These are what in the tax world are called tax-free reorganizations. These are invariably strategic transactions typically done by companies whose stock is relatively fully valued. It is a powerful form of acquisition currency. Taxes are not due at any level on the exchange itself. There can also be accounting benefits if the transaction qualifies as a pooling of interests under APB 16. This is very difficult to do almost impossible, as a matter of fact—although the Bristol-Myers-Squibb transaction qualified as a pooling. A new basis of accounting for the assets cannot be established for the transaction to qualify. The assets are carried over at their historic value. Most importantly, goodwill is not created on the surviving company’s books. There is no periodic amortization of that intangible asset against earnings. So, this is a powerful incentive for companies that are sensitive to the effect of goodwill on earnings. The Section 351 Merger has been used extensively for its tact in taxes.
Section 351 postpones gain or loss on the contribution of appreciated property to a corporation in exchange for stock, assuming certain rules are followed. Section 351 is usually thought of in connection with the organization of unseasoned start ups. However, in fact the issuer can be newly organized or pre-existing when the stock issuance occurs; it can be any size, have an unlimited number of shareholders pre- and post-financing and divide its shares into as many classes of stock as the situation warrants. In contrast to the S Corporation privilege, the principle of avoiding tax is not dependent on the resultant corporation being uncomplicated.
The principal requirement of Section 351 is that, “immediately after” the financing, the investors who contribute property and or cash in exchange for stock are in control; that is, they own at least 80% of the issuer’s combined voting power (all classes of voting stock) and 80% of the total number of all classes of nonvoting stock. If such is the case (and the property is not subject to liabilities in excess of its basis), no gain will be recognized on appreciated property so transferred, either by the transferers or the recipient corporation. And, according to the usual rules governing tax-postponed transactions, the tax basis of that property in the hands of the corporation will be carried over from the basis of the contributor. Hence, it is has a strategic advantage if implemented properly in the merging of corporations.