The Upside to a Downstairs Merger

Can Retail Ventures Inc., the parent of shoe retailer DSW, be eliminated in a tax-efficient way?

However, for an ownership change to transpire, the 5% shareholders, in the aggregate, must increase their percentage ownership of the loss corporation’s stock by more than 50 percentage points. Accordingly, it would appear that a merger of RVI with and into DSW would have no adverse affect on the latter’s ability to freely use the NOL it would inherit in the merger.

Also with regard to the merger, it seems likely that DSW would assume its predecessor’s liability with respect to the PIES.

The good news is that the satisfaction of such PIES with the obligor’s own stock would not give rise to a gain or loss.5 That is, if RVI satisfy the PIES with its stock in DSW the gain that RVI would recognize could be avoided if, prior to the satisfaction of the PIES, the obligation were assumed by DSW and then defrayed with DSW’s stock.6

The bad news is that the persons to whom such stock was issued would constitute a new 5% shareholder of DSW whose increase in ownership would have to be taken into account in determining whether there has been an ownership change. Accordingly, in order to preserve, DSW’s inherited NOL, it might be prudent to satisfy the PIES with cash, rather than DSW stock. Thus, it would appear that a downstream merger would be effective in this case. This technique was legitimized in 2000 when Seagate Technology completed a downstairs merger with and into Veritas Software, with the result that the discount at which Seagate’s stock was trading (to the value of Seagate’s stock in Veritas) was eliminated. We see no reason why a similar outcome could not occur with respect to RVI and DSW.

Contributor Robert Willens, founder and principal of

Robert Willens LLC,

writes a weekly tax column for


1 Commissioner v. Estate of Gilmore, 130 F.2d 791 (3rd Cir. 1942).
2Gregory v. Helvering, 293 US 465 (1935).
3 The merger would also exhibit the requisite degree of continuity of business enterprise. See Rev. Rul. 85-197, 1985-2 C.B. 120; P Corporation, (P), is a holding company whose only asset consists of all of the stock of an operating subsidiary, (S). P merges with and into S and the P shareholders exchange their P stock for S stock. Requisite to a reorganization is a continuity of the business enterprise under modified corporate form. Continuity of business enterprise is satisfied if the acquiring corporation (S) continues the “historic business” of the acquired corporation (P). Here, of course, P has no historic business. The ruling states that the application of this general rule to certain transactions, such as mergers of holding companies, will depend on all facts and circumstances. The policy underlying this general rule “provides the guidance necessary to make these determinations”. The ruling concludes that the policy enunciated in the regulations (to insure that reorganizations are limited to readjustments of continuing interests in property under modified corporate forms) is satisfied here. Thus, for purposes of the continuity of business enterprise requirement, the historic business of P is the business of S. Accordingly, after the merger S continues to conduct P’s historic business with the result that the continuity of business requirement was satisfied.
4  See Section 382(k)(1) and (k)(3).
5 See Section 1032.
6 However, the debtor could realize income from discharge of indebtedness (“COD income”) if, and to the extent that, the value of the stock issued is less than the adjusted issue price of the debt defrayed through such issuance. See Sec. 108(e)(8); for purposes of determining income of a debtor from discharge of indebtedness, if a debtor corporation transfers stock to a creditor in satisfaction of its recourse or non-recourse indebtedness, such corporation shall be treated as having satisfied the indebtedness with an amount of money equal to the fair market value of the stock.


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