The following article is adapted from reprinted from the M&A Tax Report, Vol. 8, No. 1, August 1999, Panel Publishers, New York, NY.
WHITHER BAUSCH & LOMB?
By Robert W. Wood, San Francisco
If you a are real old-fashioned corporate tax or M&A afficionado (some of our readers have just been eliminated), you will remember the venable Bausch & Lomb doctrine. I guess I'm dating myself here, but it was about 40 years ago (in 1959 to be exact) that the Internal Revenue Service agreed with the Second Circuit Court of Appeals in a case involving the famed optical maker. See Bausch & Lomb Optical Company v. Commissioner, 267 F.2d 75 (2d Cir. 1959), cert. denied, 361 U.S. 835 (1959). In the now hoary Bausch & Lomb case, the parties had attempted a C reorganization (an acquisition of assets for voting stock).
Because the acquiring corporation held 79% of the acquired corporation's stock before the acquisition, the buyer acquired the assets of the target in exchange for voting stock in itself (voting stock in the acquiring corporation). The target was then liquidated and, pursuant to the liquidation, the acquiring corporation received back its stock held by the target. Ignoring the issuance of stock by the acquiring corporation and the return of that same stock later on as part and parcel of the same transaction, the court viewed the acquisition as occurring pursuant to the liquidation, rather than solely in exchange for the voting stock of the acquiring corporation. C reorganization treatment was therefore not available. (See also Revenue Ruling 58-93, 1958-1 C.B. 188; and Revenue Ruling 54-396, 1954-2 C.B. 147.)
Needless to say, this Bausch & Lomb problem arises only when a corporation attempts to acquire the assets of a partially owned subsidiary. In the Bausch & Lomb case, the taxpayer owned 79% of the subsidiary's stock. The case has always been an unfortunate one—an illustration of the old adage that bad facts make bad law. It is apparent, however, that Bausch & Lomb's failure to own 80% of the stock of its subsidiary was critical, since a liquidation under Section 332 could then have been accomplished.
Moreover, if Bausch & Lomb had owned 20% or less of the acquired corporation's stock, the so-called "boot relaxation rules" would have allowed up to 20% of the consideration to be boot. See I.R.C. §368(a)(2)(B). Furthermore, even if the percentages in Bausch & Lomb were not changed at all, a B reorganization (as opposed to a C reorganization) would currently not be subject to attack. On this point, consider Revenue Ruling 69-585, 1969-2 C.B. 56, where a B reorganization was upheld where 75% of the stock was acquired solely for the parent's stock, and the remainder was acquired as a dividend from the acquiring corporation's 100% owned subsidiary. (But compare Revenue Ruling 69-294, 1969-1 C.B. 110.)
Historically, as a result of the Bausch & Lomb debacle, a liquidation of the acquired corporation shortly following the transaction has always been somewhat suspect. A safer alternative has been a statutory merger. See Revenue Ruling 58-93, 1958-1 C.B. 188. Even a D reorganization has been preferable. See Revenue Ruling 85-107, 1985-2 C.B. 107. M&A Tax Report Advisory Board Member Gil Bloom of KPMG, LLP in Washington has implored the IRS to go one step further in its proposed rules to eliminate the Bausch & Lomb problem in the C reorganization context. Indeed, Mr. Bloom has noted that the IRS has applied the Bausch & Lomb doctrine to B reorganizations. A failure to eliminate a Bausch & Lomb threat in the context of a B reorganization as well, therefore, would be inequitable, Bloom argues. (See Tax Notes Doc. No. 1999-22980.)
Winds of Change
Perhaps sometimes the IRS concludes that 40 years of adverse authority (and proverbial traps for the unwary) may be just about long enough. That is why we'll deliver a report next month on the IRS' proposal to abandon (yep, that's right!), the Bausch & Lomb doctrine. See "IRS May Drop Tax Penalty on Some Reorganizations," Wall Street Journal, June 14, 1999, p. A22.
In the meantime, until you see our full coverage on the apparent demise of the Bausch & Lomb doctrine in the September 1999 M&A Tax Report , you may want to read up on one of the IRS' lengthy manifestos on Bausch & Lomb. It is contained in General Counsel Memorandum 39404 (see Vol. 28, Tax Notes, p. 1473, September 23, 1985).
Whither Bausch & Lomb?, Vol. 8, No. 1, The M&A Tax Report (August 1999), p. 6.