ALI-ABA Course of Study Consolidated Tax Return Regulations. Cosponsored by the ABA Section of Taxation September 25-26, 2008 Washington, D.C.

Transcription

1 479 ALI-ABA Course of Study Consolidated Tax Return Regulations Cosponsored by the ABA Section of Taxation September 25-26, 2008 Washington, D.C. Intercompany Transactions By Andrew J. Dubroff Ernst & Young LLP Washington, D.C. These materials are adapted from A. Dubroff, J. Blanchard, J. Broadbent & K. Duvall, FEDERAL INCOME T AXATION OF C ORPORATIONS FILING CONSOLIDATED RETURNS (2d ed. 2008), which is published by Matthew Bender & Co., Inc., part of Lexis Publishing, New York, NY

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3 481 These materials are adapted from A. Dubroff, J. Blanchard, J. Broadbent & K. Duvall, FEDERAL INCOME TAXATION OF CORPORATIONS FILING CONSOLIDATED RETURNS (2d ed. 2008), which is published by Matthew Bender & Co., Inc., part of Lexis Publishing, New York, NY Chapter 31 Intercompany Transactions Synopsis Introduction... [1]--Consolidated groups generally... [2]--Controlled groups... [3]--Generally Accepted Accounting Principles... [a]--in general... [b]--intercompany sales... [c]--member obligations... [d]--member stock History of intercompany accounting... [1]--Overview... [2]--The early regulations: carryover basis and elimination... [3]--The 1966 regulations... [4] legislation... [5]--The 1990 temporary regulations... [6]--Current regulations Introduction to the current regulations... [1]--Background... [a]--purpose... [b]--balance between single and separate entity treatment... [c]--broad principles instead of mechanical rules... [d]--credits... [2]--Accounting methods... [a]--treatment of intercompany accounting as a method... [b]--method changes and adoption of methods... [c]--intercompany transfers and anti-avoidance rule... [3]--Effective dates Definitions and nomenclature...

4 482 [1]--Intercompany transactions, S and B... [2]--S's intercompany items... [a]--directly or indirectly... [b]--costs and expenses... [c]--accounting method... [3]--B's corresponding items... [a]--directly or indirectly... [b]--accounting method... [i]--in general... [ii]--macrs... [iii]--section [iv]--pre-acrs property... [c]--disallowed and eliminated amounts... [4]--Recomputed corresponding items... [5]--Treatment as a separate entity... [6]--Attributes... [a]--attributes of items... [b]--characteristics of property Matching rule... [1]--Attributes and holding periods... [a]--redetermination to the extent necessary... [b]--b controls S to the extent of offsetting amounts... [c]--special status... [d]--limits on recharacterization as tax-exempt income... [e]--allocation of single entity amounts to individual members... [f]--international issues... [2]--Timing... [a]--b's items... [b]--s's items Acceleration rule... [1]--S's items... [a]--timing... [i]--matching no longer possible... [ii]--nonmember reflects the intercompany transaction... [b]--attributes... [2]--B's items... [a]--timing... [b]--attributes... 2

5 Simplifying rules... [1]--Inventories; dollar-value LIFO methods... [a]--any reasonable method... [b]--b uses dollar-value LIFO... [i]--increment averaging method... [ii]--increment valuation method... [c]--s uses dollar-value LIFO... [d]--recapture of inventory adjustments under the 1966 regulations... [2]--Reserve accounting... [a]--banks and thrifts... [b]--insurance companies... [i]--direct insurance... [ii]--reinsurance... [3]--Consent to separate entity treatment... [a]--in general... [b]--procedures... [c]--effects of consent... [d]--prior period consents... [4]--Long-term contracts... [5]--Section Anti-avoidance rules... [1]--When adjustments are necessary... [a]--partnerships... [b]--corporate transactions... [c]--economic effect... [2]--The required adjustments Miscellaneous operating rules... [1]--Successors... [a]--successor assets... [b]--successor persons... [2]--Multiple triggers and successive intercompany transactions... [3]--Acquisition of group... [4]--Former common parent treated as continuation of group... [5]--Becoming a nonmember... [6]--Recordkeeping Effective dates... 3

6 484 [1]--In general... [2]--Avoidance transactions... [3]--Stock elimination transactions... [4]--Common parent stock loss disallowance... [5]--Consent to adopt method of accounting Section 267(f)... [1]-General Rules... [2]--Definitions... [a]--intercompany sale... [b]--s's loss or deduction... [c]--controlled group and member... [d]--consolidated taxable income; consolidated tax liability... [3]--Matching and acceleration... [a]--attributes... [b]--timing... [i]--application on controlled group basis... [ii]--different taxable years... [iii]--transfer to a section 267(b) or section 707(b) related person... [iv]--b's item is excluded from gross income or noncapital and nondeductible... [4]--International issues... [a]--intercompany sales of inventory involving foreign persons... [b]--treatment of a creditor with respect to a loan in nonfunctional currency.... [5]--Receivables... [6]--Anti-avoidance rule... [7]--Effective dates... 4

7 Introduction [1]--Consolidated groups generally The essence of single-entity treatment under the consolidated return regulations is the combining of the separate income and loss of each member into a single return for the consolidated group. Inherent in this treatment is the need for special rules to take into account income, gain, deduction and loss from transactions between corporations that are members of the same consolidated group (intercompany transactions). The special rules are necessary to ensure that self-dealing through intercompany transactions does not affect the group's income beyond the effect of comparable transactions between divisions of a single corporation. 1 In effect, if affiliated corporations are permitted to join in a single consolidated return, their intercompany transactions generally should not affect the income reflected on the return. Reg uses what is referred to as a deferred sale approach that treats the members of a group as separate entities for some purposes and as a single entity for other purposes. Under this approach, gain or loss on a transfer of property from one member (the selling member, or S) to another member (the buying member, or B) is generally deferred and taken into account by S based on later events such as when the property is depreciated or disposed of outside the group by B. Although S's gain or loss is deferred, B takes a cost basis in the transferred property. The primary rationale for deferral is to prevent the premature accounting for gain or loss merely because the property is transferred to a person joining in the same return. Although the principles of section 482 apply to intercompany transactions, ancillary rationales for deferral are to (i) address the ability of taxpayers to cherrypick by 1 The current regulations state that "[t]he purpose of this section [Reg ] is to provide rules to clearly reflect the taxable income (and tax liability) of the group as a whole by preventing intercompany transactions from creating, accelerating, avoiding, or deferring consolidated taxable income (or consolidated tax liability)." Reg (a)(1). See also T.D. 8295, C.B. 165 ("As a result of changes in the Internal Revenue Code, literal application of the deferral rules may produce tax consequences to the group that are inconsistent with the tax consequences that would have resulted if an intercompany transfer had not occurred. The purpose of the [March 9, 1990] temporary regulations is to assure that the deferral provisions operate as they were intended--i.e., to promote neutrality so that the overall tax consequences to the group generally are not affected by transfers of property among members."); T.D. 8478, C.B. 189 ("The deferral system is intended to prevent intercompany transactions from affecting the timing of consolidated taxable income, and to fix the location, character, and source of the deferred gain or loss, generally with reference to the selling member. The [March 9, 1993] temporary and final regulations assure that the deferral provisions operate as they were intended so that the group's overall income or loss generally is not affected by transactions between members."). 5

8 486 selling only loss assets within the group, and (ii) prevent the artificial creation of gains and losses (e.g., a member taking a loss into account from the intercompany sale or exchange of property at less than fair market value) in cases where section 482 is difficult to apply. Many of the same concerns led to the enactment of special rules under section 267(f), which apply to loss from transactions among members of a controlled group of corporations (a larger category than consolidated groups). 2 Example. Intercompany sale of land. (a) P is the common parent of the P consolidated group, and owns all of the only class of stock of subsidiaries S and B. S holds raw land with a basis of $70. On January 1 of Year 1, S sells the land to B for $100. B develops the land as residential real estate, and sells developed lots to customers during Year 3 for an aggregate amount of $110. Under the deferred sale approach, S must ultimately take into account its $30 gain ($100 proceeds minus $70 basis) and B its $10 gain ($110 proceeds minus $100 basis). But S's $30 gain is not taken into account when recognized in Year 1. Instead, it is deferred and taken into account based on later events in order to treat S and B more like divisions of a single corporation. The sales by B to customers in Year 3 are the appropriate event for taking S's gain into account. Thus, S's entire $30 gain is taken into account in Year 3. (The results would be the same if S sold the land to B in an installment sale to which section 453 would otherwise apply, because S must take its intercompany gain into account under intercompany accounting.) 3 (b) The facts are the same as in paragraph (a), except that on July 1 of Year 2, P sells 60% of S's stock to X for $60 and, as a result, S becomes a nonmember. Again, none of S's $30 gain is taken into account in Year 1. But the entire gain is accelerated and taken into account in Year 2, immediately before S leaves the group, because it is thereafter no longer possible to treat S and B as divisions of a single corporation. 4 2 For further discussion, see (section 267(f) discussion). 3 Reg (c)(7)(ii), Ex Reg (d)(3), Ex. 1. S's gain is reflected under Reg in P's basis in the S stock immediately before P's sale of the stock. Under , P's basis in the S stock is increased by $30, and therefore P's gain is reduced (or loss is increased) by $18 (60% of $30). See also and (b). For further discussion, see Chapter 51 (stock basis adjustments). 2