Seller Retention of Receivables in Asset Sale Blows C Reorganization


M&A Tax Stories

August 26, 2020


Taxes can be a major transaction cost when selling a business, especially federal income taxes. One exit plan structure for an owner of a company operating as a corporation is a C Reorganization. See Internal Revenue Code Sections 368(a)(1)(C) and 368(a)(2)(G).

Under a C reorganization structure, the company may escape federal corporate income taxation of the transaction and the owner may defer all federal income taxation on the gain from the transaction. A C reorganization is accomplished in two steps.

First, the company exchanges “substantially all” its assets for buyer stock. After the closing the owner liquidates the company and ends up with the buyer stock. The buyer will defer gain until he or she sells the buyer stock.

The deal

The company in this deal sold its assets to the buyer in exchange for buyer stock. However, the company’s receivables were not part of the deal.

The company claimed on its return that it was entitled to defer gain under the then applicable C reorganization provisions. A critical requirement for C reorganization treatment was that the company sold “substantially all” of its assets to the buyer in exchange for buyer stock.

The lawsuit

The IRS determined that the owner could not defer the gain as a C reorganization because the company did not sell substantially all of its assets to the buyer. Specifically, the company did not sell the receivables which represented 32% of the net book value of the company’s assets.

The company disagreed with the IRS and challenged the Service position in the U.S. Board of Tax Appeals, the predecessor to the Tax Court. The Board of Tax Appeals held that selling 68% of the net book value of the company’s assets was not “substantially all” of its assets: “We have repeatedly held… that 68 per cent stock ownership or control did not constitute ‘substantially all.’ … If a transaction of the sort here involved can be said to be within the provisions of the statute, then there is no limit to the proportion of assets that may be retained by a corporation …”

This case is referred to as Arctic Ice Machine Co. v. Commissioner, 23 B.T.A. 1223 (1931)


So, what is substantially all of a company’s assets? To play it safe, sell 90% of the fair market of the company’s net assets and 70% of the fair market value of the company’s gross assets. See Revenue Procedure 77-37, 1977-2 C.B. 568.

By John McCauley: I help people with M&A tax issues involving privately held companies.



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Posted in C Reorganization, substantially all assets, tax deferred reorganization Tagged with: , , ,

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