This article separates the treatment of the disappearing corporation transferring assets from the adjustment accounts recognized by the survivor. Detailed Cabinet Order calculations for those accounts are outside its scope.

Statutory definition

A non-qualified merger is one that fails the qualified-merger requirements in Article 2 of the Corporation Tax Act. Those requirements are explained in Requirements for a Qualified Merger. Here, we examine the statutory consequences of failing them.

Article 62-8 collectively defines non-qualified mergers and certain other transactions as “non-qualified mergers, etc.”:

Non-qualified mergers, etc. means mergers that are not qualified mergers, or non-qualified splits, non-qualified contributions in kind, and business acquisitions prescribed by Cabinet Order; the same applies in this article.

The term collectively covers the specified mergers, splits, contributions in kind, and business acquisitions. A non-qualified merger is the merger category within that group. For its place in reorganization taxation, see Overview of Reorganization Taxation You can check with.

Overview

How Are Assets and Liabilities Treated in a Non-Qualified Merger?

Article 62 governs transfers of assets and liabilities through mergers.

Where a domestic corporation transfers its assets or liabilities to a surviving or successor corporation through a merger or split, its income for each business year shall be calculated as if those assets and liabilities were transferred at their value at the time of the merger or split.

The disappearing corporation’s assets and liabilities are treated as transferred to the survivor at their value at the merger—fair value—rather than simply carried over at book value. Article 62 then provides for resulting gains and losses:

Gains on transferring assets and liabilities to the survivor in the merger (the excess of their value at the merger over transfer cost) or losses (the excess of cost over their value at the merger) shall be included in gross income or deductible expenses for the final business year (the disappearing corporation’s business year containing the day before the merger; the same applies in paragraph 1 of the following article).

Fair value above cost creates a gain; below cost creates a loss. Both enter the disappearing corporation’s final-year gross income or deductions. For taxation of shareholder consideration, see Reorganizations and Shareholder Taxation We are dealing with that.

Separate Adjustments Apply to Non-Qualified Mergers Within Wholly Controlled Groups

A non-qualified merger does not necessarily trigger immediate taxation of unrealized gains. Where gain-or-loss adjustment assets under Article 61-11 move between wholly related domestic corporations, both ordinary corporations or cooperatives, etc., paragraph 1 offsets transfer gains with deductions and transfer losses with gross income. Paragraph 7 subtracts those gains from, or adds those losses to, the survivor’s acquisition costs.

Only specified assets outside the Cabinet Order exclusions qualify. For example, consider this adjustment when transferring covered land in a wholly controlled non-qualified merger. It is a separate rule from qualified-merger treatment and cannot be described as a blanket book-value carryover for every asset and liability.

What Is an Asset Adjustment Account?

The survivor recognizes an asset adjustment account when consideration paid in a non-qualified merger, etc. exceeds the fair-value net assets received. Article 62-8 sets out its scope and treatment.

The account does not necessarily equal the simple difference between consideration and fair-value net assets. Consult the Enforcement Order for the calculation.

What Types of Liability Adjustment Accounts Exist?

Liability adjustment accounts arise where consideration falls below fair-value net assets or specified burdens are assumed from the disappearing corporation, etc. Article 62-8 distinguishes three categories.

Retirement-benefit liability adjustment account

This account arises when the survivor assumes retirement-benefit obligations for transferred employees. Article 62-8 defines assumption as follows:

Where the domestic corporation assumes retirement-benefit obligations for employees inherited in the non-qualified merger, etc., meaning that it agrees to calculate benefits payable upon subsequent retirement or other events with regard to pre-transaction service periods and other work history, and assumes the associated burden; the same applies in this article.

Merely taking over employees is insufficient; there must be an agreement to calculate benefits with regard to prior service and similar factors.

Short-term material liability adjustment account

This account arises on assumption of future business obligations satisfying specified conditions. Article 62-8 provides:

Where the domestic corporation assumes the burden of fulfilling future obligations relating to the business received in the non-qualified merger, etc., limited to obligations materially affecting business profits, excluding retirement-benefit obligations in the preceding item and obligations already certain to require performance, with fulfillment expected within approximately three years of the transaction date.

The obligation must materially affect profits and be expected to be fulfilled within approximately three years.

Difference liability adjustment account

Where consideration is below fair-value net assets, the shortfall forms a difference liability adjustment account. Article 62-8 provides:

If the consideration for the non-qualified merger, etc. is below the fair-value net assets received from the disappearing corporation, etc., the shortfall shall be the amount of a liability adjustment account.

When and How Are Adjustment Accounts Released?

Asset adjustment accounts and difference liability adjustment accounts are amortized evenly over a prescribed period. Article 62-8 provides for asset adjustment accounts as follows:

The initially recognized amount of each asset adjustment account (the amount recognized under that paragraph at the non-qualified merger, etc.), divided by sixty and multiplied by the months in the business year (or, in the transaction year, the months from the transaction date to year-end).

Each year, the account is reduced by the initial amount divided by sixty times the applicable months. Article 62-8 prescribes the same method for difference liability adjustment accounts. The released amount is treated as follows:

The amount by which an asset adjustment account must be reduced under the preceding paragraph shall be deducted in calculating income for the business year containing the date of that reduction.

Retirement-benefit and short-term material liability adjustment accounts, by contrast, are reduced when specified events occur rather than through straight-line amortization. For short-term material liabilities, Article 62-8 states:

Where a loss relating to the estimated short-term material obligation occurs, three years have elapsed since the non-qualified merger, etc., the corporation becomes the disappearing corporation in a non-qualified merger, or its residual assets are determined.

Release occurs when losses arise and also after three years. Article 62-8 treats the released amount as follows:

The amount by which a liability adjustment account must be reduced under the preceding two paragraphs shall be included in gross income for the business year containing the reduction date.

Where a domestic corporation subsequently undertakes a qualified merger, split, or contribution as the disappearing, splitting, or contributing corporation, provisions may transfer adjustment accounts rather than extinguish them. Article 62-8 refers to:

A qualified merger, qualified split, or qualified contribution in kind in which the domestic corporation is the disappearing, splitting, or contributing corporation.

The transferable scope differs by transaction. A qualified merger transfers the entire asset adjustment account, short-term material liability account, and difference liability account, but only the prescribed portion of the retirement-benefit liability account. A qualified split or contribution in kind transfers no asset adjustment account, and only portions of retirement-benefit and short-term material liability accounts; difference liability accounts are excluded. Article 62-8 states:

Asset adjustment accounts, retirement-benefit liability adjustment accounts, short-term material liability adjustment accounts, and difference liability adjustment accounts inherited by the survivor, etc. under the preceding paragraph shall respectively be deemed accounts held by it at the time of the qualified merger, etc.

The recipient is deemed to hold those amounts at the qualified transaction, rather than at the original non-qualified transaction. Article 62-8 delegates the reduction calculation to Cabinet Order.

Points that require care in practice

• The asset adjustment account is limited to the prescribed portion, so it does not necessarily equal the simple difference between consideration and fair-value net assets.
• Short-term material liability accounts are limited to obligations expected to be fulfilled within approximately three years of the transaction.
• Retirement-benefit liability accounts require assumption of retirement-benefit obligations; merely taking over employees is insufficient.
• Asset and difference liability accounts use straight-line amortization, while retirement-benefit and short-term material liability accounts are reduced on triggering events. Release methods differ by account.
• A subsequent qualified merger may transfer adjustment accounts to the survivor rather than extinguish them, so accounts originating in a non-qualified merger may remain afterward.
• Article 62 governs the transferring disappearing corporation; Article 62-8 governs the survivor’s adjustment accounts. Both operate in a non-qualified merger, so first establish whether qualified-merger requirements are met.

Legal basis

• Corporation Tax Act, Article 62, Paragraph 1 (Transfers of Assets, etc. at Fair Value through Mergers and Splits)
• Corporation Tax Act, Article 62, Paragraph 2
• Corporation Tax Act, Article 62-8, Paragraph 1 (Definition of Non-Qualified Merger, etc.)
• Corporation Tax Act, Article 62-8, Paragraph 1 (Asset Adjustment Account)
• Corporation Tax Act, Article 62-8, Paragraph 2, Item 1 (Retirement-Benefit Liability Adjustment Account)
• Corporation Tax Act, Article 62-8, Paragraph 2, Item 2 (Short-Term Material Liability Adjustment Account)
• Corporation Tax Act, Article 62-8, Paragraph 3 (Difference Liability Adjustment Account)
• Corporation Tax Act, Article 62-8, Paragraph 4 (Straight-Line Amortization of Asset Adjustment Accounts)
• Corporation Tax Act, Article 62-8, Paragraph 5
• Corporation Tax Act, Article 62-8, Paragraph 6, Item 2 (Events Triggering Release of Short-Term Material Liability Accounts)
• Corporation Tax Act, Article 62-8, Paragraph 8
• Corporation Tax Act, Article 62-8, Paragraph 9 (Succession upon Qualified Mergers, etc.)
• Corporation Tax Act, Article 62-8, Paragraph 9, Item 1 (Scope of Succession in Qualified Mergers)
• Corporation Tax Act, Article 62-8, Paragraph 9, Item 1(a) (Limitation for Retirement-Benefit Liability Accounts)
• Corporation Tax Act, Article 62-8, Paragraph 9, Item 1(b) (Short-Term Material Liability Account)
• Corporation Tax Act, Article 62-8, Paragraph 9, Item 1(c) (Difference Liability Account)
• Corporation Tax Act, Article 62-8, Paragraph 9, Item 2 (Scope of Succession in Qualified Splits and Contributions in Kind)
• Corporation Tax Act, Article 62-8, Paragraph 9, Item 2(a) (Limitation for Retirement-Benefit Liability Accounts)
• Corporation Tax Act, Article 62-8, Paragraph 9, Item 2(b) (Limitation for Short-Term Material Liability Accounts)
• Corporation Tax Act, Article 62-8, Paragraph 10 (Treatment of Inherited Adjustment Accounts)
• Corporation Tax Act, Article 62-8, Paragraph 12 (Delegation of Reduction Calculations, etc. to Cabinet Order)