It s All About That Basis

Transcription

1 It s All About That Basis ABA Section of Taxation May 9, 2015 Karen Gilbreath Sowell, Moderator Kevin M. Jacobs Krishna Vallabhaneni Ernst & Young LLP Internal Revenue Service U.S. Department of the Treasury Washington, DC Washington, DC Washington, DC Rebecca Burch Michael Schler Gordon Warnke Ernst & Young LLP Cravath, Swaine & Moore LLP Linklaters LLP Washington, DC New York, NY New York, NY

2 Why do we care about stock basis? a) Because it determines tax liability in many ordinary distributions, redemptions, liquidations, related party stock sales under Section 304, reorganizations involving the receipt of boot, taxable stock sales, and cross border transactions. b) So Gordon has something to write about. c) So Mike and Gordon have something to argue about. d) All of the above. Page 2

3 1955 regulations Tracing was generally not required except for singlecorporation recapitalizations and transfers of multiple classes of stock. See Reg (a)(4) and (5) of the 1955 Regulations. Unused basis resulting from a dividend equivalent redemption requires proper adjustment to basis of remaining shares. See Reg (c) published as T.D (12/2/55). Page 3

4 Withdrawn 2002 proposed regulations REG proposed to eliminate basis shifting in redemptions treated as dividends. On 19 April, 2006, the IRS withdrew the 2002 proposed regulations, stating that the better view of current law is that only the basis of the shares redeemed may be recovered under section 301(c)(2). See Announcement , C.B Page 4

5 2006 regulations Tracing is generally required in all reorganizations and Section 351 exchanges that also qualify as Section 354 exchanges. See Reg (a)(2). For stockless or stock light reorganizations and stockless Section 351/354 overlap transactions, the current regulations employ a deemed issuance/deemed recapitalization fiction. See Reg (a)(2)(iii)(A). Tracing does not apply to Section 351/354 overlap transactions if in connection with the exchange, the shareholder... exchanges property for stock in an exchange to which neither section 354 nor section 356 applies or liabilities of the shareholder are assumed.or a Section 362(e)(2)(C) election is made. See Reg (a)(2)(viii). The 2006 regulations did not address recovery or determination of basis for redemptions. Page 5

6 2009 proposed regulations REG proposes to (i) limit tracing in dividend equivalent transactions and (ii) extend tracing to capital contributions and contributions of stock in all Section 351 transactions, including non-section 354 overlap transactions, except where liabilities of the shareholder are assumed. See Prop. Reg (b)(4) (limiting tracing), -2(g) (extending tracing), and -2(f)(2) (excepting liability assumptions). Page 6

7 Basis recovery Page 7

8 What is a separate class of stock? Prop. Reg (b)(2) (with respect to Section 302(d) transactions): a class is defined with respect to economic rights to distributions rather than the labels attached to shares or rights with respect to corporate governance. But Reg (a)(1) seems to look beyond economic rights to distributions for transaction under Sections 354, 355, 356: Stock.which differ.because the rights attributable to them differ (although they are in the same corporation) are considered different classes [ ] See also Prop. Reg (a)(2). Reg (d)(1): The shares of a member having the same material terms (without taking into account voting rights) are treated as a single class of stock. Reg (j)(2)(iii)(B): a class of stock includes all stock with the same material terms. Page 8

9 Section 301 distributions Section 301(c)(1) provides: That portion of the distribution which is a dividend (as defined in section 316) shall be included in gross income. Section 301(c)(2) provides: That portion of the distribution which is not a dividend shall be applied against and reduce the adjusted basis of the stock. Unclear what is meant by the stock -- i.e., recovery of aggregate basis of all shares of stock or under share-by-share approach? Section 301(c)(3)(A) provides: [T]hat portion of the distribution which is not a dividend, to the extent that it exceeds the adjusted basis of the stock, shall be treated as gain from the sale or exchange of property. Page 9

10 Section 301 distributions - example Share 1 Δ = $1 A XCo Share 2 Δ = $10 $10 A owns 100 percent of XCo common stock represented by 2 shares: Share 1 basis = $1 Share 2 basis = $10 Each share has a value of $10. XCo has $0 E&P. XCo distributes $10. See Johnson v. United States, 435 F.2d 1257 (4th Cir. 1971); Prop. Reg (a); but cf. Reg (c)(3); Rev. Rul Page 10

11 Dividend equivalent redemptions Section 302(d) provides: Except as otherwise provided in this subchapter, if a corporation redeems its stock [ ] and if [section 302(a)] does not apply, such redemption shall be treated as a distribution of property to which section 301 applies. Section 301(c)(2) provides: That portion of the distribution which is not a dividend shall be applied against and reduce the adjusted basis of the stock. Unclear, in combination with Section 302(d), what is meant by the stock -- i.e., in the context of dividend equivalent redemptions unclear (i) whether basis is recovered on redeemed shares only, the redeemed class of shares, or all shares, and (ii) whether the aggregate or share-by-share approach applies? Page 11

12 Dividend equivalent redemptions example 1 Share 1 Δ = $1 A XCo Share 2 Δ = $10 $10 A owns 100 percent of XCo common stock represented by 2 shares: Share 1 basis = $1 Share 2 basis = $10 Each share has a value of $10. XCo has $0 E&P. XCo distributes $10 in exchange for Share 2. What if instead XCo distributes $10 in exchange for Share 1? What happens to unused basis if XCo has E&P? See Johnson v. United States, 435 F.2d 1257 (4th Cir. 1971); Reg (c); Prop. Reg (a). Page 12

13 Dividend equivalent redemptions example 2 A owns 100 percent of XCo: 100 shares of common stock with a FMV of $1,000 and an aggregate basis of $300 A 100 shares of preferred stock with a FMV of $1,000 and an aggregate basis of $1,000 XCo has $1,000 E&P. 100 common shares 100 preferred shares $ preferred shares XCo redeems 99 of A s preferred shares for $990. See Prop. Reg (a); withdrawn 2002 proposed regulations. XCo E&P: $1,000 What happens if XCo redeems 100 of A s preferred shares (i.e. all of them) for $1,000? Page 13

14 Section 304 transactions If a brother-sister Section 304 transaction is dividend equivalent, then the transferor and the acquiring corporation shall be treated in the same manner as if (i) the transferor had transferred the stock so acquired to the acquiring corporation in exchange for stock of the acquiring corporation in a transaction to which Section 351(a) applies, and then (ii) the acquiring corporation had redeemed the stock it was treated as issuing in such transaction. Reg (c) provides that, in the case of redemptions of stock which are treated as a distribution of a dividend, proper adjustment of the basis of the remaining stock will be made with respect to the stock redeemed. See, e.g., Rev. Rul ; Reg (a)-9T; Notice ; PLR Page 14

15 Section 304 transactions example 1 XCo owns 100 percent of YCo represented by: Common stock with a FMV of $1,000 and aggregate basis of $1,000 XCo YCo common XCo owns 100 percent of ZCo represented by: Common stock with a FMV of $1,000 and aggregate basis of $200 $1,000 YCo and ZCo each have $200 of E&P. XCo sells all of the YCo common to ZCo in exchange for $1,000. YCo ZCo ZCo is treated as issuing shares to XCo and then redeeming those shares for $1,000. Common YCo How many and what type of shares is ZCo treated as issuing and then redeeming? What if ZCo also has preferred stock outstanding that is owned by XCo? Does it matter to the result? Compare Prop. Reg (a). Page 15

16 Section 304 transactions example 2 Common YCo Preferred XCo $1,000 ZCo E&P: $200 E&P: $200 Common YCo YCo common and preferred Preferred XCo owns 100 percent of YCo represented by: Common stock with a FMV of $500 and aggregate basis of $500 Preferred stock with a FMV of $500 and aggregate basis of $350 XCo owns 100 percent of ZCo represented by: Common stock with a FMV of $1,000 and aggregate basis of $200 YCo and ZCo each have $200 of E&P. XCo sells all of the YCo common and preferred stock to ZCo in exchange for $1,000. ZCo is treated as issuing shares to XCo and then redeeming those shares for $1,000. What if, in addition, to cash, ZCo issues ZCo common and/or preferred stock to XCo? Page 16

17 Allocations in reorganizations Under current law, in determining a shareholder s basis in the shares received in a reorganization, the shareholder can allocate the boot received to particular shares within a class and between classes, regardless of whether any gain on any share would otherwise be dividend equivalent under Section 356(a)(2), so long as the allocation is pursuant to economically reasonable terms of the exchange. Reg (a)(2)(ii). Cf. Prop. Reg (d)(1) (restricting designated allocations among shares within a class to non-dividend equivalent reorganizations). Page 17

18 Reorganization with boot example 1 A will acquire T in a tax free reorganization. S s 5 shares in T (FMV $10/share) will be exchanged for 4 shares of A stock (FMV $10/share) and $10 in cash. 5 shares, each with value $10 Shareholder (S) Target (T) Acquiror (A) 4 shares A stock (FMV $10/share) $10 cash S is the sole shareholder of T. The agreement says that 4 of the T shares will be exchanged for shares in A and one of the T shares will be exchanged for cash. The T shares may or may not have the same tax basis. What if the basis in the shares exchanged for cash exceeds FMV? What if the terms of the exchange do not specify any allocation of the consideration among the T shares surrendered? What if the terms of the exchange identify the T shares that S will surrender in exchange for the A shares and cash? What if the reorganization is dividend equivalent rather than non-dividend equivalent? See Reg (a)(2)(ii); cf. Prop. Reg (d), (b)(4). Page 18

19 Reorganization with boot example 2 A will acquire T in a tax free reorganization. S s 5 shares in T (FMV $10/share) will be exchanged for 4 shares of A stock (FMV $10/share) and $10 in cash. 5 shares, each with value $10 Shareholder (S) Target (T) Acquiror (A) 4 shares A stock (FMV $10/share) $10 cash T is public. The agreement says that each shareholder of T will receive A stock for 80% of its T stock and cash for 20% of its T stock. Each share of S s T stock has a tax basis of $6. What if S has shares with different tax bases? Page 19

20 Reorganization with boot example 3 5 shares, each with value $10 Shareholder (S) Target (T) Acquiror (A) 4 shares A stock (FMV $10/share) $10 cash T is public. The agreement allows each T shareholder to elect to receive either one share of A stock or $10 in cash for each T share it owns, subject to proration so that exactly 80% of the consideration is stock. Each S share in T has a tax basis of $6. Either (1) S elects to receive 3 shares of A stock and $20 of cash, and receives exactly what it elected, or (2) S elects to receive all cash and receives a combination of cash and stock. What if S s shares in T have different tax bases, and in the agreement S designates such shares starting with those with the highest tax basis as being exchanged for the cash? Page 20

21 Basis determination Page 21

22 Contribution of truck for no consideration XCo Truck FMV: $300 Basis: $160 XCo owns all five outstanding voting common shares of YCo, each with a FMV of $60 and a basis of $32. XCo contributes a truck with a FMV of $100 and a basis of $80 to YCo as a capital contribution (i.e., YCo does not issue any shares of stock). YCo See PLRs and ; but cf. Prop. Reg (g) (extending tracing). Page 22

23 Transfer of truck for stock XCo Truck YCo stock FMV: $300 Basis: $160 YCo XCo owns all five outstanding shares of YCo, each with a FMV of $60 and a basis of $32. XCo transfers a truck with a FMV of $100 and a basis of $80 to YCo in exchange for stock with a postcontribution value of $100. Under Section 358, the YCo stock received by XCo in the exchange is a new block with a basis that reflects XCo s historic basis in the truck. Page 23

24 Transfer of subsidiary XCo owns 100 percent of YCo and Sub. XCo has different basis blocks in its Sub stock. XCo XCo contributes Sub stock to YCo and YCo does not issue any shares of stock. Sub stock What if YCo issues voting and nonvoting stock to XCo in exchange for Sub stock? YCo Sub What if the basis in Sub stock exceeds FMV, and XCo does or does not make a Section 362(e)(2)(C) election? Sub See Reg (a)(2)(viii)(B), (b)(2); cf. Rev. Rul See also PLRs , , , Page 24

25 Contribution of transferee shares XCo owns all five outstanding shares of YCo, each with a FMV of $60 and a basis of $32. Two YCo shares XCo XCo contributes two of its YCo shares to the capital of YCo. Is XCo s aggregate basis in the two contributed shares spread over the remaining shares pro-rata? See, e.g., Rev. Rul ; Rev. Rul YCo Is the transaction treated as a recapitalization of YCo? See Comm r v. Fink, 483 U.S. 89 (1987); cf. Section 108(e)(6). Page 25

26 Transfer of subsidiary for assumption of liability XCo XCo owns 100 percent of YCo and Sub. XCo has different basis blocks in its Sub stock. XCo transfers Sub stock to YCo in partial exchange for the assumption by YCo of a liability of XCo. Sub stock Liability assumption YCo Sub Sub Page 26