949 ALI-ABA Course of Study Consolidated Tax Return Regulations Cosponsored by the ABA Section of Taxation October 4-5, 2007 Washington, D.C. Intercompany Transactions Study Materials By Lawrence M. Axelrod Deloitte Tax LLP Washington, D.C.
950.01 HISTORICAL BACKGROUND...1.02 OVERVIEW...3.03 DEFINITIONS...7.0301 Intercompany Transactions...7.0302 Intercompany Items...9.0303 Corresponding Items...10.0304 Recomputed Corresponding Items...11.0305 Treatment as a Separate Entity...11.0306 Attributes...11.04 MATCHING RULE...14.0401 Attributes...14.0402 Holding Period...16.0403 Timing...17.0404 Divisions of a Single Corporation...18.0405 Conflict or Allocation of Attributes...18.0406 Special Status Corporations...19.0407 Disallowance or Exclusion Resulting from Corresponding Item...20.0408 Examples...23.04081 Nonrecognition Transactions - in General...23.04082 Section 1031 Exchanges...24.04083 Recapitalizations...24.04084 Transactions under Sections 351 and 721...24.04085 Depreciation and Recapture...25.04086 Intercompany Sale Followed by Installment Sale...27.04087 Intercompany Sale of Installment Obligations...28.04088 Capitalized Services...28.04089 Intercompany Sale of Partnership Interest...29.040810 Section 382 and Recognized Built-in Gains...33.040811 Bump-and-Strip...34.040812 Security Dealers under Section 475...36.040813 Manufacturer Incentives...37.040814 Straddles...39.040815 International Tax Examples...39.05 THE ACCELERATION RULE...41.0501 S's Items...41.0502 B's Items...43.0503 No Subgroups...44.0504 Cancellation of Debt and Attribute Reduction...45.0505 Successive Intercompany Transactions...46.0506 Other Acceleration Events...47.06 SIMPLIFYING RULES...48 i
951.0601 Inventory 48.06011 Simplification for Dollar-value LIFO...48.0602 Reserve Accounting - Special Status Companies...48.06021 Financial Institutions...48.06022 Insurance Companies...49.06023 Obtaining Permission Not to Defer...49.0603 Basis Adjustments and Section 362(e)(2)...50.06031 Section 362(e)(2)-In General...50.06032 Consolidated Return Issues...53.07 STOCK OF MEMBERS...60.0701 Distributions...60.07011 Exclusion of Intercompany Dividends...60.07012 Requisite Stock Basis Reduction...62.07013 Amount and Basis of a Property Distribution...65.07014 Distributions of Loss Property...65.0702 Boot in Intercompany Reorganizations...66.0703 Acquisition by Issuer of Its Own Stock...69.0704 Elective Relief in Certain Stock Transactions...71.07041 Liquidation of Subsidiary Triggering Intercompany Item.71.07042 Downstream Mergers...72.07043 Section 338(h)(10) Transactions...72.07044 Cash Mergers...74.07045 Spin-offs...75.07046 Time for and Manner of Making Election...76.07047 Effective Date for Elective Relief...76.0705 Loss Disallowance on Parent s Stock...77.0706 Relief for Zero-basis Problem...80.0707 Dealers...82.08 OBLIGATIONS OF MEMBERS...83.0801 Overview of Intercompany Obligation...83.0802 Accrual of interest...85.0803 Intercompany Obligation becomes Nonintercompany Obligation...86.0804 Section 338(h)(10) and Installment Sales...91.0805 Non-application of Section 108...92.0806 No Subgroups...93.0807 Proposed Amendments to the Intercompany Obligation Regulations.94.0808 Dissolution of Insolvent Subsidiary...100.0809 Nonintercompany Obligation Becomes an Intercompany Obligation 102.0810 Election to Waive Loss on Intercompany Obligation...104.0811 Non-application of AHYDO Rules...104.09 ANTI-AVOIDANCE RULES...106.0901 General Rule...106.0902 Purported Location Abuse...108 ii
952.0903 Sale to a Related Party...109.0904 Mixing Bowl Examples...110.09041 Corporate Mixing Bowl...110.09042 Partnership Mixing Bowl...111.09043 Other Applications...113.10 MISCELLANEOUS OPERATING RULES...115.1001 Successor Assets...115.1002 Successor Persons...116.1003 Acquisition of Group...118.1004 Lonely Parent Rule...118.1005 Recordkeeping Requirements...119.1006 Mirror Transactions...119.10061 80-percent Distributee...119.10062 No 80-percent Distributee...121.11 EFFECTIVE DATES...125.1101 General Rule...125.1102 Anti-avoidance Rule...125.1103 Stock Elimination Transactions...126.12 STATE TAX CONSEQUENCES...127.13 CHANGES TO SECTION 108 REGULATIONS...128.14 CONCLUDING OBSERVATIONS...129 iii
953 2.00 INTERCOMPANY TRANSACTION REGULATIONS.01 HISTORICAL BACKGROUND The rules governing intercompany transactions are primarily contained in Reg. 1.1502-13. Perhaps more than any other section of the consolidated return regulations, the intercompany transaction rules reflects the conflict between the single-entity and separatemember approaches inherent in treating a group as a single taxpayer for certain purposes and as an aggregate of corporations for other purposes. As in other cases, the conflict between the single versus separate entity theories gives way to the overriding objective mandated by the Code. That is, regulations are to be prescribed such that the tax liability of the group and members will be determined "in such manner as clearly to reflect the income tax liability... and in order to prevent avoidance of such tax liability." 1 The regulations were revised in 1995 to provide a comprehensive framework for analyzing all types of intercompany transactions. 2 Practitioners who began careers after the 1995 regulations were promulgated are frequently unaware of the checkered history of the intercompany rules and the legislative and judicial developments that led to the current rules. Before describing and analyzing the current rules, a brief summary of the predecessor rules is worth considering. Under the consolidated return regulations in force before 1966, an intercompany transaction was treated merely as a transfer of property between divisions of a single corporation. Thus, if one member sold an asset to another member, no gain or loss was recognized 3 and the basis of the property in the hands of the purchasing member remained the same as the basis in the hands of the selling member. 4 This simple rule had only one minor flaw. It allowed taxpayers to avoid recognizing any gain on the disposition of property outside the group, as illustrated in the landmark consolidated return case, Beck Builders. 5 To simply the facts of Beck Builders, P, the common parent, constructed a housing project for a subsidiary, S. After completion, P, sold the property to S. Under the regulations in effect at the time, P did recognize gain on the intercompany asset sale, and P's basis in the property carried over to S. Thereafter, X, an unrelated corporation, purchased the stock of S from P. Since P's basis in the S stock reflected S s fair market value, P did not recognize any gain on the stock sale. Shortly after the purchase, X liquidated S and, under section 334(b)(2) 1 Section 1502. 2 In addition to the mundane taxable sale of property between members, intercompany transactions include nonrecognition transactions, such as reorganizations, liquidations and contributions to which section 351(a) applies, loans between members, cancellation of debt. Although the 1995 regulations do not alter the deferred sale results under prior law with respect to more mundane transactions, those regulations were a quantum leap forward with respect to the appropriate treatment of more sophisticated transactions. 3 Reg. 1.1502-31A(b)(1)(i) as in effect prior to 1966. 4 Reg. 1.1502-38A(b) as in effect prior to 1966. 5 Henry C. Beck Builders, Inc. v. Comm r, 41 TC 616 (1964). 2-1
954 as in effect prior to 1982, received a basis in S's assets equal to X's purchase price for the S stock. X was then able to sell S's former assets without recognition of gain to any taxpayer. The IRS did not view the transaction kindly. Nevertheless, the Tax Court held that the IRS was bound by its own regulations. 6 That judicial defeat became the impetus for the regulations project that resulted in the revision of the entire consolidated return regulations. Although Congress replaced section 334(b)(2) with section 338 in 1982 and the tax avoidance opportunity described in Beck Builders is no longer available, other concerns (primarily avoidance of repeal of the General Utilities doctrine) prevented regulation writers in the 1990s from returning to the halcyon days in which intercompany transfers of property could be accomplished without recognition of gain or loss. Instead, the deferred gain model concept in the 1966 regulations was retained. The separate status of each member continued to be respected for purposes of the amount and location of gain o loss. For purposes of timing source, character and holding period, however, the members participating in an intercompany transaction are treated as divisions of a single corporation. The objective of the 1995 amendments to the regulations was primarily to refine the deferred sale model so that an intercompany transaction did result in the creation, elimination, acceleration, or deferral on income or loss to the group as a whole. 7. 6 Beck Builders became the primary precedent relied on by the Tax Court in Woods Inv. Co., 85 TC 274 (1985), 21 years later. 7 Reg. 1.1502-13(a)(1). 2-2