Could a parent use a later-acquired company's pre-acquisition earnings to support a franchise-tax refund after the acquired company merged into a subsidiary?

Plain-English summary

A parent formed a wholly owned subsidiary to acquire another company. The acquired company was then merged into the subsidiary, which later took the acquired company's name. The parent sought a franchise-tax refund using the acquired company's pre-acquisition earnings.

The Comptroller staff concluded that forming the subsidiary was not an acquisition, so the parent had no pre-acquisition earnings from that formation. The refund request based on the acquired company's earnings should therefore be denied. The memo added that, had the acquired company not merged into the subsidiary, its pre-acquisition earnings could have offset the subsidiary's investment in that company.

Common questions

Was the refund allowed? No.

Why not? The parent formed the subsidiary rather than acquiring it, and the acquired company was later merged into that subsidiary.

What alternative did the memo describe? Without the merger, the acquired company's pre-acquisition earnings could have offset the subsidiary's investment in it.

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/8901L0928A01

Original ruling text

BOB BULLOCK
INTEROFFICE
COMPTROLLER OF
MEMORANDUM PUBLIC
ACCOUNTS

January 4, 1989

To: Sue Baadsgaard

From: Gilbert Zamora Via: Martin Cherry

Subject: Pre-Acquisition Earnings

We have reviewed the circumstances involving the formation of Company A
(A), by Company B (B) and A's acquisition of Company C (C). (C) was
later
merged into (A), with (A) subsequently changing its name to (C).

As the formation of (A) did not involve an acquisition, there
are no pre-acquisition earnings available to (B). (B)'s request for
refund based on the pre-acquisition earnings of (C), should be denied.

Had (C) not been merged into (A), the pre-acquisition earnings of (C)
could have been used to offset (A)'s investment in its subsidiary.

BOB BULLOCK
INTEROFFICE
COMPTROLLER OF
MEMORANDUM PUBLIC
ACCOUNTS

DATE: December 20, 1988

TO: Martin Cherry

FROM: Sue Baadsgaard via: Harold R. Lee

SUBJECT: Pre-Acquisition Earnings

A franchise tax refund request has been submitted by Company A requesting
pre-acquisition earnings on Company C (C). As is explained in the attached
letter, C was not directly acquired by B. B established Company A (A) (a
wholly-owned subsidiary) for the express purpose of acquiring C. After the
acquisition was completed, C was merged into (A) whose name was subsequently
changed to C. This"new" C remained a subsidiary of B.

This is a very different situation than that addressed in Sun Refining &
Marketing and I have serious doubts that B is entitled to reduce their taxable
capital by C's pre-acquisition earnings.

Since Tom Poole is the ALJ assigned to the C hearing, he has had the
opportunity to review this transaction. We have discussed it on several
occasions. He also feels that B is not entitled to this reduction to surplus.
Please talk to him and get the facts and reasonings as he sees them.

There is currently an audit in progress on B. It is being performed by
James Park from Beaumont Audit Office. He is patiently awaiting our response.

I have also attached the notes of the financial statements of X who
acquired M in a similar transaction. They further complicated the entire mess
by liquidating out a portion of M to form P which became a sub of M. For
refund purposes, X feels entitled to the entire pre-acquisition earnings of M.
M feels that they are the new P. I do not feel that either of these companies
are entitled to claim the pre-acquisition earnings due to the structuring of
the transaction.

Please review these situations and provide us with a policy to follow.
Thanks!!

Please call me if you have any questions.