The Rules that Launched a Thousand Deals?

A recent cross-border merger met some thorny IRS requirements – including passing the Helen of Troy test – to capture tax-free status as a reorganization.

Called the merger of “generic giants” by the New Jersey press, Jerusalem-based Teva Pharmaceutical Industries announced a definitive agreement in July to acquire the properties of Barr Pharmaceuticals in a transaction that will be structured as a “forward triangular merger.” A few potential snags could have thwarted the companies’ bid for tax-free treatment — namely clearing the continuity of interest hurdle and the Helen of Troy tests. But it looks like the cross-border union of pharma companies have the right prescription to nab a healthy tax benefit.

Barr, which is based in Montvale, New Jersey, is slated to merge with and into a newly-created domestic subsidiary of Teva, and the merger deal calls for Barr stock to be converted into the right to receive 0.6272 ordinary shares of Teva (to be represented by American Depository Receipts) and $39.60 in cash. What’s more, the merger partners plainly expressed their intent that the deal meet the requirements for treatment as a tax-free reorganization within the meaning of Section 368(a) of the tax code.

By tracking the deal specifics and a few tax code subsections, it becomes clear that the pharmaceutical companies should not have a problem passing muster. To start, under Section 368(a)(1)(A) of the code, an acquisition made by a subsidiary of the properties of a target in exchange for stock of the acquiring corporation’s parent qualifies as a reorganization by reason of another subsection — Section 368(a)(2)(D) — if a few criteria are met.

For example, the subsidiary must be a first-tier subsidiary of the issuing corporation (Teva); the target must be merged with and into such subsidiary; the subsidiary must acquire “substantially all” of the properties of the target; no stock of the acquiring subsidiary can be used in the transaction (to compensate the target shareholders for their stock); and the transaction would have qualified as an ‘A’ reorganization had the merger been effected directly into the issuing corporation.

The “could have merged” test means only that the general requirements of a reorganization — in addition to the special requirements imposed by Section 368(a)(2)(D) — must be met. It is not relevant under the test, for instance, that a merger of the target and the issuing parent could have been effected under state or federal corporation law. (See Regulation Section 1.368-2(b)(2).) What is relevant, however, is that the general reorganization requirement of the continuity of interest requirement is met. In other words, the merger’s claim to reorganization treatment boils down to whether Teva will be issuing a sufficient amount of its stock to meet the COI requirement.

Continuity of Interest

The merger meets the COI requirement only if a “substantial part” of the value of the proprietary interests in the target corporation are “preserved” in the transaction. (See Regulation Section 1.368-1(e)(1)(i). ) The purpose of the COI requirement is to prevent transactions that “resemble sales” from qualifying for tax-free treatment — that is, qualifying for non-recognition of gain or loss.1 For this purpose, a proprietary interest is preserved when it is exchanged for a proprietary interest in the issuing corporation. Conversely, a proprietary interest is not preserved when, in connection with the potential reorganization, it is acquired by the issuing corporation for consideration other than stock of the issuing corporation.

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