EXHIBIT 8.3
[Letterhead of]
Ernst & Young LLP
September 11, 1996
Board of Directors Board of Directors
Axion Inc. and Axion HealthCare Inc. Bristol-Myers Squibb Company
1111 Bayhill Drive, Suite 125 345 Park Avenue
San Bruno, California 94066 New York, New York 10154
Dear Board Members:
This letter sets forth our opinion concerning certain Federal income tax
consequences that would arise from the pro rata distribution by Axion Inc.
("Distributing") to its shareholders of the stock of Axion HealthCare Inc.
("Controlled"), followed by the acquisition of the stock of Distributing by
Bristol-Myers Squibb Company ("Acquiring") solely in exchange for Acquiring
stock (the "Acquisition"). Such transactions, along with the other transactions
described herein, are hereinafter referred to as the "Proposed Transaction."
In rendering this opinion, we have relied upon the facts, summarized below, as
they have been presented to us orally and in the following documents (the
"Documents"):
1. The representation letter provided by the managements of Distributing
and Controlled dated August 2, 1996, attached hereto as Exhibit A.
2. The representation letter provided by the management of Acquiring, dated
August 2, 1996, attached hereto as Exhibit B.
3. The Agreement and Plan of Merger dated as of August 2, 1996 among
Acquiring, OTNC Acquisition Sub Inc., and Distributing (the "Merger
Agreement") and the agreements set forth in Section 3.01 thereof (the
"Ancillary Agreements").
4. The Joint Proxy Statement/Prospectus and the Required AHC Documents, as
defined in
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Section 4.01(d)(ii) of the Merger Agreement.
5. The Form S-4 Registration Statement under the Securities Act of 1933
filed by Acquiring in connection with the transaction contemplated by
the Merger Agreement (the "Form S-4").
6. Internal Revenue Service Revenue Procedure 96-30 Checklist
Questionnaire.
7. Representation letters received from various shareholders of
Distributing in the form attached hereto as Exhibit C (relating to their
intention with respect to the holding of stock of Controlled and
Acquiring.)
You have advised us that the facts contained in the Documents, and as set forth
below, provide an accurate and complete description of the facts and
circumstances concerning the proposed transactions. We have made no independent
determination regarding such facts and circumstances and, therefore, have relied
upon the Documents for purposes of this letter. Any changes to the facts or to
the Documents may affect the conclusions stated herein, perhaps in an adverse
manner.
We understand that you will include references to Ernst & Young LLP and our
opinion in the Form S-4 and will include a copy of our opinion as an exhibit
thereto. Subject to our prior review and approval, we consent to the inclusion
of such references and a copy of our opinion.
STATEMENT OF FACTS
Axion Inc. ("Distributing") was incorporated under Delaware law in 1987, as
Access Biotechnology, Inc., and changed its name to Axion in 1994. Through
subsidiaries, Distributing is engaged in the Clinical/Disease Management and
Distribution Businesses, described more fully below.
The Clinical/Disease Management Business
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The Clinical/Disease Management Business is a collection of related
cancer-focused healthcare activities designed to promote provision of the
highest quality cost-effective cancer care by office-based oncologists. This
business began upon Distributing's incorporation in 1987 through its clinical
studies activity. This activity, which continues to the present, consists of
coordinating the study of emerging cancer drugs and treatments developed by
pharmaceutical and biotechnology companies. A significant contribution of
Distributing in this area is its ability, through its relationships with the
Southwest Oncology Group and others, to facilitate these studies on patients in
doctor's offices. Depending on the particular item, the company will help
develop the parameters of the study, negotiate the contract, act as project
manager, provide logistical support (such as ordering, receiving, tracking and
disbursing drug shipments, and tracking patient sign-ups and responses), receive
and disburse payments, collect and analyze the data, and prepare a report of the
results. The drug utilization data developed is likely the most comprehensive
available in the industry. Revenues are derived from contracts with drug
companies and practice groups.
The information and relationships developed in the clinical studies activity
have resulted in the provision of other services, largely to office-based
oncologists, including reimbursement assistance, preparation of Federal Drug
Administration applications, practice management, and (through OPUS Health
Systems, described below), inventory management. Moreover, its knowledge and
experience have enabled the company to develop cancer drug protocols and
treatment guidelines which serve as integral parts of its disease management
program. In this activity, began in 1993, the company negotiates with payers to
manage the delivery of cancer care. In this regard, the company has developed a
network of physicians through which such care is provided using the protocols
and guidelines described above, and the computer resources described below, all
with a view to providing the highest quality, cost-effective cancer treatment.
At the end of 1994, the assets and liabilities of the Clinical/Disease
Management Business were contributed to a newly-formed wholly-owned subsidiary,
formerly OnCare Health Inc. (presently named Axion HealthCare Inc.)
("Controlled"), which conducts all of the foregoing activities.
The Distribution Business
In September 1990, Distributing began to distribute oncology pharmaceuticals and
related
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supplies to office-based oncology practices (the "Distribution Business"). The
Distribution Business provides these practices with next-day delivery (compared
with days or weeks when the drugs are ordered from the manufacturer), thereby
reducing inventory requirements and pharmaceutical expiration.
Distributing directly conducted both the Clinical/Disease Management and the
Distribution Businesses until 1993. In July 1993, Distributing entered into a
series of agreements with Bristol-Myers Squibb Company ("Acquiring") to form the
Oncology Therapeutics Network Joint Venture, L.P., a Delaware limited
partnership ("OTNJV"). Distributing formed a wholly-owned subsidiary, Oncology
Therapeutics Network Corporation ("OTNC"), to act as the general partner of
OTNJV. A wholly-owned subsidiary of Acquiring ("BMS Partner Sub") is the limited
partner. Distributing contributed the assets of its Distribution Business to
OTNC, which, in turn, contributed those assets to OTNJV. In addition,
Distributing agreed to provide all administrative, operational, and other
services necessary to support the joint venture, subject to reimbursement for
its costs by OTNJV. Acquiring appointed OTNJV as its exclusive sales agent for
Acquiring's oncology products for office-based practices.
In addition to the Clinical/Disease Management and Distribution Businesses,
Distributing conducts an Information Management Business and previously
conducted a Physicians Practice Management Business.
The Information Management Business
The Information Management Business, which provides inventory and information
management systems to oncology practices, is conducted through OPUS Health
Systems, Inc. formerly OnCare Systems Inc. ("OPUS"), a wholly-owned subsidiary
of Distributing. OPUS provides oncologists with state-of-the-art technology in
inventory management and drug utilization. The information provided by the
Information Management Business allows oncologists to use the most appropriate
pharmaceuticals (including generics), and then only when needed, thereby
reducing inventory carrying costs.
Included in OPUS' Information Management Business is the OPUS Station activity
("OPUS Station"). OPUS Station is an automated drug dispensing and inventory
tracking activity, specifically tailored for use in the outpatient setting.
Located in the doctor's office, the OPUS
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Station equipment links the local oncology practice with OTNJV.
OPUS also owns and operates the OPUS Matrix, a Windows-based application, that
generates recommended treatment procedures from patient diagnoses and treatment
regimens. As part of the disease management activity, OPUS Matrix provides
office-based oncology practices with access to a central database containing
drug and treatment information.
The Physician Practice Business
OnCare Inc., previously a more-than-80-percent-owned subsidiary of Distributing,
is an oncology-specific physician practice management company, which acquires
and manages local oncology practices (the "Physician Practice Business"). The
oncologists who were the former owners of the acquired practices work as
professional service providers to the company. OnCare Inc.'s providers (who
employ the OnCare treatment guidelines in their practice) are represented to
health plans as part of a select managed cancer care network that can offer
documented proof of high-quality, cost-effective care. All of Distributing's
common stock of OnCare Inc. was distributed to its shareholders on December 31,
1995.
As of June 30, 1996, Distributing had one class of common stock, and several
classes of preferred stock, issued and outstanding. Distributing also has
outstanding certain warrants and employee options with respect to its common
stock. The common stock consists of 15 million authorized shares, of which
approximately 1.6 million are issued and outstanding. Preferred stock consists
of 10 million authorized shares, of which approximately 6.7 million are issued
and outstanding. The preferred stock is divided into Classes A - F; each class
is convertible into common stock. No dividends are in arrears on any class of
preferred stock. Distributing also has outstanding certain employee stock
options.
Distributing uses the accrual method of accounting for Federal income tax
purposes and files its consolidated Federal income tax return on a calendar year
basis.
BUSINESS PURPOSE
The Acquisition is being undertaken to secure a number of strategic objectives
for Distributing
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and Acquiring, including (a) elimination of a conflict perceived by the
customers of the Distribution Business between that business and the
clinical/disease management and physician practice activities; (b) the
opportunity to increase sales to office-based oncology practices; and (c)
allowing Acquiring to expand the quality of services provided to such practices.
Distributing must separate the Distribution Business from the rest of
Distributing's activities in order to permit the Acquisition to occur. Acquiring
has stated that it has no interest in acquiring from Distributing any assets
other than (i) 100 percent of OTNC's interest in OTNJV, and (ii) the OPUS
Station activities (collectively referred to as the "Wanted Assets").
Accordingly, as a condition to the acquisition of the stock of Distributing,
Acquiring will require that Distributing divest all assets and liabilities other
than the Wanted Assets (and related liabilities) prior to Acquiring's
acquisition of that stock. Further, separation of the Distribution Business from
its other activities is integral to Distributing's decision to undertake the
Acquisition.
PROPOSED TRANSACTION
The following transactions have been proposed for the business reasons described
above.
1. OTNJV will distribute to OTNC, cash representing a preference payment
to which OTNC is entitled for periods ending June 30, 1996. OTNC will
distribute that cash to Distributing.
2. OPUS will transfer to a newly created corporation, OPUS Sub, the
assets related to the OPUS Matrix activity. OPUS Sub will assume all
related liabilities.
3. OPUS will distribute the stock of OPUS Sub to Distributing.
4. Distributing will contribute to Controlled all assets other than the
Wanted Assets. Controlled will assume all liabilities other than
those related to the Wanted Assets and those previously assumed by
OPUS Sub.
5. Previously nonvested Distributing options will become vested. All
options will be exercised or cancelled. Distributing will provide
loans to facilitate exercise.
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6. Controlled will be recapitalized through the exchange by Distributing
of all of its shares of Controlled common stock for a number of
shares of Controlled preferred stock equal to the number of shares of
Distributing stock outstanding.
7. Distributing will distribute all of the stock of Controlled to its
shareholders on a pro rata basis. (In order for the distribution to
be pro rata, and to put the Distributing shareholders in the same
position as if Step 8 below had already occurred, holders of
Distributing preferred stock will waive dividend preferences (if
any)).
8. All of Distributing's preferred stock will be converted into common
stock by vote of the preferred shareholders.
9. Acquiring will cause a newly formed wholly-owned subsidiary, OTNC
Acquisition Sub Inc., to merge into Distributing. In the merger,
Distributing's shareholders will receive solely stock of Acquiring in
exchange for their Distributing stock. Cash will be paid in lieu of
fractional shares.
MEMORANDUM OF AUTHORITIES
THE DISTRIBUTION OF CONTROLLED STOCK
Section 368(a)(1)(D) of the Internal Revenue Code of 1986, as amended (the
"Code") provides in part that a reorganization includes a transfer by a
corporation of part of its assets to another corporation if, immediately after
the transfer, the shareholders of the transferor are in "control" (as defined
below) of the transferee, and, pursuant to the plan, stock or securities of the
transferee are distributed in a transaction which qualifies under Section 355 of
the Code.
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Section 355 provides for the tax free distribution of the stock of a controlled
subsidiary. In general, to meet the requirements of Section 355 --
(i) Immediately before the distribution, the distributing corporation must
"control" the corporation whose shares are being distributed. The term
"control" is defined by Section 368(c) to mean stock possessing at least
80 percent of the total combined voting power and at least 80 percent of
the total number of shares of all other classes of stock. Section
355(a)(1)(A);
(ii) Immediately after the distribution, both the distributing and controlled
corporations must be engaged in the active conduct of a trade or business.
Section 355(a)(1)(C) and (b). This active conduct of a trade or business
requirement is satisfied only if the trade or business was actively
conducted throughout the five-year period ending on the date of
distribution, and that business (or control of a corporation conducting
that business) was not acquired within that period in a transaction in
which gain or loss was recognized. Section 355(b)(2);
(iii) The distributing corporation must distribute all of its stock and
securities in the controlled corporation or distribute enough stock to
constitute control and establish to the satisfaction of the Treasury that
the retention of stock in the controlled corporation is not part of a tax
avoidance plan. Section 355(a)(1)(D);
(iv) The transaction must not be used principally as a device for the
distribution of earnings and profits. Section 355(a)(1)(B);
(v) There must be a corporate business purpose for the transaction and a
continuity of interest. Section 1.355-2(b) and (c) of the Income Tax
Regulations (the "Regulations"); and
(vi) The transaction must not constitute a "disqualified distribution" as
defined in Section 355(d)(2) of the Code.
Control Immediately Before the Distribution
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With regard to the Section 355 requirements above, the test described in (i) is
satisfied because Distributing will own 100 percent of the stock of Controlled
immediately before the distribution.
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Active Conduct of a Trade or Business
The active trade or business requirement of Section 355(b) has several
components: (i) the distributing and controlled corporations must be engaged in
the active conduct of a trade or business immediately after the distribution;
(ii) the business(es) must have been actively conducted for the five-year period
before the distribution; and (iii) neither the active business nor the stock of
the controlled corporation may have been acquired in a taxable transaction
during the five-year period preceding the distribution. Sections 355(b)(1) and
(2).
The five-year active business requirement is satisfied if the businesses have
been actively conducted by the distributing or controlled corporations for five
years before the distribution. Corporations are considered actively engaged in
the conduct of a trade or business if they carry on a specific group of
activities, generally including the collection of income, for the purpose of
earning a profit and the payment of expenses. Section 1.355-3(b)(2)(ii) of the
Regulations. A corporation is engaged in the active conduct of a trade business
if it is directly so engaged, or if "substantially all" of its assets consist of
stock of one or more corporations which are so engaged. Section 355(b)(2)(A). A
corporation will meet this "substantially all" requirement if 90 percent of the
fair market value of its gross assets consists of stock of qualifying
corporations. Rev. Proc. 77-37, 1977-2 C.B. 568.
Generally, a trade or business is considered to be actively conducted if the
corporation itself performs active and substantial management and operational
functions. Although activities performed on behalf of the corporation by
independent contractors and other parties outside the corporation are not
considered as performed by the corporation, the active conduct requirement may
be satisfied even though some activities are performed by others. Section
1.355-3(b)(2)(iii) of the Regulations.
Distributing has been directly engaged in the Clinical/Disease Management
Business from 1987 to 1994, and indirectly engaged in the Clinical/Disease
Management Business through its wholly-owned subsidiary Controlled from 1995 to
the present. The activities of Controlled that relate to the Clinical/Disease
Management Business include the full process of earning income or profit, as
described in Section 1.355-3(b)(2)(ii) of the Regulations.
In this regard, we note that the disease management activity began in 1993. It
is unclear
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whether this activity is a part of a single business, or is a separate business
activity. Section 1.355-3(b)(3)(ii) of the Regulations provides that:
"[I]f a corporation engaged in the active conduct of one trade or
business during that five-year period purchased, created, or otherwise
acquired another trade or business in the same line of business, then
the acquisition of that other business is ordinarily treated as an
expansion of the original business, all of which is treated as having
been actively conducted during that five-year period, unless that
purchase, creation, or other acquisition effects a change of such a
character as to constitute the acquisition of a new or different
business."
As explained supra, in light of the fact that the disease management activities
evolved out of, and use the information developed by, the corporation's other
cancer focused healthcare activities, an argument can be made that these are all
part of single business activity. Even if, however, the disease management
activity is viewed to be a separate business, Controlled will nonetheless
satisfy the 5-year active business test by virtue of its remaining activities.
In addition, the proposed transactions contemplate that Controlled will have a
substantial amount of cash and similar assets. Assuming arguendo that these
assets are not viewed as active business assets (see below), nonetheless, the
Internal Revenue Service (the "Service") has held that a corporation may meet
the active business test even though a small percentage of its assets is
directly utilized in the active business activity. See Rev. Rul. 73-44, 1973-1
C.B. 182; GCM 34238 (where the active business assets amount to 5 percent of the
total assets).(1) See also, TAM 8308007 (October 29, 1982). Instead, as
described more fully below, the existence of cash has been analyzed under the
"device" rules.
In this regard, it should be noted that, on August 8, 1996, the Service issued
Rev. Proc. 96-43, 1996-35 I.R.B. 6, amplifying Rev. Proc. 96-3, 1996-1 IRB 82.
Rev. Proc. 96-43 provides that
- --------
(1) Pursuant to Section 6110(j)(3) of the Code, private letter rulings,
technical advice memorandums, and GCMs are not cited as precedent, but to
illustrate a consistent position by the Service.
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the Service will ordinarily not issue an advance ruling regarding whether a
distribution qualifies under Section 355 when the gross value of the trade or
business relied on to satisfy the active business requirement is less than five
percent of the gross value of all of the assets of the corporation. We do not
believe that the issuance of Rev. Proc. 96-43 changes the conclusions expressed
herein.
Distributing has been directly engaged in the Distribution Business from 1990 to
1993, and indirectly engaged in the Distribution Business from 1993 to the
present through its wholly-owned subsidiary OTNC (which owns a 50 percent
general partnership interest in OTNJV). The conduct of the Distribution Business
includes the full process of earning income or profit, as described in Section
1.355-3(b)(2)(ii) of the Regulations.
We believe that the formation of OTNJV and the transfer of assets to it in
1993 does not cause the Distribution Business previously conducted by
Distributing to fail to satisfy the 5-year active business test. In this regard,
we note that OTNC actively manages the operations of OTNJV. Accordingly,
applicable authorities indicate that it is still actively engaged in the
Distribution Business begun by Distributing.
In Rev. Rul. 79-394, 1979-2 C.B. 141, amplified by Rev. Rul. 80-181, 1980-2 C.B.
121, the Service concluded that operational activities relating to corporation
X, that were conducted by another member of the affiliated group of which X was
a member, could be taken together with the management activities conducted by
the officers of X to satisfy the active trade or business requirement of Section
355. Similarly, in Rev. Rul. 92-17, 1992-1 C.B. 142, a limited partnership
("LP") owned certain real estate that it operated for more than 5 years. D
corporation had been a 20 percent general partner in LP for more than 5 years.
D's officers performed active and substantial management functions for the
business conducted by LP, including supervising LP's employees. The Service
concluded that management activities conducted by D in support of the
operational activities conducted by LP satisfied the active trade or business
requirements of Section 355. See also, PLR 9510005 (December 5, 1994) in which
the Service applied Rev. Rul. 92-17 and found that a corporation met the active
trade or business requirement of Section 355 where that corporation was the
managing general partner of a partnership that conducted a business meeting that
requirement. Furthermore, we understand that the day-to-day operations of the
Distribution Business changed very little (if at all) after the formation of the
partnership, and are now conducted largely by employees of OTNC.
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Accordingly, we believe that Distributing (through OTNC) should be viewed as
continuing its Distribution Business.
Thus, for the foregoing reasons, while not free from doubt, we believe that the
active trade or business requirement for both Distributing and Controlled should
be satisfied in this case.
Distribution of Control
The requirement in (iii) will be satisfied in the proposed transaction because
Distributing will distribute 100 percent of the stock of Controlled to its
shareholders in the distribution.
Device to Distribute Earnings and Profits
As noted, Section 355(a)(1)(B) of the Code and Section 1.355-2(d) of the
Regulations provide that Section 355 does not apply to a transaction used
principally as a device for the distribution of the earnings and profits of the
distributing corporation, the controlled corporation, or both. The Regulations
provide that, generally, the determination of whether a transaction was used
principally as a device will be made from all of the facts and circumstances,
including, but not limited to, the presence or absence of certain factors
described therein. Section 1.355-2(d) of the Regulations.
Section 1.355-2(d)(2)(iii) of the Regulations provides that a sale or exchange
of the stock of the distributing or controlled corporation is evidence of a
device. Section 1.355-2(d)(2)(iii)(E) further provides, however, that if stock
is exchanged for stock in pursuance of a plan of reorganization in which no gain
or loss (or an insubstantial amount of gain) is recognized, the exchange is not
treated as evidence of device, and the device rules will be applied by reference
to the stock received. In the present case, the exchange of the stock of
Distributing after the spin-off will be effected pursuant to a transaction
qualifying as a tax-free reorganization described in Section 368(a)(1)(B) of the
Code. Accordingly, such exchange will not result in the transaction being
considered to have been used principally as a device. Further, it has been
represented that certain shareholders of Distributing have no plan or intention,
and the management of Distributing knows of no plan or intention on the part of
the remaining Distributing shareholders, to sell or exchange stock of Controlled
or Acquiring after the Acquisition.
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September 11, 1996
In general, Section 1.355-2(d)(2)(iv)(B) of the Regulations provides that the
existence of assets not used in a trade or business (including cash and liquid
assets not related to the reasonable needs of the business) is evidence that the
transaction is being used principally as a device to distribute earnings and
profits. The strength of this evidence depends on all the facts and
circumstances, including the ratio for each corporation of the value of assets
not used in a trade or business to the value of assets that satisfy the active
trade or business requirement of Section 355. Section 1.355-2(d)(3)(ii) of the
Regulations provides that the existence of a corporate business purpose for the
transfer or retention of assets not used in a trade or business can outweigh the
evidence of device presented by such transfer or retention.
In the present case, cash and other liquid assets will be transferred by
Distributing to Controlled as part of the transaction. Management of
Distributing has indicated that the disease management activity of Controlled
(which, as noted, evolved from the clinical operations) will require substantial
funds beyond expected operating profits to maintain and expand its data base and
to market its services throughout the oncology community. We further understand
that, because these activities are in their initial stages, it would be very
difficult for Controlled to obtain lending from outside sources. Similarly,
management of Distributing and Controlled have represented that the cash and
other liquid assets will only be used in the business activities retained by
Controlled or to satisfy obligations under agreements relating to the Proposed
Transaction. Further, we understand that Acquiring and Distributing never
considered that these assets would be retained in the Distribution Business or
otherwise included in the Acquisition. Therefore, arguably, the cash and other
liquid assets are related to the reasonable needs of Controlled's business; in
any event, there is a business purpose for the transfer.
The Service has ruled that a contribution to a controlled corporation, in
anticipation of a spin-off, made to allow the controlled corporation to expand
its business, is not indicative that the transaction is used principally as a
device to distribute earnings and profits. In Rev. Rul. 83-114, 1983-2 C.B. 66,
immediately prior to the spin-off, the distributing corporation canceled
indebtedness owed by a controlled corporation in order to enable the latter to
expand its business with operating proceeds and investment capital. The
cancellation resulted in more than a 100-percent increase in the controlled
corporation's net worth. Rev. Rul. 83-114 concluded that, in light of the
business purpose for the contribution, the distribution was not used principally
as a device to distribute earnings and profits.
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September 11, 1996
In addition, the Service has held that a transfer of cash to a controlled
corporation made to equalize values in a split-off transaction will not be
considered as evidence that the transaction is being used principally as a
device for the distribution of earnings and profits. See Rev. Rul. 64-102,
1964-1 C.B. 136 (capital contribution more than doubled the value of the
controlled corporation); Rev. Rul. 71-383, 1971-2 C.B. 180; Section
1.355-2(d)(3)(iv)(B) of the Regulations. Compare Rev. Rul. 86-4, 1986-1 C.B. 174
(transfer of investment assets by distributing to the controlled corporation
immediately prior to a pro-rata spin-off was a factor to be considered, along
with other factors, in determining whether the transaction was a device); cf.
Rev. Rul. 59-400, 1959-2 C.B. 114, (shift in earnings from a hotel business to a
rental real estate business approximately one year prior to a pro rata spin-off
resulted in nonqualification under Section 355 in light of the fact that rental
real estate was involved).
Accordingly, based on the facts and circumstances, cash and other liquid assets
can be contributed to a controlled corporation in anticipation of a distribution
without the transaction being considered to have been used principally as a
device to distribute earnings and profits. The instant transaction appears to
present such a case. Thus, in this case, there is an important business reason
for the distribution of the stock of Controlled, i.e., to facilitate the
acquisition by Acquiring. Further, as stated above, there is an important
business reason for the contribution of cash and similar assets--i.e., to fund
the continued development and expansion of the disease management activities.
Moreover, these assets are not to be included in the Acquisition. Accordingly,
while not free from doubt, we believe that the transaction should not be
considered to have been used principally as a device for the distribution of
earnings and profits.
Business Purpose
Section 1.355-2(b) of the Regulations provides that Section 355 applies to a
transaction only if it is carried out for one or more corporate business
purposes. A transaction is carried out for a corporate business purpose if it is
motivated, in whole or substantial part, by one or more corporate business
purposes. A corporate business purpose is a real and substantial non-Federal tax
purpose germane to the business of the distributing corporation, the controlled
corporation, or the affiliated group (as defined in Section 1.355-3(b)(4)(iv) of
the Regulations) to which the distributing corporation belongs.
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September 11, 1996
The business purpose test described in (vi) above should be satisfied because
the business purpose for the transaction is to facilitate a tax-free
reorganization. In order to complete the Acquisition under the facts of this
case, Acquiring is requiring Distributing to divest the assets described above.
The Service has long and consistently recognized that a spin-off made in order
to permit a tax-free reorganization involving the distributing corporation is
supported by a business purpose. See Rev. Rul. 68-603, 1968-2 C.B. 148, Rev.
Rul. 70-434, 1970-2 C.B. 83, and Rev. Rul. 78-251, 1978-1 C.B. 89. See also
Commissioner v. Morris Trust, 367 F. 2d 794 (4th Cir. 1966).
There are no other tax-free alternatives to accomplishing this business
objective. Thus, Acquiring cannot simply acquire the stock of OTNC directly from
Distributing, as such an acquisition would subject Distributing to
characterization as an "investment company" as that term is defined under the
Investment Company Act of 1940, 15 U.S.C. ss. 80a-1 et seq. (the "1940 Act"). If
Distributing were an investment company it would be required to register with
the Securities and Exchange Commission (the "SEC"), and would become subject to
the 1940 Act's pervasive regulatory framework. Failure to register would subject
Distributing and its management to administrative and judicial penalties,
including the possible voiding of any contracts entered into by the company and,
possibly, criminal conviction of its management. Once a company registers with
the SEC as an investment company, the company and its directors, officers,
substantial shareholders and other related persons are subject to a broad set of
regulatory restrictions administered by the SEC over a great many areas,
including the composition of the board of directors, incentive compensation,
issuances of stock, capital structure, asset composition and transactions with
affiliates.
In addition, Distributing's management believes that if it held a large amount
of its assets in the form of Acquiring stock, Controlled's disease management
activity would be severely adversely affected. Thus, one of the objectives of
this activity is to provide the most cost-effective care, including use of
pharmaceuticals. Further, Controlled's relationship with the oncology community
(including payers) is based upon this cost containment premise. Management
believes that Controlled's credibility, and consequently its ability to
function, would be seriously undermined if its 100 percent parent held as the
bulk of its assets an interest in a large pharmaceutical company devoted to
maximizing profits on pharmaceutical sales. It has been a long-standing position
of the Service that a customer's reluctance to purchase products from a
corporation (or one of its group members) because of other business activity of
the group is a
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valid business purpose under Section 355 of the Code. See Rev. Rul. 56-450,
1956-2 C.B. 201; Rev. Rul. 59-197, 1959-1 C.B. 77; PLRs 9539006 (June 27, 1995);
9524009 (March 15, 1995); 9438026 (June 28, 1994); and 9331062 (February 17,
1993).
Continuity of Interest
Similarly, the continuity of interest requirement for a Section 355 distribution
will be satisfied because 100 percent of the stock of Controlled will be owned
by the shareholders of Distributing. After the Acquisition, the historic
shareholders of Distributing will continue their interest in the business of
Distributing through their stock ownership of Acquiring. See, Rev. Rul. 68-603,
1968-2 C.B. 148, and Commissioner v. Morris Trust, 367 F.2d 794 (4th Cir. 1966).
Disqualified Distribution
Section 355 (d) of the Code provides that, in the case of a "disqualified
distribution," the distributing corporation will recognize the gain (if any)
realized on the distribution of the stock of the controlled corporation. A
"disqualified distribution" is defined as any distribution otherwise qualifying
under Section 355 if, immediately after the distribution, any person holds
"disqualified stock" in the distributing or controlled corporation which
constitutes a 50-percent or greater interest in either corporation.
"Disqualified stock" is defined in Section 355(d)(3) as any stock of the
distributing corporation acquired by purchase during the 5-year period ending on
the date of the distribution, and any stock of the controlled corporation either
acquired by purchase during this 5-year period, or attributable to purchased
distributing stock.
In the present case, no person has acquired a 50-percent or greater interest in
the stock of Distributing or Controlled within the 5-year period ending on the
date of the distribution. Therefore, Section 355(d) will not apply to cause gain
recognition.
THE ACQUISITION OF DISTRIBUTING'S STOCK BY ACQUIRING.
Section 368(a)(1)(B) of the Code provides that the term "reorganization" (a Type
B Reorganization) includes the acquisition by one corporation, in exchange
solely for all or part of its voting stock, of stock of another corporation if,
immediately after the acquisition, the
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acquiring corporation has control of such other corporation. Section 368(c)
provides that, for this purpose, the term "control" means the ownership of stock
possessing at least 80 percent of the total combined voting power of all classes
of stock entitled to vote and at least 80 percent of the total number of shares
of all other classes of stock of the corporation.
The control requirement will be met in this case, since, after the Acquisition,
Acquiring will own all of the stock of Distributing. Similarly, the "solely for
voting stock" requirement will be satisfied, as we understand that Acquiring
will acquire that Distributing stock solely for its own voting stock. The fact
that the transaction will be accomplished through a merger of a newly-created
subsidiary into Distributing does not prevent the transaction from qualifying as
a Type B Reorganization. See Rev. Rul. 67-448, 1967-2 C.B. 144. The fact that
some of the Acquiring stock will be placed in escrow will not prevent
satisfaction of the applicable requirements. Rev. Proc. 77-37, 1977-2 C.B. 568,
as amplified by Rev. Proc. 84-42, 1984-1 C.B. 521.
Section 1.368-1(b) of the Regulations imposes the following additional
requirements which must be met for a transaction to qualify as a reorganization
within the meaning of Section 368: (i) "continuity of interest" must be present,
(ii) "continuity of business enterprise" must exist, and (iii) an appropriate
business purpose must be present.
Rev. Proc. 77-37, 1977-2 C.B. 568 provides that the "continuity of interest"
requirement is satisfied if there is continuing interest through stock ownership
in the acquiring corporation on the part of the former shareholders of the
acquired corporation which is equal in value, as of the effective date of the
reorganization, to at least 50 percent of all of the formerly outstanding stock
of the acquired corporation as of that date. Sales, redemptions, and other
dispositions of stock occurring prior or subsequent to the exchange which are
part of the plan of reorganization will be considered in determining whether
there is a 50 percent continuing interest through stock ownership as of the
effective date of the reorganization. In the proposed transaction, based on the
representations received, former shareholders of Distributing will receive and
retain stock of Acquiring with a value (as of the effective date of the
reorganization) equal to 100 percent of the value of all formerly outstanding
stock of Distributing. Therefore, the continuity of interest guideline of Rev.
Proc. 77-37 will be met.
Section 1.368-1(b) of the Regulations provides that a continuity of business
enterprise (as
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September 11, 1996
described in Section 1.368-1(d) of the Regulations) is a requisite to a
reorganization. Section 1.368-1(d) of the Regulations provides that continuity
of business enterprise requires that the acquiring corporation either continue
the acquired corporation's historic business or use a significant portion of the
acquired corporation's historic assets in a business. The proposed transaction
will meet the continuity of business enterprise requirement as it has been
represented that, after the transaction, Distributing will be engaged through
OTNC in its historic Distribution Business. See Rev. Rul. 85-198, 1985-2 C.B.
121. The fact that all partnership assets and liabilities will now be held
directly by OTNC should not change this result.
Section 1.368-2(g) of the Regulations provides that a reorganization must be
undertaken for reasons germane to the continuance of the business of a
corporation a party to the reorganization. As described above, the Acquisition
will be undertaken for substantial business reasons. Thus, the proposed
transaction will be motivated by a valid business purpose in accordance with the
Regulations.
Section 368(b) of the Code defines the term "a party to a reorganization" to
include a corporation resulting from a reorganization, and both corporations, in
the case of a reorganization resulting from the acquisition by one corporation
of stock or properties of another.
Section 354(a)(1) provides that no gain or loss shall be recognized if stock or
securities in a corporation a party to a reorganization are, in pursuance of the
plan of reorganization, exchanged solely for stock or securities in such
corporation or in another corporation a party to the reorganization.
FEDERAL INCOME TAX CONSEQUENCES
Based solely upon the facts and information presented in the Documents, and on
the information set forth in this opinion letter and subject to the "SCOPE OF
OPINION," described below, it is our opinion that the following Federal income
tax consequences should result from the Proposed Transaction described above:
(1) The transfer by Distributing to Controlled of the assets other than the
Wanted Assets
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solely in constructive exchange for additional stock of Controlled and
the assumption of certain liabilities, as described above, followed by
the distribution of the Controlled stock pro rata to the shareholders of
Distributing should qualify as a reorganization within the meaning of
Section 368(a)(1)(D) of the Code. Distributing and Controlled should
each be "a party to a reorganization" within the meaning of Section
368(b).
(2) No gain or loss will be recognized to Distributing upon the transfer of
the assets, subject to liabilities, to Controlled in constructive
exchange for Controlled stock (Sections 351(a), 361(a) and 357(a)).
(3) No gain or loss will be recognized by Controlled upon the receipt of
assets in constructive exchange for Controlled stock (Section 1032(a)).
(4) The basis of the assets received by Controlled will be the same as the
basis of such assets in the hands of Distributing immediately prior to
the Proposed Transaction (Section 362(b)).
(5) The holding period of the Distributing assets received by Controlled
will include the period during which such assets were held by
Distributing (Section 1223(2)).
(6) No gain or loss should be recognized to (and no amount should be
included in the income of) the shareholders of Distributing upon the
receipt of the Controlled stock (Section 355(a)(1)).
(7) No gain or loss should be recognized to Distributing upon the
distribution of the Controlled stock pro rata to the shareholders of
Distributing (Section 361(c)(1)).
(8) The basis of the Controlled and Distributing stock in the hands of the
shareholders of Distributing should be the same as the basis of the
Distributing stock held by the shareholders of Distributing immediately
before the distribution, allocated in proportion to the fair market
value of each in accordance with Section 1.358-2(a)(2) of the
Regulations (Section 358(b)(1)).
(9) As provided in Section 312(h) of the Code, proper allocation of earnings
and profits
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between Distributing and Controlled should be made in accordance with
Section 1.312-10(a) of the Regulations.
(10) Provided the Distributing stock was held as a capital asset on the date
of the distribution of the Controlled stock, the holding period of the
Controlled stock received by the shareholders of Distributing should
include the holding period of the Distributing stock with respect to
which the distribution was made (Section 1223(1)).
(11) The acquisition by Acquiring of all the stock of Distributing solely in
exchange for Acquiring stock, as described above, will qualify as a
reorganization under Section 368(a)(1)(B) of the Code. Distributing and
Acquiring will each be "a party to a reorganization" within the meaning
of Section 368(b).
(12) No gain or loss will be recognized by the Distributing shareholders upon
the receipt of Acquiring stock solely in exchange for Distributing stock
(Section 354(a)(1)).
(13) The basis of the Acquiring stock received by Distributing's shareholders
in exchange for Distributing stock will be the same as the basis of the
Distributing stock surrendered in exchange therefor (Section 358(a)(1)).
(14) The holding period of the Acquiring stock received by the Distributing
shareholders in the Exchange will include the holding period of the
Distributing stock surrendered in exchange therefor, provided the
Distributing stock is held as a capital asset in the hands of the
Distributing shareholders on the date of the exchange (Section 1223(1)).
SCOPE OF OPINION
The scope of this opinion is expressly limited to the Federal income tax issues
specifically addressed in (1) through (14) in the section entitled "FEDERAL
INCOME TAX CONSEQUENCES" above. We have made no determination, nor expressed any
opinion as to any limitations, including those which may be imposed under
Section 382, on the availability of net operating loss carryovers (or built-in
losses), if any, after the Proposed Transaction, the application (if any) of the
alternative minimum tax to the Proposed Transaction, or on any
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consolidated return, employee benefit, or foreign tax (including, without
limitation, the application of Section 367 of the Code) issues which may arise
as a result of the Proposed Transaction. Similarly, we have made no
determination nor expressed any opinion regarding the consequences to
Distributing shareholders entitled to special treatment under the Code (such as
insurance companies, dealers in securities, or tax exempt organizations) or to
Distributing shareholders who acquired their shares of Distributing stock
pursuant to the exercise of employee stock options or otherwise in compensatory
transactions. In addition, we have expressed no opinion on the conversion of the
Distributing preferred into common stock, on the exercise of the Distributing
options, the recapitalization of Controlled, the transfer of assets or
liabilities to Distributing or any of its direct or indirect subsidiaries in
anticipation of, or as part of, the Proposed Transaction (other than as
described in (1) above), or on the effect of any arrangements between Acquiring
or its subsidiaries and Controlled or its subsidiaries subsequent to the
Acquisition. Furthermore, our opinion has not been requested, and none is
expressed, with respect to any foreign, state or local tax consequences to
Distributing, Controlled, or the shareholders of Distributing.
We note that any variation or differences in the facts or representations
recited herein, for any reason, might affect our conclusions, perhaps in an
adverse manner, and may make them inapplicable. Further, our opinions are based
upon the analysis of the Code, the Regulations thereunder, current case law, and
published rulings. The foregoing are subject to change, and such change may be
retroactively effective. If so, our views, as set forth above, may be affected
and may not be relied upon. We have undertaken no obligation to update these
opinions for changes in facts or law occurring subsequent to the date thereof.
We do note that on March 19, 1996, the Clinton Administration sent to the
Congress a proposal (the "Proposal") to require gain recognition on certain
Section 355 distributions when at least 50 percent of the stock of the
distributing or the controlled corporation is not held at all times during the
four year period commencing two years before and ending two years after the
distribution by the direct and indirect shareholders of the distributing
corporation. If the Proposal were applicable to the instant transaction,
Distributing would be required to recognize gain (if any) realized on the
distribution of the Controlled stock since the shareholders of Distributing will
own less than 50 percent of the stock of Acquiring. The Proposal would not,
however, change the treatment of Distributing's shareholders, described above.
While the Proposal stated that the provisions would generally be effective for
distributions after March 19, 1996, a statement by Senator Roth and Congressman
Archer issued on March 29, 1996, indicated that "it is intended that the
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effective date. . . will be no earlier than the date of appropriate
Congressional action." We express no opinion regarding whether the Proposal will
or will not be applicable to the proposed transaction.
This letter is not intended to be, and should not be, distributed or relied upon
by any entities or persons other than Distributing, Controlled and
Distributing's shareholders. In addition, except as expressly set forth above,
this letter should not be quoted or otherwise referred to in any documents or
filed with or furnished to any agency (other than with the Service upon
examination) without the express written consent of Ernst & Young LLP.
This letter is an opinion of our firm as to the interpretation of existing law
and, as such, is not binding on the Service or the courts.
Very truly yours,
/s/ Ernst & Young LLP
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