Corporate Mergers And Acquisitions In The Income Tax Law Research

Due to different tax implications, M&A transactions fall into two broad categories: Taxable M&A and Tax-Free M&A in the USA and in China. The principal distinguishing feature between taxable M&A and tax-free M&A is the consideration paid by the acquiring corporation. If the consideration is paid in cash, the transaction will usually be categorized into taxable M&A and the transferor is obliged to pay income tax. However, if a substantial portion (if not all) of the consideration consists of the stock of the acquiring corporation or its parent corporation, the transaction will be categorized into tax-free reorganization resulting in non-recognition of income and therefore no immediate tax duty to the tranferor. The underlying policy for this tax-free treatment is that the tranferor has not "cashed in" their investment and therefore the transaction only constitutes "change in form". The "continuity of proprietary interest", the "continuity of enterprise" and the "Business Purpose" are prerequisites for a certain M&A to be classified into tax-free reorganization in the USA.The second key element which has significant tax impact is the accounting method adopted by the acquiring corporation. Purchase method with cost basis is more preferential to the acquiring corporation since it entitles the acquiring corporation to deduct from its taxable income more depreciation or amortization cost and therefore reduce the tax burden. Pooling of Interests Method with substituted basis can not serve as "tax shield" as the purchase method has done.Meanwhile, the way of financing can also have significant tax implications: debt financing can considerably reduce the tax burden of the acquiring corporation since the interest paid to the creditor can be deducted before the calculation of taxable income. Therefore LBO has become one of the most popular method, leading to thin capitalization. Regulation on thin capitalization are tightened to mitigate the greater risk caused by LBO.