Current Developments in Consolidated Returns

Transcription

1 Current Developments in Consolidated Returns Affiliated & Related Corporations Committee American Bar Association Tax Section William D. Alexander Associate Chief Counsel (Corporate) Internal Revenue Service Washington, D.C. Krishna P. Vallabhaneni Attorney-Advisor U.S. Department of the Treasury Washington, D.C. Matthew E. Gareau Deloitte Tax LLP Washington National Tax Washington, D.C. Mark A. Schneider Deloitte Tax LLP Washington National Tax Washington, D.C. Gregory N. Kidder Steptoe & Johnson LLP Washington, D.C. January 24, 2014 Phoenix, Arizona IRS Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or applicable state or local tax law provisions or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

2 Agenda Treasury/IRS Priority Guidance Plan Granite Trust Planning Recent Rulings and Other Administrative Guidance GLAM Next Day Rule Section 336(e) Regulations 2

3 Treasury/IRS Priority Guidance Plan Consolidated Returns 1. Final regulations regarding the application of 172(h) to a consolidated group. --REG (September 17, 2012), corrected by Announcement (January 14, 2013) 2. Regulations under 1502 affecting consolidated groups, including regulations regarding loss transfers of member stock. 3. Final regulations under relating to the status as agent of a consolidated group. --REG (May 30, 2012) 4. Final regulations under regarding the redetermination of consolidated net unrealized built-in gain and loss. --REG (October 24, 2011) Corporations and their Shareholders 2. Regulations under 301, 302, and 358 regarding the recovery and allocation of basis in redemptions, organizations, and reorganizations --REG (January 21, 2009) General Tax Issues 39. Regulations under 1012 regarding basis rules for stock and debt 3

4 Granite Trust Planning

5 Basic Granite Trust Facts Built-In Loss Stock P S 100% P Unrelated Party 70% 30% S P sells 30% of the S shares (at a loss) to Unrelated Party --P recognizes and takes into account the loss on the sold S shares S later liquidates under P recognizes and takes into account the loss on its retained 70% of S shares. See Granite Trust Co. v. U.S., 238 F.2d 670 (1st Cir. 1956); Commissioner v. Day & Zimmerman, Inc., 151 F.2d 517 (3d Cir. 1945). 5

6 Related Party Granite Trust Facts USP USP Built-In Loss Stock USS FS 70% USS 30% FS USP exchanges 30% of the USS shares with FS for 351(g) stock of FS --USP recognizes any loss on the transferred USS shares, and then 267(f) defers the loss USS later liquidates under USP recognizes and takes into account the loss on its retained 70% of USS shares. See Granite Trust Co. v. U.S., 238 F.2d 670 (1st Cir. 1956); Commissioner v. Day & Zimmerman, Inc., 151 F.2d 517 (3d Cir. 1945) --What happens to USP s deferred loss on the previously transferred 30% of USS shares? 6

7 267(f) Background 267(a)(1) disallows loss on sales between related persons (as defined in 267(b)) --But it does not apply to any loss of the distributing corporation (or the distributee) in the case of a distribution in complete liquidation 267(f)(2) defers (rather than disallows) loss on sales between members of the same controlled group (as defined under 267(b)(3)) to which 267(a)(1) would otherwise apply, until the property is transferred outside the controlled group and the loss would be taken into account under consolidated return principles or until such other time prescribed by regulations --the 1563 definition of controlled group applies, requiring a greater than 50% (rather than at least 80% ) relationships among the corporations 7

8 267(f) Background (cont d) Under 1.267(f)-1(c)(1), loss deferred under 267(f) is generally taken into account under the timing principles of the matching and acceleration rules of -13(c) and (d) Under 1.267(f)-1(c)(2), the attribute redetermination principles of the matching and acceleration rules generally do not apply, and the attributes of the losses subject to 267(f) deferral are not redetermined --Under -13(c) and (d), the separate return attributes of deferred items of S and B are generally redetermined to the extent necessary to produce the effect of a transaction between divisions of a single corporation --As confirmed by -13(c)(6), this redetermination process can even treat items as excluded from gross income or as noncapital, nondeductible amounts 8

9 267(f) Background (cont d) Under 1.267(f)-1(c)(1)(iv), to the extent the loss of S (the selling member) subject to 267(f) would be redetermined to be a noncapital, nondeductible amount under the principles of -13, but is not redetermined because of 1.267(f)-1(c)(2), the loss remains deferred and is not taken into account until S and B (the buying member) are no longer in a controlled group relationship --The determination of whether a loss would be redetermined takes into account stock held by S, stock held by B, stock held by all members of S s consolidated group, stock held by any member of a controlled group of which S is a member that was acquired from a member of S s consolidated group, and stock issued to a member of the controlled group by the target corporation The operative rule 1.267(f)-1(c)(1)(iv) that extends deferral of S s preliquidation loss in the typical Granite Trust fact pattern was promulgated after a series of IRS pronouncements regarding the predecessor regulation --Compare ILM (deferring S s loss even after the 331 liquidation of T until S and B are no longer in a controlled group relationship), PLR , ILM (same) and ILM (same) with PLR (S s deferred loss on sale of T stock was taken into account on T s liquidation under 331) 9

10 Sale of Stock at a Loss, Followed by 332 Liquidation P $100 FMV S $100/B stock T stock $130 AB T T In Year 1, S sells the stock of T to B, recognizing a $30 loss. In Year 2, T liquidates under 332. If S and B are members of the same consolidated group, S s loss is initially deferred and, upon T s liquidation, S s loss is recharacterized as noncapital, nondeductible under -13(c). See -13(f)(7), Ex. 6(c). B If S and B are not members of the same consolidated group and the consideration provided by B is $100 of B s 351(g) nonqualified preferred stock, S s loss is initially deferred and, under the principles of -13, would be redetermined to be noncapital, nondeductible upon the liquidation of T; 1.267(f)-1(c)(2) prevents redetermination but 1.267(f)-1(c)(1)(iv) requires S s loss to remain deferred until S and B are no longer in a controlled group relationship. 10

11 Sale of Stock at a Loss, Followed by Liquidation 30% of T stock B cash B S S 30% T $10 FMV $100 AB 70% T S sells 30% of the T stock to B for $3, and T later liquidates when the FMV of all the T stock is $10. If S and B are members of the same consolidated group, S recognizes $27 of loss on its sale to B, and the loss is deferred under -13. By reason of the application of -34, T s later liquidation qualifies under 332. The attribute redetermination rule of -13(c)(1) redetermines S s prior loss to produce the same results to the group as if S and B were divisions of a single corporation (without regard to the application of -34). Thus, S s intercompany loss is redetermined to be noncapital, nondeductible. See -13(f)(7), Ex. 6(c). If S and B are not members of the same consolidated group, S recognizes $27 of loss on its sale to B, and the loss is deferred under 267(f). The later liquidation of T does not qualify under 332. Under 1.267(f)-1(c)(1)(iv), upon T s liquidation, to the extent S's loss would be redetermined to be a noncapital, nondeductible amount under the principles of -13, S s remains deferred. In determining whether S s loss would be redetermined to be a noncapital, nondeductible amount, stock held by B and S is taken into account. Under the principles of -13, T s liquidation would be treated as qualifying under 332, and S s loss would be redetermined to be a noncapital, nondeductible amount. Therefore, S s loss remains deferred until B and S are no longer in a controlled group relationship. See 1.267(f)-1(j), Exs. 9 & 10. If T were liquidated at a time it was worthless (and satisfies the conditions of -80(c)), would S s loss remain deferred? Does the result vary based on whether S and B are members of the same consolidated group? 11

12 1.267(f)-1(j), Example 9 Unrelated Party 25% P1 P 75% 25% 25% of L stock FMV = $50 AB = $80 M S $50 Facts: 50% 50% L P1 owns 75% of the stock of P, and P owns all of the stock of M and S. P, M and S are members of the same consolidated group. M and S each own 50% of the stock of L, a nonmember, life insurance company described in 1504(b)(2). On January 1 of Year 1, S sells 25% of L s stock (with an $80 basis) to P1 for $50 and recognizes a $30 loss. On February 18 of Year 3, at a time when the L shares held by P1 are worth $60, L liquidates under 331 and P1 recognizes a $10 gain. 12

13 1.267(f)-1(j), Example 9 (cont d) P1 75% 25% Unrelated Party P 25% FMV = $60 AB = $50 50% M 25% S Analysis: L L liquidates S s $30 loss on its sale of the L stock to P1 in Year 1 is deferred under 267(f). In Year 3, P1 takes into account a $10 gain on L s 331 liquidation. Under -13 principles, to the extent of P1 s $10 gain, S s $30 loss is not redetermined to be a noncapital, nondeductible amount. Accordingly, S takes into account $10 of loss. In determining whether S s remaining $20 of deferred loss would be redetermined to be a noncapital, nondeductible amount, 1.267(f)-1(c)(1)(iv) takes into account the L stock held by P1, M and S. Accordingly, under -13 principles, the 331 liquidation of L would be treated as a liquidation qualifying under 332, and the remainder of S s loss would be redetermined to be a noncapital, nondeductible amount. S s remaining $20 loss remains deferred until S and P1 are no longer in a controlled group relationship. 13

14 1.267(f)-1(j), Example 10 Year 1 Year 2 Year 3 FP FP Cash 60% of the stock of T FP FS P FS 40% P FS 60% 40% 60% P 40% of the stock of T Cash T T T T converts to an LLC Facts: FP (a foreign corporation) owns all the stock of FS (also a foreign corporation) and all the stock of P (a domestic corporation). P owns all the stock of T (a domestic corporation). In Year 1, FS contributes cash to T in exchange for newly issued T shares constituting 40% of T s outstanding stock. In Year 2, when the value of the T stock owned by P is less than its basis in P s hands, P sells all of its T shares to FP at a loss. In Year 3, in a transaction unrelated to the issuance of the T stock in Year 1, T converts under state law to an LLC that is treated as a partnership for US federal income tax purposes. 14

15 1.267(f)-1(j), Example 10 Year 1 Year 2 Year 3 FP FP Cash 60% of the stock of T FP FS P FS 40% P FS 60% 40% 60% P Cash 40% of the stock of T T T T T converts to an LLC Analysis: P s loss on the sale of its T stock in Year 2 is deferred under 267(f). In determining whether P s loss would be redetermined to be a noncapital, nondeductible amount, 1.267(f)- 1(c)(1)(iv) takes into account T stock held by FS (which was acquired from T) and T stock held by FP (the buyer of the T stock from P and a member of P s controlled group). Under -13 principles, T s deemed liquidation resulting from its conversion into an LLC would be treated as qualifying under 332, and P s loss would be redetermined to be a noncapital, nondeductible amount. P s loss on the sale of its T stock remains deferred until P and FP are no longer in a controlled group relationship. P s sale of T stock to FP did not facilitate recognition of the loss on the sold T shares because the loss would have been recognized on T s deemed liquidation (i.e., P would take into account its loss if it retained the T shares at the time of T s conversion to an LLC), so why is this an appropriate case for continued deferral of P s sale loss? 15

16 Granite Trust Variations P P FMV = $100 AB = $200 S1 S2 FS NQPS 21% S2 shares Facts: P is the common parent of a consolidated group that includes S1 and S2 but not FS S1 sells 21% of the S2 stock to FS in exchange for 351(g) stock of FS One day later, S2 adopts a liquidation plan and liquidates Analysis: S1 recognizes a $21 loss on its sale of S2 shares to FS, and the loss is deferred under 267(f) On S2 s later liquidation, S1 and FS recognize gain/loss; assuming no value change, S1 recognizes $79 of loss and FS recognizes no gain or loss; S1 s $79 loss is taken into account 1.267(f)-1(c)(2) prevents redetermination of S1 s loss on the sale of 21% of the S2 stock 1.267(f)-1(c)(1)(iv) requires that loss to remain deferred until S1 and FS are no longer in a controlled group relationship FS S2 E&P = 40 FTCs=15 FMV = $100 AB = $200 S1 S2 Cash 21% S2 shares FS S2 E&P = 40 FTCs=15 Facts: P is the common parent of a consolidated group that includes S1 and S2 but not FS S1 sells 21% of the S2 stock to FS in exchange for cash One day later, S2 adopts a liquidation plan and liquidates Analysis: S1 s sale of S2 stock to FS is subject to 304; S1 is treated as contributing 21% of S2 stock to FS in exchange for FS stock that is deemed redeemed Does 302(a) (sale or exchange) or 302(d) (dividend equivalent) apply to the sale proceeds? See (a) (providing that 302(b) is applied by reference to the shareholder s ownership of stock of the issuing corporation, not the acquiring corporation). Can the liquidation of S2 without a 381 successor prevent dividend equivalency? If the sale proceeds are dividend equivalent, what happens to S1 s basis in S2 shares sold to FS? Under Rev. Rul , does it hop to S1 s retained S2 shares such that, on S2 s liquidation, S1 recognizes and takes into account $121 of loss? Or, under (c), does it hop to P s FS shares? 16

17 Rev. Rul A Cash 25 X Shares Y B X Facts: A owns all 100 shares of X. B, the son of A, owns all the stock of Y. A sold 25 X shares to Y for cash. Y s earnings and profits exceed the amount of cash paid by Y to A for the X stock. Conclusions: A s sale is subject to 304(a)(1), and 304 recharacterizes the sale proceeds as dividendequivalent under 302(d). Y s basis in the X shares acquired from A is A s basis in those shares. Since A owns no stock in Y directly after the transaction, the basis of the X stock surrendered is added to the basis of the 75 X shares that A owns after the transaction 17

18 PLR Granite Trust via 304, liquidation of Target P P S1 S1 $ S2 S3 S2 S3 >50%Vote & Value P/S $ S4 S5 C/S Exchange >20% S6 shares for cash >50%Vote & Value P/S S4 S5 C/S Facts: S6 S6 Subs >50%Vote & Value C/S P/S C/S P was the common parent of a consolidated group that includes S1, S2, S3, S4, and S6, but not S5 or the S6 Subs S2 contributes cash to S4, which contributes cash to S5 S3 sells more than 20% of the stock of S6 to S5 in exchange for cash At least one day later, S6 adopts a liquidation plan and liquidates There is no specific plan, but S3 might later merge into S1 S6 S6 Subs >50%Vote & Value P/S 18

19 PLR P S1 >50%Vote & Value S2 S4 S3 C/S P/S S5 C/S >50%Vote & Value C/S S6 Subs P/S Reps: The S6 liquidation will not be authorized until after the share sale The Cash Consideration will not be directly or indirectly returned to Sub 2, Sub 5 or any other direct or indirect subsidiaries of Sub 2 Rulings: S3 s sale is subject to 304(a)(1), and 304 recharacterizes the sale proceeds as dividendequivalent under 302(d) S3 and S6 must apply -36 before S6 deconsolidates S6 s liquidation is subject to 331 and (a)(1) and (f) do not apply to any S6 or shareholder loss 19

20 PLR Granite Trust via 304, liquidation of Seller USP FS3 FA-Subs FS12 P/S Holders ordinary shares P/S Exchange of FT-Subs for cash, FA-Subs receivable and liability assumption FS12 FT-Subs Facts: FS12 sells FT-Subs (multiple corps) to FA-Subs for cash, a debt instrument and liability assumption, when there was no plan or intention to liquidate them FS12 declares and makes a 301 distribution on its Class A P/S, declared and paid prior to the adoption of FS12 s plan of liquidation, and not conditioned in any respect on FS12 s CTB Election After the 304 and 301 distribution, FS12 adopt[s] a plan of liquidation solely for US tax purposes (the Plan of Liquidation ). Pursuant to the Plan... [FS12] will make a CTB election under Treasury Regulations pursuant to which it will be deemed, solely for U.S. federal income tax purposes, to distribute all of its assets and liabilities to its shareholders in liquidation. 20

21 PLR USP FS3 ordinary shares FA-Subs FT-Subs FS12 P/S Holders P/S FS12 Ruled: FS12 s sale is subject to 304(a)(1), and 304 recharacterizes the sale proceeds as dividend-equivalent under 302(d) If FS12 s P/S preference exceeds FS12 s Net Asset Value, the P/S shareholders will recognize gain/loss under 331(a), the ordinary shareholders will recognize worthless stock loss under 165(g) and Rev. Rul , and FS12 will recognize gain or loss under (a)(1) and (f) do not apply to any FS12 or shareholder loss 21

22 Rev. Proc The Service will no longer issue rulings under sections 267, 304, 331, 332, 351, and 1502 regarding the treatment of transactions in which stock of a corporation is transferred with a plan or intention that the corporation be liquidated in a transaction intended to qualify under section 331. Section 3.01(33). 22

23 Recent Rulings & Administrative Guidance

24 Rulings & Administrative Guidance Agenda Affiliation & Group Continuation Issues PLR Hook stock did not prevent S joining the group Rev. Proc No rule position on treatment of hook equity PLR P and Subs as S Corp/QSubs--no 1504(a)(3) waiver PLR S affiliated despite Federal Agency temporary external control Transaction Structuring Issues PLR Insolvent S1 s F reorg & P downstream merger eliminated ELA PLR Commissioner s discretionary rule, (c)(6) 24

25 PLR Hook stock did not prevent S joining the group D9 D8 D9 D8 D3 & S18 stock S4 equity D3 S17 D3 Group 368(c) D3 stock D3 Group D3 S17 S18 C6 S4 Facts: D3 was the common parent of a consolidated group S17 transferred all of the equity of S4 to D3 in exchange for an amount of D3 stock constituting 368(c) control of D3 ( Contribution 2 ) D8 transferred its equity in D3 and all of the stock of S18 to newly formed C6 in exchange for all of the stock of C6, the common parent of a new consolidated group ( Contribution 10 ) Ruling: (50) The consolidated group of which [D3] is the common parent will not terminate as a result of Contribution 2 (244) [D3] will become a member of the [C6] affiliated group, as defined in 1504(a)(1), as of the end of the day on which Contribution 10 occurs 25

26 PLR D9 D8 C6 C6 Group D3 S18 S17 Background: 1504(a) requires C6 to directly own 80% of the stock voting power/value of at least one includible corporation, and includible corporations to directly own 80% of the stock voting power/value of each other includible corporation --C6 directly owns the required interest in S18 --Does C6 directly own the required interest in D3, or can S17 be treated as in the C6 group for purposes of C6 and S17 aggregating their ownership of D3? 26

27 Rev. Proc The Service will not ordinarily issue a ruling on the treatment or effects of hook equity, including as a result of its issuance, ownership, or redemption. Section 4.02(11) However, the above sentence will not ordinarily apply if: (i) an interest s status as hook equity is only transitory, such as in a triangular reorganization, or (ii) the treatment of the hook stock is not relevant to the treatment of the overall transaction and issue presented. Section 4.02(11). For purposes of the no rule, hook equity is defined as an ownership interest in a business entity (such as stock in a corporation) that is held by another business entity in which at least 50% of the interests (by vote or value) in the latter entity are held directly or indirectly by the former entity. However, if an entity directly or indirectly owns all of the equity interests in another entity, the equity interests in the latter entity are not hook equity. 27

28 PLR P and Subs as S Corp/QSubs--no 1504(a)(3) waiver Date 1 Date 2 Date 3 P P S Corp P Subs QSubs Subs Facts: P was the common parent of a consolidated group The P group terminated effective Date 2, on P electing to become an S corporation and its subsidiaries becoming disregarded QSubs P revoked its S election under 1362(d)(1), effective Date 3, causing P to be treated under 1361(b)(3)(C) as transferring the assets of its QSubs to newly formed subsidiary corporations ( Former QSubs ) P requested permission to resume filing consolidated returns for the new P group 28

29 PLR Date 1 Date 2 Date 3 P P S Corp P Subs QSubs Subs Analysis: 1504(a)(3) limits the ability resume filing consolidated returns within 5 years of leaving a consolidated return filed by the same common parent Rev. Proc provides for certain waivers of the 5-year limitation P could not provide the representations required in 5.03 and 5.14, that it was not an S corporation in the interim, and that it did not derive a tax benefit from deconsolidating 7 permits discretionary IRS waivers where tax savings was not the purpose for deconsolidating, and any tax savings was not significant P failed to establish that the amount of federal tax savings attributable to the disaffiliation was not significant Ruling: P s 1504(a)(3)(B) waiver request is denied 29

30 PLR S affiliated despite Federal Agency temporary external control X P Voting Trust P T Merger Sub Other Subs T Other Subs Other Subs Other Subs Facts: P is the common parent of a consolidated group T had been the common parent of an unrelated consolidated group P acquired all of the stock of T by merging newly formed Merger Sub into T ( Acquisition ) Both the P group and T (and its subsidiaries) are regulated by Federal Agency Federal Agency must approve the Acquisition Pending approval, P transferred all the T stock to an irrevocable Voting Trust sanctioned by Federal Agency 30

31 PLR Voting Trust P T Other Subs Other Subs Facts: Under the Voting Trust --P irrevocably appoints an independent trustee --Trustee exercises all voting rights --Trustee must further P s acquisition of control of T --Trustee cannot sell T stock, major T assets, or merge T without P s permission --P can instruct Trustee voting, provided that Federal Agency approves --Trustee pays T cash dividends to P but retains noncash distributions (e.g., T stock) --P can direct the sale of T stock --Trustee transfers the T stock to P if Federal Agency approves the Acquisition --The Voting Trust terminates after 2 years, unless extended by the parties 31

32 PLR Voting Trust P T Other Subs Other Subs Ruling: P is considered the direct owner of all the outstanding T stock for purposes of 1504(a) upon the Acquisition, and the creation of the Voting Trust and subsequent transfer of T s stock to it did not prevent T (and each of its affiliated subsidiaries) from being members of the P group, or joining a consolidated US federal income tax return with P, as of the Acquisition 32

33 PLR Insolvent S1 s F reorg & P downstream merger eliminated ELA ELA and DIG Parent Guarantee Sub 1 Subs Lenders DE Debt DE Facts: Parent is the common parent of a consolidated group that includes Sub 1. In a prior year, the Sub 1 stock was distributed under -13(f)(2), and the gain recognized by Sub 2 was deferred under -13(c), and Sub 2 later liquidated into Parent under 332, causing Parent to become Sub 2 s -13(j)(2) successor with respect to the deferred gain In connection with PRS s purchase of Parent, DE incurred the DE Debt, and DE distributed the proceeds to Sub 1, which distributed the proceeds to Parent, creating an ELA on the Sub 1 stock Sub 1 guaranteed the DE debt, the guarantee now exceeds the fair market value of the DE membership interests owned by Sub 1 33

34 PLR Contribution of Sub 1 stock ELA and DIG Parent Newco Subs Guarantee Sub 1 Conversion to SMLLC Lenders DE Debt DE Facts: Parent transferred all of the Sub 1 stock to Newco in exchange for all of the Newco stock Sub 1 converted to an SMLLC (the Conversion), causing the DE Debt to become nonrecourse to Newco under applicable state law Rulings: Sub 1 s restructuring was an F reorganization The reorganization is isolated for subsequent related steps 34

35 PLR ELA and DIG Parent Newco Subs Guarantee Sub 1 Lenders DE Debt DE Facts: Parent merged downstream into Newco, with Newco surviving Rulings: Parent s merger is an A reorganization Parent s merger eliminates the ELA in the Newco stock without recognition Parent s merger causes the DIG to be excluded from gross income under -13(c)(6)(ii)(C) The Parent consolidated group continues under -75(d)(2) No opinion is expressed regarding whether the Proposed Transaction results in a significant modification of the DE Debt under 1001 and (e) 35

36 PLR Commissioner s Discretionary Rule D3 D1 (Successor Asset B) D2 C1 (Successor Asset B) S3 DIG 1 DIG 3 DIG 5 DIG 4 C2 Facts: D3 is the common parent of a consolidated group As a result of prior intercompany transactions, gains were recognized by D3 Group members that were deferred pursuant to -13 As a result of these prior transactions, a portion of D1 s D2 stock and all of D1 s C1 stock are treated as successor assets to the C2 stock subject to DIG 1 ( Successor Asset A and Successor Asset B, respectively) under -13(j)(2). 36

37 PLR D3 D3 (Successor Asset B) D1 D1 C1 S3 D2 DIG 1 DIG 3 C1 S3 D2 DIG 1 DIG 3 DIG 5 DIG 5 DIG 4 C2 DIG 4 Facts: D1 distributes its C1 stock to D3 in partial redemption of D3 s D1 stock, and D1 merges downstream with and into D2 with the D1 shareholders (D3) receiving D2 stock Rulings: As a result of the downstream merger, the portion of DIG 1 reflected in Successor Asset B is excluded 37 under the discretionary rule, -13(c)(6)(ii)(D), and D2 becomes a successor person to D1, -13(j)(2). C2

38 PLR D3 (Successor Asset B) D3 C1 D2 C1 D2 DIG 4 S3 DIG 1 DIG 3 C2 DIG 1 DIG 3 DIG 5 DIG 5 DIG 4 C2 Facts: S3 liquidates, and D2 distributes its remaining C2 stock to D3 solely with respect to the D2 common stock [D1 received in the downstream merger occurring in the previous step] Rulings: The S3 liquidation qualifies under 332 and D2 succeeds to DIG 5 D2 takes into account the portion of DIG 1 not reflected in Successor Asset B and all of DIGs 3 and 5, which will be redetermined to be excluded under -13(c)(6)(ii)(C) 38

39 GLAM

40 GLAM Next-day scenarios under -76(b)(1)(ii)(B) X A T 11/30/XX T?? 11/30/XX Deductions?? Facts: T incurred the following costs in connection with the Acquisition on 11/30/XX: --Amounts paid to employees for and in cancellation of nonqualified stock options and stock appreciation rights (SARs) in the event of a change in control, which became fixed and determinable at the time of the Acquisition --Fees paid to financial advisory and investment banking firms to provide consulting services for T in connection with the Acquisition, contingent upon the successful closing of the acquisition, which became fixed and determinable upon closing --Retirement of T bonds at a premium after the acquisition has closed 40

41 GLAM X A T 11/30/XX T?? 11/30/XX Deductions?? Background: -76(b)(1)(ii)(A) ( End of Day Rule ) provides that, if S becomes or ceases to be a member of a consolidated group, it becomes or ceases to be a member at the end of the day on which its status as a member changes, and its tax year ends for all Federal income tax purposes at the end of that day -76(b)(1)(ii)(B) ( Next Day Rule ) provides that, if, on the day of S's change in status, a transaction occurs that is properly allocable to the portion of S's day after the event resulting in the change, then S (and all persons related to S under 267(b) immediately after the event) must treat the transaction for all Federal income tax purposes as occurring at the beginning of the following day 41

42 GLAM X A T 11/30/XX T Background:?? 11/30/XX Deductions The Next Day Rule requires evaluation of facts/circumstances, including: --Whether income, gain, deduction, loss, and credit are allocated inconsistently --If the item is from a transaction with respect to S stock, whether it reflects ownership of the stock before or after the event (e.g., if a member transfers encumbered land to nonmember S in exchange for additional S stock under 351 and the exchange results in S joining the group, the applicability of 357(c) must be determined under -80(d) by treating the exchange as occurring after the event; on the other hand, if S is a member but has a minority shareholder and becomes a nonmember as a result of its stock redemption with appreciated property, S's 311 gain is treated as from a transaction occurring before the event) --Whether the allocation is inconsistent with other requirements under the Code --Whether other facts exist, such as a prearranged transaction or multiple changes in S s status, indicating that the transaction is not properly allocable to the portion of S s day after the event resulting in S s change?? 42

43 GLAM X A T 11/30/XX T?? 11/30/XX Deductions Held: The Next Day Rule does not permit the expenses associated with the stock options, the SARs, and the success-based consulting fees to be allocated to the period after the acquisition, because: --these items are not items with respect to Target s stock --these items are not attributable to any transaction on the Acquisition date other than the Acquisition itself, became fixed and determinable upon closing --the purpose of the Next Day Rule, clarified in proposed regulation comments, is limited to the concern that S not bear a liability for post-closing events that are under the B s control (and of which S may be unaware) The Next Day Rule may be appropriate for Target s bond retirement premium because: --the liability to retire the bonds at a premium did not become fixed and determinable until after closing --the facts provide that, in contemplation of the acquisition, Acquiring and Target agreed that Target would give the bondholders the opportunity to tender their bonds at a premium by a date before the acquisition date --but Target is not obligated to purchase any of the tendered bonds and does so only after the acquisition?? 43

44 Section 336(e) Regulations

45 Background 336(e) authorizes a regulatory election that would apply if a corporation (the seller ) sells, exchanges, or distributes all stock of an affiliated corporation (the target ). The election would have the following general consequences: --The seller would recognize no gain or loss on its disposition of target stock; and --The target would be deemed to dispose of all of its assets. 336(e) was enacted in 1986 as part of the General Utilities repeal, and it was intended to be implemented using principles similar to 338(h)(10). On May 15, 2013, IRS and Treasury issued final regulations under 336(e). T.D. 9619, 78 Fed. Reg The IRS position is that no election may be made until the final regulations became effective. See 78 Fed. Reg See also REG , 73 Fed. Reg (preamble to the proposed regulations); ILM

46 Overview Although the 336(e) regulations use 338(h)(10) and its regulations as a template, the two regimes differ in several fundamental respects: --Even though both require a transfer of target stock meeting the requirements of 1504(a)(2) (an affiliated interest ), 338(h)(10) looks to the purchase of that stock, while 336(e) looks to its disposition. --Except for an S corporation target, 338(h)(10) requires the target to be affiliated with the seller on the acquisition date; 336(e) does not require affiliation on the comparable date. --If a 338(h)(10) election is made, a gain recognition election is deemed made. If a 336(e) election is made, a gain recognition election is deemed made only by an 80-percent purchaser or related person. Generally, if a stock disposition would qualify for either a 336(e) or 338 election, a 338 election must be made. 46

47 336(e) v. 338(h)(10): Differences in Terminology (e) 338 or 338(h)(10) election Purchasing corporation Selling consolidated group/affiliate Qualified stock purchase Acquisition date 12-month acquisition period Recently/nonrecently purchased stock Aggregate deemed sales price (ADSP) 336(e) election Purchaser Seller Qualified stock disposition Disposition date 12-month disposition period Recently/nonrecently disposed stock Aggregate deemed asset disposition price (ADADP) 47

48 Qualified Stock Disposition A 336(e) election may be made for a qualified stock disposition ( QSD ), which occurs if a domestic corporation or S corporation shareholders dispose of an affiliated interest in a target corporation over a 12-month disposition period. --The selling domestic corporation is called the seller. --All members of a seller s consolidated group are treated as a single seller. The disposition date is the first day on which that affiliated interest in the target is disposed of. The 12-month disposition period is the 12-month period that begins with the first stock disposition included in the QSD. 48

49 Disposed of Stock is disposed of if it is sold, exchanged, or distributed, unless it is transferred: --In a transferred-basis exchange; --Where the transferee s basis is determined under 1014; --In a transaction to which 351, 354, 355, or 356 applies; or --To a related person. Even if stock is transferred in a 355 transaction, it is disposed of if all gain is recognized under 355(d)(2) or (e)(2), except to the extent that it is a related-person transfer. Two persons are related if stock owned by one would be attributed to the other under 318(a) (other than (a)(4)). --However, stock is not attributed to (or from) a partnership from (or to) a partner unless the partner owns at least 5% in value of the partnership. --If there is a series of dispositions that are part of the QSD, this relationship is determined after the last of those dispositions. 49

50 Deemed Transactions Generally If a 336(e) election is made for a QSD not described, in whole or in part, in 355(d)(2) or (e)(2) (a general election): --The old target is treated as selling its assets to an unrelated person on the disposition date. --The new target is then treated as acquiring its assets from an unrelated person. --The old target is deemed to liquidate, typically in a 332 liquidation. --The seller s earnings and profits are typically adjusted to account for the gain or loss on the deemed sale. See, e.g., 381(c)(2). The old target (i.e., the target selling the assets in the deemed sale) and the new target (i.e., the target purchasing the assets in the deemed purchase) are generally treated as two separate corporations for federal income tax purposes. The old target is deemed to sell its assets for the adjusted deemed asset disposition price (the ADADP ). The new target is deemed to purchase its assets for the adjusted grossed up basis (the AGUB ). 50

51 ADADP The ADADP is the price at which the target is deemed to sell its assets. It equals: --The grossed-up amount realized on the disposition of recently disposed target stock, plus --Target liabilities, minus --The seller s selling costs for its sale or exchange (but not distribution) of recently disposed target stock. The grossed-up amount realized for recently disposed target stock equals (A + B)/C, where: --A = the amount realized on the sale or exchange of recently disposed target stock, --B = the fair market value of recently disposed target stock (determined on the distribution date) distributed in the QSD, and --C = The percentage of target stock (by value determined on the disposition date) attributable to the recently disposed target stock. 51

52 ADADP (cont d) Recently disposed target stock is target stock: --That is not held by the seller, the seller s consolidated group, or an S corporation shareholder immediately after the disposition date, and --That is disposed of by the seller, the seller s consolidated group or an S corporation shareholder during the 12-month disposition period. The target determines its realized gain or loss by allocating the ADADP among its assets using the seven-tier residual method described in

53 Deemed Sale Gain and Loss On its deemed sale, the old target recognizes any gain except as provided in 1.338(h)(10)-1(d)(8). --The exception applies when the seller sells target stock for an installment note. --The old target is deemed to receive a new target installment note and cash on the deemed sale of its assets, distributing that note in the deemed liquidation. --Typically, any installment gain is taken into account by the seller. A fraction of the old target s net loss on the deemed sale is disallowed. The fraction equals A/(A + B), where: --A = the value of target stock distributed by the seller during the 12- month disposition period; and --B = the value of target stock disposed of by sale or exchange in the QSD during the 12-month disposition period. 53

54 AGUB The AGUB is the amount for which the target is deemed to purchase its assets in the deemed purchase. It equals: --The grossed-up basis in the purchasers recently disposed stock, plus --The purchasers aggregate basis in nonrecently disposed target stock, plus --The target liabilities. The target determines its asset bases by allocating the AGUB among its assets using the seven-tier residual method described in Nonrecently disposed stock is target stock that meets the following requirements: --It is not recently disposed target stock; --It is held on the disposition date by a purchaser or person related to the purchaser; and --On that date, the owner owns at least 10% of the total voting power or value of target stock actually and constructively under 318(a) (other than (a)(4)). 54

55 Grossed-Up Basis The grossed-up basis of recently disposed target stock equals [(A * B/C) + D], where: A = The purchasers aggregate basis in recently disposed target stock (reduced by the capitalized costs described in D) as of the beginning of the day after the disposition date; B = 100 minus the percentage of target stock (by value determined on the disposition date) attributable to the purchasers nonrecently disposed target stock; C = The percentage of target stock (by value, determined on the disposition date) attributable to the purchasers recently disposed target stock; and D = The capitalized acquisition costs that the purchasers incurred in connection with their acquisitions of recently disposed target stock (e.g., brokerage commissions). 55

56 Gain Recognition Election If a 336(e) election is made for target stock, a gain recognition may be made for an owner s nonrecently disposed stock. If an owner makes (or is deemed to make that election), it recognizes gain, but not loss, on a deemed sale of that stock. Any 80% purchaser and any related person are deemed to make that election. Any other owner must actually make the election. --An 80% purchaser is any purchaser that owns at least 80% of the vote or value of target stock actually and constructively under 318(a) (other than (a)(4)). --A purchaser is a person that receives target stock in the QSD. 56

57 Gain Recognition Election (cont d) If a gain recognition election is not made for nonrecently disposed target stock, the owner retains its basis in that stock. If the owner makes or is deemed to make the election, it is deemed to sell that stock (and takes a basis in the stock) equal to the basis amount. The basis amount equals A * B/C, where: A = The owner s basis in recently disposed target stock at the beginning of the day after the disposition date; B = The percentage of the owner s target stock (by value determined on the disposition date) that is nonrecently disposed target stock; and C = The percentage of the owner s target stock (by value determined on the disposition date) that is recently disposed target stock. The basis formula does not work in one case where the owner owns no recently disposed target stock but is required to make the election because a purchaser that is a related person makes (or is deemed to make) the election. 57

58 Seller In general, the seller (or an S corporation shareholder) is not treated as having sold, exchanged, or distributed the stock disposed of in the QSD. --Thus, the seller (or S corporation shareholder) is treated as retaining the target stock, not disposing it, until the target is deemed to liquidate. --When does this general rule not apply? If the seller distributes any target stock in the QSD, it is deemed to purchase that stock from the new target on the disposition date and then distribute that stock to its shareholders. --If the seller distributes all of that stock, does that mean that the seller and new target may be momentarily consolidated for purposes of 1504(a)(3)? --If the target is a QSub before the distribution, should the distributing S corporation make a QSub election for the new target? If the seller retains target stock after the disposition date, it is treated as purchasing that stock on the day after the disposition date for an amount that reflects the grossed-up amount realized for recently disposed target stock. 58

59 Purchasers and Minority Shareholders Form governs the consequences to minority target shareholders. --The shareholder recognizes gain or loss on a taxable sale, exchange, or distribution of target stock. --The shareholder recognizes no gain or loss if it retains the target stock, and that stock s holding period and basis are unaffected by the 336(e) election. A person acquiring target stock is treated as acquiring that stock on the date actually acquired, even though the seller (or S corporation shareholder) is treated as retaining that stock until the disposition date. 59

60 Base Cases P T P and T join in filing consolidated returns P owns all T stock and sells an affiliated interest in that stock to Fred, an unrelated person, on one day. At the time of the sale, P has $1,000 of stated liabilities and three assets: --Asset 1 with a $500 basis and $600 value, --Asset 2 with a $200 basis and $750 value, and --Asset 3 with a $900 basis and $650 value. P and T agree to make a 336(e) election, and assume T s tax on the deemed sale is $160. What are the tax consequences to P, T, and the buyers if the P group remains primarily liable for T s tax on the deemed sale and: --Fred pays P $1,000 for all T stock --Fred transfers a $1,000 note to P for all T stock --Fred buys 80% of the T stock for $800 and P retains the remaining T stock --Fred buys 80% of the T stock and historically has owned the remaining T stock with a $150 basis --Fred buys 50% of the T stock for $500, Mary buys 30% of the T stock for $300, and the remaining T stock with a $400 basis is owned by Fred or George (assume that Fred, Mary, and George are all unrelated) 60

61 Step 1 Step 2 Consolidation X 60% S stock P 20% S stock Fred X and P are common parents of consolidated groups and before Step 1, S is a member of the P group. 20% 80% S On July 1, Year 1, P sells a 60% block of S stock to X. On June 30, Year 2, P sells its remaining 20% block of S stock to Fred. --On that date, P has made a QSD of S. --P makes a 336(e) election for S. Because of the election, P generally is treated for federal income tax purposes as owning an affiliated interest in the S stock until June 30, Year 2. However, X actually owns an affiliated interest in S stock from July 1, Year 1 and generally a 336(e) election will not affect X s federal income tax consequences. Is S a member of the P or X group between July 1, Year 1 and June 30, Year 2? 61

62 Intercompany Sale as P Fred Part of a QSD S T B 1504(a)(4) stock B and Fred P, S, B, and T are members of a consolidated group. T s assets have a $1,000 basis. No subsidiary has non-group shareholders, except B. --Fred, unrelated to S, owns B s 1504(a)(4) stock, which comprises 52% of the B stock value. On day 1, S sells 79% of the T stock to B for $790. T s value plummets from $1,000 to $100, and on day 365, S sells 12% of the T stock to Fred for $12. S has made a QSD of the T stock because it has sold an affiliated interest in the T stock to unrelated persons over a 12-month period. --Because S s sale to B is an intercompany transaction, 304 cannot apply to the sale. --P and B are not related persons, because P owns less than 50% (by value) of the B stock (so no stock owned by S or B could be attributed to the other under 318(a) (other than (a)(4)). A 336(e) election is made for the QSD. 62

63 Consequences Because new T s $811 basis reflects only $189 of the $900 loss on the deemed sale, old T takes the remaining $711 of its loss into account immediately, unless an anti-abuse rule applies. --Either (h) or 1.267(f)-1(h) should apply to eliminate any duplicated loss. 63

64 Making the 336(e) Election for a Consolidated Target If the seller and target are members of the same consolidated group, to make a 336(e) election, they must: --Enter into a written, binding agreement to make the election on or before the due date (including extensions) for the group s return for the year that includes the disposition date; and --Attach an election statement to the group s timely filed return for that year. Once made, a 336(e) election, in form, is irrevocable. --It may be unclear whether a transaction is a QSD. In that case, a protective 336(e) election may be made. That election will be binding if the transaction turns out to be a QSD; otherwise, it will have no effect. --Note that a seller (or member of its consolidated group) might transactionally revoke a 336(e) election by re-acquiring target stock during the 12-month disposition period, because the reacquired stock is not considered disposed of. 64

65 (f)(5)(ii)(C) Assume that S, B, and T are members of a consolidated group. If S sells the T stock to B at a gain, that gain may be duplicated if B later transfers the T stock to a non-member and a 336(e) election is made for the transfer. That duplication can be minimized if an election under -13(f)(5)(ii)(C) can be made. The final regulations clarify that this mitigation rule may apply if a general election is made. They also provide that the mitigation rule may apply if a 336(e) election is made for a 355(d)(2) or (e)(2) transaction, deeming the target to liquidate for purposes of applying the rule. If that mitigation rule applies, with some limitations, for each share of T stock, B is treated... as recognizing as a corresponding loss any loss or deduction (determined after adjusting stock basis under ) that it would recognize if 331 applied to T s deemed liquidation. 65

66 P Intercompany Sale Preceding a QSD S T T stock cash B P, S, B, and T are members of a consolidated group. S sells its T stock to B for cash but the sale is not a QSD, because B is a related person. S recognizes, but defers, a gain. Later B sells or distributes the T stock to an unrelated individual. B has made a QSD and a 336(e) election is made for the QSD. If the election is a general election, the regulations clarify that the group generally can mitigate any duplicate gain by making a -13(f)(5)(ii)(C) election. If the election is made for a 355(d)(2) or (e)(2) transaction, the regulations provide that the target is deemed to liquidate for purposes of -13(f)(5)(ii)(C), so that an election under that section generally can be made. 66

67 Consistency Rules In general, the principles of apply when a QSD occurs but no 336(e) election is made. Those principles are modified in one important respect: --The asset consistency rules may apply to an asset that is owned immediately after its acquisition and on the disposition date by a person that acquires at least 5%, by value, of the target stock in the QSD or by a person related to such a 5% purchaser. Because the purchaser or related person need not be a corporate affiliate of the target, the consistency rules under 336(e) are broader than under

68 Example Consistency Rules P T Fred X P owns all T stock and P and T join in filing consolidated returns. T sells an asset to Fred, recognizing a gain. Shortly thereafter P sells the T stock either to Fred or X, Fred s wholly owned corporation. --No 336(e) or 338 election is made for the stock sale. --Does a consistency rule apply to T s asset sale? 68