Continuity of the corporate doctrine

DEFINITION of the Business Continuity Doctrine

The going concern doctrine is a tax principle applicable to corporate mergers and acquisitions. The doctrine maintains that, to qualify as a tax-deferred reorganization, the acquiring entity must either continue the historical activity of the target company or use a substantial part of the business assets of the target in the course of its activities.

In summary, the doctrine applies to how taxes are treated when a business changes hands. The acquiring entity must maintain the operational activity or retain most of the assets when two entities merge to achieve tax-deferred status. It is vital for many fusions, including the inverted triangle fusion.

BREAKING the Continuity of the Commercial Enterprise Doctrine

The going concern doctrine only applies to the business activities and assets of the target company, not the acquiring company. Thus, in a situation where most of a company’s assets are sought to be sold (divested), one way of ensuring compliance with the going concern doctrine is to make this company the acquirer rather than the target. It is a technique that has been approved by the IRS.

Under the US federal tax code, corporate reorganizations have often received preferential treatment. However, taxes can become tricky depending on whether a transaction is a reorganization or the sale of an equity interest. For an operation to be qualified as a reorganization, thus treated favorably for tax purposes, the business continuity doctrine examines whether the shareholders of a target, before the reorganization, continued to hold a proprietary interest in the reorganized company. Essentially, it requires shareholders of a target entity to receive a significant portion of their consideration in shares of the acquiring entity. In addition, the doctrine requires that the acquiring company either continue the target’s operations or use a significant portion of the target’s assets in a commercial form. If these conditions cannot be met, the tax code treats the shareholders of the target as having sold, rather than maintained, their interest in the company and the assets of the target. Thus, the transaction would not be considered a reorganization and would be taxed at both the corporate and shareholder level.

For many business transactions, tax treatment can be an important motivating factor for a proposed transaction; although this is a highly technical matter, the doctrine of continuity of commercial enterprise is very important.