Favorable Treatment of Charter Sales Is Reaffirmed

Favorable Treatment of Charter Sales Is Reaffirmed

By Jennifer M. Sanders, CPA, and Melissa A. Reinbold, CPA

Disposing of a valuable corporate charter is not as simple as the sale of an asset and can have unintended tax consequences if not properly structured. The requirements for a charter transfer vary by state, but government agencies usually do not permit a charter to be transferred as a stand-alone asset. Authors Jennifer Sanders and Melissa Reinbold explain some of the regulatory hoops that insurance or banking corporations might have to jump through to transfer a charter properly.

The seller of a charter must go through certain steps and follow the requisite legal format to comply with the government agency requirements and properly effect the transfer. The Internal Revenue Service (IRS) has provided guidance on how a charter sale may be treated as a reorganization if certain conditions are met. The approved structures depend on the laws of the state and whether the state permits the sale of a single bank charter, but have generally followed the structure in IRS Revenue Procedure 89-50, with some acceptable deviations to comply with government agency requirements.

In May 2008, the IRS issued Letter Ruling 200822022, which discusses the combination of bank subsidiaries' operations with the subsequent sale of a bank charter. The ruling recasts the events leading up to the sale of the bank charter into the transaction steps constituting a tax-free reorganization and discusses the tax implications of each step of the deemed reorganization.

Overview of the Letter Ruling
Letter Ruling 200822022 provides guidance on a specific factual situation involving the sale of a bank charter when state law did not permit a bank charter to be sold alone. In the ruling, “Parent,” a bank holding company and parent of a consolidated group that includes its wholly owned subsidiaries, “Acquirer” and “Target,” sought to combine the operations of Acquirer and Target, both “State A” chartered banks. Parent also sought to sell Target’s State A bank charter to “Third-party Holding Company,” a “State B” corporation and bank holding company unrelated to Parent, which owns all the stock of “Third-party Bank.” “Government Agency” would not permit a State A bank charter to be transferred alone. Rather, it would approve the proposed sale of the bank charter only if a certain transaction form was used.

The steps required by Government Agency were as follows:

1. Target will transfer to Acquirer all of its assets and liabilities, except for Target's bank charter and the minimum capital required by Government Agency to maintain Target's corporate existence.

2. Parent will sell Target’s stock to Third-party Holding Company for a payment of $X plus the value of the minimum capital.

3. Parent will transfer to Acquirer the fair market value of the minimum capital.

4. Third-party Holding Company will merge Target with and into Third-party Bank with Third-party Bank surviving.

The steps required by Government Agency to effect the transaction are in accord with the form approved in Revenue Procedure 89-50.

Recast as a Tax-free Reorganization
When analyzing the particular factual situation and the representations outlined in the ruling, the IRS recast the steps of the transaction as follows:

1. The acquisition by Acquirer of all of Target’s assets (including the bank charter and the minimum capital) solely in exchange for constructive Acquirer common stock and the assumption by Acquirer of Target’s liabilities;

2. The distribution to Parent by Target of Acquirer’s stock in exchange for all of Parent's Target stock in complete liquidation of Target;

3. The distribution to Parent by Acquirer of the bank charter and minimum capital of Target in redemption for a portion of Parent's Acquirer stock constructively received in step 2 above;

4. The contribution by Parent of the bank charter and the minimum capital of Target received in step 3 above to the capital of New Target (the "deemed contribution") in exchange for the issuance of New Target stock to Parent; and

5. The sale of all the stock of New Target to Third-party Holding Company (the "deemed sale") for $X plus the minimum capital.

The IRS ruled, among other things, that steps 1 and 2 would constitute a tax-free reorganization within the meaning of Section 368(a)(1)(D) of the Internal Revenue Code. It also ruled that Acquirer would recognize a gain equal to the $X paid for the bank charter and that such gain would be recognized upon the deemed sale of New Target in step 5 above. The favorable conclusions in the ruling are consistent with Revenue Procedure 89-50 as well as other letter rulings.

In Revenue Procedure 89-50, the IRS addressed situations in which a target corporation did not dissolve under state law so that the value of its corporate charter could be realized. The revenue procedure established certain conditions under which the IRS will normally rule that the distribution requirement applicable to reorganizations under Sections 368(a)(1)(C) and 368(a)(1)(D) has been met. Under Revenue Procedure 89-50, as long as the additional representations for retention of corporate charters in Sections 368(a)(1)(C) and 368(a)(1)(D) reorganizations were made, the IRS agreed to recast the transaction to qualify as a C or D reorganization. However, the IRS has in the past allowed similar but varied transaction structures to qualify for tax-free reorganization treatment.

Securing Favorable Treatment
The transaction described in Letter Ruling 200822022 is another structure the IRS has permitted for a bank to consummate a charter sale while complying with certain state law requirements and still receive favorable tax-free reorganization treatment. The ruling illustrates how the IRS will allow a corporation to dispose of a valuable corporate charter without incurring unfavorable tax consequences for complying with structuring requirements of government agencies.

Jennifer Sanders is an executive with Crowe Horwath LLP in the Louisville, Ky., office. She can be reached at 502.420.4418 or jennifer.sanders@crowehorwath.com.

Melissa Reinbold is an executive with Crowe Horwath LLP in the Oak Brook, Ill., office. She can be reached at 630.586.5244 or melissa.reinbold@crowehorwath.com.

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