Problem:
Emily and Richard have invested in Faster Distribution, a small publicly traded company. They each own 40% of the stock of Faster Distribution.
They could want to sell Faster to Leeds but do not want to pay any tax on the sale. According to Section 368 of the IRS Code, there are seven allowed types of tax-free reorganizations:
- Statutory merger
- Exchange of stock for stock
- Exchange of stock for property
- Transfer of assets between commonly controlled corporations
- Recapitalization
- Change of identity or form or organization
- Tansfer in bankruptcy
Emily and Richard have controlling interest in both Leeds and Faster, so their goal of selling Faster to Leeds would qualify as a tax-free reorganization of either a type B or type D reorganization. In addition, Emily and Richard are considering how to report the combination. It is their intent to build a vertically integrated corporation to provide value to all shareholders.
Emily and Richard have been discussing the business combination with a nephew who recently earned his certified public accountant (CPA) certificate. His advice was to report the combination as a combined financial statement, but they were unsure which theory to use.
For each of the following 3 theories--proprietary theory, parent company theory, entity theory:
- Describe each theory
- Explain how each theory would apply in this situation
- Recommend a theory for them and support your choice with your rationale.