Pepsico Inc. has reached an agreement to acquire its two largest bottling companies, Pepsi Bottling Group, based in Somers, New York, and PepsiAmericas, based in Minneapolis. The transaction is conditioned on, among many other things, securing an opinion of counsel that the acquisitions will, in each case, qualify as tax-free reorganizations within the meaning of the Internal Revenue Code.1 We are as confident as we can be that these opinions will be forthcoming.

The acquisition of each bottling group will be structured as a so-called forward triangular merger. Thus, the bottlers will be merged with and into Newco, a wholly-owned subsidiary of Pepsico, named Pepsi Metropolitan Bottling Co.

For a forward triangular merger to qualify as a tax-free reorganization2, several criteria must be met. For example, Metropolitan must be a first-tier subsidiary of PepsiCo, the bottling groups must merge with and into Metropolitan, no Metropolitan stock may be used in the transaction, and Metropolitan must acquire “substantially all” of the properties of the two bottling groups. So far, all of this is slated to happen. The transaction also has to satisfy the “general requirements” of an “A” reorganization, including the continuity of business enterprise (COBE) and continuity of interest (COI) requriements.3


As far as we can tell, the instant transaction will satisfy COBE because Metropolitan will continue the bottling groups’ historic business. In the mergers, each share of stock held in Pepsi Bottling and PepsiAmericas will be converted in the following way: Pepsi Bottling shareholders will have the option to exchange each share of stock for either $36.50 in cash or 0.6432 shares of PepsiCo common stock. (The cash value is based on PepsiCo’s closing share price of $56.75 on July 31.) Similarly, for each share of stock held by PepsiAmericas shareholders, they will have the option to elect either $28.50 in cash or 0.5055 shares of PepsiCo common stock. (The exchange is also based on PepsiCo’s closing stock price at the end of July.)

Bob Willens 2“In this case, PepsiCo’s preexisting ‘old and cold’ interest in the two bottling groups counts positively toward [continuity of interest].” — Robert Willens

Moreover, the merger agreement states that the number of shares to be converted into the right to receive the “cash exchange price” is equal to the number of shares of the bottling groups’ stock, which is defined as 50% of the number of shares of the bottling groups’ stock outstanding immediately prior to the “effective time.” This limitation is designed to ensure that the COI test will be satisfied.

To be sure, the COI requirement is met only if a “substantial part” of the value of the proprietary interests in the target corporation are “preserved” in the reorganization.4

To preserve the propriety interest, two conditions must be met. First, the interest has to be exchanged for a proprietary interest in the issuing corporation (PepsiCo). Second, the interest has to be exchanged by the acquiring corporation for a direct interest in the target corporation enterprise. In this case, PepsiCo’s preexisting “old and cold” interest in the two bottling groups counts positively toward COI.

What’s more, in determining whether a proprietary interest in the target is preserved, the consideration to be exchanged “shall be valued on the last business day before the first date the contract is a binding contract[that is, on August 5, 2009] if such contract provides for fixed consideration.”5

A contract would be considered to have a fixed consideration if it provides for the number of shares of each class of stock of the issuing corporation, the amount of money, and the “other property” (if any) to be exchanged for all of the proprietary interests — or to be exchanged for each proprietary interest. We believe the instant contract is a binding contract that provides for all of these provisions.

Accordingly, the determination of whether COI is satisfied should be premised on the values existing at the close of business on August 5, 2009. At that time, a substantial part of the value of the proprietary interests in the two bottling groups will be preserved because the value of PepsiCo’s stock comprised 50% of the aggregate consideration to be conveyed to bottlers’ shareholders. Indeed, that would be the case even if PepsiCo’s old and cold stock in the bottling groups was treated as neutral for COI purposes.

For purposes of the COI requirement, it is well settled that as little as 40% constitutes the requisite substantial part.6 Therefore, we can conclude that the instant merger will satisfy the COI requirement and, accordingly, will constitute a tax-free reorganization within the meaning of the tax code.

Robert Willens, founder and principal of Robert Willens LLC, writes a weekly tax column for

1 Specifically, Internal Revenue Code Section 368(a).
2 Specifically, within the meaning of Section 368(a)(1)(A) by reason of Section 368(a)(2)(D).
3 See Revenue Ruling 74-297.
4 See Regulation Section 1.368-1(e)(1)(i).
5 See Regulation Section 1.368-1T(e)(2)(i).
6 See Regulation Section 1.368-1T(e)(2)(v), Example 1.



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