Invesco’s Tax-Free Deal for Van Kampen

Invesco's foreign status makes a tax-free acquisition of Morgan Stanley's retail Van Kampen business a little more complicated, but not out of reach.

For purposes of the rule, when a U.S. person exchanges domestic shares of the so-called Section 354 stock for shares in a foreign corporation, as is the case in the Invesco/Van Kampen deal, the person shall be treated as having made an indirect transfer of such stock to a foreign corporation that is subject to the rules of this section.1

Further, the Invesco/Van Kampen deal entails the exchange by a U.S. person of stock in a corporation for stock in a foreign corporation that controls the acquiring corporation (AlphaSub) in a reorganization described in Section 368(a)(1)(A) and Section 368(a)(2)(D).2

Therefore, the exchange, otherwise rendered tax-free by Section 354, will be taxable unless an exception applies. In the case of Invesco/Van Kampen, the exception set forth in Regulation Section 1.367(a)-3(c) appears to be available. That section provides that a transfer of stock of a domestic corporation by a U.S. person to a foreign corporation shall not be subject to Section 367(a)(1) if:
• 50% or less of both the total voting power and total value of the stock of the transferee (Invesco) is received in the transaction by U.S. transferors;
• 50% or less of each of the total voting power and the total value of the stock of the transferee is owned immediately after the transfer by U.S. persons that are officers or directors of the U.S. target or that are 5% target shareholders;
• The U.S. person is not a “5% transferee shareholder” or will become such a 5% transferee shareholder and enters into a “five year gain recognition agreement” (it would appear that here Morgan Stanley will be constrained to execute such an agreement);
• The active trade or business test is met. It will be so met if, as here, the transferee (Invesco) is engaged in the active conduct of at least one trade or business outside of the United States for the entire 36-month period immediately before the transfer; and
• The “substantiality” test is met. It will be so met if, as here, at the time of the transfer, the fair-market value of the transferee is at least equal to the fair-market value of the U.S. target.

Thus, Morgan Stanley should be positioned to receive the Invesco stock provided for in the agreement on a tax-free basis.

However, the agreement also contains a provision that permits Morgan Stanley to opt out of the merger structure and, instead, to “sell” the Van Kampen stock to Invesco (or to AlphaSub) in exchange for the merger consideration. In that case, the parties acknowledge that the sale will be fully taxable.

The transaction, if this alternative structure is adopted, cannot qualify as a “B” reorganization because a portion of the consideration to be received by Morgan Stanley for the Van Kampen stock will consist of nonvoting stock. A “B” reorganization is defined as an acquisition by a company in which the company’s voting stock3 is exchanged for the stock of another corporation, provided that immediately after the acquisition, the acquiring corporation has control within the meaning of Section 368(c) of the target.


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