The following article is adapted from reprinted from the M&A Tax Report, Vol. 7, No. 7, February 1999, Panel Publishers, New York, NY.
ONE MORE FSA—THIS TIME CONTINUITY OF INTEREST
By Robert W. Wood, San Francisco
With the recent spate of Field Service Advices now in circulation (thanks to the successful suit by Tax Analysts), it takes some work to get through all the now released IRS pieces of guidance. Some of them are highly topical, and others more dated. In a 1993 Field Service Advice (that along with most others was just released in late 1998), the IRS advised that a particular merger failed for lack of continuity of interest. Anytime there is a continuity problem, practitioners should take note, since very frequently, practitioners sail along (in the absence of a ruling) thinking that they have easily met the age-old continuity test.
In Field Service Advice 1998-411, the Service considered a merger of a mutual property and liability insurance company into another similar mutual property and liability insurance company. After the merger, there was a cash distribution to the merged company's policyholders. It was this cash distribution that caused the Service to evaluate whether continuity of interest had existed. The target company was a mutual property and liability insurance company in the reinsurance business, and was in financial difficulty. The acquiring company agreed with the target to acquire the target's assets in a reorganization.
On the merger, the target's policyholders received proprietary rights in the acquiring company similar to those that they had held in the target. The acquiring company also paid a cash distribution to the target's policyholders that was approximately equal to the target's net operating loss carryover, assuming that the transaction qualified as a type A reorganization.
Again The IRS, on the other hand, viewed the merger and the distribution as integrated steps of the same transaction. The IRS found that the target policyholders had exchanged their proprietary interest in the target for proprietary interests in the acquiring company, plus cash. Consequently, the value of the equity interest that the target policyholders received in the acquiring company was less than 50% of the value of the target equity interests they surrendered. Finding that the transaction fell below its historic 50% ruling policy, the Service concluded that continuity of interest, one of the hallmark requirements for a reorganization, was not present.
One More FSA: This Time, Continuity of Interest, Vol. 7, No. 7, The M&A Tax Report (February 1999), p. 8.