With an eye to minimizing taxes, O’Reilly Automotive Inc. and CSK Auto Corp. are taking measured steps to implement an agreement reached in April. If they can secure status as a reorganization, highly appreciated O’Reilly assets can move to CSK without tax consequences and related securities can change hands on a tax-free basis.
The transaction features two crucial steps and a third at O’Reilly’s option. Whether the transaction comprises two steps or three, O’Reilly should achieve its objective, a reorganization with the meaning of Section 368(a) of the tax code.
First, O’Reilly launched a tender offer for CSK shares. In exchange, CSK shareholders were slated to receive some number of shares linked to their trading price in a specified measurement period. For each tendered share accepted for purchase, CSK shareholders will receive fractional shares of O’Reilly, plus $1 in cash if selected deal-related expenses exceed fixed thresholds.
On completion of the tender offer, the O’Reilly subsidiary that launched it (and which will be in possession of a majority of CSK stock) will merge with CSK. Remaining CSK stock will eventually convert into a “merger consideration.”
Tender Offer and Reverse Merger
The O’Reilly transaction closely resembles an example in Internal Revenue Service annals. “Sigma” Corp., a wholly owned, newly created subsidiary of “Psi” Corp., launched a successful tender offer to exchange Psi voting stock for not less than 51 percent of the stock of unrelated “Tau” Corp. Immediately after completing the tender offer, Sigma and Tau merged. Tau holdouts eventually exchanged their remaining 49 percent of outstanding stock for Psi voting stock and cash.
The IRS verdict was hard to predict: qualifications for reorganization apply subject to particular requirements. Questions arose because “in the transaction,” the former shareholders of the surviving Tau corporation must exchange, in return for voting stock of the controlling corporation Psi, an amount of stock in the surviving corporation that constitutes “control” [see Section 368(a)(2)(E)(ii)]. Here, control means ownership of stock possessing at least 80 percent of the total combined voting power of all classes of voting stock plus at least 80 percent of the total number of shares of each class, if any, of the nonvoting stock.
The outcome hinged on contours of the transaction. A transaction comprised solely of the reverse merger (of Sigma with and into Psi) would not have satisfied the “control for voting stock” requirement. In the transaction, the Tau shareholders would have exchanged substantially less than 80 percent of Tau’s stock for voting stock of Psi [see Revenue Ruling 74-564, 1974-2 C.B. 124].
Fortunately, the ruling leaves room to negotiate. “Under general principles of tax law including the step-transaction doctrine, the tender offer and the merger are treated as an integrated acquisition by Psi of all of Tau’s stock.” The ruling cites principles embedded in King Enterprises, Inc. v. United States, 418 F.2d 511 (Ct. Cl. 1969). That decision treated the tender offer as part of the statutory merger for purposes of the reorganization provisions. Consequently, the ruling concludes that the steps must be evaluated together to determine whether the requirements of Section 368(a)(2)(E) are met. So viewed, the transaction met the requirements of Section 368(a)(2)(E) because, “in the transaction” (comprised of both the tender offer and second step merger), the former Tau shareholders exchanged some 81 percent of Tau stock for voting stock of Psi.