ALI-ABA Course of Study Consolidated Tax Return Regulations. Cosponsored by the ABA Section of Taxation. October 4-5, 2007 Washington, D.C.

Transcription

1 949 ALI-ABA Course of Study Consolidated Tax Return Regulations Cosponsored by the ABA Section of Taxation October 4-5, 2007 Washington, D.C. Intercompany Transactions Study Materials By Lawrence M. Axelrod Deloitte Tax LLP Washington, D.C.

2 HISTORICAL BACKGROUND OVERVIEW DEFINITIONS Intercompany Transactions Intercompany Items Corresponding Items Recomputed Corresponding Items Treatment as a Separate Entity Attributes MATCHING RULE Attributes Holding Period Timing Divisions of a Single Corporation Conflict or Allocation of Attributes Special Status Corporations Disallowance or Exclusion Resulting from Corresponding Item Examples Nonrecognition Transactions - in General Section 1031 Exchanges Recapitalizations Transactions under Sections 351 and Depreciation and Recapture Intercompany Sale Followed by Installment Sale Intercompany Sale of Installment Obligations Capitalized Services Intercompany Sale of Partnership Interest Section 382 and Recognized Built-in Gains Bump-and-Strip Security Dealers under Section Manufacturer Incentives Straddles International Tax Examples THE ACCELERATION RULE S's Items B's Items No Subgroups Cancellation of Debt and Attribute Reduction Successive Intercompany Transactions Other Acceleration Events SIMPLIFYING RULES...48 i

3 Inventory Simplification for Dollar-value LIFO Reserve Accounting - Special Status Companies Financial Institutions Insurance Companies Obtaining Permission Not to Defer Basis Adjustments and Section 362(e)(2) Section 362(e)(2)-In General Consolidated Return Issues STOCK OF MEMBERS Distributions Exclusion of Intercompany Dividends Requisite Stock Basis Reduction Amount and Basis of a Property Distribution Distributions of Loss Property Boot in Intercompany Reorganizations Acquisition by Issuer of Its Own Stock Elective Relief in Certain Stock Transactions Liquidation of Subsidiary Triggering Intercompany Item Downstream Mergers Section 338(h)(10) Transactions Cash Mergers Spin-offs Time for and Manner of Making Election Effective Date for Elective Relief Loss Disallowance on Parent s Stock Relief for Zero-basis Problem Dealers OBLIGATIONS OF MEMBERS Overview of Intercompany Obligation Accrual of interest Intercompany Obligation becomes Nonintercompany Obligation Section 338(h)(10) and Installment Sales Non-application of Section No Subgroups Proposed Amendments to the Intercompany Obligation Regulations Dissolution of Insolvent Subsidiary Nonintercompany Obligation Becomes an Intercompany Obligation Election to Waive Loss on Intercompany Obligation Non-application of AHYDO Rules ANTI-AVOIDANCE RULES General Rule Purported Location Abuse ii

4 Sale to a Related Party Mixing Bowl Examples Corporate Mixing Bowl Partnership Mixing Bowl Other Applications MISCELLANEOUS OPERATING RULES Successor Assets Successor Persons Acquisition of Group Lonely Parent Rule Recordkeeping Requirements Mirror Transactions percent Distributee No 80-percent Distributee EFFECTIVE DATES General Rule Anti-avoidance Rule Stock Elimination Transactions STATE TAX CONSEQUENCES CHANGES TO SECTION 108 REGULATIONS CONCLUDING OBSERVATIONS iii

5 INTERCOMPANY TRANSACTION REGULATIONS.01 HISTORICAL BACKGROUND The rules governing intercompany transactions are primarily contained in Reg Perhaps more than any other section of the consolidated return regulations, the intercompany transaction rules reflects the conflict between the single-entity and separatemember approaches inherent in treating a group as a single taxpayer for certain purposes and as an aggregate of corporations for other purposes. As in other cases, the conflict between the single versus separate entity theories gives way to the overriding objective mandated by the Code. That is, regulations are to be prescribed such that the tax liability of the group and members will be determined "in such manner as clearly to reflect the income tax liability... and in order to prevent avoidance of such tax liability." 1 The regulations were revised in 1995 to provide a comprehensive framework for analyzing all types of intercompany transactions. 2 Practitioners who began careers after the 1995 regulations were promulgated are frequently unaware of the checkered history of the intercompany rules and the legislative and judicial developments that led to the current rules. Before describing and analyzing the current rules, a brief summary of the predecessor rules is worth considering. Under the consolidated return regulations in force before 1966, an intercompany transaction was treated merely as a transfer of property between divisions of a single corporation. Thus, if one member sold an asset to another member, no gain or loss was recognized 3 and the basis of the property in the hands of the purchasing member remained the same as the basis in the hands of the selling member. 4 This simple rule had only one minor flaw. It allowed taxpayers to avoid recognizing any gain on the disposition of property outside the group, as illustrated in the landmark consolidated return case, Beck Builders. 5 To simply the facts of Beck Builders, P, the common parent, constructed a housing project for a subsidiary, S. After completion, P, sold the property to S. Under the regulations in effect at the time, P did recognize gain on the intercompany asset sale, and P's basis in the property carried over to S. Thereafter, X, an unrelated corporation, purchased the stock of S from P. Since P's basis in the S stock reflected S s fair market value, P did not recognize any gain on the stock sale. Shortly after the purchase, X liquidated S and, under section 334(b)(2) 1 Section In addition to the mundane taxable sale of property between members, intercompany transactions include nonrecognition transactions, such as reorganizations, liquidations and contributions to which section 351(a) applies, loans between members, cancellation of debt. Although the 1995 regulations do not alter the deferred sale results under prior law with respect to more mundane transactions, those regulations were a quantum leap forward with respect to the appropriate treatment of more sophisticated transactions. 3 Reg A(b)(1)(i) as in effect prior to Reg A(b) as in effect prior to Henry C. Beck Builders, Inc. v. Comm r, 41 TC 616 (1964). 2-1

6 954 as in effect prior to 1982, received a basis in S's assets equal to X's purchase price for the S stock. X was then able to sell S's former assets without recognition of gain to any taxpayer. The IRS did not view the transaction kindly. Nevertheless, the Tax Court held that the IRS was bound by its own regulations. 6 That judicial defeat became the impetus for the regulations project that resulted in the revision of the entire consolidated return regulations. Although Congress replaced section 334(b)(2) with section 338 in 1982 and the tax avoidance opportunity described in Beck Builders is no longer available, other concerns (primarily avoidance of repeal of the General Utilities doctrine) prevented regulation writers in the 1990s from returning to the halcyon days in which intercompany transfers of property could be accomplished without recognition of gain or loss. Instead, the deferred gain model concept in the 1966 regulations was retained. The separate status of each member continued to be respected for purposes of the amount and location of gain o loss. For purposes of timing source, character and holding period, however, the members participating in an intercompany transaction are treated as divisions of a single corporation. The objective of the 1995 amendments to the regulations was primarily to refine the deferred sale model so that an intercompany transaction did result in the creation, elimination, acceleration, or deferral on income or loss to the group as a whole Beck Builders became the primary precedent relied on by the Tax Court in Woods Inv. Co., 85 TC 274 (1985), 21 years later. 7 Reg (a)(1). 2-2