CODI, attribute reduction, and traps for the unwary

Transcription

1 CODI, attribute reduction, and traps for the unwary TEI presentation February 2017

2 Notice TEI presentation February 2017 The following information is not intended to be written advice concerning one or more Federal tax matters subject to the requirements of section 10.37(a)(2) of Treasury Department Circular 230. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser. 2

3 CODI, attribute reduction, and traps for the TEI presentation February 2017

4 TEI presentation February 2017 CODI & tax attribute reduction Generally, cancellation of debt income ( CODI ) is included in a taxpayer s taxable income Where the bankruptcy exception or insolvency exception applies, the debtor is allowed to exclude CODI from gross income. The cost of the exclusion (section 108(a)(1)(A),(B)) is that the debtor must reduce its tax attributes by the amount of excluded CODI. See section 108(b)(1). Order of Reduction: 1. NOLs and NOL carryovers 2. General business credits (e.g., investment credit and research credit) 3. Minimum tax credits 4. Capital losses and capital loss carryovers 5. Basis of debtor s property 6. Passive activity losses and credit carryovers 7. Foreign tax credit carryovers Black Hole CODI if the excluded COD income exceeds the sum of the taxpayer s tax attributes, the excess is permanently excluded from the taxpayer s gross income. See Treas. Reg (a)(2). 4

5 Consolidated section 108 exclusion & CODI Qualifications for the bankruptcy and insolvency exceptions are determined by reference to the specific member with CODI Attribute reduction Treas. Reg Debtor member attributes reduced Reduction follows section 108(b)(2) order 2. Look-through rules If debtor s basis in stock of a subsidiary is reduced, the subsidiary is treated as if it had CODI equal to the amount of basis reduction, and the subsidiary s tax attributes are correspondingly reduced Section 1245 recapture amount 3. Fan out rule if attributes of the debtor do not equal the amount of excluded CODI, consolidated attributes of other members of the group are also reduced Does not reduce basis TEI presentation February

6 Attribute reduction and traps for the unwary 1. Black hole CODI and excess loss accounts ( ELAs ) 2. Attribute reduction and deferred intercompany gains ( DIGs ) 3. Member leaving group in year of excluded CODI TEI presentation February

7 TEI presentation February 2017 Black hole CODI and ELAs The purpose of the consolidated return regulations under section 1502 is to treat parent ( P ) and its subsidiaries ( S ) as a single entity so that consolidated taxable income clearly reflects the group s income One aspect of these rules require adjustments to P s basis in the stock of S. These rules are found in Treas. Reg and are known as investment adjustments These adjustments may result in P s basis in the stock of S to be adjusted downward below zero and create an ELA ELA is treated as negative basis for all federal income tax purposes ELA s generally arise from: 1. Debt-financed distributions 2. Debt-financed losses absorbed by other members 3. Transfers to S of property subject to liabilities in excess of basis of property transferred (including triangular reorganizations) 7

8 TEI presentation February 2017 Black hole CODI and ELAs Generally, a consolidated group may have an ELA without negative tax consequences until P is treated as disposing of the stock of S P is treated as disposing of S stock when: 1. P ceases to own S stock for federal income tax purposes (e.g., transfer or cancellation) 2. A deconsolidation event occurs (e.g., P or S becomes a nonmember) 3. The S stock becomes worthless All of S s assets are treated as disposed, abandoned, or destroyed, or Cancellation of debt does not result in taxable income or attribute reduction Under Treas. Reg (b), ELAs are only taken into account to the extent that the excluded COD income exceeds the amount by which group members tax attributes are reduced Previously, the entire ELA would be recognized as income if a debtor-member had any amount excluded COD income without a corresponding amount of attribute reduction 8

9 TEI presentation February 2017 Black hole CODI and ELAs Parent Lender $300 Subsidiary NOL = $100 Basis = $150 Asset Parent has an ELA of $125 in its stock of Subsidiary. The consolidated group has no consolidated tax attributes, other than the NOLs at Subsidiary. Subsidiary realizes excluded CODI of $300. Under sections 108 and 1017, Subsidiary s reduces its NOLs and asset basis to zero and $50 of CODI remains unabsorbed. Because the consolidated group has no other consolidated tax attributes, Subsidiary has $50 of black hole CODI. Under Treas. Reg (c), Parent is treated as disposing of Subsidiary s stock, and Parent is required to take into income the lesser of the CODI and the ELA, which, in this case is $50. 9

10 TEI presentation February 2017 Attribute reduction and DIGs Another aspect of the consolidated rules is to defer gain recognition on transactions between members of consolidated groups these gains are known as deferred intercompany gains or DIGs (Treas. Reg ) For example, subsidiary (seller or S ) distributes an appreciated asset to parent (buyer or B ) that would be taxable under section 311(b) but for these rules. The purpose of these rules is to produce the effect on consolidated taxable income as if S and B were divisions of a single corporation (Treas. Reg (c)) Recognition of DIGs is generally deferred until certain triggering events occur, for example, when either S or B becomes a nonmember or the property that was the subject of the DIG is transferred to a nonmember (Treas. Reg (d)) If a consolidated group has excluded CODI that results in the reduction of property basis that is the subject of the DIG, such reduction may result in the recognition of that DIG and included in the group s consolidated taxable income (Treas. Reg (d)(3), example 4) 10

11 TEI presentation February 2017 Attribute reduction and DIGs Facts: Subsidiary holds land for investment with a basis of $0. On January 1 of Year 1, Subsidiary sells the land to Parent for $100. Parent also holds the land for investment. During Year 3, Parent is insolvent and Parent s nonmember creditors discharge $60 of Parent s indebtedness. Because of insolvency, Parent s $60 discharge is excluded from Parent s gross income under section 108(a), and Parent reduces the basis of the land by $60 under sections 108(b) and $60 of excluded CODI Basis = $0 Parent Subsidiary Land Sale of Land for $100 Result: Subsidiary had a DIG of $100 when Subsidiary sold the land to Parent. However, as a result of Parent s basis reduction, $60 of Subsidiary s DIG can no longer be deferred until such point when Parent eventually sells the land to a nonmember (because there is now only a $40 difference between Parent s $40 basis in the land and the $0 basis the land would have if Subsidiary and Parent were divisions of a single corporation). Accordingly, Subsidiary must take $60 of its DIG into account in Year 3 as long-term capital gain. 11

12 TEI presentation February 2017 Member leaving group in year of excluded CODI If one member of a consolidated group disposes of the stock of another member (the departing member ) during the year in which any member of the consolidated group realizes excluded CODI, special rules apply in determining the amount of the departing member s deductions and losses may be used by the consolidated group and the amount of consolidated attributes that may be reduces in respect of such excluded CODI (Treas. Reg (c)). Treas. Reg (c)(2), specifically, provides for the computation of tax liability, reduction of tax attributes, and computation of limits on absorption and reduction of attributes if a member realized excluded CODI in the taxable year during which a member disposes of the stock of the departing member. A member is treated as disposing of stock when: - P ceases to own S stock for federal income tax purposes (e.g., transfer or cancellation) - A deconsolidation event occurs (e.g., P or S becomes a nonmember) - The S stock becomes worthless All of S s assets are treated as disposed, abandoned, or destroyed, or Cancellation of debt does not result in taxable income or attribute reduction 12

13 TEI presentation February 2017 Member leaving group in year of excluded CODI Treas. Reg (c) provides for the elimination of circular stock basis adjustments when there is excluded CODI. Nine Step Process: 1. Calculate taxable income/loss for year without ramification of dispositions 2. Tentatively adjust stock basis of subs 3. Tentative computation of stock gain or loss 4. Tentative computation of tax imposed 5. Tentative reduction of attributes 6. Actual adjustment to stock basis 7. Actual computation of stock gain or loss 8. Actual computation of tax 9. Actual attribute reduction Please note that if the disposition involves the transfer of a loss share, the Unified Loss Rules (ULR) in Treas. Reg would also be implicated. 13

14 Member leaving group in year of excluded CODI Treas. Reg (c)(5), example 1 Facts: P owns all of S's stock with a $90 basis. For Year 1, P has ordinary income of $30, and S has an $80 ordinary loss and $100 of excluded COD income from the discharge of non-intercompany indebtedness. P sells the S stock for $20 at the close of Year 1. Analysis: $30 Ordinary Income $80 Ordinary Loss; $100 of Excluded CODI Basis = $90 TEI presentation February 2017 Year 1 Year 2 Parent Subsidiary Sale of S Stock for $20 The steps used to compute the tax imposed on the group, to effect the reduction of attributes, and to compute the limitations on the use and reduction of attributes are as follows: 1. Calculate taxable income/loss for year without taking into account P s income and gain from the disposition The group is tentatively treated as having a consolidated net operating loss of $50 (P's $30 of income minus S's $80 loss). Thus, $30 of S's loss is unlimited and $50 of S's loss is limited for Treas. Reg (c). All of the consolidated net operating loss is attributable to S. Acquirer Subsidiary 14

15 Member leaving group in year of excluded CODI 2. Tentative adjustment to stock basis Absorption of $30 of S s loss decreases P s basis by $30 to $ Tentative computation of stock gain or loss P is treated as recognizing a $40 loss on the sale of S stock. 4. Tentative computation of tax imposed The group has a $50 CNOL for Year 1 that is wholly attributable to S and a consolidated capital loss of $40 wholly attributable to P. 5. Tentative reduction of attributes The tax attributes of S would first be reduced to take into account its $100 excluded COD income, followed by those of P. Treas. Reg (a)(2)/(4). $100 excluded COD income reduces: $50 of CNOL attributable to S leaving it with $0; and $40 of capital loss attributable to P leaving it with $0. The remaining $10 of excluded CODI would have no effect. $30 Ordinary Income $80 Ordinary Loss; $100 of Excluded CODI Basis = $90 TEI presentation February 2017 Year 1 Year 2 Parent Subsidiary Sale of S Stock for $20 Acquirer Subsidiary 15

16 Member leaving group in year of excluded CODI 6. Actual adjustment to stock basis Absorption of $30 of S s loss to offset a portion of P s income plus the application of $90 of S s excluded CODI to reduce attributes of S and P, and the reduction of the $50 loss attributable to S in respect of the excluded CODI results in a net positive adjustment of $10 to P s basis in the S stock. P s basis in S is therefore $ Actual computation of stock gain or loss P recognizes a $80 loss on disposition of S stock. 8. Actual computation of tax The group has a $50 CNOL for Year 1 that is wholly attributable to S and a consolidated capital loss of $80 wholly attributable to P. 9. Actual attribute reduction $30 Ordinary Income $80 Ordinary Loss; $100 of Excluded CODI Basis = $90 TEI presentation February 2017 Year 1 Year 2 Parent Subsidiary Sale of S Stock for $20 Acquirer Subsidiary The tax attributes of S would first be reduced to take into account its $100 excluded COD income, followed by those of P. Treas. Reg (a)(2)/(4). $100 excluded COD income reduces: $50 of CNOL attributable to S leaving it with $0; and $40 of capital loss attributable to P leaving it with $40. The reduction would otherwise be $50; however, the limitation imposed by Treas. Reg (c)(2)(ix)(A) prevents the reduction of the capital loss attributable to P by more than $40. The remaining $10 of excluded CODI would have no effect. 16

17 Q&A

18 Contact Information TEI presentation February 2017 Alan D. Barton M&A Tax Partner KPMG Houston Office Yinka Kukoyi M&A Tax Partner KPMG Houston Office

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