Definition
A Reverse Morris Trust is a tax-optimization strategy that involves merging a subsidiary with a company it wishes to acquire to avoid capital gains tax. The parent company needs to distribute the equity shares of a subsidiary to its shareholders and then merges it with the target company. This is used when the parent company wants to sell off its assets while avoiding a hefty tax payment.
Phonetic
The phonetics of the keyword “Reverse Morris Trust” is:Ri-ˈvərs ˈmɔrɪs trʌst
Key Takeaways
- Corporate Restructuring Strategy: Reverse Morris Trust is a tax-optimization strategy that facilitates the merger of a subsidiary with a third party, while allowing the parent corporation to avoid paying taxes on any gains from the divestiture. This strategy is used in corporate restructuring.
- Tax Avoidance: It is a legitimate means of tax avoidance, not evasion. The process works in such a way that it prevents the parent company from paying capital gains tax on proceeds of a spinoff if the spinoff subsequently merges with another company.
- Legal Compliance: There are specific conditions that must be met for a transaction to qualify as a Reverse Morris Trust. These conditions include that the shareholders of the parent company must control at least 50% of the voting rights and economic value in the newly-formed company post-merger. Failure to comply with these regulations can result in the imposition of substantial tax liabilities.
Importance
A Reverse Morris Trust is a significant business/finance term due to its role in corporate mergers and divestitures, particularly for tax reasons. This financial mechanism is valuable because it allows a parent company to sell its subsidiary in a tax-efficient manner. The parent company begins by spinning off a subsidiary or unwanted business assets, which then merges with a company interested in acquiring the spun-off assets. The parent company’s shareholders must retain a controlling interest, typically more than 50% in the new or acquiring company, ensuring limited tax liabilities. This makes it a preferred strategy for corporations looking to divest non-core assets while maximizing shareholder value. Thus, the Reverse Morris Trust plays a crucial role in the strategic planning and execution of these tax-efficient corporate restructuring transactions.
Explanation
A Reverse Morris Trust is a finance strategy often used by large corporations to reduce tax implications associated from the disposal or sale of certain assets or divisions. The core purpose of this strategy is to maximize shareholder wealth by avoiding significant capital gains taxes that would typically be levied on outright sales of the assets. Given that levies can be costly, the Reverse Morris Trust arrangement helps companies streamline their operations and increase overall business efficiency by disposing of unwanted or non-core assets or subsidiaries in a tax-efficient manner.In a Reverse Morris Trust transaction, the parent company, seeking to spin off its asset or subsidiary, will first create a subsidiary and transfer the unwanted assets to it. Following this, the original company would then spin off this subsidiary to its current shareholders. Subsequently, this spun-off entity merges with a third party that is interested in acquiring these assets. The majority of voting rights of the new company must reside with the shareholders of the legacy company. In essence, the Reverse Morris Trust allows companies to effectively facilitate significant business transactions, keeping the best interests of the stakeholders, particularly shareholders, in mind without triggering burdensome tax liabilities.
Examples
1. Verizon and FairPoint Communications (2007): Verizon Communications Inc. used the reverse Morris trust structure when it spun off its landline operations in Maine, New Hampshire, and Vermont. The assets were combined with Fairpoint Communications, and Verizon’s shareholders ended up with a 60% stake in the combined company.2. Procter & Gamble and Coty Inc (2015): Procter & Gamble (P&G) used a Reverse Morris Trust to separate its 43 beauty brands (valued at $12 billion) to its shareholders, and immediately after, they merged with Coty Inc. This transaction allowed P&G to reduce its tax liability.3. Lockheed Martin and Leidos (2016): Lockheed Martin, an American aerospace, defense, security, and advanced technologies company, merged its Information Systems & Global Solutions (IS&GS) business with Leidos, a defense company, through a Reverse Morris Trust. This helped Lockheed Martin offload a low margin business while providing its shareholders a majority interest in a high-growth company.
Frequently Asked Questions(FAQ)
What is a Reverse Morris Trust?
A Reverse Morris Trust is a tax-efficient strategy used by companies wishing to sell off or spin off unwanted or unrelated assets while avoiding taxes for the capital gains. This process involves the parent company forming a subsidiary, which then merges with a purchasing company, allowing the parent company’s shareholders to gain a controlling interest in the purchasing firm.
How is a Reverse Morris Trust put into action?
For a Reverse Morris Trust to be enacted, the parent company first transfers unwanted assets into a subsidiary, which is then spun off as a separate company. Subsequently, an unrelated company merges with the spun-off division, with the original company’s shareholders retaining at least 50% control of the newly merged entity.
Who is the Reverse Morris Trust named after?
The Reverse Morris Trust gets its name from the case of Morris Trust v. Commissioner (1965). The strategy emerged from the decision of that case.
How does a Reverse Morris Trust benefit companies?
This process potentially allows companies to avoid significant taxes on capital gains from the sale of these assets. Also, the new entity is usually more profitable because it can focus on operations that it excels at without having to subserve unrelated operations.
Are there any specific criteria for a Reverse Morris Trust?
Yes, some specific IRS criteria must be met for a transaction to qualify as a Reverse Morris Trust. The transaction must be tax-free under Section 355 of the Internal Revenue Code and the shareholders of the selling company must end up with at least 50% of the voting power and value of the buying company.
Can a Reverse Morris Trust be used for any kind of business?
A Reverse Morris Trust, while not restricted to any particular industry or type, is most commonly used by large, diverse corporations looking to divest certain parts of their operations. Because of its complex and specialized nature, this strategy isn’t typically used by small business entities.
Why might a Reverse Morris Trust fail?
The main reason a Reverse Morris Trust might fail is that it may not meet the IRS criteria, potentially resulting in a large tax bill. Additionally, if the parent company’s shareholders don’t retain at least 50% ownership of the new entity, the arrangement would violate the terms of a Reverse Morris Trust.
What is the tax implication of a Reverse Morris Trust?
If properly executed, a Reverse Morris Trust transaction is generally free from federal income tax. The spin-off is tax-free under Section 355 of the Internal Revenue Code. However, poor execution of a Reverse Morris Trust could lead to significant tax liability.
Can individual investors use a Reverse Morris Trust?
No. A Reverse Morris Trust is a complex legal and financial strategy used by corporations to avoid tax on capital gains. It isn’t a strategy applicable to individual investors.
Related Finance Terms
- Spin-off
- Tax-free merger
- Shareholders
- Parent Company
- Subsidiary
Sources for More Information
