Agreement and Plan of Merger of News Corp. and Dow Jones (filed with the SEC on 8/1/2007), and Draft Form S-4 (filed 9/7/2007)

While Congress contemplates the “codification of the economic substance doctrine,” deals go on apace, in confidence that transactions will not (or “should” not) be taxed as the transactions they seem to be. This does not suggest that the economic substance doctrine should not be “codified,” but rather that first someone needs to figure out what it means.

News Corp. and Dow Jones

The pending News Corp. acquisition of Dow Jones is a classic example of how comfortable corporate tax advisors have become with applying substance over form in the taxpayer’s favor, on the one hand, and hoping that a sufficient lapse of time will allow form control over substance, on the other hand.

Facts. News Corp. (Ruby) will form Ruby Newco, which will form Diamond Merger Sub, which will merge into Dow Jones (Diamond). The big Dow Jones shareholders (up to 250 of them, presumably Bancroft family members and associates) can elect to receive Class B Ruby Newco shares, equaling up to 10 percent of the total merger consideration. The rest of the Dow Jones shareholders will get cash that News Corp. has put into Ruby Newco.

The tax discussion in the Form S-4 states that the Dow Jones shareholders who receive Ruby Newco stock should receive tax-free exchange treatment. After four months, they can exchange their Newco shares for News Corp. shares in taxable exchanges. But if they wait two years, News Corp. may cause Newco to merge into News Corp., in which case the Newco class B shareholders should enjoy a tax-free exchange for News Corp. shares.


The Diamond into Dow Jones merger looks like a failed reverse triangular reorganization. News Corp. will not obtain 80 percent control of Dow Jones for News Corp. stock, or even for Newco stock.

But over 25 years ago the tax advisors to National Starch looked at this situation and asked, why can’t section 351 apply here? The idea would be to have the relatively small percentage of target shareholders that wanted tax-free stock exchange treatment to exchange their target stock for the stock of a subsidiary of the acquirer at the same time that the acquirer put cash into the subsidiary, thus effecting one big section 351 exchange. Then the subsidiary would use the cash to buy the bulk of the target stock from the target shareholders who wanted cash and did not mind paying tax.

The IRS initially disagreed, saying that you could not effect an end run around the reorganization rules by calling a failed reorganization a good section 351 exchange. Four years later, the IRS changed its mind. Rev. Rul. 84-71, 1984-1 CB 106. The use of section 351 exchanges in acquisitive reorganizations has become common.

Reorganization Redux?

But the Dow Jones shareholders who receive Newco class B stock may be uncomfortable because the stock will not be liquid. They really would like to have News Corp. stock, but it could not have been issued to them initially because (1) no reorganization can be effected with only 10 percent continuity of shareholder interest, and (2) it would be impossible to effect a section 351 exchange for News Corp. stock. The class B owners can swap for News Corp. stock, but the swap would be taxable, and the whole reason for this complicated structure is to allow 10 percent of the Dow Jones stock to escape taxation.

Therefore, News Corp. says it may merge Newco into itself after two years, in which case the class B shareholders should get nonrecognition treatment to the extent they swap Newco stock for News Corp. stock. No binding commitment, of course, but the merger may happen.What is the significance of two years?

Two years is one of those benchmarks that tax lawyers sometimes think marks a sufficient passage of time to separate event A from event B. If the initial acquisition of Dow Jones could not be separated from a follow-on merger of Newco into News Corp., then the integrated transactions look like a failed reorganization.

Will It Work?

The News Corp. tax advisors evidently are not totally sure it will work because they tentatively will only give a “should” opinion. The treatment of the initial transaction in isolation as a section 351 exchange is a slam dunk, except perhaps for the right of the class B owners to swap for News Corp. stock within a few months. Is the absence of a “binding commitment” to merger enough to avoid problems?

“Codification of Economic Substance”

Many expect Congress to pass a so-called codification of the economic substance doctrine. The administration vehemently opposes enactment. Apparently it likes things better as they are, which can best be described as in a state of confusion in which the “doctrine” can be brandished for in terrorem effect. The bill would not affect the Dow Jones acquisition, both because it probably would be grandfathered and also because its tax deferral features seem to be within the intent of Congress. That is one of the “outs” in the proposed bill, and really leaves open the key question in the entire area: what did Congress intend the law to be? The only consistently enforceable answer to this question is that it intended the law to mean what it says.


Tax avoidance is in the eye of the beholder. One taxpayer’s wise employment of the guides in the law to wend its way to tax relief is sometimes a tax collector’s tax avoidance or even evasion. The codification of the economic substance doctrine is unlikely to change that dynamic, only to shift the playing field slightly.