Determinants of Tax Status

The general requirements for tax-free status are that the acquisition be for a business purpose, and not to avoid taxes, and that there be a continuity of equity interest. In other words, the stockholders in the target firm must retain an equity interest in the bidder.

The specific requirements for a tax-free acquisition depend on the legal form of the acquisition, but, in general, if the buying firm offers the selling firm cash for its equity, it will be a taxable acquisition. If shares of stock are offered, the transaction will generally be a tax-free acquisition.

In a tax-free acquisition, the selling shareholders are considered to have exchanged their old shares for new ones of equal value, so that no capital gains or losses are experienced.

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