Reverse Morris Trust

What is Reverse Morris Trust?

Reverse Morris Trust is a technique used in the mergers and acquisitions to avoid the tax implications by way of spin-off that results in reorganization and transfer of assets and liabilities in a tax-efficient manner. It is very prevalent in the United States of America (USA).

How does Reverse Morris Trust Work?

  1. There must be a parent-subsidiary structure.
  2. By fulfilling various conditions provided under section 355 of internal revenue code, Parent wants to sell the subsidiarySubsidiaryA subsidiary company is controlled by another company, better known as a parent or holding company. The control is exerted through ownership of more than 50% of the voting stock of the subsidiary. Subsidiaries are either set up or acquired by the controlling company.read more in a tax-efficient manner.
  3. Parent companyParent CompanyA holding company is a company that owns the majority voting shares of another company (subsidiary company). This company also generally controls the management of that company, as well as directs the subsidiary's directions and policies.read more spin-offs the subsidiary to the shareholder of the parent company.
  4. A subsidiary company is merged with the 3rd company. Such 3rd party must be looked smaller as compared to a subsidiary company. As a result minority stakeMinority StakeMinority interest is the investors' stakeholding that is less than 50% of the existing shares or the voting rights in the company. The minority shareholders do not have control over the company through their voting rights, thereby having a meagre role in the corporate decision-making.read more will be less than 50%. The assets to be acquired are spun off and promptly merged with the buyer.
  5. 51% of Shareholding of the merged company must be owned by the original parent entity’s shareholder only.

However, one needs to make sure that post-merger as well, all the conditions prescribed under Section 355 should be adequately fulfilled for at least 2 years.

Reverse Morris Trust

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History

In the world of mergers and acquisitions, each structure is either result of some loophole in the law or based on the judgement by the court of the land. Morris Trust structures are the result of a ruling by the US court of appeals in 1966 in the case of Commissioner v. Mary Archer W. Morris Trust.

Based on this judgement, people started leveraging the advantages. As a result, internal revenue survey formulated section 355 in 1977 for the Reverse Morris trust giving various conditions needed to be complied for getting the tax benefits.

Example

ABC Co. wanted to sale its XYZ Co, owning manufacturing operations for specific geo, to PQR Co. To comply with the tax requirement, ABC Co planned the Reverse Morris structure in the following manner. ABC CO. transferred assets of XYZ Co, to separate subsidiary. Also, ABC Co sells the share of XYZ Co to its own shareholders.

Then, ABC Co. completed a Reverse Morris Trust reorganization with PQR Co, in which shareholders of ABC Co. is having the majority stake in the newly merged company, while PQR co’s shareholders and management will be having the minority stake in the company.

Rules of Reverse Morris Trust

To be eligible for tax benefits under the Reverse Morris Trust structure, all the conditions given under section 355 must be fulfilled.

  1. Ownership test: In the newly merged company, the shareholding of the original parent company must remain 50% post-merger as well.
  2. Equity cannot be sold from post-merger. If it is sold, then it should not go below 50% of the threshold limit.
  3. Debt to Debt or Debt to Equity Swap ratio can be determined. However, that must be within the given criteria of 50% ownership.
  4. Parent and Subsidiary must have a track history of actively undertaken trade or business for 5 years before initiating the Reverse Morris trust structure.
  5. The newly merged company must continue the business for a specified period post-merger as well.
  6. Asset test: Parent company must have ownership of at least 80% of the asset of the subsidiary, which they want to divest out.

Advantages

  • #1 – Avoids Corporate Taxes on Gains – Main advantage of reverse Morris structure is that it enables the way of doing tax planning within the legal boundaries of tax laws.
  • #2 – Consideration Paid is the Acquirer’s Stock – Buyer can give the consideration even in equity shares as well, which makes it very much attractive in the corporate world.
  • #3 – Net Book Value of the Transmission Assets Remains the Same for Old and New Owner – Under Reverse Morris trust structure, all the assets must be transferred to 3rd company at the book value. As a result, it does not result in the irrelevant increase in the overvaluation of the assets.
  • #4 – Silent Movement of Assets – Spin-off of the assets will be happening promptly immediately after the selling of the shares to the shareholders. This will enable the free movement of assets as no further approvals are needed to be taken.
  • #5 – There will be the same management, same employees, same workforce, and the same asset with the same ideology to do the business. This will not have any impact in day to day business of the business. Hence, it is considered a silent transfer of subsidiaries.

Disadvantages

  • #1 – Limited Scope for Issue of Consideration in Cash – Consideration will be very restricted to equity as the threshold of equity is needed to be maintained. Hence, there exists a minimal scope of monetary issuance of consideration.
  • #2 – Limited Scope for Issue of Equity Post-Merger – 51% of the ownership of the original shareholder of the parent company is needed to be maintained thoroughly post-merger as well. This does not give room to issue post-merger as well.

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