Definition
A Reverse Morris Trust is a tax-optimization strategy that corporations use when they wish to spin off or sell assets without incurring a tax liability. The parent company spins off a subsidiary, which then merges with a third-party company, creating a new, tax-free entity. It’s named after a 1966 court case, Morris Trust v. Commissioner, and ensures that shareholders maintain a controlling stake in the new company.
Key Takeaways
- A Reverse Morris Trust is a tax-efficient strategy to facilitate the merger of a larger company’s unwanted assets with a smaller company.
- This structure allows the larger company’s shareholders to control the merged company while also gaining an exemption from capital gains tax that would typically apply in a divestiture.
- For a Reverse Morris Trust to take place, certain criteria must be met, including that the shareholders of the parent company should possess at least a 50% stake in the merged entity. If the criteria are not met, the parent company may face substantial tax penalties.
Importance
A Reverse Morris Trust is a tax-efficient strategy that companies use during mergers and acquisitions to reduce tax liabilities.
This finance term is important mainly because it allows a company to sell off or spin-off unwanted assets without having to pay taxes on any gains from the sale.
Under this structure, a parent company creates a subsidiary, assets are moved into that subsidiary, and it is then merged with a firm interested in acquiring the assets.
The original shareholders retain a majority stake in the new firm, thereby bypassing the usual tax implications associated with selling assets.
Therefore, understanding the Reverse Morris Trust is crucial for companies as it can potentially save millions in tax payments.
Explanation
The Reverse Morris Trust is a tax-optimization strategy often utilized by corporations during mergers and spin-offs, aiming to escape possible high tax liabilities. It’s primarily used to combine a profitable subsidiary with another company while avoiding the recognized gain and hence, tax on the transaction.
This strategy permits the merger or spin-off to occur in such a manner that shareholders of the parent company continue to retain a majority stake in the merged entity, thus ensuring the continuation of the business under the existing management, while the parent company avoids any tax related consequences. It is important to note that the Reverse Morris Trust is usable in very specific legal contexts and is not a routine part of mergers and acquisitions.
It typically involves large corporations willing to dispose of a subsidiary with significant unrealized appreciation in business assets in an effort to maximize shareholder value. To recap, the main purpose of the Reverse Morris Trust is to take advantage of certain provisions in the tax code to perform value-adding strategic actions without generating a tax bill.
The end result is a unique type of spin-off that delivers financial flexibility and advantages to the organizations involved.
Examples of Reverse Morris Trust
Northrop Grumman and Orbital ATK: In 2017, Northrop Grumman, a leading global aerospace and defense technology company, decided to spin-off a 100% of its subsidiary Orbital ATK into an independent company called ‘Sustainable Holdings Inc’. The spin-off was then merged with a subsidiary of Northrop Grumman. The transaction was completed using a Reverse Morris Trust with Northrop Grumman maintaining
3% stake in the new company.
Verizon and Frontier Communications: In 2015, Verizon Communications used the Reverse Morris Trust structure to sell its wireline operations in California, Texas, and Florida to Frontier Communications. In this deal, Verizon spun off these operations to its shareholders who exchanged their shares for shares in the new entity, which was then immediately merged with Frontier.
Procter & Gamble and Coty: In 2015, Procter & Gamble decided to divest 43 of its beauty brands to Coty in a deal valued $
5 billion. In one of the largest Reverse Morris Trusts at the time, P&G spun off the brands into a separate company whose shares were then distributed to P&G shareholders. This spun-off entity was then immediately merged with Coty.
FAQs on Reverse Morris Trust
1. What is a Reverse Morris Trust?
A Reverse Morris Trust is a tax-optimization strategy that companies use to reduce tax liability when divesting a particular business unit. It usually involves spinning off a business unit to the existing shareholders, who then merge it with a smaller company.
2. When is a Reverse Morris Trust used?
A Reverse Morris Trust is often used when a large corporation wants to spin off a less profitable or non-core business unit. It allows the corporation to avoid capital gains tax that would typically arise from selling off a subsidiary.
3. What are the requirements for a Reverse Morris Trust?
For a transaction to qualify as a Reverse Morris Trust, the parent company must distribute control of the subsidiary to its shareholders in a way that satisfies IRS requirements for a tax-free spinoff. Also, the shareholders from the parent company should own at least 50% of the voting power and value in the newly formed company.
4. What are the tax implications of a Reverse Morris Trust?
A properly executed Reverse Morris Trust allows a parent company to avoid capital gains tax that would typically be owed if it sold the subsidiary directly. However, shareholders may still owe tax on dividends received during the transaction.
5. Can any company initiate a Reverse Morris Trust?
No, the Reverse Morris Trust is a complex transaction that requires the parent company to have a specific business structure. Furthermore, only shareholders of the parent company who own their shares in the parent company’s common stock are eligible to participate.
Related Entrepreneurship Terms
- Spin-Off: A corporate action in which a company “splits off” sections as a separate business.
- Tax-Free Merger: A type of transaction where shareholders don’t have to pay income tax on profits from the sale of their shares.
- Parent Company: The corporation that owns enough voting stock in another firm to control management and operations by influencing or electing its board of directors.
- Subsidiary: A company that is completely or partly owned and governed by another company.
- Morris Trust: A tax-avoidance tactic that involves the merger of a subsidiary with a corporation not controlled by the parent company.
Sources for More Information
- Investopedia: This website is a reliable source for financial terminologies and concepts such as the Reverse Morris Trust.
- The Motley Fool: This website provides investment advice and analysis of financial case studies, including topics like the Reverse Morris Trust.
- Corporate Finance Institute: This professional website is likely to have resources on more complex financial structures, including the Reverse Morris Trust.
- Bloomberg: Known for global business and finance news, Bloomberg also provides detailed definitions and analyses of financial concepts like the Reverse Morris Trust.
