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Proprietary theory, parent company theory, entity theory

Emily and Richard have invested in Faster Distribution, a small publicly traded company. They each own 40% of the stock of Faster Distribution.

They could want to sell Faster to Leeds but do not want to pay any tax on the sale. According to Section 368 of the IRS Code, there are seven allowed types of tax-free reorganizations:
- Statutory merger
- Exchange of stock for stock
- Exchange of stock for property
- Transfer of assets between commonly controlled corporations
- Recapitalization
- Change of identity or form or organization
- Tansfer in bankruptcy
Emily and Richard have controlling interest in both Leeds and Faster, so their goal of selling Faster to Leeds would qualify as a tax-free reorganization of either a type B or type D reorganization. In addition, Emily and Richard are considering how to report the combination. It is their intent to build a vertically integrated corporation to provide value to all shareholders.

Emily and Richard have been discussing the business combination with a nephew who recently earned his certified public accountant (CPA) certificate. His advice was to report the combination as a combined financial statement, but they were unsure which theory to use.

For each of the following 3 theories--proprietary theory, parent company theory, entity theory:
- Describe each theory
- Explain how each theory would apply in this situation
- Recommend a theory for them and support your choice with your rationale.

Solution Preview

Section 368 of the IRS code is a reorganization code for acquisitions, mergers, and consolidation. There are no restrictions on the type of considerations implemented. Type D transfers assects between the controlled organizations and type B exchanges stock for stock. In this matter, Emily and Richard must ponder the three theories of proprietary, parent company, and entity and decide which will be most beneficial for their future plans.

Proprietary theory exists when there is no distinction between the legal entity and the owners, in other words the organization and its owners are identical. With this theory, the profits are available for distribution to the owners in contrast to belonging to the organization. ...

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