As a result, the August ruling clearly indicates that warrants count on the "good side" of the COI fraction. That is a surprising development. The regulations provide that a proprietary interest is preserved, for purposes of determining whether the COI requirement is satisfied, if it is exchanged for a proprietary interest in the issuing corporation. What's more, the regulations say that a proprietary interest is not preserved if, in connection with the potential reorganization, it is acquired by the issuing corporation for consideration other than stock of the issuing corporation.4
Accordingly, based on the August private-letter ruling, the IRS seems to consider warrants to purchase stock the equivalent of outright stock — at least for purposes of testing the COI requirement. This is a surprising, though by no means unwelcome, development. For example, in the Ginsberg and Levin text Mergers, Acquisitions, and Buyouts, the authors concluded that, in accordance with the consensus view, "...warrants are not to be taken into account on the good side in determining continuity of shareholder interest...i.e., in determining whether T's shareholders as a group have received P stock for the requisite portion of their old T stock...."5
It had been believed that only stock counts on the "plus side" of the COI equation, and that warrants constitute securities — albeit securities that have no principal amount, and should not be placed on the good side of the COI fraction.6
The August ruling suggests this long-held belief should be revisited. In the eyes of the IRS, it may well be that warrants now constitute stock for purposes of ascertaining whether the COI requirement — necessary to transform an "acquisitive" transaction into a tax-free reorganization — has been satisfied. Assuming that the IRS has, indeed, altered its position, we would like to know whether this dispensation is limited to the G reorganization area or whether it applies with equal force to the other types of reorganizations with respect to which COI is a key factor.
Contributing editor Robert Willens, founder and principal of Robert Willens LLC, writes a weekly tax column for CFO.com.
Footnotes
1 See Section 361(a) of the Internal Revenue Code.
2 Listed in Section 381(c) under Section 381(a).
3 COBE is satisfied if the issuing corporation, or any member of its "qualified group," either continues the historic business of the acquired corporation or uses, in a business, a "significant portion" of the target's historic business assets. In the case of a holding company, its historic business is that of its operating subsidiary. (See Revenue Ruling 85-197, 1985-2 C.B. 120.) Accordingly, here, COBE is satisfied because Sub1 will be, after the merger, continuing to carry on its historic business which, thanks to Revenue Ruling 85-197, is also TP's historic business.
4 See Regulation Section 1.368-1(e)(1)(i).
5 Ginsberg and Levin, Mergers, Acquisitions, and Buyouts, Paragraph 604.
6 See in Regulation Section 1.356-3(b).
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