Tax Executives Institute Houston chapter Indebtedness and Consolidated Returns

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1 Tax Executives Institute Houston chapter Indebtedness and Consolidated Returns Matt Gareau, Partner, Deloitte Tax LLP, Washington National Tax Diana Estrada, Senior Manager, Deloitte Tax LLP, May 2, 2016

2 Content Topic Page Introductions 3 Cancellation of Debt ( COD ) Income 6 Interest Deductibility Limitations 13 Attribute Reduction 18 Member Obligations 30 Overview of Intercompany Obligation Rules 31 Intragroup and Outbound Transactions 34 Inbound Transactions 59 Satisfaction of Intercompany Debt 52 Worthless Stock Loss: -13(g) Considerations 65 About this Presentation 71 2 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

3 Introductions

4 Introductions - Biographies Matthew E. Gareau Tax Partner, Deloitte Tax LLP magareau@deloitte.com Mr. Gareau is a partner in the subchapter C corporate tax group in the Washington National Tax office of Deloitte Tax LLP. He has 16 years of experience advising clients on corporate restructurings. His knowledge and experience covers a broad range of corporate tax and consolidated return issues, including tax-free corporate reorganizations and spin-offs, and taxable acquisitions and dispositions. He also has extensive experience with tax attribute planning, particularly for large consolidated groups. Mr. Gareau is a frequent speaker on corporate tax and consolidated return matters, regularly appearing on American Bar Association Tax Section and Tax Executives Institute panels. Mr. Gareau earned both his M.S. in Accounting and B.B.A. in Accounting, from the University of Notre Dame. He is a member of the American Institute of Certified Public Accountants (Tax Section) and was a past member of Corporations and Shareholders Technical Resource Panel. He is also an Associate Member of American Bar Association (Tax Section) and was the Past Chair, Affiliated and Related Corporations Committee. He is a Certified Public Accountant in District of Columbia, Florida, and Virginia. 4 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

5 Introductions -- Biographies (cont.) Diana Estrada Senior Manager, Deloitte Tax LLP Ms. Estrada is a senior manager in Deloitte s Tax practice and a member of the Turnaround & Restructuring Tax Services group. She has more than nine years of experience serving large multinational corporations advising on various federal and international tax issues. As part of the Turnaround & Restructuring Tax Services group she works extensively with the leaders of the practice on corporate bankruptcy, debt modification, and corporate restructuring engagements. Ms. Estrada completed a two year rotation in subchapter C corporate tax group in the Washington National Tax office of Deloitte Tax LLP. While on rotation she provided services to significant Deloitte clients and large multinationals, providing tax advice on various corporate tax and consolidated return issues, including transaction structuring, spin-offs, legal entity rationalization, bankruptcy emergence, debt restructuring and modifications, and loss company tax attribute preservation. Ms. Estrada earned her M.B.A. and M.S. in Accounting (with an emphasis in taxation) from Northeastern University and her B.B.A. from the University of Florida. She is a member of the American Institute of Certified Public Accountants, Florida Institute of Certified Public Accountants, and Greater Washington D.C. Society of Certified Public Accountants. 5 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

6 Cancellation of Debt ( COD ) Income

7 COD Income Cancellation or repurchase of debt for less than its adjusted issue price results in COD income COD is generally excluded from gross income only to the extent that a corporation is insolvent (Section108(a)(1)(B)), in Chapter 11 bankruptcy (Section108(a)(1)(A)) or qualified real property business indebtedness (Section108(a)(1)(D)) In a stock-for-debt exchange, COD income equals the excess of the adjusted issue price of old debt over the FMV of the stock (Section108(e)(8)) In a debt-for-debt exchange, COD income equals the excess of the adjusted issue price of old debt over the issue price of the new debt (Section108(e)(10)) Issue price is the stated principal amount if (i) neither new or old debt is publicly traded and the new debt provides for interest equal or greater to the applicable federal rate Issue price is equal to the FMV if either the old or new debt is publicly traded If old debt is contributed to capital, COD income is the excess of the adjusted issue price over the shareholder s adjusted basis in the debt (Section108(e)(6)) 7 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

8 COD Income Trading COD for Original Issue Discount ( OID ) A possible consequence of a debt-for-debt exchange is that the debtor has COD income but over the term of the new debt has OID deductions (to the extent the issue price of the new debt is less than the stated principal amount) (Treas. Reg (g)) There are possible limitations on the deduction of OID, including: Applicable High Yield Debt Obligation ( AHYDO ) (Sections163(e)(5) and 163(i)) Debt payable in, or linked, to equity (Section163(l)(3)) 8 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

9 Hidden COD Income Deemed Exchanges Restructuring of debt has no income tax consequences unless the restructuring is treated as an exchange for tax purposes. A significant modification of a debt instrument under Treas. Reg results in a deemed exchange of a new (modified) debt for the original (unmodified) debt. Analysis: Two steps Step 1 Is there a modification? Any alteration in the legal rights or obligations of the borrower or lender under the debt instrument. Changes pursuant to the operation of the terms of the debt generally are not modifications. Step 2 Is the modification significant? 9 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

10 Deemed Exchanges (cont.) Debt modifications / constructive changes Where a debtor simply modifies the terms of the debt, an exchange nevertheless occurs for tax purposes if there is a significant modification In general, a modification is any alteration of a legal right or obligation of the issuer or a holder of debt instrument. However, a modification generally does not include: Alterations of rights pursuant to the terms of the debt A failure of the issuer to perform and temporary forebearance by holder (generally less than two years) Tax consequences of deemed exchange are generally the same as a debt-fordebt exchange 10 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

11 Deemed Exchanges (cont.) Examples of significant modifications: A change in the debt s fixed yield by more than the greater of 25 basis points or 5% of the original annual yield A change in timing of payments that results in a material deferral of scheduled principal or interest payments (generally excluding a cumulative deferral of the lesser of 5 years or 50% of original maturity) A substitution of a new obligor on a recourse debt; exception for certain acquisition transactions Certain Section 381(a) transactions Acquisition of substantially all of the assets A change in collateral, guarantees or similar arrangements that either (i) renders the debt primarily speculative or (ii) increases the likelihood of payment from primarily speculative to adequate 11 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

12 Deemed Exchanges (cont.) Significant modifications: COD is the difference, if any, of issue price of new debt compared to holder s basis in old debt produces gain or loss. Old debt or new debt is publicly traded: - Taxable exchange could result in capital loss and OID in the future. - Recapitalization under Section 368(a)(1)(E). Old debt and new debt is not publicly traded: - Generally, no effect on original holder. - Could result in phantom income to a holder who purchased the pre-modified debt at a discount. 12 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

13 Interest Deductibility Limitations

14 Interest Deductibility Limitations Debt restructuring may limit a corporation s ability to deduct interest under the following provisions: Section 163(e)(5) may defer or disallow OID deductions on high yield OID and payment-in-kind (PIK) instruments. Section 163(l) may disallow interest deductions on debt that is convertible into, or payable in, equity of the issuer or a related party. Section 385 or case law principles may re-characterize debt as equity. 14 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

15 Interest Deductibility Limitation - AHYDO Section 163(i) - Elements of AHYDO Debt issued by a C corporation (or a partnership to the extent of C corporation partners). Term (with permitted extensions) is greater than five years. Yield-to-maturity (for tax purposes) is equal to or greater than AFR plus 5% Deferred and unpaid OID after the fifth year exceeds a threshold equal to YTM times issue price ( significant OID ). Tested at the end of every accrual period after the fifth year. 15 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

16 Interest Deductibility Limitation Section163(l) No interest deduction is allowed when: Debt is issued by a corporation and is payable in stock of the issuer or a related party. Debt is payable in stock if one of the following applies: A substantial amount of principal or interest is required to be paid or converted into stock (or is payable or convertible at the option of the issuer or a related party). A substantial amount of the principal or interest is required to be determined by reference to the value of the stock (or is determined at the option of the issuer or a related party). The debt is part of an arrangement that is reasonably expected to result in a transaction described above. 16 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

17 Interest Deductibility Limitation IRC163(l) Debt is payable in stock if payment may be required at the option of the holder or a related party and there is a substantial certainty the option will be exercised. Legislative History: Not intended to apply to convertible debt with conversion price significantly higher than stock price at issuance. Test the debt under Section 163(l) at the time of issuance and after a significant modification. For example, if the conversion feature was out-of-the-money when the debt was issued but is now deep-in-the-money and if the debt is significantly modified, the new debt may be subject to Section 163(l). 17 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

18 Attribute Reduction

19 Reduction of Tax Attributes Exclusion of COD income under Section 108 results in a reduction to tax attributes, subject to specific ordering rules; in general attribute reduction occurs in the following order: NOLs & NOL carryovers General business credits Minimum tax credits Net capital losses & capital loss carryovers Basis of assets Passive activity losses Foreign tax credit carryovers 19 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

20 Reduction of Tax Attributes Additional Considerations: Basis reduction occurs based on assets held on the 1st day after tax year of discharge Fresh start limitation reduction limited to excess of total basis of assets over liabilities after the discharge Current year losses and NOLs are reduced Credits are reduced on a 1 for 3 basis No further reduction after tax attributes reduced to zero Election is available under Section 108(b)(5) to reduce depreciable basis first - Generally, makes sense if most of the depreciable assets are real estate or other assets with a long depreciable life - Can be made for a portion of the amount of excluded COD income - Can apply to assets held by consolidated subsidiaries and partnerships Basis of stock or partnership interests must also be reduced 20 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

21 Reduction of Tax Attributes Special Rules for Reducing Stock Basis If basis in the stock or debt of a lower-tier member is reduced, Section 1017(d)(1) may apply Section 1245 recapture to the stock and/or debt Section 1245(a) recapture overrides any non-recognition provision, except as otherwise expressly provided - If the member liquidates or merges or the debt is repaid, Section 1245 may override non-recognition treatment 21 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

22 Reduction of Tax Attributes Consolidated Group Regulations provide rules for reducing attributes within a consolidated group when a member of the group recognizes excluded COD income. The rules have 3 key steps and are applied separately to each debtor member that has excluded COD income: Step 1: Reduce Tax Attributes of Debtor Applies only to specific legal entity that realizes the COD and can result in the reduction of the debtor s basis in the stock of a subsidiary Step 2: Apply Look Through Rule Reduce attributes of the debtor s subsidiaries to the extent the tax basis of stock was reduced in Step 1 Step 3: Consolidated Attribute Reduction Reduce remaining consolidated tax attributes of the group that are available to the debtor, but not basis in assets Substantial modeling necessary to determine the impact of attribute reduction Under Treas. Reg (b)(4), stock recapture is limited to any excess of stock basis reduction over inside attribute reduction 22 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

23 Reduction of Tax Attributes Consolidated Group Step 1 Reduce Attributes of Debtor Excluded COD is applied to reduce tax attributes of the debtor. Tax attributes of the debtor include: Debtor s share of consolidated tax attributes (e.g., NOLs) Debtor s SRLY-limited tax attributes (or debtor s portion of such) Debtor s basis in property, including stock in subsidiaries (stock basis not reduced below zero) Election available to apply reduction first to reduce basis of depreciable property. 23 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

24 Reduction of Tax Attributes Consolidated Group Step 2 Apply Look-Through Rule If debtor s excluded COD is applied to reduce basis in stock of subsidiary then the look-through rule is triggered. The look-through rule provides that the subsidiary is treated as realizing excluded COD to the extent of the stock basis reduction (i.e., deemed excluded COD) Attribute reduction described in Step 1 is then applied to subsidiary (i.e., reduce tax attributes of subsidiary). Repeat look-through if subsidiary s deemed excluded COD is applied to reduce stock basis in stock of a lower-tier subsidiary. To the extent that excluded COD income does not reduce attributes of a subsidiary as a result of the look-through rule, such excluded COD income does not reduce consolidated attributes as a result of Step Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

25 Reduction of Tax Attributes Consolidated Group Step 3 Consolidated Attribute Reduction After applying the look-through rule, any excess excluded COD from Step 1 is applied to reduce consolidated tax attributes of other members. Does not include asset basis of consolidated members Tax attributes of another member that arose in a separate return year are reduced if the debtor is a member of the SRLY subgroup with respect to the attribute or if no SRLY limitation applies (i.e. because of the Overlap Rule) Attribute reduction follows the same order as shown in Step 1. Attributes of all members of a group are subject to reduction even when the member of that group that realizes excluded COD income leaves the group. 25 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

26 Reduction of Tax Attributes of Consolidated Group - Example P realizes $150 of excluded COD P $20 Attributable CNOL ELA = $100 Basis = $100 S1 S2 $50 Attributable CNOL $60 SRLY NOL $20 Attributable CNOL S3 Basis = $50 $30 SRLY NOL 26 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

27 Reduction of Tax Attributes of Consolidated Group - Example P s $20 share of CNOL reduced first. P s $100 basis in S2 stock reduced, which causes S2 to be treated as if it realized $100 of excluded COD. S2 s $50 CNOL and then its $50 basis in S3 stock is reduced. S3 treated as realizing $50 of excluded COD, which causes reduction of S3 s $30 SRLY NOL. The remaining $20 of deemed COD has no further consequences to S3. The remaining $30 of unabsorbed COD of P reduces S1 s $20 CNOL. S1 s $60 SRLY NOL is not affected. $10 Black-hole COD results. 27 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

28 COD on Intercompany Obligations Reduction in basis of intercompany debt is problematic The regulations provide that, if the lending corporation s basis in an intercompany obligations is reduced under Treas. Reg , the repayment (or deemed repayment under Treas. Reg (g)) of the obligations will give rise to gain to the lending corporations The breadth of the deemed repayment rules in Treas. Reg (g) will make this income difficult to avoid 28 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

29 Excess Loss Account Changes Considerations with respect to Excess Loss Accounts ( ELAs ) Treas. Reg (c)(1)(iii)(B) provides that an ELA in the stock of a member is included in income to the extent that the member has excluded COD income that does not result in the reduction of tax attributes of the group. Section108(b)(4)(A) provides that the reduction of NOLs and capital losses occurs after the determination of the tax for the taxable year of the discharge Section 1017(a) provides that asset basis reduction applies to the basis of any property held by the taxpayer at the beginning of the taxable year following the taxable year in which discharge occurs The new regulations nevertheless provide that the ELA is included in income in the year of the discharge (thus creating significant circularity problems) 29 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

30 Member Obligations (Most significant single entity treatment)

31 Overview of Intercompany Obligation Rules Matching & acceleration rules apply to intercompany obligations (-13(g)(1)) Intercompany obligations include debt obligations and certain securities of members, other than executory contracts (-13(g)(2)) Special rules for realization events and obligations leaving the group (- 13(g)(3) and (g)(4)) Special rules for obligations entering the group (-13(g)(5) and (g)(6)) 31 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

32 Overview of Intercompany Obligation Rules -13(g), which was originally issued in 1995, applied to three types of transactions: - transactions in which a non-intercompany obligation becomes an intercompany obligation; - transactions in which an intercompany obligation ceases to be an intercompany obligation; and - transactions in which an intercompany obligation is assigned or extinguished within the consolidated group In 1998, proposed -13(g)(3) amendments (the 1998 Proposed Regulations ) were issued In 2007, new proposed -13(g)(3) regulations were issued, and the 1998 Proposed Regulations were withdrawn In 2008, the proposed regulations were adopted Each version of the -13(g)(3) regulations employed a deemed satisfaction and reissuance ( DSR ) model The -13(g) rules do not address debt:equity ambiguities See, e.g., PLR , PLR , PLR , PLR and PLR (raising various debt:equity considerations) 32 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

33 Overview of Intercompany Obligation Rules On December 24, 2008, the government issued final regulations (the 2008 Final Regulations ) regarding the treatment of certain transactions involving obligations between members of a consolidated group The 2008 Final Regulations are effective for transactions involving intercompany obligations occurring in consolidated return years beginning on or after December 24, 2008 Once there is a realization, leaving or entering event, DSR generally applies, but enumerated exceptions are provided Exceptions are subject to a tax benefit rule Where applicable, the DSR occurs independent of the transaction giving rise to the DSR DSR is generally at fair market value If the amount actually realized in transaction giving rise to DSR is different from fair market value, generally use the amount realized 33 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

34 Intragroup and Outbound Transactions Deemed satisfaction under -13(g)(3) Immediately before the actual transaction, the debt is deemed satisfied for all federal income tax purposes immediately before the transaction Deemed satisfaction transaction is separate from actual transaction Debt is generally deemed satisfied for cash in an amount equal to the obligation s fair market value Deemed satisfaction amount will differ from fair market value if amount realized in actual transaction with respect to the obligation is different Cf. PLR (prior law application of -13(g)(3) at the debt s stated amount rather than fair market value) 34 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

35 Intragroup and Outbound Transactions Deemed reissuance under -13(g)(3) Also immediately before the actual transaction, the debt is deemed reissued for the cash used in the deemed satisfaction transaction Reissued debt is not reexamined for debt: equity treatment 35 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

36 Intragroup and Outbound Transactions Under -13(g)(4)(i)(C), any income, gain, deduction, or loss from the intercompany obligation is not subject to: Section108(a) Section 354 Section 355(a)(1) Section 1091 Section 351(a) (in the case of extinguishment of an intercompany obligation in a transaction in which the creditor transfers the obligation to the debtor in exchange for stock in such debtor) Section108(e)(7) does not apply on an extinguishment 36 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

37 Actual Transaction 1. B borrows $100 from S in return for B's note providing for $10 of annual interest and repayment of $100 at the end of year As of January 1 of year 3, B has paid the interest accruing under the note and S sells B's note to X for $70, reflecting an increase in prevailing market interest rates. P P B $100 1 S B S B s $100 Note 2 X $70 B s Note $100 Face 37 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

38 DSR Model Step 1 Deemed Satisfaction Step 2 Deemed Reissuance Step 3 Actual Transaction Occurs With New Obligation P P B $70 S B $70 S B s $100 Note X B s Note $100 Face New B s Note IP $70 - $100 Face $70 B is deemed to satisfy its obligation at its FMV. B has $30 of COD Income (ordinary). Section 61(a)(12). S has $30 of capital loss. Section 1271(a)(1). B s attributes control and S s loss is treated as ordinary (-13(c)(4)(i) the Matching Rule). B is deemed to reissue the note to S with an issue price of $70 and a face of $100. S s basis in the New note is $70, under Section S sells the New B note to X for $70. S has no gain or loss on the sale. X s basis in the New B note is $70, under Section $30 of OID to B and X under Sections 163(e) and Creates fungibility issues if B s note is part of a larger B debt issuance that is publicly traded. 38 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

39 Intragroup Transfer of B Note P S B Note B $100 S lends $100 to B in exchange for a B note and B uses the proceeds in its business. The B note declines in value. P is planning to dispose of B, but must resolve B s obligation to S in advance of the disposition. What are the consequences if S sells (or distributes) the B note to P, and P contributes the B note to B? 39 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

40 Intragroup Transfer of B Note (cont d) P 1 2 (Y3) Sale of B Note for $70, or distribution of B Note (Y3) Contribution of B Note S B Note (Y1) $100 B Actual Transaction: Before the sale of B, S sells the B note to P for $70 or distributes the B note to P. Immediately thereafter, P contributes the B note to B. What are the consequences? 40 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

41 Intragroup Transfer of B Note (cont d) P S $70 B Note B STEP 1 SATISFACTION: As a result of S s sale or distribution of the B note to P, B is deemed to satisfy the note with a $70 payment to S. B has $30 of COD (ordinary) under 61(a)(12), and S has $30 of capital loss under Section 1271(a)(1). Under -13(c)(4)(i), B s attributes control and S s loss is treated as an ordinary loss. STEP 2 REISSUANCE: B is deemed to issue, directly to S, a new B note with an IP of $70 and a $100 stated redemption price at maturity. As a result, no gain or loss to B or S on the issuance. S s basis in the new B note = $70. Section Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

42 Intragroup Transfer of B Note (cont d) New B Note P S B STEP 3 TRANSACTION: S sells (or distributes) the new B note to P for $70. RESULTS: S has no gain or loss on the sale. P s basis in the new B note is $70. Section $30 of OID will be taken into account by B and P under Sections 163(e) and Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

43 Intragroup Transfer of B Note (cont d) P Contribution of New B Note S B STEP 4 P CONTRIBUTES NEW B NOTE TO B: DSR does not apply due to the extinguishment exception in -13(g)(3)(i)(B)(5). No additional amounts will be taken into account by P and B. Cf. PLR (in connection with debtor Target reorganizing into creditor Acquiring under Section 368(a)(1)(C), no gain or loss was recognized on extinguishing intercompany debt, citing Sections 357(a), 361(a) and (b), -13(g)(3)(i)(B)(5), & Rev. Rul ) 43 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

44 Intragroup and Outbound Transactions -13(g)(3)(i)(A) defines triggering transactions A triggering transaction includes an intercompany transaction, or any comparable transaction, in which a member realizes an amount from the assignment or extinguishment of intercompany debt ( intragroup transactions ) Examples of intragroup transactions include bad debt deductions and mark-tomarket transactions Creditor s reduction to basis in intercompany obligation under Section 108, Section1017 or -28 is not an intragroup transaction Consider an insolvent subsidiary s dissolution A triggering transaction also includes transactions in which an intercompany obligation becomes a non-intercompany obligation ( outbound transactions ) 44 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

45 Intragroup and Outbound Transactions Exceptions to DSR (subject to the tax benefit rule): Intercompany nonrecognition assignments: Assignment of intercompany obligations in Sections 332, 351, or 361 exchange if no amount is recognized with respect to the obligation. DSR applies to Sections 351 transfers only if: The transferor or transferee member has a loss subject to a limitation and the other member is not subject to a comparable limitation The transferor or transferee member has a special status within the meaning of - 13(c)(5) that the other member does not also possess; A member of the group realizes COD income that is excluded from gross income and the tax attributes attributable to either the transferor or the transferee member are reduced under -28(a)(2) or (a)(3); 45 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

46 Intragroup and Outbound Transactions (cont.) The transferee member has a nonmember shareholder; The transferee member issues preferred stock to the transferor member in exchange for the assignment of the intercompany obligation; or The stock of the transferee member is disposed of within 12 months from the assignment of the intercompany obligation, unless at the time of the assignment, the transferor member, transferee member and the debtor member are all in the same 80% chain, and all of the stock of the transferee held by members of the group is disposed of as part of the same plan or arrangement, either directly or indirectly, to persons that are not members of the group Intercompany assumption: All of the debtor's obligations under an intercompany obligation are assumed in connection with the debtor's sale or other disposition of property (other than solely money) in an intercompany transaction in which gain or loss is recognized under Section Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

47 Intragroup and Outbound Transactions Exceptions to DSR (subject to the tax benefit rule): Intercompany extinguishment: All or part of the rights and obligations under the intercompany obligation are extinguished in an intercompany transaction and the adjusted issue price of the obligation is equal to the creditor's basis in the obligation, and the debtor's corresponding item offsets in amount the creditor's intercompany item. Routine modification: All of the rights and obligations under the intercompany obligation are extinguished in an intercompany transaction that is an exchange (or deemed exchange) for a newly issued intercompany obligation, and the issue price of the newly issued obligation equals both the adjusted issue price of the extinguished obligation and the creditor's basis in the extinguished obligation. 47 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

48 Intragroup and Outbound Transactions Exceptions to DSR (not subject to a tax benefit rule): Section 108(e)(4) exception: The obligation became an intercompany obligation by reason of an event described in Treas. Reg (e)(2) (exception to the application of Section 108(e)(4) in the case of acquisitions by securities dealers). Reserve accounting: The amount realized is from reserve accounting under Section 585. Outbound distribution: The intercompany obligation becomes an obligation that is not an intercompany obligation in a transaction in which a member that is a party to the reorganization exchanges property in pursuance of the plan of reorganization for a newly issued intercompany obligation of another member that is a party to the reorganization and distributes such intercompany obligation to a nonmember shareholder or nonmember creditor in a transaction to which Section 361(c) applies. Outbound subgroup: The intercompany obligation becomes an obligation that is not an intercompany obligation in a transaction in which the members of an intercompany obligation subgroup cease to be members of a consolidated group, neither the creditor nor the debtor recognize any income, gain, deduction, or loss with respect to the intercompany obligation, and such members constitute an intercompany obligation subgroup of another consolidated group immediately after the transaction. 48 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

49 Tax Benefit Rule If an assignment or extinguishment otherwise excepted from DSR mechanics is engaged in with a view to shift items of built-in gain, loss, income, or deduction from the obligation from one member to another member in order to secure a tax benefit that the group or its members would not otherwise enjoy in a consolidated or separate return year, then the assignment or extinguishment will be subject to DSR. Only applies for certain exceptions from DSR A tax benefit is a net reduction, for federal income tax purposes, in income or gain, or a net increase in loss, deduction, credit, or allowance. 49 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

50 Off-Market Issuance Rule If an intercompany obligation is issued at a rate of interest that is materially offmarket (off-market obligation) with a view to shift items of built-in gain, loss, income, or deduction from the obligation from one member to another member in order to secure a tax benefit, then the intercompany obligation will be treated, for all federal income tax purposes, as originally issued for its fair market value, and any difference between the amount loaned and the fair market value of the obligation will be treated as transferred between the creditor and the debtor at the time the obligation is issued. Note that groups must go beyond the requirements of Section 482 to comply with this rule by more comprehensively identifying what is an off-market rate. 50 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

51 Intragroup and Outbound Transactions P 2 S S1 $ 1 Note B S lends $100 to B in exchange for a note S contributes the B note to S1 when it is worth $110 Neither S nor S1 has a loss subject to limitation or has special status B s note is not deemed satisfied because no amount was recognized on the contribution What if the contribution is within 12 months of the later disposition of S1 at reduced gain? What if the contribution is more than 12 months before the disposition of S1, but with a view to shift built-in items not otherwise enjoyed in the year? 51 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

52 Intragroup and Outbound Transactions P P S $ $ 1 B Note 2 2 S 1 Note B S1 S1 S lends $100 to B in exchange for a note S contributes the B note to S1 when it is worth $110 S1 is sold to an unrelated person six months after the contribution B is treated as satisfying the B note for $110 B is treated as issuing a new B note with $110 issue price and $100 stated redemption price at maturity S contributes the new B note to S1 52 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

53 Intragroup and Outbound Transactions P 2 X S $ S1 Note 1 S S1 S1 lends $100 to S in exchange for a note P sells all of the S stock to X, an unrelated party that is the common parent of a consolidated group The S note is not subject to DSR because S and S1 constitute an intercompany obligation subgroup and neither the creditor nor the debtor recognize income, gain, deduction, or loss with respect to the S note 53 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

54 Intragroup and Outbound Transactions: Exception Applied to Section108(e)(8) P S 2 $ S1 Note 1 S lends $100 to S1 in exchange for a note When the S1 note is worth $90, S exchanges the S1 note for $90 of S1 stock under Section108(e)(8) and the S1 note is extinguished Is the extinguishment of the S1 note subject to the exception to DSR for certain extinguishments? The adjusted issue price of S1's note ($100) is equal to S s basis in S1 s note S1 recognizes $10 of income under Section108(e)(8), based on the excess of the $100 adjusted issue price over the $90 FMV of the S1 stock issued S's intercompany item is a $10 loss under Sections 351(d)(2) and 1001 The exception applies due to symmetry between S and S1 items 54 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

55 Intragroup and Outbound Transactions: Exception Applied to Section 108(e)(6) P S 2 $ S1 Note 1 S lends $100 to S1 in exchange for a note When the S1 note is worth $90, S contributes the S1 note to S1 s capital under Sections108(e)(6) and the S1 note is extinguished Is the extinguishment of the S1 note subject to the exception to DSR for certain extinguishments? The adjusted issue price of the S1 note ($100) is equal S s basis in the note ($100) S1 s corresponding item ($0) and S's intercompany item ($0) offset in amount The exception applies due to symmetry between the S and S1 items PLR (permitting rescission of Section108(e)(8) transaction, and restructuring as Section108(e)(6) transaction) 55 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

56 Intragroup and Outbound Transactions Steps In 2009, B borrows $100 from S and issues a $ year note. In 2010, S sells the B note to M for $70. In 2011: M has accrued $5 of OID income, and B has accrued $5 of OID deductions the B note has a FMV of $80 M liquidates into B under Sections 332 and B s Note $100 AIP B $100 B s Note 3 S 2 B s Note $70 M 56 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

57 Intragroup and Outbound Transactions Results There would be a DSR when S sells B's note to M in step 2. If there were a DSR in step 3: B would recognize $5 of repurchase premium deductible as interest under Treas. Reg (c). M would recognize $5 of capital gain under Section 1271(a)(1) that is redetermined under - 13(c)(4)(i) to be ordinary income. There would be no further gain or loss related to the extinguishment of the debt in the liquidation. If there were no DSR in step 3: There may be no further consequences. See, e.g., Rev. Ruls and Or, B might have $5 of capital gain and $5 of repurchase premium under Treas. Reg (c). See, e.g., Rev. Ruls & The adjusted issue price of $75 equals M's basis in B s note, and B s corresponding item and M s intercompany item are both zero. See, e.g., PLR (in connection with debtor Target reorganizing into creditor Acquiring under Section 368(a)(1)(C), no gain or loss was recognized on extinguishing intercompany debt, citing Sections 357(a), 361(a) and (b), -13(g)(3)(i)(B)(5), & Rev. Rul ); PLR , PLR and (Section 332 liquidation eliminates intercompany debt without realizing intercompany items, citing Rev. Rul ). 57 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

58 Intragroup and Outbound Transactions D Creditors 2 D Shareholders C Stock C Securities D C Securities FMV = $100 C Stock FMV = $100 C 1 Asset FMV = $200 AB = $10 D has an asset with a basis of $10 and value of $200. Step 1: D contributes the asset to C for $100 of C securities and $100 of C stock. Step 2: D distributes the C securities to its creditors and the C stock to its shareholders. Assume this qualifies as a divisive D reorganization. Are the C securities subject to DSR? Pending legislation would treat C securities distributed to D creditors as boot for purposes of Section 361(b)(3). 58 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

59 Inbound Transactions -13(g)(5) & (g)(6) apply if: Nonintercompany debt becomes intercompany debt If -13(g)(5) & (g)(6) apply: Debt is subject to DSR Section108(a) will apply Sections108(e)(4), 354, and 1091 do not apply No attribute redetermination Subject to subgroup rule Single-entity Treas. Reg (c) application Defers certain repurchase premium deductions 59 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

60 Inbound Transactions Immediately after becoming an intercompany obligation, the debt is deemed satisfied for all federal income tax purposes Deemed satisfaction transaction is separate from actual transaction Debt is deemed satisfied for: An amount of cash determined under Treas. Reg (f) Also immediately after becoming an intercompany obligation, the debt is deemed reissued: Debt is reissued as a new debt issued to the holder for the deemed satisfaction cash 60 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

61 Inbound Transactions P P Note $ X 1 B S B 3 S $ 2 Note X lends $100 to B in exchange for a note X sells the B note to S for $70 and B is deemed to satisfy the B Note for $70 immediately after S s acquisition of the note from X B has $30 of COD income A new B note, with a $70 issue price and a $100 stated redemption price, is deemed issued to S 61 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

62 ULR: Satisfaction of Intercompany Debt P $800 T Note P 4 $200 1 T $800 2 $150 5 T $850 T Note Asset 3 FMV $200 A/B $150 $200 Facts: P buys T for $200 when T has an asset with a value of $200 and A/B of $150 P lends T $800 at market rate interest T sells the asset and recognizes $50 BIG Market interest rates decline and T redeems the note for $850 P sells the T stock for $ Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

63 ULR: Satisfaction of Intercompany Debt (cont d) Analysis T s sale of the asset at a gain increases P s basis in the T stock from $200 to $250. T s redemption of the note for $850 allows T to claim a $50 deduction for repurchase premium under Treas. Reg (c) and P reports $50 gain, which is characterized as ordinary to match T s deduction. T s deduction reduces the basis of P s T stock from $250 to $200. P s sale of T stock for $150 gives P a $50 loss, which is allowed because net positive investment adjustments are zero (-36(c)). 63 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

64 ULR: Satisfaction of Intercompany Debt P $800 T Note P 4 $200 $800 2 $150 $750 T Note 1 T 5 T Asset 3 FMV $200 A/B $150 $150 Facts: P buys T for $200 when T has an asset with a value of $200 and A/B of $150 P lends T $800 at market rate interest T s asset declines in value to $150 Market interest increase and T redeems the note for $750 P sells the T stock for $150, recognizing a $50 loss after ULR adjustments 64 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

65 ULR: Satisfaction of Intercompany Debt (cont d) Analysis T s redemption of the note for $750 causes T to recognize $50 of income and P reports a $50 deduction, which is characterized as ordinary to match T s deduction. T s income increases the basis of P s T stock from $200 to $250. P s sale of T stock for $150 gives P a $100 loss, $50 of which is disallowed because P s positive investment adjustments are $50 and P s stock basis ($250) exceeds T s inside attribute amount ($150) by $100 (-36(c)). 65 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

66 Definition of Worthlessness: -80(c) Subsidiary stock is not treated as worthless under Section 165 until the earlier of the time: The stock is worthless as defined in -19(c)(1)(iii), or The subsidiary ceases to be a member of the group (e.g., all of the stock is transferred/issued to the subsidiary s creditors) Query If a group elects to treat an insolvent member as disregarded, has the member ceased to be a member of the group? Pursuant to -19(c)(1)(iii), stock is worthless when: All of its assets are treated as disposed of other than in a liquidation under Section 332, or in exchange for consideration other than relief of indebtedness The subsidiary s debt is discharged, resulting in black hole COD income A member takes a deduction with respect to the subsidiary s debt that is not matched by an income inclusion by the subsidiary 66 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

67 Worthless Stock Loss: -13(g) Considerations Loan Asset $0AB NOL $100 M S Liabilities $100 Common Stock AB $100 FMV $0 Loan AB $100 FMV $0 Facts: M acquired S for $100. At that time, S owned an asset with a basis of $0 and a value of $100. M subsequently loaned S $100, which S expensed as part of its business, generating a $100 NOL. Historically, there have been no positive or negative adjustments with respect to the S stock. S s asset declines in value to $0 and M elects to treat S as a disregarded entity. 67 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

68 Worthless Stock Loss: -13(g) Considerations S s Dissolution: S becoming a disregarded entity is treated as its dissolution under Section1001 (not under Section 331) in extinguishment of its obligation. See Rev. Rul ; PLR & PLR Worthless Stock Deduction: M claims a worthless stock deduction with respect to the stock of S (-80(c) is satisfied). Intercompany Obligation Rules: Is S s loan subject to DSR? If so, M recognizes a $100 deduction and S recognizes $100 in taxable COD income, which increases M s stock basis to $200. Basis Reduction: $100 of M s $200 worthless stock loss is allowed because $100 is the lesser of: Disconformity amount: $100 (the excess of M s $200 basis in the S stock, over S s $100 net inside attributes amount) NPA: $100 (M s cumulative, net positive investment adjustment to the S stock, entirely from the DSR) Loss Duplication Result: M s $100 loss is allowed, but S must reduce its NOL from $100 to $0 to prevent duplication. Reattribution of S Losses: M cannot reattribute S s NOL because S does not become a nonmember. Cf. GLAM Is the $100 loss appropriate, where M has suffered a $200 economic loss? Loan Asset $0AB NOL $ Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved. M S Liabilities $ Common Stock AB $100 FMV $0 Loan AB $100 FMV $0

69 Worthless Stock Loss: Loan from Subsidiary S M Loan $100 T AB $100 FMV $0 Asset $0 AB NOL $100 Liabilities $100 Facts: M acquired T for $100. At that time, T owned an asset with a basis of $0 and a value of $100. S, M s cash management subsidiary, subsequently loaned T $100, which T expensed as part of its business. Historically, there have been no positive or negative adjustments with respect to the T stock. T s asset declines in value to $0, and M elects to treat T as a disregarded entity at a time when its assets have $0 value. 69 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

70 Worthless Stock Loss: Loan from Subsidiary T s Dissolution: T becoming a disregarded entity is treated as its dissolution under Section 1001 (not under Section 331). See Rev. Rul ; PLR & PLR Worthless Stock Deduction: M claims a worthless stock deduction with respect to the stock of T (-80(c) is satisfied). Intercompany Obligation Rules: Is S s loan subject to DSR? If so, S recognizes a $100 deduction and T recognizes $100 in taxable COD income, which increases M s stock basis in T to $200. Basis Reduction: $100 of M s $200 worthless stock loss is allowed because $100 is the lesser of: Disconformity amount: $100 (the excess of M s $200 basis in the T stock, over T s $100 net inside attribute amount) NPA: $100 (M s cumulative, net positive investment adjustment to the T stock, entirely from the DSR) Loss Duplication Result: M s $100 loss is allowed, but T must reduce its NOL from $100 to $0 to prevent duplication. Reattribution of S Losses: M cannot reattribute T s NOL because T does not become a nonmember. Cf. GLAM Is the $100 loss appropriate, where M s has suffered a $200 economic loss? S M Loan $100 Asset $0 AB NOL $100 T AB $100 FMV $0 Liabilities $ Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

71 About This Presentation This presentation contains general information only and Deloitte is not, by means of this presentation, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This presentation is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. Deloitte shall not be responsible for any loss sustained by any person who relies on this publication. 71 Tax Executives Institute Houston chapter Consolidated returns Copyright 2016 Deloitte Development LLC. All rights reserved.

72 About Deloitte Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited, a UK private company limited by guarantee ( DTTL ), its network of member firms, and their related entities. DTTL and each of its member firms are legally separate and independent entities. DTTL (also referred to as Deloitte Global ) does not provide services to clients. Please see for a detailed description of DTTL and its member firms. Please see for a detailed description of the legal structure of Deloitte LLP and its subsidiaries. Certain services may not be available to attest clients under the rules and regulations of public accounting. Copyright 2016 Deloitte Development LLC. All rights reserved. 36 USC Member of Deloitte Touche Tohmatsu Limited