Axle Corporation was formed in 1995. It is based in Iowa and operates throughout the US Midwest.

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Axle Corporation was formed in 1995. It is based in Iowa and operates throughout the US Midwest. Axle is owned by the Miller family, one-third each by sister Midge (age 38), sister Trudy (age 51), and brother Jack (age 45). The company controls about $250 million in productive and investment assets, most of which are located in Iowa.

Axle started out as a wholesale distributor of paint and lacquer products, purchasing gallon-size and larger containers of paints from chemical companies and selling them mainly to retailers in its operating region. Over time, though, the company moved into the manufacturing process as well, purchasing raw chemicals and processing them at its Iowa plant so as to develop its own line of paints, thinners, and spray cans. These manufactured products are sold to the big-box chains, including Ace and Lowes, for retail distribution throughout the world.

Des Moines

· Distribution division

· Corporate headquarters

Davenport

· Manufacturing division

Both divisions of Axle have been highly profitable, and they are almost recession-proof. The distribution division operates near the Des Moines airport and has prime access to the interstate highway system. There is adjacent vacant land in case Axle wants to expand those operations. The manufacturing division is located along the river in Davenport. Corporate headquarters take up an entire office building in downtown Des Moines.

The distribution operations are not quite a cash business, but the receivables cycle is very short. Axle's distribution operations have developed into the model of efficiency for the industry, with quick turnaround and a computer-based structure coordinating the flow of goods into the company, and the air and truck system of outflow.

The manufacturing division requires a larger capital investment, and thus it is highly leveraged. There also is exposure to environmental damage from chemical spills, and to lawsuits concerning the effects of the spray-can gases on the ozone. No such damages yet have been incurred by Axle, although one of its west-coast competitors recently filed for bankruptcy protection after losing a District Court challenge from a global-warming activist group.

Axle is self-insured relative to these contingencies. But it has found that the mark-up that it can build into the prices it charges customers is so large when Axle controls the product starting with raw materials, the return on investment cannot be matched in any other way.

Axle has been showing an annual fifteen to twenty percent return on equity for the past five years. The officer and management group, longtime employees not related to the Millers, see only future growth in operations and profits for the next decade, and they all are committed to Axle and to Iowa for the long-term.

The balance sheet of the company includes the sum of the sub-accounts indicated below.

As a profitable regional operation, Axle regularly receives offers from investors interested in a takeover. The Millers have resisted all of these offers so far, but Midge and Jack are interested in funding a "second career" by cashing out of the family business. Trudy, a Villanova MBA, believes that the company would be better off by downsizing operations so that the open-ended exposure to the contingent liabilities can be reduced; she also maintains that the family could better control the business if Axle remained a smaller operation.

These differences in agenda among the entity and its shareholders have frozen the parties from considering the takeover offers at any length. But the latest correspondence with the private-equity Cooke Group Inc (a closely held C corporation) is almost too tempting to refuse. Cooke wants to acquire the distribution operations, and not the manufacturing division. Cooke says that it will convey $100 million for the distribution division, but only if the transaction is completed within eighteen months and the federal income tax consequences are favorable to the group.

You are not Axle's auditor or regular tax consultant, but your reputation in the Midwest is as the "Master Deal Maker," because you bring both a high level to technical tax expertise and a skill in negotiating an offer that typically is compelling to "both sides" of the transaction.

Question:

A) Develop and diagram at least three different approaches for Axle and Cooke to consider, in executing Cooke's acquisition. Other advisors will focus on the legal and financial aspects of implementing your plans, which should take into account both current and future tax liabilities. For this purpose, consider federal tax consequences only, and ignore the corporate alternative minimum tax. Ignore the book consequences of creating deferred tax assets and liabilities.

B) Provide a summary of the tax computations that will result from a carrying-out of your plans. Include citations to controlling tax law, and a summary of the strengths and weaknesses of the alternatives that you develop.

Hints for Axle Corporation

First enumerate the tax and other goals that the parties have for this transaction. You then can compare your recommendations against these goals and prioritize them against this standard.
Analyze whether Cooke's offer is fair and should even be considered by Axle.
How might Axle modify the terms of the deal, so as to dispose of some of its common corporate assets as well, or to retain some of the distribution division's property?
Consider a cash-only takeover as one of your alternatives. Axle might prefer liquid assets for a number of reasons, one of which includes the desire on the part of two of its shareholders to "cash out" of the business.

Compute the tax liabilities of the parties, the E&P balance of the entities after the deal, and the basis of the assets held by the parties going forward.
Where there is a current tax liability to be accounted for, attempt to reduce its present value.
If Axle and its shareholders consider remaining in the manufacturing business, what legal form (e.g., corporation, partnership) should be used for the business going forward?
In your analysis, you might suggest to the client one or two ways to structure the deal that would produce less-favorable tax results than some of the other alternatives. This would allow you to discuss some of the non-tax effects of the transaction, and to illustrate how the proposed structure fails to use all of the incentives allowed by the Code, relative to your preferred alternatives. In your recommendations, include a diagram of the "before" and "after" of your structures, and a timeline of your proposed events as appropriate.
The taxpayer must meet not only the statutory requirements of a tax-deferred reorganization. The judicial requirements associated with §368 also must be met.

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