Statutory definition

Share exchanges and share transfers are reorganizations with procedures prescribed by the Companies Act. Article 2 of the Corporation Tax Act defines the names of the corporations involved. First, for share exchanges:

Means the corporation issuing the shares held by its shareholders that are acquired by another corporation through a share exchange.

Means the corporation that, by acquiring another corporation’s shares through a share exchange, comes to hold all that corporation’s issued shares.

The issuer is the wholly owned subsidiary in the share exchange; the corporation acquiring all its issued shares is the wholly owning parent. Corresponding terms are defined for share transfers.

Means the corporation issuing the shares held by its shareholders that are acquired, through a share transfer, by the corporation established through that share transfer.

Means the corporation established through a share transfer that acquires all another corporation’s issued shares through that transfer.

The wholly owned subsidiary in a share transfer is the corporation whose shares are acquired by the wholly owning parent through the transfer. The acquiring corporation is newly established, unlike a share exchange, which creates a wholly owned relationship between existing corporations.

The Corporation Tax Act also defines the following two broader terms by adding “etc.”:

Means the wholly owned subsidiary in a share exchange and the target corporation prescribed in item 12-16 in relation to a share exchange, etc. other than a share exchange.

Means the wholly owning parent in a share exchange, corporations that are the largest shareholders, etc. prescribed in item 12-16(a) and (b), and the corporation that is the single shareholder, etc. in subitem (c), in relation to a share exchange, etc. other than a share exchange.

“Wholly owned subsidiary in a share exchange, etc.” and “wholly owning parent in a share exchange, etc.” are broader terms that include parties to the following transactions in addition to parties to a share exchange in the narrow sense. “Share exchange, etc.” itself is defined as follows:

Means a share exchange and the establishment, through the acts listed in (a) through (c), of a relationship in which the target corporation (the corporation specified respectively in those subitems) is wholly controlled by the corporation that is the largest shareholder, etc. under (a) or (b), or the single shareholder, etc. under (c).

“Share exchange, etc.” is a broad tax concept. Besides a share exchange under the Companies Act, it includes the three acts in subitems (a), (b), and (c)—a resolution to acquire a class of shares subject to wholly callable provisions, a share consolidation, and a demand for sale of shares—where these result in the target becoming wholly controlled by its major shareholder, etc. For its place within reorganization taxation, see Overview of Reorganization Taxation I am organizing with.

Overview

What Are the Requirements for a Qualified Share Exchange, etc.?

Article 2 of the Corporation Tax Act defines a qualified share exchange, etc. as follows:

A share exchange, etc. falling under any of the following categories in which shareholders, etc. of the wholly owned subsidiary receive no assets other than shares in one corporation that is either the wholly owning parent in the share exchange, etc. or its wholly controlling parent (a corporation in a relationship prescribed by Cabinet Order involving direct or indirect ownership of all the share-exchange parent’s issued shares, etc.); disregarding money or other assets delivered as dividends of surplus, as consideration pursuant to appraisal rights of dissenting shareholders, to shareholders other than the share-exchange parent where that parent holds at least two-thirds of the subsidiary’s issued shares excluding treasury shares immediately before the exchange, pursuant to a petition to determine the acquisition price under subitem (a) of the preceding item, as consideration for fractional shares below one share under the act in that subitem or arising from the act in subitem (b), or as consideration for the acquisition under subitem (c).

The opening provision requires that the subsidiary’s shareholders receive no assets other than shares in one corporation that is either the wholly owning parent or its wholly controlling parent. Parentheses expressly disregard assets delivered as dividends of surplus, appraisal-rights consideration, and similar items. The provision then requires one of three categories in (a), (b), and (c): a wholly controlling relationship between subsidiary and parent; a controlling relationship with employee and business-continuity requirements satisfied; or a share exchange prescribed by Cabinet Order as being for a joint business. Article 4-3 of the Enforcement Order sets out the prescribed relationships and transactions; their details are beyond this article’s scope. Share delivery is another mechanism for making another company a subsidiary using the acquirer’s own shares. It does not require wholly owned status and differs from a share exchange in scope and procedure. For those differences, see Share Delivery You can check with.

What Are the Requirements for a Qualified Share Transfer?

Article 2 of the Corporation Tax Act defines a qualified share transfer as follows:

A share transfer falling under any of the following categories in which shareholders of the wholly owned subsidiary receive no assets other than shares in the wholly owning parent (disregarding money or other assets delivered as consideration pursuant to appraisal rights of shareholders dissenting from the transfer).

Compared with the opening provision for qualified share exchanges, etc., only dissenting-shareholder appraisal consideration is disregarded, so this provision is simpler. Its three categories are similarly a wholly controlling relationship, a controlling relationship with employee and business-continuity requirements, or a share transfer prescribed by Cabinet Order as being for a joint business. However, the wholly controlled category includes both relationships between one share-transfer subsidiary and another and “a share transfer prescribed by Cabinet Order in which only one corporation becomes the wholly owned subsidiary.” The relevant relationships differ from share exchanges, which build on existing corporations as parent and subsidiary. A share transfer newly establishes the parent while existing corporations become its wholly owned subsidiaries. It includes both joint establishment of a parent by multiple corporations and a standalone share transfer involving only one subsidiary.

Unlike Mergers and Splits, Do These Transactions Leave Assets in Place?

In a merger, the disappearing corporation’s assets and liabilities move to the survivor; in a split, part of the splitting corporation’s assets and liabilities move to the successor. In a share exchange or share transfer, the property transferred consists of shares held by the subsidiary’s shareholders. The subsidiary’s own assets remain within it. Only its shareholder composition—who holds its shares—changes; the subsidiary itself neither transfers nor succeeds to assets.

However, the absence of an asset transfer does not mean a non-qualified transaction is untaxed. Article 62-9 of the Corporation Tax Act provides:

Where a domestic corporation undertakes a share exchange, etc. or share transfer making it the wholly owned subsidiary (excluding qualified share exchanges, etc., qualified share transfers, and share exchanges or transfers where it had a wholly controlling relationship immediately beforehand with the share-exchange parent or another share-transfer subsidiary; hereinafter a “non-qualified share exchange, etc.”), valuation gains (fair value exceeding book value immediately before the transaction) or valuation losses (book value exceeding fair value at that time) on its assets subject to fair-value measurement (fixed assets, land including rights over land but excluding land classified as fixed assets, securities, monetary claims, and deferred assets, other than those prescribed by Cabinet Order) shall be included in gross income or deductible expenses for the business year containing the transaction date.

For a non-qualified share exchange, etc. or share transfer, excluding cases where a wholly controlling relationship existed immediately beforehand with the parent or another share-transfer subsidiary, the subsidiary includes the excess of fair value over book value as a valuation gain, or the reverse as a valuation loss, on assets subject to fair-value measurement held immediately beforehand. These amounts enter gross income or deductible expenses for that business year. Although only the shares move and the assets remain with the subsidiary, non-qualified status triggers taxation as though those assets had been transferred at fair value. Qualified transactions do not produce these valuation gains or losses. Taxation of the subsidiary’s shareholders must be considered separately; see Reorganizations and Shareholder Taxation We are dealing with that.

Points that require care in practice

• Article 4-3 of the Enforcement Order sets out the relationships and transactions prescribed by Cabinet Order in subitems (a), (b), and (c) for qualified share exchanges, etc. and qualified share transfers. The requirements are extensive, so the relevant Enforcement Order provisions must be consulted directly.
• Share exchanges, etc. encompass Companies Act share exchanges and three additional acts: resolutions to acquire shares subject to wholly callable provisions, share consolidations, and demands for sale of shares. Their statutory classification depends on which act occurs.
• The parenthetical definition in Article 62-9 limits assets subject to fair-value measurement to fixed assets, land, securities, monetary claims, and deferred assets other than those prescribed by Cabinet Order. Each asset’s inclusion must be checked individually.
• Many qualification requirements concern not only the relationship immediately before the transaction but also the expectation that it will continue afterward. Future expectations must therefore be assessed alongside the position at execution.

Legal basis

• Corporation Tax Act, Article 2, item 12-6 (Wholly Owned Subsidiary in a Share Exchange) / Quoted wording: “The corporation issuing the shares held by its shareholders that are acquired by another corporation through a share exchange.”
• Corporation Tax Act, Article 2, item 12-6-2 (Wholly Owned Subsidiary in a Share Exchange, etc.) / Quoted wording: “The wholly owned subsidiary in a share exchange and the target corporation prescribed in item 12-16 in relation to a share exchange, etc. other than a share exchange.”
• Corporation Tax Act, Article 2, item 12-6-3 (Wholly Owning Parent in a Share Exchange) / Quoted wording: “The corporation that, by acquiring another corporation’s shares through a share exchange, comes to hold all that corporation’s issued shares.”
• Corporation Tax Act, Article 2, item 12-6-4 (Wholly Owning Parent in a Share Exchange, etc.) / Quoted wording: “The wholly owning parent in a share exchange, corporations that are the largest shareholders, etc. prescribed in item 12-16(a) and (b), and the corporation that is the single shareholder, etc. in subitem (c), in relation to a share exchange, etc. other than a share exchange.”
• Corporation Tax Act, Article 2, item 12-6-5 (Wholly Owned Subsidiary in a Share Transfer) / Quoted wording: “The corporation issuing the shares held by its shareholders that are acquired, through a share transfer, by the corporation established through that share transfer.”
• Corporation Tax Act, Article 2, item 12-6-6 (Wholly Owning Parent in a Share Transfer) / Quoted wording: “The corporation established through a share transfer that acquires all another corporation’s issued shares through that transfer.”
• Corporation Tax Act, Article 2, item 12-16 (Share Exchange, etc.) / Quoted wording: “A share exchange and the establishment, through the acts listed in (a) through (c), of a relationship in which the target corporation (the corporation specified respectively in those subitems) is wholly controlled by the corporation that is the largest shareholder, etc. under (a) or (b), or the single shareholder, etc. under (c).”
• Corporation Tax Act, Article 2, item 12-17, opening provision (Definition of Qualified Share Exchange, etc.: Consideration Requirement) / Quoted wording: “A share exchange, etc. in any of the following categories in which the subsidiary’s shareholders, etc. receive no assets other than shares in one corporation that is either the wholly owning parent or its wholly controlling parent (a corporation in a relationship prescribed by Cabinet Order involving direct or indirect ownership of all the share-exchange parent’s issued shares, etc.); disregarding money or other assets delivered as dividends of surplus, appraisal-rights consideration for dissenting shareholders, consideration to other shareholders where the parent holds at least two-thirds of the subsidiary’s issued shares excluding treasury shares immediately before the exchange, payments pursuant to acquisition-price determination petitions under subitem (a) of the preceding item, consideration for fractions below one share under the act in that subitem or arising under subitem (b), and consideration for the acquisition under subitem (c).”
• Corporation Tax Act, Article 2, item 12-18, opening provision (Definition of Qualified Share Transfer: Consideration Requirement) / Quoted wording: “A share transfer falling under any of the following categories in which the subsidiary’s shareholders receive no assets other than shares in the parent (disregarding money or other assets delivered as consideration pursuant to appraisal rights of shareholders dissenting from the transfer).”
• Corporation Tax Act, Article 2, item 12-18(a) (Requirements for Qualified Share Transfers) / Quoted wording: “A share transfer prescribed by Cabinet Order in which only one corporation becomes the wholly owned subsidiary.”
• Corporation Tax Act, Article 62-9, paragraph 1 (Fair-Value Gains and Losses on Non-Qualified Share Exchanges, etc. and Share Transfers) / Quoted wording: “Where a domestic corporation undertakes a share exchange, etc. or share transfer making it the wholly owned subsidiary (excluding qualified transactions and exchanges or transfers where it had a wholly controlling relationship immediately beforehand with the share-exchange parent or another share-transfer subsidiary; hereinafter a ‘non-qualified share exchange, etc.’), valuation gains (fair value exceeding book value immediately beforehand) or valuation losses (book value exceeding fair value at that time) on its assets subject to fair-value measurement (fixed assets, land including rights over land but excluding land classified as fixed assets, securities, monetary claims, and deferred assets, other than those prescribed by Cabinet Order).”