Tiếng anh chuyên ngành kế toán part 37 doc

348 Planning and Forecasting that the internecine jealousies between Brad and Lisa were becoming un- manageable. Ruefully, Morris conceded that it was not unforeseeable that the manager of a significant part of his business would resent the presence of a rival who would be perceived as having attained her present position simply by dint of her relationship to the owner. This jealousy was, of course, in- flamed by the thought that Lisa might succeed to Morris’s stock upon his death and become Brad’s boss. After some months of attempting to mediate the many disputes between Lisa and Brad, which were merely symptoms of this underlying disease, Morris came to the conclusion that the corporation could not survive with both of them vying for power and influence. He determined that the only workable solution would be to break the two businesses apart once again, leaving the two rivals in charge of their individual empires, with no future binding ties. Experienced in corporate transactions by this time, Morris gave the prob- lem some significant thought and devised two alternate scenarios to accomplish his goal. Both scenarios began with the establishment of a subsidiary corporation wholly owned by the currently existing company. The assets, liabilities, and all other attributes of the molding operation would then be trans- ferred to this new subsidiary in exchange for its stock. At that point in the first scenario (known as a spin-off ), the parent corporation would declare a dividend of all such stock to its current stockholders. Thus, Morris, Lisa, and Brad EXHIBIT 11.8 Corporate redemption versus cross-purchase agreement. Corporate Redemption Cross-Purchase (Assume all parties purchased stock at $100 per share. Current fair market value, is $200 per share.) Morris Lisa Brad Morris BradLisa 80 shares 10 shares 10 shares 80 shares 10 shares 10 shares 10 shares 10 shares $8,000 $1,000 $1,000 Cost $8,000 $8,000 ++ Total basis: $9,000 $9,000Total basis: $1,000 $1,000 $8,000 $1,000 $1,000 Cost Taxes and Business Decisions 349 would own the former subsidiary in the same proportions in which they owned the parent. Morris, as the majority owner of the new corporation, could then give further shares to Brad, enter into a buy-sell agreement with him, or sell him some shares. In any case, upon Morris’s death, Brad would succeed to un- questioned leadership in this corporation. Lisa would stay as a minority stockholder or, if she wished, sell her shares to Morris while he was alive. Lisa would gain control of the former parent corporation upon Morris’s death. In the second scenario (known as a split-off), after the formation of the subsidiary, Brad would sell his shares of Plant Supply to that parent corporation in exchange for stock affording him control of the subsidiary. Lisa would remain the only minority stockholder of the parent corporation (Brad’s interest having been removed) and would succeed to full ownership upon Morris’s death through one of the mechanisms discussed earlier. Unfortunately, when Morris brought his ideas to his professional advisers, he was faced with a serious tax objection. In both scenarios, he was told, the IRS would likely take the position that the issuance of the subsidiary’s stock to its eventual holder (Morris in the spin-off and Brad in the split-off) was a taxable transaction, characterized as a dividend. After all, this plan could be used as another device to cash out the earnings and profits of a corporation at favorable rates and terms. Instead of declaring a dividend of these profits, a corporation could spin off assets, with the fair market value of these profits, to a subsidiary. The shares of the subsidiary could then be distributed to its stockholders as a nontaxable stock dividend, and the stockholders could sell these shares and treat their profits as capital gain. The second scenario allows Brad to receive the subsidiary’s shares and then make a similar sale of these shares at favorable rates and terms. As a result, the Code characterizes the distribution of the subsidiary’s shares to the parent’s stockholders as a dividend, taxable to the extent of the parent’s earnings and profits at the time of the distribution. This would cer- tainly inhibit Morris if he were the owner of a profitable C corporation. It would be less of a concern if his corporation were operating as an S corporation, although even then he would have to be concerned about undistributed earnings and profits dating from before the S election. Recognizing that not all transactions of this type are entered into to dis- guise the declaration of a dividend, the Code does allow spin-offs and split- offs to take place tax-free, under the limited circumstances described in Section 355. These circumstances track the scenarios concocted by Morris, but are limited to circumstances in which both the parent and subsidiary will be conducting an active trade or business after the transaction. Moreover, each trade or business must have been conducted for a period exceeding five years prior to the distribution and cannot have been acquired in a taxable transaction during such time. Since Morris’s corporation acquired the molding business only two years previously and such transaction was not tax free, the benefits of Section 355 are not available now. Short of another solution, it would appear 350 Planning and Forecasting that Morris will have to live with the bickering of Brad and Lisa for another three years. SALE OF THE CORPORATION Fortunately for Morris, another solution was not long in coming. Within months of the failure of his proposal to split up the company, Morris was approached by the president of a company in a related field, interested in purchasing Plant Supply. Such a transaction was very intriguing to Morris. He had worked very hard for many years and would not be adverse to an early retirement. A purchase such as this would relieve him of all his concerns over adequate liquidity for his estate and strategies for funding his retirement. He could take care of both Lisa and Victor with the cash he would receive, and both Lisa and Brad would be free to deal with the acquirer about remaining employed and collect- ing on their equity. However, Morris knew better than to get too excited over this prospect before consulting with his tax advisers. His hesitance turned out to be justi- fied. Unless a deal was appropriately structured, Morris was staring at a significant tax bite, both on the corporate and the stockholder levels. Morris knew from his experience with the molding plant that a corporate acquisition can be structured in three basic ways: a merger, a sale of stock, and a purchase of assets. In a merger, the target corporation disappears into the acquirer by operation of law, and the former stockholders of the target receive consideration from the acquirer. In the sale of stock, the stockholders sell their shares directly to the acquiring corporation. In a sale of assets, the target sells its assets (and most of its liabilities) to the acquirer, and the proceeds of the sale are then distributed to the target’s stockholders through the liquidation of the target. A major theme of all three of these scenarios involves the acquirer forming a subsidiary corporation to act as the acquirer in the transaction. In each case, the difference between the proceeds received by the target’s stockholders and their basis in the target’s stock would be taxable as capital gain. Morris was further informed that this tax at the stockholder level could be avoided if these transactions qualified under the complex rules that define tax-free reorganizations. In each case, one of the requirements would be that the target stockholders receive largely stock of the acquirer rather than cash. Since the acquirer in this case was closely held and there was no market for its stock, Morris was determined to insist upon cash. He thus accepted the idea of paying tax on the stockholder level. Morris was quite surprised, however, to learn that he might also be ex- posed to corporate tax on the growth in the corporation’s assets over its basis in them if they were deemed to have been sold as a result of the acquisition transaction. For one thing, he had been under the impression that a corporation was exempt from such tax if it sold its assets as part of the liquidation process. He was disappointed to learn that this exemption was another victim of the repeal Taxes and Business Decisions 351 of the General Utilities doctrine. He was further disappointed when reminded that even subchapter S corporations recognize all built-in gain that existed at the time of their subchapter S election, if their assets are sold within 10 years after their change of tax status. As a result of the previous considerations, Morris was determined to avoid structuring the sale of his corporation as a sale of its assets and liabilities, to avoid any tax on the corporate level. He was already determined not to structure it as a sale of stock by the target stockholders, because he was not entirely sure Brad could be trusted to sell his shares. If he could structure the transaction at the corporate level, he would not need Brad’s minority vote to accomplish it. Thus, after intensive negotiations, he was pleased that the acquiring corporation had agreed to structure the acquisition as a merger between Plant Supply and a subsidiary of the acquirer (to be formed for the purpose of the transaction). All stockholders of Plant Supply would receive a cash down payment and a five- year promissory note from the parent acquirer in exchange for their stock. Yet even this careful preparation and negotiation leaves Morris, Lisa, and Brad in jeopardy of unexpected tax exposure. To begin with, if the transaction remains as negotiated, the IRS will likely take the position that the assets of the target corporation have been sold to the acquirer, thus triggering tax at the corporate level. In addition, the target’s stockholders will have to recognize as proceeds of the sale of their stock both the cash and the fair market value of the promissory notes in the year of the transaction, even though they will receive payments on the notes over a period of five years. Under the General Utilities doctrine, a corporation that was selling sub- stantially all its assets needed to adopt a “plan of liquidation” prior to entering into the sale agreement to avoid taxation at the corporate level. The repeal of the doctrine may have left the impression that the adoption of such a liquidation plan is unnecessary because the sale will be taxed at the corporate level in any event. Yet, the Code still requires such a liquidation plan if the stockholders wish to recognize notes received upon the dissolution of the target corporation on the installment basis. Moreover, the liquidation of the corporation must be completed within 12 months of adoption of the liquidation plan. Thus, Morris’s best efforts may still have led to disaster. Fortunately, a small adjustment to the negotiated transaction can cure most of these problems. Through an example of corporate magic known as the reverse triangular merger, the newly formed subsidiary of the acquirer may disappear into Mor- ris’s target corporation, but the target’s stockholders can still be jettisoned for cash, leaving the acquirer as the parent. In such a transaction, the assets of the target have not been sold; they remain owned by the original corporation. Only the target’s stockholders have changed. In effect, the parties have sold stock without the necessity of getting Brad’s approval. Because the assets have not changed hands, there is no tax at the corporate level. In addition, since the target corporation has not liquidated, no plan of liquidation is required, and the target stockholders may elect installment treatment as if they had sold their shares directly (see Exhibit 11.9). 352 Planning and Forecasting CONCLUSION Perhaps no taxpayer will encounter quite as many cataclysmic tax decisions in as short a time as did Morris and Plant Supply. Yet, Morris’s experience serves to illustrate that tax issues lurk in almost every major business decision made by a corporation’s management. Many transactions can be structured to avoid unnecessary tax expense if proper attention is paid to tax implications. To be unaware of these issues is to play the game without knowing the rules. FOR FURTHER READING Gevurtz, Franklin A., Business Planning (New York: Foundation Press, 1995). Jones, Sally M., Federal Taxes and Management Decisions (New York: Irwin/ McGraw-Hill, 1998). Painter, William H., Problems and Materials in Business Planning, 3rd ed. (Con- necticut: West/Wadsworth, 1994). Scholes, Myron S. et al., Taxes and Business Strategy (Upper Saddle River, NJ: Prentice-Hall, 2001). INTERNET LINKS http://smallbiz.biz.findlaw.com FindLaw for Business /sections/fn_taxes/articles.html http://www.dtonline.com Deloitte and Touche Tax Planning Guide /taxguide99/cover.htm http://www.smartmoney.com/tax Smart Money.com tax guide EXHIBIT 11.9 Reverse triangle merger. Owned by T’s stockholders Owned by T’s stockholders T SUB S stock Owned by T AA S Before After 353 12 GLOBAL FINANCE Eugene E. Comiskey Charles W. Mulford MANAGERIAL AND FINANCIAL REPORTING ISSUES AT SUCCESSIVE STAGES IN THE FIRM’S LIFE CYCLE Fashionhouse Furniture started as a small southern retailer of furniture purchased mainly in bordering southeastern states. With a growing level of both competition and affluence in its major market areas, Fashionhouse decided that its future lay in a niche strategy involving specialization in a high quality line of Scandinavian furniture. Its suppliers were mainly located in Denmark, and they followed the practice of billing Fashionhouse in the Danish krone. Title would typically pass to Fashionhouse when the goods were dropped on the dock in Copenhagen. Payment for the goods was required within periods ranging from 30 to 90 days. As its business expanded and prospered, Fashion- house became convinced that it needed to exercise greater control over its furniture supply. This control was accomplished through the purchase of its principal Danish supplier. Because this supplier also had a network of retail units in Denmark, the manufacturing operations in Denmark supplied both the local Danish market as well as the U.S. requirements of Fashionhouse. More recently, Fashionhouse has been searching for ways to increase manufacturing efficiency and lower product costs. It is contemplating a reloca- tion of part of its manufacturing activity to a country with an ample and low-cost supply of labor. However, Fashionhouse has noted that many such countries experience very high levels of inflation and other potentially disrup- tive economic and political conditions. It has also become aware that in some of 354 Planning and Forecasting the countries under consideration business practices are occasionally employed that could be a source of concern to Fashionhouse management. In some cases, the practices raise issues that extend beyond simply ethical considerations. Fashionhouse could become involved in activities that could place it in viola- tion, not of local laws, but of U.S. laws. Fashionhouse management is still attempting to determine how to evaluate and deal with some of the identified managerial and financial issues associated with this contemplated move. Each of the new stages in the evolution of the Fashionhouse strategy creates new challenges that have important implications for both management and financial reporting. The evolution from a strictly domestic operation to one involving the purchase of goods abroad thrusts Fashionhouse into the global marketplace, with its attendant risks and rewards. It is common for U.S. firms with foreign activities to enumerate some of these risks. These disclosures are normally made, at least in part, to comply with disclosure requirements of the Securities and Exchange Commission (SEC). As an example, consider the disclosures made by Western Digital Corporation of risk factors associated with its foreign manufacturing operations: • Obtaining requisite U.S. and foreign governmental permits and approvals. • Currency exchange-rate fluctuations or restrictions. • Political instability and civil unrest. • Transportation delays or higher freight fees. • Labor problems. • Trade restrictions or higher tariffs. • Exchange, currency, and tax controls and reallocations. • Loss or nonrenewal of favorable tax treatment under agreements or treaties with foreign tax authorities. 1 While not listed above as a specific concern, there is the risk that a foreign government will expropriate the assets of a foreign operation. There were major expropriations of U.S. assets, for instance, located in Cuba when Fidel Castro came to power. There were also expropriations by Iran surrounding the hostage taking at the U.S. embassy in Tehran. Moreover there has been turmoil in Ecuador in recent years. Baltek, a New Jersey corporation with most of its operations in Ecuador, disclosed that it had taken out expropriation insurance to deal with this risk: All of the Company’s balsa and shrimp are produced in Ecuador. The depen- dence on foreign countries for raw materials represents some inherent risks. However, the Company, or its predecessors, has operated without interruption in Ecuador since 1940. Operating in Ecuador has enabled the Company to pro- duce raw materials at a reasonable cost in an atmosphere that has been favorable to exporters such as the Company. To mitigate the risk of operating in Ecuador, in 1999 the Company obtained a five-year expropriation insurance policy. This policy provides the Company coverage for its assets in Ecuador Global Finance 355 against expropriatory conduct (as defined in the policy) by the government of Ecuador. 2 Some of the important issues implicit in the Fashionhouse scenario out- lined above are identified below and are discussed and illustrated in the bal- ance of this chapter: 1. Fashionhouse incurs a foreign-currency obligation when it begins to acquire furniture from its Danish suppliers. A decrease in the value of the dollar between purchase and payment date increases the dollars required to discharge the Danish krone obligation and results in a foreign-currency transaction loss. Financial reporting issue: How are the foreign-currency obligations initially recorded and subsequently accounted for in the Fashionhouse books, which are maintained in U.S. dollars? Management issue: What methods are available to avoid the currency risk associated with purchasing goods abroad and also being invoiced in the foreign currency, and should they be employed? 2. The purchase of one of its Danish suppliers requires that this firm hence- forth be consolidated into the financial statements of Fashionhouse and its U.S. operations. Financial reporting issues: (a) How are the Danish statements con- verted from the krone in order to consolidate them with the U.S. dollar statements of Fashionhouse? (b) What differences in accounting practices, if any, exist between Denmark and the United States and what must be done about such differences? Management issues: (a) Is there currency risk associated with the Dan- ish subsidiary comparable to that described previously with the foreign purchase transactions? Are there methods available to avoid the currency risk associated with ownership of a foreign subsidiary and should they be employed? (b) How will the financial aspects of the management of the Danish subsidiary be evaluated in view of (1) the availability of two different sets of financial statements, those ex- pressed in krone and those in U.S. dollars, and (2) the fact that most of its sales are to Fashionhouse, its U.S. parent? 3. Fashionhouse relocates its manufacturing to a high-inflation and low- labor cost country. Financial reporting issues: How will inflation affect the local-country financial statements and their usefulness in evaluating the performance of the company and its management? Management issues: (a) Are their special risks associated with locating in a highly inflationary country and how can they be managed? (b) What are the restrictions on U.S. business practices related to dealing with business and governmental entities in other countries? 356 Planning and Forecasting For clarification and to indicate their order of treatment in the subse- quent discussion, the issues raised above are enumerated below, without dis- tinction between those that are mainly financial reporting as opposed to managerial issues: 1. Financial reporting of foreign-currency denominated transactions. 2. Risk management alternatives for foreign-currency denominated transactions. 3. Translation of the financial statements of foreign subsidiaries. 4. Managing the currency risk of foreign subsidiaries. 5. Dealing with differences between U.S. and foreign accounting policies. 6. Evaluation of the performance of foreign subsidiaries and their management. 7. Assessing the effects of inflation on the financial performance of foreign subsidiaries. 8. Complying with U.S. restrictions on business practices associated with foreign subsidiaries and governments. FINANCIAL REPORTING OF FOREIGN-CURRENCY DENOMINATED TRANSACTIONS When a U.S. company buys from or sells to a foreign firm, a key issue is the currency in which the transaction is to be denominated. 3 In the case of Fashion- house, its purchases from Danish suppliers were invoiced to Fashionhouse in the Danish krone. This creates a risk, which is born by Fashionhouse and not its Danish supplier, of a foreign exchange transaction loss should the dollar fall in value. Alternatively, a gain would result should the dollar increase between the time the furniture is dropped on the dock in Copenhagen and the required payment date. With a fall in the value of the dollar, the Fashionhouse dollar cost for the furniture will be more than the dollar obligation it originally recorded. Fashionhouse is said to have liability exposure in the Danish krone. If, instead, Fashionhouse had been invoiced in the U.S. dollar, then it would have had no currency risk. Rather, its Danish supplier would bear the currency risk associated with a claim to U.S. dollars, in the form of a U.S. dollar account receivable. If the dollar were to decrease in value, the Danish supplier would incur a foreign exchange transaction loss, or a gain should the dollar increase in value. The Danish firm would have asset exposure in a U.S. dollar account receivable. The essence of foreign-currency exposure or currency risk is that existing account balances or prospective cash flows can expand or contract simply as a result of changes in the values of currencies. A summary of foreign exchange gains and losses, by type of exposure, due to exchange rate movements is provided in Exhibit 12.1. To illustrate some of the computational aspects of the Global Finance 357 patterns of gains and losses in Exhibit 12.1, and the nature of exchange rates, assume that Fashionhouse recorded a 100,000 krone purchase when the exchange rate for the krone was $0.1180. That is, it takes 11.8 cents to purchase one krone. This expression of the exchange rate, dollars per unit of the foreign currency, is referred to as the direct rate. Alternatively, expressing the rate in terms of kroner per dollar is referred to as the indirect rate. In this case, the indirect rate is 1/0.1180, or K8.475. It requires 8.475 kroner to purchase one dollar. Both the direct and indirect rates are typically provided in the tables of exchange rates found in the financial press. The rates at which currencies are currently trading are called the spot rates. When Fashionhouse records the invoice received from its Danish supplier, it must do so in its U.S. dollar equivalent. With the direct rate at $0.1180, the dollar equivalent of K100,000 is $0.1180 × K100,000, or $11,800. That is, Fashionhouse records an addition to inventory and an offsetting account payable for $11,800. Assume that Fashionhouse pays this obligation when the dollar has fallen to $0.1190. It will now take $11,900 dollars to acquire the K100,000 needed to pay off the account payable. The combination of liability exposure and a decline in the value of the dollar results in a foreign-currency transaction loss. This result is summarized below: The exchange rate is $0.1190 when the account payable from the purchase is paid. Dollar amount of obligation at payment date, 100,000 × $0.1190 $11,900 Dollar amount of obligation at purchase date, 100,000 × $0.1180 11,800 Foreign exchange transaction loss $ 100 The dollar depreciated against the krone during the time when Fashionhouse had liability exposure in the krone. As a result, it took $100 more to discharge the account payable than the amount at which the liability was originally recorded by Fashionhouse. If the foreign exchange losses incurred were significant, it might prove difficult to pass on this increased cost to Fashionhouse customers, and it could cause its furniture to be somewhat less competitive than that offered by other U.S. retailers with domestic suppliers. Fashionhouse might attempt to avoid the currency risk by convincing its Danish suppliers to invoice it in the dollar. However, this means that the Danish suppliers would bear the currency risk. EXHIBIT 12.1 Type of foreign currency exposure. Change in Foreign Exposure Currency Value Asset Liability Appreciates Gain Loss Depreciates Loss Gain . assets as part of the liquidation process. He was disappointed to learn that this exemption was another victim of the repeal Taxes and Business Decisions 351 of the General Utilities doctrine influence. He determined that the only workable solution would be to break the two businesses apart once again, leaving the two rivals in charge of their individual empires, with no future binding. Corporate redemption versus cross-purchase agreement. Corporate Redemption Cross-Purchase (Assume all parties purchased stock at $100 per share. Current fair market value, is $200 per share.) Morris