This is an Advertisement

Relocating a Business to Kentucky: Is it Time to Adopt Domestication Statutes?

By Nathan Vinson, ELPO Law Partner (Read bio; nvinson@elpolaw.com; 270-781-6500)

Nathan Vinson

Nathan Vinson

Here at ELPO Law, we have been asked by many clients throughout the years to advise on and implement changing a company’s state of organization from out of state to Kentucky.  Historically, the procedure appeared to be fairly uniform across the states, usually invoking the merger statutes of the two states involved – the current jurisdiction of the entity’s organization and the jurisdiction to which the entity desires to relocate.  In recent years, more states are adopting “domestication” statutes which, if allowed by the organization’s home state, allows a corporation to “domesticate” in a new jurisdiction without having to wade through the merger process and learn how to satisfy every state’s merger statutes.

When we talk about relocation, we are talking about a change in domicile from a legal perspective.  The concept of “domicile” can be tricky when a corporation is incorporated in one state but headquartered in another – the corporation is considered domiciled in both states.  Therefore, let’s frame the matter at hand as changing the company’s state of incorporation – the whole point and purpose of domestication statutes.

Here, we will use the example of relocating a company from Delaware to Kentucky (which I’m sure you will find akin to what it must have been like to run the gauntlet in Medieval times).  Then, we’ll see how domestication (the alternative and “new” way to relocate a company) stacks up to the “Kentucky method” by looking at relocating from Delaware to Florida.  Finally, key federal tax considerations and their relative applications under each regime will be examined.  Though applicable to many types of entities (e.g., LLCs, LLPs, LPs, etc.), this summary will be limited to relocating a corporation from out of state to Kentucky, as the tax implications of such can be far more meticulous.

The Kentucky Method

Kentucky Revised Statutes (“KRS”) Chapter 271B, Subtitle 11 (“Merger and Share Exchange”) applies to the method of changing the Company’s state of incorporation from Delaware to Kentucky.  Chapter 1, Subchapter C, Part III of the Internal Revenue Code (“Corporate Organizations and Reorganizations”) governs the federal tax treatment of the change in domicile.  The Internal Revenue Service (“IRS”) has issued guidance on EIN issues in connection with reincorporation transactions.  The Internal Revenue Code will be referred to as the “Code” or “IRC.”

I. Procedure to Convert the Company from a Delaware Corporation to a Kentucky Corporation under State Law

Under Kentucky law, a foreign corporation (one not incorporated in Kentucky) must utilize the merger statutes under the Kentucky Business Corporation Act (i.e. KRS Chapter 271B) to change its domicile to Kentucky.  KRS § 271B.11-070(1)(a) provides that a foreign corporation may merge with a domestic corporation so long as the merger is permitted by the law of the state under whose law the foreign corporation is incorporated.  Delaware law permits such merger pursuant to 8 Del. C. § 252.  The Company’s shareholder(s) would need to form a Kentucky “shell” corporation to implement the merger.  Such corporation will be referred to herein as the “surviving corporation.”

In the case where the domestic corporation is the surviving corporation (as would be the case here), the surviving corporation must comply with other applicable merger statutes under Chapter 271B.[1]  The surviving corporation must adopt a plan of merger, and in some instances, the plan of merger must be submitted for shareholder approval.[2]  After such approval is obtained, the surviving corporation must file articles of merger with the Kentucky Secretary of State.[3]  The Delaware corporation (the “merging corporation”) must also adopt the plan of merger, and either (i) the plan of merger must be filed with the Delaware Department of State, Division of Corporations, or (ii) the surviving corporation may file a “certificate of merger” in lieu thereof.[4]  Both Delaware law and Kentucky law provide that the effect of the merger is that all assets, liabilities, rights, and obligations of the merged corporation become assets, liabilities, rights, and obligations of the surviving corporation.[5]  The merging corporation would cease to exist by operation of law.[6]

As you can see, before we even look at federal tax considerations, relocating a company to Kentucky from a state law perspective is what feels to be a monumental task relative to the desired result.  If a company want to move to another state, why can’t it just notify each state and file some necessary paperwork?  Why can’t the current entity dissolve and just reincorporate in Kentucky?  With a corporation, that comes with adverse tax consequences, and for all entities with an EIN, whether the “new” entity can keep its current EIN or must get a new one is not an easy determination (and subject to debate).

II. Federal Tax Treatment of State Law Merger; EIN

Simply dissolving the Delaware corporation and reincorporating in Kentucky would subject the corporation and its shareholders to taxation under the Code.[7]  Absent special Code provisions, most corporate transfers and exchanges would have tax consequences.  State law mergers are subject to special Code provisions.

Code § 368(a)(1) sets forth a list of corporate transformations that it defines as corporate “reorganizations.”  Mainly by application of Code §§ 354 through 362, these reorganizations are afforded tax-free treatment for federal tax law purposes.  Code § 368(a)(1)(A) defines a reorganization as “a statutory merger or consolidation” (a “Type A” reorganization), and Code § 368(a)(1)(F) defines a reorganization as “a mere change in identity, form, or place of organization of one corporation, however effected” (a “Type F” reorganization”).  The state law merger proposed herein above would therefore technically qualify as a Type A or a Type F reorganization; it is both a statutory merger and a mere change in place of organization.  However, the IRS has indicated that where an existing corporation forms a new corporation in another state for the sole purpose of reincorporating in such state (i.e. the proposed merger), the transaction will be characterized as a Type F reorganization.[8]

Because the proposed state law merger would qualify as a Type F reorganization, the merger would qualify as a tax-free reorganization under the Code.  Therefore, under Code § 361, there is no gain or loss as a result of the reorganization.  The Company’s basis in its assets generally remains the same,[9] and the shareholders and security holders take a basis in their new stock or securities equal to their basis in the old stock or securities.[10]

As is the usual case in a Type F reorganization, assets are nominally transferred to the surviving corporation.  Consequently, Code § 381(a) results in a carryover of tax attributes from the merging corporation to the surviving corporation, including net operating losses, capital loss carryovers, earnings and profits of the company, and the company’s accounting method.[11]  Generally, the taxable year of the acquired corporation in a reorganization ends,[12] and Code § 381 prohibits the surviving corporation from carrying back net operating losses to the acquired corporation’s previous tax years.[13]  However, in a Type F reorganization, the surviving corporation is a continuation of the acquired/merging (or “old”) corporation; the taxable year of the acquired corporation does not cease, and the surviving corporation may carry back net operating losses to a taxable year of the company.[14]

There are nuanced rules regarding when an entity must obtain a new employer identification number (“EIN”) upon the occurrence of certain events, such as a corporate consolidation or a change in form of business.  It is not exactly clear on its face as to the IRS’s determination of when a new EIN must be obtained after a merger.[15]

According to IRS guidance, however, in a Type F reorganization, the surviving corporation, which was only formed to effectuate the company’s reincorporation in Kentucky, continues to use the company’s EIN after the merger (i.e. the Delaware corporation’s EIN will continue).  The state law merger proposed herein is identical to the situation described and ruled on by the IRS in Revenue Ruling 73-526.[16]

So, we had to run down all of those technical details and guidance just to figure out how to relocate from Delaware to Kentucky and what federal tax consequences followed.  Now, let’s take a look at domestication by looking at Florida’s domestication statutes.

Florida Domestication

            As an alternative to using merger statutes to relocate, a corporation desiring to relocate to Florida can achieve the same result by becoming “domesticated” in Florida.[17]  Under the Florida Business Corporation Act (“FBCA”),[18] The domesticating foreign corporation becomes subject to the FBCA and any other Florida laws applicable to Florida corporations, and unlike relocating using merger statutes, such corporation’s existence is deemed to have begun on its original incorporation date in the foreign jurisdiction.[19]  Just like the merger statutes, the domestication must be permitted by the laws of the foreign corporation’s jurisdiction.  It just so happens that Delaware allows a Delaware corporation to convert to a foreign corporation (e.g. a Florida corporation).[20]  We will therefore continue with our example of a Delaware corporation desiring to relocate.

To relocate to Florida via domestication, the Delaware corporation must obtain shareholder approval similar in process to the approval of a merger discussed above.[21]  It must then prepare, execute, and file with the Florida Department of State, Division of Corporations, (i) Articles of Domestication and (ii) articles of incorporation that meet the requirements of the FBCA.[22]  The corporation must also file a Certificate of Conversion with the Delaware Secretary of State, certifying certain information about the corporation and that it agrees that it may be served with process in Delaware in any action, suit, or proceeding for the enforcement of any obligation of the corporation arising while it was a Delaware corporation.[23]  The conversion does not affect any of the corporation’s prior incurred obligations or liabilities, and it continues on practically as if it had always been a Florida corporation.[24]

Although the domestication version of relocating requires a certain amount of filings, it appears less onerous than using the merger statutes to relocate.  Also, the domestication procedure just seems to fit better with the reality of what is happening, while merging corporations just for the sake of relocating can seem a bit peculiar.  To expound on this observation, consider the federal tax and EIN analysis.

Under the Code § 368 reorganization provisions, it is clear that the domestication of a Delaware corporation in Florida is a Type F reorganization (“a mere change in identity, form, or place of organization of one corporation, however effected”).  Further, one need not rely on IRS rulings or search IRS policy too hard to conclude whether the corporation needs a new EIN.  The IRS EIN guidance on its website provides that a corporation will not need a new EIN if the corporation’s name or location changes.[25]  As compared to the analyses of these aspects in a merger situation, the conclusions are clear-cut.

Conclusion

              While several states have codified “domestication” statutes whereby a corporation may file Articles of Domestication, for instance, to change its state of incorporation, Kentucky has not adopted such a statutory scheme.  Though both relocating using state merger statutes and relocating using domestication statutes require a certain amount of paperwork and filings, the domestication route better fits reality (i.e. it makes sense) and the question of federal tax treatment and whether a new EIN is required are easily answered.  Is it time for Kentucky to adopt corporate domestication statutes?

For more information on tax law, mergers & acquisitions, business startup services, or business succession planning, call Nathan Vinson at 270-781-6500 or email nvinson@elpolaw.com

[1] KRS § 271B.11-070(1)(d).

[2] KRS § 271B.11-030.

[3] KRS § 271B.11-070(1)(d).

[4] 8 Del C. § 252(b) and (c).

[5] KRS § 271B.11-060.  8 Del. C. § 259.

[6] Id.

[7] See IRC §§ 331 and 336.  This of course assumes the absence of a parent-subsidiary structure subject to IRC §§ 332 and 337.  Given the audience for this piece, I do not feel it necessary to dive further into the details of taxation of corporate liquidations.  If you feel you would like to discuss further, by all means give me a call.

[8] Rev. Rul. 57-276, 1957-1 C.B. 126; see also Rev. Rul. 88-25, 1988-1 C.B. 116 (conversion of foreign corporation to domestic corporation by filing domestication certificate under state law is a Type F reorganization).

[9] IRC § 362(b).

[10] IRC § 358.

[11] IRC § 381(c).

[12] IRC § 381(b)(1).

[13] IRC § 381(b)(3).

[14] IRC 381(b); Treas. Reg. §§ 1.381(b)-1(a)(1) and 1.381(b)-1(a)(2).

[15] See “Do I Need a New EIN” at https://www.irs.gov/businesses/small-businesses-self-employed/do-you-need-a-new-ein.

[16] 1973-2 C.B. 404.

[17] Fla. Stat. § 607.11920(1).

[18] Chapter 607 of the Florida Statutes.

[19] Fla. Stat. § 607.11924(1)(f).

[20] 8 Del. C. § 266.

[21] 8 Del. C. § 266(b).

[22] Fla. Stat. § 607.11922.

[23] 8 Del. C. § 266(c).

[24] Fla. Stat. § 607.11924(1)(b) and 8 Del. C. § 266(e).

[25] Supra note 13.

Contact Information