictions on statutory mergers and consolidations that involve foreign disregarded entities. In general, the ownership of such an entity (for example, an NSULC) by one merging party no longer prevents a merger from qualifying as an “A” reorganization: previously, the “effected under US law” requirement created uncertainty even if both corporations involved in the merger were domestic.

The new regs encompass both foreign-to-foreign mergers and US-to-foreign mergers. Regarding the latter, the Delaware merger statute contemplates mergers of Delaware corporations and foreign corporations if the transaction is authorized under foreign-country law. The regs also appear to encompass a Canadian amalgamation; it does not qualify under the two-party US merger structure, where one corporation survives and the other disappears, but it may qualify under the consolidation structure, where a new third corporation is deemed created.