In the case of a “merger of equals,” like the one involving Delta and Northwest, it would appear that the Delta shareholders would emerge from the transaction with a majority of the combined corporation’s stock. The merger raises a few questions regarding tax ownership and treatment, however. First, does such a merger give rise to an ownership change with respect to Delta, Northwest or both? And, who are the five percent shareholders of the surviving corporation, and will those five percent shareholders experience the requisite increase in ownership?
Assume that the surviving corporation is widely-held and no person owns as much as five percent of the corporation’s stock. In that case, the surviving corporation will have at least one five percent shareholder: the so-called public group consisting of all less than five percent shareholders. This is so because Section 382(g)(4)(A) provides that “… in determining whether an ownership change has occurred, all stock owned by shareholders of a corporation who are not five percent shareholders… shall be treated as stock owned by one five percent shareholder.”
Thus, if these so-called “aggregation” rules alone applied, 100 percent of the stock would be owned by the same five percent shareholders both before and after the merger — the public group consisting of all less than five percent shareholders — and, accordingly, there would be no ownership change with respect to either loss corporations. Unfortunately, under Section 382(g)(4)(B) and (C), these less than five percent shareholders can and will be further “segregated” into groups each of which will be treated as a separate five percent shareholder.
The tax code, as is put forth in Reg. Section 1.382-2T(g)(1)(iii), states that the term “five percent shareholder” includes a public group identified as a five percent shareholder under Reg. Section 1.382-2T(j)(2) or (j)(3). Those references focus on transactions to which Section 381(a)(2) applies with respect to how shareholders are segregated before and after the transaction.* For example, a merger that qualifies as a reorganization under Section 368(a)(1)(A) would fall into the purview of Section 381.
For this purpose, the direct public group that acquires stock in the transaction is presumed not to include any members of any direct public group that existed immediately before the transaction. As a result, the surviving corporation will have (at the very least) two five percent shareholders: the Delta group, which is the public group consisting of all of Delta’s less than five percent shareholders; and the Northwest group, the public group comprised of all of Northwest’s less than five percent shareholders.
In addition, with respect to Northwest, the Delta group will have experienced a more than 50 percentage point increase in ownership relative to the five percent shareholder’s lowest percentage of ownership at any time during the testing period. Accordingly, under this scenario, Northwest would be the loss corporation which would experience the ownership change.