PLR 200029042: Merger payments to target employees avoid parachute rules

Plain-English summary

A public company acquired another public company in a merger that converted the target's shares into buyer shares. Although the buyer's original shareholders gained a substantial indirect interest in the target, the IRS ruled that the merger did not change the target's ownership or effective control for section 280G purposes, provided those shareholders did not act together to control the target. The IRS also found no transfer of a substantial portion of the target's assets. On those facts, merger-contingent compensation paid to the target's employees or former employees was outside the section 280G deduction limit and the section 4999 excise tax. The IRS did not rule on the merger's other federal tax effects.

Ruling snapshot

• Question: Did the merger trigger sections 280G and 4999 for compensation paid to the target's employees?
• Outcome: Approved for target-related payments, subject to the stated control condition.
• Key authorities: IRC §§ 280G and 4999; proposed Treas. Reg. § 1.280G-1, Q&As 27–29.

Full text (IRS public release)

Internal Revenue Service                       Department of the Treasury

Index Number:       280G.01-00                 Washington, DC 20224



Number: 200029042                              Person to Contact:
Release Date: 7/21/2000                        Telephone Number:

                                               Refer Reply To:
                                               CC:EBEO:Br.4-PLR-119813-99
                                               Date:
                                               April 21, 2000


LEGEND:

Company                    =

Target                     =

Date B                     =

Date C                     =

d shares                   =

Exchange                   =

e                          =

f                          =

g                          =

h                          =

k%                         =

m%                         =

p                          =

r                          =

s                          =

      This letter is in response to the letter dated December 13, 1999, submitted by
your authorized representative requesting rulings under section 280G of the Internal
Revenue Code. Specifically, the letter requested rulings, under the facts outlined

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below, that there would not be a change in the ownership and control of Target, nor a
change in the ownership of a substantial portion of its assets within the meaning of
section 280G of the Code, and that section 280G does not apply to any compensation
payments received by employees or former employees of Target. The facts, as
submitted, are set forth below.

       Prior the merger described below, Company and Target were widely-held,
publicly traded corporations. On Date B, Company, Target, and a newly-formed,
wholly-owned subsidiary of Company, Merger Sub, entered into an Agreement and
Plan of Merger (Agreement). Agreement provided for the acquisition of Target by
Company in a transaction in which Merger Sub merged into Target, with Target
continuing in existence following the merger. The merger was intended to be a tax-free
reorganization under the Code. The Board of Directors of Company and Target
unanimously approved the merger.

       As a result of the merger, Target is a wholly-owned subsidiary of Company. On
consummation of the merger on Date C, each outstanding share of Target common
stock was converted into d shares (Exchange Ratio) of Company common stock.
Accordingly, Target’s common stock was de-listed from trading on the Exchange and
under the Securities Exchange Act of 1934.

       Also, on consummation of the merger, each outstanding and unexercised option
to acquire shares of Target common stock was automatically converted into an option
to purchase shares of Company common stock. In each case, the number of shares of
Company common stock subject to the new Company option were equal to the product
of the Exchange Ratio and the number of shares of Target common stock subject to
such Target option.

       Immediately prior to the merger, Company had approximately e outstanding
shares of common stock and f options to purchase shares of Company common stock
which were vested as of Date C. Immediately prior to the merger, Target had
approximately g outstanding shares of common stock and h options to purchase shares
of Target common stock which were vested as of Date C.

       Immediately following the merger and taking into account the Exchange Ratio,
the pre-merger shareholders, including options holders, of Company own approximately
k% of Company and the pre-merger shareholders, including options holders, of Target
own approximately m% of Company.

      In connection with the merger, Company makes the following representations:

1.    The pre-merger Company shareholders owned 20% or more of the total voting
      power of Company’s stock immediately following the merger, and therefore,
      indirectly acquired ownership of 20% or more of the total voting power of

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      Target’s stock;

2.    The pre-merger Company shareholders owned 50% or less of the total fair
      market value and total voting power of Company stock immediately following the
      merger, and therefore, indirectly acquired ownership of 50% or less of Target;

3.    Immediately following the merger, the Board of Directors (BOD) of Company was
      increased from p to r members and is now comprised of the existing p directors
      of Company and s additional directors designated by Target. Target’s Chairman
      and Chief Executive Officer is serving as Chairman of the BOD of Company after
      the merger;

4.    The composition of Company’s BOD following the merger was endorsed by a
      majority of both Company’s and Target’s pre-merger BOD;

5.    The individual who served as Chairman, President, and Chief Executive Officer
      of Company continued as President and Chief Executive Officer of Company
      following the merger;

6.    The charter and bylaws of Target in effect immediately prior to the merger
      remained the charger and bylaws of Target immediately after the merger;

7.    To the best of Company’s knowledge, no pre-merger shareholder of Company
      owned shares representing more than five percent of the voting power in
      Company (and indirectly of Target) immediately following the merger;

8.    To the best of Company’s knowledge, no pre-merger shareholder of Company
      had any agreement, written or unwritten, express or implied, to act in concert to
      control the management and policies of Company (and indirectly of Target)
      immediately following the merger;

9.    To the best of Company’s knowledge, there is no agreement binding any pre-
      merger Company shareholder to vote for a particular nominee to the Board of
      Directors of Target at any time following the merger; and

10.   Pursuant to the terms of the various employment and/or severance agreements
      certain employees of Company and Target may receive payments as a result of
      the merger.

      Section 280G of the Code provides that no deduction will be allowed for any
excess parachute payment. Section 280G(b)(1) defines “excess parachute payment”
as an amount equal to the excess of any parachute payment over the portion of the
base amount allocated to such payment.

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        Section 280G(b)(2)(A) of the Code defines “parachute payment” as any payment
in the nature of compensation to (or for the benefit of) a disqualified individual if (i) such
payment is contingent on a change in the ownership or effective control of the
corporation or in the ownership of a substantial portion of the assets of the corporation
and (ii) the aggregate present value of the payments in the nature of compensation to
(or for the benefit of) such individual which are contingent on such change equals of
exceeds an amount equal to three times the base amount.

      Section 4999(a) of the Code imposes on any person who receives an excess
parachute payment a tax equal to 20 percent of the amount of the payment.

       Section 1.280G-1 of the Proposed Income Tax Regulations, Q&As 27, 28, and
29, published in the Federal Register on May 5, 1989 (54 Fed. Reg. 19,390), provides
guidance concerning when a corporation will be considered to have undergone a
change in ownership or effective control or a change in the ownership of a substantial
portion of its assets.

       Q&A 27(a) provides that a change in the ownership or control of a corporation
occurs on the date that any one person, or more than one person acting as a group,
acquires ownership of stock of the corporation that, together with stock held by such
person or group, possesses more than 50 percent of the total fair market value or total
voting power of the stock of such corporation. Q&A 27(b) provides that persons will not
be considered to be “acting as a group” merely because they happen to purchase or
own stock of the same corporation at the same time, or as a result of the same public
offering. However, persons will be considered to be “acting as a group” if they are
owners of an entity that enters into a merger, consolidation, purchase or acquisition of
stock, or similar business transaction with the corporation. Q&A 27(c) provides that
section 318(a) shall apply in determining stock ownership.

       Example (3) of Q&A 27 deals with a corporate merger. There, Corporation P
merged into Corporation O and the shareholders of P received O stock in exchange for
their P stock. The example concludes that because P shareholders received a greater
than 50 percent interest in O, O experienced a change in ownership. By implication,
the example concludes that P did not experience such a change.

       Q&A 28(a) provides, in part, that a change of effective control of a corporation is
presumed to occur on the date that either (1) any one person, or more than one person
acting as a group, acquires (or has acquired during the 12-month period ending on the
date of the most recent acquisition by such person or persons) ownership of stock of
the corporation possessing 20 percent or more of the total voting power of the stock of
such corporation; or (2) a majority of the members of the corporation’s board of
directors is replaced during any 12-month period by directors whose appointment or
election is not endorsed by a majority of the members of the corporation’s board of
directors, does not transfer power to control (directly or indirectly) the management and

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policies of the corporation from any one person (or more than one person acting as a
group) to another person (or group). Q&A 28(c) contains the same language as Q&A
27(b) concerning when persons will be considered to be “acting as a group.” Q&A
28(d) contains the same language as Q&A 27(c) concerning the application of section
318(a).

        Q&A 29 provides that a change in the ownership of a substantial portion of a
corporation’s assets occurs on the date that any one person, or more than one person
acting as a group, acquires (or has acquired during the 12-month period ending on the
date of the most recent acquisition by such person or persons) assets from the
corporation that have a total fair market value equal to or more than one third of the
total fair market value of all of the assets of the corporation immediately prior to such
acquisition or acquisitions. For this purpose, a transfer of assets by a corporation is
only treated as a change in the ownership of the assets if the corporation transfers the
assets to an entity in which, immediately after the transfer, the shareholders of the
corporation own a greater than 50 percent interest (by value or voting power). See
Q&A 29(b) and Example (3) of Q&A 29(d). Q&A 29(c) contains the same language as
Q&A 27(c) concerning the application of section 318(a).

       Viewing the merger from Company’s perspective, Company surrendered
potential ownership or control when it issued its stock to Target’s shareholders in
consideration for Target stock. Because Target’s shareholders acquired sufficient stock
value and voting power due to this transaction Company experienced a change in
ownership under Q&A 27.

       Viewing the merger from Target’s perspective, all of Target’s stock was
transferred to Company in consideration for the issuance of Company stock to Target’s
shareholders, which resulted in Company’s shareholders receiving a greater than 20
percent indirect voting interest in Target. Accordingly, under Q&A 28, it is presumed
that Target experienced a change in control.

        The facts submitted, however, indicate that the Company shareholders will not
act in a concerted way to control the management and policies of Target. The facts
also indicate that post-merger board of directors of Target was endorsed by a majority
of Target’s board of directors prior to the date of appointment.

      Accordingly, based strictly on the information submitted and Company’s
representations, we rule as follows:

1.    Provided that after the merger the pre-merger shareholders of Company do not
      act in a concerted way to control the management and policies of Target, the
      merger of Merger Sub into Target did not cause a change in the ownership or
      effective control of Target, nor did it cause a change in the ownership of a
      substantial portion of Target’s assets within the meaning of section 280G of the

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       Code;

2.     The provisions of section 280G of the Code do not apply to any compensation
       payments that are received by employees or former employees of Target and its
       subsidiaries and that are contingent on the merger; and

3.     The provisions of section 4999 of the Code do not apply to any compensation
       payments that are received by employees or former employees of Target and its
       subsidiaries and that are considered to be contingent on the merger.

       Except as specifically ruled on above, no opinion is expressed or implied
concerning the tax consequences of any aspect of any transaction or item discussed or
referenced in this letter. Specifically, no opinion was requested and none is expressed
regarding the federal income tax consequences of the above-described merger.

       This ruling is directed only to the taxpayer(s) requesting it. Section 6110(k)(3) of
the Code provides that it may not be used or cited as precedent. The taxpayer should
attach a copy of this ruling to any income tax return to which it is relevant.

        Temporary or final regulations pertaining to one or more of the issues addressed
in this ruling have not been adopted. Therefore, this ruling will be modified or revoked
by the adoption of temporary or final regulations to the extent that the regulations are
inconsistent with any conclusion in the ruling. However, when the criteria in section
12.05 of Rev. Proc. 00-4, 2000-1 I.R.B. 4, 47 are satisfied, a ruling is not revoked or
modified retroactively, except in rare or unusual circumstances.

        In accordance with the Power of Attorney on file with this office, copies of this
letter are being sent to your authorized representatives.

                                                  Sincerely,
                                                  Robert B. Misner
                                                  Assistant Chief, Branch 4