PRACTISING LAW INSTITUTE
TAX STRATEGIES FOR CORPORATE ACQUISITIONS,
DISPOSITIONS, SPIN-OFFS, JOINT VENTURES,
FINANCINGS, REORGANIZATIONS AND
RESTRUCTURINGS 2012
SECTION 382
June 2012
Mark J. Silverman
Steptoe & Johnson LLP
Washington, D.C.
Copyright © 2012, Mark J. Silverman, All Rights Reserved.
TABLE OF CONTENTS
Internal Revenue Service Circular 230 Disclosure: As provided for
in IRS regulations, advice (if any) relating to federal taxes that
is contained in this document (including attachments) is not
intended or written to be used, and cannot be used, for the
purpose of (1) avoiding penalties under the Internal Revenue Code
or (2) promoting, marketing or recommending to another party any
plan or arrangement addressed herein.
Page
I.
INTRODUCTION............................................... 16
II.
SUMMARY OF PROVISIONS AFFECTING NOL CARRYOVERS AND OTHER
FAVORABLE TAX ATTRIBUTES................................... 16
A.
Section 172 - Net Operating Loss Deduction............ 16
B.
Section 381 - Carryovers in Certain Corporate
Acquisitions.......................................... 26
C.
Old Section 382 - Special Limitations on Net Operating
Loss Carryovers....................................... 29
D.
Old Section 383 -- Special Limitations on Unused
Business Credits, Research Credits, Foreign Taxes, and
Capital Losses........................................ 33
E.
Libson Shops Doctrine................................. 33
F.
Consolidated Return Regulations....................... 35
1.
Separate Return Limitation Year Rules............ 35
2.
Built-in Deduction Limitation.................... 37
3.
Consolidated Return Change in Ownership.......... 38
a.
Repeal of the CRCO Rules.................... 38
b.
Summary of Old CRCO Rules................... 38
G.
Section 269 - Acquisitions Made to Avoid or Evade Income
Tax................................................... 39
H.
Section 482 -- Allocation of Income and Deductions Among
Taxpayers............................................. 41
ii
I.
Section 338 -- Certain Stock Purchases Treated as Asset
Acquisitions.......................................... 41
J.
Section 1371(b) -- Rules Regarding Carryovers Carrybacks
of Subchapter S Corporations.......................... 42
K.
Section 384 -- Acquisitions Involving Gain Corporations
...................................................... 42
III. NEW SECTION 382 -- INTRODUCTION............................ 42
A.
Reasons for Change.................................... 43
B.
General Background.................................... 44
1.
2.
Policy Considerations Behind Limitations......... 45
a.
Prevention of loss trafficking.............. 45
b.
Prevention of windfalls..................... 45
c.
Preventing losses of one business from
offsetting gains of an unrelated business... 46
d.
Losses of certain corporations should not be
subsidized by the Government................ 46
e.
Preventing distortion of business transactions
............................................ 46
Possible Modes of Regulation..................... 47
a.
Refundability............................... 47
b.
Free transferability........................ 47
c.
Limitation based on stock ownership......... 48
d.
Limitations based on continuity of business
enterprise.................................. 48
C.
Legislative Background and Other Developments......... 48
D.
The Neutrality Principle.............................. 55
1.
Neutrality as to Corporate Owners................ 55
2.
Neutrality as to Business Decisions.............. 56
3.
New Section 382.................................. 56
iii
IV.
OVERVIEW OF NEW SECTION 382................................ 56
A.
Required Change in Ownership.......................... 56
B.
Consequences of an Ownership Change................... 57
C.
NOLs Subject to Limitation............................ 58
D.
Example............................................... 58
E.
V.
1.
Fact Pattern..................................... 58
2.
Tax Consequences Under Section 382............... 58
Effective Date........................................ 59
OWNERSHIP CHANGE -- A DETAILED ANALYSIS.................... 59
A.
General Analysis...................................... 60
1.
B.
Ownership Change................................. 60
a.
Definition.................................. 60
b.
Legislative history......................... 60
2.
Determination Events -- Testing Date............. 61
3.
Measuring Changes in Stock Ownership............. 73
Defined Terms......................................... 76
1.
Owner Shift Involving a 5-Percent Shareholder.... 76
2.
Equity Structure Shift........................... 80
3.
Stock............................................ 82
4.
a.
The general rules........................... 82
b.
Treating "stock" as not stoc................ 85
c.
Treating nonstock interests as.............. 97
d.
Indirect ownership interest................ 103
e.
Valuation rules -- Discounts and Premiums.. 104
Loss Corporation................................ 104
iv
D.
E.
In general................................. 104
b.
Impact of section 381(a) transactions...... 106
c.
Separate accounting for losses............. 110
d.
End of separate accounting................. 111
e.
Effect of Treas. Reg. § 1.382-1(a)(iv)..... 112
5.
Old Loss Corporation............................ 115
6.
New Loss Corporation............................ 115
7.
Testing Period.................................. 117
8.
C.
a.
a.
General rule............................... 117
b.
Effect of recent ownership change.......... 120
c.
Shorter period where all losses arise during
the testing period......................... 120
Change Date..................................... 122
Application of the Ownership Change Rules -- Owner
Shifts Involving a 5-Percent Shareholder............. 123
1.
Taxable Purchase of Stock....................... 123
2.
Redemptions..................................... 124
3.
Multiple Owner Shifts........................... 125
4.
Split-off Transaction........................... 127
Application of the Ownership Change Rules -- Equity
Structure Shifts..................................... 129
1.
Straight "A" Reorganizatio...................... 129
2.
Successive Equity Structure Shifts.............. 129
Application of the Ownership Change Rules – Combinations
..................................................... 131
1.
Owner Shift Followed by a Merger................ 131
2.
Merger Followed by an Owner Shift............... 132
v
F.
The Constructive Ownership Rules..................... 133
1.
2.
Family Attribution.............................. 134
a.
General rule............................... 134
b.
Special limitations........................ 135
c.
Overlapping families....................... 137
Entity Attribution.............................. 140
a.
In general................................. 141
b.
No attribution through nonstock interests.. 142
c.
Limitation on attribution from certain
entities................................... 144
d.
Example – triangular A reorganization...... 148
e.
Example -- commonly controlled corporations 149
f.
Example -- commonly controlled corporations 150
3.
Back Attribution................................ 152
4.
Option Attribution -- Final Regulations......... 152
a.
Definitions................................ 152
b.
Rules...................................... 153
c.
Ownership test............................. 153
d.
Control test............................... 154
e.
Income test................................ 156
f.
Factors used in applying the ownership,
control, and income tests.................. 156
g.
Safe harbors............................... 159
h.
Additional rules........................... 161
i.
Testing date............................... 162
j.
Subsequent treatment of options............ 163
vi
5.
G.
k.
Application to ownership change............ 164
l.
Effective date............................. 165
Option Attribution – Former Temporary Regulations
(No Longer Applicable).......................... 168
a.
In general................................. 169
b.
Examples................................... 170
c.
Interests similar to options............... 174
d.
Evergreen rule............................. 179
e.
Contingencies.............................. 181
g.
Effect on value of loss corporation........ 183
h.
Options that lapse or are forfeited........ 186
i.
Actual exercise of options................. 188
j.
De minimis pre-change losses............... 190
k.
Disregarding transfers of options.......... 191
l.
Exempt options............................. 191
5-Percent Shareholder Rules.......................... 201
1.
The Statute..................................... 203
2.
The Regulations -- Definitions.................. 205
a.
First tier entity.......................... 205
b.
Higher tier entity......................... 209
c.
Highest tier entity........................ 209
d.
Public group............................... 209
e.
Public shareholder......................... 210
f.
Public owner............................... 210
g.
5-percent owner............................ 211
h.
5-percent shareholder...................... 211
vii
3.
4.
H.
Determining 5-Percent Shareholders and Their
Percentage Interest............................. 214
a.
In general................................. 214
b.
Analysis of highest tier entities.......... 216
c.
Analysis of higher tier and first tier
entities................................... 219
d.
Analysis at the loss corporation level..... 219
e.
Determining percentage stock interest...... 219
f.
Stock ownership presumptions............... 221
Illustrations of the Aggregation Rules.......... 225
a.
Identifying 5-percent shareholders -- example
one........................................ 225
b.
Identifying 5-percent shareholders -- example
two........................................ 227
c.
Takeover by publicly-held corporation...... 230
d.
Spin-off transaction....................... 232
Segregation Rules -- Loss Corporation Level.......... 233
1.
In General...................................... 233
2.
Segregation Transactions........................ 235
a.
Certain equity structure shifts and section
1032 transactions.......................... 235
b.
Redemption-type transactions............... 240
c.
Stock acquired through rights issued by the
loss corporation........................... 242
d.
Other transactions......................... 246
e.
Issuance of rights to acquire loss corporation
stock...................................... 246
3.
Multiple Transactions........................... 250
4.
Acquisitions Following Segregation.............. 251
viii
5.
I.
Special Segregation Rules -- First Tier or Higher Tier
Entity Level......................................... 255
1.
Disposition of Loss Corporation Stock........... 255
2.
Disposition of Interests in First or Higher Tier
Entities........................................ 257
3.
J.
De Minimis Public Groups........................ 253
a.
In general................................. 257
b.
Merger of a first tier entity.............. 258
c.
Forward triangular merger.................. 259
d.
B reorganization........................... 260
e.
Holding company formation.................. 261
Redemption-Type Transaction..................... 262
New Regulations Modifying Segregation Rules.......... 263
1.
Small Issuance Exception........................ 264
2.
Cash Issuance Exception......................... 267
3.
Limitation on Exempted Stock.................... 268
4.
Proportionate Acquisition of Exempted Stock..... 269
5.
Exception for Equity Structure Shifts........... 270
6.
Transitory Ownership by Underwriter............. 270
7.
Certain Related Issuances....................... 270
8.
Application to Options.......................... 271
9.
Application to First Tier and Higher Tier Entities
................................................ 271
10.
Certain Non-Stock Ownership Interests........... 271
11.
De Minimis Rule................................. 272
12.
13.
Effective Date............................. 272
Examples........................................ 272
ix
K.
L.
Certain Changes Not Taken Into Account............... 281
1.
Stock Acquired by Death, Gift or Divorce........ 281
2.
Acquisitions by ESOPs........................... 282
3.
Changes Attributable to Fluctuations in Value... 282
Operating Rules -- Presumptions and Duties Regarding
Stock Ownership...................................... 285
1.
M.
a.
Publicly traded stock...................... 285
b.
Determining changes in interest............ 286
2.
Actual Knowledge Regarding Stock Ownership...... 287
3.
Ownership Structured to Avoid Section 382....... 291
4.
Duty to Inquire as to Stock Ownership........... 292
5.
Annual Statement by Loss Corporations........... 295
6.
Records Maintenance............................. 298
Effective Dates...................................... 298
1.
VI.
Identifying 5-Percent Shareholders.............. 285
New Section 382................................. 298
a.
General rule............................... 298
b.
Plan of reorganization..................... 299
c.
Indirect ownership changes................. 300
d.
Bankruptcy proceedings..................... 300
e.
Earliest commencement of the testing period 301
f.
Transition rules........................... 301
g.
Option rules............................... 304
2.
Sunset Provisions for Old Section 382........... 305
3.
The 1976 Version of Section 382................. 307
CONSEQUENCES OF AN OWNERSHIP CHANGE....................... 307
x
A.
Annual Limitation on Earnings........................ 307
1.
The Statute..................................... 307
2.
Taxable Income.................................. 308
3.
Post-Change Year................................ 308
4.
Pre-Change Loss................................. 309
5.
Section 382 Limitation.......................... 310
6.
B.
C.
a.
General rules.............................. 310
b.
Determining the value of the old loss
corporation................................ 311
c.
The long-term tax-exempt rate.............. 316
d.
Carryover of unused limitation............. 318
e.
Special rule for short taxable years....... 320
Ordering Rules.................................. 320
a.
Coordination with section 172(b)........... 320
b.
Losses from the same year.................. 321
Special Rules for Mid-Year Ownership Changes......... 321
1.
Taxable Income.................................. 321
2.
Net Operating Loss.............................. 323
3.
Section 382 Limitation.......................... 323
Special Rules for Built-in Gains and Losses.......... 324
1.
Net Unrealized Built-in Gain or Loss............ 324
a.
Definition................................. 324
b.
Example.................................... 325
c.
Special rule for redemptions............... 325
d.
Special rule for computing net unrealized
built-in loss.............................. 325
xi
2.
3.
4.
5.
e.
Threshold test............................. 326
f.
Importance of the threshold................ 327
Recognized Built-In Gains....................... 328
a.
In general................................. 328
b.
Definition................................. 329
c.
Limitation................................. 331
d.
Gains recognized beyond the recognition period
........................................... 331
Recognized Built-In Losses...................... 332
a.
In general................................. 332
b.
Definition................................. 332
c.
Limitation................................. 333
d.
Accrued deductions......................... 333
e.
Losses recognized beyond the recognition
period..................................... 334
f.
Carryover of disallowed built-in losses.... 334
Post-Change Years that Include the Change Date.. 350
a.
Prorating taxable income................... 350
b.
Section 382 limitation..................... 351
c.
Comparisons................................ 352
d.
Tax-Free Transactions...................... 353
Closing-of-the-Books Election................... 354
a.
General rule............................... 355
b.
Election................................... 355
c.
Unified elections for consolidated and
controlled groups.......................... 356
d.
Operating rules............................ 356
xii
D.
2.
3.
F.
Coordination with other rules.............. 358
f.
Examples................................... 358
Special Anti-Abuse Provisions........................ 362
1.
E.
e.
Capital Contributions........................... 362
a.
Contributions received as part of a plan... 362
b.
Irrebuttable presumption................... 362
c.
Scope of provision......................... 362
d.
Administrative Guidance.................... 363
e.
Conversions of debt........................ 367
f.
Adjustment to value........................ 368
Nonbusiness Assets.............................. 368
a.
Definitions................................ 368
b.
Look-through rule.......................... 369
c.
Reduction in value......................... 369
d.
Purpose of the rule........................ 371
Interrelationship of Provisions................. 371
Continuity of Business Enterprise Requirement........ 372
1.
In General...................................... 372
2.
Consequences of Failing the Test................ 374
a.
In general................................. 374
b.
Exception.................................. 374
3.
Purpose of the Rule............................. 375
4.
Objections to the Rule.......................... 376
Consequences of an Ownership Change -- Application... 378
1.
General Operation of Section 382................ 378
xiii
2.
Built-in Gains.................................. 380
VII. BANKRUPT CORPORATIONS AND TROUBLED THRIFT INSTITUTIONS.... 381
A.
Section 382(l)(5).................................... 381
B.
The Section 382(l)(5) Final Regulations.............. 392
1.
Definition of Qualified Creditors............... 392
a.
Conceptual framework....................... 392
b.
General rules of the final regulation...... 393
c.
Duty of inquiry............................ 397
C.
Section 382(l)(6).................................... 405
D.
The Section 382(l)(6) Final Regulations.............. 406
1.
Conceptual Framework............................ 406
2.
Value Increases................................. 406
3.
E.
a.
The stock value test....................... 407
b.
The Asset value test....................... 408
Coordination Rules.............................. 408
a.
Certain capital contributions.............. 408
b.
Redemptions or other corporate contractions 409
c.
Substantial nonbusiness assets............. 409
5.
Miscellaneous................................... 411
6.
Effective Date.................................. 413
Reorganizations of Financially Troubled Thrift
Institutions......................................... 413
VIII.AUTHORITY TO ISSUE REGULATIONS............................ 415
A.
In General........................................... 415
B.
Successive Ownership Changes......................... 416
C.
Short Taxable Years.................................. 417
xiv
IX.
X.
D.
Pass-Thru Entities................................... 418
E.
Controlled Group Rules............................... 419
1.
Background...................................... 419
2.
Section 382 Limitation with Respect to Controlled
Group Loss...................................... 420
3.
Restoration of Value............................ 424
4.
Disposal and Reacquisition of Controlled Group
Stock........................................... 427
5.
Rules Preventing Double Reduction............... 427
6.
Coordination with Consolidated Section 382
Regulations..................................... 428
INTERRELATIONSHIP OF SECTION 382 WITH SELECTED OTHER
PROVISIONS................................................ 433
A.
Section 269.......................................... 433
B.
Consolidated Return Provisions....................... 434
C.
Section 338.......................................... 440
1.
One-Step Acquisitions........................... 440
2.
Two-Step Acquisitions........................... 443
D.
Section 381 -- Impact of Subsequent Events........... 447
E.
Section 383.......................................... 448
PLANNING TRANSACTIONS..................................... 451
A.
B.
Avoiding Ownership Changes........................... 451
1.
Issuing Debt Instruments........................ 451
2.
Sale or Lease of L's Assets..................... 452
3.
Subsidiary Tracking Stock....................... 452
Increasing the Section 382 Limitation................ 453
1.
Corporate Combinations Prior to the Ownership
Change.......................................... 453
xv
2.
C.
D.
Leveraged Buyout Transactions................... 453
General Planning..................................... 455
1.
L Purchases Assets of P......................... 455
2.
L Acquires P Stock.............................. 456
Monitoring Stock Ownership........................... 457
SECTION 382 AS AMENDED BY THE
TAX REFORM ACT OF 1986
I.
II.
INTRODUCTION
A.
A key element in planning many transactions is the
survival and subsequent use of net operating loss
("NOL") carryovers and other favorable tax attributes
including unused business and research credits, excess
foreign tax credits and capital losses.
B.
The Tax Reform Act of 1986, P.L. 99-514 (the "Act"),
made sweeping changes in the rules governing the use
and availability of NOL carryovers following certain
changes in the stock ownership of a corporation
possessing NOL carryovers (a "loss corporation"). In
particular, section 382 was substantially altered.
C.
This outline will briefly review the wide array of
statutory, regulatory and judicial rules governing NOL
carryovers. Following this review, section 382 will
be analyzed in detail.
SUMMARY OF PROVISIONS AFFECTING NOL CARRYOVERS AND OTHER
FAVORABLE TAX ATTRIBUTES
A.
Section 172 - Net Operating Loss Deduction
1.
Section 172 is an exception to the general rule
that income tax liability must be determined on
an annual basis. Section 172 allows a taxpayer
to average income and losses over a period of
years so that, overall, a taxpayer with
fluctuating income does not pay more Federal
income tax than a taxpayer with a relatively
constant level of income.
xvi
2.
A NOL arises when a taxpayer's allowable deductions exceed gross income, as modified by section
172(d), for any taxable year. Section 172(b).
3.
For tax years ending before August 5, 1997, a NOL
may be carried back to each of the three taxable
years preceding the taxable year of such loss and
carried over to each of the fifteen taxable years
following the taxable year of such loss.
Different carryback and carryover periods apply
to certain taxpayers such as real estate
investment trusts, certain financial
institutions, and to certain losses such as foreign expropriation losses. Section 172(b).
4.
Section 1082 of the Taxpayers Relief Act of 1997
(P.L. 105-34) amended section 172(b)(1)(A) to
change the carryback and carryforward periods for
taxable years ending after August 5, 1997.
Accordingly, for taxable years ending after
August 5, 1997, the carryback period is reduced
from three years to two years, and the
carryforward period is increased from fifteen to
twenty years. In addition, the Taxpayer Relief
Act adds section 172(b)(1)(F) to preserve the
former carryback and carryforward periods for
farmers (as defined in section 263(A)(e)(4)) and
small businesses (as defined in section
172(b)(1)(F)(iii)) where the losses occurred in
Presidentially declared disaster areas.
5.
Section 1211 of the American Recovery and
Reinvestment Tax Act of 2009 (P.L. 111-5) amended
section 172(b)(1)(H) to change the carryback
provisions for eligible small businesses that
elect to apply section 172(b)(1)(H) to any
applicable 2008 net operating loss. The
amendment applies for net operating losses
arising in tax years ending after December 31,
2007.
a.
If an eligible small business makes a
section 172(b)(1)(H) election:
(1)
The taxpayer can elect any whole number
which is more than 2 and less than 6 to
replace to “2” in the section
17
172(b)(1)(A)(i) 2 year carryback
period;
b.
(2)
Section 172(b)(1)(E)(ii) shall be
applied by substituting the whole
number which is one less than the whole
number substituted under section
172(b)(1)(H)(i)(I) for “2”; and
(3)
Section 172(b)(1)(F) shall not apply.
For section 172(b)(1)(H) purposes,
“applicable 2008 net operating loss” means:
(1)
The taxpayer’s net operating loss for
any taxable year ending in 2008; or
(2)
If the taxpayer elects to have section
172(b)(1)(H)(ii)(II) apply in lieu of
section 172(b)(1)(H)(ii)(I), the
taxpayer’s net operating loss for any
taxable year beginning in 2008.
c.
For section 172(b)(1)(H) purposes, “eligible
small business” has the same meaning as in
section 172(b)(1)(F)(iii), except that
section 448(c) shall be applied by
substituting “$15,000,000” for “$5,000,000”
each place it appears.
d.
Anti-Abuse Rules — The Secretary of Treasury
or the Secretary’s designee shall prescribe
such rules as are necessary to prevent the
abuse of the purposes of the amendments made
to section 172 by section 1211 of the
American Recovery and Reinvestment Tax Act,
including anti-stuffing rules, anti-churning
rules (including rules relating to saleleasebacks), and rules similar to the rules
under section 1091 relating to losses from
wash sales. American Recovery and
Reinvestment Tax Act § 1211(c).
e.
Effective Date – Except as otherwise
provided in section 1211(d) of the American
Recovery and Reinvestment Tax Act, amended
section 172(b)(1)(H) shall apply to net
18
operating losses arising in taxable years
ending after December 31, 2007.
f.
6.
Transitional Rule — Under section 1211(d)(2)
of the American Recovery and Reinvestment
Tax Act, in the case of a net operating
loss for a taxable year ending before the
date of the enactment of the American
Recovery and Reinvestment Tax Act:
(1)
Any election made under section
172(b)(3) with respect to such loss may
(notwithstanding such section) be
revoked before the applicable date,
(2)
Any election made under section
172(b)(1)(H) with respect to such loss
shall (notwithstanding such section) be
treated as timely made if made before
the applicable date, and
(3)
Any application under section 6411(a)
with respect to such loss shall be
treated as timely filed if filed before
the applicable date.
(4)
“Applicable date” means the date which
is 60 days after the date of the
enactment of the American Recovery and
Reinvestment Tax Act.
Section 13 of the Worker, Homeownership, and
Business Assistance Act of 2009 (P.L. 112-92)
further amended section 172(b)(1)(H) to expand
the availability of the carryback provision to
either 2008 or 2009 for companies of any size.
a.
Unless noted below, the amendments made to
section 172(b)(1)(H) by the American
Recovery and Reinvestment Tax Act of 2009
and noted above remain effective after
enactment of the Worker, Homeownership, and
Business Assistance Act of 2009.
(1)
Specifically, the general carryback
period allowed, anti-abuse rules and
effective dates remain unchanged.
19
b.
For Section 172(b)(1)(h) purposes,
“applicable net operating loss” means the
taxpayer’s net operating loss for a taxable
year ending after December 31, 2007, and
beginning before January 1, 2010.
c.
Election — Any election made under section
172(b)(1)(H) may be made only with respect
to 1 taxable year.
(1)
d.
Limitation on Amount of Loss Carryback to
5th Preceding Taxable Year — The amount of
any net operating loss which may be carried
back to the 5th taxable year preceding the
taxable year of the applicable net operating
loss shall not exceed 50 percent (computed
without regard to the net operating loss for
the loss year or any taxable year
thereafter) for such preceding tax year.
(1)
e.
Special Rule for Small Businesses — An
eligible small business which makes or
made an election effective before
enactment of the Worker, Homeownership,
and Business Assistance Act of 2009 may
make such election for 2 taxable years
(i.e., 2008 and 2009).
This limitation does not apply to
eligible small businesses with respect
to elections made prior to enactment of
the Worker, Homeownership, and Business
Assistance Act of 2009.
Transitional Rule — Under Section 13(d) of
the Worker, Homeownership, and Business
Assistance Act, in the case of any net
operating loss for a taxable year ending
before the date of enactment of the Worker,
Homeownership, and Business Assistance Act:
(1)
Any election made under section
172(b)(3) with respect to such loss may
(notwithstanding such section) be
revoked before the due date (including
extension of time) for filing the
return for the taxpayer’s last taxable
year beginning in 2009, and
20
(2)
f.
Any application under section 6411(a)
with respect to such loss shall be
treated as timely filed if filed before
such due date.
Exception for TARP Recipients — The
amendments made to section 172(b)(1)(H) by
the Worker, Homeownership, and Business
Assistance Act do not apply to:
(1)
Any taxpayer if:
(a)
The Federal Government acquired
before the date of the enactment
of the Worker, Homeownership, and
Business Assistance Act an equity
interest in the taxpayer pursuant
to the Emergency Economic
Stabilization Act of 2008,
(b)
The Federal Government acquired
before the date of the enactment
of the Worker, Homeownership, and
Business Assistance Act any
warrant (or other right) to
acquire any equity interest with
respect to the taxpayer pursuant
to the Emergency Economic
Stabilization Act of 2008, or
(c)
Such taxpayer receives after the
date of the enactment of the
Worker, Homeownership, and
Business Assistance Act funds from
the Federal Government in exchange
for an interest described in
either of the above two paragraphs
pursuant to a program established
under title I of division A of the
Emergency Economic Stabilization
Act of 2008 (unless such taxpayer
is a financial institution (as
defined therein) and the funds are
received pursuant to a program
established by the Secretary of
the Treasury for the stated
purpose of increasing the
21
availability of credit to small
businesses using funding made
available under such Act), or
7.
(2)
The Federal National Mortgage
Association and the Federal Home Loan
Mortgage Corporation, and
(3)
Any taxpayer which at any time in 2008
or 2009 was or is a member of the same
affiliated group (as defined in section
1504 without regard to section 1504(b))
as a taxpayer described in paragraph
(1) or (2), above.
On June 23, 2010, the IRS issued temporary
regulations to reflect the amendments made to
section 172(b)(1)(H) by the Worker,
Homeownership, and Business Assistance Act. T.D.
9490, 2010-31, I.R.B. 176. Under the temporary
regulations added by T.D. 9490:
a.
A consolidated group may elect to carry back
a consolidated net operating loss arising in
a consolidated return year ending after
December 31, 2007, or beginning before
January 1, 2010 (“Applicable CNOL”) to the
Extended Carryback Period;
b.
The group may revoke a prior election
pursuant to Treas. Reg. § 1.1502-21(b)(3)(i)
in order to make an election pursuant to
section 172(b)(1)(H);
(1)
c.
See Rev. Proc. 2009-52 for the manner
in which a group makes the election
pursuant to section 172(b)(1)(H) and
revokes a prior election pursuant to
Treas. Reg. § 1.1502-21(b)(3)(i).
If a member (the “Electing Member”) of a
consolidated group elects an Extended
Carryback Period pursuant to section
172(b)(1)(H) for an applicable net operating
loss arising in a separate return year
ending before the Electing Member’s
acquisition by a consolidated group, the
election will not disqualify the acquiring
22
group from making an otherwise available
election pursuant to section 172(b)(1)(H)
with regard to an applicable CNOL for a
consolidated return year;
d.
If a group elects pursuant to section
172(b)(1)(H) to make a five-year carryback
into a consolidated return year of the same
group, for purposes of computing the group’s
50 percent limitation under revised section
172(b)(1)(H), the taxpayer’s taxable income
means the consolidated taxable income
(“CTI”) (computed without regard to any CNOL
deduction attributable to the loss year or
any equivalent taxable year as defined in
Treas. Reg. § 1.1502-21(b)(2)(iii), or any
taxable year thereafter) of the group in its
fifth consolidated return year preceding the
year of the loss for which the group has
elected the five-year carryback;
e.
A limitation applies to each year of a
consolidated group that absorbs a five-year
carryback, even if the group itself has not
made a section 172(b)(1)(H) election (e.g.,
the annual limitation provided may serve to
limit the amount of loss absorbed by the
group where such loss represents a five-year
carryback from separate return years of a
former member(s));
f.
Consolidated groups are allowed to waive the
entire carryback period or the extended
carryback period with regard to the portion
of the Applicable CNOL that is allocable to
certain acquired members. The carryback
period, however, may be waived only to the
extent of years preceding the acquisition
during which the acquired members were
included in another consolidated group, and
such election is available only to groups
that did not make an election under Treas.
Reg. § 1.1502-21(b)(3)(ii)(B) to waive all
carrybacks with respect to the acquired
members. See Temp. Treas. Reg. § 1.15022T(b)(3)(ii)(C).
23
g.
The temporary regulations issued under T.D.
9490 set forth two elections for
consolidated groups:
(1)
(2)
First, an acquiring group may waive the
part of the five-year carryback period
during which the member was a member of
another group.
(a)
With regard to the apportioned
loss, the election may result in a
waiver of the entire five year
carryback period to the taxable
years prior to the acquisition.
(b)
The waiver is only available where
none of the loss was previously
carried back to a taxable year of
a group of which the acquired
member was previously a member.
Second, an acquiring group may waive
the part of the extended carryback
period during which the member was a
member of another group.
(a)
With regard to the apportioned
loss, the election permits a
waiver of the third, fourth, and
fifth carryback years only (to the
extent these years are prior to
the acquisition).
(b)
This election is available even
where the loss has been carried
back to the first or second
carryback years of the acquired
member that are pre-acquisition
years.
(c)
The election is available only
where none of the loss has been
carried back to a taxable year of
a group of which the acquired
member was previously a member
which is prior to the second
taxable year proceeding the
taxable year of the loss.
24
h.
The elections apply only to a group’s
Applicable CNOL with regard to which the
taxpayer makes an election pursuant to
section 172(b)(1)(H). In other words, the
elections apply to a single taxable year.
i.
The election that relates to an Applicable
CNOL must be made by the due date (including
extensions) for filing the return for the
taxpayer’s last taxable year beginning in
2009.
j.
On June 9, 2011, speaking at the Texas
Federal Tax Institute, IRS Associate Chief
Counsel (Corporate), Bill Alexander stated
that consolidated groups that missed the
deadline to elect the expanded net operating
loss carrybacks of the Worker,
Homeownership, and Business Assistance Act
of 2009 may be granted section 9100 relief
to extend the time available for making the
election if they request a private letter
ruling. He indicated that the IRS views the
carryback deadlines for consolidated groups
as regulatory deadlines. He further stated
that if enough consolidated group taxpayers
request section 9100 relief, the Service may
consider issuing a revenue procedure to
grant extensions automatically. See
Consolidated Groups May Make Late NOL
Carryback Elections, Alexander Says, 2011
TNT 112-2 (June 10, 2011).
8.
A taxpayer may elect to relinquish the entire
carryback period with respect to a NOL. Section
172(b)(3)(C).
9.
Unless a taxpayer elects to forego the carryback
period, the entire amount of the NOL is carried
to the earliest of the taxable years to which
such loss may be carried. The excess, if any, of
the amount of such loss over the sum of the taxable income for each of the prior taxable years
to which such loss may be carried is carried to
each of the other taxable years. Section 172(b).
25
10.
B.
Any portion of the NOL carryover remaining after
the end of the 20-year carryover period is eliminated.
Section 381 - Carryovers in Certain Corporate
Acquisitions
1.
2.
Generally, a corporation's tax attributes,
including NOL carryovers, are preserved as long
as the corporation continues its legal existence.
Section 381 governs the extent to which an
acquiring corporation succeeds to the tax attributes of another corporation following certain
transactions.
a.
Under section 381(a), a corporation that
acquires the assets of another corporation
in a section 332 liquidation or in a reorganization qualifying under section
368(a)(1)(A), (C), (D), (F) or (G), succeeds
to, and takes into account, as of the close
of the date of distribution or transfer,
certain items, including NOL carryovers, of
the distributor or transferor corporation.
b.
In order for a reorganization to be treated
as meeting the requirements of section
368(a)(1)(D) or (G), the transferee corporation must acquire substantially all of the
assets of the transferor and the stock,
securities and other properties received by
the transferor, as well as the transferor's
remaining properties, must be distributed in
pursuance of the plan of reorganization.
NOL carryovers are taken into account by the
acquiring corporation subject to the limitations
specified in sections 381, 382 and 383 and the
regulations thereunder. Sections 381(b) and (c)
limit the use of the distributor or transferor
corporation's NOL carryovers as follows:
a.
NOL carryovers of the distributor or transferor corporation are carried to the first
taxable year of the acquiring corporation
ending after the date of distribution or
transfer. Section 381(c)(1)(A). In such
first taxable year, the allowable NOL deduc26
tion attributable to the NOL carryovers of
the distributor or transferor corporation is
limited to an amount which bears the same
ratio to the taxable income of the acquiring
corporation in such taxable year as the
number of days in the taxable year after the
date of distribution or transfer bears to
the total number of days in the taxable
year. Section 381(c)(1)(B).
b.
(1)
This limitation does not apply for
purposes of determining the portion of
any NOL (whether of the distributor,
transferor or acquiring corporation)
which may be carried to any taxable
year of the acquiring corporation following its first taxable year ending
after the date of distribution or
transfer. Treas. Reg. § 1.381(c)(1) 1(d)(2).
(2)
For example, assume Y corporation has
taxable income of $100,000 for its taxable year ending December 31, 1985. On
December 16, 1985, X corporation, which
has NOL carryovers of $500,000, transferred all of its assets to Y corporation in a statutory merger qualifying
under section 368(a)(1)(A). The amount
of the NOL carryovers of X corporation
carried under section 381(c)(1)(A) to Y
Corporation's taxable year ending
December 31, 1985, is $500,000; but
pursuant to section 381(c)(1)(B), only
$4,110 of such aggregate amount
($100,000 x 15/365) may be used in computing Y Corporation's NOL deduction
for such taxable year under section
172(a). The remaining $495,890 is
carried over to Y corporation's next
taxable year for use in computing its
NOL deduction for such year.
If the date of distribution or transfer is
on a day other than the last day of the
acquiring corporation's taxable year, such
taxable year is considered to be two taxable
27
years, the pre-acquisition part year and the
post-acquisition part year. The pre-acquisition part year begins on the first day of
the acquiring corporation's taxable year and
ends on the date of transfer. The postacquisition part year begins on the day
following the date of transfer and ends on
the last day of the acquiring corporation's
taxable year.
3.
(1)
The acquiring corporation's taxable
income for such taxable year is divided
between the pre-acquisition part year
and the post-acquisition part year in
proportion to the number of days in
each.
(2)
For purposes of section 172(b)(2), a
NOL of the acquiring corporation is
carried to the pre-acquisition part
year and then to the post-acquisition
part year, whereas a NOL of a distributor or transferor corporation is
carried only to the post-acquisition
part year and then to the acquiring
corporation's subsequent taxable years.
(3)
Though considered as two separate taxable years for purposes of section
172(b)(2), the pre-acquisition part
year and the post-acquisition part year
are treated as one taxable year in
determining the years to which a NOL is
carried under section 172. Section
381(c)(1)(C); Treas. Reg. § 1.381(c)
(1)-1(f).
A net operating loss of the acquiring corporation
for any taxable year ending after the date of
transfer cannot be carried back, except in an F
reorganization, in computing the taxable income
of the transferor corporation.
a.
However, a net operating loss of the acquiring corporation for any such taxable year
can be carried back in accordance with section 172(b) in computing the taxable income
28
of the acquiring corporation for a taxable
year ending on or before the date of transfer.
b.
4.
C.
If a transferor corporation remains in existence after the date of transfer, a net
operating loss sustained by it for any taxable year beginning after such date is carried back in accordance with section 172(b)
in computing the taxable income of such corporation for a taxable year ending on or
before that date, but may not be carried
back or over in computing the taxable income
of the acquiring corporation. Treas. Reg.
§ 1.381(c)(1)-1(b).
Despite the general rule of section 381 under
which an acquired corporation's tax attributes
survive the acquisition, several statutory rules
and judicial principles restrict the availability
of NOL carryovers.
Old Section 382 - Special Limitations on Net
Operating Loss Carryovers
1.
Old section 382 provided special limitations on
the availability of NOL carryovers after certain
purchases (or other taxable acquisitions) of 50
percent or more of a corporation's stock and
after certain tax-free reorganizations. The
rules of old section 382(a) relating to purchases
of stock were different than the rules of old
section 382(b) relating to reorganizations.
Failure to satisfy the requirements of old
section 382(a) resulted in elimination of NOL
carryovers, whereas failure to satisfy the
requirements of old section 382(b) resulted only
in a proportionate reduction of such carryovers.
As a result, there was a bias toward structuring
a transaction as a reorganization rather than as
a purchase of stock.
2.
Old section 382 was substantially amended by the
Tax Reform Act of 1976, but the effective date of
the amendments was repeatedly postponed.
a.
The most recent postponement expired
December 31, 1985, so that the 1976 amend29
ments technically became effective on
January 1, 1986.
b.
3.
However, the Act repealed the 1976 amendments as of January 1, 1986. Thus, in
effect, the 1976 version of section 382
never became law (with the exception of taxpayers who elected to use the 1976 version
under an election which was available in
1978). See Act §§ 621(e) and (f)(2).
Old Section 382(a) Limitations
Under old section 382(a), NOL carryforwards were
disallowed entirely where: (1) one or more of
the loss corporation's ten largest shareholders
increased their stock ownership within a two year
period by 50 percentage points or more; (2) the
change in stock ownership resulted from a purchase or a decrease in the amount of outstanding
stock; and (3) the loss corporation did not continue the conduct of a trade or business substantially the same as that conducted prior to the
change in stock ownership. Thus, even a 100 percent change in ownership did not result in any
limitation on the use of NOL carryovers if the
corporation continued to conduct substantially
the same trade or business.
a.
The ten largest shareholders of the loss
corporation were the ten persons (or such
lesser number of persons owning the outstanding stock at the end of the taxable
year) who owned, directly or indirectly, the
greatest percentage of the fair market value
of such stock at the end of the taxable
year. However, if any other person owned
the same percentage of such stock at such
time as was owned by one of the ten persons,
such person was also included for purposes
of determining if there had been a more than
50 percentage point increase in ownership.
Old section 382(a)(2).
b.
The stock ownership change was measured by
reference to the total fair market value of
the corporation's outstanding stock. How-
30
ever, for this purpose, "stock" did not
include non-voting preferred stock. Old
section 382(c).
c.
Warrants, options and convertible instruments were not counted as "stock" until
exercised. Stock acquired by the exercise
of an option was considered as having been
acquired on the date the option was
acquired. Treas. Reg. §§ 1.382-1A(a)(2),
1.382-3A.
d.
An increase in stock ownership was considered to occur upon the purchase of stock in
a corporation which owned stock of a loss
corporation (i.e., a parent corporation), or
upon the purchase of an interest in a partnership or a trust that owned stock of a
loss corporation. Old section
382(a)(1)(B)(i); Treas. Reg. § 1.382-1A(f).
e.
A decrease in the amount of outstanding
stock of a loss corporation resulting from a
section 303 redemption to pay death taxes
was disregarded. Old section
382(a)(1)(B)(ii); Treas. Reg. § 1.3821A(g)(3).
f.
The constructive ownership rules of section
318 applied as modified by old section
382(a)(3). Treas. Reg. § 1.382-1A(a)(2).
g.
Stock was considered to be acquired by "purchase" if the basis of the stock was determined solely by reference to its cost to the
acquirer. An acquisition of stock by gift
or bequest was not a purchase. Treas. Reg.
§ 1.382-1A(e).
h.
Generally, a proscribed change in a corporation's trade or business occurred where
there was a more than a minor or insubstantial change in the business conducted before
the first increase in stock ownership.
Among the relevant factors considered were
changes in the corporation's employees,
plant, equipment, product, location and customers. Treas. Reg. § 1.382-1A(h)(5).
31
Investment activity was not considered to be
a trade or business unless such activity
historically constituted the corporation's
primary activity. Treas. Reg. § 1.3821A(h)(4). The addition of a new trade or
business did not necessarily constitute a
proscribed change in business. Treas. Reg.
§ 1.382-1A(h)(8).
4.
Old Section 382(b) Limitations
Under old section 382(b), NOL carryovers were
reduced after a tax-free reorganization (other
than a "B" or "E" reorganization) if the prereorganization shareholders of the loss corporation
did not receive, in exchange for their stock in
the loss corporation, at least 20 percent of the
fair market value of the acquiring corporation's
outstanding stock. NOL carryovers were reduced
by 5 percent for every percentage point less than
the requisite 20 percent received by the former
loss corporation shareholders. Thus, if the former loss corporation's shareholders received 15
percent of the fair market value of the stock of
the acquiring corporation, the NOL carryovers
available after the reorganization were reduced
by 25 percent ((20 - 15) x 5 percent). The
remaining 75 percent of the NOL carryovers were
available for use by the acquiring corporation.
a.
Stock did not include non-voting preferred
stock. Old section 382(c).
b.
Stock of a parent corporation received in a
reorganization was treated as stock of the
subsidiary of equivalent fair market value.
Old section 382(b)(6). As long as the loss
corporation's shareholders were deemed to
receive 20 percent of the value of the subsidiary's stock, there was no reduction in
NOL carryovers even if the value of the
stock in the parent corporation received was
less than 1 percent of the value of the
parent's outstanding stock.
c.
Old section 382(b) did not apply if the loss
corporation and the acquiring corporation
32
were owned by substantially the same persons
in the same proportion, i.e., a merger of
brother-sister corporations. Old section
382(b)(3).
D.
d.
In a bankruptcy or other insolvency proceeding, creditors of the loss corporation who
exchanged their claims for acquiring
corporation stock were counted as shareholders for purposes of the 20 percent
continuing interest requirement. Old section 382(b)(7).
e.
To qualify as a reorganization, the transaction must satisfy the continuity of business
enterprise rule. Treas. Reg. § 1.368-1(d).
This is an easier test to satisfy than the
business continuation rule under old section
382(a)(1)(C).
f.
In order for a "D" or "G" reorganization to
be treated as a reorganization for purposes
of old section 382(b), the transferee corporation had to acquire substantially all of
the assets of the transferor. In addition,
the stock, securities and other properties
received by the transferor, as well as the
transferor's remaining properties, had to be
distributed in pursuance of the plan of
reorganization. Old section 382(b)(1).
g.
The limitations of old section 382(b)
applied regardless of whether the loss
corporation was the acquiring or acquired
corporation.
Old Section 383 -- Special Limitations on Unused
Business Credits, Research Credits, Foreign Taxes, and
Capital Losses
Old section 383
old section 382
credits, unused
credits and net
E.
applied the limitations contained in
to carryovers for unused business
research credits, excess foreign tax
capital losses.
Libson Shops Doctrine
33
1.
2.
In Libson Shops v. Koehler, 353 U.S. 382 (1957),
a case decided under the Internal Revenue Code of
1939, the Court established a continuity of business test to determine the availability of NOL
carryovers following an acquisition.
a.
In Libson Shops, 16 separate corporations
which had filed separate returns were merged
into another corporation. All corporations
were owned in the same proportions by the
same individuals.
b.
Prior to the merger, 3 corporations incurred
NOLs. Following the merger the surviving
corporation attempted to use these premerger NOL carryovers to offset the combined
entity's income.
c.
The Court denied a deduction for NOL
carryovers because the business generating
the income after the merger was not substantially the same business that incurred the
loss.
It was uncertain whether the Libson Shops doctrine had any application under the 1954 Code.
a.
Numerous courts held that the Libson Shops
doctrine did not apply under the 1954 Code.
See Exel Corp. v. United States, 451 F.2d 80
(8th Cir. 1971); Frederick Steel Co. v.
Commissioner, 375 F.2d 351 (6th Cir. 1967);
Maxwell Hardware Co. v. Commissioner, 343
F.2d 713 (9th Cir. 1965). The Tax Court
held that Libson Shops has no application
where the conditions of section 382(a) were
met. See Clarksdale Rubber Co. v. Commissioner, 45 T.C. 234 (1965).
b.
However, the Service stated that it will
assert the Libson Shops doctrine if there is
both (i) a 50 percent or more shift in the
benefits of a corporation's NOL carryover
and (ii) a proscribed change in the corporation's business within the meaning of section 382(a). Rev. Rul. 63-40, 1963-1 C.B.
46, as modified by T.I.R. 773 (October 13,
1965).
34
c.
3.
F.
The legislative history of the amendments to
section 382 in the Tax Reform Act of 1976
indicated that Libson Shops would not apply
to years governed by those amendments. See
S. Rep. No. 938, 94th Cong., 2d Sess. 206
(1976).
The legislative history under the Act indicates
that the Libson Shops doctrine will no longer
apply to transactions subject to section 382.
See H. R. Rep. No. 841, 99th Cong., 2d Sess. II194 (1986).
a.
From a strict reading of this language, one
can conclude that Libson Shops continues to
apply in cases where an ownership change
under section 382 has not occurred.
b.
It is unclear whether this result is
intended or whether Libson Shops no longer
applies in any case.
Consolidated Return Regulations
In addition to the rules applicable to acquisitive
transactions, the consolidated return regulations provide additional independent limitations affecting the
use of a corporation's net operating loss and net
capital loss carryovers within an affiliated group of
corporations filing a consolidated federal income tax
return. Final regulations effective June 25, 1999
more closely coordinate section 382 rules and the
consolidated return regulations, and will be discussed
briefly below.
1.
Separate Return Limitation Year Rules
a.
Under the old separate return limitation
year ("SRLY") rules, carryovers and carrybacks of NOLs and other tax attributes arising in a taxable year of a member corporation prior to joining a consolidated group
cannot exceed the excess of consolidated
taxable income minus consolidated taxable
income excluding items of income and deduction of the member corporation, over the
NOLs attributable to such member which may
be carried to the consolidated return year
35
arising in taxable years ending prior to the
particular SRLY. Treas. Reg. §§ 1.1502-1(f)
(SRLY definition), -21(c) (NOLs), and -22(c)
(capital losses).
b.
Under the SRLY rules promulgated in June
1996 and finalized in 1999, NOLs and other
tax attributes arising in a taxable year of
a corporation (or previously affiliated
corporations that compose a "subgroup")
prior to joining a consolidated group can
only be offset against income generated by
that corporation or corporations. The SRLY
rules do not apply if the loss corporation
is the common parent of the group unless the
losses were generated by a predecessor to
such common parent. Treas. Reg. §§ 1.15021(f) (SRLY definition); Treas. Reg. §§
1.1502-21(c) and 21A(c) (NOLs), -22(c) and 22A(c) (capital losses). See also Treas.
Reg. §§ 1.1502-3(c) (investment tax
credits), -4(f) (foreign tax credits).
c.
Note: The final regulations eliminate the
SRLY limitation in circumstances in which
the application overlaps with that of
section 382. T.D. 8823, 1999-29 I.R.B. 34.
d.
(1)
An overlap occurs if a corporation
becomes a member of a consolidated
group within six months of an ownership
change giving rise to the application
of section 382. Treas. Reg. § 1.150221(g)(2)(ii).
(2)
Thus, taxpayers no longer need to
calculate both the SRLY limitation and
the section 382 limitation when both
the SRLY rules and the section 382
rules apply close in time.
(3)
However, if a SRLY subgroup exists,
then the overlap rules will only apply
if there is an identical section 382
subgroup.
In January and March of 1998, temporary
amendments to the SRLY regulations were
36
issued which extended this new approach to
the general business credit and the minimum
tax credit, effective for consolidated
return years beginning on or after January
1, 1997. T.D. 8751, 1998-10 I.R.B. 23. In
addition, T.D. 8751 eliminated the
application of the SRLY rules to foreign tax
credits and overall foreign losses. Id. On
March 13, 1998, Treasury issued temporary
amendments to change the effective date of
T.D. 8751 to March 13, 1998. However, a
taxpayer may elect to continue to use the
January 1997 effective date of T.D. 8751.
See T.D. 8766, 1998-16 I.R.B. 17. These
temporary regulations were finalized,
without substantive change, on May 24, 2000.
See T.D. 8884, 2000-24 I.R.B. 1250. Prior to
the amendments, the SRLY rules only applied
to net operating losses and net capital
carryovers and carrybacks. See also Part
IX.B., below.
2.
Built-in Deduction Limitation
a.
Under the regulations, the built-in loss and
deduction limitations of the consolidated
return rules are coordinated with the builtin gain and loss rules of section 382(h).
See Treas. Reg. § 1.1502-15 and Part VI.C.,
below.
b.
Prior to the 1991 proposed rules (which were
finalized on June 27, 1996), built-in deductions in excess of a 15 percent de minimis
amount, realized within a 10 year period
after an acquisition, were subject to the
SRLY rules. Built-in deductions included
(and generally would still include) those
deductions or losses of a corporation which
economically accrue prior to an acquisition
but are recognized after the acquisition in
a consolidated return year. The SRLY rules
did not apply to deductions attributable to
acquired assets if the aggregate adjusted
basis of all such assets did not exceed the
fair market value of all such assets by more
37
than 15 percent.
15A(a).
3.
See Treas. Reg. § 1.1502-
Consolidated Return Change in Ownership
a.
Repeal of the CRCO Rules
The 1996 temporary regulations (finalized in
1999) repealed the consolidated return
change in ownership ("CRCO") rules
prospectively, and replaced them with rules
consistent with section 382. See Treas.
Reg. §§ 1.1502-90 to §§ 1.1502-99. The CRCO
rules were an anomaly after 1986 since they
used old section 382 principles. The old
CRCO rules are summarized below.
b.
Summary of Old CRCO Rules
(1)
A consolidated return change in ownership ("CRCO") occurs if the 10 largest
shareholders described in section
382(a) increase their percentage ownership of the common parent of an affiliated group by more than 50 percentage
points by purchase or redemption within
two taxable years.
(2)
After a CRCO occurs, the NOL carryovers
and other favorable tax attributes of
the members of the group ("old
members") on the last day of the taxable year preceding the CRCO can be
used only to offset the income later
generated by the old members. Treas.
Reg. §§ 1.1502-1(g) (CRCO), -3(e)
(investment tax credits), -4(g)
(foreign tax credits), -21A(d) (NOL's),
-22A(d) (capital losses).
(3)
The CRCO limitation applies where a
more than 50 percent ownership change
occurs but loss carryovers are not
eliminated under section 382 (or the
counterpart thereto in Treas. Reg.
§ 1.1502- 21A(e)(1)(i)) because each
corporation in the consolidated group
continues to carry on substantially the
38
same trade or business. The CRCO rule
is similar to the Libson Shops doctrine
because it prevents losses generated by
one business from being used to offset
income generated by another.
(4)
G.
After an ownership change to which section 382(a) applies, the portion of any
consolidated net operating loss
attributable to a member of a consolidated group that does not continue to
carry on substantially the same trade
or business is disallowed. Treas. Reg.
§ 1.1502-21A(e)(1)(i).
Section 269 - Acquisitions Made to Avoid or Evade Tax
1.
2.
The Secretary of the Treasury or his delegate may
disallow NOL carryovers and other beneficial tax
attributes if the principal purpose for an acquisition or liquidation to which section 269
applies is the evasion or avoidance of Federal
income tax by securing the benefit of a deduction, credit, or other allowance which the
acquirer would not otherwise have enjoyed.
Section 269(a). Section 269, unlike section 382,
requires an inquiry into the acquirer's subjective intent.
a.
Tax avoidance is the principal purpose if it
exceeds any other purpose in importance. It
is not necessary that tax avoidance be the
sole purpose for the transaction. Scroll,
Inc. v. Commissioner, 447 F.2d 612 (5th Cir.
1971) (citing S. Rep. No. 627, 78th Cong.
lst Sess. (1943) reprinted in 1944 C.B. 973,
1017).
b.
This subjective standard creates significant
uncertainty in the pricing of a loss
corporation.
Section 269 applies to acquisitions in which: (i)
one or more persons acquire, directly or indirectly, control of a corporation; (ii) any corporation acquires, directly or indirectly, property
of another corporation, not controlled directly
or indirectly immediately before such acquisition
39
by such acquiring corporation or its stockholders, and the basis of the property in the hands
of the acquiring corporation is determined by
reference to the basis in the hands of the transferor corporation; or (iii) a corporation makes a
qualified stock purchase of another corporation,
does not make a section 338 election and liquidates the acquired corporation pursuant to a plan
of liquidation adopted not more than two years
after the acquisition date. Section 269(a),(b).
3.
a.
Control means the ownership of stock possessing at least 50 percent of the total
combined voting power of all classes of
stock entitled to vote or at least 50 percent of the total value of shares of all
classes of stock of the corporation. Section 269(a).
b.
The determination of the acquirer's motive
is made as of the time of acquisition of
control. Section 269(a) does not apply if
the taxpayer develops a tax avoidance motive
after acquisition of control. Hawaiian
Trust Co. Ltd. v. United States, 291 F.2d
761 (9th Cir. 1961).
A transaction in which a profitable corporation
(or other business enterprise) acquires control
of a corporation with NOL carryovers and effects
such transfers as are necessary to offset its
income with the NOL carryover, indicates that the
principal purpose for acquiring control was
evasion or avoidance of Federal income tax.
a.
Section 269 may be applied to disallow a NOL
carryover even though such carryover is not
disallowed, in whole or in part, under section 382. See FSA 199949002. However, the
fact that the section 382 limitation applies
is relevant to the determination of whether
the principal purpose of the acquisition is
the avoidance or evasion of tax. Treas.
Reg. § 1.269-7.
b.
Examples in the regulations provide that
section 269 applies where a profitable cor-
40
poration: (i) purchases all of the stock of
a corporation with NOL carryovers for the
principal purpose of utilizing the NOL
carryovers by changing the loss corporation's business to a profitable new business; (ii) acquires all of the assets of a
corporation with NOL carryovers in a merger
with the principal purpose of utilizing the
NOL carryovers against the income of the
acquiring corporation's business; or (iii)
acquires all the stock of a corporation with
NOL carryovers for the purpose of improving
and continuing the loss corporation's business and within one year transfers a profitable business to the loss corporation for
the principal purpose of using the profits
of such business to absorb the NOL
carryovers. Treas. Reg. § 1.269-6.
4.
H.
Once tax avoidance has been determined to be the
principal purpose for an acquisition, disallowance of NOL carryovers and other tax attributes
is presumptively correct. H. F. Ramsey Co. v.
Commissioner, 43 T.C. 500, 516 (1965).
Section 482 -- Allocation of Income and Deductions
Among Taxpayers
The Secretary of the Treasury or his delegate is
authorized to apportion or allocate gross income,
deductions, credits, or allowances, between or among
related taxpayers, if such action is necessary to
prevent evasion of tax or to clearly reflect the
income of a taxpayer. Section 482 may be applied to
prevent the diversion of income to a loss corporation
in order to absorb NOL carryovers.
I.
Section 338 -- Certain Stock Purchases Treated as
Asset Acquisitions
1.
In general, where a qualified stock purchase is
made with respect to a corporation possessing NOL
carryovers, an actual or deemed section 338 election will eliminate the loss corporation's tax
attributes, including NOL carryovers.
2.
However, if a section 338(h)(10) election is
made, the target corporation is deemed to sell
41
all of its assets in a single, fully taxable
transaction followed by a liquidation of the target under section 332. In such a case, the target's shareholders succeed to any unabsorbed NOL
carryovers.
J.
K.
Section 1371(b) -- Rules Regarding Carryovers
Carrybacks of Subchapter S Corporations
1.
No carryover, and no carryback, arising for a
taxable year for which a corporation is a C
corporation may be carried to a taxable year for
which such corporation is an S corporation.
2.
No carryover, and no carryback, arises at the
corporate level for a taxable year for which a
corporation is an S corporation.
3.
A taxable year
corporation is
ing the number
may be carried
172(b).
for which a corporation is an S
counted for purposes of determinof taxable years to which an item
back or carried over under section
Section 384 -- Acquisitions Involving Gain
Corporations
1.
Section 10226 of the Omnibus Budget Reconciliation Act of 1987, P.L. 100-203 ("OBRA 87"), added
section 384. The general purpose of section 384
is to prohibit loss corporations from using their
losses to shelter built-in gains of a target
corporation that are recognized within the five
year period after the target's acquisition. See
H.R. Rep. No. 100-391, 100th Cong., 1st Sess.
1093-94 (1987). However, the original version of
section 384 was so flawed that Congress substantially revised it in the Technical and Miscellaneous Revenue Act of 1988, P.L. 100-647.
2.
In general, the provision applies to certain
stock acquisitions in which control of a target
is acquired and certain tax-free asset acquisitions, regardless of whether the loss corporation
acquired the gain corporation (or its assets) or
vice versa.
III. NEW SECTION 382 -- INTRODUCTION
42
A.
Reasons for Change
1.
Old section 382 attempted to restrict "loss
trafficking" by limiting the survival of NOL
carryovers after certain changes in ownership of
a corporation. However, it was evident that
revisions to old section 382 were necessary to
correct technical deficiencies and to reduce the
number of circumstances in which loss trafficking
was still possible.
2.
The technical defects and discontinuities
inherent in old section 382 included the following.
a.
b.
Different continuity of interest requirements were applicable depending upon whether
the change in ownership occurred through a
taxable or a tax-free transaction.
(1)
If the acquisition of a corporation
took the form of a taxable transaction,
a 50 percent continuity of interest was
required. If the transaction was
effected in a tax-free manner, only a
20 percent continuity of interest was
required. Thus, economically similar
transactions could receive different
tax treatment.
(2)
In addition, if the purchase rule
applied, all NOL carryovers were lost
completely. However, in the case of
tax-free acquisitions, NOLs were
proportionately reduced if the
continuity of interest requirements
were not met.
Different business continuation requirements
were also applicable. In the case of "purchase" transactions, NOL carryovers were
eliminated if the loss corporation changed
its trade or business. See old section
382(a)(1)(C) and Treas. Reg. § 1.382-1A(h).
In the case of reorganization transactions,
the more liberal continuity of business
enterprise requirement applied. See Treas.
Reg. § 1.368-1(d).
43
B.
c.
Taxpayers could use specially tailored
classes of stock, e.g., participating stock,
which could shift the beneficial interests
in a NOL carryover without triggering the
section 382 requirements.
d.
Old section 382 did not regulate certain
types of losses. Built-in losses were not
governed by old section 382 even though such
losses are economically equivalent to NOL
carryovers. Taxpayers could recognize
built-in losses after the prescribed change
in ownership without triggering old section
382.
e.
Transactions could be designed to escape the
old section 382 limitations. Such transactions include:
(1)
Section 351 exchanges,
(2)
Capital contributions,
(3)
Liquidations of partnerships owning
stock in a loss corporation,
(4)
Acquisitions of interests in partnerships owning loss corporation stock,
(5)
"B" reorganizations,
(6)
Triangular reorganizations where the
measurement of continuing interests
allowed for circumvention of the continuity of interest rules, and
(7)
Reverse mergers where taxpayers took
the position that the reorganization
rule did not apply to reverse mergers.
General Background
In developing a scheme to regulate NOL carryovers,
several proposals were evaluated in light of the
policy reasons for imposing special limitations. See
American Law Institute, Federal Income Tax Project:
Subchapter C, 207-209 and 216-225 (1982).
44
1.
Policy Considerations Behind Limitations
a.
Prevention of loss trafficking
The prevention of loss trafficking is often
cited as a justification for imposing
special limitations on NOL carryovers. The
ability of a taxpayer to acquire stock in a
corporation for the purpose of obtaining its
tax benefits has long been perceived as an
abuse of the tax system. Although the concept of loss trafficking has seldom been
reduced to concrete terms, it is probably
best epitomized by the purchase of a shell
corporation possessing large NOL carryovers.
b.
Prevention of windfalls
The full value of a corporation's NOL
carryovers frequently is not reflected in
the purchase price of the corporation's
stock. As a result, the new owners could
unjustly receive a windfall when these
carryovers are realized.
(1)
Some have argued that it is the existence of special limitations themselves
that is the cause of this unjust
enrichment. Due to limitations in NOL
carryovers, a purchaser is never
assured of receiving the benefit of
such carryovers and therefore must discount the value of loss corporation
stock. Proponents of this argument
contend that if NOL carryovers were
freely transferable, i.e., no special
limitations were imposed on NOL
carryovers after a change in corporate
ownership, a seller would receive full
value for the loss corporation's NOL
carryovers.
(2)
However, Congress has not been
persuaded by this argument. It fears
that a purchaser might still obtain a
windfall by using its superior bargaining position to obtain a price which
does not fully reflect the value of
45
such carryovers. See The Tax Reform
Act of 1976, Gen. Expl. at 191.
c.
Preventing losses of one business from offsetting gains of an unrelated business
The NOL carryover provisions were intended
to operate as an averaging device to
mitigate the effects of a strict annual
accounting system on businesses with
fluctuating income. Without special
limitations, unintended benefits may accrue
to taxpayers where unrelated businesses are
combined and losses of one are allowed to
offset gains of another. This justification
is a variant of the "business enterprise"
theory first announced in Libson Shops,
Inc., v. Koehler, 353 U.S. 382 (1957), and
later reflected in the regulations. See
Treas. Reg. §§ 1.269-3(b)(1), 1.382-1A(h)(5)
and (7).
d.
Losses of certain corporations should not be
subsidized by the Government
Certain loss corporations may experience
continued losses due to heavy debt, rental
obligations, or compensation payments to
shareholder-employees. Without special
limitations, the tax collection process may
be harmed if such continued losses could be
offset against income from other profitable
businesses. This justification seems to
address the ill effects of a perceived
unfairness in the tax system.
e.
Preventing distortion of business
transactions
Free transferability of NOL carryovers could
encourage corporate acquisitions regardless
of the business or financial justification
for the transaction. Special limitations
are required so that the tax law remains
neutral with respect to business decisions.
46
2.
Possible Modes of Regulation
Several methods of dealing with NOL carryovers
have been proposed.
a.
Refundability
Under this proposal, a loss corporation
would receive a refund directly from the
Federal government equal to the tax savings
that would have resulted if the loss corporation had sufficient income to offset the
loss.
b.
(1)
A system based on refundability would
ensure that the benefit of loss
carryovers would be received by the
loss corporation shareholders who
incurred the economic burden of the
loss. Thus, the potential windfall
gain to purchasers would be avoided.
(2)
However, such a system would in effect
transform the Federal government into a
partner in all loss corporations -- a
role which many believe to be
inappropriate.
Free transferability
Under this proposal, tax attributes such as
NOL carryovers would be freely transferable
between corporations. No limitations on the
use of NOL carryovers would apply following
a change in corporate control.
(1)
If the purchaser was assured of its
ability to use the NOL carryovers of a
loss target, the loss corporation
shareholders presumably would receive
full value for the corporation's NOL
carryovers. As above, this proposal
would prevent windfall gains to the
purchaser.
(2)
However, such a system is tantamount to
an indirect reimbursement by the
Federal government. In addition, free
47
transferability would mean that unrelated income could be offset by NOL
carryovers. Thus, the averaging function of the NOL carryover provisions
would be nullified.
c.
Limitation based on stock ownership
The 1976 version of section 382 imposed
limitations on NOL carryovers based solely
on shareholder continuity of interest. One
rationale supporting such a method of regulation is that the shareholders of a loss
corporation bear the economic burden of the
losses incurred. The NOL carryover provisions help reduce this economic loss by
allowing future deduction against income.
Thus, there is less of a reason to allow NOL
carryovers where the original shareholders
no longer own stock in the loss corporation.
d.
Limitations based on continuity of business
enterprise
Limitations based on continuity of business
enterprise reflect the theory that the NOL
carryover provisions intended to average out
the income of a single business. Once the
business is no longer continued, NOL
carryovers should not be deductible.
C.
Legislative Background and Other Developments
1.
Congress substantially revised old section 382 as
part of The Tax Reform Act of 1976. P.L. 94-455,
§§ 806(e) and (f). However, the 1976 amendments
were heavily criticized due to their complexity
and inherent arbitrariness. Consequently, the
effective date of these amendments was postponed
several times to permit further study of this
area.
2.
In 1982, the American Law Institute (the "ALI")
released its proposed revisions to section 382.
See American Law Institute, Federal Income Tax
Project: Subchapter C, 198-301 (1982) (the "ALI
proposal"). The ALI proposal contained two
separate sets of limitations on NOL carryovers.
48
One applied to "purchases" and the other applied
to "mergers."
3.
In September, 1983, the Senate Finance Committee
staff released its preliminary proposals for
revising section 382. See Staff, Committee on
Finance, The Reform and Simplification of the
Income Taxation of Corporations, S. Rep. No. 95,
98th Cong., lst Sess. (1983). These proposals,
like the ALI proposals, contained two sets of
rules which would limit NOL carryovers following
a change of control in the loss corporation.
4.
In February, 1985, the American Bar Association
(the "ABA") released its section 382 proposals.
See Report on American Bar Association Legislative Recommendation No. 1985-1, February 6, 1985.
5.
In May, 1985, the Senate Finance Committee staff
released its final proposals for revision of section 382. See Staff, Committee on Finance, The
Subchapter C Revision Act of 1985: A Final
Report Prepared by the Staff, S. Rep. No. 47,
99th Cong., 1st Sess. (1985). In contrast to the
preliminary proposals, the final proposals contained a single rule limiting the use of NOL
carryovers following a more than 50 percent
change in ownership of the loss corporation.
6.
In December, 1985, the House of Representatives
passed H.R. 3838, the Tax Reform Act of 1985.
Section 321 of H.R. 3838 reflected the basic concepts contained in the Subchapter C Revision Act
of 1985, with many technical modifications.
7.
In June, 1986, the Senate passed its version of
H.R. 3838. Section 621 of the Senate version
also bore a strong resemblance to the May, 1985
proposals.
8.
In August, 1986, House and Senate conferees
reported an agreement on H.R. 3838. The conference report was formally issued on September 18,
1986, and passed by the House of Representatives
on September 25, 1986 and by the Senate on
September 27, 1986.
49
9.
The President signed the Act on October 22, 1986.
The Act was signed without the technical changes
contained in House Concurrent Resolution 395.
10.
On May 4, 1987, the general explanation of the
Act was released. See Staff, Joint Committee on
Taxation, General Explanation of the Tax Reform
Act of 1986 (1987) (the "Blue Book").
11.
On August 5, 1987, Treasury released temporary
and proposed regulations dealing with limited
aspects of section 382. See T.D. 8149, 1987-2
C.B. 85.
12.
OBRA 87 made additional changes affecting section
382 and loss corporations in general (viz., section 384 was added).
13.
On March 31, 1988, identical technical corrections bills were introduced in the House and
Senate. See H.R. 4333 and S. 2238, respectively.
These provisions ultimately were enacted as the
Technical and Miscellaneous Revenue Act of 1988,
P.L. 100-647 ("TAMRA"). A general explanation of
TAMRA's predecessors was prepared. See Staff,
Joint Committee on Taxation, Description of the
Technical Corrections Act of 1988 (H.R. 4333 and
S. 2238) (1988) (TAMRA Gen. Expl.). See also
H.R. (Conf.) Rep. No. 1104, 100th Cong., 2d Sess.
(1988); H.R. Rep. No. 795, 100th Cong., 2d Sess.
43 (1988); S. Rep. No. 445, 100th Cong., 2d Sess.
45 (1988). TAMRA made further changes to section
382.
14.
The Financial Institutions Reform, Recovery and
Enforcement Act of 1989, P.L. 101-73 ("FIRREA"),
moved back the effective date for the elimination
of certain provisions granting favorable section
382 treatment for insolvent financial institutions.
15.
On September 19, 1989, Treasury issued temporary
and proposed regulations under section 383. T.D.
8264, 1989-2 C.B. 73.
16.
Section 7205 of the Revenue Reconciliation Act of
1989, P.L. 101-239 ("RRA 89") made changes
affecting the built-in gain and loss rules of
50
sections 382 and 384. See H.R. (Conf.) Rep. No.
386, 101st Cong., 1st Sess. 559 (1989).
17.
On August 13, 1990, Treasury issued proposed
regulations concerning the interrelationship of
sections 382 and 269, and proposed regulations
regarding the section 382(l)(5) rules for bankruptcy reorganizations. 55 Fed. Reg. 33137 (Aug.
14, 1990), 1990-2 C.B. 682.
18.
On September 5, 1990, Treasury issued temporary
and proposed regulations concerning application
of the option attribution rules in bankruptcy
reorganization transactions covered by section
382(l)(5). 55 Fed. Reg. 36657 (Sept. 6, 1990),
as corrected by 55 Fed. Reg. 36751 (Sept. 6,
1990), 1990-2 C.B. 680.
19.
On November 20, 1990, Treasury issued temporary
and proposed regulations amending the "entity"
definition under Treas. Reg. § 1.382-2T(f)(7).
55 Fed. Reg. 48639 (Nov. 21, 1990), 1990-2 C.B.
693.
20.
On January 29, 1991, Treasury issued proposed
regulations primarily under section 382(m)(2),
concerning short taxable years, and section
382(m)(5), concerning adjustments to value and
built-in gain or loss in the case of members of a
controlled group of corporations. 56 Fed. Reg.
4183 (Feb. 4, 1991), 1991-1 C.B. 749. Also on
that date, Treasury issued proposed regulations
concerning the application of section 382 to
affiliated groups filing consolidated returns, 56
Fed. Reg. 4194 (Feb. 4, 1991), 1991-1 C.B. 728,
as well as revisions to the SRLY rules to more
closely coordinate them with section 382. 56
Fed. Reg. 4228 (Feb. 4, 1991), 1991-1 C.B. 757.
(Notice 91-27 clarified the effective date provisions of these regulations regarding consolidated
loss rules. 1991-2 C.B. 629).
21.
On June 26, 1991, the definitions of loss corporation and pre-change loss were finalized, as
well as the proposed regulations under Code section 383). T.D. 8352, 1991-2 C.B. 67.
51
22.
On September 20, 1991, Treasury issued proposed
regulations concerning the treatment of widely
held indebtedness for purposes of section
382(l)(5)(E). 55 Fed. Reg. 47921 (September 23,
1991), 1991-2 C.B. 909.
23.
On October 29, 1991, Treasury issued proposed
regulations which would limit the operation of
the segregation rules in the case of certain
transactions involving regulated investment companies ("RICs"). 56 Fed. Reg. 55858 (October 30,
1991), 1991-2 C.B. 907.
24.
On December 31, 1991, the proposed regulations
issued on August 13, 1990 under sections 269 and
382(1)(5) were finalized. T.D. 8388, 1992-1 C.B.
137.
25.
On March 27, 1992, the proposed regulations
issued on November 20, 1990 dealing with the
"entity" definition were finalized. T.D. 8405,
1992-1 C.B. 146.
26.
On April 8, 1992, the proposed regulations issued
on September 5, 1990 under section 382(1)(5) were
finalized. T.D. 8407, 1992-1 C.B. 148.
27.
On August 5, 1992, Treasury issued proposed regulations under section 382(l)(6) providing rules
for calculating the increase in the value of a
loss corporation following an insolvency transaction to which section 382(l)(5) does not apply.
57 Fed. Reg. 34736 (August 6, 1992). 1992-2 C.B.
616.
28.
On August 27, 1992, the proposed regulations
issued on October 29, 1991 dealing with the segregation rules were finalized. T.D. 8428, 1992-2
C.B. 239.
29.
On October 2, 1992, Treasury issued final and
temporary regulations to except certain designated options from the option attribution rules.
T.D. 8440, 1992-2 C.B. 72.
30.
On November 4, 1992, Treasury issued proposed
regulations which would treat an option as exercised only if it was issued or transferred for a
52
principal purpose of manipulating the timing of
an owner shift to avoid or ameliorate the impact
of an ownership change. 57 Fed. Reg. 52743
(November 5, 1992), 1992-2 C.B. 606.
31.
On November 4, 1992, Treasury issued proposed
regulations which would amend the segregation
rules to presume overlapping ownership between
existing less-than-5 percent shareholders and
less-than-5 percent shareholders purchasing stock
in a stock offering. 57 Fed. Reg. 52718
(November 5, 1992), 1992-2 C.B. 621.
32.
On November 18, 1992, Treasury issued proposed
regulations to allow the new loss corporation to
make a closing-of-the-books election instead of
applying ratable allocation for NOL carryovers
arising in the year of the ownership change. 57
Fed. Reg. 54535 (November 19, 1992), 1992-2 C.B.
602.
33.
On May 7, 1993, Treasury issued proposed regulations under section 382(l)(5) to determine
whether stock of a loss corporation is owned as a
result of being a qualified creditor. 58 Fed.
Reg. 27498 (May 10, 1993), 1993-1 C.B. 594.
34.
On October 4, 1993, the proposed regulations
issued November 4, 1992, under the segregation
rules were finalized. T.D. 8490, 1993-2 C.B.
120.
35.
On March 17, 1994, the proposed regulations
issued May 7, 1993, under section 382(l)(5) were
finalized. T.D. 8529, 1994-1 C.B. 131.
36.
On March 17, 1994, the proposed
issued on August 5, 1992, under
providing rules for calculating
the value of a loss corporation
insolvency transaction to which
does not apply were finalized.
C.B. 136.
37.
On March 17, 1994, final regulations were issued
under section 382 that provide rules on the
treatment of options in determining change for
53
regulations
section 382(l)(6)
the increase in
following an
section 382(l)(5)
T.D. 8530, 1994-1
purposes of section 382.
121.
T.D. 8531, 1994-1 C.B.
38.
On June 22, 1994, the proposed regulations issued
November 18, 1992, under the closing-of-the-books
rules were finalized. T.D. 8546, 1994-2 C.B. 43.
39.
On June 27, 1996, the proposed regulations issued
January 29, 1991 (relative to short taxable years
and affiliated groups filing consolidated
returns) were finalized in substantially similar
form. The only major change was a provision
moved from the consolidated return regulations to
the § 382 regulations. The final regulations are
effective as of January 1, 1997. T.D. 8677,
1996-2 C.B. 119; T.D. 8678, 61 Fed. Reg. 33395
(June 27, 1996); T.D. 8679, 61 Fed. Reg. 33313
(June 27, 1996).1
40.
Section 1082 of the Taxpayer Relief Act of 1997,
P.L. 105-34 (“TPRA 97”) amended § 172(b)(1)(a) to
reduce the carryback period from three to two
years and to extend the carryforward period from
fifteen to twenty years, effective for tax years
beginning after August 5, 1997.
41.
On January 12, 1998, Treasury issued temporary
amendments to the June 1996 regulations to extend
the SRLY principals of the June 1996 regulations
to other tax attributes, effective for
consolidated return years beginning on or after
January 1, 1997. T.D. 8751, 1998-10 I.R.B. 23
(January 12, 1998).
42.
On March 13, 1998, Treasury issued temporary
amendments to change the effective date of T.D.
8751 to March 13, 1998. In addition, a taxpayer
may elect to use the effective dates of T.D.
8751. T.D. 8766, 1998-16 I.R.B. 17 (March 13,
1998).
43.
Treasury issued Notice 98-38 which informs
taxpayers that Treasury is considering an
approach which would replace the current SRLY
1References
in this outline are to the new regulations, as
opposed to the proposed regulations issued on January 29, 1991.
54
limitation with an approach modeled on section
382. Notice 98-38, 1998-32 I.R.B. 1 (July 31,
1998).
D.
44.
On June 25, 1999, Treasury adopted final
regulations relating to deductions and losses of
members who join consolidated groups, credits
following an ownership change of a consolidated
group, and limitations on NOL carryovers and
certain built-in losses following an ownership
change. T.D. 8823, 1999-29 I.R.B. 34; T.D. 8824,
1999-29 I.R.B. 62; T.D. 8825, 1999-28 I.R.B. 19.
The regulations are effective as of June 25,
1999.
45.
On May 25, 2000, Treasury promulgated final
regulations that adopted, without substantive
change, the temporary regulations described above
in paragraphs 41 and 42. T.D. 8884, 2000-24
I.R.B. 1250.
The Neutrality Principle
The major policy theme underlying the legislative proposals described above (other than the 1976 revision
of section 382) is the so-called "neutrality" principle. The neutrality principle has been expressed in
two ways.
1.
Neutrality as to Corporate Owners
a.
Neutrality means that NOL carryovers should
neither increase nor decrease in value as a
result of changes in corporate ownership.
That is, NOL carryovers should have the same
value to the new owners as they had to the
old owners.
(1)
If the new owners are permitted to
absorb NOL carryovers at a faster rate
than the old owners could, such
carryovers would be more valuable to
the buyer than to the seller.
(2)
If the new owners are denied the benefits of the loss corporation's NOL
carryovers, such carryovers would be
55
more valuable to the seller than to the
buyer.
b.
2.
The proposals implement this neutrality concept by limiting the amount of income which
the new owners can offset by the old owners'
NOL carryover to an approximation of the
loss corporation's stream of income. NOL
carryovers theoretically have equal value to
the old and new owners if such carryovers
can be offset by the same level of income
after the acquisition as was generated by
the corporation before the acquisition.
Neutrality as to Business Decisions
Neutrality has also been expressed by the view
that tax considerations should not interfere with
business decisions to purchase, sell, or combine
loss corporations, or to alter or terminate such
corporations' business operations. The extent to
which NOL carryovers are available after a change
in ownership is an important factor that could
affect such business decisions.
3.
Section 382
In general, section 382 incorporates the
neutrality principle. However, some of its provisions have been criticized as being unnecessary
in light of the neutrality principle. The Outline below analyzes section 382 and points out
where some of the provisions deviate from the
principle.
IV.
OVERVIEW OF NEW SECTION 382
A.
Required Change in Ownership
1.
Section 382 ("section 382") applies only after a
change, however effected, in ownership of more
than 50 percent of the stock (by value) in a loss
corporation over a prescribed period of time.
a.
Such a change is referred to as an "ownership change." The date on which an ownership change occurs is referred to as the
"change date."
56
b.
B.
An ownership change may occur either through
an "owner shift involving a 5-percent shareholder," an "equity structure shift," or
through a combination of the two.
2.
In general, the change in ownership of the loss
corporation must occur within a three-year testing period ending on the day of any owner shift
or equity structure shift. A shorter testing
period applies where a previous change has
occurred during the testing period, or where the
loss corporation's NOLs have all originated after
the beginning of the three-year period.
3.
Presumably, there will be no ownership change
unless the technical requirements of section 382
are met, even if a transaction is specifically
designed to avoid triggering an ownership change.
LTR 9630017.
4.
For purposes of determining stock ownership, the
constructive ownership rules of section 318 apply
with certain modifications.
Consequences of an Ownership Change
1.
2.
Section 382 places an annual limit on the amount
of post-change taxable income that may be offset
by the loss corporation's pre-change NOL
carryovers.
a.
The annual amount of income which may be
offset by pre-change NOL carryovers is an
amount equal to the product of a prescribed
rate of return and the value of the loss
corporation.
b.
However, the annual limitation may be
increased by certain built-in gains of the
loss corporation and section 338 gain as
well.
However, if an ownership change occurs, a loss
corporation's carryovers will be eliminated
unless the loss corporation satisfies the
continuity of business enterprise requirement
applicable to reorganizations throughout the twoyear period beginning on the change date.
57
C.
D.
NOLs Subject to Limitation
1.
In general, NOLs incurred prior to the ownership
change are subject to the section 382 limitations.
2.
NOLs generated in the year of an ownership change
are allocated to the periods before and after the
change. That portion allocated to the period
after the ownership change is not subject to
limitation; that portion allocated to the period
prior to the ownership change is subject to the
section 382 limitations, i.e., those losses may
only offset income to a limited extent.
3.
The Service has issued final regulations allowing
the new loss corporation to make a closing-ofthe-books election instead of applying ratable
allocation for NOL carryovers arising in the year
of the ownership change. Treas. Reg. § 1.382-6.
4.
In addition, if the corporation has built-in
losses as of the ownership change, such losses
may also be subject to limitation.
Example
1.
Fact Pattern
On January 1, 1996, L corporation is wholly owned
by individual A. A has held all of the L stock
since L's inception in 1992. L has a $200 NOL
carryover from a previous year. On December 31,
1996, A sells all of his stock to B for $500 (the
fair market value of L). At that time, the
applicable statutory rate for section 382 purposes is 5 percent. During 1997, L generates
$200 in taxable income.
2.
Tax Consequences Under Section 382
a.
The sale of all of the L stock by A to B is
an ownership change which triggers section
382. The sale resulted in a more than 50
percent change in L stock ownership during
the three-year testing period ending on
December 31, 1996. Therefore, section 382
applies.
58
b.
c.
E.
V.
Under section 382, income generated after
December 31, 1996 may be offset by L's NOL
carryover only to the extent of $25 (the
product of L's value ($500) and the rate
prescribed under section 382 (5 percent)).
(1)
Thus, with respect to 1997, L may not
fully offset its $200 taxable income
with its $200 NOL carryover. Only $25
of its 1997 taxable income may be offset by the NOL carryover.
(2)
L has an NOL carryover to 1998 of $175
($200 - $25).
If B caused L to sell all of its assets
(assume at their book value), L's NOL
carryover would be eliminated.
Effective Date
1.
In general, the rules will apply to ownership
changes that occur on or after January 1, 1987.
The 1954 version of section 382 will apply to any
transactions not covered by these rules because
of their effective date.
2.
Under current law, the earliest testing period
will not begin before May 6, 1986. Thus, any
changes in stock ownership occurring before that
date will not be considered in determining if
future stock changes constitute an ownership
change.
OWNERSHIP CHANGE -- A DETAILED ANALYSIS
In this Part of the Outline the triggering mechanism
of section 382 -- the ownership change provisions -will be covered in detail. As previously indicated at
Part III.C.11., Treasury has promulgated regulations
that implement and expand the ownership change provisions as contained in the statute. See T.D. 8149,
1987-2 C.B. 88, adopting Treas. Reg. §§ 1.382-lT and 2T (amended by T.D. 8405). These regulations will be
covered in this Part of the Outline. See Silverman
and Keyes, "An Analysis of the New Ownership Change
Regs. Under Section 382: Part I," 68 JTAX 68
(February, 1988).
59
A.
General Analysis
1.
Ownership Change
a.
Definition
(1)
b.
Under section 382(g)(1), an ownership
change occurs if immediately after "any
owner shift involving a 5-percent
shareholder or an equity structure
shift":
(a)
the percentage of stock of the
loss corporation owned by 1 or
more 5-percent shareholders
(b)
has increased by more than 50 percentage points over
(c)
the lowest percentage of
the loss corporation (or
predecessor corporation)
such shareholders at any
ing the testing period.
stock of
any
owned by
time dur-
(2)
Both the House and Senate versions of
section 382 contained separate definitions of an ownership change. The conference agreement modified these
versions to provide only a single
definition of an ownership change.
(3)
TAMRA amended section 382(g)(1) to
remove references to new and old loss
corporations, and replaced them with a
reference only to the loss corporation.
This amendment was designed only to
remove the circularity built into the
statute; it was not intended to have a
substantive impact. TAMRA Gen. Expl.
at 48.
Legislative history
(1)
As the statute indicates, section 382
is activated by changes in stock ownership. Congress believed that such
changes provide the best indication of
60
a potentially abusive transaction,
i.e., "loss-trafficking." See H.R.
Rep. No. 426, 99th Cong., lst Sess. 256
(1985) (hereinafter referred to as the
"House Report"). See also S. Rep. No.
313, 99th Cong., 2nd Sess. 232 (1986)
(hereinafter referred to as the "Senate
Report").
2.
(2)
Congress was concerned that once a
change in control occurred, the new
owners could abuse the carryover provisions by contributing income-producing
assets or by diverting profitable
opportunities to the loss corporation
in order to absorb NOL carryovers more
rapidly than could the old owners.
(3)
Thus, the rules apply only after a 50
percent change in ownership of stock in
the loss corporation.
Determination Events -- Testing Date
a.
In order to determine whether an ownership
change has occurred, the statute requires
that an initial determination first be made
as to whether an "owner shift involving a 5percent shareholder" ("owner shift") or an
"equity structure shift" has occurred.
These two terms are defined in detail below.
b.
The regulations modify the statute slightly
by stating that the ownership change calculation must be made immediately after the
close of the "testing date." Treas. Reg. §
1.382-2(a)(4).
(1)
For testing dates after November 4,
1992, the final regulations apply.
Under those regulations, the first
testing date for an option is the date
of issuance or transfer. Treas. Reg. §
1.382-2(a)(4)(i).
(a)
The first testing date is also
significant because it is the date
for determining whether an option
61
has an abusive principal purpose
under the ownership, control, or
income tests. See Id. Percentage
increases are calculated at the
close of the testing date, and all
transactions creating a testing
date on that day are deemed to
occur simultaneously. Treas. Reg.
§ 1.382-2(a)(4)(i).
(b)
If an option has an abusive principal purpose under the ownership,
control, or income tests, but the
option is not part of an ownership
change on the date of issue or
transfer, the option is permanently “evergreen” (see Part
IV.A.). ABA Tax Section:
Corporate Tax Committee Considers
Section 382, 94 TNT 94-3 (May 16,
1994). Therefore, these options
are deemed exercised on all
subsequent testing date under
Treas. Reg. § 1.382-2(a)(4)(i).
(c)
Under Treas. Reg. § 1.3822(a)(4)(i), a testing date occurs
immediately after:
i)
Any owner shift, or
ii)
an issuance or transfer of an
option in the loss corporation stock if that option is
treated as exercised under
Treas. Reg. § 1.382-4(d)(2)
(this rule also applies to a
contract as described under
Treas. Reg. § 1.3824(d)(8)(i) or to an indirect
transfer of an option under
Treas. Reg. § 1.3824(d)(8)(ii)).
Example
January 1, 1995 Testing Date
62
Loss Corporation (L) has 100
shares of stock outstanding, all
of which is equally owned by
individuals A and B. On January
1, 1995, individual C acquires 30
shares of L stock from A and an
option to acquire an 15 additional
shares of L stock from A. Assume
C has an abusive principal purpose
under Treas. Reg. § 1.382-4(d) for
using the option.
Because the 15 share option is
abusive, the option will be deemed
exercised on January 1, 1995,
thereby resulting in a 45 percentage point shift (30 percentage
points for the stock and 15 percentage points for the option).
However, the 45 percentage point
shift does not trigger an ownership change.
June 1, 1995 Testing Date
On June 1, 1995, L issues an
option to key employee D allowing
D to acquire 2 shares of L stock
from L. Assume L does not have an
abusive principal purpose under
Treas. Reg. § 1.382-4(d)(2) for
using the option.
June 1, 1995 is not a testing date
because L did not have an abusive
principal purpose under Treas.
Reg. § 1.382-4(d) for issuing the
option. Therefore, C's 15 share
option for L stock is not deemed
exercised on June 1, 1995.
December 1, 1995 Testing Date
On December 1, 1995, L issues 20
shares of L stock to key employee
D in exchange for cash.
December 1, 1995 is a testing
date, and therefore, C's 15 share
option for L stock is deemed exer-
63
cised on that date. As a result,
L has an ownership change on
December 1, 1995 (20.83 percentage
points (25/120) for C's acquisition of L stock, 12.5 percentage
points (15/120) for C's acquisition of the option for L stock,
and 16.67 percentage points
(20/120) for D's acquisition of L
stock).
(d)
However, under Treas. Reg.
§ 1.382-4(d)(ll), the following
transfers do not trigger testing
dates under the final option
attribution regulations:
i)
Transfers between persons who
are not 5-percent shareholders (taking into option held
by the transferor and transferee if these options were
treated as exercised);
ii)
Transfers between separate
public groups resulting from
the segregation rules of
Treas. Reg. §§ 1.382-T(j)(2)
and -2T(j)(3).
iii) Transfers described in section 382(1)(3)(B) (relating
to stock acquired by reason
of death, gift, divorce,
separation, etc . . . )
(2)
For testing date prior to November, 5,
1992, the temporary regulations apply.
Under the temporary regulations, the
term "testing date" refers to any date
on which the loss corporation is
required to make a determination of
whether an ownership change has
occurred. Treas. Reg. § 1.3822T(a)(2)(i).
(a)
Consistent with section 382(g)(1),
the regulations provide that any
64
date on which an owner shift or
equity structure shift occurs is a
testing date. Treas. Reg.
§ 1.382-2T(a)(2)(i).
(b)
In addition, the regulations
explicitly provide that the term
"testing date" includes any date
on which an option with respect to
stock of the loss corporation is
(A) transferred to (or by) a 5percent shareholder (or a person
who would be a 5-percent shareholder if the option were treated
as exercised), or (B) issued by
the loss corporation, a "first
tier entity", or a "higher tier
entity" that owns 5 percent or
more of the loss corporation stock
(determined without regard to certain constructive ownership rules
found in Treas. Reg. § 1.3822T(h)(2)(A)(ii)).
i)
The term "first tier entity"
and "higher tier entity" will
be discussed in detail below.
The rules to determine which
shareholders are 5-percent
shareholders also will be
discussed below.
ii)
Presumably, Treasury was of
the view that special rules
were required to deal with
the transfer or issuance of
an option, since, under
section 382(l)(3)(A)(iv), an
option will trigger an owner
shift only if it also triggers an ownership change.
iii) By making the issuance or
transfer of an option an
explicit testing event, the
regulations ensure that an
ownership change calculation
65
will be made even if the
option is not treated as
being exercised.
(3)
With respect to this special option
rule, several aspects are noteworthy.
(a)
First, the provision treats as a
testing event the transfer of an
option to or by a 5-percent shareholder (or a person who would be a
5-percent shareholder if the
option were treated as exercised).
i)
Although all of a loss corporation's stock ultimately is
treated as being owned by 5percent share- holders -either by individual 5-percent shareholders or groups
of shareholders that are
treated as a single 5-percent
shareholder -- certain transfers of options nevertheless
should not be treated as
testing events.
ii)
For example, assume that
individual A owns 4 percent
of the loss corporation stock
and A grants to individual B
an option to acquire such
stock. A and B would be
aggregated as part of a public group which is treated
under the aggregation rules
as a single individual. See
Treas. Reg. § 1.3822T(j)(l)(ii) and (iv)(C).
iii) Thus, for section 382
purposes, the transfer by A
to B should be disregarded
since an individual cannot
transfer an option to himself. In addition, Treas.
Reg. § 1.382-2T(h)(4)(xi)
66
states that transfers of
options between persons who
are not 5-percent shareholders are to be disregarded.
(b)
Second, this special option rule
does not seem to work properly in
the case of transfers by entities.
i)
For example, assume that an
option with respect to 10
percent of the outstanding
stock of the loss corporation
(L) is transferred by one
corporation (P) to another
corporation (X). Technically, the transfer would not
be by or to a 5-percent
shareholder since a corporation generally cannot be a 5percent shareholder. See
Treas. Reg. § 1.382-2T(g)(1)
and (h)(2).
ii)
If the option were treated as
exercised, the shareholders
of the corporation would be
treated as owning the L stock
and thus would be 5-percent
shareholders; however, such
persons did not in fact
transfer the option or the
underlying stock.
iii) Moreover, unless the option
were treated as stock pursuant to section
382(k)(6)(B)(i), it does not
seem that the option can be
attributed to such shareholders so that they would be
deemed to transfer the
option.
iv)
67
This problem can be avoided
by providing, as in the case
of the issuance of an option,
that the attribution rule
under Treas. Reg. § 1.3822T(h)(2)(i)(A) (disregarding
actual or constructive ownership of stock by an entity)
will not apply for purposes
of determining 5-percent
shareholder status under the
testing date rules.
(c)
Third, the provision refers to "an
option with respect to stock of
the loss corporation." This
language itself would not include
options with respect to interests
in a first tier entity or higher
tier entity. However, the regulations elsewhere provide that "as
the context may require," loss
corporation "stock" includes any
"indirect ownership interest" in
the loss corporation. Treas. Reg.
§ 1.382-2T(f)(18)(iv).
i)
An "indirect ownership interest" is defined by Treas.
Reg. § 1.382-2T(f)(15) as an
interest a person owns in an
entity determined solely as
the result of the constructive ownership rules (and
without regard to any direct
or beneficial interest in the
entity).
ii)
Thus, if an indirect ownership interest in the loss
corporation is created by
virtue of direct ownership
interest in a first tier or
higher tier entity, it would
seem that an option with
respect to the first tier or
higher tier entity would also
be treated as an option with
respect to the loss corporation.
68
iii) This result is further supported by the fact that in
the case of the issuance of
an option, the regulations
refer to options (with
respect to loss corporation
stock) that are "issued by"
the loss corporation, a first
tier entity, or a higher tier
entity.
(d)
iv)
Inasmuch as a first tier or
higher tier entity generally
would not "issue" an option
physically exercisable into
loss corporation stock, the
regulations again seem to
contemplate that an option
with respect to first tier or
higher tier entities will be
treated as an option with
respect to loss corporation
stock.
v)
Accordingly, the transfer of
an option on outstanding
stock of a first tier or
higher tier entity seems to
be a testing event. If this
is the intended result, then
the regulations should be
clarified.
With respect to the issuance of an
option by a loss corporation,
first tier entity or higher tier
entity (that owns 5-percent or
more of the loss corporation stock
without regard to Treas. Reg.
§ 1.382-2T(h)(2)(i)(A)), any issuance of an option will give rise
to a testing event.
i)
69
Thus, for example, the issuance of an option with
respect to one share of stock
in a first tier or higher
tier entity will create a
testing event.
ii)
(e)
(4)
Also, the issuance of an
option to a corporation
normally would create a testing event, even though, as
discussed above, a corporation cannot be a 5-percent
shareholder.
Importantly, according to Treas.
Reg. §§ 1.382-2T(f)(9) and (14), a
corporation's status as a first
tier or higher tier entity is
determined without regard to the
constructive ownership rules.
Thus, certain issuances of options
may not create a testing event.
i)
For example, assume that a
corporation (X) owns an
interest in the loss corporation (L) solely because of an
option with respect to L
stock (such option, if exercised, would cause the corporation to be treated as a
first tier entity).
ii)
If X issues an option with
respect to its own stock,
such issuance apparently
would not be treated as a
testing event. X is not a
first tier entity since its
interest in the loss corporation arises through attribution only.
The regulations provide that all computations of increases in percentage ownership are to be made at the close of
the testing date. If more than one
transaction requiring a section 382
determination occurs on the testing
date, all such transactions will be
70
treated as occurring simultaneously at
the close of the testing date. Treas.
Reg. § 1.382-2T(a)(2)(i). See LTR
8809081 as modified by LTR 8823002.
c.
(5)
Transactions described in section
382(1)(3)(B) (stock acquired by reason
of death, gift, divorce, etc.) and
equity structure shifts which are not
also owner shifts are not transactions
that require a determination of whether
an ownership change occurred under section 382(g)(1). Treas. Reg. § 1.3822T(a)(2).
(6)
The Outline may refer to an owner
shift, an equity structure shift or an
option transaction (as described above)
that invokes section 382(g)(1) as a
"testing event."
On September 29, 2008, the IRS and Treasury
announced in Notice 2008-76 their intent to
issue regulations providing that the term
“testing date” shall not include any date on
or after the date on which the United States
(or and agency or instrumentality thereof)
acquires, in a Housing Act Acquisition,
stock (including stock described in section
1504(a)(4)) or an option to acquire stock in
the corporation.
(1)
Notice 2008-76 defines “Housing Act
Acquisition” as an acquisition made by
the Secretary of the Treasury pursuant
to section 1117(a) and (b) of the
Housing and Economic Recovery Act of
2008, Pub. L. No. 110-289 (2008). The
Housing and Economic Recovery Act
authorizes the Secretary of the
Treasury to purchase obligations and
other securities issued by Fannie Mae
and Freddie Mac.
(2)
Notice 2008-76 indicates that the
regulations described in the notice
will apply on or after September 7,
71
2008, and will apply unless and until
there is additional guidance.
d.
On October 14, 2008, the IRS and Treasury
announced in Notice 2008-84 their intent to
issue regulations under section 382(m) that
address the application of section 382 in
the case of certain acquisitions not
described in Notice 2008-76 in which the
United States (or any agency or
instrumentality thereof) becomes a direct or
indirect owner of a more-than-50-percent
interest in a loss corporation.
(1)
The regulations the IRS and Treasury
will issue under section 382(m) will
provide that notwithstanding any other
provision of the Code or the
regulations thereunder, for purposes of
section 382 and the regulations
thereunder, with respect to a loss
corporation, the term “testing date”
(as defined in § 1.382-2(a)(4)) shall
not include any date as of the close of
which the United States directly or
indirectly owns a more-than-50-percent
interest in the loss corporation.
Thus, the loss corporation will be
required to determine whether there is
a testing date and, if so, whether
there has been an ownership change for
purposes of section 382, on any date as
of the close of which the United States
does not directly or indirectly own a
more-than-50-percent interest in the
loss corporation.
(2)
These regulations will apply for any
taxable year ending on or after
September 26, 2008, and will apply
unless and until there is additional
guidance.
(3)
For the purposes of these regulations,
a “more-than-50-percent interest” is
stock of the loss corporation
possessing more than 50 percent of the
72
total value of shares of all classes of
stock (excluding stock described in
section 1504(a)(4)) or more than 50
percent of the total combined voting
power of all classes of stock entitled
to vote, or an option to acquire such
stock.
3.
Measuring Changes in Stock Ownership
The precise method for measuring changes in stock
ownership under section 382(g)(1) is unclear from
the statutory language.
a.
b.
Under the regulations, to determine if an
ownership change has occurred at the close
of the testing date, the increases in percentage ownership for each separate 5-percent shareholder whose percentage ownership
has increased during the testing period must
be aggregated. See Treas. Reg. § 1.3822T(c)(1).
(1)
Under the regulations, the amount of
the increase is the difference between
the 5-percent shareholder's percentage
holdings immediately after the close of
the testing date and such shareholder's
lowest percentage holdings in the loss
corporation (or any predecessor corporation) during the testing period.
(2)
If the total increases for each separate 5-percent shareholder exceeds 50
percentage points, then an ownership
change has occurred.
The regulations explicitly provide that the
lowest percentage holdings of each 5-percent
shareholder may be determined at different
dates during the testing period. This
interpretation is supported by the legislative history.
(1)
The conference report states that an
ownership change occurs if the percentage of stock in the new loss corporation owned by any one or more 5-percent
73
shareholders has increased by more than
50 percentage points relative to the
lowest percentage of stock owned by
those 5-percent shareholders at any
time during the testing period. See
Conf. Rep. at II-172.
(2)
c.
4.
The conference report goes on to state
that the determination of whether an
ownership change has occurred is made
by aggregating increases in percentage
ownership in each 5-percent shareholder
whose interest has increased during the
testing period. See Conf. Rep. at II173.
A controversy had arisen because section
382(g)(1) requires a comparison of current
percentage holdings of 5-percent shareholders in the loss corporation with "the lowest
percentage of stock of the loss corporation
... owned by such shareholders at any time
during the testing period."
(1)
Some had interpreted this language to
mean that the lowest percentage holdings of 5-percent shareholders must be
determined at a single date during the
testing period.
(2)
The regulations consider and reject
this interpretation. See Treas. Reg.
§ 1.382-2T(c)(3) and (4).
Section 382(n) – Special Rules for Certain
Ownership Changes
a.
Section 1262(a) of the Amercian Recovery and
Reinvestment Tax Act of 2009 added
subsection (n) to section 382, which applies
to ownership changes occurring after
February 17, 2009.
b.
Section 382(n) states that the section
382(a) limitation shall not apply in the
case of an ownership change which is
pursuant to a restructuring plan of a
taxpayer which:
74
(1)
Is required under a loan agreement or a
commitment for a line of credit entered
into with Treasury under the Emergency
Economic Stabilization Act of 2008
(P.L. 110-343), and
(2)
Is intended to result in a
rationalization of the costs,
capitalization, and capacity with
respect to the manufacturing workforce
of, and suppliers to, the taxpayer and
its subsidiaries.
c.
Section 382(n)(1) shall not apply in the
case of any subsequent ownership change
unless such ownership change is described in
section 382(n)(1).
d.
Limitations on section 382(n) based on
control in the corporation.
(1)
e.
Section 382(n)(1) shall not apply in
the case of any ownership change if,
immediately after such ownership
change, any person (other than a
voluntary employees' beneficiary
association under section 501(c)(9))
owns stock of the old loss corporation
possessing 50 percent or more of the
total combined voting power of all
classes of stock entitled to vote, or
of the total value of the stock of such
corporation.
Under section 382(n)(3), related persons
shall be treated as a single person.
(1)
For section 382(n)(3)(B)((i) purposes,
a person shall be treated as related to
another person if:
(a)
Such person bears a relationship
to such other person described in
section 267(b) or 707(b), or
(b)
Such persons are members of a
group of persons acting in
concert.
75
B.
Defined Terms
1.
Owner Shift Involving a 5-Percent Shareholder
a.
b.
c.
Under section 382(g)(2), an "owner shift
involving a 5-percent shareholder" occurs if
there is:
(1)
any change in the respective stock ownership in a corporation, and
(2)
such change affects the percentage of
stock in the corporation owned by any
person who is a 5-percent shareholder
before or after such change. Section
382(g)(2); Treas. Reg. § 1.3822T(e)(1)(i).
In general, the term "5-percent shareholder"
means any person holding 5 percent or more
of the stock in a corporation at any time
during the testing period. Section
382(k)(7). See further discussion below at
Part V.G.
(1)
The percentage of stock held by any
person is made on the basis of value.
Section 382(k)(6)(C).
(2)
Generally, the term testing period
refers to the three-year period preceding the owner shift. See further discussion below at Part V.B.7.
An owner shift may occur in a number of
ways. Some of these include the following.
(1)
Purchase transactions
A purchase of stock either from or by a
5-percent shareholder.
(2)
Redemptions
A redemption transaction involving a
corporation having at least one 5-percent shareholder. However, the Service
has ruled that the issuance of cash in
76
lieu of fractional shares on conversion
of preferred stock will not be
considered an owner shift. LTR 9405011
(November 3, 1993).
(3)
Section 351 exchanges
A section 351 exchange that affects the
percentage of stock held by 5-percent
shareholders.
(4)
Issuances of stock
An issuance of stock which affects the
holdings of 5-percent shareholders.
(5)
Conversion transactions
A conversion by creditors of debt to
equity which affects the holdings of 5percent shareholders.
(6)
Equity structure shifts
Equity structure shifts affecting the
holdings of 5-percent shareholders also
constitute owner shifts.
(a)
The House version of H.R. 3838
excepted equity structure shifts
from the definition of an owner
shift. The Senate version
excepted only equity structure
shifts which constituted more than
50 percent equity structure
shifts.
(b)
These exceptions were not included
in the final drafting of section
382 (due to the move to a single
definition of an ownership
change). Thus, technically, an
equity structure shift may constitute an owner shift.
(c)
One may question the need for a
separate definition of an equity
structure shift. The difference
between owner shifts and equity
77
structure shifts appears to be in
the operation of the 5-percent
shareholder rules. However, as
discussed at Part V.B.2.b.3.,
below, section 382(g)(4)
adequately deals with ownership
changes involving one corporation
(a typical owner shift or recapitalization) or multiple corporations (a typical equity structure
shift other than a recapitalization).
(7)
(d)
The regulations recognize this
fact by specifically including
recapitalization transactions and
equity structures shifts that
affect the percentage of stock
held by 5-percent shareholders as
examples of owner shifts. See
Treas. Reg. § 1.382-2T(e)(1)(i).
(e)
The regulations also recognize
that the equity structure shift
provisions are unnecessary. See
Preamble to T.D. 8149. Under
Treas. Reg. § 1.382-2T(a)(2)(i),
equity structure shifts that are
not also owner shifts are not
testing events.
Worthless stock deductions
(a)
OBRA 87 added section 382(g)(4)
(D), which provides that if any
stock held by a "50-percent
shareholder" is treated by such
shareholder as becoming worthless
during the taxable year, and such
stock is held by the shareholder
as of the close of the taxable
year, such shareholder in effect
would be treated as if he acquired
his interest for the first time as
of the first day of the following
year. This treatment would result
in an owner shift (query to what
78
degree if the stock is worthless
and percentage interest is based
on value).
(b)
For purposes of this rule, the
term "50-percent shareholder"
means any person owning 50 percent
or more of the stock of the corporation at any time during the 3year period ending on the close of
the year.
(c)
The language of section
382(g)(4)(D) strongly suggests
that it applies only when the loss
deduction is actually claimed. It
thus appears to be volitional; the
rule should have no application
merely because stock becomes
worthless (and even though section
165 states that a loss shall be
claimed when incurred).
(d)
The Bankruptcy Court precluded a
parent from claiming a worthless
stock deduction in the case of In
Re Prudential Lines, Inc., 107
B.R. 832 (Bkrtcy). S.D.N.Y. 1989),
114 B.R. 27 (Bkrtcy S.D.N.Y.
1989), aff'd, 119 B.R. 430
(S.D.N.Y. 1990), aff'd, 928 F.2d
565 (2d Cir. 1991) on the grounds
that such action would destroy the
subsidiary's NOLs (due to section
382(g)(4)(D)). The court viewed
the NOLs as property of the bankruptcy estate). See 11 U.S.C.
§ 541.
d.
In general, unless a corporation is solely
owned by non-5-percent shareholders, almost
any non pro rata transaction involving stock
of a corporation will constitute an owner
shift.
e.
The regulations confirm that transfers of
stock between persons who are not 5-percent
79
shareholders are not owner shifts.
Treas. Reg. § 1.382-2T(e)(1)(ii).
2.
See
Equity Structure Shift
a.
b.
An equity structure shift is defined as "any
reorganization (within the meaning of
section 368)." Section 382(g)(3)(A).
(1)
However, "F" reorganizations are not
equity structure shifts. Section
382(g)(3)(A)(ii). In addition, "D" and
"G" reorganizations do not constitute
equity structure shifts unless the
requirements of section 354(b)(1) are
met, i.e., divisive reorganizations are
excluded from the definition of an
equity structure shift. Section
382(g)(3)(A)(i).
(2)
The regulations correct an oversight in
the statute by limiting the definition
of an equity structure shift to
reorganizations in which the loss
corporation is a party. Treas. Reg.
§ 1.382-2T (e)(2)(i). Thus, an equity
structure shift could not occur where a
corporate shareholder of the loss
corporation is involved in a merger
with another corporation.
(3)
The regulations confirm an equity
structure shift that affects the
percentage of stock owned by a 5percent shareholder also constitutes an
owner shift. See Treas. Reg. § 1.3822T(e)(2)(iii).
Section 382(g)(3)(B) grants Treasury the
authority to promulgate regulations that
treat "taxable reorganization-type transactions, public offerings and similar transactions" as equity structure shifts.
(1)
Section 382(g)(3)(B) was added by the
conferees apparently because it was
felt that the definition of an equity
structure shift for section 382 pur80
poses should not be tied exclusively to
the tax-free nature of the reorganization under section 368.
(2)
For section 382 purposes, the taxable
or tax-free nature of a reorganization
should not be relevant. What is important is that a measurable stock ownership change occurs as a result of the
reorganization.
(3)
However, the addition in conference of
sections 382(g)(4)(C) (applying the
segregation rules to owner shift transactions) and (m)(4) (applying the
(g)(4) rules to a single corporation)
obviated the need for section
382(g)(3)(B).
(4)
Given that both of these sections were
added in conference, it was unclear
precisely how they interrelated.
(a)
For example, it was unclear
whether section 382(g)(4)(C) was
restricted in scope to those
transactions that were treated as
equity structure shifts under section 382(g)(3)(B), or whether sections 382(g)(4)(C) and (m)(4)
could be applied to any transaction to achieve results similar to
section 382(g)(3)(B).
(b)
If sections 382(g)(4)(C) and
(m)(4) applied independently of
section 382(g)(3)(B), it was
unclear whether such sections
could be applied retroactively,
even though the legislative
history indicated that section
382(g)(3)(B) was to apply prospectively. See Silverman and Keyes,
"New Limitations on NOL Carryovers
Following the Tax Reform Act:
Part I," 66 JTAX 194 (April,
1987), at 198.
81
(5)
c.
3.
TAMRA clarified that section
382(g)(4)(C) is not limited in scope to
transactions described in section
382(g)(3)(B), but that section
382(g)(3)(B) merely provides additional
authority to segregate groups of shareholders. TAMRA Gen. Expl. at 45.
Treasury did not exercise its regulatory
authority under section 382(g)(3)(B), preferring instead to reserve the issue of section 382(g)(3)(B). See Preamble to T.D.
8149; Treas. Reg. § 1.382-2T(e)(2)(ii).
(1)
By relying on the segregation rules of
sections 382(g)(4)(C) and (m)(4) (as
implemented by Treas. Reg. §§ 1.3822T(j)(2) and (3)), similar results
under the owner shift rules can be
achieved as those that would obtain if
such transactions were treated as
equity structure shifts.
(2)
In fact, as the regulations point out,
any equity structure shift that affects
the holdings of 5-percent shareholders
is also an owner shift. Thus, there is
no substantive difference (other than
the statutory effective dates) between
owner shifts and equity structure
shifts.
Stock
Section 382 is triggered by changes in "stock"
ownership. Therefore, the determination of
whether an ownership change has occurred is
dependent upon an initial determination of which
interests in the loss corporation qualify as
"stock" for section 382(g)(1) purposes. Unfortunately, as will be pointed out below, it may be
quite difficult to determine whether a particular
interest in the loss corporation constitutes
stock for purposes of section 382.
a.
The general rules
82
(1)
(2)
For purposes of determining whether an
ownership change has occurred, the term
"stock" means all stock other than
stock described in section 1504(a)(4).
Section 382(k)(6)(A); Treas. Reg.
§ 1.382-2(a)(3)(i). See LTR 8945055.
(a)
In general, section 1504(a)(4)
stock is stock which is nonvoting,
nonparticipating, nonconvertible,
limited and preferred as to dividends, and not entitled to an
unreasonable redemption or liquidation premium.
(b)
The exclusion of section
1504(a)(4) stock from the definition of stock means that changes
in the ownership of such stock
will be disregarded in determining
whether an ownership change has
occurred. The retention of such
stock by the historic shareholders
will not prevent an ownership
change.
(c)
Congress wanted to exclude section
1504(a)(4) stock from the definition of "stock" for this purpose
in order to prevent the result
reached in Maxwell Hardware Co. v.
Commissioner, 343 F.2d 713 (9th
Cir. 1965). Conf. Rep. at II-173.
In Maxwell Hardware, the parties
avoided old section 382(a) by
having the existing shareholders
of a loss corporation retain stock
similar to that described in section 1504(a)(4).
Consistent with the legislative
history, the regulations provide that
section 1504(a)(4) stock which becomes
voting stock solely because of dividend
arrearages will remain nonstock under
section 382 (even though this may not
be the case under section 1504). See
83
Treas. Reg. § 1.382-2(a)(3)(i); Conf.
Rep. at II-173.
(a)
This rule reflects the sound
policy judgment that a loss corporation that is experiencing significant financial difficulty
should not suffer an unexpected
ownership change because nonvoting
stock became voting stock due to
dividend arrearages.
(b)
However, the regulations failed to
extend this policy objective to
analogous and equally deserving
cases. For example, the terms of
redeemable, nonvoting preferred
stock may provide that the stock
will become voting if a prescribed
redemption schedule is not maintained. If such stock does become
voting stock because of the corporation's financial inability to
meet the redemption schedule, such
stock should still be treated as
nonstock. This does not appear to
be the case under the regulations.
(c)
For the possibility that such
stock could nevertheless be
treated as "stock" under Treas.
Reg. § 1.382-2T(f)(18)(iii), see
Part V.B.3.c., below.
(3)
For purposes of determining the
percentage of stock owned by a person,
each share having the same material
terms should be treated as having the
same value. Control premium or blockage discount should not be taken into
account. This is confirmed by Treas.
Reg. § 1.382-2(a)(3)(i). See Part
V.B.3.e., below.
(4)
For purposes of determining the value
of the loss corporation, "stock"
includes section 1504(a)(4) stock. See
84
section 382(e); Treas. Reg. § 1.3822(a)(3)(i).
b.
(a)
The value of the loss corporation
is used to determine the section
382 limitation amount. See below
at Part VI.A.5.b.
(b)
This is a beneficial rule since it
should result in an increased section 382 limitation amount.
Treating "stock" as not stock
Under sections 382(k)(6)(A) and
(k)(6)(B)(ii), Treasury has authority to
exclude from the definition of "stock,"
interests which otherwise qualify as stock.
(1)
Treasury exercised this authority in
drafting the regulations. Under Treas.
Reg. § 1.382-2T(f)(18)(ii), an ownership interest that would otherwise constitute "stock" will not be treated as
stock if:
(a)
As of the time of its issuance or
transfer to (or by) a 5-percent
shareholder, the "likely participation" of such interest in future
corporate growth is "disproportionately small" when compared to
the value of such stock as a proportion of total value of the outstanding stock of the corporation
(the "growth participation" test);
(b)
Treating the interest as not constituting "stock" would result in
an ownership change (the "ownership change" test); and,
(c)
The amount of pre-change loss
(determined as if the testing date
were the change date and treating
any net unrealized built-in loss
as a pre-change loss) exceeds a
certain threshold amount -- twice
85
the product of the value of the
loss corporation on the testing
date and the long term tax exempt
rate (as defined in section
382(f)) for the calendar month in
which the testing date occurs
(i.e., essentially double the section 382 amount for a single 365day post-change year) (the "de
minimis" test).
(2)
The growth participation test originated in the conference report. See
Conf. Rep. at II-173. Unfortunately,
the regulations fail to provide any
objective guidance or safe harbor provisions as to what is the "likely participation" of an interest in future
growth and whether such participation
may be considered to be "disproportionately small." Thus, applying the
growth participation test in practice
may be quite difficult. Rulings on the
subject have given a limited amount of
guidance.
(a)
Nonvoting, nonparticipating, nonconvertible preferred stock callable at 102-105 percent of issue
price was ruled not stock under
Treas. Reg. § 1.382-2T(f)(18)(i)
(now Treas Reg. § 1.3822(a)(3)(i)) and (iii). LTR
8911061.
(b)
The common stock of a corporation
with NOL carryovers of $153 million and a negative net worth was
ruled stock within the meaning of
regulation section 1.3822T(f)(18)(i). Conversely, subordinated debentures and senior subordinated debt of the same corporation were ruled not stock, as
was nonvoting, nonconvertible preferred stock of a corporate shareholder. LTR 8917007; LTR 8841038.
86
(c)
Preferred stock received in
exchange for corporate debt, with
a yield not materially in excess
of market and a redemption price
not exceeding 110% of issue price,
was ruled not stock. The corporation also represented that it
would have sufficient cash flow to
meet required payments on the preferred stock. LTR 8940006.
(d)
Nonconvertible, nonvoting preferred stock was ruled not stock
unless the provisions of Treas.
Reg. § 1.382-2T(f)(18)(iii)
applied. However, the Service
also stated that so long as current earnings were sufficient to
permit the taxpayer to pay dividends at the highest rate with
respect to each class of preferred, none of those classes
would offer a potential significant participation in growth
solely because of the dividend
rate. LTR 8945055.
(e)
Payment-in-kind notes (the “PIK
facility”) were determined not to
be treated as stock under Treas.
Reg. § 1.382-2T(f)(18)(iii) in LTR
200938010. The conditions placed
on this determination were: (1)
Parent (nor any person related to
Parent within the meaning of
sections 267(b) or 707(b)) is not
actively involved in placing the
PIK facility with acquiring
persons; (2) the PIK facility is
not issued or transferred to an
acquiring person and such person
becomes the owner of more than 50
percent of the PIK facility; and
(3) there is no change in the
terms of the PIK facility that is
either in kind or extent.
87
(3)
(4)
Several additional problems arise in
applying this three-part test.
(a)
First, all three elements of the
test must be met in order for
stock to be disregarded. However,
the temporal relationship between
the three elements is unclear.
That is, the growth participation
test is clearly applied only when
the ownership interest in question
is issued or transferred (to or by
a 5-percent shareholder); however,
it is not clear whether the ownership change test and the de
minimis test are applied only when
the interest in question is issued
or transferred, or whether such
tests are to be applied anew as of
any testing date (including testing dates where the interest in
question was not issued or transferred).
(b)
Second, with respect to the ownership change test, one cannot
determine whether treating a stock
interest as nonstock will result
in an ownership change unless one
knows whether the reclassification
of stock as nonstock will be given
retroactive effect throughout the
testing period.
(c)
Third, it is not clear whether the
three-part test applies only to
the ownership interest that was
actually issued or transferred, or
whether it applies to the entire
class of the ownership interest
(only part of which may have been
transferred or issued).
To illustrate some of these uncertainties, assume that individual A owns all
100 shares of the outstanding common
stock of loss corporation (L). On
88
January 1, 1987, L issues 20 shares of
voting preferred stock (representing 20
percent of the total value of L stock)
to individual B. On June 15, 1990, A
transfers 51 shares of the L common
stock to individual C. Assume that the
"de minimis" test is satisfied at all
times. Further assume that when the
voting preferred stock was issued to B,
the growth participation test was satisfied (i.e., the likely participation
of such stock in future growth of L was
disproportionately small compared to
the preferred stock's proportionate
value of 20 percent).
(a)
At the time of the issuance of the
preferred stock to B, such stock
would not be disregarded since the
ownership change test within the
three-part rule would not be met.
At the time of the later transfer
of common stock by A to C, under a
literal interpretation of the
three-part test, the preferred
stock would be disregarded and
section 382 would apply.
(b)
The preferred stock satisfied the
growth participation test at the
time of its issuance; the de
minimis test is met; and disregarding the preferred stock would
result in an ownership change
since the common stock would be
treated as the only class of stock
outstanding, and A transferred 51
out of the 100 outstanding shares
of such stock.
(c)
This result apparently obtains
even though the preferred stock
was not issued or transferred during the testing period.
(d)
However, if the three-part test
were interpreted to mean that each
89
element of the test must be
applied at the same time, and only
when the interest in question is
issued or transferred, the preferred stock would not be disregarded as stock. A's transfer to
C would not cause an ownership
change since only 41 percent (51
percent of 80 percent) of the L
stock was transferred.
(5)
If each element of the three part test
is applied at different times,
anomalous results may occur.
(a)
For example, assume the same facts
as in the preceding example (i.e.,
the growth participation test is
met at the time of the issuance of
the preferred stock and the de
minimis test is satisfied at all
times) except that subsequent to
the issuance of the preferred
stock to B, the financial condition of L deteriorates rapidly.
For the foreseeable future, the
preferred stock arguably represents the only class of stock that
will participate in L's growth. A
then transfers 51 shares of the L
common stock to C on June 15, 1990
(i.e., more than three years after
the initial issuance of preferred
stock).
(b)
Based on a literal application of
the three-part test, an ownership
change would occur at the time of
transfer of common stock to C -the de minimis test is met; the
preferred stock had little participation in growth at the time
of issuance; and treating the
interest as nonstock on the date
of A's transfer of common stock to
C would result in an ownership
change. This result is reached
90
even though, in effect, the only
class of currently participating
stock, B's preferred stock, did
not change hands during the testing period.
(c)
Had B transferred one share of
preferred stock to C at the same
time that A conveyed the common
stock to C, the actual transfer of
the share apparently would force a
re-application of the growth participation test. However, it is
unclear whether the entire class
of preferred stock would be
treated as stock, or just the one
share that B transferred.
(d)
In this example, the better result
is obtained by applying all three
elements of the test at the same
time, and only when the interest
in question is issued or transferred.
(e)
Another approach would be to treat
B's voting preferred stock as
"stock" as of the time of A's
transfer of common stock to C,
inasmuch as the preferred stock at
that time is a participating
stock. In other words, the growth
participation test would be reapplied on each testing date even
if the interest in question was
not issued or transferred. If
this approach were adopted, the
ownership change test would also
have to be clarified to provide
that retroactive effect will be
given to the reclassification of
an interest.
(f)
Note that section 382(l)(3)(C)
states that changes in proportionate ownership that are attributable solely to fluctuation in the
91
relative fair market values of
different classes of stock will be
disregarded. This fluctuation-invalue issue should not be confused
with the timing issue illustrated
in the example (i.e., when should
the growth participation test be
applied). Factoring in the fluctuation issue renders the analysis
exceedingly complex.
(g)
(6)
Where the preferred stock has a
fixed liquidation preference, one
can argue that such stock is not
participating stock even if the
value of the loss corporation's
assets are below the liquidation
preference and subsequent asset
appreciation will redound to the
benefit of the preferred shareholders to the extent of such
preference.
According to the legislative history,
the authority to treat stock as not
stock was granted to Treasury, in part,
to prevent the results obtained in
Maxwell Hardware Co. Conf. Rep. at II173. See discussion above at Part
V.B.3.a. However, it is not clear that
the test, as currently formulated,
would achieve this goal.
(a)
In Maxwell Hardware, new shareholders transferred cash to a loss
corporation that had conducted a
hardware business. The loss corporation used the cash to develop
a real estate department; the
hardware business was discontinued. The new shareholders
received a class of nonvoting preferred stock that entitled them to
90 percent of the real estate
department's assets upon liquidation. The preferred stock represented 40 percent of the value of
92
the loss corporation at the time
of issuance. The historic shareholders apparently retained, and
did not transfer, their common
stock interests in the loss corporation.
(b)
Under section 382, this transaction will result in an ownership
change only if: (1) the historic
shareholders' common stock is
ignored, and (2) the new
investors' preferred stock is
treated as "stock." This would
trigger an ownership change
because of the shift in percentage
value to the new investors.
(c)
Applying the regulations to the
Maxwell Hardware facts, it is
assumed that the preferred stock
will be treated as stock. With
respect to the common stock, however, such stock can be ignored
under the three-part test only if
its likely participation in future
growth was disproportionately
small when such stock was issued
or transferred.
(d)
The facts of Maxwell Hardware
indicate that the common stock was
not transferred, and presumably,
such stock represented the only
class of participating stock when
it was issued.
(e)
The issuance of preferred stock to
the new investors would not cause
a reapplication of the growth participation test with respect to
the common stock (only the preferred stock is tested). Thus,
the common stock would continue to
be treated as stock for section
382 purposes, and the Maxwell
93
Hardware result would not be prevented.
(7)
(8)
Some have suggested that this stock-asnonstock rule may be used to trigger an
ownership change where so-called
"alphabet stock" is present. This does
not appear possible under the threepart rule.
(a)
For example, assume that a corporation (P) has held the loss corporation (L) stock throughout the
testing period, and P issued to
new investors a special class of P
stock having dividend rights based
strictly on L's earnings. By disregarding the currently
outstanding classes of P stock, an
ownership change with respect to L
could result. However, under the
three-part test, such common stock
could not be disregarded unless an
issuance or transfer of such stock
first occurred.
(b)
Problems can arise in the converse
situation. Assume that P acquires
all of the stock of L in exchange
for a special class of P stock
having dividend rights based
strictly on L's earnings. Without
applying the three-part rule, the
transaction constitutes an ownership change. If under the threepart rule the common stock of P
were disregarded, the transaction
presumably would not even constitute an owner shift since the historic L shareholders would hold
100 percent of L before and after
the exchange.
Importantly, it appears that any block
of "straight" voting preferred stock
could be disregarded as stock that does
not participate at all in the future
94
growth of the corporation. Apparently,
Congress was concerned that the general
definition of the term "stock" could be
manipulated by taxpayers in order to
avoid an ownership change.
(a)
For example, if individual (A)
sells all of the L stock to individual (B), an ownership change
would occur. However, this result
could be avoided if A first
recapitalized L so that A held
voting preferred stock representing more than 50 percent of the
value of L and common stock representing the remaining value inherent in L. A could then sell all
of the common stock to B without
triggering an ownership change.
Even though all future appreciation in the value of the loss corporation would accrue to the new
owner, an ownership change would
not occur in the absence of regulations disregarding the newly
issued preferred stock.
(b)
It seems that A's preferred stock
should not be excluded, absent
some evidence that B effectively
controlled the loss corporation.
If A uses independent judgment in
exercising his voting rights, his
stock ownership should be
respected even though the transaction falls outside of section 382.
(c)
Even if the parties plan on
redeeming all of A's preferred
stock in the future, B generally
must wait a full three years after
the time that his stock first
exceeds 50 percent of the value of
L in order to avoid section 382.
A complete redemption of A's
interest prior to this time would
trigger an ownership change
95
because B would own 100 percent of
L after the redemption and his
lowest percentage during the testing period would be less than 50
percent.
(d)
(9)
Here, the parties have done
nothing more than plan their
transaction so that the changes in
stock ownership fit within the
confines sanctioned by Congress.
Not only do the above problems of
application exist, but the scope of the
three-part test appears to be overly
broad.
(a)
The legislative history states
that a stock interest is to be
disregarded only "in appropriate
cases . . . when necessary to prevent avoidance of the [section
382] limitations." Thus, Congress
clearly intended to disregard
interests otherwise qualifying as
stock only in cases of abuse.
(b)
Unfortunately, the regulations do
not appear to be so limited, but
apparently can apply even where no
tax avoidance motive is present
(such as in the case of a routine
issuance of voting preferred
stock).
(10) Two final points should be made with
respect to this stock-as-nonstock rule.
(a)
The amount prescribed under the de
minimis test essentially is double
the section 382 limitation amount
for a normal post-change year,
i.e., the amount computed under
section 382(b)(1) without any of
the adjustments under section
382(b)(2) and (3).
96
(b)
c.
Stock that is not treated as
"stock" for purposes of determining whether an ownership change
occurs is nevertheless treated as
stock for purposes of determining
the value of the loss corporation.
Section 382(e); Treas. Reg.
§ 1.382-2T(f)(18)(ii).
Treating nonstock interests as "stock"
Under sections 382(k)(6)(A) and (k)(6)
(B)(i), Treasury has authority to treat
warrants, options, contracts to acquire
stock, convertible debt interests and other
similar interests as "stock" for purpose of
section 382.
(1)
It is unclear what purpose section
382(k)(6)(B)(i) serves. Under section
382(1)(3)(A)(iv), outstanding options
will be treated as being exercised if
such treatment results in an ownership
change. A similar statutory rule
applies to contingent purchases, warrants, convertible debt, put options
and other similar interests.
(a)
By treating options and similar
interests as being exercised under
section 382(1)(3)(A)(iv), it would
appear unnecessary to also treat
such interests as stock under section 382(k)(6)(B)(ii).
(b)
The regulations appear to correct
this overlap by excluding options
that are subject to Treas. Reg.
§ 1.382-2T(h)(4) (the option
attribution rules) from the rules
treating nonstock interests as
stock. See Treas. Reg. § 1.3822T(f)(18)(iii).
(c)
Thus, rights to acquire stock -options, warrants, etc. -apparently will be covered by the
option attribution rules and not
97
rules treating nonstock interests
as stock. LTR 9515037 states that
if an option is irrevocable and
exercisable and the seller grants
the buyer a voting trust for the
shares covered by the option, the
sale of the option is triggered as
a sale of the underlying stock.
(d)
(2)
If this conclusion accords with
Treasury intent, the section 382
regulations would have to be
amended if regulations under section 1504(a)(5)(A) treat such
stock rights as stock. As the
rule is currently written, such
options first have to be excepted
from the general definition of
stock under Treas. Reg. § 1.3822(a)(3)(i) before they can be
excepted from Treas. Reg. § 1.3822T(f)(18)(iii).
Under Treas. Reg. § 1.3822T(f)(18)(iii), an ownership interest
that would not be treated as stock
under the general rules will nevertheless be treated as stock if:
(a)
As of the time of its issuance or
transfer to (or by) a 5-percent
shareholder such interest "offers
a potential significant participation in the growth of the corporation" (the "potential growth participation" test);
(b)
Treating the interest as constituting stock would result in an
ownership change (the "ownership
change" test); and,
(c)
The amount of pre-change loss
(determined as if the testing date
were the change date and treating
any net unrealized built-in loss
as a pre-change loss) exceeds a
98
certain threshold amount -- twice
the product of the value of the
loss corporation on the testing
date and the long term tax exempt
rate (as defined in section
382(f)) for the calendar month in
which the testing date occurs (the
"de minimis" test).
(3)
The Preamble states that this provision
could apply to an instrument that is
otherwise treated as debt under the
income tax laws, but nevertheless
offers a potential significant participation in the growth of the loss corporation. See, e.g., LTR 9441036 (holding that a debt instrument will not be
"stock" only after taxpayer represented
that there will be sufficient assets to
meet payments of principal and interest). This statement is in conflict
with the rule itself which provides
only that "ownership interests" may be
treated as stock.
(4)
With respect to stock interests, Treas.
Reg. § 1.382-2T(f)(18)(iii) may be
unnecessary. The types of stock that
would be within its purview -- participating stocks generally -- would also
seem to be treated as "stock" under
section 1504 (and, accordingly, section
382).
(a)
For example, nonvoting preferred
stock issued at a discount could
be viewed as stock having a potential significant participation in
the growth of the loss corporation; however, such stock presumably would fall outside of section
1504(a)(4) as stock having an
unreasonable redemption premium.
The discount could also be viewed
as a substitute for a below market
dividend rate.
99
(5)
(b)
In addition, the conference report
states that section 1504(a)(4)
stock which carries a dividend
rate materially in excess of the
prevailing market rates may be
treated as participating stock,
and thus includible as stock for
purposes of section 382. See
Conf. Rep. at II-173. Such stock
presumably is covered by the first
part of the three-part test above
(the potential growth participation test) but may also be treated
as participating stock under section 1504, in which case the
interest would be treated as stock
for section 382 purposes without
regard to the three-part rule.
(c)
The differences, if any, between
stock interests treated as "stock"
herein and those treated as
"stock" under section 1504 will
not be known until regulations are
issued under section 1504.
As with the test for disregarding nominal "stock" interests, the test for
treating nonstock as "stock" is plagued
by similar problems of application.
(a)
The regulations fail to provide
objective guidance as to when an
ownership interest (otherwise
treated as nonstock) will be considered to offer "potential significant participation" in the
growth of the corporation. Note
that the potential growth participation test does not compare the
growth potential of an ownership
interest with the proportionate
value of such interest, as does
the growth participation test.
(b)
Also, as with the previous test,
an apparent timing difference
100
exists as to when each element of
the test is applied, and it is
unclear whether the test applies
only to the portion of the stock
issued or transferred or the
entire class of stock.
(c)
(6)
Further, it is unclear whether
reclassification of an ownership
interest as stock will be given
retroactive effect throughout the
testing period or whether the
interest will be treated as
nonstock up until the immediate
testing date (in which case a
deemed recapitalization -- stock
for nonstock -- in effect occurs
on the testing date).
To illustrate some of these issues,
assume that individual A owns all 20
outstanding shares of common stock in
the loss corporation (L). A also owns
all 80 shares of outstanding "straight"
preferred stock of L (i.e., section
1504(a)(4) stock). No other stock is
outstanding. The de minimis test is
assumed to be met at all times. On
January 1, 1987, A transfers 30 shares
of the preferred stock -- representing
30 percent of the value of both classes
of stock -- to individual B. At the
time of the transfer, assume that the
potential growth participation test is
not met (i.e., the stock did not offer
"potential significant participation"
in the growth of L). On June 15, 1990,
A transfers an additional 21 shares of
the preferred stock (representing 21
percent of the value of L) to B.
Assume that as of this second transfer
date, the financial condition of L has
deteriorated to the extent that the
preferred stock has the potential for
significant participation in the future
growth of L. Thus, the potential
growth participation test is satisfied.
101
(7)
(a)
In applying the ownership change
test, it is unclear whether the
preferred stock should be treated
as stock only as of the second
testing date or throughout the
testing period. If the preferred
stock is treated as stock only as
of the second testing date, B
would be viewed as increasing his
interest in L from 0 percent to 51
percent (30 percent + 21 percent
(assuming the 30 shares of stock
transferred earlier still represents 30 percent of the value of
L)). Under this approach, the
ownership change test would be
satisfied, and section 382 would
apply.
(b)
However, if the preferred stock is
treated as stock throughout the
testing period, B would be treated
as increasing his interest from 30
percent to 51 percent -- only a 21
percent change -- during the testing period. Under this approach,
the ownership change test would
not be satisfied, and section 382
would not apply.
This rule may lead to unintended
results where preferred stock is in
dividend arrearages. As discussed
earlier, Treas. Reg. § 1.382-2(a)(3)(i)
states that stock described in section
1504(a)(4) does not become "stock"
solely because the stock became voting
stock as a result of dividend
arrearages. However, dividend
arrearages also signal the deteriorating financial condition of the
loss corporation. Where the loss corporation is experiencing such difficulties, the value of its assets may be
well below the liquidation preference
of the preferred stock.
102
d.
(a)
In such a case, the preferred
stock may be viewed as offering
potential significant participation in the growth of the corporation. Moreover, if such an interest is not retroactively treated
as stock throughout the testing
period, the reclassification from
nonstock to stock could trigger an
ownership change.
(b)
Thus, even though such preferred
stock remains as nonstock under
Treas. Reg. § 1.382-2(a)(3)(i), it
may nevertheless be treated as
stock under Treas. Reg. § 1.3822T(f)(18)(iii) and trigger an ownership change.
Indirect ownership interests
Treas. Reg. § 1.382-2T(f)(18)(iv) states
that "stock" of the loss corporation
includes stock as that term is defined by
Treas. Reg. § 1.382-2T(f)(18) and, as the
context may require, includes any indirect
ownership interest in the loss corporation.
(1)
It is unclear what is intended by the
inclusion of indirect ownership interests in the definition of the term
"stock" or when "the context may
require" such treatment. The regulations offer no insight into the extent
of this provision.
(2)
Applied literally, this provision
treats a purely constructive ownership
interest in the loss corporation as
stock. As discussed earlier in connection with the transfer of an option as
a testing event (see Part V.A.2.,
above), this provision apparently operates to treat options on ownership
interests in a first tier or higher
tier entity as options with respect to
loss corporation stock.
103
e.
4.
Valuation rules -- Discounts and Premiums
(1)
Solely for purposes of determining the
percentage of stock owned by a person,
each share of stock having the same
material terms is treated as having the
same value. Thus, control premiums or
blockage discounts are not allowed.
Treas. Reg. § 1.382-2(a)(3)(i).
(2)
This provision applies only to testing
dates occurring after January 29, 1991.
Id.
Loss Corporation
The term "loss corporation," as defined in section 382(k)(1) was amended by TAMRA. See Part
V.B.6.d., below, for a discussion of the reasons
supporting the technical correction. The regulations follow section 382(k)(1) as amended. However, the regulations also expand on the definition of a loss corporation.
On June 26, 1991, the definition of loss corporation contained in the 1987 temporary regulations
(as amended by T.D. 8264 in 1989) was finalized.
T.D. 8352, 1991-2 C.B. 67. Importantly, the
final regulations do not include the amendments
to the loss corporation definition proposed in
January 1991. Thus, two sets of regulations
apply in defining a loss corporation--final and
proposed. The preamble indicates that the final
regulations may be amended to reflect those
proposals. 56 Fed. Reg. 29433.
a.
In general
(1)
The term "loss corporation" means a
corporation entitled to use a net operating loss carryforward or having a net
operating loss for the taxable year in
which a testing event occurs. Treas.
Reg. § 1.382-2(a)(1)(i)(A),(B).
(2)
In order to coordinate sections 382 and
383, the regulations' definition of
loss corporation was amended to include
104
corporations entitled to use capital
loss carryovers, foreign tax credit
carryovers, general business credit
carryforwards, or minimum tax credit
carryovers. T.D. 8264, 1989-2 C.B. 73.
(3)
In addition, any corporation with a
"net unrealized built-in loss" is also
a loss corporation. Section 382(k)(1);
Treas. Reg. § 1.382-2(a)(1)(i)(C). The
term "net unrealized built-in loss" is
discussed below at Part VI.C.l. For
purposes of determining whether the
corporation has a net unrealized builtin loss, the date on which the testing
event occurs is treated as the change
date.
(4)
A loss corporation also includes a
predecessor or successor to a loss corporation. Treas. Reg. § 1.3822(a)(1). Predecessor and successor are
defined, generally, as a distributor or
transferor, or distributee or
transferee, respectively, of assets in
a transaction described in section
381(a).2; Treas. Reg. § 1.3822(a)(5),(6).
(a)
For example, L incurs large net
operating losses. Subsequently, L
is merged or liquidated into P in
a transaction described in section
381. P has become a loss corporation as successor to L even though
A loss corporation can also include a successor
corporation other than a successor in a section 381(a)
transaction if, for example, a corporation receives assets from
a loss corporation that have basis in excess of value, the
recipient corporation's basis for the assets is determined by
reference to the loss corporation's basis, and the amount by
which basis exceeds value is material. Treas. Reg. § 1.3822(a)(1)(v) (applicable to testing dates on or after January 1,
1997). See T.D. 8825, 1999-28 I.R.B. 19.
2
105
P had no previous NOL carryovers
of its own.
(b)
b.
TAMRA added section 382(l)(8) to
treat predecessor and successor
entities as one entity.
Impact of section 381(a) transactions
The regulations add special rules covering
the case where the loss corporation, as a
distributor or transferor corporation in a
section 381(a) transaction (certain reorganization transactions and section 332
liquidations), ceases to exist under state
law.
(1)
The regulations state that "notwithstanding that a loss corporation ceases
to exist under state law," if the loss
corporation's NOL carryforwards (or
other section 381(c) items) are succeeded to by the acquiring corporation
in a section 381(a) transaction, then
the loss corporation will be treated as
continuing in existence until:
--all pre-change losses and credits
(determined as if the testing date were
the change date) are fully utilized or
expire under section 172, section 1212,
section 39, section 53, or section
904(c), and
--any net unrealized built-in losses
(determined as if the testing date were
the change date) may no longer be
treated as pre-change losses. Treas.
Reg. § 1.382-2(a)(1)(ii).
The regulations go on to state that
following such a transaction, the stock
of the acquiring corporation shall be
treated as the stock of the loss corporation for purposes of determining
whether an ownership change occurs with
respect to the pre-change losses and
net unrealized built-in losses (that
106
may be treated as pre-change losses) of
the distributor or transferor corporation. Id.
(2)
As indicated above, Treas. Reg.
§ 1.382-2(a)(1)(ii) states that the
loss corporation is treated as continuing in existence until "any net
unrealized built-in losses (determined
as if the testing date were the change
date) may no longer be treated as prechange losses."
(a)
Although it is unclear what this
language means, it is understood
through conversations with
Treasury officials that this
language is intended to mean
merely that the transferor will
remain in existence until the
unrealized losses are recognized,
or the limitation in section
382(h)(1)(B)(ii) is met.
(b)
For example, assume that loss
corporation (L) merges into
profitable corporation (P) in a
transaction that does not cause an
ownership change. L is a loss
corporation solely because it has
a net unrealized built-in loss.
At the time of the merger, L has
three assets -- asset #1 (built-in
gain of $100); asset #2 (built-in
loss of $50); and asset #3 (builtin loss of $150). P must treat
the net unrealized built-in loss
of $100 as a pre-change loss, and
L will be treated as remaining in
existence until such losses can no
longer be treated as pre-change
losses.
(c)
Thus, if P subsequently sells
asset #3 and recognizes the builtin loss of $150, the full amount
of net unrealized loss ($100)
107
would be recognized. Under
section 382(h)(1)(B)(ii), no
further recognized built-in losses
could be treated as pre-change
losses. Thus, L's continued
existence under this rule would
cease.
(d)
(3)
Note that under the general
definition of a pre-change loss, a
"net unrealized built-in loss"
cannot be a pre-change loss
(unless and until it is
recognized). See Treas. Reg.
§ 1.382-2(a)(2) (definition of
pre-change loss). However, under
Treas. Reg. § 1.382-2(a)(1)(iii),
any net unrealized built-in loss
that is accrued as of the change
date will be treated as a prechange loss.
It is not clear whether this rule
applies only where the transferor
ceases to exist but does not undergo an
ownership change, or whether it applies
regardless of whether an ownership
change occurs with respect to the
transferor. The examples in the
regulations indicate that this rule
applies in the former case. See Treas.
Reg. § 1.382-2T(e)(2)(iv) (Ex. (2))
(ownership change as to transferor;
(a)(1)(ii) rule not applied)) and (Ex.
(3) (no ownership change as to
transferor; (a)(1)(ii) is applied)).
(a)
If the transferor does undergo an
ownership change as a result of
the section 381(a) transaction,
there seems to be no need to treat
the transferor as continuing in
existence. As discussed below,
the surviving corporation must
account for the transferor's prechange losses separately and can
108
directly apply the section 382
limitations to such losses.
(b)
Further, since a new testing
period begins on the day after the
change date with respect to the
transferor's losses (section
382(i)(2) and Treas. Reg. § 1.3822T(d)(2)), there seems to be no
need to treat the survivor's stock
as stock of the old loss
corporation.
(c)
Also, the regulations state that
the stock of the surviving
corporation will be treated as
stock of the "loss corporation,"
not stock of the "old loss
corporation," thus implying that
the rule applies only where the
transferor does not experience an
ownership change.
(4)
The regulations clarify that separate
accounting terminates once an ownership
change occurs. See Treas. Reg.
§ 1.382-2(a)(1)(iv);3 discussion at Part
V.B.4.d., below.
(5)
This rule apparently serves as a
mechanism to keep track of shareholder
interests in section 382 attributes loss carryforwards and built-in losses
rather than in the loss corporation
itself. Cf. Treas. Reg. § 1.382-2T(e)
(2)(iv) (Ex. (3)).
(a)
If the acquiring corporation's
assets have a sufficiently large
built-in gain, a combination of
the two corporation's assets may
Treas. Reg. § 1.382-2T(f)(1)(ii), providing for the
termination of separate accounting for losses and credits, has
been finalized and redesignated as Treas. Reg. § 1.3822(a)(1)(iv). T.D. 8825, 1999-28 I.R.B. 19.
3
109
eliminate the pre-existing builtin loss of the loss corporation.
c.
(b)
For example, assume that loss
corporation (L) merges into
profitable corporation (P) with
the loss corporation shareholders
receiving 90 percent of the P
stock. This transaction is an
owner shift (and an equity
structure shift) but not an
ownership change.
(c)
In testing future owner shifts,
the P stock will be treated as L
stock, and L shall be treated as
continuing in existence under the
above rule.
(d)
Thus, if P is later merged into a
third corporation (X), the
historic P shareholders' lowest
percentage interest in the loss
corporation apparently will be
treated as being 0 percent rather
than 10 percent as would be the
case if P were treated as the only
loss corporation.
(e)
P's assets, and any related builtin gain, apparently will not be
combined with L's assets. Thus,
any built-in loss inherent in L's
assets apparently will not be
diluted.
(f)
Even though L is treated as
continuing in existence, the
regulations apparently still treat
the successor corporation (P) as
the nominal loss corporation. See
Treas. Reg. § 1.382-2T(j)(2)(iii)
(B)(2) (Ex. (1)).
Separate accounting for losses
The regulations provide that pre-change
losses (determined as if the testing date
110
were the change date and treating the amount
of any net unrealized built-in loss as a
pre-change loss) that are succeeded to by an
acquiring corporation in a section 381(a)
transaction must be accounted for separately
from losses of the acquiring corporation for
purposes of applying the ownership change
provisions. See Treas. Reg. § 1.382-2(a)
(1)(iii).
d.
(1)
This rule acts as a complement to the
previous rule that treats loss
corporations as continuing in existence
until the loss carryovers are utilized
or expire, or are no longer treated as
pre-change losses.
(2)
Some losses may be subject to section
382 and others may not. See, e.g.,
Treas. Reg. § 1.382-2T(e)(2)(iv) (Ex.
(2))(a loss corporation merges into
another loss corporation). In
addition, some losses may be restricted
by different section 382 limitation
amounts than others. Different testing
dates may apply to some losses as well.
End of separate accounting
(1)
Treas. Reg. § 1.382-2(a)(1)(iv) and (v)4
provide that the distributor or
transferor will cease to be treated as
continuing in existence upon a "foldin" event, which is either:
(a)
an ownership change of the
distributor or transferor
corporation in connection with or
after the 381(a) transaction, or
(b)
on the close of five years
beginning after the 381(a)
Treas. Reg. § 1.382-2(a)(1)(iv) and (v) were first
promulgated as temporary regulations. Treas. Reg. § 1.3822T(f)(1)(ii) and (iii), T.D. 8679, I.R.B. 1996-31.
4
111
transaction.
2(a)(1)(iv).
e.
Treas. Reg. § 1.382-
(2)
If either of the above conditions are
satisfied, then the separate accounting
for losses is no longer required or
permitted.
(3)
The regulations also state that any
ownership change that occurred in
connection with or subsequent to the
section 381 transaction could result in
an additional, lesser limitation with
respect to the pre-change losses.
(4)
Treas. Reg. § 1.382-2(a)(1)(iv) applies
to any testing date occurring on or
after January 29, 1991. Treas. Reg.
§ 1.382-2(a)(1)(v) applies to any
testing date occurring on or after
January 1, 1997.
Effect of Treas. Reg. § 1.382-1(a)(iv)
As described above, Treas. Reg. § 1.3821(a)(iv) terminates the separate accounting
requirements with respect to a Section 381
transaction upon a fold-in event. The
ramifications of this regulation are
illustrated in the following example:
(1)
Assume L1 is wholly owned by A and L2
is wholly owned by B. L1 merges into
L2. After the merger, A owns 40
percent of the L2 stock and B owns 60
percent. B subsequently sells 15
percent of the L2 stock to C.
(a)
Prior to enactment of Treas. Reg.
§ 1.382-2(a)(1)(iv):
i)
L1 undergoes an ownership
change.
ii)
L1's losses are separately
tracked and receive a "fresh
start."
112
iii) L2 is 40 percent of the way
toward an ownership change
after the merger with L1.
iv)
(b)
After B's sale of stock to C,
L2 undergoes an ownership
change as to its original
losses. The losses of L1 are
15 percent of the way to a
second ownership change.
Under Treas. Reg. § 1.3822(a)(1)(iv):
i)
L1 undergoes an ownership
change as a result of the
merger, and because it is the
distributor in the
transaction, its separate
existence ceases.
ii)
Because L1's losses are not
separately accounted for, L1
falls into the ownership
change track of L2, and its
losses are "folded in" with
those of L2.
iii) Thus, since L2's losses are
40 percent of the way toward
an ownership change, L1's
losses are also 40 percent of
the way toward a second
ownership change.
iv)
(2)
After B's sale of stock to C,
L2's losses will undergo an
ownership change and be
subject to limitation, and
the losses from L1 will be
subject to a second ownership
change.
As a variation, suppose in the above
example that L2 merges into L1. After
the merger, B owns 60 percent of L1 and
A owns 40 percent. B later sells 15
percent of the L1 stock to C.
113
(a)
Prior to the enactment of Treas.
Reg. § 1.382-1(a)(iv):
i)
L1 undergoes and ownership
change.
ii)
L2 is treated as continuing
in existence and is 40
percent of the way to an
ownership change.
iii) B's sale of L1 stock to C
causes an ownership change of
L2 and a 15 percent shift in
the ownership of L1.
(b)
Under Treas. Reg. § 1.3821(a)(iv):
i)
L2 is treated as continuing
in existence and is 40
percent of the way to an
ownership change.
ii)
B's sale of L1 stock to C
causes an ownership change
with respect to former L2's
losses. After the ownership
change, L2’s separate
existence ceases.
iii) After the second ownership
change, L1 and former L2
losses are combined and 15
percent of the way to a
second ownership change.
f.
Treas. Reg. § 1.382-2(a)(1)(ii) and (iii)
prescribe rules of accounting for pre-change
losses where two corporations are fused in a
section 381(a) transaction. Their impact
extends beyond the mere definition of a loss
corporation. Thus, these rules seem to be
inappropriately placed in Treas. Reg. §
1.382-2(a)(1) and should be moved to a
different section of the regulations to
prevent any confusion.
114
5.
6.
Old Loss Corporation
a.
Under the regulations, an "old loss
corporation" is any corporation with respect
to which there is an ownership change and
that was a loss corporation immediately
before the ownership change. Treas. Reg.
§ 1.382-2T(f)(2). This definition follows
section 382(k)(2) as amended by TAMRA.
b.
Under old section 382(k)(2), the term "old
loss corporation" was defined as:
(1)
Any corporation which (before the
ownership change) was a loss
corporation, or
(2)
Any corporation with respect to which
there is a "pre-change loss" described
in section 382(d)(1)(B), i.e., a
corporation that incurs a net operating
loss in the year of change which is
allocable to the period prior to the
change date.
New Loss Corporation
a.
A "new loss corporation" is a corporation
which immediately after an ownership change
is a loss corporation. Section 382(k)(3);
Treas. Reg. § 1.382-2T(f)(3).
b.
The same corporation may be both the old
loss corporation and the new loss
corporation. Section 382(k)(3).
c.
(1)
In contrast, the new loss corporation
may be a different corporation than the
old loss corporation.
(2)
For example, if L merges with P under
section 368(a)(1)(A) with P surviving,
P inherits L's NOL carryovers and
becomes the new loss corporation. The
old loss corporation ceases to exist.
In addition, Treas. Reg. § 1.382-2T(f)(3)
states that a "successor corporation" to a
115
new loss corporation is also a new loss
corporation. Thus, in the example above, if
P is merged into a third corporation (X), X
would also be a new loss corporation
(apparently only with respect to loss
carryovers inherited from L).
d.
As originally drafted, the statute contained
a discontinuity in the definitions of loss,
old loss and new loss corporation.
(1)
Under old section 382(k)(1), the
definition of a loss corporation did
not include a corporation suffering
only current year losses (unless such
corporation also had a net unrealized
built-in loss) as did the old loss
corporation definition as originally
drafted. However, a new loss
corporation was defined by reference to
the loss corporation definition (not
the old loss corporation definition as
one would expect).
(2)
The problem is best illustrated by an
example. Assume that L incurs current
year losses but has no NOL carryovers.
All the stock of L is acquired during
the current year. Technically, an
ownership change would not occur.
(a)
As originally drafted, section
382(g)(1) looked to stock held by
shareholders in the "new loss
corporation."
(b)
In this case, L technically was
not a new loss corporation
because, before the acquisition, L
did not fall within the definition
of a loss corporation as
originally drafted (even though L
was an old loss corporation).
Therefore, since there was no
stock held in a new loss
corporation, section 382(g)(1) by
its terms was not triggered.
116
(c)
(3)
7.
As originally drafted, L was not a
loss corporation because it had no
NOL carryovers, yet L was an old
loss corporation because it had
current year losses allocable to
the period prior to the change in
ownership.
TAMRA resolved this problem by
redefining the term "loss corporation"
to include a corporation having a
current year loss. As redefined, the
definitions of loss, old loss, and new
loss corporations would be essentially
the same, except for the occurrence of
an ownership change. TAMRA also
replaced the references to a "new loss
corporation" in section 382(g) with
references to loss corporations.
Testing Period
In determining whether an ownership change
occurs, the increases in holdings of 5-percent
shareholders are determined by reference to such
shareholder's lowest percentage holdings during
the testing period.
a.
General rule
(1)
In general, the testing period is the
3-year period ending on the day of any
owner shift or equity structure shift.
Section 382(i)(1); Treas. Reg. § 1.3822T(d)(1).
(2)
Thus, the beginning of the testing
period generally will not be known
until it is determined that subsequent
owner shifts or equity structure shifts
have occurred. Cf. section 338(h)(1)
(beginning of the 12-month acquisition
period is not known until a qualified
stock purchase occurs).
(3)
Because the testing period spans such
an extended period, shareholders who
117
bore the burden of losses may find
themselves subject to the limitations.
(4)
(a)
For example, on January 2, 1987, A
acquires a 45 percent block of L
stock. L incurs all of its losses
during the succeeding 3-year
period. On December 31, 1989, B
acquires a 6 percent block of
stock from shareholders other than
A in an unrelated transaction.
(b)
As a result of B's purchase, the
section 382 limitations apply
notwithstanding the fact that only
6 percent of the L stock changed
owners after the losses were
incurred -- 94 percent of the
shareholders who indirectly bore
the losses remain as L
shareholders.
(c)
Section 382(i)(3) attempts to
alleviate this problem by
shortening the testing period if
the NOL carryover first arises
during the normal testing period.
See discussion below at Part
V.B.7.c. However, section
382(i)(3) is an imperfect cure
because it provides that the
testing period begins on the first
day of the first year from which
there is an NOL carryover. Thus,
in the example above, no relief is
provided.
(d)
Section 382(i)(3) could be
improved by providing that the
testing period will not begin
until the first day "to which"
(not "from which") there is a NOL
carryover.
The regulations indicate that the
testing period will not be lengthened
even if loss corporation shareholders
118
or their associates intend to acquire
additional stock after the close of the
testing period.
(5)
(a)
For example, A owns all 100 shares
of the stock of loss corporation
(L). A sells 40 shares of L stock
to B on January 1, 1988. On July
1, 1991, C acquires 20 shares of L
stock from A. In the past, B and
C have been partners in a number
of business ventures.
(b)
According to the regulations, even
if B knew of C's intent to acquire
L stock at the time of his own
purchase of L stock, the testing
period ending with C's purchase
will not be extended backward to
encompass the sale by A to B. See
Treas. Reg. § 1.382-2T(d)(5)(ii).
(c)
Note, however, that if C entered
into a contract to acquire the L
stock within the three-year period
beginning with B's purchase, an
ownership change would occur.
Such a contract would be treated
as an option under Treas. Reg. §
1.382-2T(h)(4)(v).
As illustrated above, the drawback to
using a three-year "look back" period
is that transactions bearing no
relation to one another may be combined
in determining if an ownership change
has occurred. Conversely, as indicated
by the regulations, transactions will
not be combined if they occur outside
of the testing period, even if they are
related. A better policy may be to
combine only related transactions -- no
matter how separate in time -- in
determining if an ownership change has
occurred.
119
b.
c.
Effect of recent ownership change
(1)
A shorter testing period applies if
there has been a previous ownership
change within the usual testing period.
Under section 382(i)(2), the testing
period for determining whether a second
ownership change has occurred does not
begin before the first day following
the change date for the previous
ownership change. See also Treas. Reg.
§ 1.382-2T(d)(2).
(2)
For example, A plans to acquire L. A
currently holds no stock of L. On
December 31, 1987, A purchases a block
of stock representing 51 percent of the
value of L. An ownership change with
respect to L occurs on that date.
Accordingly, the testing period for
future owner shifts and equity
structure shifts will not begin before
January 1, 1988.
Shorter period where all losses arise during
the testing period
(1)
The testing period does not begin
before the earlier of the first day of
either (1) the first taxable year from
which there is a carryover of a loss or
of an excess credit to the first postchange year, or (2) the taxable year in
which the testing date occurs. Treas.
Reg. § 1.382-2T(d)(3)(i).
(a)
In effect, owner shifts and equity
structure shifts are disregarded
if they occur before the year from
which an NOL carryover arises.
(b)
This rule reflects the intent to
impose section 382 limitations
only where the beneficial interest
in an NOL carryover has shifted.
(c)
The regulations reflect section
382(i)(3) as amended by TAMRA.
120
(2)
In general, this shorter testing period
does not apply if the loss corporation
has a net unrealized built-in loss
immediately before the change date
which exceeds the threshold requirement
of section 382(h)(3)(B). See
discussion at Part VI.C., below.
(a)
However, the regulations provide
an exception to this rule if the
loss corporation establishes the
taxable year in which the net
unrealized built-in loss first
occurred. See Treas. Reg.
§ 1.382-2T(d)(3)(ii). See also
Conf. Rep. at II-185.
(b)
If the loss corporation
establishes the taxable year in
which the built-in loss occurred,
then the testing period will not
begin before the earlier of:
--the first day of the taxable
year in which such loss accrued,
or
--the earlier of the first day of
the taxable year from which there
is a loss or credit carryover, or
the first of the year in which the
testing event occurs.
(c)
In other words, if the loss
corporation has a net unrealized
built-in loss, the shorter testing
period does not apply, but rather
the typical testing period does
(i.e., three years). If the loss
corporation desires to fix a
shorter testing period, it must
establish the year in which the
built-in loss arose, in which case
the testing period begins on the
first day of the earlier of the
current year, the year the builtin loss arose or the year that
121
loss or credit carryovers were
first generated.
8.
Change Date
The "change date" is the date on which the
ownership change occurs. Section 382(j); Treas.
Reg. § 1.382-2T(f)(19).
a.
Thus, in the case where the last component
of an ownership change is an owner shift,
the change date is the date of such shift.
b.
In the case where the last component of an
ownership change is an equity structure
shift, the change date is the "date of the
reorganization."
(1)
The phrase "date of the reorganization"
is not defined in the statute. It is
unclear whether the phrase refers to
the first date that all the steps in
the plan of reorganization have been
consummated, or the date that the
statutory requirements of a
reorganization are first met.
(2)
For example, on June 30, 1987, P
corporation acquires 80 percent of the
L stock in exchange solely for A's
voting stock. On July 31, 1987,
pursuant to the same plan, P acquires
the remaining 20 percent of L stock in
exchange solely for P voting stock.
For section 382 purposes, it is unclear
whether the "date of the
reorganization" is June 30, 1987, or
July 31, 1987.
(3)
If the date of the reorganization means
the first date that all of the steps in
a plan of reorganization are completed,
a taxpayer could delay the occurrence
of the change date by delaying
consummation of the steps in the plan.
Through this course of action, a
taxpayer might obtain a more favorable
long-term tax-exempt rate, change the
122
beginning of the recognition period, or
obtain a more favorable allocation of
income (loss) in post-change years that
include the change date. See sections
382(f)(1), (h)(7)(A), (b)(3)(A) and
(d)(1)(B), respectively.
c.
C.
The regulations merely define the "change
date" as the date on which the shift "that
is the last component of an ownership change
occurs." Treas. Reg. § 1.382-2T(f)(19).
Application of the Ownership Change Rules -- Owner
Shifts Involving a 5-Percent Shareholder
1.
Taxable Purchase of Stock
a.
Fact pattern
On January 1, 1996, A and B own 30-percent
and 70 percent, respectively, of the L
outstanding stock. A and B are unrelated.
A has held his stock since L was formed in
1989. B acquired his stock in 1994 from a
former shareholder of L. L has incurred
losses since its inception. On July 1,
1996, A purchases B's stock for cash.
b.
The testing period is the three-year period
ending on July 1, 1996 (assuming the
acquisition is an owner shift). Section
382(i)(1); Treas. Reg. § 1.382-2T(d)(1).
Thus, the testing period would run from July
2, 1993 to July 1, 1996.
c.
A's acquisition is an owner shift involving
a 5-percent shareholder. Section 382(g)(2);
Treas. Reg. § 1.382-2T(e)(1)(i). The
acquisition constitutes a change in the
respective ownership of L stock which
affected the percentage of stock held by 5percent shareholders.
(1)
Both A and B are 5-percent
shareholders. A qualifies as a 5percent shareholder since he owns 100
percent of L after the change in
ownership.
123
(2)
d.
e.
2.
B is a 5-percent shareholder even
though after the change B owns no stock
in L. B held 5-percent of L during the
testing period and therefore qualifies
as a 5-percent shareholder.
Having determined that A's acquisition is an
owner shift involving a 5-percent
shareholder, it must next be determined
whether an ownership change occurred.
(1)
That is, A's acquisition is an event
requiring a section 382 determination.
See Treas. Reg. § 1.382-2T(a)(2)(i).
The date of A's acquisition -- July 1,
1996 -- is a testing date.
(2)
In this case, an ownership change has
occurred since the percentage of stock
held by 1 or more 5-percent
shareholders (A) has increased by more
than 50 percentage points over the
lowest percentage held by A during the
testing period (100 percent minus 30
percent equals a 70 percent increase).
(3)
Even though B is a 5-percent
shareholder, his percentage interest
declined over the testing period (from
70 percent to zero) and therefore his
stock ownership is ignored in
determining if an ownership change
occurred.
The same result would occur if A owned no
stock in L prior to acquiring B's interest.
Redemptions
a.
Fact pattern
L is equally owned by three individuals -A, B and C. A, B and C have held their L
stock since the corporation was formed in
1992. On July 1, 1996, B and C's interest
in L is redeemed for cash and notes. The
notes are treated as debt for tax purposes.
124
3.
b.
The testing period begins July 2, 1993 and
ends on July 1, 1996 (assuming the
redemption is an owner shift).
c.
The redemption is an owner shift involving a
5-percent shareholder. Section 382(g)(2);
Treas. Reg. § 1.382-2T(e)(1)(i). The
redemption transaction is a change which
affects the percentage interest of A, B and
C who are all 5-percent shareholders.
(1)
B and C were 5-percent shareholders
before the redemption.
(2)
A is a 5-percent shareholder both
before and after the redemption.
d.
Since the redemption is an owner shift
involving a 5-percent shareholder, an
analysis under section 382(g)(1) is required
to determine if an ownership change has
occurred. The date of the redemption -July 1, 1996 -- is a testing date. Treas.
Reg. § 1.382-2T(a)(2)(i).
e.
In this case, the percentage of stock in the
new loss corporation (L) owned by one or
more 5-percent shareholders (A) has
increased by more than 50 percentage points
over A's lowest percentage interest in the
old loss corporation (L). A's interest has
increased from 33 percent to 100 percent.
Multiple Owner Shifts
a.
Fact pattern
On January 1, 1995, A owns all 1,000 shares
of L stock outstanding. A has held such
stock since L's formation in 1988. On
June 15, 1995, A sells 300 of his L shares
to B. On June 15, 1996, L issues 100 shares
to each of C, D and E. On December 15,
1996, L redeems 200 shares of stock held by
A.
b.
The sale of A to B of 300 shares of L stock
is an owner shift involving 5-percent
125
shareholders (A and B). However, no
ownership change has occurred because B is
the only 5-percent shareholder whose
percentage interest has increased during the
testing period -- June 16, 1992 to June 15,
1995 -- and B's percentage increase does not
exceed 50 percentage points (30 percent).
c.
The issuance of shares by L to C, D and E is
also an owner shift involving 5-percent
shareholders (A and B's interest was
affected by the issuance). However, the
issuance of shares does not constitute an
ownership change since the aggregate
percentage increase of 5-percent
shareholders does not exceed 50 percentage
points.
Percentage
After
A
B
C
D
E
54.0%
23.0
7.7
7.7
7.7
d.
70%
0
0
0
0
The redemption of A's
1996 is also an owner
percent shareholder.
result of this shift,
has occurred.
Percentage
After
A
B
C
D
E
Lowest
Percentage Before
e.
0.0%
23.0
7.7
7.7
7.7
46.1%
stock on December 15,
shift involving a 5In addition, as a
an ownership change
Lowest
Percentage Before
45%
27
9
9
9
54%
0
0
0
0
Increase
Increase
0%
27
9
9
9
54%
Note that the decline in A's percentage
interest does not offset increases in the
other shareholders' percentage interests.
126
4.
Split-off Transaction
a.
Fact pattern
Individual A owns 40 percent of L.
Individual B owns the remaining 60 percent
of L. L owns all of the stock of L-1. The
views of A and B differ as to how L should
be managed. Accordingly, L distributes all
of the stock of L-1 to A in exchange for all
of A's L stock. The transaction qualifies
as a "split-off" under section 355.
b.
c.
With respect to L-1, the transaction
constitutes an ownership change.
(1)
Under the constructive ownership rules,
L's ownership of the L-1 stock will be
attributed pro rata (by value) to A and
B. L's ownership is disregarded. See
section 382(l)(3)(A)(ii).
(2)
After the transaction, A actually owns
all of the stock of L-1. Thus, the
percentage of stock held by a 5-percent
shareholder (A) in the new loss
corporation (L-1) has increased by more
than 50 percentage points over A's
lowest percentage interest in the old
loss corporation (L-1) (100 percent
less the 40 percent held prior to the
transaction).
With respect to L, an ownership change has
not occurred.
(1)
Prior to the reorganization, B's lowest
percentage interest in the potential
old loss corporation (L) was 60
percent.
(2)
After the reorganization, B's
percentage interest in the potential
127
new loss corporation (L) is 100
percent.
(3)
d.
Thus, only a 40 percentage point
increase has occurred with respect to
L's stock.
Suppose the businesses of L and L-1 were
conducted as divisions of L. To effect the
split-off, L transfers assets to L-1 in
exchange for all of the L-1 stock. L
immediately distributes the L-1 stock to A
in exchange for his L stock.
(1)
This transaction, as altered,
constitutes a "D" reorganization under
section 368(A)(1)(D). However, since
the requirements of section 354(b)(1)
have not been met, the transaction does
not constitute an equity structure
shift. See section 382(g)(3)(A)(i).
The transaction is an owner shift under
section 382(g)(2).
(2)
In applying section 382 to this
transaction, several issues arise.
(a)
It is unclear whether L-1
constitutes a loss corporation.
The Service's position is that tax
attributes (other than earnings
and profits) remain with the
transferor corporation. See Rev.
Rul. 77-133, 1977-1 C.B. 96.
Thus, under section 382(k)(1), L-1
would not be a loss corporation.
Without a loss corporation,
section 382(g)(1) appears to be
irrelevant.
(b)
If L's NOL carryovers are
allocable to L-1, an additional
issue must be addressed. In
testing the reorganization under
section 382(g)(1), L-1's testing
period must be determined. Under
normal circumstances, the testing
period is the three-year period
128
ending on the owner shift.
However, L-1 was not in existence
for this entire period. In this
case, it would seem that L's
testing period would apply.
D.
Application of the Ownership Change Rules -- Equity
Structure Shifts
1.
Straight "A" Reorganization
a.
Fact pattern
All of the L stock is owned by individual A.
All of the P stock is owned by individual B.
L is merged into P, with P surviving. A
receives 25 percent of the P stock
outstanding after the merger. The merger
qualifies as a reorganization under section
368(a)(1)(A).
2.
b.
The merger of L into P constitutes an equity
structure shift. See section 382(g)(3)(A);
Treas. Reg. § 1.382-2T(e)(2)(i).
c.
If the merger constitutes an ownership
change, P would be the new loss corporation.
Section 382(k)(3); Treas. Reg. § 1.3822T(f)(3). L would be the old loss
corporation. See section 382(k)(2); Treas.
Reg. § 1.382-2T(f)(2).
d.
Under section 382(g)(1), the merger results
in an ownership change. The percentage of
stock in the new loss corporation (P) held
by B, a 5-percent shareholder, has increased
by more than 50 percentage points over B's
lowest percentage interest in the old loss
corporation (L) (0 percent to 75 percent).
Successive Equity Structure Shifts
a.
Fact pattern
A owns all of the stock of L. B owns all of
the stock of P. On June 30, 1995, L is
merged into P, with P surviving. A receives
60 percent of the P stock outstanding after
129
the merger. On June 30, 1996, P is merged
into X, a corporation wholly owned by
individual C. The former P shareholders (A
and B) receive 50 percent of the X stock
outstanding after the merger.
b.
c.
d.
The merger of L into P is an equity
structure shift. Section 382(g)(3)(A);
Treas. Reg. § 1.382-2T(e)(2). In addition,
P inherits L's full NOL carryovers under
section 381.
(1)
Therefore, P is a loss corporation.
Section 382(k)(1); Treas. Reg. § 1.3822(a)(1)(i).
(2)
P is neither a new loss nor an old loss
corporation since an ownership change
has not yet occurred.
(3)
Note, however, that under Treas. Reg.
§ 1.382-2(a)(1)(ii), L is treated as
continuing in existence. The stock of
P is treated as stock of L for purposes
of determining whether an ownership
change occurs with respect to L's
losses.
The merger of L into P is not an ownership
change because B's interest in the potential
new loss corporation (P) is only 40 percent.
(1)
Under the regulations, B apparently is
treated as owning 40 percent of the L
stock.
(2)
This does not exceed B's lowest
percentage interest in the old loss
corporation (L) (0 percent) by more
than 50 percentage points.
The merger of P into X is also an equity
structure shift. X inherits P's NOL
carryovers under section 381.
(1)
Therefore, X is a loss corporation.
Section 382(k)(1); Treas. Reg. § 1.3822(a)(1)(i).
130
(2)
e.
E.
In addition, X will be a new loss
corporation if the merger results in an
ownership change.
Following the merger of P into X, A owns 30
percent of X, B owns 20 percent of X, and C
owns 50 percent.
(1)
In applying section 382(g)(1), C has
increased its interest in the loss
corporation by 50 percent.
(2)
With respect to B, B must compare his
current holdings (20 percent) with his
lowest percentage holdings in the loss
corporations (P) or any predecessor
(L). See section 382(g)(1). B's
lowest percentage holdings in L was
zero percent; therefore, B has
increased his interest by 20 percentage
points.
(3)
Thus, B and C's aggregate increases
result in an ownership change.
Application of the Ownership Change Rules –
Combinations
A series of owner shifts and equity structure shifts
may together result in an ownership change.
1.
Owner Shift Followed by a Merger
a.
Fact pattern
A owns all of the outstanding L stock. On
January 1, 1995, individual B purchases 40
percent of the stock of L. On July 1, 1995,
L is merged into P. P corporation is
wholly-owned by C. The L shareholders (A
and B) receive stock representing 60 percent
of the value of P after the merger. After
the merger C owns 40 percent of the P stock.
b.
The purchase of stock by B on January 1,
1995, is an owner shift involving a 5percent shareholder (both A and B).
However, an ownership change does not occur
131
because B has only increased his holdings by
40 percentage points.
2.
c.
The merger of L into P on July 1, 1995, is
an equity structure shift which in
conjunction with the prior owner shift,
constitutes an ownership change. In this
case, P is the new loss corporation and L is
the old loss corporation.
d.
An ownership change occurs because,
following the merger, B and C's percentage
interest in the new loss corporation (P) is
64 percent. B received 24 percent in the
merger (40 percent of 60 percent), and C
owns 40 percent after the merger (diluted
from 100 percent in the merger). Thus, B
and C's percentage interest exceeds their
lowest percentage interest (0 percent) in
the old loss corporation (L) by more than 50
percentage points.
Merger Followed by an Owner Shift
a.
Fact pattern
On January 1, 1995, individual A owns all of
the outstanding L stock. P corporation is
wholly owned by individual B. On January 1,
1996, L is merged into P corporation. In
the merger, A receives 54 percent of the P
stock outstanding after the merger. On
January 1, 1997, A sells five percent of his
L stock to individual C.
b.
The merger of L into P on January 1, 1996 is
an equity structure shift. However, an
ownership change does not occur because B (a
5-percent shareholder) has only increased
his holdings by 46 percentage points.
c.
The purchase of stock by C on January 1,
1997 is an owner shift both involving a 5percent shareholder (both A and B). In
addition, the purchase, in conjunction with
the prior equity structure shift,
constitutes an ownership change.
132
F.
d.
An ownership change occurs because,
immediately after C's purchase, B and C hold
51 percent of the L stock. This is more
than 50 percentage points over their lowest
percentage interest in L during the testing
period (0 percent each).
e.
This example illustrates the leverage that a
small shareholder may hold over a loss
corporation. By purchasing a small block of
stock, such a shareholder may cause an
ownership change where prior transactions
during the testing period have brought the
percentage change in stock close to, but not
over, 50 percentage points.
f.
A similar result could obtain where C is an
employee of L, and L grants C an option to
acquire 5 percent of the L stock
outstanding. The grant of the option may be
treated the same as the purchase above. See
section 382(l)(3)(A)(iv); Treas. Reg.
§ 1.382- 2T(h)(4). The constructive
ownership rules for options are discussed
below at Part V.F.4.
The Constructive Ownership Rules
Before section 382 can be applied to any transaction,
the ownership of the loss corporation must be
determined. In determining the ownership of stock for
purposes of section 382, the constructive ownership
rules of section 318 apply with several novel
modifications. Congress intended to prevent the
application of section 382 after an acquisition that
does not change the ultimate beneficial ownership of a
loss corporation by more than 50 percentage points.
See Conf. Rep. at II-180. Thus, the section 318
modifications were designed to determine the "ultimate
beneficial interest" in a loss corporation. See
Silverman and Keyes, "An Analysis of the New Ownership
Change Regs. Under Section 382: Part II," 68 JTAX 142
(March, 1988).
133
1.
Family Attribution
a.
General rule
(1)
For purposes of section 382, the family
attribution rules of section 318(a)(1)
do not apply. The prohibition on
"chain attribution" contained in
section 318(a)(5)(B) also does not
apply. Section 382(l)(3)(A)(i); Treas.
Reg. § 1.382-2T(h)(6)(i).
(2)
Accordingly, stock held by an
individual will not be attributed to
his spouse, or other family member
described in section 318(a)(1).
However, all stock held by section
318(a)(1) family members will be
aggregated and treated as if held by
one individual. Section
382(l)(3)(A)(i).
(a)
Section 318(a)(1) defines a family
to include an individual's spouse,
parents, children, and
grandchildren.
(b)
The legislative history, however,
includes grandparents, as opposed
to grandchildren, in the
definition of a family. See Conf.
Rep. at II-182. Presumably, this
is not an intended modification to
the definition of family in
section 318(a)(1).
(c)
Query whether the individual
serving as the basis of family
attribution must be alive or a
shareholder of the loss
corporation during the testing
period. See ILM 200245006 (IRS
position that two brothers should
not treated as a single
shareholder because their parents
were deceased throughout the
testing period and the commonly
used meaning of the term
134
“individual” does not include a
deceased parent); Garber
Industries Holding Co., v.
Commissioner, 435 F.3d 555 (5th
Cir. 2006), aff’g 124 T.C. 1
(2005)(on same facts, 5th Circuit
held in favor of the IRS but, in
dictum, supported the position
that the individual serving as
basis of family aggregation must
be a shareholder of the loss
corporation during the testing
period).
i)
(d)
b.
Arguably Garber could have
been decided in a more
straightforward manner by
relying on the plain language
of section section
382(l)(3)(A)(i) (excluding
siblings from the scope of
“family”) and section
318(a)(5)(B) (precluding
“double family attribution”).
See LTR 8738023, LTR 9030012, LTR
9517049, and LTR 199918051 for
application of the family
attribution rules in a section 382
context.
Special limitations
(1)
The regulations provide that the family
attribution rule described above will
not apply to members of a family who,
without regard to the section 382
family attribution rule, would not be
treated as 5-percent shareholders.
Treas. Reg. § 1.382-2T(h)(6)(iii).
This is favorable since, to some
extent, it appears to relieve the loss
corporation of the burden of
investigating each shareholder's
relatives and their stock ownership.
135
(2)
(a)
The regulations state that this
override of the family attribution
rule is subject to Treas. Reg.
§ 1.382-2T(k)(2).
(b)
For this purpose, Treas. Reg.
§ 1.382-2T(k)(2) provides that if
the loss corporation has "actual
knowledge" of stock ownership as
of the testing date by an
individual that would be a 5percent shareholder, but for the
limitation on attribution, then
the loss corporation must take
such stock ownership into account
for purposes of determining
whether an ownership change
occurred.
(c)
Thus, if L had "actual knowledge"
that two or more individuals were
related under section 318(a)(1),
such individuals would have to be
aggregated as one individual,
regardless of their percentage
interest. Treas. Reg. § 1.3822T(k). The meaning of the term
"actual knowledge" will be
discussed below.
(d)
The loss corporation apparently
must still inquire as to whether
individual 5-percent shareholders
are related to other individual 5percent shareholders.
Thus, for example, if an individual,
his spouse and his child each own 2
percent of the loss corporation stock,
such individuals apparently will not be
aggregated into one shareholder owning
6 percent of the stock, unless the loss
corporation has actual knowledge of the
familial relationship.
(a)
Under a literal application of
this rule, even if A held more
136
than 5 percent of the loss
corporation stock, the interest of
A's spouse and child would not be
aggregated with A's interest.
(b)
c.
Also, if A's spouse acquired an
additional 3.1 percent of the L
stock, apparently only A and his
spouse -- and not their child -would be aggregated together
(absent actual knowledge by the
loss corporation of the parents'
relationship to the child).
Overlapping families
(1)
(2)
The effect of the general rule is to
create separate "family units"
comprised of an individual and his
parents, spouse, children and
grandchildren. Each family unit
collectively owns the stock held by any
member of that unit.
(a)
An individual may be a member of
more than one family unit.
(b)
Thus, under this rule, a share of
stock held by that individual
could be considered to be held by
more than one family unit.
(c)
As a result, in such cases it is
unclear from the statute how the
family will be composed for
purposes of determining percentage
ownership and whether such
percentage will reflect the
multiple counting of a single
share of stock.
The regulations resolve this problem by
providing that if an individual may be
treated as a member of more than one
family, and each family that is treated
as an individual is a 5-percent
shareholder (or would if the individual
were a member of that family), then the
137
individual will be treated only as a
member of the family that results in
the smallest increase in total
percentage stock ownership of the 5percent shareholders on the testing
date. Such individual will not be
treated as a member of any other
family. Treas. Reg. § 1.3822T(h)(6)(iv). See LTR 9030012.
(3)
To illustrate, assume that throughout
the testing period all of the loss
corporation (L) stock is owned equally
by individual A, A's spouse (AS), A's
father (GP) and A's son (GC) (i.e., 25
percent each). On January 1, 1988, GP
sells his stock to GC. To determine
the extent to which the transaction
constitutes an owner shift, the family
holdings must be analyzed before and
after the transaction.
(a)
(b)
Prior to the transaction, the L
stock can be considered to be held
by at least four shareholders:
--
Family One, owning 75 percent
of L (GP, A and GC);
--
Family Two, owning 100
percent of L (A, GP, AS and
GC);
--
Family Three, owning 75
percent of L (AS, A and GC);
and,
--
Family Four, owning 75
percent of L (GC, A and AS).
Because GP and GC can be treated
as members of more than one family
and each family is treated as a 5percent shareholder, GP and GC
will be treated as being members
of the family that results in the
smallest increase in percentage
ownership.
138
(c)
(4)
(5)
In this case, if GP, GC, A and AS
were treated as members of Family
Two and no other family, no change
in the ownership of L stock for
section 382 purposes would occur
as a result of GP's sale (and no
double counting of shares would
occur).
As a variation of this example, suppose
AS's father were living and that L had
actual knowledge of this fact and of
his relationship to AS. If the family
attribution rule were applied
literally, another family would be
created around AS's father -- Family
Five, owning 50 percent of L before the
transaction (AS's father (0 percent),
AS (25 percent) and GC (25 percent)),
and 75 percent of L after the
transaction (AS's father (0 percent),
AS (25 percent) and GC (50 percent)).
However, since AS and GC can be treated
as members of more than one family and
each such family is (or would be) a 5percent shareholder, AS and GC will be
treated as being members of Family Two
only.
(a)
Thus, Family Five is treated as
owning zero percent of L before
and after the transaction.
(b)
Although it is not clear from the
regulations, if L did not actually
know of AS's father, the family
attribution rules apparently would
not apply to him under Treas. Reg.
§ 1.382-2T(h)(6)(iii), and Family
Five would not be created.
The interaction of Treas. Reg.
§§ 1.382-2T(h)(6)(iii) and (iv) is
unclear. Treas. Reg. § 1.3822T(h)(6)(iv) applies only if each
overlapping family is a 5-percent
shareholder (or would be if the common
139
members were included in the family).
The parenthetical phrase in Treas. Reg.
1.382-2T(h)(6)(iv) tends to defeat the
apparent purpose of Treas. Reg. §
1.382-2T(h)(6)(iii).
2.
(a)
That is, it appears to encompass
individuals who currently own less
than 5 percent of the loss
corporation, but who, when
combined with other family
members, own 5 percent or more.
(b)
In order to know whether this
parenthetical rule applies, one
must determine the identity of all
the shareholders, their relatives,
and their percentage interest -- a
determination Treas. Reg. § 1.3822T(h)(6)(iii) apparently seeks to
avoid.
(c)
It seems that Treas. Reg. § 1.3822T(h)(6)(iv) should apply after
Treas. Reg. § 1.382- 2T(h)(6)(iii)
is applied, so that its scope
would be limited to those rare
cases such as where the loss
corporation has actual knowledge
of the family relationships of
non-5 percent shareholders.
(d)
Also, because Treas. Reg. § 1.3822T(h)(6)(iv) requires overlapping
families to be 5 percent
shareholders, double counting
problems persist where family
members own less than 5 percent
collectively and the loss
corporation has actual knowledge
of the family relationship.
Entity Attribution
Section 382 generally adopts the constructive
ownership rules of section 318(a)(2), but with
certain key modifications.
140
a.
In general
(1)
(2)
(3)
Under section 318(a)(2) stock held by a
corporation, partnership, estate or
trust will be attributed
proportionately to the respective
shareholders, partners and
beneficiaries.
(a)
However, with respect to corporate
attribution, the 50 percent
threshold test of section
318(a)(2)(C) does not apply for
section 382 purposes. Section
382(l)(3)(A)(ii)(I); Treas. Reg.
§ 1.382-2T(h)(2)(i)(B).
(b)
Thus, in general, stock that is
owned by a corporation is
proportionately owned (by value)
by its shareholders.
Section 382(l)(3)(A)(ii)(I) states
that, except as provided in
regulations, an entity is not
considered as owning any stock
attributed to its shareholders,
partners or beneficiaries.
(a)
Under this rule, subject to the
limitations discussed in Part
V.F.2.b. and c., below, stock
ownership is continuously
attributed up the chain of
ownership until no more entities
are encountered.
(b)
At this point, the ultimate owners
of the loss corporation have been
determined.
TAMRA added section 382(l)(3)(A)(v) to
provide that loss corporation stock
will not pass through an entity to an
owner of a "nonstock" ownership
interest in the entity.
141
b.
No attribution through nonstock interests
(1)
Consistent with the statute, as
modified by TAMRA, the regulations
provide that loss corporation "stock"
will not be attributed to owners of
"nonstock" interests or through such
nonstock interests. See Treas. Reg.
§ 1.382-2T(h)(2)(ii).
(2)
The regulations provide that section
318(a)(2) will not apply to treat loss
corporation stock that is owned
directly by a first tier entity (or
indirectly by any higher tier entity)
as being owned by any person that has
an ownership interest in such entity,
to the extent that such interest is (or
is attributable to):
(3)
(a)
Section 1504(a)(4) stock;
(b)
An ownership interest that does
not constitute stock under Treas.
Reg. § 1.382-2T(f)(18)(ii) (stock
treated as nonstock); or
(c)
With respect to noncorporate
entities, any ownership interest
in such entities that have
"characteristics similar to" the
two types of corporate stock
interests mentioned above.
To illustrate, assume that all of the
common stock of loss corporation (L) is
owned by individual A. A contributes
all of his common stock to HC, a newly
formed corporation, in exchange solely
for HC common stock. Simultaneously,
individuals B and C transfer cash to HC
in exchange for 20 percent interests in
HC.
(a)
Under the general attribution
rules, the L stock held by HC is
attributed to A, B and C, and HC
is no longer treated as owning L
142
stock. No ownership change would
occur, since B and C have
increased their collective
interest in L by only 40
percentage points.
(4)
(b)
However, now assume that A
received solely "straight"
preferred stock in HC (i.e.,
section 1504(a)(4) stock). In
this case, no L stock would be
attributed to A through HC. The L
stock would be attributed to B and
C equally, in which case an
ownership change would occur since
B and C increased their interest
in L by 100 percentage points.
See Treas. Reg.§ 1.3822T(h)(2)(iv) (Ex. (1) and (2)).
(c)
The same result would occur if A
received voting preferred stock in
HC and such stock was disregarded
as "stock" under Treas. Reg.
§ 1.382-2T(f)(18)(ii).
The application of the entity
attribution rule in light of this
limitation may become extremely complex
and uncertain where loss corporation
stock must be attributed through
several entities or tiers of entities.
(a)
The capital structure of each
entity must be analyzed to
determine which ownership
interests in the entity constitute
"nonstock" interests. Only after
one has determined which interests
constitute stock can the entity
attribution rules be applied.
(b)
The process of determining whether
stock constitutes section
1504(a)(4) stock is inherently
uncertain due to the lack of
regulations under section 1504.
143
The determination of whether a
nominal "stock" interest will be
disregarded (i.e., treated as
"nonstock") under Treas. Reg.
§ 1.382-2T(f)(18)(ii) was
discussed above, at Part V.B.3.b.
c.
(c)
All of the uncertainties and
problems of application outlined
therein will be incorporated into
the entity attribution rules by
virtue of this limitation.
(d)
Further, it is unclear whether
each of the three tests contained
in Treas. Reg. § 1.3822T(f)(18)(ii) are applied with
reference to the underlying loss
corporation, or the immediate
first tier or higher tier entity.
See LTR 8841038.
Limitation on attribution from certain
entities
The regulations provide that attribution of
stock will not pass through certain
entities.
(1)
Under Treas. Reg. § 1.3822T(h)(2)(iii), the following entities
will be treated as an individual that
is unrelated to any other owner (direct
or indirect) of the loss corporation:
--
Any entity other than a
higher tier entity that owns
five percent or more of the
loss corporation stock, a
first tier entity or the loss
corporation,
--
A qualified trust under
section 401(a) (Cf. section
318(a)(2)(B));
--
Any state, any possession of
the U.S., the U.S. itself,
any foreign government or any
144
political subdivision of the
following; and
-(2)
(3)
Any other person designated
by the Service.
Loss corporation stock that is owned by
any such person will not be attributed
to any other person for purposes of
determining if an ownership change
occurred.
(a)
Since attribution ceases under
section 382 with individuals, the
effect of treating such entities
as unrelated individuals is that
attribution ceases with such
entities, and the loss corporation
stock will not be attributed
further.
(b)
For example, if a higher tier
entity owns 4 percent of loss
corporation stock, such stock will
not be attributed to such entity's
owners.
(c)
The apparent purpose of this rule
is to relieve the loss corporation
of the burden of identifying all
the entities and their owners that
may own less than five percent of
the loss corporation.
(d)
Just as the statute relieves loss
corporations from the burden of
identifying individual non-5percent shareholders, the
regulations extend this relief as
to non-5-percent shareholders who
are not individuals.
Exception for distributions from
qualified trusts
(a)
On June 28, 2006, the IRS issued
final regulations that provide an
exception to Treas. Reg. § 1.382-
145
2T(h)(iii) for distributions from
qualified trusts. Treas. Reg. §
1.382-10(a).
(b)
The regulations were issued
originally as temporary
regulations on June 23, 2003 based
upon IRS concern that a
distribution by a qualified trust
of an ownership interest in an
entity may cause an ownership
change, even though that event may
not change the ultimate beneficial
ownership of the loss corporation.
See Preamble to Treas. Reg. §
1.382-10(a).
(c)
Under Treas. Reg. § 1.38210(a)(1), if a qualified trust
distributes an ownership interest
in an entity (as defined in Treas.
Reg. § 1.382-3(a)(1))), then for
testing dates on or after the date
of the distribution, the
distributed ownership interest is
treated as having been acquired by
the distributee on the date and in
the manner acquired by the trust.
As a result, the distributee
“steps into the shoes” of the
qualified trust and no ownership
change occurs.
(d)
For purposes of this rule, in
order to determine which ownership
interest in an entity is
distributed from a qualified
trust, a loss corporation must
either specifically identify the
ownership interests that are the
subject of dispositions by the
qualified trust of ownership
interests in an entity, or apply
the first-in, first-out (FIFO)
method of accounting to all such
dispositions. Treas. Reg. § 1.38210(a)(2).
146
(4)
The regulations do not address entities
other than corporations, partnerships,
estates, and trusts.
(a)
Presumably, stock held by a mutual
insurance company will be
considered to be held by its
policyholders. Indeed, the
Service has confirmed this result.
LTR 9138029.
(b)
Stock held by a regulated
investment company (RIC) (mutual
fund) presumably will be treated
as owned by the owners of the RIC.
The Service has also confirmed
this result. See LTR 9109013; LTR
9104043. However, under the
regulations, segregation rules do
not apply when a RIC issues new
stock or redeems outstanding
stock. Treas. Reg. § 1.3822T(j)(2)(iii)(A).
(c)
Stock owned by a section 501(c)(3)
organization should not be
attributed to its owning members.
As a practical matter, there
generally are no shareholders or
owning members with respect to a
section 501(c)(3) organization.
If there are, such persons are
prevented from receiving a benefit
from the organization. See
section 501(c)(3) and Treas. Reg.
§ 1.501(c)(3)-1(b)(4). Thus, such
persons cannot be the "ultimate
beneficial owner."
i)
147
However, in LTR 9137024, a
nonstock, nonmembership, notfor-profit corporation
converted into a mutual
insurance company owned by
its policyholders.
ii)
d.
The Service ruled that the
conversion was not an
ownership change. This would
suggest that the Service may
"look through" nonprofit
entities in determining the
beneficial owners of losses.
See also LTR 9222028.
Example -- triangular "A" reorganization
(1)
Fact pattern
Individual A owns all of the
outstanding stock of L. Individual B
owns all of the outstanding stock of P.
P wishes to acquire L. Accordingly, on
January 1, 1988, P forms P-1, and P-1
is merged into L with L surviving. As
a result of the merger, A receives P
stock representing 25 percent of the
total P stock outstanding after the
merger. The merger qualifies as a
reorganization under section
368(a)(2)(E).
(2)
The merger of P-1 into L constitutes an
equity structure shift. See section
382(g)(3)(A); Treas. Reg. § 1.3822T(e)(2).
(3)
To determine whether an ownership
change has occurred, the ownership of
the L stock must first be ascertained.
P's ownership of L stock is attributed
to P's shareholders in proportion to
the value of their P stock holdings.
Section 382(l)(3)(A)(ii); Treas. Reg.
§ 1.382-2T(h)(2)(i).
(a)
Thus, A is considered to own 25
percent of the L stock and B is
considered to own 75 percent of
the L stock.
(b)
P's actual ownership of L stock is
disregarded. Section
148
382(l)(3)(A)(ii); Treas. Reg.
§ 1.382-2T(h)(2)(i).
(4)
e.
Having determined the stock ownership
of L for purposes of section 382, it
can now be determined whether an
ownership change has occurred.
(a)
Under section 382(g)(1), B's
percentage interest in the new
loss corporation (L) has increased
by 75 percentage points over L's
lowest percentage interest in the
old loss corporation (L).
(b)
Thus, an ownership change has
occurred.
Example -- commonly controlled corporations
(1)
Fact pattern
Individual A owns all of the stock of
P. P, in turn, owns all of the stock
of L-1 and L-2. Both L-1 and L-2 are
loss corporations. A has held all of
the P stock for many years. For valid
business reasons, L-1 is merged into L2. As a result of the merger, the L-1
stock held by P is canceled and P
receives an additional 30 percent of
the L-2 stock outstanding after the
merger.
(2)
The merger of L-1 into L-2 is an equity
structure shift under section
382(g)(3)(A). However, the
constructive ownership rules must be
applied to determine if an ownership
change has occurred.
(3)
Before the merger, under section
382(l)(3)(A)(ii)(I), P's ownership
L-1 and L-2 stock is attributed to
and P is not considered to own any
such stock. Similarly, after the
merger, A is considered to own all
the L-2 stock.
149
of
A,
of
of
(4)
f.
Thus, there is no ownership change
because A's interest in L-2 (100
percent) has remained constant
throughout the testing period (even
though A is deemed to own more shares
of L-2 stock). See LTR 9005048; LTR
9001063.
Example -- commonly controlled corporations
(1)
Fact pattern
Corporation X is held by A, a group of
non 5-percent shareholders. X owns 80
percent of corporations Y and Z. The
remaining 20 percent of Y and Z is held
by individuals B and C, respectively.
Y and Z, in turn, own 100 percent of L
and P, respectively. On January 1,
1988, L merged into P. As a result of
the merger, Y receives 30 percent of
the P stock outstanding after the
merger.
(2)
The merger of L into P is an equity
structure shift. See section
382(g)(3)(A).
(3)
Prior to the merger, under the
constructive ownership rules, A owned
80 percent of L, and B owned 20
percent. Y's ownership is attributed
to B and X, pro rata, and X's ownership
is attributed in its entirety to A.
(4)
After the merger, P is owned as
follows:
B 6 percent -- 20 percent
percent
C 14 percent -- 20 percent
percent
A 80 percent -- 80 percent
percent
-- 80 percent
percent
150
of 30
of 70
of 30
of 70
(5)
In testing the merger as an ownership
change, the only 5-percent shareholder
who increased its percentage holdings
in the loss corporation is C. Since C
only increased its interest by 14
percentage points over its lowest
interest in L prior to the merger (0
percent), an ownership change has not
occurred.
(6)
This example is based on example 16
found in the conference report.
However, the facts of example 16 vary
in one important aspect. The example
states that in the merger of L into P,
"[Y] is completely cashed out." Given
this fact, it is unclear why the
example goes on to examine the stock
ownership of P.
(7)
(a)
Such a forward merger of L into P
in exchange for cash would not be
a tax-free "A" reorganization
because the requisite continuity
of interest would be lacking. L
would be deemed to sell its assets
to P and then liquidate under
section 332. See Rev. Rul. 69-6,
1969-1 C.B. 104.
(b)
Thus, under section 381, Y and not
P would inherit L's NOL carryover.
Therefore, the ownership of Y's
stock, not P's stock, should be
examined following the merger.
Since Y's stock was not altered,
no ownership change would result.
(c)
Example 16 also refers to P as the
new loss corporation. However,
since no ownership change
occurred, there can be no "new
loss corporation." See section
382(k)(3).
Had the merger of L and P been a
reverse cash merger, the transaction
151
would have constituted a purchase of
stock from Y. See Rev. Rul. 73-427,
1973-2 C.B. 301. In such a case, the
stock ownership of P, not L, should be
analyzed.
3.
4.
Back Attribution
a.
For purposes of section 382, "back"
attribution (i.e., attribution pursuant to
section 318(a)(3)) does not apply, except to
the extent provided in regulations. See
section 382(l)(3)(A)(iii).
b.
Thus, stock held directly or indirectly by a
shareholder, partner or beneficiary will not
be attributed to the respective entity under
section 318(a)(3).
c.
The regulations currently provide no
exception to this rule, but allow for such
exceptions to be made in the future through
subsequent regulations or rulings by the
Service. Treas. Reg. § 1.382-2T(h)(3).
Option Attribution -- Final Regulations
The Service promulgated final regulations to
govern the treatment of options under section 382
on March 17, 1994. These regulations are
effective as of November 5, 1992. Treas. Reg. §
1.382-4(d). For a discussion of the prior rules,
see Part V.F.5., below.
a.
Definitions
(1)
The final regulations define an option
as any contingent purchase, warrant,
convertible debt, put, stock subject to
risk of forfeiture, contract to acquire
stock, or similar interest. Treas.
Reg. § 1.382-4(d)(9)(i).
(2)
Convertible stock is treated as an
option only if the terms of the
conversion feature permit or require
the tender of consideration other than
152
the stock being converted.
§ 1.382-4(d)(9)(ii).
b.
c.
Treas. Reg.
(3)
An option to acquire an option with
respect to the stock of the loss
corporation, and each one of a series
of such stock options, is treated as an
option to acquire stock. Treas. Reg.
§ 1.382-4(d)(9)(iii).
(4)
The final regulations provide that
notwithstanding (1) through (3) above,
general principles of tax law (such as
substance over form) will still affect
the determination of whether an
instrument is an option or stock.
Treas. Reg. § 1.382-4(d)(9)(iv).
Rules
(1)
The final regulations establish a
general rule that an option is not
treated as exercised under section
382(l)(3)(A). Treas. Reg. § 1.3824(d)(1). This largely reverses the
deemed exercise rule of the former
temporary regulations. See Part
V.F.5., below.
(2)
Pursuant to Treas. Reg. § 1.3824(d)(2)(i), an option is deemed
exercised only if it satisfies either
an:
(a)
ownership test,
(b)
control test, or
(c)
income test.
Ownership test
An option satisfies the ownership test if
the principal purpose of the issuance,
transfer, or structuring of the option is to
avoid, or ameliorate the impact of, an
ownership change of the loss corporation by
providing the option holder, prior to the
153
exercise of the option, with a substantial
portion of the attributes of ownership of
all or part of the stock covered by the
option. Treas. Reg. § 1.382-4(d)(3).
d.
Control test
(1)
An option satisfies the control test
if:
(a)
A principal purpose of the
issuance, transfer, or structuring
of the option is to avoid, or
ameliorate the impact of, an
ownership change of the loss
corporation, and
The holder of the option and any
related persons have, in the
aggregate, a direct and indirect
ownership interest in the loss
corporation of more than 50
percent. Treas. Reg. § 1.3824(d)(4)(i).
(b)
Interest in the loss corporation
is determined as if the increase
in those persons' percentage
ownership interests that would
result from the exercise of the
option in question and any other
options to acquire stock held by
such persons, and any intended
increases in such persons'
percentage ownership interest,
actually occurred on the date the
option is issued or transferred.
Id.
(c)
The effective date for the
application of the control test is
March 17, 1994 as opposed to
November 5, 1992, which is the
general effective date for the
final regulations. Treas. Reg.
§ 1.382-4(h)(2)(ii).
154
(2)
(3)
Persons and related groups
(a)
The term "person" includes an
individual or entity, but not a
public group, as defined in Treas.
Reg. § 1.382-2T(f)(13). Treas.
Reg. § 1.382-4(d)(4)(ii)(1).
(b)
Persons are related if they bear a
relationship set forth in sections
267(b) or 707(b). Moreover,
persons are related if they have a
formal or informal understanding
among themselves to make a
coordinated acquisition of stock,
within the meaning of Treas. Reg.
§ 1.382-3(a)(1)(i). Treas. Reg.
§ 1.382-4(d)(4)(ii)(1).
Indirect ownership interest
(a)
The constructive ownership rules
of Treas. Reg. § 1.382-2T(h) (with
two exceptions) are used to
determine the indirect ownership
interest that the option holder
and any persons related to the
holder have in the loss
corporation. The rules of the
following two subparts of Treas.
Reg. § 1.382-2T(h) do not apply:
i)
Treas. Reg. § 1.3822T(h)(2)(i)(A), which treats
stock attributed pursuant to
section 318(a)(2) as no
longer being owned by the
entity from which it is
attributed,
ii)
Treas. Reg. § 1.382-2T(h)(4),
which treated options as
exercised in certain
circumstances.
Treas. Reg. § 1.382-4(d)(4)(ii)(B).
155
(b)
e.
If applying the constructive
ownership rules without regard to
Treas. Reg. § 1.382-2T(h)(2)(i)(A)
would result in the same stock of
the loss corporation being owned
by two or more such persons,
appropriate adjustments must be
made so that such stock is not
counted more than once in
computing the aggregate ownership
interests of such persons. Id.
Income test
An option satisfies the income test if a
principal purpose of the issuance, transfer,
or structuring of the option is to avoid, or
ameliorate the impact of an ownership change
of the loss corporation by facilitating the
creation of income (including accelerating
income or deferring deductions) or value
(including unrealized built-in gains) prior
to the exercise or transfer of the option.
Treas. Reg. § 1.382-4(d)(5).
f.
Factors used in applying the ownership,
control, and income tests
(1)
In general
(a)
Whether an option satisfies the
ownership, control, or income
tests is determined based on all
relevant facts and circumstances.
Treas. Reg. § 1.382-4(d)(6)(i)
provides the following factors
that are relevant in applying all
three tests-i)
any business purposes for the
issuance, transfer or
structure of the option;
ii)
the likelihood of exercise of
the option (taking into
account, for example, any
contingencies to its
exercise);
156
iii) transactions related to the
issuance or transfer of the
option; and
iv)
(2)
the consequences of treating
the option as exercised.
(b)
An option does not meet the
ownership, control, or income
tests if it is issued, transferred
or structured with the intent that
it be treated as exercised to
prevent an ownership change.
Treas. Reg. 1.382-4(d)(6)(i).
(c)
The weight given to any factor
depends on all the facts and
circumstances. The presence or
absence of any factor does not
create a presumption. Id.
Application of ownership test
Treas. Reg. § 1.382-4(d)(6)(ii)
provides that additional factors are
taken into account in applying the
ownership test. These factors include-(a)
the relationship, at the time of
issuance or transfer of the
option, between the exercise price
of the option and the value of the
underlying stock;
(b)
whether the option provides its
holder or a related person with
the right to participate in the
management of the loss corporation
or with other rights that
ordinarily would be afforded to
owners of the underlying stock;
(c)
the existence of a reciprocal
option (e.g. a call option held by
the prospective purchaser and a
corresponding put option held by
the prospective seller.
157
(d)
(3)
the ability of the holder of an
option with a fixed exercise price
to share in future appreciation of
the underlying stock. However,
this factor alone is not
sufficient for the option to
satisfy the ownership test.
Conversely, the fact that the
holder of such an option does not
bear the risk of loss due to
declines in value of the
underlying stock does not preclude
the option from satisfying the
ownership test.
Application of control test
Treas. Reg. § 1.382-4(d)(6)(iii)
provides that additional factors are
taken into account in applying the
control test. These factors include--
(4)
(a)
the economic interests in the loss
corporation of the option holder
or related persons, and
(b)
the influence of those persons
over the management of the loss
corporation.
Application of income test
Treas. Reg. § 1.382-4(d)(6)(iv)
provides that additional factors are
taken into account in applying the
income test.
(a)
These factors include:
whether in connection with the
issuance or transfer of the
option, the loss corporation
engages in income acceleration
transactions, and
whether the option holder or a
related person purchases stock
from, or makes a capital
158
contribution or loan to, the loss
corporation that can be reasonably
expected to avoid or ameliorate
the impact of an ownership change.
g.
(b)
Examples of income acceleration
transactions include those outside
the ordinary course of the loss
corporation's business that
accelerate income or gain into the
period prior to the exercise of
the option (or defer deductions to
the period after the exercise of
the option).
(c)
A stock purchase, capital
contribution, or loan is more
probative toward an option
satisfying the income test the
larger the amount received by the
loss corporation in the
transaction or related
transactions.
(d)
A stock purchase, capital
contribution or loan is as a
general rule not taken into
account in applying the income
test if it is made to enable the
loss corporation to continue basic
operations of its business, e.g.,
to meet the monthly payroll or
fund other basic operating
expenses of the loss corporation.
Safe harbors
An option to which a safe harbor applies is
generally not subject to the ownership,
control or income tests. The safe harbor
rules apply to-(1)
A stock purchase agreement or similar
arrangement, the terms of which are
commercially reasonable, in which the
parties obligations to complete the
transaction are subject only to
reasonable closing conditions, and
159
which is closed on a change date within
one year after it is entered into. A
contract to acquire stock, however, is
not exempted from the income test
regardless of whether it is described
in the safe harbor applicable to
contracts. Treas. Reg. § 1.3824(d)(7)(i).
(2)
An option that is part of a security
arrangement, in a typical lending
transaction (including purchase money
loan), if the arrangement is subject to
customary commercial conditions. A
security arrangement includes, for
example, an agreement for holding stock
in escrow or under a pledge or other
security agreement, or an option to
acquire stock contingent upon a default
under a loan. Treas. Reg. § 1.3824(d)(7)(ii).
(3)
An option to acquire stock in a
corporation with customary terms and
conditions provided to an employee,
director, or independent contractor in
connection with the performance of
services for the corporation or a
related person (and that is not
excessive by reference to the services
performed) and which-(a)
is transferable within the meaning
of Treas. Reg. § 1.83-3(d); and
(b)
does not have a readily
ascertainable fair market value on
the date the option is issued.
Fair market value is defined with
reference to Treas. Reg. § 1.837(b).
Treas. Reg. § 1.382-4(d)(7)(iii).
(4)
An option entered into between
stockholders of a corporation (or a
stockholder and the corporation) with
respect to stock of either stockholder,
160
that is exercisable only upon the
death, disability, mental incompetency,
of the stockholder, or, in the case of
stock acquired in connection with the
performance of services for the
corporation or related person (and that
is not excessive by reference to the
services performed), the stockholder's
retirement. Treas. Reg. § 1.3824(d)(7)(iv).
h.
(5)
A bona fide right of first refusal with
customary terms, entered into between
stockholders of a corporation (or
between the corporation and a
stockholder) and regarding the
corporation's stock. Treas. Reg. §
1.382-4(d)(7)(v).
(6)
An options designated in the Internal
Revenue Bulletin as being exempt from
one or more of the ownership, control,
or income tests. Treas. Reg. §1.3824(d)(7)(vi).
Additional rules
(1)
A contract to acquire stock is
considered to be issued or transferred
on the date it is entered into or
assigned, respectively. Treas. Reg.
§ 1.382-4(d)(8)(i).
(2)
If an entity is formed or availed of
for the principal purpose of
facilitating an indirect transfer of an
option by issuing or transferring
interests in the entity, an issuance or
transfer of an interest in the entity
will be treated as a transfer of the
option for purposes of applying the
ownership, control or income tests.
Treas. Reg. § 1.382-4(d)(8)(ii).
(3)
The rules of Treas. Reg. § 1.382-2(d)
apply, with appropriate adjustments, to
options to acquire or transfer
161
interests in non-corporate entities.
Treas. Reg. § 1.382-4(d)(8)(iii).
(4)
i.
In applying the rules of Treas. Reg.
§ 1.382-2(d) to puts, appropriate
adjustments must be made that take into
account that a put provides its holder
with the right to transfer, instead of
acquire stock. Treas. Reg. § 1.3824(d)(8)(iv).
Testing date
(1)
The loss corporation is required to
determine whether an ownership change
has occurred immediately after any
owner shift or issuance or transfer of
an option with respect to the stock of
the loss corporation, that is treated
as exercised under Treas. Reg. § 1.3824(d)(2). Treas. Reg. § 1.3822(a)(4)(i).
(2)
Under the former temporary regulations,
discussed below at Part V.F.5., a
testing date occurred on any date on
which an owner shift, an equity
structure shift, or certain issuances
or transfers of options to acquire loss
corporation stock took place. Treas.
Reg. § 1.382-2T(a)(2)(i). In practice,
a testing date arose whenever the
deemed exercise of options would result
in an ownership change.
(3)
A transfer of stock of the loss
corporation in any of the circumstances
described in section 382(l)(3)(B)
(acquisition by death, gift, divorce,
or separation) does not require the
loss corporation to make a
determination of whether an ownership
change has occurred. Treas. Reg.
§ 1.382-2(a)(4)(ii)(A).
(4)
A transfer of an option between persons
who are not 5-percent shareholders does
not require the loss corporation to
162
make a determination of whether an
ownership change has occurred. Treas.
Reg. § 1.382-2(a)(4)(ii)(A).
j.
(5)
A transfer of an option between members
of separate public groups resulting
from the application of the segregation
rules of Treas. Reg. § 1.382-2T(j)(2)
does not require the loss corporation
to make a determination of whether an
ownership change has occurred. Treas.
Reg. § 1.382-2(a)(4)(ii)(B).
(6)
Calculations of increases in percentage
ownership are made at the close of the
testing date and any transactions that
create a testing date are treated as
occurring simultaneously at the close
of the testing date. Treas. Reg.
§ 1.382-2(a)(4)(i). This rule,
together with Treas. Reg. § 1.3823(j)(7), which provides that transitory
ownership of stock by an underwriter of
the issuance is disregarded, clearly
exempts the application of the
aggregation rules, discussed below,
from firm commitment underwriters.
Subsequent treatment of options
(1)
If an option is deemed exercised on a
change date, the option is not treated
as exercised on any subsequent testing
date and prior to a transfer that would
itself cause the option to satisfy the
ownership, control or income tests.
Treas. Reg. § 1.382-4(d)(10)(i)(A).
Exercise of the option by the person
who owned the option immediately after
the ownership change does not cause
another ownership change on the date of
exercise. Treas. Reg. § 1.3824(d)(10)(i). It is unclear how the
final regulations apply if less than
all the options outstanding before an
ownership change are exercised or
deemed exercised. It is ambiguous
163
whether options that are not deemed
exercised will benefit from the relief
afforded by this rule.
(2)
k.
The final regulations give a loss
corporation the ability to apply a
look-back rule. Under this
alternative, if an option is exercised
within three years after the ownership
change, the corporation may elect to
treat the option as having been
exercised on the change date for
purposes of determining whether an
ownership change occurs on any and all
testing dates after the change date.
Treas. Reg. § 1.382-4(d)(10)(ii). This
rule may prevent a subsequent ownership
change.
Application to ownership change
Once the constructive ownership rules have
been applied, the corporation can determine
its 5-percent shareholders based on the
percentage of stock that they own.
Generally, an ownership change occurs if the
stock ownership of any one or more of the 5percent shareholders has increased by more
than 50 percentage points during the testing
period.
(1)
A 5-percent shareholder is any person
holding 5-percent or more (by value) of
the loss corporation stock at any time
during the testing period. Sections
382(k)(6)(C) and (7); Treas. Reg.
§ 1.382-2T(g).
(2)
Shareholders who own less than 5
percent are aggregated and treated as
one 5-percent shareholder. Section
382(g)(4); Treas. Reg. § 1.3822T(j)(1).
(3)
One or more groups of non-5-percent
shareholders may be aggregated
separately as a result of certain
segregation transactions, such as
164
public stock offerings, mergers and
redemptions. Treas. Reg. §§ 1.3822T(j)(2) and (3). See discussion of
final regulations regarding the
segregation rules at Part V.H., below.
l.
Effective date
(1)
The regulations provide that the option
rules of Treas. Reg. § 1.382-4(d) apply
to any testing date on or after
November 5, 1992. Treas. Reg. § 1.3824(h)(2)(i).
(2)
An option issued on or before March 17,
1994, or an option issued within 60
days after that date pursuant to a plan
existing before that date is not
treated as exercised under the control
test. The control test will apply to
such option, however, on a testing date
on or after the date of a transfer of
an option that would itself cause the
option to satisfy the control test.
Treas. Reg. § 1.382-4(h)(2)(ii).
(3)
The final regulations contain special
timing rules relating to convertible
stock.
(a)
In general, convertible stock
issued prior to July 20, 1988, is
not treated as an option. Treas.
Reg. § 1.382-4(h)(2)(iii)(A).
(b)
Nonvoting convertible preferred
stock issued prior to July 20,
1988, is treated as an option if:
i)
165
the stock would be described
in section 1504(a)(4),
disregarding subparagraph (D)
thereof (i.e., the fact that
it is convertible into
another class of stock), and
ignoring the potential
participation in corporate
growth that the conversion
feature may offer; and
ii)
the loss corporation makes
the election described in
Notice 88-67 on or before the
date prescribed in the Notice
or December 7, 1992.
Treas. Reg. § 1.3824(h)(2)(iii)(B)(1).
(c)
Other convertible stock issued
prior to July 20, 1988 is treated
as an option subject to the rules
of Treas. Reg. § 1.382-2T(h)(4)
and Treas. Reg. § 1.382-4(d)(2)
if:
i)
The terms of the conversion
feature permit or require the
tender of consideration other
than the stock being
converted; and
ii)
The loss corporation makes
the election in Notice 88-67
on or before the date
provided in the Notice.
Treas. Reg. § 1.3824(h)(2)(iii)(B)(2).
(d)
Convertible stock issued on or
after July 20, 1988, and before
November 5, 1992, is treated as an
option only if:
i)
166
The stock, when issued, would
be described in section
1504(a), disregarding
subparagraph (D) and ignoring
the potential participation
in corporate growth that the
conversion feature may offer;
or
ii)
The terms of the conversion
feature permit or require the
tender of consideration other
than the stock being
converted.
Treas. Reg. § 1.382-4(h)(2)(iv)
(e)
If an option existed immediately
before and after an ownership
change occurring on a testing date
to which Treas. Reg. § 1.3822T(h)(4) applies-i)
the option is not treated as
exercised on any testing date
after the change date and
prior to a transfer of the
option that would itself
cause the option to satisfy
the ownership, control, or
income tests; and
ii)
the actual exercise of the
option, if by a person who
owned the option immediately
after the ownership change
(or by a transferee who
acquired the option, directly
or indirectly, from that
person in a transfer not
subject to the principal
purpose test), will not cause
an ownership change on any
testing date on or after the
date of exercise.
Treas. Reg. § 1.382-4(h)(2)(v).
(f)
The final regulations allow a loss
corporation to elect to apply the
option rules of the former
temporary regulations for an
extended period.
i)
167
In general, the election
applies to all testing dates
that occur prior to May 17,
1994. Treas. Reg. § 1.3824(h)(2)(vi)(A)(1).
ii)
If the loss corporation,
however, is subject to a
title 11 or similar case
filed on or before May 17,
1994, the election applies to
all testing dates on or
before the time the plan of
reorganization becomes
effective. Treas. Reg.
§ 1.382-4(h)(2)(vi)(A)(2).
iii) In determining whether any
convertible preferred stock
issued by the loss
corporation during the period
that the election is in
effect is treated as an
option or stock, the
convertible preferred stock
is treated as if it were
issued on November 4, 1992.
Treas. Reg. § 1.3824(h)(2)(vi)(B)(1).
iv)
5.
The special effective date
for the control test set
forth in Treas. Reg. § 1.3824(h)(2)(ii) will not apply if
the election is made. Treas.
Reg. §1.3824(h)(2)(vi)(B)(2).
Option Attribution – Former Temporary Regulations
(No Longer Applicable)
The final regulations discussed above superseded
temporary regulations (“former temporary
regulations”) that had been promulgated on August
5, 1987. Treas. Reg. § 1.382-2T(h)(4).
The
final regulations became effective as of November
5, 1992. See T.D. 8531, 1994-1 C.B. 121; Part
V.F.4., above. The former temporary regulations
were replaced in response to numerous comments
regarding the practical difficulties of applying
168
the option rules of these regulations. Id. For
purpose of comparison to the final regulations,
the former temporary regulations are discussed
below.
a.
In general
(1)
Under the former temporary regulations,
and solely for purpose of determining
whether there was an ownership change
on any testing date, stock of the loss
corporation that was subject to an
option was be treated as acquired on
such date pursuant to an exercise of
the option, if such deemed exercise
would result in an ownership change.
Treas. Reg. § 1.382-2T(h)(4)(i).
(2)
According to Treas. Reg. § 1.3822T(h)(4)(i), this option attribution
rule was applied separately with
respect to:
(3)
(a)
each class of options (i.e.,
options with terms that are
identical, issued by the same
issuer, and issued on the same
date) that is owned by each 5percent shareholder, and
(b)
each 5-percent shareholder, each
owner of an option that would be a
5-percent shareholder if the
option were exercised, and each
combination thereof.
Under this test, some options may be
treated as exercised while others may
not. Note that because the former
temporary regulations define a "class
of options" in very narrow terms, many
options may be tested on a separate
basis. However, under a rule referred
to as the "linked option rule," options
created under two agreements required
to be consummated jointly were only be
deemed exercised jointly. LTR 8930045.
169
b.
(4)
Although Treas. Reg. § 1.3822T(h)(4)(i) refers only to options with
respect to loss corporation stock,
options with respect to "stock" of a
first tier or higher tier entity
apparently were also subject to the
option attribution rule. See Treas.
Reg. § 1.382-2T(f)(18)(iv).
(5)
Options held by members of a public
group that were treated as a 5-percent
shareholder under Treas. Reg. § 1.3822T(g)(1)(ii), (iii) or (iv) were
subject to the option rule on an
option-by-option basis. See Treas.
Reg. § 1.382(h)(4)(ii) (Ex. (1))
(option held with respect to 4 percent
of stock subject to attribution).
(6)
The former temporary regulations did
not indicate when options were treated
as being issued on the same date. For
a definition of a similar term, see
Prop. Treas. Reg. § 1.1275-1(e)
(defining "issue date" for purposes of
the original issue discount rules).
Examples
(1)
Fact pattern one
Individual A owns all of the 100 shares
of outstanding loss corporation (L)
stock. On January 1, 1988, A issues an
option to individual B to acquire 4
shares of L stock. On June 1, 1988, A
issues an option to individual C to
acquire 6 shares of L stock. On
July 30, 1989, A issues an option to
individual D to acquire 15 shares of L
stock. Each option is exercisable for
ten years from the date of grant. On
July 30, 1990, A sells 41 shares of his
L stock to individual E. Treas. Reg.
§ 1.382-2T(h)(4)(ii) (Ex. (1)).
(a)
Under the former temporary
regulations, the issuance of each
170
of the options by A is a testing
event under Treas. Reg. § 1.3822T(a)(2)(i). However, none of the
options were treated as being
exercised on any such testing
dates since an ownership change
would not result by doing so.
(b)
Under the former temporary
regulations, the date on which A
sells his stock to E is a testing
date, and on such date an
ownership change is deemed to
occur. Individuals B, C, D and E
are considered to own 4 percent, 6
percent, 15 percent and 41 percent
of L, respectively. An ownership
change has occurred because B, C,
D and E have increased their
collective interest by 66 percent.
(c)
This example indicates that in
determining the percentage
interest of the optionholder, the
denominator will not reflect a
double counting of the option and
the stock subject to the option
(e.g., D is treated as owning 15
percent of L (15/100 shares), not
13 percent of L (15/115 shares)).
However, the former temporary
regulations were silent as to
whether a corresponding decrease
occurs as to A's percentage
interest. Although section 382
generally is not concerned with
decreases in interest, such
downward shifts are important in
determining the extent of future
increases. See generally New York
State Bar Association, Report on
Proposed Section 382 Option
Attribution, 93 TNT 94-10 (April
30, 1992) (Recommendation E)
(recommending that an option
deemed exercised should generally
171
be treated as equivalent to the
underlying stock).
(2)
(d)
In the example, if A buys back the
options from B, C, and D, it is
unclear whether A is treated as
increasing his interest by 25
percent. Also, if, after A issued
the options to B, C, and D, L
issued 10 additional shares to A,
it is unclear whether A's interest
would be treated as being 100
percent (110/110 shares, no
percentage change) or 77 percent
(85/110 shares, a 2 percent
increase (from 75 percent)).
(e)
Similarly, assume that A owned
only 25 shares of the 100 shares
of outstanding L stock, and A
transferred all of his shares to
individual G, subject to the
outstanding options held by B, C,
and D. It is unclear whether G
will be treated as acquiring 25
percent of L, or 0 percent. In
each of these cases, it would seem
that A should be treated as if he
continued to hold 25 percent of L
stock after the grant of the
options to B, C, and D that A
owned immediately before the
grant.
Fact pattern two
Individual A owns all 100 shares of
loss corporation (L) stock. On July
22, 1988, A sells 40 shares of his
stock to individual B, and grants an
option to B to acquire the remaining 60
shares of L stock. On the same day, L
issues to A an option to acquire an
additional 100 shares of L stock.
Treas. Reg. § 1.382-2T(h)(4)(ii) (Ex.
(2)).
172
(a)
As the former temporary
regulations point out, if both A
and B were treated as exercising
their options on the July 22, 1988
testing date, B would be treated
as owning 50 percent of L (40
shares purchased + 60 shares
deemed acquired/200 shares
outstanding (actual and deemed)),
and A would be treated as owning
50 percent of L (100 shares deemed
acquired/200 shares outstanding
(actual and deemed)). Thus, an
ownership change would not occur
since B only increased his
interest by 50 percent.
(b)
However, if only B's option were
treated as exercised, and not A's,
B would be deemed to own 100
percent of L (100 shares (actually
and constructively)/100 shares
(actually outstanding)). Thus, an
ownership change would occur on
July 22, 1988. This result is
compelled by the former temporary
regulations which applied on a
shareholder-by-shareholder basis.
See Treas. Reg. 1.382-2T(h)(4)(i).
(c)
The former temporary regulations
did not provide any relief where
the actual exercise of outstanding
options ultimately proved to be
inconsistent with the presumption
underlying the deemed exercise of
such options. If A exercised his
option to acquire the 100
additional shares, an ownership
change could not have resulted,
since B could own a maximum of
only 50 percent of L (assuming B
also exercises his option).
(d)
The former temporary regulations
should have allowed L to amend its
return for subsequent events that
173
were inconsistent with earlier
assumptions as to the deemed
exercise, as is the case with
lapsed and forfeited options.
c.
Interests similar to options
Under the former temporary regulations,
interests that are "similar to an option"
were treated as options and were subject to
the option attribution rules. Section
382(l)(3)(A); Treas. Reg. § 1.3822T(h)(4)(v). Interests that are similar to
an option included, but were not limited to,
the following:
(1)
--
A warrant;
--
A convertible debt instrument;
--
An instrument other than debt that
is convertible into stock;
--
A put;
--
A stock interest subject to risk
of forfeiture;
--
A contract to acquire or sell
stock; and,
--
Any contingent purchase.
Compared to the statute, the former
temporary regulations failed to list
"contingent purchases" as options, but
included "an instrument other than debt
that is convertible into stock."
(a)
The final regulations corrected
this omission and list contingent
purchases within the definition of
an option. Treas. Reg. § 1.3824(d)(9)(i).
(b)
Presumably, the former temporary
regulations included contingent
purchases as options because the
statute lists them, and the above
174
list of items, by its terms, is
not exhaustive.
(2)
Note that many of the rights listed
above are also described in section
382(k)(6)(B)(i) as rights that may be
treated as stock. The former temporary
regulations apparently treated such
rights as subject to the option rule
only.
(3)
In addition, under the former temporary
regulations, an option to acquire an
option, and each one of a series of
such options was also treated as an
option. Treas. Reg. § 1.3822T(h)(4)(iv).
(4)
Importantly, under the former temporary
regulations, an option might have be
treated as exercised even though the
likelihood of exercise was minimal
(e.g., where the option is "out-of-themoney"). The final regulations altered
this approach by focusing on abuse
potential. See Treas. Reg. § 1.3824(d)(3), 4(d)(4), 4(d)(5). However,
under the final regulations, once an
option to acquire stock is determined
to have an abusive principal purpose,
the fact that its exercise is
contingent is disregarded. Treas. Reg.
§ 1.382-4(d)(9)(i).
(5)
The underlying principle of the former
temporary regulations appeared to be
that any contingent right to cause a
transfer of stock potentially may be an
option. This includes tender or
exchange offers, rights of first
refusal, bankruptcy plans and a pledge
of stock pursuant to a loan guarantee.
(6)
An offer that cannot be withdrawn as a
legal or practical matter was
considered an option. LTR 9247007; LTR
8930045; LTR 8929018; LTR 8917007; LTR
175
8903043; LTR 8841038. Cf. Rev. Rul.
90-11, 1990-1 C.B. 10 (certain "poison
pill" rights exempted from the option
rules so long as the corporation can
redeem the rights for a nominal amount
without shareholder approval).
(a)
A nonbinding letter of intent was
not considered an option. LTR
8847067.
(b)
A contract clause providing that
one corporation will not be
required to sell stock to the
other, or that the other is
required to purchase such stock,
if such purchase or sale were
likely to cause an ownership
change ("savings clause"), was
disregarded, since it does not
absolutely restrict the amount of
stock that may be received. LTR
8903043.
(7)
A tender offer for stock may have
constituted an option under the former
temporary regulations. LTR 8822074.
Similarly, an offer to exchange debt
for new debt and stock was an option.
LTR 8834086. A plan of merger also was
an option. LTR 9250009; LTR 8923021.
(8)
A plan of reorganization in bankruptcy
was considered an interest similar to
an option on the date the plan was
confirmed. LTR 9247007; LTR 9019036;
LTR 9005049; LTR 8949040; LTR 8903043.
However, such options were not subject
to the option attribution rules (until
the effective date of the plan) for
testing dates after September 5, 1990.
Treas. Reg. § 1.382-2T(h)(4)(x)(J).
(9)
With respect to convertible instruments
other than debt, the literal effect of
Treas. Reg. § 1.382-2T(h)(4)(v) was to
treat convertible stock both as an
176
option and as stock. Normally,
convertible stock is treated as "stock"
under section 1504 (and, consequently,
section 382), and the option rule
should not have applied. Notice 88-67,
1988-1 C.B. 555, generally provided for
the application of only the stock rules
or the options rules, but not both.
See also Treas. Reg. §§ 1.3822(b)(2)(ii) and 1.382-4(h)(2)(iii).
(a)
The effects of treating
convertible stock as an option
rather than stock would appear to
be: (1) to reduce the total
number of shares otherwise
outstanding, thus increasing the
likelihood of an ownership change
due to shifts in other stock
interests, (2) to reduce the value
of the loss corporation by the
value of such interest (see Treas.
Reg. § 1.382-2T(h)(4)(vii)(C)),
and (3) to lengthen the testing
period as to such stock under the
"evergreen rule," discussed below.
(b)
In Notice 88-67, 1988-1 C.B. 555,
Treasury confirmed that
convertible stock could have been
treated as options under the
former temporary regulations.
However, Treasury intended option
treatment to apply to "stock" that
was treated as such solely because
of its convertibility feature
(i.e., stock described in section
1504(a)(4) but for a conversion
feature). Such interests would
not be treated as "stock" for
purposes of determining if an
ownership change occurs (but they
would be treated as stock for
purposes of determining the loss
corporation's value).
177
(c)
Other types of convertible stock
were treated solely as stock and
not as an option, as long as the
terms of the conversion feature do
not permit or require the tender
of consideration other than the
stock being converted, and as long
as Treas. Reg. § 1.3822T(f)(18)(iii) does not apply.
(d)
The provisions of Notice 88-67
applied to stock issued on or
after July 20, 1988. Thus, all
convertible stock issued before
July 20, 1988 was treated as stock
and not as an option. An election
to apply Notice 88-67
retroactively was provided. See
Notice 88-67; LTR 8947053; LTR
8917007.
(e)
Consistent with Notice 88-67, the
final regulations expanded the
definition of "stock" to include
convertible stock. Treas. Reg. §
1.382-2(a)(3)(ii). Convertible
stock is treated as an option only
if the terms of the conversion
feature permit or require the
tender of consideration other than
the stock being converted. Treas.
Reg. § 1.382-4(d)(9)(ii). A more
detailed discussion of the
convertible stock aspects of the
final regulations is contained in
Part V.F.4., above.
(10) Under the former temporary regulations,
the result was unclear if a shareholder
holds stock subject to a risk of
forfeiture (e.g., an employeeshareholder).
(a)
It was unclear whether the
shareholder's actual present stock
ownership was to be disregarded,
with the shareholder's interest
178
being treated as a right to
receive unissued stock; or whether
the present stock interest was to
be respected, but treated as being
subject to a call option held by
the loss corporation (i.e., a
right to acquire outstanding
stock).
(b)
The latter characterization had
the effect of increasing the
number of shares outstanding (and
thus reducing the risk of an
ownership change due to shifts in
stock held by other shareholders)
and was also consistent with the
notion that the former option
attribution rules applied to
contingent rights to cause a
transfer of stock.
(11) For rulings on the stock/option issue,
under the former temporary regulations,
see LTR 9146049; LTR 8909060; LTR
8841038; LTR 8811030; LTR 8809081. For
rulings as to what interests are
options, see LTR 9203014; LTR 9113032;
LTR 9113016; LTR 8930045; LTR 8930034;
LTR 8929018; LTR 8928028; LTR 8927079;
LTR 8923021; LTR 8919056; LTR 8917007;
LTR 8903043; LTR 8902047; LTR 8847067;
LTR 8841038; LTR 8834086; LTR 8822074;
LTR 8811030; LTR 8808063.
d.
Evergreen rule
(1)
The former temporary regulations
indicated that if an option is treated
as exercised, the underlying stock was
be deemed to be acquired on the testing
date, regardless of when the option
itself was acquired. See Treas. Reg. §
1.382-2T(h)(4)(ii) (Ex. (1)(iv)).
(2)
This rule, known as the "evergreen
rule," was contrary to the regulations
under the pre-1986 version of section
179
382, which provided that if an option
was deemed to be exercised, the
underlying stock was treated as being
acquired on the date that the option
was acquired. Treas. Reg. § 1.382A1(a)(2).
(3)
The evergreen rule in effect extended
the testing period by the option term.
(a)
Except in a clear abuse case, this
result was objectionable since the
optionholders first acquired an
economic interest in the loss
corporation -- and its loss
attributes -- on the date that the
option was acquired. This is
especially the case with options
that are not out-of-the-money.
(b)
Thus, the underlying stock should
have been treated as having been
acquired on the date the option
was acquired.
(4)
The Blue Book stated that Treasury
would consider whether there were
circumstances in which it may be
appropriate to limit the operation of
this rule to transactions occurring
during the testing period that includes
the date the option or other interest
was issued or transferred. See Staff,
Joint Committee on Taxation, General
Explanation of the Tax Reform Act of
1986 311, n.32 (1987) (hereinafter
"Blue Book").
(5)
The evergreen rule is maintained in the
final regulations, but its impact is
considerably lessened insofar as the
final regulations only deal with
abusive situations, where options
appear more likely to be exercised
within three years.
180
e.
Contingencies
(1)
The fact that an option is contingent
or otherwise not currently exercisable
was disregarded under the former
temporary regulations. Treas. Reg. §
1.382- 2T(h)(4)(iii). See, e.g., LTR
9039008 (purchase agreement contingent
on FDIC approval resulted in an
ownership change).
(a)
An exception was provided for
options that were subject to
Treas. Reg. § 1.382-2T(h)(4)(x)(D)
(options exercisable at death,
disability, etc.).
(b)
This exception apparently was
unnecessary since such options
were already exempt from the
attribution rules.
(2)
For example, under the former temporary
regulations, if individual A, a 5percent shareholder, acquired warrants
with respect to a loss corporation’s
stock, and such warrants were not
exercisable for two years, A
nevertheless may have been treated as
if he exercised the warrants currently
if such a deemed exercise would trigger
an ownership change. See Blue Book at
312; LTR 8841038 (contract contingent
on consummation of exchange offer;
option deemed exercised on contract
date, not consummation date).
(3)
Similarly, if the number of shares
purchasable under the warrant were
contingent upon such events as the
income levels of the loss corporation
or future public offerings, A would
have been treated as acquiring the
maximum number of shares possible. Id.
(4)
This rule is the same under the final
regulations. See Treas. Reg. § 1.3824(d)(9)(i).
181
(5)
(6)
The former temporary regulations did
not address cases where a single share
of stock was subject to multiple
options or the related case where two
options are outstanding but the
exercise of one option prevents the
exercise of the other.
(a)
For example, L is a loss
corporation which holds all of the
stock of operating loss
corporation (L-1). As a condition
of making a loan, bank (B)
receives an option with respect to
one-third of the L stock and onethird of the L-1 stock; however,
under the terms of the two
options, the exercise of one
option prevents exercise of the
other.
(b)
For section 382 purposes, the
cross-contingencies should not be
ignored. B should be treated as
having the ability to exercise
only one of the options (whichever
would singly cause an ownership
change).
(c)
Otherwise, in the example, an
ownership change could occur with
respect to L-1 since B would be
deemed to acquire two-thirds of
the L-1 stock.
As indicated above, the Service ruled
that under the linked option rule,
options created under two agreements
that were required to be jointly
consummated were only deemed exercised
jointly. LTR 8930045.
182
f.
Effect of deemed exercise of options on
outstanding stock
(1)
Right (or obligation) to issue stock
According to the former temporary
regulations, the deemed exercise of an
option with respect to unissued stock
(or treasury stock) resulted in a
corresponding increase in the total
outstanding stock of the corporation,
for purposes of determining whether an
ownership change occurs. Treas. Reg.
§ 1.382-2T(h)(4)(vii)(A). The final
regulations did not alter this rule.
(2)
Right (or obligation) of loss
corporation to acquire outstanding
stock
Similarly, under the former temporary
regulations, the deemed exercise of an
option to transfer outstanding stock to
the issuing corporation (or a right of
the issuing corporation to acquire
outstanding stock) resulted in a
corresponding decrease in the amount of
total outstanding stock. Treas. Reg.
§ 1.382-2T(h)(4)(vii)(B).
(3)
Right (or obligation) of shareholder to
transfer stock
The former temporary regulations did
not discuss the effect on a
shareholder's percentage interest where
the shareholder's stock was subject to
an option, and such option was either
deemed to be exercised, or the
shareholder transferred his stock
subject to the outstanding option.
g.
Effect on value of loss corporation
(1)
According to Treas. Reg. § 1.3822T(h)(4)(vii)(C), the deemed exercise
of an option with respect to unissued
(or treasury) stock had no effect on
183
the determination of the value of the
old loss corporation (and the
computation of the section 382
limitation).
(a)
The issue underlying this
provision apparently went to
timing: when will the stock that
is subject to an option be deemed
to be issued. The former
temporary regulations apparently
took the position that the stock
will always be deemed to be issued
on the day of the ownership change
(i.e., the deemed exercise date).
(b)
The apparent theory of this rule
was that the exercise price of the
option -- if received by the
corporation -- would be treated as
a capital contribution under
section 382(l)(1)(B). See LTR
8927079.
(c)
Thus, for example, assume that
loss corporation (L) has $100
convertible debt outstanding and
such debt can be converted into 40
percent of the L stock. The debt
was issued on January 1, 1987. On
January 1, 1990, when the debt is
still outstanding, an L
shareholder transfers 11 percent
of the L stock. Under the former
temporary regulations, an
ownership change occurred. The
value of the L stock immediately
before the ownership change is
assumed to be $200; if the
convertible debt were actually
converted, assume the value of the
L stock would be $300. The value
of L for purposes of computing the
section 382 limitation apparently
is only $200.
184
(d)
(2)
Suppose the conversion feature was
designed to allow the creditor to
participate in the appreciation of
the L stock (as is the case in
many convertible debt instruments)
and that, upon conversion, the
creditor was entitled to receive
$150 of L stock after the
conversion. The total value of L
stock after conversion would be
$350. Although it is not entirely
clear from the former temporary
regulations, the section 382 value
of L apparently would still be
$200. This is because the value
of L is the value of its stock,
and the deemed conversion has no
effect on such value.
Treas. Reg. § 1.382-2T(h)(4)(vii)(C)
was inconsistent with the conference
report, which required Treasury to
"prescribe such regulations as are
necessary to treat warrants, options,
contracts to acquire stock, convertible
debt, and similar interests as stock
for purposes of determining the value
of the loss corporation." Conf. Rep.
No. 841, 99th Cong., 2d Sess. II-187
(1986) (hereinafter "Conf. Rep.").
(a)
The conference report thus
mandated that, for valuation
purposes, options and similar
interests must be included in
valuing the loss corporation.
(b)
Technically, this could have been
accomplished by treating the
deemed issuance of stock as if it
occurred on the date the option
was issued, or by providing an
exception for deemed issuances
under regulatory authority granted
in section 382(l)(1)(B).
185
h.
(3)
Further, Treas. Reg. § 1.3822T(h)(4)(vii)(C) produced harsh and
anomalous results since under a literal
application of this rule, convertible
stock that is treated as an option
would be ignored in computing the loss
corporation's value; whereas, pure
section 1504(a)(4) stock is included in
the calculation of value. See Treas.
Reg. § 1.382-2T(f)(18)(iii) (nonstock
interests other than options are
included in value). However, since
such convertible stock also constitutes
"stock", one could have argued that it
should be included in the loss
corporation's value unless issued
within the two-year period. See Notice
88-67, 1988-1 C.B. 555.
(4)
The former temporary regulations did
not discuss the effect on the loss
corporation's value of a deemed
exercise of a right (or obligation) of
the loss corporation to acquire
outstanding stock. Such a right
presumably would result in a decrease
in the value of the loss corporation.
Cf. section 382(e)(2).
Options that lapse or are forfeited
(1)
Under the former temporary regulations,
if an option that is treated as
exercised should lapse unexercised, or
if the owner of such option irrevocably
forfeits his right to acquire stock
pursuant to the option, then the option
would have been treated as if it never
had been issued. Treas. Reg. § 1.3822T(h)(4)(viii); Conf. Reg. at II-183.
Note that the final regulations do not
contain a similar provision. However,
as with the evergreen rule, this should
be of little significance inasmuch as
options issued with an abusive
principal purpose are not likely to
lapse.
186
(2)
In such a case, under the former
temporary regulations, the loss
corporation could have filed an amended
return for prior years (subject to the
applicable statute of limitations) if
the section 382 limitation became
inapplicable (i.e., no ownership change
in fact occurred). Id.
(3)
Under the former temporary regulations,
the loss corporation could have treated
the option attribution rule as being
inapplicable if an option was treated
as exercised, but such option lapses or
the holder irrevocably forfeits his
interest in the option prior to the
filing of the tax return. Apparently,
the rule applied even if the return was
filed beyond the due date (including
extensions).
(4)
What constitutes a lapse
(a)
A contract, agreement, or offer
that expires unexercised was
considered as the lapse of an
option under the former temporary
regulations. LTR 8943080; LTR
8930045; LTR 8841038.
(b)
An agreement to increase the
convertibility ratio of
convertible debentures did not
result in the lapse of an option
because at no time did the holders
relinquish their right to convert.
LTR 8903043.
(c)
The redemption or other purchase
for cash of outstanding options
and warrants did not constitute
the lapse or forfeiture of the
options and warrants. LTR
9244017; LTR 9109035; LTR 8930034.
Similarly, the surrender of
convertible debentures for
unsecured notes and preferred
187
stock did not constitute a lapse.
LTR 8940006.
i.
Actual exercise of options
(1)
(2)
In general
(a)
Under the former temporary
regulations, the actual exercise
of an option that was in existence
immediately before and after an
ownership change -- regardless of
whether such option was deemed to
be exercised in connection with
the ownership change -- was
disregarded for purposes of
determining if a future ownership
change occurred, but only if the
option was exercised by the same
5-percent shareholder who held the
option at the time of the
ownership change. Treas. Reg.
§ 1.382-2T(h)(4)(vi)(A).
(b)
Where such an option was
disregarded, the effect on other
5-percent shareholders whose
percentage interests were affected
by the options was unclear.
Perhaps, retroactive effect was
given to the resulting adjustment
in such shareholders' percentage
interest.
Special 120-day rule
(a)
Under the former temporary
regulations, Treas. Reg. § 1.3822T (h)(4)(vi)(B), if the actual
exercise of an option occurs
within 120 days after the date on
which the option was treated as
exercised, the loss corporation
could elect to disregard the
option attribution rule, and to
take into account only the actual
exercise of the option.
188
(b)
Importantly, the former temporary
regulations pointed out that this
rule could not prevent the
ownership change from occurring,
but merely operated to postpone
the change date.
(c)
This election was made in the
statement that must be filed
annually by the loss corporation.
(d)
Whether the loss corporation
should have made the election to
postpone the change date depended
upon a number of interrelated
factors. For example, the longterm tax-exempt rate was likely to
increase or decrease during the
120-day period. In addition, the
value of the stock of the loss
corporation -- which determines
the value of the old loss
corporation under section 382(e) - may increase or decrease during
the 120-day period due to market
forces or other outside events.
An increase in interest rates
generally may cause an increase in
the long-term tax-exempt rate, but
such an increase may also result
in a diminished value of preferred
stock carrying a fixed dividend
rate. Further, postponing the
change date may allow a greater
amount of income to be fully
offset by pre-change losses or,
conversely, may increase the
amount of loss that is subject to
section 382.
(e)
This provision was intended to
avoid the necessity of valuing
both the stock and assets of the
loss corporation at a time prior
to the date that actual control is
acquired. Preamble to T.D. 8149,
1986-2 C.B. 85, 88.
189
(3)
(f)
For applications of the 120-day
rule, see LTR 9113016; LTR
9006065; LTR 9005049; LTR 8947053;
LTR 8945007; LTR 8943080.
(g)
No similar ability to move the
change date is provided under the
final regulations with respect to
abusive options that are deemed
exercised.
Option not treated as stock
Under the former temporary regulations,
except for options in existence before
and after an ownership change, the
acquisition of stock pursuant to the
actual exercise of an option was taken
into account if the option attribution
rule did not apply to the option.
Treas. Reg. § 1.382-2T(h)(4)(xii).
j.
De minimis pre-change losses
(1)
Under the former temporary regulations,
the option attribution rule did not
apply to options existing on the
testing date if the pre-change losses
of the corporation were below a
prescribed threshold amount -- double
the section 382 limitation for a normal
post-change year (as computed under
section 382(b)(1) without any
adjustments). Treas. Reg. § 1.3822T(h)(4)(ix).
(2)
According to the Preamble, the de
minimis rule was intended to prevent a
taxpayer from triggering an ownership
change through the use of an option
just before significant losses were
expected to be realized. Preamble to
T.D. 8149, 1986-2 C.B. at 88.
(3)
The de minimis rule, however, also
operated to the taxpayer's benefit as a
safe harbor (although its utility as
such is limited by the fact that the
190
value of the loss corporation is
subjective).
k.
Disregarding transfers of options
Under the former temporary regulations, the
following transfers of options were
disregarded for purposes of option
attribution:
(1)
Transfers of options between non-5percent shareholders (and, presumably,
persons who would not be 5-percent
shareholders if the option were
exercised);
(2)
Transfers of options between members of
public groups that are separated under
the segregation rules;
(3)
Transfers of options under
circumstances described in section
382(l)(3)(B) (death, gift, divorce,
etc.) are also disregarded. Treas.
Reg. §§ 1.382-2T(h)(4)(xi).
(4)
l.
(a)
The former temporary regulations
stated that in section
382(l)(3)(B) cases the transferee
is treated as having owned the
option for the period that it was
owned by the transferor.
(b)
This treatment appears to have
nullified as a testing event only
the transfer of the option. The
transferee still may have been
treated as exercising the option
if an independent testing event
occurred.
This treatment is retained in the final
regulations. Treas. Reg. § 1.3824(d)(11).
Exempt options
Under the former temporary regulations, Treas.
191
Reg. § 1.382-2T(h)(4)(x), the option attribution
rules did not apply to certain enumerated types
of options. In providing for these exemptions
from the option attribution rule, the Service
attempted to include as many rights as possible
without compromising the purpose of the rule.
Preamble to T.D. 8149, 1986-2 C.B. at 88.
However, almost every exemption was criticized as
being overly restrictive.
(1)
Long held options on actively traded
stock
The option attribution rule did not
apply to any option on "actively
traded" loss corporation stock (as
defined in section 1273(b)) for which
market quotations are readily
available, but only if:
(a)
--
The option has been
continuously owned by the
same 5-percent shareholder
(or person who would be a 5percent shareholder if the
option were exercised) for at
least three years,
--
and then only until the
earlier of such time as the
option is transferred by (or
to) a 5-percent shareholder,
or the fair market value of
the underlying stock exceeds
the strike price on the
testing date (i.e., the
option is "in-the-money" on
the testing date). Treas.
Reg. § 1.382-2T(h)(4)(x)(A).
Solely for purposes of this
exception, options on loss
corporation stock that are assumed
(or substituted) in a
reorganization and converted into
options of another party to the
reorganization, were not treated
as transferred, provided that
192
there were no changes in the terms
of the stock and the amount of
stock subject to the option was
adjusted only to reflect the
exchange ratios. Treas. Reg.
§ 1.382-2T(h)(4)(x)(A).
(2)
(b)
This rule had its most obvious
application in the case of "outof-the-money" options on traded
stock, but could also have been
applied to outstanding convertible
debt of a publicly traded company
(whether or not the debt itself is
actively traded) and convertible
stock (where such stock is treated
as an option rather than stock).
However, the value of this rule
was limited by the continued need
to monitor the fair market value
of the underlying stock.
(c)
Importantly, during the three-year
"gestation" period, it appears
that an option otherwise eligible
for this exemption was be treated
as being exercised. Although the
former temporary regulations were
silent on this point, if the
option was in fact held for the
requisite three-year period, but
triggered an ownership change in
the interim period, the loss
corporation should have been able
to amend its return to take this
fact into account.
Certain convertible debt interests
(a)
The option attribution rule did
not apply to any right to receive
(or obligation to issue) stock
pursuant to the terms of a debt
instrument, where the right to
receive stock of the issuer was
set at a fixed dollar amount and
the number of shares to be
193
acquired was based upon the value
of the underlying stock at or near
the time the stock is transferred
pursuant to the debt. Treas. Reg.
§ 1.382-2T(h)(4)(x)(B).
(3)
(b)
Such a debt instrument, in
economic terms, is similar to
nonconvertible debt. The exercise
of the right amounts to a purchase
of stock at its then fair market
value.
(c)
This exemption should have been
expanded to include any option or
right having similar
characteristics.
Right (or obligation) to redeem stock
of the loss corporation
(a)
The option attribution rule did
not apply to any right (or
obligation) of the loss
corporation "to redeem any of its
stock at the time the stock is
issued," but only to the extent
such stock was issued to persons
who were not 5-percent
shareholders immediately
beforehand. Treas. Reg. § 1.382 2T(h)(4)(x)(C).
(b)
Presumably, this language was
intended to cover redeemable stock
and not stock that literally could
be redeemed only at issuance.
(c)
Literally, this provision applied
to the issuance of stock to new
shareholders -- whether such
shareholders are 5-percent
shareholders in their individual
capacity or as a public group
after the issuance.
(d)
Thus, where loss corporation (L)
issued redeemable stock to the
194
public -- representing 20 percent
of the outstanding L stock -- the
exemption applied so that the
redemption feature of the stock
was ignored (the actual issuance
of the stock was not ignored and
constituted an owner shift).
(e)
It is unclear whether this
exemption applied where a
shareholder holding less than five
percent of the L stock received
redeemable stock in the loss
corporation. On the one hand, the
redemption rights could have been
ignored since such shareholder was
not a 5-percent shareholder
immediately before the issuance in
his individual capacity, yet he
was a member of a public group
that was treated as a 5-percent
shareholder.
(f)
By the same token, this provision
was drafted so that redemption
rights inherent in stock issued to
historic 5-percent shareholders
would not be ignored. For
example, individual A owned all of
the loss corporation (L) stock. A
wished to sell all of his L stock
to individual B without triggering
an ownership change. Accordingly,
A recapitalized L, and received in
exchange for his old L stock
redeemable, voting preferred stock
and common stock, representing 55
percent and 45 percent of L,
respectively. A sells the common
stock to B; the redeemable
preferred stock may be redeemed
three years and one day after the
sale to B. The redemption rights
would not be exempt from option
attribution under the former
temporary regulations, and
treating such rights as being
195
exercised by L produced an
ownership change.
(g)
(4)
Thus, this provision served
Treasury's goal of preventing
abuse. The principal advantage of
this exemption to taxpayers was
that after the close of the
testing period which included the
issuance of such stock, an
ownership change could not be
triggered by deeming the
redemption rights to be exercised.
If the stock was subsequently
transferred after issuance to a 5percent shareholder, the exemption
from the option rules apparently
still applied, although the
transfer would constitute an owner
shift since the transferred
interest constitutes stock.
Options exercisable at death,
disability, etc.
The option attribution rule did not
apply to any option entered into
between owners of the same entity (or
an owner and an entity in which the
owner has a direct ownership interest)
with respect to such owner's interest
in the entity if the option was
exercisable only at death, complete
disability or mental incompetency of
the owner. Treas. Reg. § 1.3822T(h)(4)(x)(D).
(5)
Right to receive (or obligation to
issue) stock as interest or dividends
(a)
The option attribution rule did
not apply to any right to receive
(or obligations to issue) stock in
payment of interest or dividends.
Treas. Reg. § 1.3822T(h)(4)(x)(E).
196
(b)
(6)
(7)
The actual issuance of stock
pursuant to such rights, though,
was not disregarded. See LTR
8841038.
Options outstanding following an
ownership change
(a)
The option attribution rule did
not apply to any option in
existence immediately before and
after an ownership change -whether or not the option was
treated as exercised in connection
with the ownership change -- only
so long as the option continued to
be held by the same holder who
held the option at the time of the
ownership change. Treas. Reg.
§§ 1.382-2T(h)(4)(x)(F) and 1.3824(h)(2)(v).
(b)
This rule complemented Treas. Reg.
§ 1.382-2T(h)(4)(vi)(A), which
disregarded the actual exercise of
such options.
Options pursuant to default
(a)
The option attribution rule did
not apply to any right to acquire
stock of a corporation by a bank
(see section 581), an insurance
company (see Treas. Reg. § 1.8013(a)), or a trust (qualified under
section 401(a)) solely as a result
of a default under a loan
agreement entered into in the
ordinary course of the trade or
business of such bank, life
insurance company or qualified
trust. Treas. Reg. § 1.3822T(h)(4)(x)(G).
(b)
Although the term "bank" under
section 581 includes domestic
building and loan associations,
options granted to other lending
197
institutions such as finance
companies or investment banking
firms did not appear to be covered
by this exemption. See LTR
9148015 (Aug. 23, 1991) (a
nonrecourse pledge of stock on a
loan is an option since it is
outside Treas. Reg. § 1.3822T(h)(4)(x)(G)).
(c)
(8)
This provision appeared intended
to cover options that were
contained in the original loan
agreement itself. However, the
language was broad enough to
include options subsequently
granted to a qualified lender in
consideration of an agreement not
to take action as a creditor with
respect to a loan in default
(e.g., foreclosure). In contrast,
many lending institutions acquire
options with respect to loss
corporation stock as a condition
of making the loan (i.e., prior to
the time of default). The former
temporary regulations did not
appear to exempt such options. An
argument could have been made,
however, that such options should
have been treated as the
equivalent of interest and thus
disregarded under Treas. Reg. §
1.382-2T(h)(4)(x)(E).
Retirement agreements
(a)
The option attribution rule did
not apply to any option entered
into between noncorporate owners
of the same entity (crossownership buy-sell agreement) or
between an owner and the loss
corporation (entity buy-sell
agreements), but only if (1) each
of such owners "actively
participate" in the management of
198
the trade or business, (2) the
option is issued at a time when
the corporation is not a loss
corporation, and (3) the option is
exercisable only upon retirement
of the owner. Treas. Reg. §
1.382-2T(h)(4)(x)(H).
(9)
(b)
This provision did not indicate
how much participation was
required before an owner would be
deemed to actively participate in
the management nor what is meant
by "retirement" of the owner.
(c)
Although this exemption attempted
to eliminate tax barriers to the
use of buy-sell agreements, the
conditions for its availability
appear to have been too strict.
For example, why was it necessary
that the corporation not be a loss
corporation when the option was
created? The business reasons for
entering into such agreement would
appear to have clearly outweighed
any tax considerations. To avoid
this rule, such agreements should
have be entered into upon
formation of the corporation.
Title 11 or similar case
(a)
The option attribution rule did
not apply to any option to acquire
stock in a loss corporation
reorganized pursuant to a plan of
reorganization (the "Plan") in a
Title 11 or similar case (as
defined section 368(a)(3)(A)), but
only until the Plan became
effective, if the option was
--
created by the solicitation
or receipt of acceptances to
the Plan
--
created by the confirmation
199
of the Plan, or
--
created under the terms of
the Plan. Treas. Reg.
§ 1.382-3(o)(1).
(b)
This regulation, first proposed on
September 5, 1990, and adopted on
April 8, 1992, provided relief
from the administrative position
taken by the Service that a
bankruptcy plan creates an option
or interest similar to an option
on the confirmation date. See,
e.g., LTR 9019036.
(c)
Therefore, an ownership change, if
any, arising out of a plan of
bankruptcy should did occur until
the effective date, when any new
stock, options or other interests
were actually issued. This was a
significant improvement,
substantially easing the burden of
measuring changes in stock
ownership during bankruptcy
proceedings.
(10) Other designated options
(a)
Any option designated by the
Service in the Internal Revenue
Bulletin was excepted from the
option attribution rules. Treas.
Reg. § 1.382-2T(h)(4)(x)(Z).
(b)
This provision was added to give
the Service greater flexibility in
providing additional exceptions to
the attribution rules "as
circumstances justifying those
exceptions are identified."
Preamble to T.D. 8277, 1990-1 C.B.
96.
(c)
Under this authority, the Service
exempted from the option
attribution rules rights under
200
certain "poison pill" plans.
Rev. Rul. 90-11, 1990-1 C.B. 10.
i)
A plan gives shareholders
rights to acquire stock, at
less than fair market value,
after the occurrence of
certain triggering events
(tender offer for or
acquisition of a certain
percentage of stock). The
corporation can redeem the
rights for a nominal amount
without shareholder approval
up to a certain number of
days after the triggering
event. Such rights, or
rights similar to those
provided for in the plan,
will be exempt from the
operation of the option rules
until the rights can no
longer be redeemed for a
nominal amount without
shareholder approval.
ii)
The principal purpose of the
plan must be to provide
shareholders of a publicly
held corporation with rights
to purchase stock at
substantially less than fair
market value as a means of
responding to unsolicited
offers to acquire the
corporation.
iii) A plan that does not meet the
parameters of Rev. Rul. 90-11
apparently was still
considered an option subject
to attribution.
G.
5-Percent Shareholder Rules
As discussed previously in this Outline, an ownership
change is triggered by changes in the percentage of
201
"stock" held by 5-percent shareholders. Part V.B.3 of
this Outline discussed the rules to determine what
ownership interests in the loss corporation constitute
"stock." Part V.F. discussed the rules to determine
who owns such interests for section 382 purposes
(i.e., the constructive ownership rules). This part
of the Outline will discuss the rules to determine
which shareholders will be treated as "5-percent
shareholders" of the loss corporation -- in
particular, the aggregation and segregation rules. As
discussed in Part V.J., below, on November 5, 1992,
the Service issued proposed regulations (finalized on
October 4, 1993) that modify the segregation rules as
applied to certain stock issuances. What follows is a
discussion of the general rules as well as the special
segregation rules at the loss corporation level and at
higher levels.
Note that on June 11, 2010, the IRS and Treasury
issued Notice 2010-49 indicating that the IRS and
Treasury are considering modifications to these rules.
Notice 2010-49 described two general approaches and
asked for public comments. The two possible
approaches to the treatment of less than 5-percent
shareholders that are described in the notice are: (i)
the Ownership Tracking Approach and (ii) the Purposive
Approach. The notice indicates that either of these
approaches may be used to modify the regulations. The
Ownership Tracking Approach tracks all changes in
ownership without regard to the particular
circumstances. Under this approach, any transaction
that allows the corporation to track the increase in
ownership interests held by less than 5-percent
shareholders results in the segregation of the less
than 5-percent shareholders into a new public group,
which is treated as a single 5-percent shareholder.
Under the Purposive Approach, the rules would seek to
identify more specifically the circumstances in which
abuses are likely to arise. As discussed below, the
current regulations primarily reflect the Ownership
Tracking approach. Notice 2010-49 requested comments
concerning whether the regulations should follow the
Ownership Tracking Approach, the Purposive Approach,
or another approach.
On November 23, 2011, the IRS and Treasury issued
Proposed Regulations adopting a limited version of the
202
purposive approach in response to comments received in
response to Notice 2010-49. The proposed regulations
provide that the segregation rules do not apply to
transfers of loss corporation stock from 5-percent
entities or individuals who are 5-percent shareholders
to entities or individuals that are not 5-percent
shareholders. In these cases, the stock transfer will
be treated as being acquired proportionately by the
public groups existing at the time of the transfer.
In addition, the proposed regulations adopt a “small
redemption exception” under which the loss corporation
may redeem 10 percent of the value of its outstanding
stock corporationwide (or 10 percent of the shares of
its outstanding stock in the redeemed class) each year
without triggering the segregation rules and the
creation of new 5 percent groups. Where this exception
applies, each public group existing immediately before
the redemption will be treated as redeeming its
proportionate share of exempted stock.
The proposed regulations also provide that the
segregation rules do not apply to 5-percent
shareholders in certain circumstances. The proposed
regulations state that the segration rules will not
apply to transactions if on the testing date on which
the rules would otherwise apply: (1) the 5-percent
entity owns ten percent or less (by value) of all the
outstanding stock of the loss corporation, and (2) the
5-percent entity’s direct or indirect investment in
the loss corporation does not exceed 25 percent of the
entity’s gross assets.
1.
The Statute
In general, 5-percent shareholders can be
classified into two types -- individual 5-percent
shareholders and groups of shareholders who are,
in the aggregate, each treated as one 5-percent
shareholder.
a.
According to section 382(k)(7), a "5-percent
shareholder" is any shareholder holding five
percent or more of the stock of the
corporation at any time during the testing
period.
203
b.
c.
The statute contains special rules to
aggregate the interests of non-5-percent
shareholders.
(1)
Section 382(g)(4)(A) provides that,
except as provided in sections
382(g)(4)(B)(i) and (g)(4)(C), the
holdings of all shareholders who are
not 5-percent shareholders will be
aggregated and treated as if held by
one 5-percent shareholder.
(2)
One purpose of aggregating all non-5percent shareholders is to relieve
publicly-held corporations from the
administrative burden of monitoring
daily stock changes amongst such
stockholders. Conf. Rep. at II-176.
Additional rules are contained in the
statute to segregate groups of non-5-percent
shareholders.
(1)
In the case of an equity structure
shift, the aggregation rule for non-5percent shareholders is applied
immediately before the reorganization
to each group of shareholders of each
corporation that is a party to the
reorganization. Section
382(g)(4)(B)(i).
(2)
Section 382(g)(4)(C) provides that
except as provided in the regulations,
rules similar to the special
aggregation rules applicable to equity
structure shifts are to be applied in
testing whether a transaction is an
owner shift and whether such owner
shift results in an ownership change.
(3)
Section 382(m)(4) also provides
additional authority to apply the above
rules to transactions involving a
single corporation (e.g., a redemption
or recapitalization).
204
d.
2.
Prior to the issuance of regulations, it was
reasonable to assume that a loss corporation
would have only one aggregated 5-percent
shareholder, except where sections
382(g)(4)(B) and (C) applied to segregate
the group of non-5-percent shareholders into
separate groups as a result of certain
transactions.
(1)
That is, stock ownership would be
attributed up through the corporate
chain in accordance with the
constructive ownership rules, and any
shareholders that did not own -actually or constructively -- five
percent or more of the loss corporation
stock at any time during the testing
period would be aggregated and treated
as one 5-percent shareholder.
(2)
However, the regulations provide for a
dramatically more complex set of
aggregation rules.
(3)
To understand the operation of these
regulatory rules, one must first be
familiar with a whole new set of terms
and concepts.
The Regulations -- Definitions
To illustrate the terms and definitions created
by the regulations, assume that loss corporation
(L) is owned 95 percent by P-2 corporation and 5
percent by individual A. P-2, in turn, is owned
entirely by P-1 corporation, and P-1 is owned
entirely by P corporation. P, in turn, is owned
10 percent by individual B, and the remaining 90
percent is widely held (i.e., no person
(individual or entity) other than B owns as much
as 5 percent of P at any time during the testing
period).
a.
First tier entity
Under Treas. Reg. § 1.382-2T(f)(9), a "first
tier entity" is an entity that, at any time
during the testing period, owns a five
205
percent or more direct ownership interest in
the loss corporation. Under Treas. Reg.
§ 1.382-2T(f)(8), a "direct ownership
interest" means an interest that a person
owns in an entity without regard to the
constructive ownership rules of Treas. Reg.
§ 1.382-2T(h).
(1)
(2)
It is unclear whether the term "direct
ownership interest" includes interests
in section 1504(a)(4) stock or stock
described in Treas. Reg. § 1.3822T(f)(18)(ii).
(a)
If so, under Treas. Reg. §§ 1.3822T(f)(8) and (9), an entity that
owns solely section 1504(a)(4)
stock (or Treas. Reg. § 1.3822T(f)(18)(ii) interests)
representing five percent or more
of the loss corporation value
would be a first tier entity even
though such an entity would be
ignored in determining if an
ownership change occurred.
(b)
In addition, an entity owning such
interests in a first tier entity
would be a higher tier entity even
though that entity would not own
an "indirect ownership interest"
in the loss corporation and thus
would be ignored under section 382
generally. See Treas. Reg.
§§ 1.382-2T(f)(14) and (15), and 2T(h)(2)(ii).
(c)
Literally, Treas. Reg. § 1.3822T(f)(8) appears to encompass such
interests.
According to Treas. Reg. §§ 1.3822T(f)(7) and 1.382-3(a)(1), an "entity"
means any corporation, estate, trust,
association, company, partnership or
similar organization.
206
(a)
An entity includes a group of
persons who have a formal or
informal understanding to make a
coordinated acquisition of stock.
Treas. Reg. § 1.382-3(a)(1)(i). A
principal element in determining
whether an understanding exists is
whether the investment decision of
each member of a group is based
upon the investment decision of
one or more other members. Id.
(b)
LTR 9610012 ruled that two or more
funds that hold a loss
corporation's stock will not
constitute an "entity" merely
because a single corporation acts
as investment advisor to the
funds, votes the securities
purchased on behalf of the funds,
the funds have the same board of
directors, and the aggregate
investment by the funds in a
particular corporation is limited
to a fixed percentage of such
corporation's total stock
outstanding.
(c)
LTR 200806008 ruled that entities
with reporting ownership, but
without economic ownership, in a
loss corporation are not
considered shareholders of the
company's common stock under
section 382, and the clients of
the entities collectively are not
considered an entity within the
meaning of reg. section 1.3823(a)(1)(i).
(d)
In the example, P-2 is a first
tier entity. P-2 would remain a
first tier entity even if it sold
all of its L stock during the
testing period (because P-2 owned
L stock at one point during the
testing period).
207
(e)
(3)
Similarly, LTR 200605003 ruled
that three investment funds
purchasing a bankrupt company’s
stock would not be treated as a
single entity under Treas. Reg. §
1.382-3(a)(1). The three funds
were managed by the same
investment advisor and generally
invested in the same stock or
security. However, the three
funds were organized to attract
specific types of investors and to
possess the same investment
objectives; in addition, the
manager served as manager of other
private investment funds. The IRS
ruling was contingent upon
compliance with certain guidelines
relating to the ongoing bankruptcy
proceeding.
On March 27, 1992, Treasury transferred
the "entity" definition to Treas. Reg.
§ 1.382-2(a)(3), and amended it to
include "a group of persons who have a
formal or informal understanding among
themselves to make a coordinated
acquisition of stock." A provision was
included, however, to provide that
creditors formulating a workout plan
for an insolvent debtor would not be
considered an entity. Treas. Reg.
§ 1.382-2(a)(3)(i).
(a)
Thus, a group of 20 individuals
each acquiring 3 percent of L's
stock pursuant to a plan will
cause an ownership change, since
the new "entity" will be treated
as a separate public group.
Treas. Reg. § 1.382-2(a)(3)(ii)
(Ex. (1)).
(b)
If L's management separately
approaches 15 investors to each
acquire 4 percent of L's stock,
the regulations also treat the
208
group of investors as an "entity,"
if each investor is aware that L's
management is meeting with other
investors. Treas. Reg. § 1.3822(a)(3)(ii) (Ex. (2)).
(c)
b.
In LTR 9725039, various
organizations affiliated with
Acquiror and various organizations
holding assets for the benefit of
Acquiror purchased more than 5% of
the outstanding stock of a
company. However, no single
Acquiror organization owned 5% or
more of the stock. The Service
ruled that two or more of the
Acquiror organizations do not
constitute an “entity” within the
meaning of § 1.382-3(a)(1) merely
because one or more of the
Acquiror organizations have
overlapping officers, directors,
or trustees. See LTR 9725039.
Higher tier entity
According to Treas. Reg. § 1.382-2T(f)(14),
a "higher tier entity" is an entity that, at
any time during the testing period, owns a
five percent or more direct ownership
interest in a first tier entity or in any
other higher tier entity. In the example,
both P-1 and P are higher tier entities.
c.
Highest tier entity
According to Treas. Reg. § 1.382-2T(f)(16),
a "highest tier entity" is a first tier
entity or higher tier entity that is not
owned, in whole or in part, at any time
during the testing period by a higher tier
entity. Thus, in the example, P is a
highest tier entity. Although there may be
more than one highest tier entity with
respect to a loss corporation, in the
example P is the only highest tier entity.
d.
Public group
209
Under Treas. Reg. § 1.382-2T(f)(13), a
"public group" is a group of individuals,
entities or other persons each of whom owns,
directly or constructively, less than five
percent of the loss corporation.
e.
(1)
That entities can be treated as members
of a public group reflects the fact
that, in general, entities that own
less than five percent of the loss
corporation stock are treated as
individuals, and the entity attribution
rules do not apply to such
corporations. See Treas. Reg. § 1.3822T(h)(2)(iii). In this regard, the
regulations have modified section
382(l)(3)(A)(ii)(II).
(2)
As is stated in Treas. Reg. § 1.3822T(j)(1), a public group can include
"public shareholders," "public owners,"
and "5-percent owners" who are not 5percent shareholders. See also LTR
9652019 (stating that a public group
can include ESOP participants). It is
unclear whether the list contained in
Treas. Reg. § 1.382-2T(j)(1) is
exhaustive or otherwise restricts the
definition of a public group.
Public shareholder
Treas. Reg. § 1.382-2T(f)(11) states that
the term "public shareholder" means any
individual, entity or other person with a
direct ownership interest in the loss
corporation of less than 5 percent at all
times during the testing period. In the
example, since L is owned entirely by
persons who own at least five percent of L,
there are no public shareholders.
f.
Public owner
According to Treas. Reg. § 1.382-2T(f)(12),
the term "public owner" means any
individual, entity or other person that, at
all times during the testing period, owns a
210
less than five percent direct ownership
interest in a first tier or higher tier
entity. In contrast to a public
shareholder, a public owner does not own a
direct interest in the loss corporation
itself. In the example, the shareholders of
P, other than B, are public owners because
they own a direct interest in a higher tier
entity (P) of less than five percent.
g.
5-percent owner
Under Treas. Reg. § 1.382-2T(f)(10), a
"5-percent owner" is any individual that, at
any time during the testing period, owns a
five percent or more direct ownership
interest in a first tier or higher tier
entity. In the example, since individual B
owns five percent or more of the P stock, B
is a 5-percent owner.
h.
5-percent shareholder
Treas. Reg. § 1.382-2T(g)(1) defines the
term "5-percent shareholder" in effect by
listing categories of 5-percent
shareholders. These categories generally
fall into two types -- (i) individual 5percent shareholders and (ii) groups of
shareholders (i.e., public groups) that, in
the aggregate, are each treated as a single
5-percent shareholder.
(1)
The term 5-percent shareholder includes
an individual that owns at any time
during the testing period a direct
ownership interest in the stock of the
loss corporation of five percent or
more. Treas. Reg. § 1.382-2T(g)(1)
(i)(A). In the example, A is a 5percent shareholder under this
provision.
(2)
The term 5-percent shareholder also
includes an individual that owns at any
time during the testing period an
"indirect ownership interest" in the
stock of the loss corporation of five
211
percent or more by virtue of an
ownership interest in any one first
tier or higher tier entity. Treas.
Reg. § 1.382-2T(g)(1)(i)(B).
(a)
According to Treas. Reg. § 1.3822T(f)(15), an "indirect ownership
interest" is an interest a person
owns solely as a result of the
application of the constructive
ownership rules and without regard
to any direct ownership interest
(or other beneficial ownership
interest) in the entity.
(b)
This type of 5-percent shareholder
generally will qualify as a "5percent owner" initially. Through
the constructive ownership rules,
such 5-percent owners may become
5-percent shareholders.
(c)
Under Treas. Reg. § 1.3822T(g)(1)(i), if an individual owns
two percent of the loss
corporation (L) through one first
tier entity and three percent of L
through another first tier entity,
the individual would not be a 5percent shareholder because the
individual does not separately
have a 5- percent direct ownership
interest or a 5-percent indirect
ownership interest.
(d)
However, since Treas. Reg.
§ 1.382-2T(g)(l) is generally
subject to Treas. Reg. §§ 1.3822T(k)(2) (actual knowledge) and
(k)(4)(the anti-avoidance rules),
presumably the individual would be
treated as a 5-percent shareholder
of L if, for example, L had actual
knowledge of his interests,
notwithstanding the reference to a
single entity in Treas. Reg.
§ 1.382-2T(g)(1)(i)(B). See also
212
Treas. Reg. § 1.382- 2T(g)(2) and
(3).
(e)
(3)
(4)
In the example, B is a 5-percent
shareholder because B indirectly
owns more than 5-percent of L by
virtue of its 10 percent interest
in P.
The term 5-percent shareholder also
includes a "public group" of either a
highest tier entity, a higher tier
entity, or a first tier entity that is
identified as a 5-percent shareholder
under the aggregation rules (see Treas.
Reg. § 1.382-2T(g)(1)(ii)); a public
group of the loss corporation that is
identified as a 5-percent shareholder
under the aggregation rules (see Treas.
Reg. § 1.382-2T(g)(1)(iii)); and
finally, a public group of either the
loss corporation, a first tier entity,
or a higher tier entity that is
identified as a 5-percent shareholder
by virtue of the segregation rules (see
Treas. Reg. § 1.382-2T(g)(1)(iv)).
(a)
Treas. Reg. §§ 1.382-2T(j)(2) and
(3) implement the segregation
rules contained in sections
382(g)(4)(B) and (C) and section
382(m)(4).
(b)
As will be explained below, in the
example the non-5-percent
shareholders of P would be
aggregated into a public group
that is treated as a single 5percent shareholder.
Consistently with section 382(k)(7),
Treas. Reg. § 1.382-2T(g)(1) provides
that an individual 5-percent
shareholder remains a 5-percent
shareholder even though his interest on
a specific testing date within the
testing period is below five percent.
213
3.
Determining 5-Percent Shareholders and Their
Percentage Interest
a.
In general
(1)
As discussed above, a 5-percent
shareholder may be an individual or a
public group. The 5-percent
shareholder determination generally is
made after the application of the
constructive ownership rules.
(2)
In this regard, Treas. Reg. § 1.3822T(g)(2) provides that a person will be
treated as constructively owning stock
pursuant to the entity attribution
rules only if the loss corporation
stock is attributed to such person in
the person's capacity as a higher tier
entity or a 5-percent owner of the
first tier or higher tier entity from
which stock is being attributed.
However, Treas. Reg. § 1.382-2T(g)(2)
also states that nothing is to prevent
the attribution of stock to public
owners.
(3)
(a)
Although this latter statement
literally negates the first, the
overall rule apparently is
intended to act as a limitation on
stock that will be attributed to
specific individuals or entities.
See Preamble to T.D. 8149, 1992-2
C.B. at 86-87.
(b)
That is, while attribution itself
is not impeded by this rule, the
loss corporation only has to
identify 5-percent owners and
higher tier entities (not public
owners) -- and even then
apparently only to the extent
required by Treas. Reg. § 1.3822T(k)(3).
Public groups are created, in part, as
a result of special aggregation rules
214
contained in Treas. Reg. § 1.3822T(j)(1). Under Treas. Reg. § 1.3822T(j)(1)(ii), each public group that is
treated as a 5-percent shareholder
generally is treated as a single
individual.
(a)
Under Treas. Reg. § 1.3822T(j)(1)(iii), the members of any
public group are presumed: (1) not
to be members of any other public
group, and (2) to be unrelated to
all other shareholders (direct and
indirect) of the loss corporation.
(b)
Thus, the members of a public
group that exists by virtue of its
direct ownership interest in an
entity are presumed not to be
members, nor to be related to any
member, of any other public group
that exists at any time by virtue
of its direct ownership interest
in any other entity. See Treas.
Reg. § 1.382- 2T(j)(1)(vi) (Ex.
(2)) (spun-off subsidiary
initially presumed to be owned by
an entirely new, and separate,
public group, but this presumption
was overcome by actual knowledge
(discussed further below)).
(c)
However, Treasury exercised its
authority granted in the
conference agreement to prescribe
rules allowing the loss
corporation to establish the
extent, if any, of crossmembership by shareholders in more
than one public group. See Treas.
Reg. §§ 1.382-2T(j)(1) and (k)(2);
see Conf Rep. at II-178; Blue Book
at 308 n.31.
(d)
According to Treas. Reg. § 1.3822T(j)(1), the presumption that
shareholders are unrelated and are
215
members of only one public group
will not apply if the loss
corporation has actual knowledge
of facts to the contrary or if the
stock ownership of the loss
corporation was arranged to avoid
section 382. Treas. Reg. § 1.3822T(k)(2) and (4).
(e)
(4)
b.
Where these presumptions are
inapplicable, additional public
groups may be created to take into
account overlapping ownership.
See Treas. Reg. §§ 1.3822T(j)(1)(iii) and
(j)(2)(iii)(B)(2) (Ex. (4)).
As described below, the basic rules for
determining which shareholders and
other entities will be aggregated into
public groups, and whether such public
groups will be treated as 5-percent
share-holders, are set forth in Treas.
Reg. § 1.382-2T(j)(1)(iv).
Analysis of highest tier entities
(1)
Treas. Reg. § 1.382-2T(j)(1)(iv)(A)
states that the loss corporation must
first identify first tier entities and
higher tier entities in order to
identify any highest tier entity that
it is obligated to identify under
Treas. Reg. § 1.382-2T(k)(3). Under
Treas. Reg. § 1.382-2T(k)(3) the loss
corporation apparently is only
obligated to identify highest tier
entities that constructively own 5
percent or more of the loss corporation
on the testing date. The analysis of
5-percent shareholders begins with such
entities. For an example of a case
where a highest tier entity is present,
but does not have to be identified, see
Treas. Reg. § 1.382-2T(j)(1)(vi) (Ex.
(4)) (analysis pertaining to P-4
corporation).
216
(2)
Having identified such highest tier
entities, the loss corporation must
identify any 5-percent owners of each
such highest tier entity who, at any
time during the testing period,
indirectly own (i.e., through
application of the constructive
ownership rules) five percent or more
of the loss corporation stock through
their ownership interest in such
highest tier entity. Such 5-percent
owners are treated as 5-percent
shareholders. See Treas. Reg.§ 1.3822T(g)(1)(i)(B).
(3)
Each person who has an ownership
interest in any highest tier entity who
is not treated as a 5-percent
shareholder (i.e., public owners and 5percent owners who are not 5-percent
shareholders) is treated as a member of
the public group of that highest tier
entity. If that public group
indirectly owns five percent or more of
the loss corporation as of the testing
date, then it will be treated as a 5percent shareholder. See Treas. Reg.
§§ 1.382-2T(g)(1)(ii) and
(j)(1)(iv)(A). Importantly, when
testing public groups at first tier and
higher tier levels, public groups are
treated as 5-percent shareholders only
if they own 5-percent or more of the
loss corporation stock on the testing
date, not at any time during the
testing period. See Treas. Reg.
§ 1.382-2T(j)(iv)(A).
(4)
Under Treas. Reg. § 1.382-2T(j)(1)
(iv)(A), if the public group of a
highest tier entity constructively owns
less than five percent of the loss
corporation as of the testing date,
then such a group is treated as part of
the public group of the "next lower
tier entity." According to Treas. Reg.
§ 1.382-2T(f)(17), the "next lower tier
217
entity" with respect to a higher tier
entity is any first tier entity or
other higher tier entity in which the
higher tier entity owns, at any time
during the testing period, a five
percent or more direct ownership
interest.
(5)
(6)
It is unclear how this rule applies
where several "next lower tier
entities" are present. For example,
assume that P corporation owns stock in
both P-1 and P-2 corporations. P-1 and
P-2 own stock in the loss corporation
(L). There are non-5-percent
shareholders with respect to each
corporation; however, Public P owns
less than 5 percent of L
constructively.
(a)
In applying the aggregation rules,
Public P must be included with the
public group of the next lower
tier entity.
(b)
However, since both P-1 and P-2
qualify as next lower tier
entities, it is uncertain whether
Public P should be aggregated with
Public P-1 or with Public P-2.
(c)
Depending on the percentages held
by Public P-1 and Public P-2,
Public P ultimately could be
aggregated with Public L under
Treas. Reg. § l.382-2T(j)(l)(iv).
Also, if there is more than one public
group with respect to the next lowest
tier entity (e.g., P-2 makes a public
offering which results in the formation
of two public groups at the P-2 level),
it is unclear which of such public
groups would be combined with the
public group from the higher tier
entity.
218
c.
Analysis of higher tier and first tier
entities
Under Treas. Reg. § 1.382-2T(j)(1)(iv)(B),
the process outlined above is repeated for
any next lower tier entity and successively
thereafter for each next lower tier entity
until the process is applied to each first
tier entity. The next lowest tier entity
with respect to a first tier entity is the
loss corporation.
d.
Analysis at the loss corporation level
The public shareholders are aggregated and
treated as a 5-percent shareholder -without regard to whether such group, at any
time during the testing period, owns five
percent or more of the loss corporation.
Treas. Reg. §§ 1.382-2T(g)(1)(iii) and
(j)(1)(iv)(C). The regulations provide that
if the public group of any first tier entity
indirectly owns less than five percent of
the loss corporation stock on the testing
date, the ownership interest of that public
group will be aggregated with the ownership
interest of the public group of the loss
corporation.
e.
Determining percentage stock interest
(1)
Treas. Reg. § 1.382-2T(g)(3) provides
that an individual 5-percent
shareholder's percentage ownership
interest in the loss corporation is
determined by adding together the
following percentage interests:
--
The shareholder's direct ownership
interest, if any, but only to the
extent such interest constitutes
five percent or more of the loss
corporation stock; and,
--
Each indirect ownership interest
that he may have in the loss
219
corporation in his capacity as a
"5-percent owner" of any one first
tier or higher tier entity, but
only to the extent that each such
indirect ownership interest
constitutes five percent or more
of the stock of the loss
corporation.
(2)
Thus, subject to the application of
Treas. Reg. §§ 1.382-2T(k)(2) and (4),
a shareholder's percentage interests
apparently are combined if, and only to
the extent that, the shareholder is
both a direct 5-percent shareholder and
an indirect 5-percent shareholder. The
language of Treas. Reg. § 1.3822T(g)(3) further suggests that such
interests of a 5-percent shareholder
will only be combined if they represent
current ownership in the loss
corporation of five percent or more,
not past ownership during the testing
period of 5-percent or more.
(3)
This interpretation is consistent with
Treas. Reg. § 1.382-2T(k)(3) which
apparently imposes a duty on the loss
corporation to determine the identity
of individual 5-percent shareholders
that currently own at least 5 percent
of the loss corporation, and Treas.
Reg. § 1.382-2T(g)(5)(i)(B) which
provides presumptions where a
shareholder's interest falls below five
percent.
(4)
Treas. Reg. § 1.382-2T(g)(3) does not
apply to the extent that the loss
corporation has actual knowledge of
stock ownership or the stock interests
were arranged to avoid section 382.
See Treas. Reg. § 1.382-2T(k)(2) and
(4).
(5)
To illustrate, assume that the loss
corporation (L) is owned 30 percent by
220
individual A and 70 percent by P
corporation. P in turn is owned as
follows: 6 percent by A and the
remaining 94 percent equally by 500
unrelated shareholders ("Public P").
See Treas. Reg. § 1.382-2T(g)(4)
(Ex.
(3)).
(6)
f.
(a)
A is a 5-percent shareholder of L
because he directly owns 30
percent of L. A is also a 5percent owner of P. In his
capacity as a 5-percent owner, A
owns 4.2 percent of L (6 percent x
70 percent).
(b)
Because A's indirect ownership
interest is less than five
percent, it is not taken into
account in determining A's
percentage interest. Instead, A's
interest is treated as part of
Public P's interest. For section
382 purposes, A owns only 30
percent of L.
(c)
If L has "actual knowledge" of A's
4.2 percentage interest through P,
A will be treated as owning 34.2
percent (30 percent directly + 4.2
percent indirectly).
Also, if A held 10 percent of the P
stock instead of 6 percent, A's
indirect ownership interest in L in his
capacity as a 5-percent owner of P
would equal 7 percent. In this case, L
would have to take both A's direct
ownership interest of 30 percent and
his indirect ownership interest of 7
percent into account in determining A's
percentage interest. See Treas. Reg. §
1.382-2T(g)(4) (Ex. (4)).
Stock ownership presumptions
(1)
Treas. Reg. § 1.382-2T(g)(5) provides
for certain stock ownership
221
presumptions that may be applied to
determine the percentage interest of a
shareholder following certain
acquisitions and dispositions of loss
corporation stock.
(2)
(a)
In contrast to other regulatory
presumptions, Treas. Reg. § 1.3822T(g)(5) may be applied even if
the loss corporation has actual
knowledge of facts that are
contrary to the presumptions. See
Treas. Reg. § 1.382-2T(k)(2).
(b)
The regulations do not state
whether these presumptions, once
applied, are irrevocable during
the remainder of the testing
period. The regulations seem to
indicate that the presumptions
will apply as to subsequent
testing dates as well. See Treas.
Reg. §§ 1.382-2T(g)(5)(i)(B) and
(ii) (Ex.) (last sentence).
(c)
However, the better view would be
to freely allow the loss
corporation to apply, or refrain
from applying, the presumptions on
each testing date.
(d)
For applications of actual
knowledge in lieu of the
regulations' presumptions, see LTR
9104043.
The first presumption, contained in
Treas. Reg. § 1.382-2T(g)(5)(i)(A),
provides that if an individual owns
less than five percent of the loss
corporation stock during the testing
period (excluding the testing date) and
the individual acquires sufficient
stock to become a 5-percent shareholder
on the testing date, then the loss
corporation may disregard any interest
in the loss corporation owned by such
222
individual during the testing period
and treat such interest in the loss
corporation as being owned by a public
group.
(a)
Treas. Reg. § 1.382-2T(g)(5)(i)(A)
refers to a shareholder that
"acquires" a five percent
interest. It is unclear what
result obtains if a shareholder's
interest increases to more than
five percent as a result of the
redemption of another
shareholder's stock.
(b)
By disregarding the shareholder's
previous stock ownership, it seems
that this presumption will always
produce a greater percentage
increase than is actually the
case, and would serve only the
loss corporation that cannot
timely obtain information or that
desires to trigger an ownership
change.
(c)
For example, all of the loss
corporation (L) stock is owned by
40 unrelated individuals each of
whom owns 2.5 percent of the L
stock ("Public L"). Individual A
is a member of Public L. On
June 8, 1989, A acquires an
additional 5 percent interest in L
over the public stock exchange,
thus increasing his interest to
7.5 percent of L. As a result of
A's stock purchase, A has become a
5-percent shareholder. Although A
had an actual increase in L of 5
percentage points (2.5 percent to
7.5 percent), Treas. Reg. § 1.3822T(g)(5)(i)(A) allows L to
disregard A's previous 2.5 percent
interest and treat A as having
increased his interest from 0 to
7.5 percent.
223
(3)
The second presumption, contained in
Treas. Reg. § 1.382-2T(g)(5)(i)(B),
provides that if a 5-percent
shareholder's interest is reduced to
less than five percent, the loss
corporation may presume that the stock
owned by such 5-percent shareholder
immediately after the reduction remains
fixed at that amount for each
subsequent testing date within a
testing period that includes the
earlier reduction date, provided that
the shareholder continues to own less
than five percent of the loss
corporation. For an application of
this rule, see LTR 9222014.
(a)
If the shareholder's interest once
again reaches the five percent or
more level, the presumption would
not apply, and the loss
corporation would be required to
identify that shareholder under
Treas. Reg. § 1.382-2T(k)(3).
(b)
Under this presumption, the stock
held by such shareholder will be
treated as owned by a separate
public group for purposes of
testing subsequent purchases or
redemptions of stock as ownership
changes. See Treas. Reg. § 1.3822T(g)(5)(i)(B) (incorporating the
rules of Treas. Reg. § 1.3822T(j)(2)(vi)).
(c)
For example, assume that
individual A owns 10 percent of
the loss corporation (L), and that
A sells 7 percent of L. A's
remaining stock would be treated
as if held by a public group
owning 3 percent of L.
Presumably, the 5-percent
shareholder's interest remains
constant as to the number of
224
shares held, not as to the
percentage interest.
(4)
4.
Pursuant to Treas. Reg. § 1.3822T(j)(1)(v), a loss corporation may
apply the principles of Treas. Reg.
§ 1.382-2T(g)(5) with respect to: (1)
any public group that is treated as a
5-percent shareholder on the testing
date if such public group, at any time
during the testing period, was treated
as part of the public group of the next
lower tier entity, or (2) any public
group that is treated as part of the
public group of the next lower tier
entity if such public group, at any
time during the testing period, was
part of the public group of a higher
tier entity that was treated as a 5percent shareholder and had a direct or
indirect ownership interest in such
next lower tier entity.
(a)
With respect to the first
scenario, the only presumption
that appears to make sense is that
contained in Treas. Reg. § 1.3822T(g)(5)(i)(A).
(b)
With respect to the second
scenario, it is unclear precisely
which presumptions are applicable,
but it appears that Treas. Reg.
§ 1.382-2T(g)(5)(i)(B) is intended
to apply. Applying this Treas.
Reg. § 1.382-2T(g)(5)(i)(B)
presumption appears to counteract
Treas. Reg. § 1.382-2T(j)(1)(iv),
which would operate to combine the
public groups of a higher tier and
next lower tier entity into one
group.
Illustrations of the Aggregation Rules
a.
Identifying 5-percent shareholders -example one
225
(1)
Fact pattern
Individual (A) owns 20 percent of the
stock of loss corporation (L); P-1 owns
10 percent of L; an entity (E) owns 20
percent of L; and, Public L, a public
group composed of public shareholders,
owns the remaining 50 percent of L.
Individual (B) owns 15 percent of P-1
and Public P-1, a public group composed
of public owners, owns the remaining 85
percent of P-1. P-2 owns 30 percent of
E and P-3 owns the remaining 70 percent
of E. P-2 and P-3 are owned by Public
P-2 and Public P-3, respectively. See
Treas. Reg. § 1.382-2T(j)(1)(vi) (Ex.
(3)).
(2)
(3)
Classifying entities and groups
(a)
P-1 and E, having a direct
interest in L of more than five
percent, are first tier entities.
(b)
B is a 5-percent owner of P-1.
(c)
P-2 and P-3 are higher tier
entities because of their direct
interest in E of five percent or
more. P-2 and P-3 are also the
highest tier entities.
(d)
The shareholders of P-1, P-2 and
P-3 are public owners of such
entities because such shareholders
do not own at least five percent
of such entities at any time
during the testing period.
(e)
The shareholders of Public L are
public shareholders of L because
such shareholders do not own at
least five percent of L at any
time during the testing period.
5-percent shareholders
226
In determining ownership interests, the
analysis begins with any highest tier
entity that L must identify under
Treas. Reg. § 1.382-2T(k)(3) (in this
case, P-2 and P-3).
b.
(a)
Through attribution, the public
owners of P-2, Public P-2, are
deemed to own 6 percent of the L
stock ((30 percent ownership of E)
x (20 percent ownership of L)).
Thus, Public P-2 is treated as a
5-percent shareholder of L.
(b)
Through attribution, the public
owners of P-3, Public P-3, are
deemed to own 14 percent of L ((70
percent ownership of E) x (20
percent ownership of L)). Thus,
Public P-3 is treated as a 5percent shareholder of L.
(c)
The public owners of P-1 are
deemed to own 8.5 percent of L
((85 percent ownership of P-1) x
(10 percent ownership of L)).
Through attribution, B is treated
as owning 1.5 percent of L. B is
a 5-percent owner who is not a 5percent shareholder. Public P-1
and B are aggregated as a public
group that is treated as a 5percent shareholder of L that owns
10 percent of L.
(d)
The public shareholders of L,
Public L, are aggregated and
treated as a 5-percent
shareholder.
(e)
A owns 20 percent of L and is a 5percent shareholder.
Identifying 5-percent shareholders -example two
(1)
Fact pattern
227
Individuals A and B each own 14 percent
of loss corporation (L); P-1 and P-2
each own 30 percent of L; individual C
and P-3 each own 4 percent of L;
individuals D and AA each own 2 percent
of L. P-1 is owned 30 percent by each
of A, B and P-4 and 10 percent by D.
P-2 is owned 70 percent by A; 10
percent each by B and D; 6 percent by
DD and 4 percent by C. AA owns 100
percent of P-3. P-4 is owned 60
percent by C and 20 percent each by BB
and CC. See Treas. Reg. § 1.3822T(j)(1)(vi) (Ex. (5)).
(2)
Determining ownership interests
In determining ownership interests, the
analysis begins with any highest tier
entity that L must identify under
Treas. Reg. § 1.382-2T(k)(3) (in this
case, it can begin with P-4).
(a)
Each of the shareholders of P-4 is
a 5-percent owner. Through
attribution, C owns 5.4 percent of
L and, therefore, is treated as a
5-percent shareholder. Note that
although C's actual interest in L,
through attribution is 10.6
percent (5.4 percent through P-4,
4 percent directly and 1.2 percent
through P-2), C's ownership
interest is presumed to include
only the 5.4 percent.
(b)
BB and CC are 5-percent owners of
P-4, but since they each
indirectly own only 1.8 percent of
L, they are not 5-percent
shareholders. BB and CC are
treated as members of the public
group of P-4. However, because
Public P-4 only owns 3.6 percent
of L, Public P-4 is treated as a
228
part of the public group of next
lower tier entity, P-1.
(c)
With respect to P-1, a first tier
entity, each of its shareholders
(other than P-4) is 5-percent
owners. Because A and B each
indirectly own 9 percent of L as
5-percent owners of P-1 and A
indirectly owns 21 percent of L as
a 5-percent owner of P-2, they are
each 5-percent shareholders
without regard to their direct
ownership interests in L.
(d)
A's ownership interest in L as a
5-percent shareholder is 44
percent (14 percent directly, 9
percent in his capacity as a 5percent owner of P-1, and 21
percent in his capacity as a 5percent owner of P-2).
(e)
B's ownership in L as a 5-percent
shareholder is 23 percent (14
percent directly and 9 percent in
his capacity as a 5-percent owners
of P-1). B's ownership interest
as a 5-percent shareholder does
not include the 3 percent interest
he owns indirectly through P-2,
unless L has actual knowledge of
such interest.
(f)
D is a 5-percent owner of P-1.
Although D owns 8 percent of L (2
percent directly, 3 percent
indirectly through P-1, and 3
percent indirectly through P-2),
he is not a 5-percent shareholder
because he does not separately own
five percent or more of L stock
either directly or in his capacity
as a 5-percent owner of either P-1
or P-2 (assuming L has no actual
knowledge of D's interests).
229
c.
(g)
The public group of P-1
(comprising the public group of P4 and D) has a 6.6 percent
interest in L and is therefore
treated as a separate 5-percent
shareholder.
(h)
With respect to P-2, D is a 5percent owner who is not a 5percent shareholder. DD is a 5percent owner of P-2, who is not a
5-percent shareholder because DD
indirectly owns only 1.8 percent
of L. Therefore, each of P-2's
shareholders, except A who is a 5percent shareholder in his
capacity as a 5-percent owner of
P-2, are treated as members of the
public group of P-2 that owns 9
percent of L and is thus treated
as a separate 5-percent
shareholder.
(i)
Because the direct ownership
interest of P-3 is less than five
percent, P-3 is a public
shareholder. Therefore, assuming
that L does not have actual
knowledge of C's, D's, or AA's
direct and/or indirect ownership
interests in L, the public group
of L is a separate 5-percent
shareholder owning 12 percent of L
(comprised of the direct ownership
interests of C, D, AA and P-3).
Takeover by publicly-held corporation
(1)
Fact pattern
All of stock of loss corporation (L) is
owned by 1,000 shareholders, none of
whom own as much as five percent of L
(Public L). All of the stock of a
second corporation (P) is owned by
150,000 shareholders, none of whom own
five percent or more of P stock (Public
230
P). Between July 12, and August 13,
1988, P acquires all of the L stock. P
first acquired five percent of L on
July 15, 1988 and increased its
interest to 51 percent of L on July 30,
1988. See Treas. Reg. § 1.3822T(j)(1)(vi) (Ex. (1)).
(2)
(3)
Status as a first tier entity
(a)
Before July 15, 1988, P was a
public shareholder of L. Thus, P
was aggregated with the other L
shareholders as a member of Public
L, the public group composed
strictly of public shareholders of
L. No L stock is attributed to
the public owners of P (Public P).
(b)
As of July 15, 1988, when P first
acquired a five percent interest
in L, P became a first tier
entity. P is also a highest tier
entity. P will retain this status
throughout any testing period that
includes July 15, 1988.
(c)
Under the constructive ownership
rules, stock held by P is
attributed to Public P.
(d)
Under the aggregation rules,
Public P is treated as a public
group that is a 5-percent
shareholder.
(e)
Each acquisition of L stock by P
on or after July 15, 1988, affects
the percentage ownership of a 5percent shareholder and thus
constitutes an owner shift.
Ownership change
(a)
On July 30, 1988, P increased its
interest to 51 percent of L, and
thus Public P is deemed to own 51
231
percent of L and Public L owns 49
percent of L.
d.
(b)
Under Treas. Reg. § 1.3822T(j)(1)(iii), Public L and Public
P are presumed not to have any
common members, nor to have any
members related to any other
member of either of the two groups
(i.e., no inter- or intra-group
relatives).
(c)
Assuming the presumption is not
rebutted, Public P is treated as a
5-percent shareholder who has
increased its percentage interest
by 51 points, thus causing an
ownership change immediately after
the close of the July 30, 1988
testing date.
Spin-off transaction
(1)
Fact pattern
All of the stock of P corporation is
owned by 1,000 shareholders, none of
whom own five percent or more of the P
stock. Loss corporation (L) is a
wholly owned subsidiary of P. On
January 2, 1988, P distributes all of
the L stock to P shareholders pro rata
in a spin-off transaction. Treas. Reg.
§ 1.382- 2T(j)(1)(vi) (Ex. (3)).
(2)
Determining stock ownership
(a)
Prior to the distribution, the
public owners of P are members of
a public group (Public P) that is
treated as the sole 5-percent
shareholder of L.
(b)
Following the stock distribution,
L is owned by 1,000 shareholders,
none of whom own five percent or
more of the L stock. Accordingly,
L is deemed to be wholly owned by
232
a public group composed of public
shareholder (Public L).
(3)
H.
Determining change in stock ownership
(a)
Under Treas. Reg. §§ 1.3822T(j)(1)(ii) and (iii), Public L
and Public P are treated as
unrelated, individual 5-percent
shareholder (i.e., no common
members). Under these
presumptions, an ownership change
would occur because Public L
increased its percentage interest
by 100 points.
(b)
However, L has actual knowledge
that the members of Public P are
the same as those of Public L.
Under Treas. Reg. § 1.3822T(k)(2), L may take into account
the identity of membership to
establish that Public L did not
increase its percentage interest.
(c)
Based on L's actual knowledge, the
transaction would not constitute
an owner shift.
Segregation Rules -- Loss Corporation Level
The regulations contain special rules to segregate the
loss corporation's public shareholders into separate
groups. Treas. Reg. § 1.382-2T(j)(2). These
segregation rules apply after certain specified
transactions (henceforth referred to as "segregation
transactions") involving the loss corporation have
occurred. See generally Silverman and Keyes, "An
Analysis of the New Ownership Change Regs. Under
Section 382: Part IV," 69 J.Tax'n 42 (July, 1988).
1.
In General
a.
Treas. Reg. § 1.382-2T(j)(2)(i) states that
if:
233
b.
c.
--
a transaction is described in
Treas. Reg. § 1.382-2T(j)(2)(iii)
(a "segregation" transaction), and
--
the loss corporation has one or
more "direct public groups"
immediately before and after the
transaction,
--
then the stock owned by such
direct public group(s) is subject
to the segregation rules for
purposes of determining whether an
ownership change has occurred on
the date of the transaction (and
also on any subsequent testing
date with a testing period that
includes the date of the
transaction).
Under Treas. Reg. § 1.382-2T(j)(2)(ii), a
"direct public group" is defined as:
(1)
Any public group formed at the loss
corporation level and composed of
public shareholders and any public
group of any first tier entity that
itself is not treated as a 5-percent
shareholder (see Treas. Reg. § 1.3822T(j)(1)(iv)(C)); or,
(2)
Any public group at the loss
corporation level resulting from the
application of the segregation rules
(see Treas. Reg. § 1.382-2T(j)(2)(iii);
or,
(3)
Any public group at the first or higher
tier entity level resulting from the
application of the segregation rules
(see Treas. Reg. § 1.382-2T(j)(3)(i)).
Any direct public group that is identified
as a result of a segregation transaction is
treated as a 5-percent shareholder, without
regard to whether the public group so
identified owned five percent or more of the
loss corporation stock at any time during
234
the testing period. Treas. Reg. §§ 1.3822T(j)(2)(iii)(A) and (g)(1)(iv).
d.
2.
Additional direct public groups may be
created if L has actual knowledge of stock
ownership interests that is contrary to the
presumptions utilized by the segregation
rules. See Treas. Reg. § 1.3822T(j)(2)(iii)(A).
Segregation Transactions
The segregation rules apply only to special
transactions (i.e., segregation transactions)
that are listed in Treas. Reg. § 1.3822T(j)(2)(iii). There are four major categories
of segregation transactions listed in Treas. Reg.
§§ 1.382-2T(j)(2)(iii)(B) through (E). In
addition, a special rule contained in Treas. Reg.
§ 1.382-2T(j)(2)(iii)(F) is applicable where
options are issued in connection with a
segregation transaction.
a.
Certain equity structure shifts and section
1032 transactions
(1)
In general
In the case of equity structure shifts
described in section 381(a)(2), and
transfers of loss corporation stock
(including Treasury stock) by the loss
corporation in a section 1032
transaction, each direct public group
that exists immediately before such
transaction is segregated from any
direct public group that acquires stock
in the transaction. Treas. Reg.
§ 1.382-2T(j)(2)(iii)(B)(1).
(a)
The direct public group that
acquires stock of the loss
corporation is presumed not to
include any members of any direct
public group that existed
immediately before the transaction
(i.e., no overlapping ownership).
Cf. Treas. Reg. § 1.382235
2T(j)(1)(iii) (no cross ownership
between public groups of different
corporations).
(2)
(b)
For purposes of this rule, if a
section 381(a)(2)-type equity
structure shift occurs, and the
loss corporation ceases to exist,
the acquiring corporation
shareholders are treated as if
they acquired loss corporation
stock. For example, if L merges
into P, with P surviving, the
historic P shareholders are deemed
to acquire L stock.
(c)
A transfer by the loss corporation
of any nonstock interest that is
treated as "stock" for section 382
purposes (i.e., Treas. Reg.
§ 1.382-2T(f)(18)(iii) interests)
will be treated as a transfer of
stock for purposes of determining
whether the transaction is
described in section 1032.
Example -- section 381(a)(2) equity
structure shift
P-1 owns 60 percent of the stock of L.
The remaining 40 percent is owned by
Public L. Individual A owns 40 percent
of the P-1 stock while the remaining 60
percent is owned by Public P-1. P-2 is
a publicly traded corporation owned by
shareholders who each own less than
five percent of the P-2 stock (Public
P-2). On May 22, 1988, L merges into
P-2 (under section 368(a)(1)(A)), with
the L shareholders receiving 70 percent
of the P-2 stock immediately after the
merger. Treas. Reg. § 1.3822T(j)(2)(iii) (B)(2) (Ex. (1)).
(a)
Immediately before the merger, L's
5-percent shareholders were Public
236
L (40 percent), Public P-1 (36
percent) and A (24 percent).
(b)
Although the P-2 shareholders did
not acquire any stock as a result
of the merger, such shareholders
are treated as if they acquired a
direct ownership interest in the
loss corporation because P-2
succeeds to L's loss carryovers
and other tax attributes.
(c)
The merger constitutes a
segregation transaction under
Treas. Reg. § 1.3822T(j)(2)(iii)(B). Accordingly,
Public L must be segregated from
the direct public group that would
otherwise exist after the
transaction (Public L and Public
P-2 combined). Public L's
continuing interest in the loss
corporation is 28 percent (70
percent x 40 percent).
(d)
Public P-1, is also segregated
from any other public group under
the aggregation rules of Treas.
Reg. § 1.382-2T(j)(1).
(e)
Public P-2 is thus segregated from
Public P-1 and Public L. Under
Treas. Reg. §§ 1.382-2T(j)(1) and
(2), Public P-2 is treated as a 5percent shareholder. Since Public
P-2 only increased its interest in
L by 30 percentage points, an
ownership change did not occur.
(f)
Public P-2 will continue to be
segregated from Public L and
Public P-1 for purposes of
measuring owner shifts on
subsequent testing dates that
include May 22, 1988 in the
testing period.
237
(3)
(g)
Assuming no other transactions
with respect to P-2 occur, query
whether an owner shift will occur
on May 22, 1991 (three years and
one day later) when the two public
groups are combined? On that
date, Public P-2's ownership
should be 58 percent (Public L's
and former Public P-2's interests
combined), while Public P-2's
lowest percentage interest during
the testing period would be 30
percent. The actual knowledge
exception of Treas. Reg. § 1.3822T(k)(2) should provide relief.
(h)
Note that although under Treas.
Reg. § 1.382-2T(f)(1)(ii), L is
treated as continuing in
existence, the example in the
regulations nevertheless refers to
P-2 as the loss corporation.
(i)
Except for recapitalizations, the
final segregation regulations do
not provide any relief for equity
structure shifts. Treas. Reg.
§ 1.382-3(j)(6).
Example -- public offering
Loss corporation (L) is owned entirely
by Public L. L commences and completes
a public offering of common stock on
January 22, 1988, with the result that
its outstanding stock increases from
100,000 shares to 300,000 shares. No
person becomes a 5-percent shareholder
following the public offering. See
Treas. Reg. § 1.382-2T(j)(2)(iii)(B)(2)
(Ex. (3)).
(a)
The public offering is a
transaction described in section
1032. Immediately before the
public offering, L's sole 5percent shareholder was Public L,
238
a direct public group. Therefore,
Public L, as in existence
immediately before the offering,
must be segregated from the direct
public group that would otherwise
exist.
(4)
(b)
The acquisition of 200,000 shares
is treated as being acquired by a
second direct public group (New
Public L). Public L and New
Public L are treated as separate
5-percent shareholders.
(c)
After the offering, Public L owns
33 percent of L and New Public L
owns 67 percent of L. The members
of Public L are presumed not to be
members of New Public L.
(d)
New Public L is a 5-percent
shareholder that has increased its
percentage interest by more than
50 points. Thus, an ownership
change occurs.
(e)
For purposes of testing subsequent
transactions, Public L and New
Public L will not be segregated
because a new testing period
begins the day following the
ownership change, and the January
22, 1988 transaction will not fall
within the new testing period.
Example -- overlapping ownership
P and L corporations are each owned by
21 equal shareholders. Of these
shareholders, 14 are owners of both
corporations (common owners). L has
actual knowledge of this cross
ownership. Thus, the common owners own
67 percent of each corporation. P
stock is valued at $600 and the L stock
is valued at $400. P merges into L on
June 10, 1988 in a transaction
qualifying as a section 368(a)(1)(A)
239
reorganization. Treas. Reg. § 1.3822T(j)(2)(iii)(B)(2) (Ex. (2)).
b.
(a)
Under the segregation rules,
without taking actual knowledge
into account, the direct public
group of L (existing immediately
before the merger (Public L))
would be segregated from the
direct public group of P (the
group that acquires L stock in the
merger (Public P)).
(b)
However, due to the common
interests, a third group of
shareholders --composed of the
common owners--may be created.
See Treas. Reg. § 1.3822T(j)(2)(iii)(A). The common
owners would own 67 percent, the
remaining Public L shareholders
would own 13 percent and the
remaining Public P shareholders
would own 20 percent.
(c)
The only 5-percent shareholder to
increase its percentage interest
is Public P, who increased its
interest by 20 points -- not
enough for an ownership change.
Redemption-type transactions
The second major category of segregation
transactions are "redemption-type"
transactions.
(1)
In general
Where the loss corporation acquires its
own stock in exchange for property,
each direct public group that exists
immediately before the transaction is
segregated at that time (and thereafter), so that the stock acquired in
the transaction will be treated as
being owned by a separate direct public
group from each public group that
240
continues to own stock. Treas. Reg. §
1.382- 2T(j)(2)(iii)(C)(1).
(2)
(a)
Each direct public group that
owned stock acquired by the loss
corporation is presumed not to own
any stock after the transaction.
That is, the regulations presume
there is no overlapping ownership
between the continuing shareholder
group and the group that transfers
stock to the loss corporation.
(b)
The scope of this class of
segregation transactions is
unclear since the regulations do
not define the term "property".
(c)
However, the regulations provide
that, for purposes of this rule,
the term "property" includes
section 1504(a)(4) stock and stock
described in Treas. Reg. § 1.3822T(f)(18)(ii). In other words,
not only are redemption
transactions covered, but
recapitalization transactions
(stock for nonstock) are also
covered by this segregation rule.
Treas. Reg. § 1.3822T(j)(2)(iii)(C)(2) (Ex. (2)).
Example -- redemption
Loss corporation (L) has 500,000 shares
of stock outstanding. L is considered
to be owned by Public L (i.e., there
are no 5-percent shareholders other
than the public group). On July 12,
1988, L redeems 150,000 shares of its
stock for cash. Treas. Reg. § 1.3822T(j)(2)(iii)(C)(2) (Ex. (1)); LTR
8945055.
(a)
L's acquisition is a redemption;
therefore, Public L must be
segregated into two different
groups immediately before the
241
transaction -- the redeemed
shareholders (Public RL) and the
continuing shareholders (Public
CL).
c.
(b)
Immediately before the transaction
Public CL owned 70 percent of L
(350,000 shares/ 500,000 total
shares). Public RL owned 30
percent of L (150,000
shares/500,000 total shares).
(c)
Immediately after the close of the
July 12, 1988 testing date, the
interest of Public CL has
increased by 30 percentage points
-- not enough to trigger an
ownership change.
(d)
For purposes of determining
whether an ownership change occurs
on any subsequent testing date
(having a testing period that
includes the redemption), Public
CL will be treated as a 5-percent
shareholder whose percentage
ownership interest in L increased
by 30 percentage points (or
conversely, had a lowest interest
to date of 70 percent).
(e)
Similar results would obtain if
the Public RL shareholders
exchanged their L stock for
nonstock interests in L. Treas.
Reg. § 1.382- 2T(j)(2)(iii)(C)(2)
(Ex. (2)) (involving a
recapitalization where L issued
section 1504(a)(4) stock).
(f)
The final regulations provide no
special relief for redemption
transactions.
Stock acquired through rights issued by the
loss corporation
The third major category of segregation
242
transaction involves certain deemed
acquisitions of stock.
(1)
In general
Under Treas. Reg. § 1.3822T(j)(2)(iii)(D), where a deemed
acquisition of loss corporation stock
occurs as a result of the ownership of
a right issued by the loss corporation
to acquire stock, each direct public
group that exists immediately after the
deemed acquisition will be segregated,
so that each direct public group in
existence before the transaction is
treated as a separate group from the
direct public group that is deemed to
acquire stock.
(a)
The deemed acquisition of loss
corporation stock occurs pursuant
to the option attribution rules
found in Treas. Reg. § 1.3822T(h)(4).
(b)
The direct public group that is
treated as acquiring loss
corporation stock is presumed not
to include members of any other
direct public group.
(c)
According to the regulations, the
segregation rules are to be
applied before the option
attribution rule. In the usual
situation, the aggregation rules
are applied after the constructive
ownership rules are applied.
However, given that the option
attribution rule is triggered only
if an ownership change occurs, the
segregation rules are applied
first in this case in order to
isolate the option transaction and
its deemed effect on stock
ownership.
243
(2)
Example -- convertible debt
Loss corporation (L) has 700,000 shares
of common stock outstanding, all of
which are owned by Public L. On May
20, 1988, L issues a class of
debentures to the public that, in the
aggregate, may be converted into
300,000 shares of L common stock. On
September 7, 1988, P-1 acquires 210,000
shares of L common stock over a public
stock exchange. None of the L
debentures have been converted as of
September 7, 1988. See Treas. Reg. §
1.382-2T(j)(2)(iii)(D)(2).
(a)
Due to L's issuance of convertible
debentures, May 20, 1988 is a
testing date. Public L must be
segregated from the direct public
group that would otherwise exist
immediately after the transaction
for purposes of applying the
option attribution rules (i.e.,
whether an ownership change
results). Thus, any acquisition
of L stock through conversion of
the debentures is treated as if
made by a public group other than
Public L (New Public L).
(b)
In this case, the maximum
percentage increase in stock
ownership by New Public L would be
30 percent (300,000
shares/1,000,000 total shares).
Therefore, an ownership change
would not occur, and the stock is
not deemed to be acquired pursuant
to the option attribution rules.
(c)
Due to P-l's acquisition of L
common stock, September 7, 1988 is
a testing date. For purposes of
applying the option attribution
rules, Public L must again be
segregated from the direct public
244
group that would otherwise result
from the conversion of the
debentures, so that, as before, a
deemed acquisition of L stock
through the conversion of L
debentures on September 7, 1988
will result in a new public group
(New Public L).
(d)
The 30 percentage point increase
by New Public L (300,000 shares/
1,000,000 total shares) combined
with P-l's acquisition of 21
percent (210,000 shares/1,000,000
total shares) results in an
ownership change.
(e)
If the debentures were converted
into L stock before P-1's
acquisition on September 7, 1988,
a new public group composed of the
shareholders that acquired stock
in the conversion ("New Public L")
would be created. Treas. Reg. §
1.382-2T(j)(2)(iii)(B)(1) (section
1032 transactions trigger the
segregation rules). P-1's
subsequent acquisition of 30
percent of the L stock would be
deemed to be made pro rata from
Public L and New Public L. Treas.
Reg. § 1.382-2T(j)(2)(vi). New
Public L's and P-1's respective
interests in L would have
increased by only 24 and 21
percent (i.e., P-1's purchase is
deemed to reduce New Public L's
increase). As a result, no
ownership change would occur.
(f)
The result of this example is
significantly different under the
final regulations. In particular,
if the convertible debt was not
issued with an abusive principal
purpose, there would be no option
attribution. Treas. Reg. § 1.382-
245
4(d). Furthermore, even if the
options were deemed exercised,
however, neither the small
issuance exception nor the cash
issuance exception to the
segregation rules would apply. The
amount of stock exceeds the small
issuance exception, and the cash
issuance exception appears to
apply only when stock is issued
directly for cash. Treas. Reg. §§
1.382- 3(j)(2), -3(j)(6). See
Part V.J., below.
d.
Other transactions
The fourth and final category is simply
referred to as "other transactions."
e.
(1)
The regulations authorize the Service
to designate other transactions -through publication in the Internal
Revenue Bulletin -- that will be
subject to rules "similar to" the
segregation rules contained in the
regulations. Treas. Reg. § 1.3822T(j)(2)(iii)(E). Currently, there are
no transactions that fall into this
category.
(2)
Treasury's attempt to elevate revenue
rulings from their status as such to
that of a regulation merely by
providing blanket authorization to the
Service in advance is questionable.
Although one can empathize with
Treasury's predicament in foreseeing
all possible abuses, the method chosen
to deal with this problem appears to
short circuit the administrative
process which must be followed in the
drafting and amendment of regulations.
See Tax Executives Institute, Comments
dated December 30, 1987.
Issuance of rights to acquire loss
corporation stock
246
The old regulations contain a special rule
that applies where the loss corporation
issues rights to acquire its stock as part
of certain segregation transactions.
(1)
Treas. Reg. § 1.382-2T(j)(2)(iii)(F)
states that in the case of any
segregation transaction (other than a
redemption-type transaction) in which
the loss corporation issues rights to
acquire its stock to members of more
than one group, the actual exercise by
the holders of those rights will be
presumed to occur pro rata by each such
public group.
(2)
Presumably, where options are issued to
more than one public group as part of a
redemption-type transaction (e.g.,
stock is redeemed for cash and
warrants), the warrant issuance would
be treated as a section 1032
transaction. Thus, Treas. Reg. §
1.382-2T(j)(2)(iii)(F) would apply to
the actual exercise of such options.
See Treas. Reg. § 1.382- 2T(j)(2)(v).
(3)
This rule itself is apparently
unchanged by the final regulations,
although its application may be
significantly affected by both the
final option attribution rules and the
exceptions to the segregation rules.
(4)
For example, loss corporation (L) has
600 shares of stock outstanding, all of
which are owned by public shareholders
("Public L"). P is an unrelated
corporation that is owned entirely by
non-5 percent shareholders ("Public
P"). On November 30, 1988, P merges
into L in a tax-free A reorganization,
with Public P receiving 400 new shares
of L stock. Thus, there are 1,000
shares of L stock outstanding after the
merger. Pursuant to the plan of
reorganization, L also issues warrants
247
to all of its shareholders pro rata.
The warrants entitle the holders to
acquire an amount of L stock which, if
exercised, would result in a total
issuance of 200 additional shares of L
stock. One year later, on November 30,
1989, when only one-half of the
outstanding warrants have been
exercised, individual A acquires the
remaining unexercised warrants. Treas.
Reg. § 1.382- 2T(j)(2)(F)(2).
(5)
Under both the old regulations and the
final regulations, warrants are treated
as options.
(a)
Under the old regulations, the
transaction should be analyzed in
the following manner.
(b)
First, in testing the merger as an
ownership change, any deemed
exercise of the warrants, which
typically would occur under the
old option attribution rules, will
not create an additional public
group under Treas. Reg. § 1.3822T(j)(2)(iii)(D) because L has
actual knowledge that the warrants
were issued pro rata to the L and
former P shareholders.
(c)
Second, the reorganization in its
entirety (the merger plus the
issuance of warrants) will not
trigger an ownership change
because the issuance of stock to
Public P, plus the deemed exercise
of warrants held by Public P (and
only Public P) does not create an
owner shift of more than 50
percentage points -- Public P
would be deemed to own only 44
percent of L (480 shares actually
and constructively owned/1,080
shares deemed outstanding).
248
(6)
(d)
Third, the actual exercise of
shareholder warrants is deemed to
occur pro rata. Thus, of the 100
shares actually issued pursuant to
the exercise of the warrants
before November 30, 1989, 60
shares are deemed to be acquired
by Public L and 40 shares are
deemed to be acquired by former
Public P. Accordingly, the actual
exercise as so treated would not
result in an owner shift.
(e)
Fourth, A's acquisition of the
unexercised warrants on
November 30, 1989 is a testing
event under the old option
attribution regulations, since A
would be a 5-percent shareholder
if he exercised the acquired
options. However, no ownership
change occurs on that date because
A's interest under the option
attribution rule would be
approximately 8 percent (100
deemed shares held by A out of
1,200 actual and deemed shares)
and Public P's would be
approximately 37 percent (400
actual and deemed shares held by
Public P out of 1,000 actual and
deemed shares). Thus, only a 45
percent owner shift would occur.
This example highlights the unfair and
oftentimes unrealistic operation of the
old option attribution regulations. In
testing the original merger transaction
itself, the regulations deemed Public P
(and only Public P) to have exercised
its options (but not Public L), even
though the regulations themselves treat
the actual exercise as occurring pro
rata between Public P and Public L.
The better approach would be to treat
deemed exercises under Treas. Reg. §
1.382- 2T(h)(4) just as the regulations
249
treat the actual exercise of such
options.
(7)
3.
Under the final regulations, this harsh
rule no longer applies. The warrants
will be deemed exercised only if issued
with an abusive principal purpose, and
then, presumably, by all holders to
whom the abusive principal purpose
applies.
Multiple Transactions
a.
Treas. Reg. § 1.382-2T(j)(2)(v)(A) provides
that if a transaction (or any part thereof)
qualifies as more than one type of
segregation transaction, the rules
applicable to the specific segregation
transaction will apply to the transaction
(or each part thereof) in the manner that
results in the largest increase in
percentage stock ownership of 5-percent
shareholders.
b.
For example, all of the common stock of loss
corporation (L) is owned by 1,000 unrelated
persons, none of whom is a 5-percent
shareholder ("Public CL"). L also has
outstanding a class of preferred stock
described in section 1504(a)(4) that is
owned by 500 unrelated persons ("Public
PL"). On September 4, 1988, L rearranges
its capital structure by redeeming 70
percent of the common stock owned by 700
shareholders in exchange for cash. In
addition, all of the preferred stock is
exchanged for a new class of nonvoting
common stock which represents 40 percent of
the value of L.
(1)
With respect to the redemption aspects
of the transaction, under Treas. Reg.
§ 1.382-2T(j)(2)(iii)(C) Public CL is
segregated into two different public
groups immediately before the
transaction -- the redeemed
250
shareholders ("Public RCL") and the
continuing shareholders ("Public CCL").
c.
4.
(2)
As a result of the redemption, Public
CCL's percentage ownership interest in
L increased 30 percentage points -from 30 percent to 60 percent. As
provided in Treas. Reg. § 1.3822T(a)(2)(i), this calculation is made
after both the redemption and the
recapitalization are taken into
account, since both occurred on the
same testing date (and are deemed to
occur simultaneously at the close of
such date).
(3)
The recapitalization aspect of the
transaction -- the exchange of
preferred stock for nonvoting common
stock -- is described in section 1032.
Accordingly, the segregation rules of
Treas. Reg. § 1.382-2T(j)(2)(iii)(B)
apply to treat the public group that
acquired the stock in the
recapitalization (Public PL) as a
separate group from the other public
groups -- Public CCL and Public RCL.
Public PL increased its percentage
ownership by 40 points. Consequently,
as a result of the combination of the
redemption and recapitalization
transactions, an ownership change
occurs.
Another example of a multiple transaction
would include a leveraged recapitalization
where the loss corporation shareholders
receive, in exchange for their old stock, a
package consisting of cash and a new, but
reduced, stock interest.
Acquisitions Following Segregation
Once a group of shareholders is segregated as a
result of the segregation rules, the group
generally remains segregated until a new testing
251
period begins.
a.
Treas. Reg. § 1.382-2T(j)(2)(vi) provides
that, in testing subsequent transactions for
ownership changes, unless a different
proportion is established by either the loss
corporation or the Service, an acquisition
of loss corporation stock by either a 5percent shareholder or the loss corporation
itself, on any date in which more than one
public group of the loss corporation exists
by virtue of the segregation rules, will be
treated as being made proportionately from
each public group existing immediately
before the acquisition.
(1)
This pro rata rule apparently will not
apply with respect to subsequent
purchases from persons who would be 5percent shareholders without regard to
the aggregation/segregation rules.
(2)
The statutory underpinnings for this
rule can be found in section
382(g)(4)(B)(ii). However, the
regulations differ from the statute in
that they specifically state that the
pro rata rule will not apply if a
different proportion is established by
either the loss corporation or the
Service. See also Blue Book at 310.
b.
To illustrate, assume that loss corporation
(L) is owned 40 percent and 60 percent by
two public groups -- Public L and Public L1, respectively. If individual A acquires
10 percent of L in the open market, A will
be treated as acquiring 6 percent from
Public L-1 and 4 percent from Public L,
unless the Service or L establishes a
different proportion.
c.
Treas. Reg. § 1.382-2T(j)(2)(vi) indicates
that this pro rata acquisition rule also
applies if the loss corporation redeems its
own stock at a time when multiple groups of
shareholders are present at the loss
252
corporation level. In such a case, it is
unclear what results obtain.
5.
(1)
For example, instead of a subsequent
purchase of stock by A as in the above
example, assume that L redeems 10
percent of its stock pro rata. If 4
percent of the stock is simply deemed
to be acquired from Public L and 6
percent from Public L-1, an owner shift
would not result.
(2)
However, if the transaction is also
treated as a segregation transaction
under Treas. Reg. § 1.382-2T(j)(2)
(iii)(C), a third public group would be
created ("Public L-2"). Public L-2
would be deemed to own the 10 percent
that was redeemed. Of the 10 percent
attributed to Public L-2, 6 percent
would be treated as coming from Public
L-1 and 4 percent from Public L. A 10
percent owner shift would thus occur
because the continuing groups ("Public
CL" and "Public CL-1") would have
increased their collective interest
from 90 percent before the redemption
to 100 percent of L afterwards.
(3)
Treating the redemption as a
segregation transaction in this context
is consistent with the segregation
rules of Treas. Reg. § 1.3822T(j)(2)(iii)(C). In any case,
clarification in this area would be
helpful.
De Minimis Public Groups
The regulations contain a special rule under
which the loss corporation may elect to combine
certain public groups that have been segregated
under the segregation rules.
a.
Treas. Reg. § 1.382-2T(j)(2)(iv) states that
any public group first identified as a
result of a segregation transaction (other
253
than a redemption-type transaction) that
owns less than five percent of loss
corporation stock may be combined, at the
option of the loss corporation, with any
other such group that is also first
identified during the same taxable year as a
result of any such segregation transaction.
That is, apparently for reasons of
administrative convenience, public groups
may be combined but only if such groups were
created within the same year and the groups
each own less than five percent of the loss
corporation.
b.
For example, assume that loss corporation
(L) has an employee stock option plan under
which employees are entitled to receive
stock of L. Options may be exercised on a
quarterly basis. On each of four quarterly
dates during L's taxable year ended December
31, 1988, L issues 1 percent of its stock to
different employees. Also, on May 1, 1988,
L issues 4 percent of its stock to the
public, and on October 31, 1988 L issues an
additional 6 percent of its stock to the
public. Finally, sometime during 1989, L
acquires all of the stock of a target
corporation in exchange for 3 percent of its
stock.
(1)
Ordinarily, each issuance of stock
during 1988 would create a separate
group under Treas. Reg. § 1.3822T(j)(2)(iii)(B). Thus, six groups of
public shareholders would be created.
(2)
However, under Treas. Reg. § 1.3822T(j)(2)(iv), the public groups created
as a result of the exercise of the
employee stock options and the first
public offering can be combined at the
close of 1988 into one group. The
group created as a result of the second
public offering cannot be combined with
the other groups since it owns five
percent or more of L. Also, the public
group created as a result of the target
254
acquisition cannot be combined with the
other groups since it was first
identified in another year (1989).
(3)
I.
Presumably, the combination of public
groups would not alter the fact that a
testing date occurred on each of the
six 1988 dates when each de minimis
group was created.
Special Segregation Rules -- First Tier or Higher Tier
Entity Level
1.
Disposition of Loss Corporation Stock
a.
b.
Under Treas. Reg. § 1.382-2T(j)(3)(i), if a
loss corporation is owned, in whole or in
part, by a public group(s), the segregation
rules applicable to section 381(a)(2) equity
structure shifts and section 1032
transactions (Treas. Reg. § 1.382-2T
(j)(2)(iii)(B)) will apply to any
transaction in which a first tier entity or
an individual that owns 5 percent or more of
the loss corporation stock transfers a
direct ownership interest in the loss
corporation to public shareholders.
(1)
Apparently, this rule applies even if
such persons transfer only a portion of
their stock (e.g., less than five
percent).
(2)
It is unclear why this provision
applies only to individual(s) or first
tier entities that own five percent or
more of the loss corporation stock at
the time of the transfer. This class
of shareholders is more narrow than 5percent shareholders who own a direct
interest in the loss corporation.
Under this segregation rule, each direct
public group that exists immediately after
such a disposition must be segregated so
that the ownership interests of each public
group existing immediately before the
transaction will be treated separately from
255
the public group that acquires loss
corporation stock from the individual or
first tier entity. The rules aggregating de
minimis public groups are also applicable.
See Treas. Reg. § 1.382-2T(j)(3)(i).
c.
d.
To illustrate, assume that loss corporation
(L) is owned equally by Public L, P
corporation and Partnership E. P is owned
by Public P (i.e., no 5-percent shareholders
with respect to L); E is owned by Public E,
a group of partners none of whom are 5percent owners of L. On October 22, 1988, E
disposes of its L stock over a public
exchange; no individual or entity acquires
as much as five percent of the L stock.
Treas. Reg. § 1.382- 2T(j)(3)(ii) (Ex.).
(1)
The disposition of stock by E triggers
the segregation rule above, so that L's
direct public group that exists
immediately before the transaction is
segregated from the group that acquires
stock from E (Public EL).
(2)
Thus, L is considered to be owned by
three 5-percent shareholders -- Public
L, Public P and Public EL. Only Public
EL has increased its percentage
interest (by 33 points).
(3)
For purposes of testing subsequent
transactions, Public L and Public EL
will continue to be treated as separate
direct public groups until any
subsequent testing period no longer
includes the date of E's disposition.
(4)
Note that the segregation rule affected
only Public L and Public EL -- the
direct public groups of L. Public P
was treated as a separate 5-percent
shareholder under the aggregation rules
and is not affected by shifts in L
stock not held by P.
As a variation of this example, suppose E
first distributed its L stock to its
256
partners, who then sold the stock to the
public. It is unclear whether a new group
would be created.
2.
(1)
On the one hand, the transaction could
be viewed technically as a disposition
by E to public shareholders which, as
so characterized, would render the
transaction subject to Treas. Reg.
§ 1.382-2T(j)(3)(i).
(2)
However, if Treas. Reg. § 1.3822(T)(j)(3)(i) does not apply, the
distribution of stock to the partners
should not constitute an owner shift
since, under the constructive ownership
rules, the partners already are deemed
to own the L stock and the
partnership's actual ownership is
ignored.
(3)
Although Public L would increase its
ownership from 33 percent to 66 percent
as a result of the distribution, L
presumably could take into account its
"actual knowledge" that its new public
shareholders owned L as public owners
of a first tier entity. A subsequent
sale by the partners (Public E) of
their L stock to other public
shareholders would be disregarded.
Treas. Reg. § 1.382- 2T(e)(1)(ii)
(transactions between persons who are
not 5-percent shareholders are
disregarded).
Disposition of Interests in First or Higher Tier
Entities
a.
In general
The segregation rules applicable to the loss
corporation itself also apply to segregation
transactions that involve either a higher
tier entity that constructively owns five
percent or more of the loss corporation
stock or a first tier entity.
257
b.
(1)
In applying these rules, a "direct
public group" of a first tier or higher
tier entity is defined generally as any
public group formed at a higher tier or
first tier entity level which is
treated as a 5-percent shareholder
under the aggregation rules (Treas.
Reg. § 1.382-2T(j)(1)(iv)(A) or (B)),
or under the segregation rules (Treas.
Reg. § 1.382-2T(j)(3)(iii)).
(2)
As with acquisitions of loss
corporation stock following a
segregation transaction, subsequent
acquisitions of stock of a first tier
or higher tier entity will be treated
as being made pro rata, unless a
different proportion is established.
Treas. Reg. § 1.382- 2T(j)(3)(v).
(3)
Since Treas. Reg. § 1.382-2T(j)(3)
essentially adopts the just-described
segregation rules applicable at the
loss corporation level, the balance of
this section will be devoted to
illustrations of these segregation
rules in the context of transactions
involving a first tier or higher tier
entity.
Merger of a first tier entity
Assume the facts are the same as those
depicted in the example beginning on page
179, except that a holding corporation (HC)
is interposed between the loss corporation
(L) and its shareholders -- Public L and P-1
corporation. That is, Public L owns 40
percent of HC and P-1 owns 60 percent of HC.
HC, in turn, owns 100 percent of L.
(1)
In this example, HC is the target
rather than L, so that HC is merged
into P-2 in exchange for 70 percent of
the P-2 stock.
(2)
The merger is a segregation transaction
that involves a first tier entity.
258
According to Treas. Reg. § 1.3822T(j)(3)(iii), HC's direct public group
is Public L (a group of public owners
aggregated as a public group under
Treas. Reg. § 1.382-2T(j)(1)(iv)(B)).
(3)
c.
Under Treas. Reg. § 1.3822T(j)(3)(iii), the segregation rules of
Treas. Reg. § 1.382-2(j)(2)(iii)(B)
apply to segregate Public L from the
direct public group that is deemed to
acquire loss corporation stock (Public
P-2). Accordingly, the results here
are similar to those described earlier.
Forward triangular merger
Assume that all of the stock of loss
corporation (L) is owned by unrelated public
shareholders ("Public L"). P corporation
similarly is owned by unrelated
shareholders, none of whom owns as much as
5-percent of the P stock ("Public P"). On
November 22, 1988, P incorporates P-1 and
contributes P stock to P-1. Immediately
thereafter, P-1 acquires all of the
properties of L in exchange for its P stock
in a forward triangular merger qualifying
under sections 368(a)(1)(A) and (a)(2)(D).
The P stock transferred by P-1 constitutes
45 percent of the total P stock outstanding
after the transaction. Treas. Reg. § 1.3822T(j)(3)(iv) (Ex. (3)).
(1)
Immediately before the merger of L into
P-1, P's only 5-percent shareholder was
Public P, a direct public group of P.
Under Treas. Reg. § 1.3822T(j)(3)(iii), the rules of Treas. Reg.
§ 1.382- 2T(j)(2)(iii)(B) apply since
P, a first tier entity, is a party to
the reorganization. Although Public P
does not acquire any stock in the
merger, it is treated as acquiring
stock in the loss corporation because
such corporation succeeds to the pre-
259
change losses of L in a transaction to
which section 381(a) applies.
d.
(2)
As a result of the merger, Public P,
the direct public group of P that
exists immediately before the merger,
must be segregated from the direct
public group acquiring P stock in the
reorganization (Public L). Therefore,
in the transaction Public P is treated
as acquiring 55 percent of the
outstanding stock of the loss
corporation -- which in this case is P1, the successor to L.
(3)
Accordingly an ownership change results
for P-1.
B reorganization
Assume that loss corporation (L) is owned
solely by public shareholders ("Public L").
P corporation is owned solely by unrelated
individuals, none of whom owns as much as 5
percent of the P stock ("Public P"). On
October 31, 1988, P acquires all of the L
stock in exchange for P stock representing
20 percent of the value of P (determined
immediately after the acquisition) in a B
reorganization.
(1)
Under Treas. Reg. § 1.3822T(j)(3)(iii), the segregation rules of
Treas. Reg. § 1.382-2T(j)(2)(iii)(B)
apply to the reorganization, since the
transaction is a section 1032
transaction involving a first tier
entity of L.
(2)
Thus, the direct public group of P that
exists immediately after the
transaction must be segregated into two
public groups -- the direct public
group of P that existed immediately
before the acquisition (Public P) and
the direct public group that acquired P
stock in the transaction (Public L).
Accordingly, immediately after the
260
reorganization, Public P and Public L
owned 80 percent and 20 percent of L
respectively.
(3)
e.
The reorganization results in an
ownership change, because Public P
increased its percentage ownership in L
by 80 percentage points as compared to
its lowest percentage ownership in L at
any time during the testing period (0
percent prior to the acquisition).
Holding company formation
The regulations also offer the following as
an example of a segregation transaction.
Treas. Reg. § 1.382-2T(j)(3)(iv) (Ex.(2)).
(1)
Loss corporation (L) is owned equally
by 25 individual shareholders (these
public shareholders are aggregated as
"Public L"). Public L is thus the only
5-percent shareholder of L. All of the
public shareholders of L contribute
their L stock to a newly formed
corporation (HC). In exchange for
their contributions of L stock, HC
issues 100 percent of each of its two
classes of common stock (voting and
non-voting).
(2)
It is not clear why the regulations
treat the formation of HC as a
segregation transaction.
(3)
As the regulations point out, the
formation of HC, a first tier entity of
L, is a transaction to which section
1032 applies. However, for the
segregation rules of Treas. Reg.
§ 1.382- 2T(j)(2)(iii)(B) to apply by
virtue of Treas. Reg. § 1.3822T(j)(3)(iii), the first tier entity
apparently must have one or more direct
public groups immediately before and
after the transaction. Here, HC was
not owned by a public group prior to
261
the transaction and apparently had no
shareholders.
(4)
(5)
3.
The appropriate analysis appears to be
made under the aggregation rules of
Treas. Reg. § 1.382-2T(j)(1). The
results of such an analysis are similar
to those outlined in the regulations.
That is, the shareholders of HC
("Public HC") immediately after the
issuance of the HC stock are presumed
not to include any persons that
previously held a direct or indirect
ownership interest in L (Public L).
Treas. Reg. § 1.382-2T(j)(1)(iii).
(a)
This presumption, however, is
rebutted by establishing that all
of the HC stock outstanding
immediately after the transaction
was issued solely in exchange for
L stock. Treas. Reg. § 1.3822T(K)(2).
(b)
Thus, Public HC (immediately after
the transaction) should be treated
as being composed of the same
shareholders as Public L
(immediately before the
transaction).
Accordingly, not even an owner shift
should occur as a result of the
formation of new corporation HC.
Redemption-Type Transaction
a.
Treas. Reg. § 1.382-2T(j)(3)(iii) also
states that the principles set forth in
Treas. Reg. § 1.382-2T(j)(2)(iii)(C)
(redemption-type transactions involving the
loss corporation) are to apply to any
transaction that has the "effect" of a
redemption-type transaction.
(1)
Treas. Reg. § 1.382-2T(j)(3)(iii)
indicates that this rule will apply to
"e.g., an acquisition by the loss
262
corporation of stock in a first tier
entity."
(2)
b.
J.
Unfortunately, they do not provide any
examples to illustrate the operation of
this rule. The following is an attempt
to fill this gap.
Loss corporation (L) is 50 percent owned by
public shareholders ("Public L") and 50
percent owned by P corporation. P, in turn,
is wholly owned by public owners ("Public
P"). L acquires 10 percent of the P stock
in the open market. Although it is by no
means clear, the effect of Treas. Reg.
§ 1.382- 2T(j)(2)(iii)(C) would appear to be
as follows:
(1)
The Public P shareholders would be
segregated into two groups -- the
continuing P shareholders ("Public CP")
and the shareholders who sold their P
stock ("Public SP").
(2)
Since the transaction is characterized
by the regulations as having the effect
of a redemption-type transaction, the
stock purchase by L apparently reduces
the total outstanding stock of P.
(3)
Under this premise, Public CP after the
transaction would own 100 percent P
and, through attribution, 50 percent of
L. Before the transaction Public CP
held only 45 percent of L through
attribution. Thus, the transaction
apparently would result in a 5 percent
owner shift.
Final Regulations Modifying Segregation Rules
On November 5, 1992, the Service issued proposed
regulations that modify the segregation rules of
Treas. Reg. § 1.382-2T(j)(2)(iii). On October 4,
1993, the proposed regulations were finalized with
some revisions. The regulations exempt, in whole or
in part, certain issuances of stock by a loss
corporation from the segregation rules. According to
263
the preamble to the proposed regulations, the
temporary regulations were modified because:
--
The temporary regulations imposed
significant administrative burdens on loss
corporations because the temporary
regulations often created de minimis public
groups (despite the application of Treas.
Reg. 1.382-2T(j)(2)(iv));
--
The presumption of no cross-ownership
between the different public groups created
as a result of an issuance appeared to be
unrealistic; and
--
Less than 5-percent shareholders receiving
stock in an issuance generally had little
incentive for undertaking transactions to
enhance the use of a loss corporation's
losses.
Similar arguments to those above can be made to modify
the segregation rules for redemptions under Treas.
Reg. § 1.382-2T(j)(2)(iii)(C). Public Comments on the
Proposed Regulations from the American Bankers
Association, Tax Notes Today (Jan. 11, 1993).
1.
Small Issuance Exception
The final regulations provide that the
segregation rule of Treas. Reg. § 1.3822T(j)(2)(iii)(B) does not apply to a small
issuance, except to the extent that the total
amount of stock issued in the issuance and all
other small issuances previously made during the
same taxable year (determined in each case on
issuance) exceeds the small issuance limitation.
The exception does not apply to an issuance of
stock that, by itself, exceeds the small issuance
limitation. Treas. Reg. § 1.382-3(j)(2)(i).
a.
A "small issuance" is an issuance by the
loss corporation of an amount of stock in a
section 1032 transaction or a
recapitalization that does not exceed the
small issuance limitation. For purposes of
defining a small issuance, all stock issued
264
in the issuance is taken into account,
including stock owned immediately after the
issuance by a 5-percent shareholder that is
not a direct public group. Treas. Reg. §
1.382-3(j)(2)(ii).
b.
The "small issuance limitation" is
determined by the loss corporation as
described below.
(1)
For each taxable year, the loss
corporation may elect to apply the
small issuance exception on a
corporation-wide basis or a class-byclass basis.
Treas. Reg. § 1.3823(j)(2)(iii).
(2)
On a corporation-wide basis, the small
issuance limitation is 10-percent of
the total value of the loss
corporation's stock outstanding at the
beginning of the taxable year excluding
the value of stock described in section
1504(a)(4)). Treas. Reg. § 1.3823(j)(2)(iii)(A)(1).
(3)
On a class-by-class basis, the small
issuance limitation is 10-percent of
the number of shares of the class
outstanding at the beginning of the
taxable year. Treas. Reg. § 1.3823(j)(2)(iii)(A)(2). A class of stock
includes all stock with the same
material terms. Treas. Reg. § 1.3823(j)(2)(iii)(B).
(4)
The computation of the number of shares
of a class outstanding at the beginning
of the taxable year shall be adjusted
to take into account any stock split,
reverse stock split, stock dividend to
which section 305(a) applies,
recapitalization, or similar
transaction that occurs during the
taxable year. Treas. Reg. § 1.3823(j)(2)(iii)(C).
265
c.
(5)
The loss corporation may not apply the
small issuance exception on a class-byclass basis if, during the taxable
year, more than one class of stock is
issued in a single issuance or in two
or more issuances that are treated as a
single issuance under Treas. Reg.
§ 1.382-3(j)(8). Treas. Reg. § 1.3823(j)(2)(iii)(D).
(6)
In the case of a short taxable year
(less than 365 days), the small
issuance limitation is reduced by
multiplying it by a fraction, the
numerator of which is the number of
days in the taxable year, and the
denominator of which is 365.
Treas.
Reg. § 1.382-3(j)(2)(iv).
(7)
As a planning matter, a corporation
with a single class of stock should
compute the small issuance limitation
on a corporation-wide basis (i.e., 10
percent of the total value) if the
value of its stock declines during the
year, and on a class-by-class basis
(i.e., 10 percent of the total number
of shares) if the value of its stock
increases during the year.
Examples
(1)
L, a calendar year taxpayer, has 1,000
shares of stock outstanding on
January 1, 1993. L chooses to compute
its small issuance limitation for 1993
on a class-by-class basis with the
result that L's small issuance
limitation for 1993 is 100 shares. L
issues 60 shares of stock on February
1, 1993, and 60 shares of stock on
December 1, 1993. The two issuances
are unrelated and not treated as a
single issuance under Treas. Reg. §
1.382-3(j)(8).
266
2.
(2)
The first issuance is a "small
issuance." The second issuance is a
"small issuance," but only to the
extent of 40 shares of stock, and is
subject to the cash issuance exception
(described below) to the extent 20
shares of stock, if applicable, and
Treas. Reg. § 1.382-2T(j)(2)(iii)(B) to
the extent of the remainder.
(3)
Assume the same facts as above, except
that the February 1, 1993, issuance was
of 150 shares of stock. Because the
first issuance exceeds the small
issuance limitation, the entire first
issuance is subject to Treas. Reg.
§ 1.382-2T(j)(2)(iii)(B). Under Treas.
Reg. § 1.382-3(j)(2)(i), the entire
second issuance is a "small issuance
since the first issuance is not
eligible for the small issuance to any
extent."
Cash Issuance Exception
If the loss corporation issues stock solely for
cash, the segregation rule of Treas. Reg.
§ 1.382- 2T(j)(2)(iii)(B) does not apply to stock
issued in an amount equal (as a percentage of the
total stock issued) to one-half of the aggregate
percentage ownership interest of direct public
groups immediately before the issuance. Treas.
Reg. § 1.382-3(j)(3)(i). In other words, the
percentage of a stock issuance eligible for the
cash issuance exception is:
--The percentage of L's stock held by public
groups immediately before the issuance;
--Multiplied by one-half.
a.
This exception does not apply to a small
issuance exempted in its entirety from the
segregation rule of Treas. Reg. § 1.3822T(j)(2)(iii)(B). Treas. Reg. § 1.3823(j)(3)(iii).
267
3.
b.
In the case of a small issuance exempted in
part from the segregation rule of Treas.
Reg. § 1.382-2T(j)(2)(iii)(B), this
exception applies only to the portion of the
small issuance that is not so exempted. The
portion of the issuance that is not exempt
under the small issuance exception is
treated as a separate issuance for purposes
of applying subsection (j)(3). Treas. Reg.
§ 1.382-3(j)(3)(iii).
c.
This exception does not apply to convertible
debentures exchanged for stock, as the
exchange is not “solely for cash.” See LTR
9508030.
d.
The final regulations specify that the cash
issuance exception applies only if a loss
corporation issues stock solely for cash.
Treas. Reg. § 1.382-3(j)(3). A share of
stock is not issued solely for cash if the
acquirer is required to purchase other stock
for non-cash consideration as a condition to
acquiring that share for cash. Treas. Reg.
§ 1.382-3(j)(3)(ii).
e.
It has been suggested that the cash issuance
exemption be extended to include cash-type
items, such as negotiable instruments.
Public Comments on Proposed Regulations from
Agribank, Tax Notes Today (Jan 12, 1993).
Limitation on Exempted Stock
The total amount of stock exempt from the
application of the segregation rule of Treas.
Reg. § 1.382-2T(j)(2)(iii)(B) under the small
issuance and cash issuance exceptions cannot
exceed the total amount of stock issued less the
amount of the issued stock owned by a 5-percent
shareholder (other than a direct public group)
immediately after the issuance. Except to the
extent that the loss corporation has actual
knowledge to the contrary, any increase in the
amount of the loss corporation's stock owned by
the 5-percent shareholder on the day of the
issuance is considered to be attributable to an
268
acquisition of stock in the issuance.
Reg. § 1.382-3(j)(4).
4.
Treas.
Proportionate Acquisition of Exempted Stock
a.
Each direct public group that exists
immediately before an issuance to which the
small issuance or cash issuance exceptions
apply is treated as acquiring its
proportionate share of the amount of stock
exempted from the application of the
segregation rule of Treas. Reg. § 1.3822T(j)(2)(iii)(B). Treas. Reg. § 1.3823(j)(5)(i).
b.
The loss corporation may treat direct public
groups existing immediately before an
issuance covered by the small issuance or
cash issuance exceptions as acquiring in the
aggregate more stock than the amount
determined to be its proportionate share,
but only if the loss corporation actually
knows that the aggregate amount acquired by
those groups in the issuance exceeds the
amount so determined. Treas. Reg. § 1.3823(j)(5)(ii)(A).
c.
In the issuance of stock on the exercise of
an option, the loss corporation must take
into account any transfers of the option,
including transfers between persons who are
not 5-percent shareholders, members of
separate public groups, and transfers
described in section 382(l)(3)(b). Even if
transferable options are distributed pro
rata to members of an existing public group,
the actual knowledge exception applies only
to the extent that the loss corporation
actually knows that the persons acquiring
stock on exercise of the options are members
of a pre-existing public group. Treas. Reg.
§ 1.382-3(j)(5)(ii)(B). This amendment
terminates the previously deployed technique
of avoiding the segregation rules for stock
issuances by distributing, pro rata, options
to the loss corporation's shareholders.
Prior to these amendments, the presumption
269
under the temporary regulations permitted
the loss corporation to disregard the fact
(and expectation) that the options would be
exercised by persons other than those who
were distributed the options. For a
detailed discussion of this issue, See New
York State Bar Association Report on
proposed Section 382 Option Attribution, 93
TNT 94-101 (April 30, 1993) (Recommendation
H).
5.
Exception for Equity Structure Shifts
The final regulations do not apply to any
issuance of stock in an equity structure shift,
except that the small issuance exception applies,
if its requirements are met, to the issuance of
stock in a recapitalization under section
368(a)(1)(E).
Treas. Reg. § 1.382-3(j)(6).
Therefore, an exchange of common stock for
section 1504(a)(4) preferred stock may qualify.
However, stock issued in an acquisition
reorganization where Bigco acquires Smallco
cannot qualify for relief. Although the
acquisition mode of raising capital is not given
any relief, equivalent relief is available to the
extent proceeds are raised through an IPO which
are used to acquire target stock or assets.
6.
Transitory Ownership by Underwriter
For purposes of Treas. Regs. §§ 1.382-2T(g)(1)
and (j), and the final regulations, the
transitory ownership of stock by an underwriter
of the issuance is disregarded. Treas. Reg. §
1.382-3(j)(7).
7.
Certain Related Issuances
Under Treas. Reg. § 1.382-3(j)(8), two or more
issuances of stock, including issuances by first
tier or higher tier entities, are treated as a
single issuance if-a.
Issuances occur at approximately the same
time pursuant to the same plan or
arrangement; or
270
b.
8.
A principal purpose of issuing the stock in
separate issuances rather than in a single
issuance is to minimize or avoid an owner
shift under the rules of this section.
Application to Options
The principles of the final regulations govern
for purposes of applying the rule of Treas. Reg.
§ 1.382-2T(j)(2)(iii)(D) relating to the deemed
acquisition of stock as a result of the ownership
of an option. Treas. Reg. § 1.382-3(j)(9). If
transferable options are issued to more than one
public group, Treas. reg. § 1.3822T(j)(2)(iii)(F) does not apply to treat options
as exercised pr-rata by each group. Treas. Reg.
§ 1.382-3(j)(9).
9.
Application to First Tier and Higher Tier
Entities
The principles of this section apply to issuances
of stock by a first tier entity or a higher tier
entity that owns 5-percent or more of the loss
corporation's stock, determined without regard to
the application of Treas. Reg. 1.3822T(h)(2)(i)(A) (relating to attribution of stock
under section 318(a)(2)). Treas. Reg. § 1.3823(j)(11).
10.
Certain Non-Stock Ownership Interests
As the context may require, a non-stock ownership
interest in an entity other than a corporation is
treated as stock for purposes of this section.
Treas. Reg. § 1.382-3(j)(12).
a.
This section apparently is aimed at cases
where a partnership interest or beneficial
interest in a trust might be treated as
stock.
b.
However, neither the regulations nor the
Preamble provide an example of when this
section may apply. Presumably, the rules
are available in analogous cases. For
271
example, a partnership interest received for
cash should be covered by the cash issuance
exception, and the issuance for a
partnership interest amounting to less than
10 percent of the value of the partnership
at the beginning of the year should be
covered by the small issuance exception.
11.
De Minimis Rule
The de minimis rule of Treas. Reg. § 1.3822T(j)(2)(iv) should still apply to any new public
groups formed where the small issuance or cash
issuance exceptions do not apply.
12.
Effective Date
The final regulations apply to issuances of stock
during taxable years ending on or after November
4, 1992. However, that effective date does not
apply to Treas. Reg. § 1.382-3(j)(10) if an
option was issued before May 4, 1993 and the
issuer filed a registration statement before
November 4, 1992. Taxpayers also may elect to
have the regulations apply retroactively before
November 4, 1992. Treas. Reg. § 1.383-3(j)(14).
13.
Examples
a.
L is a calendar year taxpayer. On January
1, 1994, L has 1,000 shares of a single
class of common stock outstanding. All of
L's outstanding common stock is owned by a
single direct public group ("Public L"). On
February 1, 1994, L issues to employees as
compensation 60 new common shares of the
same class. On May 1, 1994, L issues 50 new
common shares of the same class for cash.
Following each issuance, L's stock is owned
entirely by public shareholders. No other
changes in the ownership of L's stock occur
prior to May 1, 1994. L chooses to
determine its small issuance limitation for
1994 on a class-by-class basis. Treas. Reg.
§ 1.382-3(j)(14) (Ex. (1)).
272
(1)
The February issuance is a small
issuance because the number of shares
issued (60) does not exceed the small
issuance limitation of 100 (10-percent
of the number of common shares
outstanding on January 1, 1994). Under
the small issuance exception, the
segregation rule of Treas. Reg. §
1.382-2T(j)(2)(iii)(B) does not apply
to the February issuance. Under the
proportionate acquisition rules, Public
L is treated as acquiring all 60 shares
issued. Treas. Reg. § 1.382-3(j)(5).
(2)
The May issuance is a small issuance
because the total number of shares
issued (50) does not exceed the small
issuance limitation of 100. However,
only 40 of the 50 shares issued are
exempt under the small issuance
exception, because the total number of
shares of common stock issued in
February and May (110) exceeds the
small issuance limitation (100).
(3)
Because the May issuance is for cash,
the cash issuance exception applies to
exempt a portion of the remaining
shares from the segregation rule of
Treas. Reg. § 1.382-2T(j)(2)(iii)(B).
Treas. Reg. § 1.382-3(j)(3). The 10
remaining shares are multiplied by 50
percent, which represents one-half of
Public L's 100 percent ownership
interest immediately before the May
issuance. This results in 5 shares
being exempted from the segregation
rules on account of the cash issuance
exception.
(4)
Accordingly, Public L is treated as
acquiring 45 shares in the May
transfer. The segregation rule of
Treas. Reg. § 1.382-2T(j)(2)(iii)(B)
applies to the remaining 5 shares
issued. The remaining 5 shares are
treated as having been acquired by a
273
direct public group ("New Public L")
separate from Public L. Each such
public group is treated as an
individual that is a separate 5-percent
shareholder.
b.
(5)
If L actually knows that at least 10
shares (or any other number of shares
less than or equal to the 45 shares
deemed acquired) of the May issuance
are acquired by members of Public L,
the result is the same. However, if L
actually knows that all 50 shares of
the May issuance are acquired by
members of Public L, L may treat Public
L as acquiring 50 shares in the May
issuance. Treas. Reg. § 1.3823(j)(5)(ii).
(6)
Under the old regulations each issuance
would have created a public group. The
February 1, 1994 issuance would have
created Public L1 owning 60 shares.
The May 1, 1994 issuance would have
created Public L2 owning 50 shares.
Thus, under the old regulations, the
new direct public groups arising from
the 1994 stock issuance would have an
aggregate increased percentage
ownership interest in L of 9.91
percentage points relative to the
increase of only 0.05 percentage points
by the new Public L under the final
regulations.
Assume, instead, that L is a calendar year
taxpayer. On January 1, 1995, L has 1,000
shares of Class A common stock outstanding,
the aggregate value of which is $1,000.
Five hundred shares are owned by one direct
public group ("Public 1") and 500 shares are
owned by another public group ("Public 2").
On August 1, 1995, L issues 200 shares of
Class B common stock for $200 cash. A, an
individual, acquires 120 Class B shares in
the transaction. The remaining 80 Class B
shares are acquired by public shareholders.
274
No other changes in the ownership of L's
stock occur prior to August 1, 1995. Treas.
Reg. § 1.382-3(j)(14) (Ex. (2)).
(1)
On a corporation-wide basis, the August
issuance is not a small issuance. The
total value of the Class B stock issued
($200) exceeds the small issuance
limitation of $100, which is calculated
by multiplying 10 percent by the value
of L's stock on January 1, 1995 (10
percent x $1,000).
(2)
The class-by-class application of the
segregation rules is not available
since no class B stock was outstanding
at the end of the year. On a class-byclass basis, the total number of Class
B shares issued (200) exceeds the small
issuance limitation of zero, which is
calculated by multiplying 10 percent by
the number of Class B shares
outstanding on January 1, 1995 (zero).
(3)
The cash issuance exception exempts 80
shares from the segregation rules of
Treas. Reg. § 1.382-2T(j)(2)(iii)(B).
The 80 shares represents the amount of
Class B shares that have a value equal
to the lesser of the value of the 200
Class B shares issued multiplied by 50
percent (which represents one-half of
the combined 100 percent pre-issuance
ownership interest of Public 1 and
Public 2), or the value of the 200
Class B shares issued less the value of
the 120 Class B shares acquired by A.
Public 1 and Public 2 are treated as
acquiring a proportionate share of the
80 exempted Class B shares. Treas.
Reg. § 1.382-3(j)(5). Because Public 1
and Public 2 each owned 500 Class A
shares prior to the issuance, Public 1
and Public 2 are treated as having
acquired 40 Class B shares each.
275
(4)
c.
Under the old regulations, the 80 class
B shares issued on August 1, 1995 and
not acquired by A would all be deemed
acquired by a new direct public group
Public 3. This result would have
created an increase in its percentage
ownership interest in L of 16.67
percentage points. Instead, under the
final regulations, there is no direct
public group having an increase in its
percentage ownership interest in L.
L, a calendar year taxpayer, has 1,000
shares of stock outstanding on January 1,
1993. All 1,000 shares of L stock are owned
by a direct public group, Public L. L
chooses to compute its small issuance
limitation for 1993 on a class-by-class
basis with the result that L's small
issuance limitation for 1993 is 100 shares.
L issues 70 shares of stock on February 1,
1993, 60 shares of stock on July 1, 1993,
and 50 shares of stock on December 31, 1993.
All of the issuances are to employees for
purposes of compensation, but none of the
employees is a 5 percent shareholder. The
three issuances are unrelated and not
treated as a single issuance under Treas.
Reg. § 1.382-3(j)(8).
(1)
The first issuance is a "small
issuance" since the 10 shares issued on
February 1 is less than the 100 share
limitation.
(2)
The second issuance is a "small
issuance," but only to the extent of 30
shares of stock since the cumulative
issuance for the year that is eligible
for the exception cannot exceed 100.
The remaining 30 shares are not
eligible for the small issuance
exception and are subject to Treas.
Reg. § 1.382- 2T(j)(2)(iii), creating a
new direct public group, Public L1.
276
d.
(3)
The third issuance is not a "small
issuance," and is subject to Treas.
Reg. § 1.382-2T(j)(2)(iii)(B) in its
entirety, creating another new public
group, Public L2.
(4)
However, both Public L1 and Public L2
own less than 5 percent of the stock of
L, and may be combined under the de
minimis rule of Treas. Reg. § 1.3822T(j)(2)(iv). As a result of these
issuances, therefore, Public L is
considered to own 1,100 shares of L
stock, and the new (combined) public
group, New Public L, is considered to
own 80 shares of L stock.
Loss corporation (L) is owned entirely by
Public L. L commences and completes a
public offering of 200,000 shares of common
stock on January 22, 1988, with the result
that its outstanding stock increases from
100,000 shares to 300,000 shares. No person
becomes a 5-percent shareholder following
the public offering. Treas. Reg. § 1.3822T(j)(2)(iii)(B)(2) (Ex. (3)).
(1)
The public offering is a transaction
described in section 1032. Immediately
before the public offering, L's sole 5percent shareholder was Public L, a
direct public group.
(2)
Under the old regulations, Public L, as
in existence immediately before the
offering, must be segregated from the
direct public group that would
otherwise exist.
(3)
Under the old regulations, the
acquisition of 200,000 shares is
treated as being acquired by a second
direct public group (New Public L).
Public L and New Public L are treated
as separate 5-percent shareholders.
(4)
After the offering, Public L owns 33
percent of L and New Public L owns 67
277
percent of L. The members of Public L
are presumed not to be members of New
Public L.
(5)
New Public L is a 5-percent shareholder
that has increased its percentage
interest by more than 50 points. Thus,
an ownership change occurs.
(6)
For purposes of testing subsequent
transactions, Public L and New Public L
will not be segregated because a new
testing period begins the day following
the ownership change, and the
January 22, 1988 transaction will not
fall within the new testing period.
Treas. Reg. § 1.382-2T(j)(2)(i)
(segregation events are only relevant
for keeping public groups separate if
the groups have formed within the
testing period).
(7)
If the final regulations were to apply
to this example, however, the cash
issuance exception of Treas. Reg. §
1.382-3(j)(3) would apply to one-half
of the shares sold in the public
offering (100,000 shares), because all
of the L stock was owned by Public L (a
direct public group) immediately before
the issuance.
(8)
Accordingly, Treas. Reg. § 1.3822T(j)(iii)(B) would apply to create a
New Public L which owns only 100,000
shares of L stock.
(9)
New Public L's ownership would increase
by only one-third. Therefore, under
the final regulations, no ownership
change would result from the public
offering.
(10) Under the final regulations, it is
clear that, in all cases, the same
treatment will be applied to firm
commitments and best efforts
underwriting. Treas. Reg. § 1.382278
3(j)(7) (disregarding transitory
ownership by underwriters).
e.
Loss corporation (L) is owned entirely by
Public L1 and Public L2 and there are 1,000
shares of common stock outstanding. L is
within only a few percentage points of an
ownership change. On February 1, 1994 when
the value of each share of L stock is $100,
L issues options to its employees for the
acquisition of, in the aggregate, 60 new
shares of its common stock at $90 per share.
The options are not exercisable until
January 31, 1996. No elections are made
under section 83(b). Assume the final
option rules are applicable. On December 1,
1994, L obtains a patent which causes its
stock to double in value causing each share
to have a $200 value. On December 15, 1994,
L issues to the public 100 shares of its
common stock at $200 a share. All of the
outstanding options ultimately are exercised
in January 1996.
(1)
The principles of Treas. Reg. § 1.3822T(j)(2)(iii)(D) are applicable to the
deemed acquisition of stock under the
option attribution rules. Treas. Reg.
§ 1.382-3(j)(9). Therefore, even if
the options were considered to have
been issued for an abusive principal
purpose, the small business issuance
exception would be available since the
issuance of options to acquire 60
shares of L stock would not exceed the
10 percent limitation. Therefore, the
segregation rules of Treas. Reg.
§ 1.382-2T(j)(iii)(B) do not apply to
the deemed issuance of the options.
(2)
Assuming the employee options were
issued to a group of management/
shareholders with an abusive principal
purpose, the application of the
principles of Treas. Reg. § 1.382-3(j)
to the options deemed exercised would
seem to require that both the 60 shares
279
deemed issued pursuant to the option
and the 100 shares actually issued each
should be treated as separate small
issuances.
(3)
Assuming that the L options (for 60
shares) could not be deemed exercised
prior to the December 15, 1994 stock
issuance (of 100 shares) because any
such exercise would not have caused an
ownership change, it is unclear under
the final regulations what effect the
deemed exercise of the options could
have on the stock. New York State Bar
Association, Report on Proposed Section
382 Option Attribution rules, 93 TNT
94-101 (April 30, 1993) (Recommendation
P).
(a)
It is possible, owing to the
mechanical nature of the option
attribution rules which create a
deemed exercise on each testing
date, that the stock deemed issued
pursuant to the options (i.e., the
deemed stock) and the stock issued
to the public would be treated as
part of the same issuance, thereby
disqualifying both issuances from
being eligible for the small
issuance exception.
(b)
If the options are deemed issued
first, the 60 shares deemed
pursuant to the options issued and
40 of the 100 shares actually
issued during 1994 would be
eligible for the small issuance
exception. The remaining 60
shares actually issued would be
fully eligible for treatment only
under the cash issuance exception.
(c)
If the options are deemed issued
after the stock actually issued,
the 100 shares actually issued
during 1994 would be eligible,
280
perhaps only in part, for the
small issuance exception while the
remaining 60 shares deemed issued
pursuant to the options would be
eligible for treatment under the
cash issuance exception. Because
the employees are deemed to
acquire their stock both for cash
and as compensation for services,
it is possible that the cash
issuance exception may be
available only for 27 of the
shares deemed issued (($90 cash
component/$200) x 60 shares). See
Ernst & Young Recommends changes
to the Proposed Option and
Segregation Regs., 93 TNT 71-30
(March 24, 1993) (Recommending
that employee stock options be
treated as options issued for
cash).
(d)
K.
Another alternative is that the
small issuance exception applies
on a pro rata basis to both the
stock and options.
Certain Changes Not Taken Into Account
Section 382 provides that, in effect, certain changes
in stock holdings will be disregarded in determining
whether an ownership change has occurred.
1.
Stock Acquired by Death, Gift or Divorce
a.
Under section 382(l)(3)(B), certain
transferees of stock will be treated as if
they owned the transferred stock throughout
the period in which the transferor owned the
stock. In other words, transactions covered
by this section will not constitute owner
shifts.
b.
Section 382(1)(3)(B) applies where:
(1)
the basis of stock in the hands of any
person is determined;
281
2.
3.
--
under section 1014 (property
acquired from a decedent),
--
under section 1015 (property
acquired by a gift or transfer in
trust), or
--
under section 1041(b)(2)
(transfers between spouses or
pursuant to a divorce);
(2)
stock is received in satisfaction of a
right to receive a pecuniary bequest;
or
(3)
stock is acquired pursuant to any
divorce or separation instrument
(within the meaning of section
71(b)(2)).
Acquisitions by ESOPs
a.
Former section 382(l)(3)(C) provided that,
if certain ownership and allocation
requirements are met, the acquisition of
employer securities by either a tax credit
employee stock ownership plan or an employee
stock ownership plan are not taken into
account in determining whether an ownership
change has occurred.
b.
However, section 382(l)(3)(C) was repealed
by OBRA 89, effective for transactions
entered into after July 12, 1989.
Changes Attributable to Fluctuations in Value
a.
Section 382(l)(3)(C) provides that except to
the extent provided in regulations, changes
in proportionate ownership solely
attributable to fluctuations in the fair
market value of different classes of stock
will not be taken into account in
282
determining if an ownership change has
occurred.
b.
For example, individual A owns 2 classes of
L stock each representing 50 percent of the
total value of L. On January 1, 1988, A
sells one class to B so that B now owns 50
percent of the L stock. As of January 1,
1989, B's class of stock has appreciated in
value so that it now represents 60 percent
of the value of L.
(1)
Even though B now owns 60 percent of L,
no ownership change will occur. The
increase in percentage interest due to
the appreciation in value is ignored.
(2)
However, an actual sale of stock by
either A or B (even if only one share)
on January 1, 1989, could result in an
ownership change if section
382(l)(3)(C) is interpreted strictly
(i.e., the percentage shift is not
attributable solely to fluctuation in
value).
(3)
However, one can also argue that the
fluctuation in value inherent in the
unsold shares should continue to be
ignored.
c.
The regulations reserved this issue.
Treas. Reg. § 1.382-2T(l).
d.
On June 11, 2010, the IRS and Treasury
issued Notice 2010-50. The notice states
that the IRS and Treasury are aware that
taxpayers employ a number of differing
methodologies to interpret and apply section
382(l)(3)(C), including what the notice
described as the “Full Value Methodology”
and the “Hold Constant Principle.” The
notice states that because of the complexity
of the issues involved the IRS will not
challenge any reasonable application of
either the Full Value Methodology or the
Hold Constant Principle, provided that a
single methodology is applied consistently.
283
See
The notice states that either of the two
alternative methodologies for implementing
the Hold Constant Principle are reasonable
applications of that principle. The notice
states that taxpayers may rely on the
guidance in the notice until the IRS and
Treasury issue additional guidance regarding
fluctuation in value under section
382(l)(3)(C).
(1)
Under the Full Value Methodology, the
determination of the percentage of
stock owned by any person is made on
the basis of the relative fair market
value of the stock owned by such person
compared to the total fair market value
of the outstanding stock of the
corporation. Thus, changes in
percentage ownership as a result of
fluctuations in value are taken into
account if a testing date occurs,
regardless of whether a particular
shareholder actively participates or is
otherwise party to the transaction that
causes the testing date to occur;
essentially all shares are “marked to
market” on each testing date.
(2)
Under the Hold Constant Principle, the
value of a share, relative to the value
of all other stock of the corporation,
is established on the date that share
is acquired by a particular
shareholder. On subsequent testing
dates, the percentage interest
represented by that share (the “tested
share”) is then determined by factoring
out fluctuations in the relative values
of the loss corporation’s share classes
that have occurred since the
acquisition date of the tested share.
There are generally two alternative
methodologies for implementing the Hold
Constant Principle. Under the first
methodology, the hold constant
percentage represented by a tested
share is recalculated to factor out
284
changes in its relative value since the
share’s acquisition date. Under the
second methodology, the percentage
interest represented by a tested share
is tracked from the date of acquisition
forward, adjusting for subsequent
dispositions and for the subsequent
issuance or redemption of other stock.
L.
Operating Rules -- Presumptions and Duties Regarding
Stock Ownership
The regulations provide certain operating rules for
purposes of applying the following sections of the
regulations -- definitions section (-2T(f)), 5-percent
shareholder rules (-2T(g)), constructive ownership
rules (-2T(h)) and the aggregation rules (-2T(j)(1)).
See Silverman and Keyes, "An Analysis of the New
Ownership Change Regulations Under Section 382: Part
III," 68 JTAX 300 (May, 1988).
1.
Identifying 5-Percent Shareholders
a.
Publicly traded stock
The regulations provide a rule of
convenience where the loss corporation stock
is subject to regulation by the Securities
and Exchange Commission (SEC).
(1)
With respect to "registered stock," a
loss corporation may rely on the
existence and absence of filings of
schedules l3D and l3G (or similar
schedules) as of any day to identify
all of the loss corporation's
shareholders who have a direct
ownership interest of five percent or
more (both individuals and first tier
entities) on such date. "Registered
stock" means stock described in Rule
l3d-1(d) of Regulation l3D-G (or any
similar rule) promulgated by the SEC
under the Securities and Exchange Act
of 1934. Treas. Reg. § 1.3822T(k)(1)(i).
285
b.
(2)
A loss corporation may also rely on the
existence and absence of such filings
as of any date with respect to
registered stock of any first or higher
tier entity to identify the 5-percent
owners of such entity on such date.
The loss corporation may then use this
information to determine if such 5percent owners are 5-percent
shareholders. Treas. Reg. § 1.3822T(k)(1)(i).
(3)
If a corporation has actual knowledge
that the person filing the Schedule 13G
is not the true owner of the stock for
tax purposes, the loss corporation may
disregard the Schedule 13G. LTR
9104043. In that ruling, the person
filing the schedule was an investment
advisor to certain diversified
investment funds, with power to vote
and dispose of the shares. The funds
retained the right to dividends and
sales proceeds.
Determining changes in interest
(1)
Under Treas. Reg. § 1.382-2T(k)(l)(ii),
a loss corporation may rely on a
statement made on behalf of a first or
higher tier entity to establish the
extent, if any, to which the ownership
interest in such entities held by any
5-percent owners or higher tier
entities have changed during a testing
period.
(a)
The statement must be made under
penalties of perjury by an
officer, director, partner,
trustee, executor or "similar
responsible person" of the entity.
(b)
This rule apparently applies to
all first tier and higher tier
entities, not just publicly traded
entities.
286
(2)
2.
However, a loss corporation may not
rely on statements (A) that it knows to
be false, or (B) that are made by a
first or higher tier entity that owns
50 percent or more of the stock of the
corporation.
(a)
For purposes of this rule, any
first or higher tier entities that
are known by the loss corporation
to be members of the same
"controlled group" must be treated
as one corporation.
(b)
A "controlled group" is one within
the meaning of section 267(f).
Actual Knowledge Regarding Stock Ownership
a.
In determining whether an ownership change
occurs, the regulations generally rely
heavily on the previously discussed stock
ownership presumptions and attribution
limitations to determine the 5-percent
shareholders of a loss corporation and their
percentage interests.
b.
However, under Treas. Reg. § 1.382-2T(k)(2),
if the loss corporation has actual knowledge
of stock ownership as of any testing date
(or acquires such knowledge before the tax
return is filed) by:
(1)
An individual who would be a 5-percent
shareholder but for the limitation on
attribution among family members owning
less than five percent (Treas. Reg.
§ 1.382-2T(h)(6)(iii));
(2)
An individual who would be a 5-percent
shareholder but for the limitation on
attribution through corporations owning
less than five percent of the stock of
the loss corporation (Treas. Reg.
§ 1.382-2T(h)(2)(iii));
(3)
An individual who would be a 5-percent
shareholder but for the limitation on
287
attribution to persons other than 5percent owners and higher tier entities
(Treas. Reg. § 1.382-2T(g)(2));
c.
(4)
A 5-percent shareholder who would be
taken into account but for the
limitation on the family attribution
and entity attribution rules; or
(5)
A 5-percent shareholder who would be
taken into account but for the
limitation on additions to percentage
ownership (Treas. Reg. § 1.382-2T
(g)(3));
(6)
then such loss corporation must take
such actual knowledge into account in
determining whether an ownership change
occurred (i.e., the respective
presumption, or limitation on
attribution or aggregation of
interests, would not apply in such a
case).
The first three items appear to apply where
an individual's percentage interest in the
loss corporation would have increased to at
least five percent but for the application
of the respective limitation.
(1)
For example, individual A owns all of
the stock of two higher tier entities
that each own 3 percent of the loss
corporation (L).
(2)
Absent actual knowledge by L, such
higher tier entities would be treated
as unrelated individuals under Treas.
Reg. § 1.382-2T(h)(2)(iii) and no stock
would be attributed to A. If L has
actual knowledge of A's interest, the
higher tier entities would not be
treated as individuals and L stock
would be attributed to A, since in such
case A would be a 5-percent
shareholder.
288
d.
With respect to the last two items, it is
unclear what is meant by the phrase "a 5percent shareholder who would be taken into
account."
(1)
This language may mean that a 5-percent
shareholder's percentage interest will
be increased by the additional
percentage amount that otherwise would
not be taken into account under Treas.
Reg. §§ 1.382-2T(h)(2)(iii),
(h)(6)(iii) or (g)(3).
(2)
An example of such a case would be
individual B in the example at Part
V.G.4.b. above, in that B was a 5percent shareholder but his percentage
interest did not include his 3 percent
interest in L through P-2 due to L's
lack of knowledge. If this is the
intended meaning of this language, then
Treas. Reg. § 1.382-2T(k)(2)(ii) should
include a reference to paragraph
(g)(2), since an individual otherwise
determined to be a 5-percent
shareholder may have an interest in the
loss corporation as a public owner.
e.
If the loss corporation acquires actual
knowledge after the return is filed it may
take such information into account, and file
an amended return if appropriate. Note that
an amended return is not required.
f.
To the extent the loss corporation has
knowledge as to the ownership interest by
members of one public group and the interest
of members of another group, the loss
corporation may take such interest into
account for purposes of determining whether
an ownership change occurred.
g.
The regulations do not define the term
"actual knowledge," nor do they provide any
guidance or standards as to when the loss
corporation will be deemed to possess
289
"actual knowledge" regarding stock
ownership.
(1)
A negligence standard (i.e., the loss
corporation "should have known" of
stock ownership) is clearly
insufficient to trigger Treas. Reg. §
1.382-2T(k)(2).
(2)
It seems that a "reckless disregard" of
facts would also be insufficient (such
as where the loss corporation has
access to information but either
refuses or lacks the resources to
analyze the data).
(3)
Also, it is unclear whether actual
knowledge of any employee of the loss
corporation (whether clerical employees
who keep stock records or executive
management) will be attributed to the
loss corporation.
(4)
In LTR 9533024, the IRS allowed a
corporation to rely on the existence or
absence of schedule 13D or 13G to
identify all persons who directly own
five percent or more of the
corporation's common stock, absent
actual knowledge.
(5)
In LTR 201024037, a corporation relied
on its corporate records to identify
investor entities and the amount of
shares such entities had previously
acquired. Further, the corporation sent
a questionnaire regarding the existence
of 5% shareholders and indirect
shifting of its stock to
representatives of applicable entities,
and then conducted interviews with
these individuals. The IRS ruled that
the corporation’s use of its records
and the information collected from the
questionnaire and in the interviews
were acceptable methods of determining
“actual knowledge.”
290
(6)
3.
In a related vein, if the loss
corporation had actual knowledge of
stock ownership on one date, but is
unsure whether the status quo has been
maintained (e.g., whether the
shareholder has sold any stock
subsequently), it would seem that
actual knowledge is lacking.
Ownership Structured to Avoid Section 382
a.
b.
Under Treas. Reg. § 1.382-2T(k)(4), if the
ownership interests in a loss corporation
are structured by a person with a direct or
indirect interest in the corporation to
avoid treating a person as a 5-percent
shareholder (or to permit the corporation to
rely on the presumption of (g)(5)(i)(B)),
for a principal purpose of circumventing
section 382, then
(1)
The limitations on entity attribution
(Treas. Reg. § 1.382-2T(h)(2)(iii)),
shall not apply;
(2)
Treas. Reg. §§ 1.382-2T(g)(2) and (3)
will be modified so that a person's
percentage interest will represent the
aggregate of all direct and indirect
interests; and,
(3)
Treas. Reg. § 1.382-2T(g)(5)(i)(B) will
not apply.
The regulations do not define or otherwise
provide guidance as to when a prohibited
purpose of avoiding section 382 will rise to
the level of "a principal purpose." This
rule applies only if an ownership change
would result. To illustrate, L corporation
is owned by 25 individuals, each of whom
owns 4 percent of L. Individual A purchases
40 percent of L from the shareholders on
August 13, 1988. Individual B wishes to
acquire a 15 percent interest in L.
However, a direct purchase would trigger
section 382. Therefore, B structures his
purchase through four corporations -- each
291
corporation acquiring 3.75 percent of L
corporation.
4.
(1)
A principal purpose of acquiring L
stock through four corporations is to
avoid treating B as a 5-percent
shareholder.
(2)
Therefore, the limitations on entity
attribution do not apply, and B is
treated as owning 15 percent of L.
(3)
Thus, an ownership change occurs.
Duty to Inquire as to Stock Ownership
a.
Treas. Reg. § 1.382-2T(a)(2)(i) imposes a
duty on the loss corporation to determine if
an ownership change occurred as of the close
of any testing date. Although this
determination theoretically requires the
loss corporation to determine all of its 5percent shareholders and their change in
percentage interest, Treas. Reg. § 1.3822T(k)(3) sets forth only a limited duty to
identify shareholders and the change in
their percentage interest.
b.
Specifically, Treas. Reg. § 1.382-2T(k)(3)
states that the loss corporation is required
to determine the stock ownership on each
testing date, and except as otherwise
provided in the regulations, the changes in
the stock ownership during the testing
period of each of the following persons:
--
Any individual shareholder who has a
direct ownership interest of five
percent or more in the loss
corporation;
--
Any first tier entity;
--
Any higher tier entity that has an
indirect ownership interest of five
percent or more in the loss
corporation; and
292
--
c.
Any 5-percent owner who indirectly owns
five percent or more of the stock of
the loss corporation in his capacity as
a 5-percent owner in any one first tier
or higher tier entity.
With the exception of first tier entities,
the language of Treas. Reg. § 1.382-2T(k)(3)
indicates that the loss corporation's duty
extends only to those individuals and
entities that own five percent or more of
the loss corporation on the testing date.
Conversely, 5-percent shareholders currently
owning less than five percent of the loss
corporation apparently need not be
identified.
(1)
This rule is consistent with both
Treas. Reg. § 1.382-2T(g)(3) which
combines direct and indirect ownership
interests of a single shareholder only
if such interests separately constitute
at least five percent of the loss
corporation on the testing date, and
Treas. Reg. § 1.382-2T(h)(2)(iii) which
apparently cuts off attribution from a
higher tier entity if the higher tier
entity does not currently own at least
five percent of the loss corporation.
(2)
Moreover, forcing the loss corporation
to identify 5-percent shareholders who
currently own less than five percent of
the loss corporation on the testing
date would defeat the apparent purpose
of the presumptions contained in Treas.
Reg. § 1.382-2T(g)(5).
(3)
Treasury's apparent desire to alleviate
the loss corporation's burden of
section 382 compliance has produced
something of a schizophrenic quality in
the regulations.
(a)
That is, status as a first tier
entity, higher tier entity,
highest tier entity, individual 5-
293
percent shareholder, and 5-percent
owner is determined at any time
during the testing period and is
retained during the remainder of
such period.
(b)
d.
e.
However, the loss corporation
apparently only has a duty to
identify any higher tier entities
that currently own (albeit
indirectly) at least five percent
of the loss corporation on the
testing date. Also, under Treas.
Reg. § 1.382-2T(j)(1) public
groups with respect to higher tier
entities generally are treated as
5-percent shareholders only if
they own at least five percent of
the loss corporation on the
testing date.
Treas. Reg. § 1.382-2T(k)(3) specifically
states that the loss corporation has no
obligation to inquire about facts relating
to the stock ownership of any shareholders
that are not listed therein.
(1)
In addition, the loss corporation has
no duty to determine if the actual
facts regarding stock ownership are
consistent with the ownership interests
of the loss corporation as determined
by applying the various presumptions
and rules contained in the regulations
(viz., paragraphs (g), (h), (j) and
(k)(1)).
(2)
Thus, as Treas. Reg. § 1.382-2T(k)(3)
indicates, the loss corporation may
utilize the rules in Treas. Reg.
§ 1.382-2T(k)(1) to identify its
shareholders to the extent it is so
obligated.
In addition, the Preamble offers further
guidance as to how the loss corporation may
294
discharge its duty under Treas. Reg.
§ 1.382-2T(k)(3).
f.
5.
(1)
That is, if a first tier entity (P)
owns 100 percent of the loss
corporation (L) stock, the Preamble
indicates that the loss corporation
must inquire as to all shareholders of
P who own five percent or more of P,
since these are the only shareholders
who could possibly own five percent or
more of L constructively.
(2)
Similarly, according to the Preamble,
if P held five percent of L, L would
only have to inquire as to shareholders
who own 100 percent of P.
The regulations unfortunately do not set
forth a standard of care with respect to
this duty. That is, if the loss corporation
attempts to obtain the required information
using reasonable and good faith efforts,
this should be sufficient for Treas. Reg.
§ 1.382-2T(k)(3) purposes.
Annual Statement by Loss Corporations
a.
Under Treas. Reg. § 1.382-2T(a)(2)(ii) and
Treas. Reg. § 1.382-11, a loss corporation
must file an annual statement with its
income tax return for each taxable year that
it is a loss corporation.
b.
For taxable years beginning on or after May
30, 2006, the statement must include:
(1)
The dates of any owner shifts, equity
structure shifts, or other transactions
described in Treas. Reg. § 1.3822T(a)(2)(i);
(2)
The date(s) on which any ownership
change(s) occurred; and
(3)
The amount of any attributes described
in Treas. Reg. § 1.382(a)(1)(i) that
295
caused the corporation to be a loss
corporation. Treas. Reg. § 1.382-11.
c.
d.
For taxable years beginning on or after May
30, 2006, a loss corporation may also be
required to include certain elections on
this statement, including:
(1)
An election made under Treas. Reg. §
1.382-2T(h)(4)(vi)(B) to disregard the
deemed exercise of an option if the
actual exercise of that option occurred
within 120 days of the ownership
change; and
(2)
An election made under Treas. Reg. §
1.382-6(b)(2) to close the books of the
loss corporation for purposes of
allocating income and loss to periods
before and after the change date for
purposes of section 382. Treas. Reg. §
1.382-11.
For taxable years beginning before May 30,
2006, the statement must:
(1)
indicate whether any testing events
occurred during the taxable year;
(2)
identify each testing date, if any, on
which an ownership change occurred;
(3)
identify the testing date, if any, that
occurred during the closest to the end
of the three-month period ending on
March 31, June 30, September 30, and
December 31 during the taxable year,
regardless of whether an ownership
change occurred on the testing date;
(4)
identify each 5-percent shareholder on
each testing date;
(5)
state the percentage holdings of each
5-percent shareholder as of each
testing date and the increase, if any,
296
in such holdings during the testing
period;
(6)
e.
f.
disclose the extent that the loss
corporation relied on the presumption
contained in Treas. Reg. § 1.382-2T
(k)(1) to determine if an ownership
change occurred on any identified
testing date. Treas. Reg. § 1.3822T(a)(2)(ii).
The statement, as required for taxable years
beginning before May 30, 2006, falls short
of requiring complete disclosure of the
ownership change calculation, but not by
much. Even though the regulations impose a
duty to ascertain some of the requested
information, the reporting burden that this
statement imposes can be onerous.
(1)
The compliance cost of some items -such as requiring disclosure of the
testing date closest to prescribed
quarterly dates -- seems to outweigh
any perceived benefits of disclosure.
(2)
Further, if a taxpayer is permitted to
rely on a certain presumption to
determine if an ownership change
occurred, why is it necessary to
disclose such reliance (possibly
chilling its use)?
(3)
Moreover, since a corporation may be a
loss corporation solely because its
assets have a net unrealized built-in
loss, this statement theoretically
requires every corporation to
commission an annual appraisal of its
assets. A corporation otherwise may be
unaware that it is required to file
this statement.
The reporting burden imposed under Treas.
Reg. § 1.382-11, for taxable years beginning
on or after May 30, 2006, is less onerous
than the reporting burden that was required
297
for prior taxable years under Treas. Reg. §
1.382-2T(a)(2)(ii).
g.
6.
M.
The annual statement is required to be filed
with respect to any taxable year for which
the due date (including extensions) falls
after October 5, 1987. The regulations do
not indicate what consequences, if any,
result from the failure to file this
statement or the filing of an incomplete or
erroneous statement.
Records Maintenance
a.
Under Treas. Reg. § 1.382-2T(a)(2)(iii), a
loss corporation must maintain "such records
as are necessary" to determine (A) the
identity of 5-percent shareholders, (B)
percentage of stock owned by such
shareholders, and (C) whether the section
382 limitation is applicable.
b.
The regulations state that these records
must be retained "so long as they may be
material in the administration of any
internal revenue law." Id.
Effective Dates
1.
Section 382
a.
General rule
(1)
According to Treas. Reg. § 1.3822T(m)(1), the section 382 limitations
will apply to any ownership change
occurring immediately after:
--
an owner shift (excluding an owner
shift that also constitutes an
equity structure shift) occurring
on or after January 1, 1987;
--
an equity structure shift
occurring pursuant to a "plan of
reorganization" adopted on or
after January 1, 1987; or,
298
--
(2)
b.
Any transfer or issuance of an
option that occurs on or after
January 1, 1987, and that is
treated as a testing event.
With respect to equity structure shifts
completed pursuant to plans adopted
before January 1, 1987, section 382
will be inapplicable only if the equity
structure shift (treated as occurring
on the date the plan is adopted)
results in an ownership change. Treas.
Reg. § 1.382-2T(m)(1).
Plan of reorganization
(1)
A plan of reorganization is considered
adopted on the date that the boards of
directors of all parties to the
reorganization either adopt the plan or
recommend the plan for shareholder
approval, or the plan is approved by
shareholder vote, whichever occurs
earlier. Treas. Reg. § 1.382-2T(m)(2).
(2)
The legislative history provides that a
binding agreement need not be existent
prior to board approval. The board may
approve a plan "based on principles,
and negotiations to date and delegate
to corporate officials the power to
refine and execute a binding
reorganization agreement, including a
binding agreement subject to regulatory
approval."
(a)
Subsequent board approval or
ratification taken at the time of
consummating the transaction may
occur without affecting the
application of the effective date
rule if such action is a
formality.
(b)
Subsequent board ratification will
be treated as a formality if the
reorganization agreement is
299
legally binding under prior board
approval.
c.
(3)
The principles under which a plan may
be adopted apparently need not be well
developed. Further, "negotiations to
date" apparently may encompass even
exploratory negotiations.
(4)
Perhaps an intention to dispose of a
subsidiary corporation would provide
sufficient substance for the above
rule, so long as full power to bind the
selling corporation is delegated by the
board. In a closely held corporation,
this may not be a problem.
Indirect ownership changes
Special guidance is provided in the case of
indirect ownership changes.
d.
(1)
If an ownership change with respect to
a subsidiary occurs as the result of
the acquisition of the parent
corporation, the subsidiary's treatment
is governed by the nature of the
parent-level transaction. Treas. Reg.
§ 1.382-2T(m)(2).
(2)
For purposes of this rule, a
corporation is treated as a subsidiary
of another corporation only if the
other corporation owns stock in that
corporation meeting the section
1504(a)(4) requirements. Id.
(3)
Thus, if a parent corporation is
acquired in a tax-free reorganization
pursuant to a plan adopted before
January 1, 1987, the indirect ownership
change with respect to the subsidiary
will be treated as having occurred by
reason of a plan adopted before
January 1, 1987.
Bankruptcy proceedings
300
In the case of a reorganization occurring
under Title 11 or other court supervised
proceeding, the final regulations do not
apply to any ownership change resulting from
the proceeding if the petition was filed
before August 14, 1986. See Treas. Reg.
§ 1.382-2T(m)(5); LTR 8933001.
e.
Earliest commencement of the testing period
(1)
(2)
f.
For purposes of determining whether an
ownership change occurs after December
31, 1986, the testing period shall not
begin before the latter of:
(a)
May 6, 1986, or
(b)
The day after the date of any
ownership change which occurs
after May 5, 1986 and before
January 1, 1987. Treas. Reg. §
1.382-2T(m)(3).
Shifts in ownership prior to May 6,
1986 are disregarded.
Transition rules
(1)
Testing dates prior to September 4,
1987 - aggregation rules
The regulations contain special
transitional rules as to the
applicability of the aggregation/
segregation rules of Treas. Reg.
§ 1.382-2T(j). See Treas. Reg.
§ 1.382-2T(m)(4)(i). For purposes of
determining whether an ownership change
occurs on any testing date before
September 4, 1987, the following rules
apply.
(a)
The aggregation rules (Treas. Reg.
§ 1.382-2T(j)(1)) apply only to
stock acquired after May 5, 1986
by any first tier entity or higher
tier entity, and do not apply to
stock acquired before that date.
301
(2)
(b)
The segregation rules applicable
to the loss corporation (Treas.
Reg. § 1.382-2T(j)(2)) apply only
to equity structure shifts in
which more than one corporation is
a party to the reorganization, and
do not apply to other
transactions.
(c)
The segregation rules applicable
to first tier or higher tier
entities (Treas. Reg. § 1.3822T(j)(3)) apply only to
dispositions of stock acquired by
an individual, first tier or
higher tier entity after May 5,
1986, and to equity structure
shifts in which more than one
corporation is a party.
(d)
However, the loss corporation is
permitted to apply the rules of 2T(j), provided all of such rules
are applied. The regulations do
not specify what rules are
applicable during the preSeptember 4, 1987 period if such
an election is not made. The
regulations also do not indicate
how such an election is to be made
mechanically.
(e)
The segregation rules do not apply
to create separate public groups
with respect to the deemed or
actual exercise of options issued
before September 4, 1987. Rev.
Rul. 90-15, 1990-7 I.R.B. 17.
Similar rules apply with respect
to public offerings prior to that
date. See LTR 8945055; LTR
8940006.
Testing dates after September 3, 1987
-- aggregation rules
302
(a)
(3)
For purposes of determining
whether an ownership change occurs
for any testing date on or after
September 4, 1987 the rules of 2T(j)(2) and (3) do not apply:
--
to identify any public group
resulting from a segregation
transaction unless the
segregation transaction is
one to which such rules could
apply in the pre-September 4,
1987 period,
--
or to any disposition of
stock acquired before May 6,
1986,
--
but only if such stock is
disposed of before September
4, 1987.
(b)
Importantly, once the aggregation
rules become fully effective on
September 4, 1987, (and no
election was made to apply the
aggregation rules retroactively)
owner shifts technically could
have occurred since new 5-percent
shareholders (i.e., new public
groups) were created whereas
before they did not exist.
(c)
The regulations should be amended
to apply the aggregation rules
retroactively--even if no election
is made to prevent such a result.
Determination of stock
For purposes of determining whether an
ownership change occurs for any testing
date, the rules of Treas. Reg. §§
1.382-2T(f)(18)(ii) and (iii) apply
only to stock that is:
--
issued on or after September 4,
1987, or
303
--
g.
transferred to (or by) a person
who is a 5-percent shareholder on
or after September 4, 1987.
Option rules
(1)
Options issued before May 6, 1986
An option issued before May 6, 1986, is
subject to the option attribution rules
only if it is transferred by (or to) a
5-percent shareholder (or a person who
would be a 5-percent shareholder if the
option were treated as exercised) on or
after such date. In all other cases,
such an option shall not be subject to
the option attribution rules but will
be subject to Treas. Reg. § 1.3822T(h)(4)(xii) (actual exercise of
option not disregarded).
(2)
Options issued after May 5, 1986 and
before September 18, 1986
An option issued or transferred on or
after May 6, 1986, and before September
18, 1986, is subject to the option
attribution rules.
(3)
Options issued after September 17,
1986 and before January 1, 1987
An option issued or transferred on or
after September 18, 1986, and before
January 1, 1987, is subject to the
option attribution rules, except that
the option shall be treated for
purposes of this section as if it never
had been issued in the event that
either -(a)
the option lapses unexercised or
is irrevocably forfeited by the
holder thereof, or
(b)
on the date the option was issued,
there was no significant
likelihood that such option would
304
be exercised within the five year
period from the date of such
issuance and a purpose for the
issuance of the option was to
cause an ownership change prior to
January 1, 1987.
2.
Sunset Provisions for Old Section 382
a.
The conference agreement provides that old
section 382 (the 1954 version) remains
applicable to transactions that are not
subject to the present rules because of the
effective dates.
b.
However, the conference agreement does not
state when the potential applicability of
old section 382 ceases.
c.
(1)
TAMRA clarified that old section 382(a)
does not apply to any increase in
percentage points occurring after
December 31, 1988, and old section
382(b) does not apply to any
reorganization occurring after December
31, 1986.
(2)
In addition, TAMRA clarified that old
section 382 will not apply if the
provisions of section 382 are
applicable. See also Treas. Reg.
§ 1.382-2T(m)(7).
For example, as of January 1, 1986, A owns
all of the stock of L. L is a calendar year
taxpayer. On May 1, 1986, B "purchases" 40
percent of the L stock from A. On May 1,
1987, B purchases an additional 40 percent
of the L stock from A.
(1)
Present section 382 does not apply to
this transaction. For present section
382 purposes, A has increased his
percentage interest by only 40
percentage points since May 6, 1986
(the beginning of the earliest testing
period).
305
(2)
(3)
d.
However, old section 382 does apply.
Under old section 382(a), B's holdings
at December 31, 1987 amount to 80
percent. Compared to his holding at
January 1, 1987, B's interest has
increased by only 40 points. However,
compared to his holding at January 1,
1986, B's interest has increased by 80
points.
(a)
Therefore, old section 382(a) will
apply if the requirements of
section 382(a)(1)(C) are also met.
(b)
If section 382(a)(1)(C) is
violated, L's carryovers to 1987
are disallowed.
The sunset period extends until
December 31, 1988, in order to disallow
any NOL carryovers from 1987. In
applying the test at December 31, 1988
B holds 80 percent but at January 1,
1987 B held only 40 percent.
Therefore, any NOL carryover from 1987
to 1988 would not be disallowed.
Technically, until the TAMRA sunset
provision was enacted, transactions
consummated after January 1, 1987, were
covered by both old section 382 and present
section 382. This created considerable
uncertainty since a transaction could fall
outside of present section 382, yet fail old
section 382.
(1)
For example, X corporation (publicly
held) owns all of the stock of loss
corporation (L) and profitable
corporation (P). The values of L and P
are $100 and $900, respectively. On
January 15, 1987, a plan of
reorganization is adopted and approved
under which L will merge into P in
exchange for 10 percent of the P stock
outstanding after the merger. The
interests of the X shareholders have
306
remained stable during the testing
period.
e.
3.
(2)
Since L is deemed to be owned by the X
shareholders, this transaction would
not be subject to present section 382.
See section 382(l)(3)(A)(ii). The
merger did not affect the X
shareholders.
(3)
However, old section 382 continues to
apply in the absence of a sunset
provision. In this case, L's NOL
carryovers would be proportionately
reduced since X did not receive at
least a 20 percent interest in P as a
result of owning stock in L. See old
section 382(b)(1) and (2) and Treas.
Reg. § 1.382(b) -1(a)(2).
The regulations reserved the issue of the
termination of old section 382. Treas.
Reg. § 1.382-2T(m)(7)(iii).
The 1976 Version of Section 382
The amendments made to sections 382 and 383 by
the Tax Reform Act of 1976 have been repealed
retroactively as of January 1, 1986. Act
§§ 621(e) and (f)(2).
VI.
CONSEQUENCES OF AN OWNERSHIP CHANGE
A.
Annual Limitation on Earnings
1.
The Statute
a.
Once an ownership change occurs, section 382
does not impair a NOL carryover itself, but
restricts the amount of income which may be
offset by pre-change NOL carryovers.
b.
The general operating rule of section 382 is
contained in section 382(a). Broken into
its component parts, section 382(a) states
that:
307
c.
2.
the amount of taxable income of any new
loss corporation
(2)
for any post-change year
(3)
which may be offset by pre-change
losses
(4)
shall not exceed the section 382
limitation for such year.
Section 382(a) contains a number of key
phrases and terms. These are discussed in
the sections below in their order of
appearance within section 382(a).
Taxable Income
a.
Under section 382(k)(4), taxable income of a
new loss corporation must be computed with
the modifications specified in section
172(d).
b.
In general, only two modifications must be
made in the case of corporate taxpayers.
c.
3.
(1)
(1)
No net operating loss deduction is
allowed in computing taxable income.
Section 172(d)(1).
(2)
The dividends received deduction is
computed without regard to the section
246(b) aggregate limitation on the
deduction (80 percent of taxable
income). Section 172(d)(5).
Where the ownership change occurs during the
middle of the taxable year, the taxable
income for that year must be allocated. See
discussion below at Part VI.B.l.
Post-Change Year
Section
change"
taxable
Section
year in
382 applies with respect to any "postyear. A "post-change year" is any
year ending after the change date.
382(d)(2). Under this definition, the
which the change date occurs constitutes
308
a post-change year, unless the change date occurs
on the last day of the taxable year.
4.
a.
For example, L is a calendar year taxpayer.
On June 30, 1987, P acquires all the stock
of L in a transaction which constitutes an
ownership change. L's taxable year ending
December 31, 1987 is a post-change year.
Every subsequent year of L is also a postchange year.
b.
If P acquired all of L's stock on December
31, 1987, L's taxable year ending December
31, 1987 would not constitute a post-change
year. Section 382 would not apply until
1988.
c.
Similar results obtain where L's taxable
year closes as a result of the ownership
change (e.g., through a merger or the
joining of a new consolidated group).
d.
Where an ownership change occurs through a
qualified stock purchase under section
338(d)(3), the section 338 acquisition date
corresponds to the section 382 change date.
In this case, the target loss corporation
must file a final return, or one-day deemed
sales return, for the period ending on the
change date.
(1)
Any section 338 gain would be reported
on this return. Since this return does
not pertain to a "post-change" period,
the section 382 limitations do not
apply.
(2)
However, the results vary if the change
date and the acquisition date are
different. See discussion below at
Part IX.C.2.
Pre-Change Loss
a.
Only "pre-change losses" of the loss
corporation are subject to limitation under
section 382. In general, a "pre-change
loss" means: (1) any net operating loss
309
carryover from a prior year to the year of
change, and (2) the portion of losses
incurred during the year of change which are
allocable to the period on or before the
change date. Section 382(d)(1); Treas. Reg.
§ 1.382-2(a)(2).
b.
5.
(1)
In general, pre-change losses are those
net operating losses incurred prior to
the change date.
(2)
The allocation of losses incurred
during the year of change is discussed
below at Part VI.B.2.
The regulations also add that any recognized
built-in loss for any recognition period
taxable year is also a pre-change loss. See
Treas. Reg. § 1.382-2(a)(2)(iii)
Section 382 Limitation
Since pre-change losses may offset post-change
income only to the extent of the "section 382
limitation," the computation of such amount is of
critical importance.
a.
General rules
(1)
Under section 382(b), the section 382
limitation is the product of "the
value" of the old loss corporation and
"the long-term tax-exempt rate."
(2)
In theory, this amount represents the
loss corporation's stream of earnings
that would have been generated had no
ownership change occurred.
(3)
Both the value of old loss corporation
and the rate should be determinable as
of the change date. Thus, the amount
of the section 382 limitation may be
calculated at that time.
(4)
In general, the amount of the section
382 limitation remains constant
throughout the carryover period, except
310
that adjustments may be made for builtin gains and other special items.
b.
Determining the value of the old loss
corporation
(1)
Value of stock determines value
The value of the old loss corporation
is the value of the stock of such
corporation, including any stock
described in section 1504(a)(4) or
stock treated as non-stock. Section
382(e)(1); Treas. Reg. § 1.3822T(f)(18)(iii)(c).
(a)
In addition to including section
1504(a)(4) stock in determining
the value of an old loss
corporation, any interest treated
as stock under the authority of
section 382(k)(6)(B) presumably
will also be included in
determining the value of the loss
corporation.
(b)
The statute itself provides little
help in determining the value of
the loss corporation stock.
Section 382(k)(5) merely states
that "value" means fair market
value. Thus, where stock and
interests treated as stock are not
publicly traded, valuation
problems are likely to be present.
(c)
However, the conference agreement
provides that the purchase price
of the stock provides "evidence,
but not conclusive evidence," of
the value of stock. See Conf.
Rep. at II-187.
(d)
Regulations are expected to
provide a valuation formula based
on a "gross-up" of all of the
acquired stock, if a control block
of stock is acquired within a 12311
month period. See Conf. Rep. at
II-187. Cf. sections 338(b)(1)
and (4) and Treas. Reg. § 1.3384T(j)(2).
(2)
Time for determining value
(a)
The general rule is that the value
of the loss corporation is
determined immediately before the
ownership change. Section
382(e)(1).
(b)
However, section 382(e)(2)
provides that if a redemption
occurs "in connection with" an
ownership change, the value must
be determined after taking the
redemption into account. The
redemption may occur before or
after the change date.
(c)
Congress has expressed its intent
that redemption treatment will
extend to bootstrap acquisitions
and leveraged buy-outs which have
the effect of a redemption,
because the loss corporation value
is reduced through acquisition
debt. See H.R. Rep. No. 391,
l00th Cong., lst Sess. 1179
(1987).
(d)
Accordingly, TAMRA amended section
382(e)(2) to provide that value
will also be determined after any
"corporate contraction" that
occurs as part of the ownership
change. The statute originally
provided only regulatory authority
for this treatment. See pre-TAMRA
section 382(m)(4).
i)
312
In Berry Petroleum Co. v.
Commissioner, 104 T.C. 584
(1995), aff’d, 142 F.3d 442
(9th Cir. 1998), the Tax
Court held that a corporate
contraction occurred when an
acquiring corporation caused
a loss corporation to pay a
substantial dividend after an
ownership change and the
acquiring corporation used
the proceeds to pay the old
shareholders of the loss
corporation.
ii)
313
In FSA 200140049, the
Service, relying on Berry
Petroleum, concluded that a
corporate contraction
occurred when the acquiring
corporation received a
substantial dividend from the
loss corporation after an
ownership change.
Immediately before the
ownership change, the loss
corporation raised additional
cash through an IPO. The
purchase price paid to the
loss corporation’s
shareholders by the acquiring
corporation reflected the
increase in the value of the
loss corporation as a result
of the IPO. Immediately
after the ownership change,
the acquiring corporation
received a dividend from the
loss corporation equal to the
amount raised by the loss
corporation in the IPO. The
Service concluded that this
dividend had the same effect
as the loss corporation
redeeming the stock of its
shareholders prior to the
ownership change (when viewed
together with the amount paid
for the loss corporation by
the acquiring corporation),
and that a corporate
contraction therefore
occurred.
(e)
(3)
In addition, TAMRA added section
382(e)(3) to provide that, in the
case of an old loss corporation
that is a foreign corporation, the
value is determined by taking into
account only items connected with
the conduct of a United States
trade or business.
Adjustments to value
The statute is equipped with several
anti-abuse provisions. If applicable,
such provisions may change the value of
the old loss corporation for purposes
of section 382. These provisions are
described below at Part VI.D.
(4)
Effect of valuation based on stock
The section 382 limitation is an
approximation of the earnings stream of
the loss corporation. The effect of
using stock as the value of the loss
corporation is to compute a return
based on the net assets of the loss
corporation.
(a)
This has been criticized as
discriminating against loss
corporations that are highly
leveraged.
(b)
Take, for example, the case where
operating assets were purchased
with borrowed funds. Prior to an
ownership change, income generated
by such leveraged assets would be
offset by NOL carryovers.
Following the ownership change,
the new loss corporation, in
effect, loses the ability to use
NOL carryovers to offset income
generated by leveraged assets.
314
This is contrary to the neutrality
concept.
(5)
Special rule for insolvency cases
A special rule applies under section
382(l)(6) if an ownership change occurs
as a result of a G reorganization or
any exchange of debt for stock in a
title 11 case, and if section 382(l)(5)
does not apply (see Part VII.A.,
below). In this case, the value of the
old loss corporation will reflect the
increase (if any) in value resulting
from any surrender or cancellation of
creditors' claims in the transaction.
Treas. Reg. § 1.382-9(j) provides that
in the case of an ownership change to
which section 382(l)(6) applies the
value of the loss corporation under
section 382(e) is equal to the lesser
of: the value of the stock of the loss
corporation, or the value of the loss
corporation's assets immediately before
the ownership change (determined
without regard to liabilities),
disregarding section 382(e)(2).
(a)
In determining stock value,
"stock" includes stock that is not
treated as stock under Treas. Reg.
§ 1.382-2T(f)(18) and does not
include non-stock that is treated
as stock under Treas. Reg.
§ 1.382-2T(f)(18), disregarding
section 382(l)(1). Stock that is
not subject to the entrepreneurial
risks of the corporate business
and that is issued with a
principal purpose of avoiding the
section 382 limitation is
disregarded. Treas. Reg. § 1.3829(k)(6).
(b)
The regulations are designed to
give equal treatment under section
382(l)(6) to a company that
315
exchanges stock-for-debt and a
company which issues stock for
cash and then uses the cash to
retire its debt. The preamble to
the regulations explain that this
equality of treatment is to apply
solely for purposes of section
382(l)(6) and not for applying the
common law stock-for-debt
exception.
(c)
c.
On July 17, 1998, the Treasury
Department issued a request for
comments under Treas. Reg. §
1.382-9. Comments are due no later
than September 17, 1998. See
Comment Request CO-88-90 (July 17,
1998).
The long-term tax-exempt rate
In computing the section 382 limitation, the
"long-term tax-exempt rate" must be used.
(1)
(2)
Section 382(f)(1) provides that the
long-term tax-exempt rate is the
highest of the "adjusted Federal longterm rates" under section 1274 for any
month in the 3-calendar month period
ending with the month in which the
change date occurs.
(a)
In general, the "adjusted Federal
long-term rate" is the rate
applicable under section 1274,
except that such rates are to be
"properly adjusted" to reflect
differences between rates on
taxable and tax-exempt
obligations. Section 382(f)(2).
(b)
In accordance with the conference
report, the adjusted Federal longterm rates are published monthly.
See Conf. Rep. at II-188.
Prior to the conference agreement it
was unclear how the Federal taxable
316
rate would be adjusted to arrive at the
tax-exempt rate.
(3)
(a)
One-possible method is to compare
actual market rates on various
taxable and tax-exempt debt
instruments. Another method would
be to adjust the section 1274 rate
by using a factor of .66 (1-.34
(the maximum marginal tax rate in
effect)).
(b)
However, the conference agreement
opted for the market method by
providing that the section 382
rate will be computed "as the
yield on a diversified pool of
prime, general obligation taxexempt bonds with remaining
periods to maturity of more than
nine years." See Conf. Rep. at
II-188.
(c)
In general, the tax-exempt rate
will vary between 66 and 100
percent of the long-term Federal
rate.
The conference agreement follows the
House version of section 382 in
adopting the "long-term tax-exempt"
rate as an appropriate rate of return
on L's assets.
(a)
The choice of such a rate may be
justified on the grounds that L
could have sold its assets and
invested the proceeds in taxexempt investments.
(b)
The legislative history indicates
that a rate lower than the lowest
taxable rate was chosen to prevent
a faster utilization of NOL
carryovers by P. See Conf. Rep.
at II-188.
317
(c)
(4)
d.
In other words, a tax-exempt rate
was chosen to compensate for the
fact that the value of the loss
corporation is likely to reflect
the value of NOL carryovers -- an
asset which did not generate
income prior to the ownership
change but merely sheltered it.
The use of a tax-exempt rate offsets any inflation in the value of
the loss corporation due to NOL
carryovers.
However, the choice of a long-term taxexempt rate has been heavily
criticized.
(a)
If the rate is to measure the rate
of return on L's operating assets,
an equity rate of return should be
used, not a bond rate of return.
A typical businessman would not
consider a bond rate of return to
be acceptable given the levels of
risk involved in an operating
business.
(b)
In addition, a tax-exempt rate of
return is not an appropriate
measure of L's income since L's
actual earnings are taxable, not
tax-exempt.
Carryover of unused limitation
(1)
If, for any given post-change year, the
actual amount of taxable income of the
new loss corporation that is offset by
pre-change losses is less than the
section 382 limitation, the new loss
corporation may carryover the unused
portion of the section 382 limitation
to the next post-change year. Section
382(b)(2).
(2)
The unused section 382 limitation may
be carried over until either the new
loss corporation generates an amount of
318
taxable income that will absorb the
unused carryover, or the NOL carryover
itself expires.
(3)
Although this carryover is indefinite
on its face, no benefit is provided
once the NOL carryover itself expires.
For example, assume that an ownership
change with respect to L occurs on
January 1, 1986. L has $300 NOL
carryover at that time (subject to
section 382) that will expire in 1987.
The initial section 382 limitation is
assumed to be $100.
(a)
If L generates $75 of taxable
income for 1986, L will have an
NOL carryover to 1987 of $225
($300-$75) and an unused section
382 limitation carryover of $25
($100-$75).
(b)
L's total section 382 limitation
for 1987 is $125 ($100 + $25). If
L generates $50 of taxable income
during 1987, L will have an unused
NOL carryover of $175 ($225 - $50)
which expires without benefit.
(c)
L also has an unused section 382
limitation of $75 ($125 - $50).
(d)
In 1988, L generates $75 of
taxable income. Since L has no
pre-change loss carryover (due to
the expiration of the $175 NOL
carryover in 1987), the section
382 limitation amount for 1988 is
irrelevant.
Section 382(a)
contemplates the existence of prechange losses as a prerequisite
condition. Without such losses,
the section 382 limitation, of
which the carryover is part, is
never computed.
(e)
Thus, the section 382 limitation
sets only a maximum amount. If
319
the losses themselves are less
than that amount, no additional
benefits accrue under section
382(b)(2).
(4)
e.
6.
Query: if the new loss corporation
only has a net unrealized built-in
loss, and such loss remains
unrecognized for several post-change
years, could the loss corporation
accumulate the section 382 limitation
amounts for such years as an unused
amount?
Special rule for short taxable years
(1)
The Senate version of the Act contained
section 382(b)(4) which provided that
if any post change year is less than
365 days, i.e., a short taxable year,
the section 382 limitation amount must
be pro rated based on the number of
days in the short taxable year.
(2)
However section 382(b)(4) was deleted
in conference.
(3)
In its place, section 382(m)(2)
authorizes Treasury to prescribe
regulations dealing with the
application of sections 382 and 383 in
the case of a short taxable year.
(4)
Treasury has issued final regulations
under section 382(m)(2). See
discussion at Part VIII.C., below.
Ordering Rules
a.
Coordination with section 172(b)
(1)
Under section 172(b)(2), a NOL
carryover must be carried to each
successive year in the carryforward
period and absorbed in its entirety (or
to the extent of taxable income if the
carryover exceeds income). Any unused
NOL carryover is carried to the next
320
year, until the NOL carryover has been
fully absorbed.
(2)
b.
B.
Section 382(1)(2)(A) provides that the
term "taxable income" as used in
section 172(b)(2) means the section 382
limitation amount for such year,
reduced by unused pre-change losses for
preceding years.
Losses from the same year
(1)
Section 382(1)(2)(B) provides that if a
corporation has taxable income that may
be offset by both pre-change losses and
losses which are not subject to section
382, then taxable income for that year
will be considered to be first offset
by the losses subject to limitation.
(2)
This is a beneficial rule since it
allows L to use up its limited loss
first and retain its unlimited losses
for future use.
Special Rules for Mid-Year Ownership Changes
Special rules apply in the case of a post-change year
that includes the change date. These special rules
arise in the case of an ownership change that occurs
during the taxable year in which L's year remains
open.
1.
Taxable Income
a.
Section 382(b)(3) provides that, for any
post-change year that includes the change
date, the taxable income for the year of
change must be allocated. Under section
382(b)(3)(A), taxable income allocated to
the period:
(1)
On or before the change date may be
fully offset by NOL carryovers, and
(2)
after the change date is subject to the
section 382 limitation.
321
b.
Subject to two exceptions, section 382(b)(3)
allocates taxable income on a daily pro rata
basis. The two exceptions are as follows:
(1)
Regulations may provide an alternative
method of allocation. The Conference
Report states that a daily pro rata
might not be appropriate where income
producing assets are contributed to the
new loss corporation's capital after
the change date. Conf. Rep. at II-188.
(a)
The final regulations under
section 382(b)(3) provide a new
loss corporation with an option of
closing its books as of the change
date ("closing-of-the-books
election"). Treas. Reg. § 1.3826. See Part VI.D. below for a
discussion of those rules. The
closing-of-the-books election is
available in all instances and is
not limited to cases where there
is a post-change contribution to
capital.
(b)
In private letter rulings issued
since 1990, the Service has
consistently imposed a "ceiling
rule" which limited the amount of
income or loss allocated to either
the pre-change or post-change
period to the total amount of
income or loss for the taxable
year which includes the change
date. See, e.g., LTR 9644004, LTR
9637048, LTR 9436027, LTR 9223026,
LTR 9221023, LTR 917014, LTR
9110047, LTR 9101008, LTR 9017020.
LTR 9017020 was the first ruling
to impose this rule. These
rulings rejected a previous
approach permitting an allocation
of gross items of income and
deductions. LTR 89310004
(explicitly sanctioning an
allocation of income to the pre-
322
change period and loss to the
post-change period). The Preamble
to Prop. Treas. Reg. § 1.382-6 and
an example in the regulations
continue the ceiling rule,
although the rule is not
explicitly stated in the operating
provisions of the regulations.
(2)
2.
3.
The second exception is that
"recognized built-in gains and losses"
(and certain section 338 gains) under
section 382(h) are not allocated under
section 382(b)(3).
Net Operating Loss
a.
Subject to the two exception described above
in Part VI.B.1., as in the case of taxable
income, net operating losses incurred during
the year of change are generally allocated
to the periods before and after the change
date on a daily pro rata basis. Section
382(d)(1).
b.
That portion of the loss which is allocated
to the period on or before the change date
is subject to the section 382 limitation.
Section 382(d)(1)(B). That portion
allocated to the period after the change
date is not a pre-change loss and may be
used to offset income without limitation.
Section 382 Limitation
a.
During the year of change, the section 382
limitation is prorated based on the ratio of
the number of days in the year after the
change date to the total number of days in
the year. Section 382(b)(3)(B). The
portion of the taxable income in the year of
change to which section 382 applies (see
discussion above at Part VI.B.l.) may be
offset only to the extent of such prorated
section 382 limitation amount.
b.
Section 382(h)(5)(B) prevents the proration
of the section 382 limitation with respect
323
to that portion of the section 382
limitation where built-in gains and certain
338 gain is recognized in a post-change year
that includes the change date. This is
discussed below at Part VI.C.5.b.
C.
Special Rules for Built-in Gains and Losses
Special rules apply if an old loss corporation has a
"net unrealized built-in gain” (NUBIG) or a net
unrealized built-in loss" (NUBIL). In general,
subject to certain threshold requirements, built-in
gains may be offset by pre-change losses as if
recognized before the change date. However, built-in
losses are subject to the same limitations as prechange losses. On April 26, 2001 the Service issued a
business plan announcing its intention to promulgate
regulations addressing built-in gains and losses,
including the issue of wasting assets. No regulations
have been issued to date. However, on September 12,
2003, the Service issued Notice 2003-65, I.R.B. 200340, which offers two alternative approaches for the
identification of built-in items--the section 1374
approach and the section 338 approach. These
approaches are discussed below in Part VI.C.4.
Pending the issuance of regulations, both of these
approaches will serve as safe harbors to taxpayers.
1.
Net Unrealized Built-in Gain or Loss
To determine whether the special rules for builtin gains or losses apply, it first must be
determined whether the loss corporation has a
NUBIG or NUBIL.
a.
Definition
A loss corporation has a NUBIG or NUBIL if
the fair market value of the corporation's
assets immediately before an ownership
change is more or less (respectively) than
the aggregate adjusted basis of those
assets. Section 382(h)(3)(A)(i) (emphasis
added). Presumably, the gross value of
assets, as opposed to net value, will be
used in testing for unrealized built-in gain
or loss.
324
b.
Example
L owns two assets. The first asset has a
value of $200 and basis of $50 (built-in
gain of $150). The second asset has a basis
of $100 and a value of $20 (built-in loss of
$80). L's net unrealized built-in gain is
$70.
c.
Special rule for redemptions
Under section 382(h)(3)(A)(ii), if a
redemption occurs "in connection with" an
ownership change, such redemption must be
taken into account in determining whether a
loss corporation has a net unrealized builtin gain or loss.
d.
(1)
Thus, if built-in gain assets are
distributed to a shareholder, this may
cause the loss corporation to fail the
threshold test discussed below, or it
may result in a net unrealized built-in
loss.
(2)
Such a situation may occur in a Zenztype boot strap purchase where
appreciated, but unwanted, assets are
distributed to the shareholder.
(3)
It appears that if a shareholder
receives a note in exchange for his
stock in the redemption, the unrealized
built-in gain or loss would not be
affected (unless value is determined on
a net basis).
(4)
TAMRA expanded section 382(h)(3)(A) to
encompass corporate contractions as
well as redemptions.
Special rule for computing NUBIG or NUBIL
(1)
Section 382(h)(8) provides that, if 80
percent or more in value of the stock
of the loss corporation is acquired
during a 12 month period in one
transaction (or a series of
325
transactions), then for purposes of
computing NUBIL, the fair market value
of the assets cannot exceed "the
grossed-up amount paid for such stock
properly adjusted for indebtedness of
the corporation and other relevant
items." For an example of the
application of section 382(h)(8), see
FSA 199914002; FSA 200010003.
(2)
e.
Section 382(h)(8) appears to adopt a
value calculation similar to the
calculation of "adjusted grossed-up
basis" under section 338. Treas. Reg.
§ 1.338-4T(j).
Threshold test
(1)
If a loss corporation's NUBIG or NUBIL
does not exceed the lesser of 15
percent of the fair market value of the
old loss corporation's assets or $10
million, the old loss corporation's
unrealized built-in gain or loss will
be treated as being zero. Section
382(h)(3)(B)(i). RRA 89 changed the
threshold limitation from 25 percent of
fair market value to the 15 percent/$10
million test.
(2)
However, section 382(h)(3)(B)(ii)
states that any cash or cash item, and
any marketable security which has a
value which does not "substantially
differ" from its adjusted basis, is to
be excluded in making the threshold
determination. For the definition of
the term "cash item," see section
368(a)(2)(F)(iv).
(3)
In the last example above, L would pass
the threshold test since it has a
built-in gain of 32 percent (70/220).
If L also had $500 in a bank account,
the result would be the same since such
an item would be excluded in the
calculation.
326
(4)
f.
The threshold test presumably should be
applied after taking into account any
redemptions (and, under TAMRA,
corporate contractions as well) that
occurred in connection with the
ownership change. Acquisition debt
that results in a corporation
contraction should not affect built-in
gain computations, so long as gross
value is used.
Importance of the threshold
(1)
The threshold requirement was fixed at
25 percent in order to relieve loss
corporations from making burdensome
asset valuations where the amount of
built-in gain or loss was not
substantial. Congress, believing the
25 percent threshold too generous,
reduced the threshold to the lesser of
15 percent or $10 million. See H.R.
Rep. No. 247, 101st Cong., 1st Sess.
1231-1232 (1989).
(2)
The threshold requirement cuts both
ways.
(a)
A corporation having significant
built-in gains (for example, 14
percent) will not be able to fully
offset such gains against prechange losses. This is true even
though, prior to the ownership
change, a complete offset was
available.
(b)
A corporation having significant
built-in losses (for example, 14
percent) receives a benefit since
such losses will not be subject to
section 382. This is true even
though such losses would be
subject to the section 382
limitations had they actually been
realized prior to the ownership
change.
327
2.
(3)
A corporation having significant builtin gains which do not exceed the
threshold amount may want to consider
recognizing such gains prior to the
ownership change. If necessary, such
assets could be sold to the acquiring
party.
(4)
Similarly, a corporation having builtin losses which exceed the threshold by
only a slight amount may want to
consider recognizing sufficient losses
so that the remainder can drop below
the threshold amount.
Recognized Built-In Gains
a.
In general
Section 382(h)(1)(A) provides that if the
old loss corporation has NUBIG as computed
above, the section 382 limitation for any
"recognition period taxable year" shall be
increased by the "recognized built-in gains"
(RBIG) for such taxable year.
(1)
The term "recognition period taxable
year" means "any taxable year any
portion of which is in the recognition
period." Section 382(h)(7)(B).
(2)
The "recognition period" is the fiveyear period beginning on the change
date. Section 382(h)(7)(A).
(3)
Thus, if the change date occurs on
July 1, 1988, the "recognition period"
would close on June 30, 1993. However,
if L is a calendar year taxpayer, there
will be six "recognition period taxable
years" (1988 through 1993, inclusive).
(4)
Note, however, gains must be recognized
in the recognition period (not in a
recognition period taxable year) to
qualify as RBIG. See discussion below
at Part VI.C.2.b.
328
b.
Definition
Under section 382(h)(2)(A), the term RBIG
means any gain recognized during the
recognition period on the disposition of any
asset, but only to the extent the new loss
corporation establishes that: (1) the
disposed asset was held by the old loss
corporation immediately before the change
date, and (2) the recognized gain does not
exceed the excess of the fair market value
of the disposed asset on the change date
over its adjusted basis as of such date.
(1)
The statute in effect presumes that
gains recognized in the recognition
period are not RBIG. Unless the new
loss corporation can prove the
contrary, such gains will be treated as
other taxable income subject to
limitation under section 382.
(2)
While NUBIG is determined on an
aggregate basis, RBIG is computed on an
asset-by-asset basis.
(3)
Thus, if a new loss corporation plans
to avail itself of the eased
restrictions on RBIG, detailed records
must be prepared which identify the
assets held as of the change date. In
addition, evidence to prove the value
of each asset as of the change date
must also be collected. This may
require an expensive and detailed
appraisal of assets.
(4)
Note that the gain must be recognized
during the recognition period, not
during a recognition period taxable
year. Section 382(h)(2)(A).
(5)
In addition, RBIG may arise only "on
the disposition of any asset." Section
382(h)(2)(A).
(6)
Under section 382(h)(6)(A), the
recognition of items of income which
329
are properly taken into account during
the recognition period but which are
attributable to periods before the
ownership change date shall be treated
as RBIG for the taxable year in which
they are properly taken into account.
Section 382(h)(6)(A).
(a)
An adjustment to NUBIG or NUBIL
will be made in such cases.
Section 382(h)(6)(C).
(b)
An example of such an item would
be an account receivable held by a
cash basis loss corporation.
(c)
The Service has found that income
from wasting assets should not be
treated as RBIG under section
382(h)(6)(A). TAM 200217009.
However, the Service anticipated
that this result may be modified
as a result of the adoption of
temporary or final regulations on
this issue. Further, as described
below in Part VI.C.4., pending the
promulgation of regulations, the
Service has adopted certain safe
harbors for the treatment of
wasting assets in Notice 2003-65.
(d)
The Service and Treasury have
issued final regulations that
prevent prepaid income from being
treated as recognized built-in
gain for purposes of section
382(h). See Treas. Reg. § 1.3827; see also TAM 199942003 (not
treating prepaid service income
properly taken into account in a
tax period following an ownership
change as RBIG under section
382(h)(6)(A)).
(e)
The Service has ruled that
cancellation of indebtedness
income may be treated as RBIG
330
under section 382(h)(6)(A). LTR
9328021; LTR 9291040; LTR 9226026.
Further, as described below in
Part VI.C.4., pending the
promulgation of regulations, the
Service has adopted certain safe
harbors for the treatment of
cancellation of indebtedness
income in Notice 2003-65.
c.
Limitation
Under section 382(h)(1)(A)(ii), the increase
in the section 382 limitation amount shall
not exceed the net unrealized built-in gain
reduced by built-in gains recognized in
prior years ending in the recognition
period.
d.
Gains recognized beyond the recognition
period
(1)
Built-in gains recognized beyond the
close of the recognition period do not
increase the section 382 limitation.
Such gains only add to the taxable
income of the new loss corporation,
which can be offset by prechange NOL
carryovers only to the extent of the
section 382 limitation. This would
include, for example, built-in gain
recognized outside of the recognition
period on an installment sale of
property made within the period.
(2)
The Service intends to issue
regulations providing that if a
taxpayer sells a built-in gain asset
prior to or during the recognition
period in an installment sale, the
provisions of section 382(h) will
continue to apply to gain recognized
from the installment sale after the
recognition period. Notice 90-27,
1990-1 C.B. 336. In the meantime, as
described below in Part VI.C.4., the
Service has adopted certain safe
331
harbors with respect to the treatment
of installment sales in determining
RBIG in Notice 2003-65.
3.
Recognized Built-In Losses
a.
In general
Under section 382(h)(1)(B), if an old loss
corporation has a NUBIL, the "recognized
built-in loss" (RBIL) for any "recognition
period taxable year" is subject to
limitation under section 382 as if such loss
were a pre-change loss. The term
"recognition period taxable year" is defined
above at VI.C.2.a.(1).
b.
Definition
Under section 382(h)(2)(B) the term RBIL
means any loss recognized during the
recognition period on the disposition of any
asset except to the extent that the new loss
corporation establishes that: (1) the
disposed asset was not held by the old loss
corporation immediately before the change
date, or (2) the recognized loss exceeds the
excess of the adjusted basis of the asset on
the change date over its value as of such
date.
(1)
The statute presumes that all losses
recognized in the recognition period
are RBIL.
(2)
Unless the corporation can prove the
contrary, such losses will be treated
as pre-change losses which may offset
taxable income only to the extent of
the section 382 limitation.
(3)
As with RBIG, losses must be recognized
during the recognition period (not
during a recognition period taxable
year) to constitute RBIL.
(4)
OBRA 87 amended section 382(h)(2)(B) to
treat depreciation deductions as built-
332
in losses, except to the extent that
the new loss corporation establishes
that such deductions are not
attributable to excess basis as of the
change date. Further, as described
below in Part VI.C.4., pending the
promulgation of regulations, the
Service has adopted certain safe
harbors with respect to the treatment
of depreciation deductions in
determining RBIL in Notice 2003-65.
c.
Limitation
Under section 382(b)(1)(B)(ii), RBIL is
subject to limitation only to the extent
that the loss does not exceed the NUBIL,
reduced by built-in losses recognized in
prior years ending in the recognition
period.
d.
Accrued deductions: Under section
382(h)(6)(B), the recognition of items which
are allowable as deductions during the
recognition period (determined without
regard to any carryover) but which are
attributable to periods before the ownership
change date shall be treated as RBIL for the
taxable years for which they are allowed as
deductions. An adjustment to NUBIG or NUBIL
will be made in such cases. Section
382(h)(6)(C).
(1)
Examples of built-in deduction items
include accounts payable held by a cash
basis loss corporation and deductions
deferred by virtue of section 267 or
465. See Conf. Rep. No. at II-191.
(2)
Relying on Treas. Reg. § 1.13744(b)(2), the Service stated that a
deduction is “attributable” to periods
before the change date, and thereby
treated as a RBIL, if the deduction
would have been allowed as a deduction
of an accrual method taxpayer prior to
the change date, applying the “all
333
events test” and economic performance
requirement of section 461. FSA
200225014. As described below in Part
VI.C.4, the Service has adopted this
approach as a safe harbor in Notice
2003-65.
e.
Losses recognized beyond the recognition
period
Built-in losses recognized beyond the close
of the recognition period are not subject to
limitation under section 382. Thus, such
losses may offset taxable income of the new
loss corporation without regard to the
section 382 limitation.
f.
4.
Carryover of disallowed built-in losses
(1)
If a RBIL (or portion thereof) is
disallowed for any post-change year,
the disallowed portion may be carried
forward as if it were a NOL carryover,
but subject to the section 382
limitation. Section 382(h)(4).
(2)
TAMRA amended section 382(h)(4) to
provide that this rule will not operate
to convert a capital loss into a net
operating loss. S. Rep. No. 445, 100th
Cong. 2d Sess. at 50.
Safe Harbors for Treatment of Built-in Items in
Calculating NUBIG, NUBIL, RBIG, and RBIL
a.
In general
On September 12, 2003, the Service issued
Notice 2003-65, I.R.B. 2003-40. In Notice
2003-65, the Service announced that is was
studying the circumstances under which
certain items of income, gain, deduction,
and loss that a loss corporation recognizes
after an ownership change should be treated
as RBIG and RBIL under section 382(h). In
addition, pending the issuance of
regulations, the Service provided two
alternative safe harbor approaches for the
334
identification of built-in items. Taxpayers
may rely upon either of these approaches,
but not both, in calculating NUBIG and NUBIL
and identifying RBIG and RBIL. These
approaches are the “1374 approach” and the
“338 approach.”
b.
1374 Approach
(1)
In general
The 1374 approach generally
incorporates the rules of section
1374(d) and Treas. Reg. §§ 1.1374-3,
1.1374-4, and 1.1374-7 in calculating
NUBIG, NUBIL, RBIG, and RBIL.
(2)
Calculation of NUBIG and NUBIL
(a)
Under the 1374 approach, NUBIG or
NUBIL is the net amount of gain or
loss that would be recognized in a
hypothetical sale of the assets of
the loss corporation immediately
before the ownership change.
(b)
NUBIG or NUBIL is calculated by
determining the amount that would
be the amount realized if
immediately before the ownership
change the loss corporation had
sold all of its assets, including
goodwill, at fair market value to
a third party that assumed all of
its liabilities, decreased by the
sum of any deductible liabilities
of the loss corporation that would
be included in the amount realized
on the hypothetical sale and the
loss corporation's aggregate
adjusted basis in all of its
assets, increased or decreased by
the corporation's section 481
adjustments that would be taken
into account on a hypothetical
sale, and increased by any RBIL
that would not be allowed as a
335
deduction under section 382, 383,
or 384 on the hypothetical sale.
(3)
(c)
The amount by which this result
exceeds $0 is the loss
corporation's NUBIG; the amount by
which $0 exceeds this result is
the loss corporation's NUBIL.
(d)
Example 1. Immediately before an
ownership change, a loss
corporation has one asset with a
fair market value of $100 and an
adjusted basis of $10, and a
deductible liability of $30.
Disregarding the threshold
requirement of section
382(h)(3)(B), the loss corporation
has a NUBIG of $60 ($100, the
amount the loss corporation would
realize if it sold all its assets
to a third party that assumed all
of its liabilities, decreased by
$40, the sum of the deductible
liability ($30) and the aggregate
basis in the assets ($10)).
(e)
Example 2. The facts are the same
as in Example 1 except that the
asset has an adjusted basis of $90
instead of $10. Disregarding the
threshold requirement of section
382(h)(3)(B), the loss corporation
has a NUBIL of $20 (the amount by
which $0 exceeds -$20 ($100, the
amount the loss corporation would
realize if it sold all its assets
to a third party that assumed all
of its liabilities, decreased by
$120, the sum of the deductible
liability ($30) and the aggregate
basis in the assets ($90)).
Calculation of RBIG and RBIL
(a)
Gain and Loss from Sales or
Exchanges of Assets
336
(b)
i)
Under the 1374 approach, the
amount of gain or loss
recognized during the
recognition period on the
sale or exchange of an asset
is RBIG or RBIL,
respectively, subject to the
limitations described in
section 382(h)(2)(A) or (B).
The sum of the RBIG or RBIL
(including deductions that
are treated as RBIL as
described below) attributable
to an asset cannot exceed the
unrealized built-in gain or
loss in that asset on the
change date.
ii)
With respect to gain from
sales reported under the
section 453 installment
method, the 1374 approach
follows the section 1374
regulations and Notice 90-27,
as described above in Part
VI.C.2.d.
Items of Income and Deduction
i)
In General
In cases other than sales and
exchanges, the 1374 approach
generally relies on the
accrual method of accounting
to identify income or
deduction items as RBIG or
RBIL, respectively. Under
this approach, items of
income or deduction properly
included in income or allowed
as a deduction during the
recognition period are
considered "attributable to
periods before the change
date" under sections
382(h)(6)(A) and (B) and,
337
thus, are treated as RBIG or
RBIL, respectively, if an
accrual method taxpayer would
have included the item in
income or been allowed a
deduction for the item before
the change date.
ii)
Income Generated by Built-in
Gain Assets
In general, the 1374 approach
does not treat income from a
built-in gain asset during
the recognition period as
RBIG because such income did
not accrue before the change
date.
Example. Loss corporation has
a NUBIG of $300,000 that is
attributable to several nonamortizable assets with an
aggregate fair market value
of $650,000 and an aggregate
adjusted basis of $500,000,
and a patent with a fair
market value of $170,000 and
an adjusted basis of $20,000.
In Year 1 of the recognition
period, loss corporation has
gross income of $75,000,
$20,000 of which is
attributable to royalties
collected in connection with
the license of the patent. No
part of the $20,000
attributable to the royalties
is RBIG in Year 1 because the
income would not have been
properly taken into account
before the change date by an
accrual method taxpayer.
iii) Depreciation, Amortization
and Depletion Deductions with
338
Respect to Built-in Loss
Assets
iv)
339
a)
The 1374 approach
departs from the tax
accrual rule and the
regulations under
section 1374 in its
treatment of amounts
allowable as
depreciation,
amortization, or
depletion (collectively,
"amortization")
deductions during the
recognition period. In
accordance with the
second sentence of
section 382(h)(2)(B),
except to the extent the
loss corporation
establishes that the
amount is not
attributable to the
excess of an asset's
adjusted basis over its
fair market value on the
change date, these
amounts are treated as
RBIL, regardless of
whether they accrued for
tax purposes before the
change date.
b)
However, a loss
corporation may use any
reasonable method to
establish that the
amortization deduction
amount is not
attributable to an
asset's built-in loss on
the change date.
Discharge of Indebtedness
Income and Bad Debt
Deductions
340
a)
The 1374 approach
generally treats any
income or deduction item
properly taken into
account during the first
12 months of the
recognition period as
discharge of
indebtedness income
("COD income") as RBIG
or RBIL if that item (i)
is included in gross
income pursuant to
section 61 or as a bad
debt deduction under
section 166 and (ii) if
the item arises from a
debt owed by or to the
loss corporation at the
beginning of the
recognition period.
b)
Any reduction of tax
basis under sections
108(b)(5) and 1017(a)
that occurs as a result
of COD income realized
within the first 12
months of the
recognition period is
treated as having
occurred immediately
before the ownership
change for purposes of
determining whether a
recognized gain or loss
is an RBIG or an RBIL
under section 382(h)(2).
c)
The reduction of tax
basis does not affect
the loss corporation's
NUBIG or NUBIL under
section 382(h)(3).
d)
The treatment of COD
income under the 1374
approach differs from
the treatment of that
item as described in
Notice 87-79, which
treats COD income that
is "integrally related
to an ownership change"
but is recognized after
the ownership change as
RBIG. Taxpayers that
otherwise follow the
1374 approach may apply
the rules described in
Notice 87-79 (rather
than the rules included
in the 1374 approach) to
COD income for ownership
changes that occur
before September 12,
2003, but may not rely
on the rules described
in Notice 87-79 for
ownership changes that
occur on or after
September 12, 2003.
c.
338 Approach
(1)
In general
The 338 approach identifies items of
RBIG and RBIL generally by comparing
the loss corporation's actual items of
income, gain, deduction, and loss with
those that would have resulted if a
section 338 election had been made with
respect to a hypothetical purchase of
all of the outstanding stock of the
loss corporation on the change date
(the "hypothetical purchase"). As a
result, under the 338 approach, (unlike
under the 1374 approach) built-in gain
assets may be treated as generating
RBIG even if they are not disposed of
at a gain during the recognition
period, and deductions for liabilities,
in particular contingent liabilities,
341
that exist on the change date may be
treated as RBIL.
(2)
Calculation of NUBIG and NUBIL
Under the 338 approach, NUBIG or NUBIL
is calculated in the same manner as it
is under the 1374 approach.
Accordingly, unlike the case in which a
section 338 election is actually made,
contingent consideration (including a
contingent liability) is taken into
account in the initial calculation of
NUBIG or NUBIL, and no further
adjustments are made to reflect
subsequent changes in deemed
consideration.
(3)
Calculation of RBIG and RBIL
(a)
In General
The 338 approach identifies RBIG
or RBIL by comparing the loss
corporation's actual items of
income, gain, deduction, and loss
with the items of income, gain,
deduction, and loss that would
have resulted if a section 338
election had been made for the
hypothetical purchase. For
purposes of identifying those
items that would have resulted had
a section 338 election been made
with respect to the hypothetical
purchase, after the hypothetical
purchase, the loss corporation is
treated as using those accounting
methods that the loss corporation
actually uses.
(b)
Gain and Loss from Sales or
Exchanges of Assets
i)
342
The 338 approach identifies
RBIG or RBIL from sales and
exchanges of assets by
comparing the loss
corporation's actual item of
gain or loss with the gain or
loss that would have resulted
if a section 338 election had
been made for the
hypothetical purchase.
ii)
(c)
With respect to gain from
sales reported under the
section 453 installment
method, the 338 approach
follows Notice 90-27, which,
as described above, treats
built-in gain recognized from
installment sales that occur
before or during the
recognition period as RBIG,
even if recognized after the
recognition period.
Wasting or Consumption of Built-in
Gain Assets
i)
As described above, for loss
corporations with a NUBIG,
the 338 approach treats
certain built-in gain assets
of the loss corporation as
generating RBIG even if such
assets are not disposed of
during the recognition
period. The 338 approach
assumes that, for any taxable
year, an asset that had a
built-in gain on the change
date generates income equal
to the cost recovery
deduction that would have
been allowed for such asset
under the applicable Code
section if an election under
section 338 had been made
with respect to the
hypothetical purchase.
ii)
With respect to an asset that
had a built-in gain on the
343
change date, the 338 approach
treats as RBIG an amount
equal to the excess of the
cost recovery deduction that
would have been allowable
with respect to such asset
had an election under section
338 been made for the
hypothetical purchase over
the loss corporation's actual
allowable cost recovery
deduction.
iii) The cost recovery deduction
that would have been allowed
to the loss corporation had
an election under section 338
been made with respect to the
hypothetical purchase will be
based on the asset's fair
market value on the change
date and a cost recovery
period that begins on the
change date. The excess
amount is RBIG, regardless of
the loss corporation's gross
income in any particular
taxable year during the
recognition period.
iv)
344
Example. Loss Corporation has
a NUBIG of $300,000 that is
attributable to various nonamortizable assets with an
aggregate fair market value
of $710,000 and an aggregate
adjusted basis of $500,000,
and a patent with a fair
market value of $120,000 and
an adjusted basis of $30,000.
The patent is a section
197(c) asset for which 10
years of depreciation remain.
In Year 1 of the recognition
period, Loss Corporation has
gross income of $75,000. In
Year 1, $5,000 is RBIG
attributable to the patent.
The $5,000 amount is the
excess of the $8,000
amortization deduction that
would have been allowed had a
section 338 election been
made with respect to a
hypothetical purchase of all
of the stock of Loss
Corporation over $3,000, the
actual allowable amortization
deduction. This $5,000 of
RBIG increases Loss
Corporation’s section 382
limitation for Year 1.
Note: The same test applies
for all tangible and
intangible assets with a
NUBIG, whether or not the
property is amortizable or
depreciable.
(d)
Depreciation, Depletion, and
Amortization Deductions with
Respect to Built-in Loss Assets
For loss corporations with a
NUBIL, the 338 approach treats as
RBIL certain deductions of the
loss corporation. In particular,
with respect to an asset that has
a built-in loss on the change
date, the 338 approach treats as
RBIL the excess of the loss
corporation's actual allowable
cost recovery deduction over the
cost recovery deduction that would
have been allowable to the loss
corporation with respect to such
asset had an election under
section 338 been made with respect
to the hypothetical purchase.
(e)
Contingent Liabilities
345
(f)
i)
The 338 approach treats a
deduction for the payment of
a liability that is
contingent on the change date
as RBIL to the extent of the
estimated liability on the
change date.
ii)
Example. Loss corporation has
a contingent liability
estimated at $25 on the
change date. During Year 2 of
the recognition period, loss
corporation pays $30 to
settle the liability and
claims a deduction for that
amount. Of that amount, $25
is RBIL.
Discharge of Indebtedness Income
i)
346
Under the 338 approach, COD
income that is included in
gross income under section 61
and that is attributable to
any pre-change debt of the
loss corporation is RBIG in
an amount not exceeding the
excess, if any, of the
adjusted issue price of the
discharged debt over the fair
market value of the debt on
the change date. The 338
approach treats a reduction
of tax basis under sections
108(b)(5) and 1017(a) that
occurs during the recognition
period as having occurred
immediately before the
ownership change for purposes
of section 382(h)(2) to the
extent of the excess, if any,
of the adjusted issue price
of the debt over the fair
market value of the debt on
the change date.
ii)
(g)
The reduction of tax basis
does not affect the loss
corporation's NUBIG or NUBIL
under section 382(h)(3). As
with the 1374 approach,
taxpayers that otherwise
follow the 338 approach may
apply the rules described in
Notice 87-79, 1987-2 C.B. 387
(rather than the rules
included in the 338 approach)
to COD income for ownership
changes that occur before
September 12, 2003, but may
not rely on the rules of
Notice 87-79 for ownership
changes that occur on or
after September 12, 2003.
Other Items
The 338 approach incorporates the
special rules in Treas. Reg. §
1.1374-4(i) concerning partnership
items and Treas. Reg. § 1.13744(d) concerning section 481
adjustments, to the extent those
items are not already taken into
account in the basic methodology
of the section 338 approach of
comparing actual items of the loss
corporation to those that would
have resulted had a section 338
election been made with respect to
the hypothetical purchase.
d.
Reliance on Notice 2003-65
(1)
Taxpayers may rely on the approaches
set forth in this notice for purposes
of applying section 382(h) to an
ownership change that occurred prior to
the issuance of this notice on
September 12, 2003 or on or after the
issuance of this notice and prior to
the effective date of temporary or
final regulations under section 382(h).
347
The IRS will not assert an alternative
interpretation of section 382(h)
against a taxpayer that consistently
applies either the 1374 approach or the
338 approach described in this notice.
5.
(2)
Taxpayers may use either the 1374
approach or the 338 approach, but not
elements of both, for each ownership
change with respect to a loss
corporation or a loss subgroup as
defined in Treas. Reg. § 1.1502-91(d).
Although the approaches described in
this notice serve as safe harbors, they
are not the exclusive methods by which
a taxpayer may identify built-in items
for purposes of section 382(h). Other
methods taxpayers use to identify
built-in items for purposes of Section
382(h) will be examined on a case-bycase basis.
(3)
On February 25, 2011, Donald Bakke,
attorney-advisor in Treasury’s Office
of Tax Legislative Counsel, speaking at
a tax law conference, indicated that
even though section 382(h) guidance is
not on the IRS’s 2010-2011 Priority
Guidance Plan, Treasury may pursue a
regulatory project to address the
treatment of cancellation of
indebtedness income for purposes of
NUBIG, NUBIL, RBIG, and RBIL.
Application of Section 382(h) to Banks for
Ownership Changes Occurring or Entered into
Pursuant to Binding Contract on or Before January
16, 2009.
a.
On October 20, 2008, the IRS and Treasury
announced in Notice 2008-83 that they were
studying the proper treatment under section
382(h) of certain items of deduction or loss
allowed after an ownership change to a
corporation that is a bank (as defined in
section 581) both immediately before and
348
after the change date (as defined in section
382(j)).
b.
Under Notice 2008-83, for purposes of
section 382(h), any deduction properly
allowed after an ownership change (as
defined in section 382(g)) to a bank with
respect to losses on loans or bad debts
(including any deduction for a reasonable
addition to a reserve for bad debts) shall
not be treated as a built-in loss or a
deduction that is attributable to periods
before the change date.
c.
The American Recovery and Reinvestment Act
of 2009, Pub. L. No. 111-5, limited the
force and effect of law of Notice 2008-83
to:
d.
(1)
Any ownership change occurring on or
before January 16, 2009, and
(2)
Any ownership change occurring after
January 16, 2009 if such change:
(a)
Is pursuant to a written binding
contract entered into on or before
such date, or
(b)
Is pursuant to a written agreement
entered into on or before such
date in a public announcement or
in a filing with the Securities
and Exchange Commission required
by reason of such ownership
change.
Congress found in the American Recovery and
Reinvestment Act that:
(1)
The delegation of authority to the
Secretary of the Treasury under section
382(m) of the Internal Revenue Code of
1986 does not authorize the Secretary
to provide exemptions or special rules
that are restricted to particular
industries or classes of taxpayers,
349
6.
(2)
Internal Revenue Service Notice 2008–38
is inconsistent with the congressional
intent in enacting such section 382(m),
and
(3)
The legal authority to prescribe
Internal Revenue Service Notice 2008–38
is doubtful.
Post-Change Years that Include the Change Date
As set forth above, in a post-change year that
includes the change date, the taxable income is
prorated under section 382(b)(3). However, the
general rules of allocation do not work properly
where the new loss corporation recognizes builtin gains or losses during such a year.
a.
Prorating taxable income
Section 382(h)(5)(A) provides that in
applying section 382(b)(3), taxable income
is determined exclusive of RBIG (including
section 338 gain covered by section
382(h)(1)(C)) and losses. That is, such
gains and losses are not to be allocated on
a daily pro rata basis.
TAMRA amended section 382(h)(5) to provide
that RBIG and RBIL are not allocated on a
daily basis, but only to the extent that
such gains increase the section 382
limitation and such losses are treated as
built-in losses. Thus, for example, the
daily allocation rule would apply if the
threshold limit is not exceeded.
(1)
Fact pattern
L is a calendar year taxpayer. On June
30, 1987, an ownership change occurs in
a transaction that does not terminate
L's taxable year. For 1987, L has
total taxable income of $100,000. Of
this amount, $10,000 represents RBIG(L
sold an asset on August 1, 1987). L
has a NUBIG of $20,000, which exceeds
the threshold limit. The section 382
350
limitation under section 382(b) is
$50,000.
b.
(2)
Under section 382(h)(5)(A), the taxable
income subject to proration under
section 382(b)(3) is $90,000 ($100,000
- 10,000). Thus, under section
382(b)(3), $45,000 of income would be
allocated to the period ending on the
change date (which is not subject to
limitation) and $45,000 of income would
be allocated to the post-change period
(which is subject to limitation).
(3)
Section 382(h)(5)(A) does not provide
for the treatment of the unallocated
gain of $10,000. Presumably, this
amount is allocated in full to the
post-change period. Therefore, for
1987, $55,000 of taxable income is
subject to limitation, and $45,000 may
be offset by NOL carryovers without
limitation.
(4)
If the asset had been sold by L on
June 1, 1987, the $10,000 gain would
not constitute RBIG (gain not
recognized in the recognition period).
See section 382(h)(2)(A). Therefore,
the full $100,000 of taxable income
would be prorated under section
382(b)(3), with the result that only
$50,000 (not $55,000) would be subject
to limitations.
Section 382 limitation
The rules to adjust taxable income
(paragraph a., above) are complemented with
rules to adjust the section 382 limitation.
Section 382(h)(5)(B) provides that in
prorating the section 382 limitation for a
post-change year that includes the change
date, the section 382 limitation is computed
without regard to RBIG (including section
338 gain covered by section 382(h)(1)(C)).
Therefore, any increase in the section 382
351
limitation for such year on account of RBIG
is not allocated on a daily pro rata basis
under section 382(b)(3)(B).
c.
(1)
Under section 382(h)(1)(A), the section
382 limitation would ordinarily be
increased to $60,000 on account of the
RBIG of $10,000.
(2)
However, section 382(h)(5)(B) provides
that the full $60,000 is not to be
allocated under section 382(b)(3).
Only $50,000 is to be allocated -- the
section 382 limitation computed without
regard to RBIG. Therefore, under
section 382(b)(3), the pro rated
section 382 limitation is $25,000.
(3)
Section 382(h)(5)(B) does not provide
for any special treatment as to the
excluded RBIG. Presumably, the general
rule of section 382(h)(1)(A) applies.
Therefore, the section 382 limitation
for 1987 would be increased from
$25,000 (the prorated amount) to
$35,000 to reflect the RBIG.
Comparisons
(1)
In the example above, L's income
subject to limitation was increased by
the full RBIG of $10,000. However, the
section 382 limitation was also
increased by this amount, so that L
suffered no detriment.
(2)
However, such symmetry will not always
result. This is because the offsetting
increase in the section 382 limitation
under section 382(h)(1)(A) remains tied
to the existence of NUBIG. Thus, if
the old loss corporation has a NUBIG of
zero (e.g., the threshold is not met),
a RBIG, while it may be partially
allocated to the pre-change period (and
not subject to limitation), will not
result in a corresponding increase in
352
the section 382 limitation for the
post-change period.
(3)
d.
In addition, under section
382(h)(5)(A), built-in gains and losses
are not to be allocated as part of
taxable income under section 382(b)(3).
However, section 382(h)(5)(B) only
deals with built-in gains. Thus, if in
the facts above the sale of the asset
by L on August 1, 1988, resulted in
recognized built-in loss of $10,000,
taxable income would be allocated
without regard to the loss ($110,000 on
the facts above).
(a)
If L had a NUBIL, the $10,000 of
recognized loss would be treated
as a pre-change loss which could
offset income only to a limited
extent.
(b)
If L did not have a NUBIL, the
taxable income allocated to the
post-change portion of the year
would be reduced by the full
$10,000 loss.
Tax-Free Transactions
(1)
Section 382(h)(9) currently grants
Treasury authority to promulgate
regulations to carry out the purposes
of section 382(h) where property held
on the change date is transferred in a
transaction in which gain or loss is
not recognized in whole or in part.
(2)
TAMRA clarified that the regulatory
authority applies to cases where
property held on the change date was
acquired or is subsequently transferred
in a transaction where gain or loss is
not recognized in whole or in part. J.
Comm. on Tax'n Description of the
Technical Corrections Act of 1988, 53.
353
(3)
7.
(a)
Thus, for example, property
transferred in such a nonrecognition transaction prior to
the date of the ownership change
would be subject to the regulatory
authority. Id.
(b)
Presumably where the corporation
transfers property after the
change date and receives new
property with an exchanged basis
(within the meaning of section
7701(a)(44)), any gain or loss on
the subsequent disposition of the
such new property will be treated
as built-in gain or loss to the
same extent as if it were the
original property being disposed
of. Id.
The TAMRA General Explanation states
that it is expected, as one example,
that built-in gain with respect to
property transferred in a
nonrecognition transaction (including,
for example, a tax-free reorganization
as well as a section 351 contribution
to capital) may in appropriate cases be
disregarded for purposes of determining
the amount of NUBIG and for purposes of
determining the addition to the section
382 limitation following an ownership
change. It is expected that cases
where such built-in gain will be
disregarded may include transactions in
which the value transferred to the
corporation would be disregarded under
section 382(l)(1) if the transaction
had been a contribution to capital.
Id.
Closing-of-the-Books Election
Final regulations under section 382(b)(3) provide
a new loss corporation with an alternative to the
daily pro ration rule through an elective closing
of its books as of the change date ("closing-of-
354
the-books election"). Treas. Reg. § 1.382-6.
The final regulations are consistent with the
principles set forth in Notice 87-79, 1987-2 C.B.
387. On March 3, 1999, the Service requested
public comments on the final regulations. 64 F.R.
10338-10339.
a.
General rule
The final regulations reaffirm the general
rule that a loss corporation must allocate
its NOL or taxable income and its net capital loss or modified capital gain net income
for the change year between the pre-change
and post-change periods by ratably allocating an equal portion to each day of the
year. Treas. Reg. § 1.382-6(a).
b.
(1)
The "change year" is the loss corporation's taxable year which includes the
change date. Treas. Reg. § 1.3826(g)(1).
(2)
The "pre-change period" is the portion
of the change year ending on the close
of the change date. Treas. Reg.
§ 1.382-6(g)(2).
(3)
The "post-change period" is the portion
of the change year beginning with the
day after the change date. Treas. Reg.
§ 1.382-6(g)(2).
Election
The final regulations provide that a loss
corporation may elect to allocate its NOL or
taxable income and its net capital loss or
modified capital gain net income for the
change year between the pre-change and postchange periods as if the loss corporation's
books were closed on the change date. See,
e.g., LTR 9817012; LTR 9617030; LTR 9616027;
and LTR 9611045, where the service allowed
taxpayers to make the closing-of-the-books
election. However, a closing-of-the-books
election does not terminate a loss
corporation's taxable year. Treas. Reg. §
355
1.382-6(b)(1).
c.
d.
(1)
The closing-of-the-books election is
made by the loss corporation by reciting on the information statement
required by Treas. Reg. § 1.382-11(a)
for the change year the explicit
language contained in the regulations.
Treas. Reg. § 1.382-6(b)(2)(i).
(2)
The election is irrevocable and must be
made on or before the due date (including extensions) of the loss corporation's income tax return for the change
year. Treas. Reg. § 1.382-6(b)(2)(i).
Unified elections for consolidated and
controlled groups
(1)
If an election is made in a consolidated return year, all allocations with
respect to that ownership change must
be consistent with the election.
Treas. Reg. § 1.382-6(b)(3)(i). See
LTR 9447040; LTR 9443028.
(2)
If, under a common plan, two or more
members of a controlled group that do
not qualify as a loss group or loss
subgroup have ownership changes and
continue as members of the same controlled group, a closing-of-the-books
election applies only if the election
is made by all members having the ownership changes. Treas. Reg. § 1.3826(b)(3)(ii).
Operating rules
Under the final regulations, capital items
are allocated separately from ordinary
items.
(1)
NOL or taxable income is determined
without regard to gains or losses on
the sale or exchange of capital assets.
Treas. Reg. § 1.382-6(c)(1)(i).
356
(2)
Under Treas. Reg. § 1.382-6(c)(1)(ii),
the NOL or taxable income and net capital loss or "modified capital gain net
income" (defined in Treas. Reg. §
1.382-6(g)(ii) as the excess of the
gains from sales or exchanges of capital assets in the change year over the
loss from such sales or exchanges,
excluding short-term capital losses
under section 1212) are determined
without regard to the section 382 limitation and do not include the following:
(a)
any income, gain, loss, or deduction to which section 382(h)(5)(A)
applies; or
(b)
any income or gain recognized on
the disposition of assets transferred to the loss corporation
during the post-change period for
a principal purpose of
ameliorating the section 382 limitation.
The amounts described in (a) and (b)
are allocated entirely to the postchange period.
(3)
Special rules apply for NOL adjustments.
(a)
Modified capital gain net income
allocated to each period is offset
by capital losses to which section
382(h)(5)(A) applies and capital
loss carryovers, subject to the
section 382 limitation. Treas.
Reg. § 1.382-6(c)(2)(i).
(b)
The NOL allocated to each period
is reduced (but not below zero)
first by the modified capital gain
net income remaining in the same
period, then by the modified capital gain net income remaining in
the other period, without regard
357
to the section 382 limitation.
Treas. Reg. § 1.382-6(c)(2)(ii).
e.
f.
Coordination with other rules
(1)
The allocation of items under the general rule or the closing-of-the-books
election is determined after applying
Treas. Reg. § 1.1502-76 (relating to
the taxable year of members of a consolidated group), if that section is
applicable. Treas. Reg. § 1.382-6(d).
(2)
For example, if a short taxable year
under Treas. Reg. § 1.1502-76 is also a
change year under section 382, the section 382 allocation applies only to
items allocated to the short taxable
year under Treas. Reg. § 1.1502-76.
Treas. Reg. § 1.382-6(d).
(3)
The final regulations apply to the section 383 allocation of excess foreign
taxes under section 904(c), current
year business credits under section 38,
and the minimum tax credit under section 53. Treas. Reg. § 1.382-6(e).
(4)
The same method of allocation (ratable
or closing-of-the-books) must be used
for purposes of sections 382 and 383.
Id.
Examples
(1)
Closing-of-the-books election
(a)
Loss corporation, L, a calendar
year taxpayer with a May 26, 1995,
change date, computes a section
382 limitation of $100,000 under
section 382(b)(1). For the change
year, the section 382 limitation
is $100,000 x (219/365) = $60,000.
L properly makes a closing-of-thebooks election. Treas. Reg. §
1.382-6(f) (Ex. (1)).
358
(b)
Assume further that L has a
$150,000 capital loss carryover
and a $300,000 NOL carryover from
its 1993 taxable year to the
change year. In the pre-change
period of 1994, L recognizes
$200,000 of ordinary loss. In the
post-change period of 1995, L
recognizes $150,000 of capital
gain and $100,000 of ordinary
income. Assume that section
382(h) does not apply to the capital gain or ordinary income.
(c)
L has a $100,000 NOL for the
change year (representing $200,000
pre-change loss less $100,000
post-change income). Because L
has no current capital losses, L's
$150,000 capital gain recognized
in the post-change period is its
modified capital gain net income
for the change year. L allocates
$100,000 of its 1995 NOL to the
pre-change period and $150,000 of
its 1994 modified capital gain net
income to the post-change period.
(d)
Under Treas. Reg. § 1.3826(c)(2)(i), L uses its 1994 capital loss carryover to offset its
modified capital gain net income
allocated to the post-change
period, subject to the section 382
limitation. Since L's section 382
limitation is $60,000, L uses
$60,000 of its 1994 capital loss
carryover to offset $60,000 of its
total 1994 ($150,000) modified
capital gain net income. L has
absorbed its entire section 382
limitation for the change year and
has $90,000 of 1995 modified capital gain net income remaining in
the post-change period.
359
(2)
(e)
Under Treas. Reg. § 1.3826(c)(2)(ii), L offsets its 1995
NOL of $100,000 allocated to the
pre-change period by the $90,000
of 1995 modified capital gain net
income remaining in the postchange period, without regard to
the section 382 limitation,
thereby reducing its 1995 prechange NOL to $10,000.
(f)
From its 1994 taxable year, L will
carry over $90,000 of capital loss
and $300,000 of NOL to its 1995
taxable year. From its 1996
taxable year, L will carry over
$10,000 of NOL subject to the section 382 limitation to its 1996
taxable year.
Ratable allocation
(a)
Assume the same facts as above,
except that L does not make a
closing-of-the-books election.
Treas. Reg. § 1.382- 6(f)
(Ex. (2)).
(b)
L ratably allocates its $100,000
NOL and its $150,000 of modified
capital gain net income for the
change year. The 1995 pre-change
period is allocated $40,000 of NOL
($100,000 x (146/365)) and $60,000
of modified capital gain net
income ($150,000 x (146/365)).
The 1994 post-change period is
allocated $60,000 of NOL ($100,000
x (219/365)) and $90,000 of modified capital gain net income
($150,000 x (219/365)).
(c)
Under Treas. Reg. § 1.3826(c)(2)(i), L uses its 1994 capital loss carryovers of $150,000 to
offset modified capital gain net
income. The 1994 capital loss
360
carryovers offset the 1995 modified capital gain net income of
$60,000 allocated to the prechange period without limitation.
The remaining $90,000 of 1994
capital loss carryovers offset the
1995 modified capital gain net
income allocated to the postchange period, subject to the section 382 limitation. Therefore, L
uses $60,000 (because the section
382 limitation limits L's use to
this amount) of its 1994 capital
loss carryover to offset $60,000
of its total 1995 modified capital
gain net income of $90,000
allocated to the post-change
period. L has absorbed its entire
section 382 limitation for the
change year.
(3)
(d)
L's 1995 NOL of $60,000 allocated
to the post-change period is offset by its remaining 1995 postchange modified capital gain net
income of $30,000, thereby reducing its post-change NOL to
$30,000.
(e)
From its 1994 taxable year, L will
carry over $30,000 of capital loss
and $300,000 of NOL to its 1996
taxable year. From its 1995 taxable year, L will carry over
$70,000 of NOL ($40,000 pre-change
and $30,000 post-change) to its
1995 taxable year. The $40,000
pre-change portion of the
carryover is subject to the section 382 limitation.
Effective date
The regulations apply to ownership
changes occurring on or after June 22,
1994.
361
D.
Special Anti-Abuse Provisions
1.
Capital Contributions
a.
b.
c.
Contributions received as part of a plan
(1)
Section 382(1)(1) states that "any
capital contribution received by any
old loss corporation as part of a plan
a principal purpose of which is to
avoid or increase any limitation under
this section may not be taken into
account" for purposes of section 382.
(2)
Section 382(1)(1) serves to prevent a
taxpayer from obtaining an increase in
the amount of the section 382 limitation by making last-minute capital contributions in order to inflate the
value of L.
(3)
Presumably, the phrase "increase in any
limitation" refers to an attempted
increase in the amount of the section
382 limitation. An example of a contribution "to avoid" a limitation would
be the contribution of appreciated
property (built-in gain) to avoid the
built-in loss rules.
Irrebuttable presumption
(1)
Section 382(1)(1)(B) states that,
except as provided in the regulations,
"any capital contribution made during
the 2-year period ending on the change
date" will be treated as part of a prohibited plan.
(2)
The conference report adds that such
presumption is an "irrebuttable presumption," unless regulations provide
otherwise. See Conf. Rep. at II-189.
Scope of provision
(1)
However, the scope of section 382(1)(1)
is overly broad for its intended pur362
pose since, on its face, any capital
contribution constitutes a tainted contribution.
d.
(2)
Moreover, the House report states that
this provision is intended to cover
both direct and indirect infusions of
capital. See House Report at 269.
(3)
The conference report states that a
section 351 transfer will constitute a
capital contribution for this purpose.
See Conf. Rep. at II-189. Query,
whether a pre-change merger of two commonly owned corporations would
constitute an indirect infusion of
capital?
Administrative Guidance
(1)
Regulations are expected to provide
exceptions to this rule for:
(a)
Capital contributions received on
formation of the loss corporation,
(b)
Capital contributions received
before the first year from which
there is an NOL carryover, and
(c)
Capital contributions made to fund
continuing operations of the business. See LTR 9835027 (ruling
that a parent’s capital
contributions to its subsidiary
within two years of the
subsidiary’s sale were used to
continue basic corporate
operations, and thus were not part
of a plan a principal purpose of
which was to avoid or increase any
limitation for purposes of section
382). See also LTR 9706014
(ruling that Acquiring’s purchase
of Target stock prior to ownership
change will not be considered a
contribution received by Target as
part of a plan a principal purpose
363
of which was to avoid or increase
the section 382 limitation because
Target used the proceeds from such
purchase to continue basic
operations).
(2)
In addition, the conference report
states the regulations may take into
account the existence of "substantial
nonbusiness assets" on the change date.
See Conf. Rep. at II-189.
(3)
Regulations may also take into account
distributions made by the loss corporation subsequent to the capital contribution. See Conf. Rep. at II-189.
(4)
Contributions made to fund continuing
operations are ones that are made to
meet operating expenses arising proximate in time to the capital contribution and are traceable to a basic
operational expense. LTR 9508035. See
LTR 9630038, where the service ruled
that section 382(l)(1) does not prevent
taking into account a capital contribution made within two years of the
change date if such contribution is
made to meet operating expenses arising
proximate in time to the contribution.
See also LTR 9541019 (allowing proceeds
of offerings to be included for purposes of § 382 because such offerings
were made to continue basic operations).
(5)
On September 26, 2008, the IRS and
Treasury announced in Notice 2008-78
their intent to issue regulations that
are expected to set forth certain rules
as described in Notice 2008-78.
(a)
Notice 2008-78 provides that a
capital contribution shall not be
presumed to be part of a plan for
purposes of section 382(l)(1)(A)
solely as a result of having been
364
made during the two-year period
ending on the change date.
Instead, the determination of
whether a capital contribution is
part of a plan a principal purpose
of which is to avoid or increase
any limitation under section 382
generally shall be made under all
the facts and circumstances.
(b)
Notice 2008-78 provides four safe
harbors under which a capital
contribution will not be
considered part of a plan:
i)
The first safe harbor
includes contributions made
by a person who is neither a
controlling shareholder nor a
related person where no more
than 20% of the total value
of the loss corporation's
outstanding stock is issued
in connection with the
contribution, the ownership
change occurs more than six
months after the
contribution, and there was
no agreement, understanding,
arrangement, or substantial
negotiations at the time of
the contribution regarding a
transaction that would result
in an ownership change.
ii)
The second safe harbor
includes contributions made
by a related party, but only
where no more than 10% of the
total value of the loss
corporation's outstanding
stock is issued, the
ownership change occurs more
than one year after the
contribution, and there was
no agreement, understanding,
arrangement, or substantial
365
negotiations at the time of
the contribution regarding a
transaction that would result
in an ownership change.
iii) The third safe harbor
includes contributions made
in exchange for stock issued
in connection with the
performance of services, or
stock acquired by a
retirement plan, under the
terms and conditions of
Treas. Reg. § 1.355-7(d)(8)
or (9), respectively.
iv)
(c)
(6)
The fourth safe harbor
includes contributions
received on the formation of
a loss corporation (unless
accompanied by the
incorporation of assets with
a net unrealized built-in
loss) or before the first
year from which there is a
carryforward of a net
operating loss, capital loss,
excess credit, or excess
foreign taxes (or in which a
net unrealized built-in loss
arose).
Taxpayers may rely on the rules
provided in Notice 2008-78 in
determining whether a capital
contribution is part of a plan
with respect to an ownership
change that occurs in any taxable
year ending on or after September
26, 2008.
On October 14, 2008, the IRS and
Treasury announced guidance in Notice
2008-100 regarding the application of
section 382 to loss corporations whose
instruments are acquired by Treasury
under the Capital Purchase Program
366
pursuant to Emergency Economic
Stabilization Act of 2008 (P.L. 110343).
e.
(7)
On January 30, 2009, the IRS and
Treasury amplified and superseded
Notice 2008-100 with Notice 2009-14,
which provided additional guidance to
corporations whose instruments are
acquired by Treasury under the Troubled
Asset Relief Program.
(8)
On April 13, 2009, the IRS and Treasury
amplified and superseded Notice 2009-14
with Notice 2009-38. In Notice 200938, the IRS and Treasury announced that
for purposes of section 382(l)(1), any
capital contribution made by Treasury
pursuant to the Emergency Economic
Stabilization Act of 2009 programs
shall not be considered to have been
made as part of a plan a principal
purpose of which was to avoid or
increase any section 382 limitation.
(9)
On December 11, 2009, the IRS and
Treasury amplified and superceded
Notice 2009-38 with Notice 2010-2. In
Notice 2010-2, the IRS and Treasury
added guidance on the section 382
treatment of stock sold by Treasury to
public shareholders. The Notice
provides that, if Treasury sells stock
that was issued to it under any of the
Emergency Economic Stabilization Act
programs (either directly or upon the
exercise of a warrant), and the sale
creates a public group, the new public
group’s ownership in the issuing
corporation will not be considered to
have increased solely as a result of
the sale. See part IX., below.
Conversions of debt
(1)
The ABA proposal would provide an
exception for the conversion of "old
367
and cold" debt into equity. See ABA
proposal cited above at Part III.C.
(2)
f.
The statute does not make such an
exception, and the conference report is
silent on the matter. Failure to provide such an exception in the regulations would likely hurt the closely
held corporation.
Adjustment to value
Section 382(1)(1)(A) merely provides that if
a capital contribution is treated as part of
a prohibited plan, such contribution "shall
not be taken into account" for purposes of
section 382. However, no guidance is provided as to the meaning of "shall not be
taken into account."
2.
(1)
Does this mean that the value of the
loss corporation stock would be reduced
by the value of the contributed property either at the time of contribution
or at the change date?
(2)
How will a contribution of cash be
taken into account if the loss corporation uses the cash to purchase assets
that subsequently appreciate in value?
(3)
If the contributed property is incomeproducing property, will the earnings
generated from the property (and
retained in the business) also be taken
into account?
Nonbusiness Assets
Under section 382(1)(4), the value of the old
loss corporation may be reduced if it holds "substantial nonbusiness assets" immediately after
the ownership change.
a.
Definitions
(1)
"Nonbusiness assets" are defined as
assets held for investment. Section
368
382(1)(4)(C). "Substantial" means onethird of the total value of all assets.
See section 382(1)(4)(B)(i).
b.
(2)
The conference report provides that
assets held as an integral part of the
conduct of a trade or business will not
be considered to be nonbusiness assets
(e.g., assets used to fund life insurance reserves).
(3)
Determining whether particular assets
are held for investment will be difficult. For example, assets retained for
working capital needs should not constitute investment assets. However,
will a Bardahl type formula be used to
determine the amount needed for working
capital? Cf. section 537 and Treas.
Reg. § 1.537-1.
Look-through rule
Under section 382(1)(4)(E), the ownership of
stock or securities in any "subsidiary corporation" is disregarded. The parent corporation will be treated as owning its ratable
share of the subsidiary's assets.
c.
(1)
For this purpose, a corporation is
treated as a subsidiary if the parent
owns 50 percent or more of the combined
voting power of all classes of stock
and 50 percent or more of the total
value of shares of all classes of
stock.
(2)
Under this rule, only stock or securities in a subsidiary are ignored.
Intercompany receivables from, and
loans on open account to, the controlled subsidiary would not be disregarded.
Reduction in value
If a corporation holds substantial nonbusiness assets immediately after an ownership
369
change, the value of the loss corporation
will be reduced by the excess of the fair
market value of the nonbusiness assets over
the "nonbusiness asset share" of the loss
corporation's indebtedness. Section
382(1)(4)(A). See Berry Petroleum, supra,
for an example where an asset changes from a
business asset immediately before an ownership change to a non-business asset immediately after an ownership change; LTR
9630038.
(1)
The "nonbusiness asset share" of the
loss corporation's indebtedness is
determined by using the ratio of the
fair market value of nonbusiness assets
to the total fair market value of all
the assets. See section 382(1)(4)(D).
The net effect of this calculation is
to subtract from the net value of the
loss corporation (i.e., the stock
value) the net value of nonbusiness
assets.
(2)
Apparently, all of the loss corporation's liabilities are to be considered
in making this determination.
(3)
The calculation presumes that a loss
corporation's assets are carried
equally by its debt. Thus, distortions
may occur.
(a)
For example, where business assets
are leveraged, the above calculation will assign a portion of the
debt to the nonbusiness assets,
thereby improperly reducing the
amount of the reduction in the
loss corporation's value.
(b)
The converse holds true where
specific nonbusiness assets are
leveraged. In this latter case,
the debt would be allocated to
business assets pro rata with the
370
result that the corporation's
value is overly reduced.
d.
3.
Purpose of the rule
(1)
Most commentators, and even Treasury,
agree that the nature of the loss corporation's assets are irrelevant under
the neutrality concept. Under
neutrality, the level of earnings are
relevant, not the type of asset which
produced those earnings.
(2)
However, Treasury felt that where a
corporation held substantial investment
assets, a reduction in value was
required to prevent a "perception
problem." That is, if limitations were
not placed on a loss corporation that
holds "substantial nonbusiness assets,"
the appearance of "loss trafficking"
would result. See House Report at 259.
See also Senate Report at 233.
Interrelationship of Provisions
a.
It is unclear how the rules relating to
built-in gains and losses, capital contributions and nonbusiness assets interrelate.
b.
It appears that these provisions may overlap
each other. To illustrate, suppose A contributes substantially appreciated securities to L one day before an ownership change
occurs in order to increase the amount of
the section 382 limitation.
(1)
The contribution of the securities
should constitute a tainted capital
contribution, which (presumably) would
result in a reduction in L's value for
section 382 purposes under section
382(1)(1).
(2)
In addition, if such appreciated securities constitute (or cause L to possess) substantial nonbusiness assets, a
371
further reduction in L's value may be
possible under section 382(1)(4).
c.
E.
(3)
In other words, the contribution of
appreciated property may twice reduce
L's value, thus twice reducing the section 382 limitation. If L sells the
securities at a gain after the change
date, the section 382 limitation might
be increased but only if -- and to the
extent that -- L has a net unrealized
built in gain under section
382(h)(1)(A).
(4)
Note, however, that the increase in the
section 382 limitation for recognized
built in gains applies only for the
post-change year that includes the
sale, while the double reduction in L's
value affects the section 382 limitation applicable for all post-change
years.
The statute does not contain any explicit
guidance as to whether one provision takes
precedence over another.
(1)
The conference report only indicates
that regulations in the capital contributions area may consider the existence
of substantial nonbusiness assets. See
Conf. Rep. at II-189.
(2)
The exact meaning of this statement is
unclear, but it implies that the effect
of double counting on the computation
of the section 382 limitation will be
eliminated through regulations.
Continuity of Business Enterprise Requirement
Section 382(c) imposes upon the new loss corporation
the continuity of business enterprise (COBE) requirement applicable under section 368.
1.
In General
372
a.
b.
c.
A stricter business continuation test
applied under old section 382(a). Under old
section 382(a)(1)(C), a loss corporation had
to continue "a trade or business substantially the same" as that conducted before
the change in ownership.
(1)
The determination of whether a trade or
business was "substantially the same"
became very subjective. Under the
regulations, factors such as changes in
the loss corporation's location,
employees, product, plant, or equipment
had to be examined. See, e.g., Treas.
Reg. § 1.382-1A(h)(5). In addition, a
discontinuation of "more than a minor
portion" of the business could also
violate the test. See Treas. Reg. §
1.382-1A(h)(7).
(2)
Old section 382(a)(1)(C) resulted in
much litigation and planning uncertainty. The test hindered prudent
business decisions and encouraged the
retention of uneconomic businesses.
The conference report provides that the section 382(c) test is the same as that under
Treas. Reg. § 1.368-1(d). See Conf. Rep. at
II-189.
(1)
The COBE requirement applicable under
section 368 is a more liberal standard.
(2)
Under this standard, the new loss corporation must retain a significant portion of the old loss corporation's historic business or assets. See Treas.
Reg. § 1.368-1(d). A new loss corporation may discontinue or dispose of an
old loss corporation's historic business and still satisfy the COBE
requirement. See Berry Petroleum v.
Commissioner, supra.
This provision in effect extends a reorganization requirement to all ownership changes,
even those that fall outside section 368.
373
2.
Consequences of Failing the Test
a.
In general
Section 382(c)(1) states that if the new
loss corporation does not continue the business enterprise of the old loss corporation
at all times during the two year period
beginning on the change date, then the new
loss corporation's section 382 limitation
shall be zero. In other words, pre-change
NOL's will be disallowed entirely if this
requirement is not met. See LTR 8949065.
b.
(1)
For example, assume that P acquires all
of the L stock in a transaction that
constitutes an ownership change.
Within two years after the acquisition,
L sells its assets to an unrelated
buyer for cash.
(2)
If the sale of assets violates the COBE
requirement, L's NOL carryovers will be
lost. In addition, if the sale does
not violate the COBE requirement, any
loss on the sale of assets may constitute a "built-in" loss.
Exception
Section 382(c)(2) provides an exception to
the total disallowance rule.
(1)
Under section 382(c)(2), the section
382 limitation for any post-change year
will not be less than:
(a)
the increase for built-in gains
(as provided in section
382(h)(1)(A));
(b)
the increase for section 338 gain
(as provided in section
382(h)(1)(C)); and,
(c)
any carryover for the unused portion of the section 382 limitation
pertaining to the above two items.
374
(2)
3.
For example, assume a loss corporation
has a net unrealized built-in gain of
$100 (which exceeds the threshold). In
the first year after the ownership
change, L violates the COBE requirement
by selling all of its assets for a gain
of $100.
(a)
Under the House version of H.R.
3838, it was unclear whether L
could offset its $100 gain with
its pre-change losses. That is,
it was unclear whether section
382(c) took precedence over section 382(h)(1)(A). If it did, the
pre-change losses would be eliminated without being allowed to
offset the recognized built-in
gains.
(b)
Section 382(c)(2) clarifies this
by allowing L to offset its recognized built-in gain with prechange losses. Under section
382(c)(2), L may increase the section 382 limitation by $100, thus
allowing the recognized built-in
gain of $100 to be fully offset by
L's NOL carryover.
Purpose of the Rule
a.
In justifying the inclusion of the COBE
requirement, the House report states that
the ongoing business enterprise is an essential element of a corporation's identity.
See House Report at 260.
(1)
This statement appears to be an attempt
to interject Libson Shops-type principles into present section 382.
(2)
One can argue that a corporation's
"identity" is best reflected by the
identity of its shareholders, not its
asset pool.
375
b.
4.
Section 382(c) might be better understood as
a complement to the nonbusiness asset rules
found in section 382(1)(4).
(1)
If a corporation liquidates its assets
prior to the ownership change, section
382(1)(4) will operate to reduce the
section 382 limitation.
(2)
Without section 382(c), a loss corporation could avoid these rules by selling
its assets shortly after the ownership
change without a resulting adjustment
to the section 382 limitation. So long
as the corporation's assets were
retained until after the ownership
change, "trafficking" in shell corporations could continue.
(3)
For example, in Alprosa Watch Corporation v. Commissioner, 11 T.C. 240
(1948), a taxpayer purchased the stock
of a loss corporation, sold its assets
back to the original shareholders, and
contributed new assets to the
corporation. The Tax Court allowed the
NOL carryovers from the old business to
offset income generated by the new
assets. This case received much
notoriety, and was cited in the House
report. See House Report at 256.
(4)
Thus, it appears that section 382(c) is
an attempt to provide consistency with
respect to asset sales on either side
of the change date.
Objections to the Rule
Serious objections to the COBE requirement have
been voiced.
a.
Imposing a business continuity rule contravenes the neutrality principle for two
reasons.
(1)
First, neutrality dictates that tax
considerations should not influence
376
business decisions. However, the
presence of this continuity requirement
encourages the retention of historic,
but uneconomic, businesses or assets.
(2)
Second, neutrality states that NOL
carryovers should have the same value
to the new owners as to the old owners.
NOL carryovers obviously have a lower
value to the new owners if the section
382 limitation is zero.
b.
In addition, the new owners may use the
business continuity requirement to obtain a
lower price for the loss corporation stock,
thereby producing a windfall when the NOL
carryover is ultimately realized.
c.
The addition of the COBE requirement imports
unwelcome uncertainty into the section 382
arena. Since the test is applied on a facts
and circumstances basis, it is never clear
whether the test is satisfied given a particular set of facts. See Treas. Reg. §
1.368-1(d). Moreover, it may be possible
that the requirement will be applicable
under section 382, even though it would not
apply to the underlying reorganization.
(1)
For example, the Service has ruled that
the COBE requirement does not apply to
an "E" reorganization. See Rev. Rul.
82-34, 1982-1 C.B. 59. It seems likely
that, for section 382 purposes, it will
apply to an "E" reorganization.
(2)
Also, the Service has ruled that the
COBE requirement applies only with
respect to the transferor's business.
See Rev. Rul. 81-25, 1981-1 C.B. 132.
(a)
Thus, the transferee's business
may be completely terminated without violating the COBE requirement.
(b)
In a section 382 setting, it seems
likely that the requirement never377
theless will apply to the transferee where the transferee is the
loss corporation.
d.
F.
Finally, discontinuities exist in the treatment of asset sales before and after the
change date.
(1)
Under section 382(1)(4), one-third of a
loss corporation's assets may be sold
prior to the change date. Under the
COBE requirement, two-thirds of a loss
corporation's assets may be sold after
the change date. See Treas. Reg. §
1.368(a)-1(d).
(2)
In addition, if section 382(1)(4) is
triggered, the loss corporation's value
is only reduced by the excess of the
nonbusiness assets over the allocated
liabilities, i.e., no cliff effect.
However, if the COBE requirement is not
met, the NOL carryover is lost
entirely.
(3)
These are the types of discontinuities
which led to the revisions in old section 382.
Consequences of an Ownership Change -- Application
1.
General Operation of Section 382
a.
Fact pattern
A owns all of the stock of L. L has a NOL
carryover from 1985 of $1,000,000. On June
30, 1988, A sells all of his L stock to B
for $500,000 in a transaction which constitutes an ownership change (L's year remains
open). For 1988, L had taxable income of
$100,000. L is a calendar-year taxpayer.
The highest published tax rate for the 3
month period ending in June was 10 percent.
b.
In general, the taxable income of the new
loss corporation (L) for any post-change
year may be offset by pre-change losses only
378
to the extent of the section 382 limitation.
Section 382(a).
c.
d.
(1)
L's taxable year ended December 31,
1988, constitutes a post-change year.
See section 382(d)(2).
(2)
L's NOL carryover from 1985 constitutes
a pre-change loss. See section
382(d)(1)(i).
(3)
B believes, and the facts support his
conclusion, that the fair market value
of the L stock is $500,000 -- the price
paid by B. Therefore, the section 382
limitation is $50,000 (value ($500,000)
times applicable rate (10 percent)).
See section 382(b)(1).
(4)
In a normal post-change year (i.e., a
full 365-day year), L could offset up
to $50,000 of taxable income by L's
pre-change NOL carryover of $1,000,000.
However, for the year 1988, special rules
apply since 1988 is a post-change year which
includes the change date. Under section
382(b)(3)(A), L's taxable income must be
allocated to the periods January 1, through
June 30, inclusive, and July 1, through
December 31, 1988.
(1)
Under section 382(b)(3)(A) income is
allocated on a daily pro rata basis.
(2)
Thus, the income allocated to the prechange date period is $50,000 (1/2 of
$100,000). This income may be fully
offset by pre-change losses.
In addition, for the year 1988, the section
382 limitation must also be pro rated. This
amount, as with taxable income, is allocated
on a daily pro rata basis. See section
382(b)(3)(B). Thus, L's section 382 limitation for 1988 is $25,000 (one half of
$50,000).
379
e.
2.
Thus, for the year 1988, L may offset
$75,000 ($50,000 (income not subject to
limitation) plus $25,000 (the prorated section 382 limitation)) of its total $100,000
income by the 1985 NOL carryover.
Built-in Gains
a.
Fact pattern
On December 31, 1987, P acquires all of the
L stock in a transaction that constitutes an
ownership change. L's balance sheet as of
December 31, 1987, includes the following
assets:
Value
Basis
Gain (Loss)
Cash
10
10
0
Land
200
100
100
Building
500
250
250
Machinery
50
70
(20)
Inventory
0
80
(80)
250
b.
As of the change date, L has an actual net
unrealized built-in gain of $250. For section 382 purposes, the threshold requirement
has been met ($250/$750 = 33 percent).
Therefore, L's net unrealized built-in gain
is not treated as being zero.
c.
On July 1, 1988, L sells the machinery and
inventory for $50. The resulting loss of
$100 is not subject to limitations under
section 382. L must first have a net unrealized built-in loss before limitations will
apply. See section 382(h)(1)(B)(i).
d.
During the recognition period, the land
appreciates in value to $300. L sells the
land on July 1, 1990, for a total gain of
$200.
380
e.
(1)
L's recognized built-in gain is only
$100--the extent of the gain as of the
change date. See section 382(h)(2)(A).
(2)
Thus, L may increase its section 382
limitation only by that amount. See
section 382(h)(1)(A)(i).
(3)
The remaining gain is blended with L's
other taxable income to be offset by
pre-change losses only to the extent
permitted under section 382.
On July 1, 1991, L sells the building at a
gain of $250.
(1)
The full amount of the gain ($250) constitutes recognized built-in gain. See
section 382(h)(2)(A).
(2)
However, L may only increase its section 382 limitation by $150 (total net
un-realized built-in gain ($250) less
previously recognized built-in gain
($100)).
VII. BANKRUPT CORPORATIONS AND TROUBLED THRIFT INSTITUTIONS
The statute provides a separate (and mutually exclusive) set of limitations for ownership changes that
occur in a Title 11 or similar proceeding (e.g., pursuant to a section 368(a)(1)(G) reorganization or a
stock-for debt exchange).
A.
Section 382(l)(5)
1.
Under section 382(l)(5)(A), these alternative
limitations on NOL carryovers apply after an ownership change of a loss corporation if:
a.
such corporation was under the jurisdiction
of a bankruptcy court immediately before the
ownership change, and
b.
the corporation's shareholders and creditors
(determined immediately before the ownership
change) own at least 50 percent (both in
vote and in value) of the loss corporation's
381
stock immediately after the ownership
change.
2.
TAMRA amended section 382(l)(5)(A) to clarify
that the shareholders and creditors must own at
least 50 percent of the corporation's stock as a
result of being shareholders and creditors
immediately before the ownership change. Thus,
stock received by a former shareholder for new
consideration (e.g., guarantee) would not be
taken into account, nor would stock purchased
from other shareholders.
3.
Creditors who receive stock in exchange for their
claims will be treated as continuing shareholders
only to the extent that: (1) their claims were
held for 18 months before the date in which the
bankruptcy case was filed, or (2) the claim arose
in the ordinary course of the loss corporation's
trade or business. Section 382(l)(5)(E). See
LTR 8902047. TAMRA clarified that stock received
by such a qualified creditor is taken into
account only to the extent such stock was
received in exchange for qualified debt (for the
definition of a qualified creditor, see Part
VII.B). Stock received by a guarantor as a
result of being subrogated to the rights of a
qualified creditor is counted toward the 50-percent requirement so long as the principal purpose
of the guarantee was not to avoid section
382(l)(5)(E). LTR 9012039.
a.
In September 1991, the Service and Treasury
issued proposed regulations (1991-2 C.B.
909) on whether indebtedness will be treated
as held by a qualified creditor within the
meaning of section 382(l)(5)(E). The
September 1991 proposed regulations contained special rules intended to simplify
the tracking of holders of widely held
indebtedness. These regulations (1993-1
C.B. 594) were re-proposed in May 1993 in
favor of a simpler version, which generally
eliminated tracking for de minimis holders
(regardless of whether the debt was deemed
to be widely held). The May 1993 proposed
regulations will be effective on or after
382
the date the regulations are issued in final
form.
4.
b.
The Service and Treasury have also indicated
that they will issue regulations which will
treat the holders of section 1504(a)(4) preferred stock as creditors for purposes of
section 382(l)(5)(E). Notice 88-57, 1988-1
C.B. 545. To date, no such regulations have
been issued.
c.
The service has indicated that if a company
transfers its stock to a trust owned by
various creditors, the stock will be treated
as owned by the beneficiaries of the trust
in proportion to their respective interests
in such trust. LTR 9619051 and LTR 9603006.
This rule applies whether or not the beneficiaries of the trust are identifiable at the
time of the transfer. Id.
d.
The Service prohibited a taxpayer from
benefiting from section 382(l)(5) when a
transaction in form might support
application of section 382(l)(5), but the
economic reality of the transaction does
not. See ILM 200915033.
Section 382(l)(5) Option Attribution
a.
Solely for purposes of determining whether
the 50 percent stock ownership requirement
of section 382(l)(5)(A)(ii) is met, stock
that is subject to an option is treated as
acquired if it would result in the 50 percent test being failed. Treas. Reg. §
1.382-9(e)(1). For purposes of Treas. Reg.
§ 1.382-9(e)(1), the following rules similar
to the option attribution rules of Treas.
Reg. § 1.382-2T apply:
(1)
The rules of Treas. Reg. § 1.3822T(h)(4)(iii) relating to contingencies;
(2)
The rules of Treas. Reg. § 1.3822T(h)(4)(iv) relating to a series of
options;
383
(3)
The rules of Treas. Reg. § 1.3822T(h)(4)(v) relating to interests that
are similar to options;
(4)
The rules of Treas. Reg. § 1.3822T(h)(4)(vii) relating to the effect of
a deemed issuance or redemption on the
amount of L's outstanding stock;
(5)
Various exceptions from the option rule
described in Treas. Reg. § 1.3822T(h)(4)(x):
(a)
Long-held options with respect to
actively traded stock, Treas. Reg.
§ 1.382-2T(h)(4)(x)(A));
(b)
Options providing the holder with
a right to receive or obligation
to issue a fixed dollar amount of
stock upon maturity of certain
debt, Treas. Reg. § 1.3822T(h)(4)(x)(B), except with
respect to a debt instrument that
was issued after the filing of a
title 11 or similar case;
(c)
Options exercisable only upon
death, disability, or mental
incompetency, Treas. Reg. § 1.3822T(h)(4)(x)(D);
(d)
Options providing the holder with
the right to receive or obligation
to issue stock as interest or
dividends, Treas. Reg. § 1.3822T(h)(4)(x)(E), except for a right
on a debt instrument or stock
issued after the filing of a title
11 or similar case;
(e)
Options providing the holder with
a right to acquire L stock pursuant to a default under a loan
agreement, Treas. Reg. § 1.3822T(h)(4)(x)(G);
384
(f)
Agreements to acquire or sell
stock owned by certain shareholders, Treas. Reg. § 1.3822T(h)(4)(x)(H);
(g)
Options to be designated in the
Internal Revenue Bulletin, Treas.
Reg. § 1.382-2T(h)(4)(x)(Z).
b.
The final option attribution rules, which
limit the deemed exercise of options to
those instances where they are issued or
transferred for an abusive principal purpose, do not apply to the option attribution
rules of Treas. Reg. § 1.382-9(e). Preamble
to Prop. Treas. Reg. § 1.382-4(d), 1992-2
C.B. at 608. The commentators have recommended that the proposed option attribution
rules should apply. Sidley & Austin Urges
Conforming Changes to Stock Ownership Rules,
93 TNT 153-15 (July 2, 1993); New York State
Bar Association, Report on Proposed Section
382 Option Attribution Rules, 93 TNT 94-101
(April 26, 1993) (Recommendation O).
c.
Effective date
These option attribution rules are effective
for ownership changes occurring on or after
September 5, 1990 (except that Treas. Reg.
§ 1.382-2T(h)(4)(x)(E) will apply to postpetition debt instruments and stock issued
prior to April 8, 1992). Treas. Reg.
§ 1.382-3(e)(4).
d.
Examples of the general rule
(1)
Pursuant to a bankruptcy court order, L
cancels all of its existing L stock,
issues 100 shares of new L stock to
qualified creditors, and issues an
option to a new investor to acquire 90
shares of new L stock at fair market
value on the date the plan becomes
effective. Under Treas. Reg. § 1.3829(e)(1), the option held by the new
investor is not deemed exercised since
the deemed exercise of the option would
385
not cause the qualified creditors of L
to own less than 50 percent of the L
stock after the ownership change. As a
result, the ownership change qualifies
for section 382(l)(5). Treas. Reg.
§ 1.382- 9(e)(3) (Ex. (1)).
e.
(2)
The facts are the same as in the example above, except that L issues an
option to the new investor to acquire
110 shares of new L stock. Under
Treas. Reg. § 1.382-9(e)(1), this
option is deemed exercised on the date
the plan becomes effective because the
deemed exercise causes the qualified
creditors to own only 100 of 210 shares
of the new L common stock (approximately 48 percent). As a result, the
ownership change does not qualify for
section 382(l)(5). Treas. Reg. §
1.382-9(e)(3) (Ex. (2)).
(3)
The facts are the same as in Example
(2), except that L also issues an
option to the qualified creditors to
acquire 100 shares of new L stock on
the date the plan becomes effective.
Under Treas. Reg. § 1.382-9(e)(1), this
option is not deemed exercised because
the deemed exercise would allow the
qualified creditors to own at least 50
percent of L's stock (200 shares out of
310). As a result, the ownership
change again does not qualify for section 382(l)(5).
Special rules taking into account subsequent
events (lapses and actual exercises)
(1)
Lapse or forfeiture
(a)
L generally may apply rules similar to Treas. Reg. § 1.3822T(h)(4)(viii). Treas. Reg. §
1.382-9(e)(2)(i). In other words,
if the option lapses or is irrevocably forfeited, the option will
386
be treated as if it had never been
issued.
(b)
(2)
(3)
However, L may not apply this
lapse or forfeiture rule with
respect to an option to the extent
any person owning the option
acquires, on or after the change
date until on or before the lapse
or forfeiture date, additional
stock or another option to acquire
additional stock. Treas. Reg.
§ 1.382-9(e)(2)(i).
Actual exercise
(a)
If an option was not deemed exercised under Treas. Reg. § 1.3829(e)(1), a loss corporation may
nonetheless treat the option as
stock if stock was actually
acquired pursuant to the option.
Treas. Reg. § 1.382-9(e)(2)(ii).
(b)
However, this actual exercise rule
applies only if the option is
actually exercised within the 3
years of the ownership change by
the 5-percent shareholder who, as
a result of being a pre-change
shareholder or qualified creditor,
acquired the option under the
plan. Treas. Reg. § 1.3829(e)(2)(ii).
Amended returns
L may file an amended return for a
prior taxable year (subject to any
applicable statute of limitations) if L
determines that section 382(1)(5)
applies to an ownership change as a
result of the lapse or forfeiture rule
or the actual exercise rule described
above. However, if L chooses to amend
its return, L must make corresponding
adjustments on amended returns for all
387
affected taxable years (subject to any
applicable statute of limitations).
(4)
Examples of the special rules
(a)
Pursuant to a bankruptcy court
order, L cancels all of its existing L stock and issues 100 shares
of new L stock to qualified creditors. In addition, L issues 5year options to the qualified
creditors to acquire an additional
50 shares of L stock from L, and L
issues a 5-year option to a new
investor to acquire 110 shares
from L. Under Treas. Reg.
§ 1.382-9(e)(1), the option held
by the new investor is deemed
exercised on the change date (and
the option held by the qualified
creditors are not deemed exercised
on the change date) because this
treatment of the options causes
the qualified creditors of L to
own less than 50 percent of the L
stock after the ownership change
(100 of 210 shares or approximately 48 percent). As a result,
section 382(l)(5) does not apply
to the ownership change. Treas.
Reg. § 1.382-9(e)(3) (Ex. (3)(b)).
(b)
The facts are the same as in Example (a) except that the qualified
creditors actually exercise their
options (issued pursuant to the
plan of reorganization) to purchase 30 additional shares during
the 3 year period after the plan
becomes effective. Under Treas.
Reg. § 1.382-9(e)(2)(ii), L may
take into account the 30 shares
purchased for purposes of the 50
percent stock ownership requirements of section 382(1)(5)(A)(ii).
If L takes such purchases into
account, the qualified creditors
388
of L are deemed to own more than
50 percent of the L stock after
the ownership change (130 of 240
shares or approximately 54
percent). As a result, section
382(l)(5) applies to the ownership
change. Treas. Reg. § 1.3829(e)(3) Ex. (3)(c)).
(c)
The facts are the same as in Example (a), except that the qualified
creditors acquire 30 additional
shares by exercise of options more
than 3 years after the plan
becomes effective. Under this
scenario, the acquisition of the
30 shares is not taken into
account. As a result, section
382(l)(5) does not apply to the
ownership change. Treas. Reg.
§ 1.382-9(e)(3) (Ex. (3)(d)).
(d)
The facts are the same as in Example (a) except that during the 3
year period after the plan becomes
effective, the new investor exercises part of his option and purchases 105 shares of stock. The
exercise causes a lapse of the
rights to acquire the remaining 5
shares of stock. Also during that
time, the qualified creditors
exercise part of their options and
acquire 6 additional shares of
stock. Under Treas. Reg. § 1.3829(e)(2)(i), L may treat the lapse
as if the options to acquire 5
shares were never issued to the
new investor. Also, under Treas.
Reg. § 1.382-9(e)(2)(ii), L may
take into account the 6 shares
purchased by the qualified creditors through the exercise of their
options. As a result, the qualified creditors are deemed to own
more than 50 percent of L's stock
after the ownership change (106 of
389
211 shares or approximately 50.2
percent) and section 382(1)(5)
applies to the ownership change.
Treas. Reg. § 1.382-9(e)(3) (Ex.
(3)(d)).
(e)
5.
The facts are the same as in Example (d), except that Investor
acquires 5 shares of L stock from
the qualified creditors sometime
after the ownership change but
before Investor's option to
acquire 5 shares lapses. Under
Treas. Reg. § 1.382-9(e)(2)(ii),
because of the acquisition of the
5 shares of L stock, Investor must
be treated as if it acquired 110
shares of L stock on the ownership
change date. As a result, the
qualified creditors are deemed to
own less than 50 percent of L's
stock immediately after the ownership change (106 of 216 shares or
approximately 49 percent), and
section 382(1)(5) does not apply
to the ownership change.
If the alternate set of limitations contained in
section 382(l)(5) applies to a bankruptcy reorganization, the NOL carryovers would be subject
to reduction.
a.
First, if the claims of creditors discharged
in bankruptcy exceed the value of the stock
(of the loss corporation or acquiring corporation, as the case may be) transferred to
creditors, the NOL carryovers would be
reduced by 50 percent of such excess. See
section 382(l)(5)(C).
(1)
TAMRA clarified that the amount of the
reduction is 50 percent of the amount
that would have reduced section 108(b)
tax attributes but for section
108(e)(10)(B) (i.e., the excess of the
amount of canceled debt over the fair
390
market value of the stock issued in
satisfaction of the debt).
(2)
6.
TAMRA also clarified that the amount of
debt outstanding does not include previously accrued but unpaid interest
that is deducted from NOL carryovers
under section 382(l)(5)(B) (see paragraph b. below).
b.
Second, the NOL carryovers would be reduced
by the amount of any interest on indebtedness that was converted to stock in the proceeding and paid or accrued during the
period beginning on the first day of the
third taxable year preceding the taxable
year in which the ownership change occurs
and ending on the change date. Section
382(l)(5)(B). See FSA 200006004 (stating
that tax attributes must be reduced by
prechange interest regardless of whether the
corporation incurred any NOLs during the
prechange period). The underlying rationale
of section 382(l)(5)(B) is that the
creditors are the true stockholders;
therefore, payments to them cannot be
deductible interest.
c.
Third, after an ownership change that qualifies for the bankruptcy exception, a second
ownership change during the following two
year period will result in elimination of
the NOL carryovers that arose before the
first ownership change. Section
382(l)(5)(D).
d.
LTR 200751011 ruled that section
382(l)(5)(D) does not operate to limit the
amount of pre-change NOLs that a taxpayer
can carry forward to the period between the
first and second ownership changes with
respect to a bankruptcy reorganization
involving two ownership changes.
This alternate set of limitations applies in lieu
of the general limitations. Thus, the limitations on earnings and the continuity of business
391
enterprise requirement do not apply to an ownership change that qualifies for the bankruptcy
exception. See Treas. Reg. § 1.382-3(m). But
see Treas. Reg. § 1.269-3(d) (corporation must
carry on more than an insignificant amount of an
active trade or business or an acquisition will
be considered to have been made for the prohibited purpose under section 269).
B.
a.
The taxpayer may elect not to have the bankruptcy limitations apply. See section
382(l)(5)(H); LTR 9005049.
b.
In this case, the general limitations would
apply. Under section 382(l)(6), the value
of the new loss corporation would be the
value immediately after the ownership
change. TAMRA clarified that such value
would reflect any increase in value resulting from the surrender or cancellation of
creditors' claims.
The Section 382(l)(5) Final Regulations
1.
Definition of Qualified Creditors
a.
Conceptual framework
As stated above, in order for section
382(l)(5) to apply to an ownership change,
at least 50 percent of L's stock must be
owned by pre-change shareholders and qualified creditors immediately after the ownership change. Section 382(l)(5)(A)(ii).
Under section 382(l)(5)(E), a creditor is a
qualified creditor to the extent that the
debt exchanged by the creditor: (i) was
held by such creditor at least 18 months
before the date of the filing of the title
11 or similar case, or (ii) arose in the
ordinary course of the trade or business of
L before the ownership change and is held by
a person who at all times held the beneficial interest in such indebtedness.
392
b.
General rules of the final regulations
(1)
For purposes of section
382(l)(5)(A)(ii), a qualified creditor
owns stock of L as a result of being a
qualified creditor only to the extent
that the qualified creditor receives
stock in full or partial satisfaction
of "qualified indebtedness" pursuant to
a transaction or plan that is approved
by an order of the court in a title 11
or similar case. For purposes of this
rule, ownership of stock is determined
without applying the constructive ownership rules of section 382(1)(3)(A) or
the option attribution rules of Treas.
Reg. § 1.382-2T(h). Treas. Reg. §
1.382-9(d)(1).
(2)
Under Treas. Reg. § 1.382-9(d)(2)(i),
indebtedness of L is qualified indebtedness if:
(3)
(a)
It has been owned by the same
"beneficial owner" since 18 months
before the date of the filing of
the title 11 or similar case; or
(b)
It arose in the ordinary course of
the trade or business of the loss
corporation (i.e., "ordinary
course indebtedness") and has been
owned at all times by the same
"beneficial owner."
In determining whether indebtedness is
qualified indebtedness for purposes of
the above tests:
(a)
Beneficial ownership of indebtedness is determined without applying attribution rules. Treas.
Reg. § 1.382-9(d)(2)(ii).
(b)
Ordinary course indebtedness is
indebtedness that is incurred by
the loss corporation in connection
with the normal, usual, or
393
customary conduct of business,
determined without regard to
whether the indebtedness funds
ordinary or capital expenditures
of the loss corporation. Conf.
Rep at II-192; Treas. Reg.
§ 1.382-9(d)(2)(iv). For example,
under Treas. Reg. § 1.3829(d)(2)(iv), indebtedness (other
than indebtedness acquired for a
principal purpose of being
exchanged for stock) arises in the
ordinary course of the loss corporation's trade or business if it
is:
i)
Trade debt;
ii)
A tax liability;
iii) A liability arising from a
past or present employment
relationship, a past or
present business relationship
with a supplier, customer, or
competitor of the loss
corporation, a tort, a breach
of warranty, or a breach of
statutory duty;
(4)
iv)
Indebtedness incurred to pay
a section 162 deductible
expense or included in the
cost of goods sold; or
v)
A claim that arises upon the
rejection of a burdensome
contract or lease pursuant to
the title 11 or similar case
if the contract or lease
arose in the ordinary course
of business.
The preamble to the September 1991
regulations (1991-2 C.B. 912) requested
comments as to whether a creditor
receiving indebtedness should be able
to tack the ownership period of a
394
creditor transferor. The March 1994
final regulations allowed a creditor
transferee to tack the ownership period
of a creditor transferor if there was a
"qualified transfer." Treas. Reg.
§ 1.382-9(d)(5)(i). A transfer is a
qualified transfer if:
(a)
The transfer is between related
parties under section 267(b) or
707(b) (substituting "at least 80
percent" for "more than 50
percent" wherever it appears);
(b)
The transfer is pursuant to a
customary syndication transaction
and occurs within 90 days after
its origination;
(c)
The transfer is by an underwriter
pursuant to an underwriting of
newly incurred debt;
(d)
The transferee's basis in the
indebtedness is determined under
section 1014 or 1015 or with
reference to the transferor's
basis in the indebtedness;
(e)
The transfer is in satisfaction of
a right to receive a pecuniary
bequest;
(f)
The transfer is pursuant to any
section 71(b)(2) divorce or
separation instrument;
(g)
The transfer is pursuant to a
subrogation in which the
transferee acquires a claim
against the loss corporation by
reason of a payment to the
claimant pursuant to an insurance
policy or a guarantee, letter of
credit or similar security
arrangement; or
395
(h)
(5)
(6)
The transfer is a transfer of an
account receivable in a customary
commercial factoring transaction
made within 30 days after the
account arose to a transferee that
regularly engages in such
transactions.
Nevertheless, a transfer of
indebtedness is not a qualified
transfer if the transferee acquired
the indebtedness for a principal
purpose of benefiting from the losses
of L. Treas. Reg. § 1.3829(d)(5)(iii). A transferee is deemed
to receive the benefit of L's losses
by:
(a)
Receiving L's stock in the workout
(the value of which is increased
because of the tax benefits
provided by section 382(l)(5)), or
(b)
Selling the indebtedness at a
profit that reflects the tax
benefits provided by section
382(l)(5).
The final regulations also provide a
tacked holding period for a creditor in
a debt-for-debt exchange with L (These
rules allow the creditor to rely on the
holding period of its old debt).
Treas. Reg. § 1.382-9(d)(5)(iv). Under
these rules, a creditor exchanging old
debt for new debt in an actual or
deemed exchange with L is:
--
Deemed to own the new debt for the
same period of time that the
creditor held its old debt; and
--
The new debt is deemed to be
ordinary course indebtedness if
the old debt was ordinary course
indebtedness.
396
Unlike the qualified transfer rule of
Treas. Reg. § 1.382-9(d)(5)(ii), this
tacked holding period rule does not
contain an anti-abuse exception.
c.
Duty of inquiry
(1)
As a general rule, L must determine
whether its indebtedness satisfies the
ownership period requirements of
section 382(l)(5)(E). In making this
determination, L may rely on a
statement, signed under penalties of
perjury, of a beneficial owner. The
statement should indicate the amount
and length of time that the
indebtedness was held by the beneficial
owner. Treas. Reg. § 1.3829(d)(2)(iii).
(2)
Because the tracking of indebtedness
may be burdensome, especially for
widely held debt, the final regulations
provide an exception to the duty of
inquiry where the amounts are
considered de minimis (i.e., less than
5-percent). The presumption is
especially favorable to taxpayers
because de minimis amounts are
generally presumed to be qualifying
indebtedness.
(3)
Under the regulation, L may generally
treat indebtedness as always having
been owned by a beneficial owner
immediately before the ownership change
(which effectively means that the
indebtedness is qualified indebtedness
held by a qualified creditor for
purposes of section 382(l)(5)(A)(ii)).
However, for this rule to apply, the
beneficial owner, immediately after the
ownership change, must not be either a
5-percent shareholder or an entity
through which a 5-percent shareholder
owns an indirect ownership interest in
397
L (a "5-percent entity"). Treas. Reg.
§§ 1.382- 9(d)(3)(i) and (3)(iii).
(a)
The term 5-percent shareholder is
defined in § 1.382-2T(g), without
regard to the option attribution
rules of section 382(l)(3)(A) or §
1.382-2T(h)(4). Treas. Reg. §
1.382-9(d)(3)(ii)(C).
(b)
If L has actual knowledge
regarding stock ownership
described in § 1.382-2T(k)(2), L
must take this ownership into
account in determining which
beneficial owners of indebtedness
are 5-percent shareholders or 5percent entities immediately after
the ownership change. L is not
required to take into account
Treas. Reg. § 1.382-2T(k)(4)
(ownership interests structured to
avoid the section 382 limitation)
unless L has actual knowledge of
the ownership interest. Treas.
Reg. § 1.382-9(d)(3)(ii)(B).
(c)
If L has actual knowledge of a
coordinated acquisition of its
indebtedness by a group of
persons, (through a formal or
informal understanding among
themselves) for a principal
purpose of exchanging the
indebtedness for stock, the
indebtedness (and any stock
received in exchange therefor) is
treated as owned by an entity. A
principal element in determining
if an understanding exists is
whether the investment decision of
each member is based upon the
investment decision of another
member. Treas. Reg. § 1.3829(d)(3)(ii)(A).
398
(4)
The de minimis presumption of Treas.
Reg. § 1.382-9(d)(3)(i) does not apply
to indebtedness beneficially owned by a
person whose participation in
formulating a plan of reorganization
makes evident to L that the person has
not owned the indebtedness for the
requisite period. Treas. Reg. § 1.3829(d)(3)(i).
(5)
The de minimis presumption of Treas.
Reg. § 1.382-9(d)(3)(i) does not apply
if L has actual knowledge that the
exercise of an option (or an interest
similar to an option under Treas. Reg.
§ 1.382-2T(h)(4)(v)) would cause the
beneficial owner to be a 5-percent
shareholder or 5-percent entity after
the ownership change. Treas. Reg. §
1.382-9(d)(3)(ii)(D).
(6)
Example
L, a corporation in a title 11 case,
issues the following amounts of stock
to its creditors pursuant the
bankruptcy plan:
A
B
C
P1
P2
P3
P4
P5
2.0
7.5
2.5
3.0
10.0
4.9
4.9
4.9
percent
percent
percent
percent
percent
percent
percent
percent
P2 is owned by Public P2. L has actual
knowledge that D owns P3, P4 and P5.
In addition, L has actual knowledge,
immediately after the ownership change,
that C owns an option to acquire newlyissued L stock that would increase C's
percentage ownership of L stock to 8
percent. An ownership change of L
occurs on the date the plan becomes
399
effective. Treas. Reg. § 1.3829(d)(3)(iv) (Ex.).
(a)
L may treat the indebtedness owned
by A and P1 immediately before the
ownership change as always having
been owned by A and P1 under the
de minimis presumption of Treas.
Reg. § 1.382-9(d)(3)(i) because
neither A nor P1 is a 5-percent
shareholder immediately after the
ownership change. Further,
because P1 owns less than 5
percent of the L stock, P1 is
treated as an individual, and the
stock of P1 is not attributed to
any other person. See Treas. Reg.
§ 1.382- 2T(h)(2)(iii).
Therefore, P1 is not a 5-percent
entity.
(b)
The de minimis presumption of
Treas. Reg. § 1.382-9(d)(3)(i)
does not apply to the indebtedness
owned by B because B is a 5percent shareholder immediately
after the ownership change.
(c)
The de minimis presumption of
Treas. Reg. § 1.382-9(d)(3)(i)
does not apply to the indebtedness
owned by C because L has actual
knowledge immediately after the
ownership change that the exercise
of C's option would cause C to be
a 5-percent shareholder. (L does
not take the option into account,
however, for purposes of any other
person because the deemed exercise
would not cause any other person
to be a 5-percent shareholder or a
5-percent entity after the
ownership change).
(d)
The de minimis presumption of
Treas. Reg. § 1.382-9(d)(3)(i)
does not apply to the indebtedness
400
owned by P2 because it is a 5percent entity (a 5-percent
shareholder owns an indirect
ownership interest in L through
P2).
(e)
d.
The de minimis presumption of
Treas. Reg. § 1.382-9(d)(3)(i)
does not apply to the indebtedness
owned by P3, P4, and P5. P3, P4,
and P5 are 5-percent entities
because D, a 5-percent
shareholder, owns an indirect
ownership interest in L through
P3, P4, and P5. Because L has
actual knowledge that D would be a
5-percent shareholder but for the
application of § 1.3822T(h)(2)(iii), that section does
not apply to P3, P4, or P5. See
Treas. Reg. § 1.382-2T(k)(2).
Thus, under § 1.382-2T(h)(2)(i),
the L stock owned by P3, P4, or P5
is attributed to D, and D is a 5percent shareholder.
Effect of a creditor ownership change where
the indebtedness represents a large portion
of the creditor's assets
(1)
As a general rule, qualification for
section 382(l)(5) is not affected by
changes in the stock ownership of a
creditor. Stated another way, there is
no attribution rule which would
attribute an ownership shift of a
creditor's stock to a shift in
ownership with respect to the debt of L
held by the creditor.
(2)
Special rules apply to prevent the
creation of special purposes entities
to hold corporate indebtedness. Thus,
the stock of such corporations cannot
be sold without adversely affecting L's
ability to qualify under section
382(l)(5). Preamble to the May 1993
401
Proposed Regulations, 1993-22 I.R.B. at
15.
(3)
Under this anti-avoidance rule
prescribed by Treas. Reg. § 1.3829(d)(4), indebtedness is not qualified
indebtedness if -(a)
The beneficial owner of the
indebtedness is a corporation or
other entity that had an ownership
change on any day during the
applicable period (i.e., within 18
months before the filing of the
title 11 or similar case (or the
day on which the beneficial owner
acquired the indebtedness, if
later) and ending with the change
date of L);
(b)
The indebtedness represents more
than 25 percent of the fair market
value of the total gross assets
(excluding cash or cash
equivalents) of the beneficial
owner on its change date; and
(c)
The beneficial owner is a 5percent entity under Treas. Reg.
§ 1.382-9(d)(3) immediately after
the ownership change of L.
(4)
In determining whether the beneficial
owner of the indebtedness has an
ownership change within the applicable
period described above, the principles
of section 382 are applied without
regard to whether the beneficial owner
was a loss corporation at the time of
the change. Treas. Reg. § 1.3829(d)(4)(iii).
(5)
The anti-abuse rule of Treas. Reg.
§ 1.382-9(d)(4) does not apply to an
indebtedness if L obtains a statement,
signed under penalties of perjury, of
the beneficial owner that states that
402
the anti-abuse rule does not apply to
the indebtedness.
(6)
Example
L, a corporation in a title 11 case, is
indebted to various parties including
P, a creditor who held L's indebtedness
at all times since 1990. P, a
corporation without any NOL carryovers
or other tax attributes, has gross
assets having a fair market value of
$100, including the L secured
indebtedness which has a fair market
value of $30. On January 1, 1994,
Investor acquires all of the stock of
P, and on February 1, 1994, L undergoes
a workout in which L stock is issued to
P in exchange for the $30 indebtedness
held by P. In accordance with Treas.
Reg. § 1.382-9(d)(4), the indebtedness
is not qualified indebtedness. The
indebtedness held by P represents more
than 25 percent of the fair market
value of P's assets, and P had an
ownership change within the applicable
period (within the meaning of Treas.
Reg. § 1.382-9(d)(4)(iii)).
e.
Effective date
(1)
In general
The regulations generally apply to any
ownership change occurring on or after
March 17, 1994. Treas. Reg. § 1.3829(d)(6)(i). However, L may elect to
apply these rules in their entirety to
any ownership change occurring before
that date. Treas. Reg. § 1.3829(d)(6)(ii)(A). Once made, the
election under is irrevocable. Id.
The election must be made by the later
of the due date (including any
extensions) of the loss corporation's
tax return for the taxable year which
includes the change date or the date
403
that the loss corporation files its
first tax return after March 17, 1994.
Id.
(2)
Election to revoke election not to
apply section 382(l)(5)
L, pursuant to Treas. Reg. § 1.3829(d)(6)(ii)(B) may elect to revoke a
prior election made under section
382(l)(5)(h), with respect to an
ownership change occurring before March
17, 1994, by including the statement
found in that section with its election
to apply Treas. Reg. § 1.392-9(d)
retroactively.
(3)
Amended returns
(a)
If the retroactive application of
Treas. Reg. § 1.382-9(d) affects
the amount of taxable income or
loss for a prior taxable year,
then, except as precluded by the
applicable statute of limitations,
the loss corporation (or the
common parent of any consolidated
group of which the loss
corporation was a member for the
year) must file an amended return
that reflects the retroactive
application of the rules of Treas.
Reg. § 1.382-9(d). Treas. Reg. §
1.382-9(d)(6)(ii)(C).
(b)
If the statute of limitations
precludes the filing of an amended
return for one or more prior
taxable years, the loss
corporation (or the common parent)
must make appropriate adjustments
under the principles of section
382(l)(2)(A) in subsequent taxable
years to reflect the difference
between the losses and credits
actually used in such prior
taxable years and the amount that
would have been used in those
404
years applying the rules of Treas.
Reg. § 1.382-9(d). Id.
C.
Section 382(l)(6)
If section 382(l)(6) applies, the value of L will
"reflect the increase (if any) in value of the old
loss corporation resulting from any surrender or
cancellation of creditors' claims in the transaction."
1.
As originally enacted in the 1986 Tax Reform Act,
section 382(l)(6) provided that the value of L
will "be the value of the new loss corporation
immediately after the ownership change." This
language was amended as part of the 1988
Technical Corrections Act to prevent stuffing
that would increase the value of L by virtue of
capital contributions not directly associated
with a stock-for-debt exchange. This purpose is
confirmed by the preamble to the proposed
regulation under section 382(l)(6) which states
that the 1988 amendment was designed to limit the
increase in value of L to conversions of debt
into stock, but to deny an increase in value
attributable to a fresh infusion of capital.
2.
Example
a.
L has total stock outstanding with a value
of $100. L's assets have a fair market
value of $1,000 and the amount of its
liabilities are $900. In a stock-for-debt
exchange occurring under the jurisdiction of
title 11 case, L issues its stock in
cancellation of $50 of debt, thereby
increasing the total value in L's stock to
$150. The stock-for-debt exchange causes L
to have an ownership change and L elects to
apply section 382(l)(6).
b.
Notwithstanding treatment of the stock-fordebt exchange as a capital contribution to
which section 382(l)(1) generally applies,
L's stock is treated under section 382(l)(6)
as having a value of $150 for purposes of
the section 382 limitation (rather than the
$100 value that L had before the exchange),
405
thus reflecting the increase in value of L
resulting from the stock-for-debt exchange.
D.
The Section 382(l)(6) Final Regulations
1.
Conceptual Framework
Based upon concepts of fundability, the final
regulations mechanically distinguish between
increases in value that are attributable to the
conversion of debt into stock, and those
increases that are attributable to fresh
infusions of capital. The fundability model
sanctions indirect conversions of debt into stock
and treats them as actual stock-for-debt
exchanges. For example, if L issues stock for
cash and then the cash is used to satisfy the
debt, the final regulations allow the increase in
value to be reflected in the value of L's stock.
2.
a.
From L's perspective, this indirect
conversion is economically the same as a
direct stock-for-debt exchange. Because of
this reason, the absence of a creditor
continuity of interest requirement in
connection with the application of the
common law stock-for-debt exception from
income recognition, and the section 382
neutrality principle, equivalent tax
treatment is provided to similarly situated
restructurings not involving actual stockfor-debt exchanges.
b.
It should be noted that the preamble to the
proposed regulations (1992-2 C.B. at 618)
states that the treatment of an indirect
conversion as if it were a direct conversion
is limited solely to section 382(l)(6).
Therefore, the indirect conversion of debt
into stock is not eligible for the benefits
of the common law stock-for-debt exception
to section 61(a)(12). See Rev. Rul. 92-52,
C.B. 34.
Value Increases
If any ownership change occurs to which section
382(l)(6) applies, Treas. Reg. § 1.382-9(j)
406
provides that the value of L immediately after
the ownership change will be equal to the lesser
of the stock value test or the asset value test.
a.
The stock value test
The value of the stock of L immediately
after the ownership change.
(1)
The value of L's stock issued in
connection with an ownership change
cannot exceed the cash and the value of
any property (including debt of L)
received by L in consideration for the
issuance of the stock. Treas. Reg. §
1.382-9(k)(7). According to the
preamble to the proposed regulations,
the purpose of this limitation is to
prevent "valuation" disputes in which L
would take the position that the
"intrinsic value of the stock is more
than the amount paid for it. This
argument may arise if the stock trades
at a higher price at some later date
when trading stabilizes after the title
11 reorganization.
(2)
The regulations contain an anti-abuse
rule designed to prevent artificial
increases in the value of L's stock for
purposes of the stock value test.
Under the rule, the value of L's stock
is reduced by the value of the stock
that is issued with a principal purpose
of increasing the section 382
limitation without subjecting the
investment to the entrepreneurial risks
of corporate business operations.
Treas. Reg. § 1.382-9(k)(6)(i).
(3)
Under Treas. Reg. § 1.382-9(k), the
term "stock" includes section
1504(a)(4) "pure preferred" stock and
stock that is not treated as stock
under Treas. Reg. § 1.382-2T(f)(18)(i).
Treas. Reg. § 1.382-9(k)(1)(i). The
term stock does not include a non-stock
407
interest treated as stock under Treas.
Reg. § 1.382-2T(f)(18)(iii). Treas.
Reg. § 1.382-9(k)(1)(ii).
b.
The Asset value test
The value of L's pre-change assets.
3.
(1)
L's pre-change assets include the value
of L's assets immediately before the
ownership change. This determination
is made without regard to L's
liabilities. Treas. Reg. § 1.3829(l)(1).
(2)
The asset valuation rule refers to the
value of L's pre-change assets without
limitation to either liquidation value
or tangible assets. Therefore, if a
loss corporation is able to establish
the existence and value of any
intangible assets, that value may be
taken into account.
Coordination Rules
Both the "stock value" and the "asset value"
tests contain a number of coordination rules.
a.
Certain capital contributions
(1)
Stock value test
The capital contribution rule of
section 382(l)(1) does not apply in
determining the value of L's stock for
purposes of the stock value test.
Treas. Reg. § 1.382-9(k)(4).
(2)
Asset value test
For purposes of the asset value test,
the value of L's assets are reduced by
the amount of any capital contribution
to which section 382(l)(1) applies.
Treas. Reg. § 1.382-9(l)(4). Under
this coordination rule, L's receipt of
cash or property in exchange for an
issuance of debt is considered a
408
capital contribution if it is part of a
plan one of the principal purposes of
which is to increase the value of L's
stock under section 382(l)(6). Id.
Because the asset value test is based
on gross assets without regard to
liabilities, the conversion of debt
into stock presumably has no effect
upon the asset value test.
b.
Redemptions or other corporate contractions
(1)
Stock value test
The value of L's stock under the stock
value test will be reduced to the
extent that there is any section
382(e)(2) redemption or other corporate
contraction occurring after and in
connection with an ownership change to
which section 382(l)(6) applies.
Treas. Reg. § 1.382-9(k)(2).
(2)
Asset value test
This reduction for post-change
redemptions and corporate contractions
does not apply for purposes of the
asset value test. Treas. Reg. § 1.3829(l)(2).
c.
Substantial nonbusiness assets
(1)
Stock value test
If L has substantial nonbusiness assets
under section 382(l)(4) immediately
after the ownership change, the value
of L's stock for purposes of the stock
value test is reduced by the excess of
the value of the nonbusiness assets
asset over the nonbusiness asset share
of indebtedness for which L is liable.
Treas. Reg. § 1.382-9(k)(5); see also
section 382(l)(4)(A).
(2)
Asset value test
409
For purposes of the asset value test,
application of the substantial
nonbusiness asset rule of section
382(l)(4) requires exclusion of the
nonbusiness assets. Treas. Reg. §
1.382-9(l)(5).
4.
Examples
a.
Example (1)
L has assets with a value of $100 and
liabilities of $150. In a stock-for-debt
exchange occurring under the jurisdiction of
a title 11 case, L issues stock to Creditor
A in cancellation of $100 of its
liabilities. The stock-for-debt exchange
causes L to have an ownership change.
Immediately before the ownership change L's
stock has a value of $0, and as a result of
the stock-for-debt exchange, L's stock
increases to a value of $50. L elects to
apply section 382(l)(6) to the ownership
change. Under the stock value test, L has a
value of $50. Under the asset value test, L
has a value of $100. Therefore, as a result
of section 382(l)(6), L's stock has a value
of $50 for purposes of the section 382
limitation.
b.
Example (2)
The facts are the same as Example (3),
except that L issues stock to Underwriter B
in exchange for cash, and then L transfers
the $50 to Creditor A in exchange for
Creditor A's cancellation of $100 of debt.
The result is the same as in Example (3).
Section 382(l)(6) equally permits direct as
well as indirect conversions of debt into
stock. Notwithstanding the treatment of the
two-step/three party transaction as being
equivalent to the one-step/two party direct
stock-for-debt exchange for purposes of
section 382(l)(6), the indirect conversions
do not qualify for the stock-for-debt
exception under the discharge of
indebtedness rules. Therefore, L will have
410
$50 of discharge of indebtedness as result
of the cash-for-debt exchange.
c.
5.
Example (3)
(1)
The facts are the same as Example (1),
except that approximately 3 months
before the workout Creditor A sold $25
of assets to L in exchange for a note
secured by the purchased property, L
issued stock to Creditor A in
cancellation of all of its liabilities
and L's total stock outstanding is
trading at $125 immediately after the
exchange. Even though L's stock has a
value of $125 immediately after the
exchange, the value of L's stock cannot
be increased in excess of $100 under
the asset value test if "a" principal
purpose of L's asset acquisition was to
increase the value of L for the purpose
of increasing its section 382
limitation. Treas. Reg. § 1.3829(l)(4). Therefore, as a result of
section 382(l)(6), L has a value of
either $100 or $125 for purposes of the
section 382 limitation.
(2)
Assume further that $25 of L's assets
consist of goodwill. Under this
scenario, if L is able to establish the
existence and value of the goodwill,
the $25 of goodwill should be part of
L's value for purposes of the asset
value test.
Miscellaneous
a.
If L is going to elect the rules of section
382(l)(6) in lieu of the rules of section
382(l)(5), L must make this election on its
return for the taxable year that includes
the change date. Treas. Reg. § 1.382-9(i).
The election must be made by the due date
(including any extensions of time) of the
loss corporation's tax return for the
taxable year which includes the change date.
411
Id. Once made, the election is irrevocable.
Id. The irrevocable nature of the election
prevents taxpayers from using the election
under section 382(l)(6) to avoid the effect
of section 382(l)(5)(D) (which imposes a
section 382 limitation of zero if an
ownership change occurs within a two-year
period immediately following an ownership
change to which section 382(l)(5) applies).
Preamble to Prop. Treas. Reg. § 1.382-3(i),
1992-2 C.B. at 619.
b.
The continuity of business enterprise rules
of section 382(c) apply to an ownership
change under section 382(l)(6). Treas. Reg.
§ 1.382-9(m)(2).
c.
The regulations contain a special rule for
ownership changes occurring within 2 years
after an ownership change to which section
382(l)(6) applies. Under these rules, the
capital contribution rules of section
382(l)(1) do not apply to the second
ownership change to the extent that the
increase in value was taken into account
under section 382(l)(6) on the first
ownership change. Treas. Reg. § 1.3829(n)(2). Without this rule, section
382(l)(1) apparently would reduce the
section 382 limitation with respect to the
second ownership change.
d.
Example
L has assets with a value of $100 and
liabilities of $150. On January 1, 1994, in
a stock-for debt exchange occurring under
the jurisdiction of a title 11 case, L
issues stock to Creditor A in cancellation
of $100 of its liabilities. As a result of
the application of section 382(l)(6), L's
stock has a value of $50 for purposes of the
section 382 limitation. On January 20,
1994, Creditor A sells all of its L stock,
causing a second ownership change. Without
the application of Treas. Reg. § 1.3823(n)(2), the $50 increase in value as a
412
result of the stock-for-debt exchange on
January 1, 1994, would be disregarded under
section 382(l)(1) for the second ownership
change occurring on January 20, 1994.
However, Treas. Reg. § 1.382-3(n)(2) allows
the $50 increase to be taken into account
for the second ownership change.
6.
Effective Date
The regulations generally apply to any ownership
change occurring on or after March 17, 1994.
Treas. Reg. § 1.382-9(p)(1). However, L may
elect to apply these rules in their entirety to
any ownership change occurring before that date,
including an ownership change to which section
382(1)(5) applied. Treas. Reg. § 1.382-9(p)(2).
E.
Reorganizations of Financially Troubled Thrift
Institutions
1.
2.
From January 1, 1981 to May 10, 1989, section 382
provided special rules allowing an acquiring
corporation to succeed to the NOL carryovers of a
"thrift" institution.
a.
The special rules are in old section
382(b)(7)(B) and present section
382(l)(5)(F). The 1986 Act provided that
the special rules would expire December 31,
1988. TAMRA extended the provision to
December 31, 1989. FIRREA moved the
expiration date back to May 10, 1989.
b.
A "thrift" is a mutual savings bank,
domestic building and loan association, or
cooperative bank without capital stock
organized and operated for mutual purposes
and without profit.
Under old law, if a reorganization qualified
under section 368(a)(1)(G) by virtue of section
368(a)(3)(D)(ii), depositors of the acquired
corporation were treated as continuing
stockholders for purposes of determining whether
a change of ownership has occurred as a result of
the reorganization. Old section 382(b)(7)(B).
For this purpose, the fair market value of the
413
outstanding stock of the acquiring corporation
included the amount of deposits in the acquiring
corporation immediately after the reorganization.
Old section 382(b)(7)(B)(iii).
3.
Section 382(l)(5)(F) worked within the bankruptcy
reorganization rules of section 382(l)(5).
Generally, the 382(l)(5) exception to the
ownership change rules applied to thrifts if
shareholders and creditors (including depositors)
retained a 20-percent (rather than 50-percent)
interest. Section 382(l)(5)(F) applied to equity
structure shifts which were reorganizations under
section 368(a)(3)(D)(ii), or equity structure
shifts that occurred as an integral part of such
reorganizations.
4.
Under section 368(a)(1)(G), the transferor
corporation must transfer all or part of its
assets to another corporation, and in pursuance
of the plan of reorganization approved by the
Board, stock or securities of the transferee
corporation must be distributed in a transaction
which qualifies under section 354, 355, or 356.
5.
However, under section 368(a)(3)(D)(ii), as in
effect before FIRREA, the transaction qualified
as a G reorganization even if no stock or
securities of the transferee were received or
distributed, but only if all of the following
conditions were met:
a.
The transferor was a thrift;
b.
The transferee acquired substantially all of
the assets of the transferor;
c.
The stock, securities or other properties
received by the transferor, as well as the
remaining properties of the transferor, were
distributed in pursuance of the plan of
reorganization;
d.
Substantially all of the liabilities of the
transferor immediately before the transfer,
including deposits, became, as a result of
the transfer, liabilities of the transferee;
414
6.
e.
The Federal Home Loan Bank Board, the
Federal Savings and Loan Insurance
Corporation or, where neither has
supervisory authority with respect to the
transfer, an equivalent state authority,
(the "Board"), certified that the transferor
thrift was insolvent, that it could not meet
its obligations currently, or that it would
be unable to meet its obligations in the
immediate future.
f.
The transfer was made pursuant to a plan of
reorganization approved by the Board. Old
section 368(a)(3)(D)(i)(II).
For applications of the thrift rules see LTR
9010077; LTR 8943033; LTR 8942077; LTR 8938033.
VIII. AUTHORITY TO ISSUE REGULATIONS
A.
In General
1.
Section 382(m) directs Treasury to prescribe
"such regulations as may be necessary or
appropriate to carry out the purposes of" section
382. This delegation of authority is similar to
that contained in section 338 (which produced
massive regulations). See, e.g., section 338(i).
2.
Section 382(m) currently mentions five specific
areas to be developed by regulations.
a.
Section 382(m)(1) involves application of
section 382 and 383 to successive ownership
changes.
b.
Section 382(m)(2) concerns the application
of section 382 and 383 in the case of a
short taxable year.
c.
Section 382(m)(3) involves avoidance of the
purposes of sections 382 and 383 through the
use of related persons and pass-through
entities.
d.
Section 382(m)(4) concerns the application
of section 382(g)(4) in the context of a
single corporation.
415
e.
3.
B.
TAMRA also added section 382(m)(5). Section
382(m)(5) provides generally that in the
case of any group of corporations described
in section 1563(a) (using 50 percent instead
of 80 percent), appropriate adjustments to
value, built-in gain or loss, and other
items will be made so that items are not
omitted or taken into account more than
once.
Treasury issued regulations under sections
382(m)(2) (short taxable years) and 382(m)(5)
(controlled groups of corporations) on January
29, 1991. 1991-1 C.B. 749. These are discussed
below. In addition, the problem of successive
ownership changes and pass-through entities is
also discussed.
Successive Ownership Changes
1.
Section 382(m)(1) directs Treasury to issue
regulations providing for the application of
sections 382 and 383 where an ownership change of
an old loss corporation is followed by an
ownership change of the new loss corporation.
2.
In the case of such successive ownership changes,
two section 382 limitation amounts will apply -one for the first ownership change and one for
the second. These two amounts are likely to
differ.
3.
The final proposal of the Senate Finance
Committee staff included rules addressing the
issue. See Staff, Committee on Finance, The
Subchapter C Revision Act of 1985, S. Prt. No.
47, 99th Cong., 1st Sess. (1985).
a.
Under the proposal, if the limitation amount
pertaining to the second ownership change is
smaller than the first, the smaller amount
would apply to all pre-change losses
(including those that arose before the first
change).
b.
If the second limitation is greater than the
first, the second limitation would not apply
to those pre-change losses subject to the
416
first limitation. In addition, the second
section 382 limitation would be reduced by
any taxable income that is offset by NOL
carryovers under the first limitation.
c.
4.
C.
This approach apparently is intended to
discourage deliberate ownership changes
designed to obtain a higher section 382
limitation (for example, if the long-term
tax-exempt rate should subsequently increase
after the first change).
Final regulations have adopted this approach.
Under Treas. Reg. § 1.382-5(d), if a loss
corporation has two (or more) ownership changes,
any losses attributable to the period preceding
the earlier ownership change are treated as prechange losses with respect to both ownership
changes. Thus, the later ownership change may
result in a lesser (but never in a greater)
section 382 limitation with respect to such
losses. Further, the amount of taxable income
for any post-change year that can be offset by
pre-change losses may not exceed the section 382
limitation for such ownership change, reduced by
the amount of taxable income offset by pre-change
losses subject to any earlier ownership
change(s).
Short Taxable Years
1.
On June 25, 1999, Treasury issued final
regulations under section 382(m)(2) regarding the
application of section 382 to short taxable
years. Treas. Reg. § 1.382-5(c).
2.
The regulations provide, generally, that the
section 382 limitation for any post-change year
that is less than 365 days is the amount that
bears the same ratio to the section 382
limitation as the number of days in the postchange year bears to 365. Treas. Reg. § 1.3825(c). This is the same approach that is taken
under section 382(b)(3)(B) with respect to a
post-change year that includes the change date.
417
3.
D.
The rules apply to any loss corporation that has
an ownership change under section 382, as amended
by the Tax Reform Act. Treas. Reg. § 1.382-5(f).
Pass-Thru Entities
1.
Section 382(m)(3) directs Treasury to prescribe
such regulations as are "necessary to prevent the
avoidance of the purposes. . . . [of section 382]
. . . including the avoidance of such purposes
through the use of related persons, pass-thru
entities or other such intermediaries."
2.
Apparently, the concern here is a taxpayer's
continued ability to use the partnership vehicle
to obtain a greater utilization of NOL carryovers
through so-called "Leslie Fay deals" or "Goldome
transactions." See Senate Report at 233-34.
a.
In such transactions, a loss corporation
usually forms a partnership with venture
capitalists in order to acquire the assets
of a target corporation in a leveraged
buyout. During the early years, the loss
partner is allocated typically 90 percent of
the partnership income. Such income is
sheltered by the loss partner's NOL
carryovers.
b.
The partnership income is allocated to the
loss partner, while the partnership cash
flow is used to service the acquisition
indebtedness.
c.
In later years, the loss partner receives a
pre-arranged cash distribution from the
partnership to reduce its capital account
(which accumulated due to earlier income
allocation).
3.
The legislative history to section 382 clearly
indicates that Congress felt that such a
transaction lacks substantial economic effect
under section 704(b). See House Report at 259
and Senate Report at 234.
4.
However, when the final regulations under section
704(b) were released in December, 1985, it was
418
not clear whether such arrangements would fail
the substantial economic effect test. Therefore,
the Senate version of the Act dealt with the
problem by authorizing regulations under section
382, not section 704(b).
5.
6.
E.
In addition, the conference report goes further
by stating that "any rules that the Treasury
Department considers appropriate" may be
promulgated to deal with this problem. See Conf.
Rep. at II-194.
a.
Thus, it is likely that regulations will not
permit special allocations of income to
result in a greater utilization of NOL
carryovers than would be permitted under
section 382.
b.
This is true regardless of whether the
partnership agreement passes muster under
the section 704 regulations. See Senate
Report at 234.
However, these provisions should not apply to the
case where the loss corporation and other joint
ventures contribute their assets to a
partnership, and the partnership agreement
provides that the allocation of income and loss
will be based strictly on the values of the
contributed property. In such a case, any income
allocated to the loss partner that exceeds the
section 382 limitation is the result of sound
business judgment in combining the enterprises
within the partnership, and not tax motivated
machinations.
Controlled Group Rules
1.
Background
a.
An ownership change with respect to a nonconsolidated controlled group is determined
on a separate entity basis. In addition, a
section 382 limitation is separately
determined for each member of the controlled
group.
419
2.
b.
However, section 382(m)(5), added by the
Technical and Miscellaneous Revenue Act of
1988, gives the Commissioner authority to
promulgate regulations providing appropriate
adjustments to value, built-in gain or loss
and other items so that such items are not
omitted or taken into account more than
once.
c.
The regulatory authority applies in the case
of any group of corporations described in
section 1563(a) ("controlled group of
corporations"), substituting 50 percent for
80 percent control. See section 382(m)(5);
Treas. Reg. § 1.382-8(e)(2).
(1)
On June 27, 1996, Treasury issued
Treas. Reg. § 1.382-8T (finalized in
modified form as Treas. Reg. § 1.382-8
on July 2, 1999), concerning
adjustments to value of controlled
groups of corporations. See T.D. 8825,
1999-28 I.R.B. 19. The final
regulations replace the proposed §
1.382-5 regulations issued on January
29, 1991.
(2)
In general, the regulations reduce the
value of any loss corporation that is a
member of a controlled group by the
value of the stock of each component
member owned by the loss corporation
immediately after the ownership change.
Treas. Reg. § 1.382-8(a).
Section 382 Limitation with Respect to Controlled
Group Loss
a.
For purposes of computing the section 382
limitation with respect to a "controlled
group loss", the value of the stock of the
member before the ownership change is
reduced by the value of stock directly owned
by the member of any other component member.
Treas. Reg. § 1.382-8(c)(1).
b.
For this purpose, a "controlled group loss"
is a pre-change loss or net unrealized
420
built-in loss attributable to a taxable year
of the corporation during which the
corporation is a component member of a
controlled group. Treas. Reg. § 1.3828(b)(1).
c.
On July 2, 1999, Treasury issued Treas. Reg.
§ 1.382-8(b)(2) providing a presumption
regarding net unrealized built-in loss. In
order to address the difficulties associated
with determining the tax year in which a net
unrealized built-in loss accrued, the final
regulations provide an irrebutable
presumption that certain built-in losses are
attributable to the period before a
particular taxable year.
d.
The controlled group with respect to each
controlled group loss is composed of the
loss corporation and each other corporation
that is a component member both:
e.
(1)
With respect to the taxable year to
which the controlled group loss is
attributable; and
(2)
On the date the loss corporation has an
ownership change. Treas. Reg. § 1.3828(b)(1).
Example. L, L1 and L2 are loss corporations
that do not file a consolidated return.
Individual A owns all the stock of L. L
owns the stock of L1, which in turn owns the
stock of L2. The value of L is $250
(including the value of L1 and L2), the
value of L1 is $100, and the value of L2 is
$75. Individual A sells all her L stock to
individual B. As a result, L, L1 and L2
undergo an ownership change. The long-term
tax-exempt rate is 10 percent. Absent the
duplication in value rules, L would have a
$25 section 382 limitation, L1 would have a
$10 limitation, and L2 would have a $7.50
limitation.
421
A
L
f.
B
$250 FMV
L
L1
$100 FMV
L1
L2
$75 FMV
L2
(1)
If L, L1 and L2 were a consolidated
group, the section 382 limitation for
any group losses would be limited to
$250.
(2)
It is clear that the group as a whole
is worth only $250, not $425. Stock
ownership in other members of the group
increases the aggregate limitation by
$175.
(3)
Congress and Treasury apparently felt
that permitting this duplication in
value was inappropriate.
(4)
Example. Assume the same facts as in
the above fact pattern--L's value is
$250, L1's value is $100, and L2's
value is $75, and that each member's
loss is a controlled group loss
(discussed below).
(5)
For purposes of the each member's
section 382 limitation, L's value would
be $150, L1's value would be $25, and
L2's value would be $75.
Example. L is a loss corporation by reason
of a NOL carryover arising in 1990 that is
carried to 1992. L1 has a NOL arising in
1989 that is carried to 1992. L is owned by
Public L, and L1 is owned 30 percent by L
and 70 percent by Public L1. T is a wholly
owned subsidiary of L1. In 1991, L acquires
30 percent of the stock of L1. Also in
422
1991, L purchases all the stock of S. On
November 1, 1992, corporation P acquired all
the L stock, resulting in an ownership
change of L and L1. See Treas. Reg. §
1.382-8(g) (Ex. (1)).
PUBLIC L
PUBLIC L1
PUBLIC L
L
PUBLIC L1
L
40%
30%
70%
L1
60%
L1
T
T
PUBLIC L
PUBLIC L1
PUBLIC L1
P
L
L
40%
60%
40%
L1
T
60%
L1
T
S
423
S
3.
(1)
L was not part of a controlled group at
the time its 1990 NOL carryover arose,
even though it was part of a controlled
group at the time of the ownership
change. Thus, the value of L for
purposes of its section 382 limitation
does not need to be reduced by the
value of the L1 stock.
(2)
L1's loss carryover from 1989 is a
controlled group loss with respect to T
because L1 and T were a controlled
group (1) at the time the NOL arose,
and (2) at the time of L1's ownership
change.
(3)
Thus, L1's section 382 limitation must
be reduced by the value of the T stock.
L1 need not however, reduce its value
by the value of the S stock, because S
was not part of the group at the time
NOL arose.
Restoration of Value
a.
The regulations permit a member ("the
electing member") to restore the value of
its stock to another member that owns its
stock. The member may elect to restore
value to another member in an amount not
exceeding the lesser of:
(1)
The value (as determined under Treas.
Reg. § 1.382-8(c)(1)) of the electing
member's stock before the ownership
change directly owned by the other
component member immediately after the
ownership change, plus any value
restored to the electing member by
another member; or
(2)
The value (without the adjustment under
Treas. Reg. § 1.382-8(c)(1)) of the
electing member's stock immediately
before the ownership change directly
owned by the other component member
immediately after the ownership change,
424
without regard to any restoration of
value. Treas. Reg. § 1.382-8(c)(2).
b.
(3)
Any value restored to another member
reduces the value of the electing
member. Treas. Reg. § 1.382-8(c)(3).
(4)
The regulations also provide for
additional adjustments to be made to
prevent duplication of value, including
adjustments to take into account
indirect ownership in another component
member and cross ownership. Treas.
Reg. § 1.382-8(c)(4).
Example. Assume the same facts as in the
first example above--L has $250 value, L1
has $100 value and L2 has $75 value. The
value restoration election permits the
following alternative values, among others,
for purposes of the section 382 limitation.
Of course, the number of possibilities is
limitless.
L
L1
L2
c.
$250
0
0
$150
100
0
$175
0
75
$150
50
50
Example. Individual A owns all the stock of
L, which owns 80 percent of P, which in turn
owns 75 percent of L1. Individual B owns
the other 20 percent of P, and individual C
owns the other 25 percent of L1. L and L1
each have a NOL carryover from 1990 that is
carried to 1991. On December 1, 1991, A
sells all the L stock to D, resulting in an
ownership change of L and L1. Immediately
before the ownership change, the value of L
is $200 (including the value of P and L1),
the value of P (including the value of L1)
is $100, and the value of L1 is $40.
425
$200 FMV
C
B
A
D
B
C
L
L
80%
80%
20%
20%
P
$100 FMV
P
75%
$40 FMV
25%
L1
25%
75%
L1
(1)
The 1990 NOL carryovers of L and L1 are
both controlled group carryovers.
(2)
The value of L1 for purposes of its
section 382 limitation is $40 if it
does not elect to restore any value to
P.
(3)
The value of P is reduced by $30 (75% X
$40 L1 value) to $70. P may elect to
restore this value to P, a wise choice
since P is not subject to any
limitation and cannot otherwise use the
value.
(4)
The value of L is reduced by $80 (80% X
$100 P value) and increased by the $70
P elected to restore to it. Thus, L's
value is $190 for purposes of its
section 382 limitation. See Treas.
Reg. § 1.382-8(g) (Ex. (2)).
(5)
If L1 elects to restore $20 of value to
P:
(a)
L1's value will be reduced to $20.
(b)
P's value will be $90 ($70 plus
$20 restored by L1); and
426
(c)
4.
P may restore up to $80 of value
to L, this being the lesser of (a)
the value of its stock after the
initial adjustment ($70) plus any
value restored to it ($20), or (2)
the value of the P stock without
regard to any adjustments ($80).
See Treas. Reg. § 1.382-8(g) (Ex.
(3)).
Disposal and Reacquisition of Controlled Group
Stock
A loss corporation that has an ownership change
is required to make an adjustment to value
(notwithstanding the controlled group and
controlled group loss requirements) if stock of
another corporation is disposed of before the
ownership change and:
5.
a.
Both corporations were component members of
a controlled group with respect to a taxable
year to which a controlled group loss of the
loss corporation is attributable and at any
time during the two year period prior to the
ownership change; and
b.
Both corporations are component members of a
controlled group at any time during the twoyear period following the ownership change.
Treas. Reg. § 1.382-8(c)(5).
Rules Preventing Double Reduction
a.
The regulations provide that section 382 and
the controlled group rules should not be
applied to duplicate a reduction in value of
the loss corporation. The regulations use
an example of a contribution to capital of
stock of a component member. The value of
such stock is not taken into account under
section 382(l)(1).
b.
The controlled group rules do not then apply
to further reduce the 382 limitation by the
value of the stock contributed. Treas. Reg.
§ 1.382-8(d).
427
6.
IX.
Coordination with Consolidated Section 382
Regulations
a.
Generally, the consolidated section 382
regulations apply rather than the controlled
group rules to controlled group members that
are also members of a consolidated group.
Treas. Reg. § 1.382-8(f). This makes sense
in that the consolidated section 382
limitation is based on the value of the
entire loss group and avoids duplication.
b.
The controlled group rules may apply,
however, if a member of a consolidated
group, a loss group, or loss subgroup is
also a member of a controlled group with
respect to a controlled group loss. Treas.
Reg. § 1.382-8(f).
c.
For purposes of applying the controlled
group rules, a consolidated group, loss
group, or loss subgroup is treated as a
single corporation. Id.
d.
Example. P owns all the stock of L, and P
and L file a consolidated return. L owns 79
percent of L1. The P group has a
consolidated NOL arising in 1990 that is
carried to 1992. L1 also has an NOL arising
in 1990 that is carried in 1992. On January
1, 1992, the P group and L1 both undergo an
ownership change. The consolidated NOL is a
controlled group loss with respect to the P
group and L1. In computing the consolidated
section 382 limitation, the P group's value
is reduced by the value of its L1 stock. L1
may, however, elect to restore value to the
P group. See Treas. Reg. § 1.382-8(g) (Ex.
(4)).
EFFECTS ON SECTION 382 OF TREASURY’S ACQUISITIONS OF
INSTRUMENTS PURSUANT TO THE EMERGENCY ECONOMIC
STABILIZATION ACT OF 2008
A.
In Notice 2010-2, the IRS and Treasury provided
guidance regarding the application of section 382 to
corporations whose instruments are acquired by the
Treasury Department pursuant to the Emergency Economic
428
Stabilization Act of 2008, P.L. 110-343 (“EESA”).
Notice 2010-2 amplified and superceded Notice 2009-38,
which in turn amplified and superseded Notice 2009-14,
2009-7 I.R.B. 516, which in turn amplified and
superseded Notice 2008-100, 2008-44 I.R.B. 1081.
B.
The IRS and Treasury’s stated purpose for issuing
Notice 2010-2 was to announce that they will issue
regulations implementing certain of the rules as
described in the notice.
C.
Notice 2010-2 provides guidance to corporate issuers
with respect to Treasury’s acquisition of instruments
pursuant to the following EESA programs (collectively
“the Programs”):
D.
1.
The Capital Purchase Program for publicly-traded
issuers (“Public CPP”);
2.
The Capital Purchase Program for private issuers
(“Private CPP”);
3.
The Capital Purchase Program for S corporations
(“S Corp CPP”);
4.
The Targeted Investment Program (“TARP TIP”);
5.
The Asset Guarantee Program;
6.
The Systemically Significant Failing Institutions
Program;
7.
The Automotive Industry Financing Program; and
8.
The Capital Assistance Program for publiclytraded issuers (“TARP CAP”).
Rules from Notice 2010-2:
1.
Rule #1: Characterization of instruments (other
than warrants) issued to Treasury
a.
Any instrument issued to Treasury pursuant
to any of the Programs except TARP CAP,
whether owned by Treasury or subsequent
holders, shall be treated for all Federal
income tax purposes as an instrument of
indebtedness if denominated as such, and as
429
stock described in section 1504(a)(4) if
denominated as preferred stock.
2.
3.
b.
No instrument denominated as preferred stock
shall be treated as stock for purposes of
section 382 while held by Treasury or by
other holders, except that preferred stock
described in section 1504(a)(4) will be
treated as stock for purposes of section
382(e)(1).
c.
In the case of any instrument issued to
Treasury pursuant to TARP CAP, the
appropriate classification of such
instrument shall be determined by applying
general principles of Federal tax law.
Rule #2: Characterization of warrants issued to
Treasury
a.
For all Federal income tax purposes, any
warrant to purchase stock issued to Treasury
pursuant to any of the Programs except
Private CPP and S Corp CPP, whether owned by
Treasury or subsequent holders, shall be
treated as an option (and not as stock).
b.
While held by Treasury, warrants will not be
deemed exercised under Treas. Reg. § 1.3824(d)(2).
c.
For all Federal income tax purposes, any
warrant to purchase stock issued to Treasury
pursuant to the Private CPP shall be treated
as an ownership interest in the underlying
stock, which shall be treated as preferred
stock described in section 1504(a)(4).
d.
For all Federal income tax purposes, any
warrant issued to Treasury pursuant to the S
Corp CPP shall be treated as an ownership
interest in the underlying indebtedness.
Rule #3: Value-for-value exchange
a.
For all Federal income tax purposes, any
amount received by an issuer in exchange for
instruments issued to Treasury under the
430
Programs shall be treated as received, in
its entirety, as consideration for such
instruments.
4.
5.
Rule #4: Section 382 treatment of stock acquired
by and redeemed from Treasury
a.
For purposes of section 382, with respect to
any stock (other than preferred stock
described in section 1504(a)(4)) issued to
Treasury pursuant to the Programs (either
directly or upon the exercise of a warrant),
the ownership represented by such stock on
any date on which it is held by Treasury
shall not be considered to have caused
Treasury’s ownership in the issuing
corporation to have increased over its
lowest percentage owned on any earlier date.
b.
Except as described below, such stock is
considered outstanding for purposes of
determining the percentage of stock owned by
other 5-percent shareholders on a testing
date.
c.
For purposes of measuring shifts in
ownership by any 5-percent shareholder on
any testing date occurring on or after the
date on which an issuing corporation redeems
stock held by Treasury pursuant to the
Programs (either directly or upon the
exercise of a warrant), the stock so
redeemed shall be treated as if it had never
been outstanding.
Rule #5: Section 382 treatment of stock sold by
Treasury to public shareholders
a.
If Treasury sells stock that was issued to
it pursuant to the Programs (either directly
or upon the exercise of a warrant) and the
sale creates a public group (“New Public
Group”), the New Public Group’s ownership in
the issuing corporation shall not be
considered to have increased solely as a
result of such a sale.
431
b.
6.
Rule #6: Section 382(l)(1) not applicable with
respect to capital contributions made by Treasury
pursuant to the Programs
a.
7.
E.
A New Public Group’s ownership shall be
treated as having increased to the extent
the New Public Group increases its ownership
pursuant to any transaction other than a
sale of stock by Treasury, including
pursuant to a stock issuance described in
section 1.382-3(j)(2) or a redemption (see
section 1.382-2T(j)(2)(iii)(C)). Such stock
is considered outstanding for purposes of
determining the percentage of stock owned by
other 5-percent shareholders on any testing
date, and section 382 (and the regulations
thereunder) shall otherwise apply to the New
Public Group in the same manner as with
respect to other public groups.
For purposes of section 382(l)(1), any
capital contribution made by Treasury
pursuant to the Programs shall not be
considered to have been made as part of a
plan a principal purpose of which was to
avoid or increase any section 382
limitation.
Rule #7: Certain exchanges
a.
Rules 3, 4, 5, and 6, but not rules 1 and 2,
listed above, apply to “Covered Instruments”
as though such instruments were issued
directly to Treasury under the Programs.
b.
For purposes of Notice 2009-38, the term
“Covered Instrument” means any instrument
acquired by Treasury in exchange for an
instrument that was issued to Treasury under
the Programs. The term also includes any
instrument acquired by Treasury in exchange
for a Covered Instrument. General
principles of Federal tax law determine the
characterization of all Covered Instruments.
Taxpayers’ reliance on Notice 2010-2
432
X.
1.
The rules in Notice 2010-2 will continue to apply
unless and until there is additional guidance.
2.
Any future contrary guidance will not apply to
any instrument (i) issued to Treasury pursuant to
the Programs, or acquired by Treasury in an
exchange described in rule 7, above, prior to the
publication of that guidance, or (ii) issued to
Treasury pursuant to the Programs, or acquired by
Treasury in an exchange described by rule 7,
above, under a binding contract entered into
prior to the publication of that guidance.
3.
In exercising its authority under EESA in Notice
2010-2, the IRS and Treasury intend no
implication regarding the Federal income tax
results that would obtain with respect to
instruments that are not specifically described
in Notice 2010-2. Accordingly, the Federal
income tax consequences of instruments not
described in this notice continue to be
determined based upon the application of general
principles of Federal tax law to the specific
facts and circumstances of each case.
INTERRELATIONSHIP OF SECTION 382 WITH SELECTED OTHER
PROVISIONS
A.
Section 269
1.
Section 382 does not alter the continued
application of section 269 to acquisitions (even
if covered by section 382). Treas. Reg. § 1.2697. This was a disappointment to many
practitioners who favored repeal of section 269.
a.
Many argued that section 269 serves only to
add uncertainty in the pricing of the loss
corporation.
b.
In addition, it was questioned whether
section 269 was necessary under section 382.
(1)
The acquisition of a loss corporation
primarily for its tax benefits should
not be economical under section 382.
Therefore, tax motivated transactions
are unlikely.
433
(2)
2.
B.
In addition, section 382 covers builtin gains and losses. A principal usage
of section 269 was in preventing the
acquisition of built-in losses.
Section 269 no longer appears necessary
for such purposes under the law.
The final regulations under section 269 reiterate
that it still applies notwithstanding section
382. Treas. Reg. § 1.269-7. See also Treas.
Reg. § 1.269-3(d) (prohibited purpose exists in a
section 382(l)(5) bankruptcy reorganization
unless the corporation carries on more than an
insignificant amount of an active trade or
business). However, the regulations also provide
that the fact that the amount of tax or taxable
income is limited or reduced under sections 382
or 383 is relevant to the determination of
whether the principal purpose of an acquisition
is the avoidance or evasion of tax. Treas. Reg.
§ 1.269-7.
Consolidated Return Provisions
1.
Prior to January 1991, the application of section
382 in a consolidated return setting was
uncertain. In enacting section 382, Congress
merely indicated that the CRCO (consolidated
return change of ownership) rules (Treas. Reg.
§§ 1.1502-1(g) and -21(d)) and the SRLY (separate
return limitation year) rules (Treas. Reg.
§§ 1.1502-1(f) and -21(c)) would continue to
apply. No other guidance was provided.
2.
Application of section 382 in a consolidated
return context turns upon one overall policy
decision: whether section 382 should apply to an
affiliated group filing consolidated returns on a
"single entity" basis, whether it should apply on
a "member-by-member" basis, or whether a
combination of these two approaches is best.
a.
This policy decision must be made at two
levels. That is, first it must be decided
whether the section 382(g) ownership change
test should be applied on a single entity or
434
a member-by-member basis. Second, it must
be decided whether the operating provisions
of section 382 (i.e., the annual limitation
under section 382(a)) should be applied on a
single entity or member-by-member basis.
b.
3.
Also, one approach may be applied with
respect to consolidated net operating losses
and a different approach may be applied with
respect to losses incurred in separate
return limitation years ("SRLY" losses).
On January 29, 1991, Treasury issued proposed
regulations (the “former proposed regulations”)
regarding the application of section 382 to
corporations filing consolidated returns. 56
Fed. 4194 (February 4, 1991).
a.
These regulations generally adopted the
single entity approach with respect to
losses that are not SRLY losses.
(1)
(2)
The single entity approach applies to
determine ownership changes and the
section 382 limitation with respect to
such losses.
(a)
This treatment reflects the
general approach of the
consolidated return regulations,
which treats the members of a
consolidated group as divisions of
a single taxpayer with the common
parent as the sole agent for each
member of the group. See Preamble
to Proposed Regulations.
(b)
This treatment also reflects the
ability of consolidated group
members to use each other's
losses.
The single entity approach fosters the
neutrality principle in that
consolidated losses of one member could
offset income of another member before
an ownership change, and can do so
after an ownership change as well,
435
subject only to restrictions that would
be imposed on a stand alone
corporation.
4.
b.
The regulations also generally adopted the
single entity approach with respect to loss
subgroups (as to losses that were not SRLY
losses of the subgroup).
c.
The former proposed regulations generally
followed a separate entity approach,
however, with respect to corporations that
join or leave a consolidated group.
According to the Preamble to the proposed
regulations, section 382 applies separately
with respect to such members because their
losses cannot be used by other members.
At the same time, Treasury also issued proposed
regulations that would have substantially amended
the consolidated return regulations. 56 Fed.
Reg. 4228 (February 4, 1991).
a.
b.
The regulations revised the SRLY rules to
apply on a "subgroup" basis rather than on a
"fragmentation" (i.e., on a member-bymember) basis.
(1)
Two or more corporations that are
members of a consolidated group can
offset one corporation's income against
the other's losses, and vice versa.
(2)
It was thought to be more appropriate
and consistent with the single entity
approach that the SRLY rules be applied
to those members forming or leaving a
group on an aggregate or subgroup
basis, rather than on a member by
member basis.
The proposed SRLY regulations retained
apportionment of consolidated net operating
losses for members leaving the group. There
had been prior speculation that the
regulations would provide that consolidated
net operating losses would stay with the
common parent.
436
c.
The CRCO rules were repealed, subject to
transition rules. The continued application
of the CRCO rules caused considerable
confusion, since those rules generally
paralleled the ownership change rules of
section 382 before its amendment by the Tax
Reform Act of 1986.
5.
On August 8, 1991, the Service issued Notice 9127, 1991-2 C.B. 629, which proposed transitional
relief relating to the built-in gain and loss
rules, as well as clarifying the effective date
for amendments to the SRLY rules.
6.
New Temporary and Proposed Regulations
Substantial uncertainty arose as a result of the
effective date of the former proposed
regulations, which generally were proposed to be
effective for consolidated return years ending on
or after January 29, 1991. Because of the
potentially retroactive application of the
proposed regulations, taxpayers could not be sure
which approach would govern their use of losses
for years after January 29, 1991. To resolve
this uncertainty, the proposed regulations were
withdrawn on June 27, 1996 and replaced by
temporary regulations (the "temporary
regulations"). 61 Fed. Reg. 33,313 (June 27,
1996). The temporary regulations were issued
primarily to address effective date concerns, are
substantially identical to the former proposed
regulations, and do not address comments received
regarding the former proposed regulations.
Instead, the temporary regulations were also
issued as proposed regulations (the "new proposed
regulations") and may be amended to reflect
comments at a future date.
7.
Effective Dates
The temporary regulations are generally effective
for consolidated return years beginning on or
after January 1, 1997. In contrast to the former
proposed regulations, this effective date also
applies to the amendments to the SRLY and builtin deduction rules. Under the former proposed
regulations, the amendments to the SRLY and
437
built-in deduction rules applied only to losses
and deductions of corporations that became
members after the effective date without regard
to when such losses arose; losses and deductions
of members acquired prior to that date remained
subject to the old regime. In contrast, under
the temporary regulations, the amendments to the
SRLY and built-in deduction rules apply to losses
and deductions carried to years after the
effective date, regardless of when such losses or
deductions arose.
8.
Transitional Effective Dates
A consolidated group may elect to apply the
temporary regulations to years ending on or after
January 29, 1991 and before January 1, 1997 if
three conditions are met: (1) the temporary
regulations must be consistently applied on the
group’s return (original or amended) for each
such year for which the statute of limitations
does not preclude the filing of an amended
return; (2) the temporary SRLY and built-in
deduction rules must be applied only to losses of
corporations becoming members and acquisitions
occurring on or after January 29, 1991; and (3)
adjustments must be made to the earliest
subsequent open year to reflect any inconsistency
in a closed year.
9.
On June 25, 1999, Treasury issued new final
regulations that modify the temporary
regulations. See T.D. 8823, 1999-29 I.R.B. 34;
T.D. 8824, 1999-29 I.R.B. 62; T.D. 8825, 1999-28
I.R.B. 19.
a.
In T.D. 8823, Treasury finalized the SRLY
rules with one significant modification.
The final regulations generally eliminate
the SRLY limitation when its application
overlaps with the section 382 limitation.
b.
In T.D. 8824, Treasury finalized the rules
provided in the temporary regulations on the
operation of section 382 with respect to
consolidated groups. New provisions in the
438
final regulations include: (a) an election
to treat the subgroup parent requirement as
satisfied; (b) changes in the supplemental
change method; and (c) the apportionment of
a group’s net unrealized built-in gain to a
departing member.
c.
10.
In T.D. 8825, Treasury finalized the
temporary regulations with respect to the
application of section 382 to controlled
groups, with some modifications, including
the addition of a presumption that certain
built-in losses are attributable to tax
years before the tax year at issue.
However, if a SRLY subgroup exists, then the
overlap rules will only apply if there is an
identical section 382 subgroup.
Example -- The Consolidated 382 Regulations
a.
A is the common parent of an affiliated
group consisting of A, B and C. X is the
common parent of an affiliated group
consisting of X, Y and Z. The A group has a
consolidated net operating loss. A sells
the stock of B and C to X. $75 of the A
group's net operating loss is apportioned to
B and C. The value of B and C immediately
before the sale is $100. The long-term tax
exempt rate is 10 percent.
b.
B and C have undergone an ownership change.
Treas. Reg. § 1.1502-92(b). B and C compose
a 382 loss subgroup. Treas. Reg. § 1.150291(d). The $75 NOL will be subject to a
section 382 subgroup limitation of $10.
Treas. Reg. § 1.1502-93(a) (value of loss
subgroup multiplied by long-term tax exempt
rate). The NOL will also be SRLY with
respect to the rest of the members of the X
group.
c.
B and C file consolidated returns as members
of the X group. The X group incurs
consolidated NOLs after the acquisition of B
and C.
439
11.
C.
d.
X undergoes an ownership change. At the
time of the ownership change, the value of
the X group (including B and C) is $250, and
the long term tax exempt rate is 10 percent.
At the time of the ownership change, the
value of B and C has fallen to $50.
e.
The X group consolidated NOL will be subject
to an X group consolidated limitation of
$25. The $75 B-C subgroup NOL remains
subject to the its earlier $10 limitation.
The $75 subgroup NOL is also subject to the
$25 X group limitation. See Treas. Reg.
§§ 1.1502-96(c) and 1.382-5(d).
Treasury issued amendments to the temporary
regulations to extend the SRLY principles to the
general business credit, the minimum tax credit,
the foreign tax credit and overall foreign losses
for consolidated return years beginning on or
after January 1, 1997. Treasury subsequently
issued other temporary amendments that changed
that effective date to January 13, 1998. However,
this second amendment allows the taxpayer to
elect the January 1, 1997 effective date. These
temporary regulations were finalized, without
substantive change, on May 24, 2000. See T.D.
8884, 2000-24 I.R.B. 1250.
Section 338
The application of section 382 in a section 338
setting depends upon whether the stock of the target
loss corporation (referred to herein as "LT") is
acquired in a single transaction or in a two-step (or
creeping) transaction. In addition, if the parties
make an election under section 338(h)(10), different
tax consequences may result.
1.
One-Step Acquisitions
a.
Fact pattern
T owns all of the stock of LT, a loss
corporation. T and LT file consolidated
returns. On December 31, 2000, P purchases
all of the LT stock from T.
440
b.
The transfer of stock from T to P
constitutes an ownership change. See
section 382(g)(1). In addition, the
transfer constitutes a qualified stock
purchase. See section 338(d)(3). Assuming
P is a gain corporation, the acquisition of
LT stock would be subject to section 384.
See section 384(a).
c.
If P makes a section 338 election, and a
section 338(h)(10) election is not made, the
following tax consequences should result.
d.
(1)
The election causes LT to recognize
gain as if it sold all of its assets in
a single, fully taxable transaction.
See section 338(a). LT must report
this gain on a one-day "deemed sale
return." See Treas. Reg. § 1.33810(a)(2)(i). The deemed sale occurs in
a separate taxable year beginning and
ending on December 31, 2000. See
Treas. Reg. § 1.338-10(a)(2)(ii).
(2)
The section 382 limitations apply only
in post-change years. See section
382(a). A post-change year is defined
as any year ending after the change
date. Section 382(d)(2) (emphasis
added).
(3)
Because the one-day separate year ends
on, rather than after, the change date,
it should not constitute a post-change
year. Accordingly, the section 382
limitations do not apply.
If the parties make a joint election under
section 338(h)(10), the following tax
consequences should result.
(1)
An election under section 338(h)(10)
causes the sale of the LT stock to P to
be treated as if LT sold all of its
assets to P in a single, fully taxable
transaction, followed by a section 332
liquidation of LT. All gain recognized
by LT is reported in T's consolidated
441
return for the period including
December 31, 2000. No gain or loss is
recognized by T with respect to the LT
stock.
(2)
LT's NOL carryover should be allowed to
offset the gain recognized by LT on the
deemed sale of assets for several
reasons.
(a)
For tax purposes, a section
338(h)(10) transaction is treated
as an asset sale. No gain is
recognized on the actual transfer
of LT stock. Therefore, it should
follow that for tax purposes, T
should be treated as never having
transferred its stock in LT.
Without a stock transfer, section
382 is not applicable.
(b)
In addition, LT is deemed to
liquidate under section 332
following the deemed sale of
assets. In such a liquidation,
all of LT's attributes, including
any unabsorbed NOL carryovers, are
inherited by T. In other words,
such attributes are not
transferred to the buyer but
remain with the selling group.
The averaging function of the
carryover provisions is upheld and
there is no "loss trafficking."
(c)
Neither Treasury nor the Service
have yet taken the position that
section 382 does apply due to the
fact that an actual transfer of
the LT stock took place. Such a
position would be totally
inconsistent with the theory
underlying both sections 338 and
338(h)(10) (stock sale treated as
an asset sale). See LTR 8947053.
442
2.
e.
If LT did not file a consolidated return
with its parent, T, the results described
above (in paragraph c.) would not change.
LT would not file a one-day deemed sales
return. However, LT would report its
section 338 gain in its final taxable year
ending on December 31, 2000. As above, such
year would not constitute a post-change
year.
f.
Importantly, the analysis above assumes that
the option rule under section 382 does not
apply to accelerate the change date, or if
it does not apply, that the 120-day rule in
Treas. Reg. § 1.382-2T(h)(4)(vi)(B) is
elected (causing the change date to match
the acquisition date). Otherwise, if the
change date precedes the acquisition date,
the analysis for two-step acquisitions
discussed below applies.
Two-Step Acquisitions
A qualified stock purchase may take place in
stages. In addition, the section 382 change date
may precede the section 338 acquisition date by
operation of the option attribution rules of
section 382. In such acquisitions, the section
382 limitations may be triggered before a
qualified stock purchase has occurred.
a.
Fact pattern
P wishes to acquire L, a publicly held
corporation. On January 1, 1988, P buys 55
percent of the L stock in a cash tender
offer. On July 1, 1988, P acquires the
remaining 45 percent of the L stock in a
merger transaction.
b.
Ignoring option attribution (which could
accelerate the change date to an earlier
date), section 382 is triggered on January
1, 1988. However, for section 338 purposes,
the acquisition date does not occur until
July 1, 1988.
443
c.
L reports gain recognized under section 338
on its return for the period ended July 1,
1988. Since such year is a post-change
year, section 382 applies.
d.
Prior to TAMRA, section 382 appeared to
apply two sets of rules with respect to the
section 338 gain. One set applied to the
gain attributable to the period ending on
the change date -- January 1, 1988; another
set applied to the gain attributable to the
interim period following the change date -January 2 through July 1, 1988.
(1)
(2)
The section 338 gain attributable to
the period ending on the change date
constituted recognized built-in gain
and was governed by the usual built-in
gain rules. See section 382(h)(1)(A).
(a)
With respect to this portion of
the section 338 gain, L was not
assured of being able to offset
such gain by its NOL carryovers.
(b)
Under section 382(h)(1)(A),
recognized built-in gain only
results in an increase to the
section 382 limitation to the
extent of L's net unrealized
built-in gain (reduced by prior
recognized built-in gains). See
section 382(h)(1)(A)(ii).
(c)
However, if L's net unrealized
built-in gain did not exceed the
25 percent threshold, L was
treated as having net unrealized
built-in gain of zero. Section
382(h)(3) (B). In this case, if
the threshold test was not met,
L's section 338 gain accrued as of
the change date could not be
offset by L's NOL carryovers.
Under section 382(h)(1)(C), prior to
TAMRA, the section 382 limitation was
increased by the portion of the section
444
338 gain "not taken into account in
computing recognized built-in gain."
(3)
e.
(a)
In this case, such gain would be
the gain attributable to any
appreciation during the period
January 2, through July 1, 1988.
(b)
With respect to this portion of
the section 338 gain, L could use
its NOL carryovers to offset such
gain. See section 382(h)(1)(C).
Under section 382(h)(5), the income
allocation rules of section 382(b)(3)
do not apply to recognized built-in
gain and section 338 gain that is not
treated as recognized built-in gain.
Under this reading of original section
382(h)(1)(C), present section 382 deviated
from the policy considerations underlying
both sections 382 and 338.
(1)
Section 338 was enacted to conform the
tax treatment between asset sales and
stock sales. Present section 382, as
originally enacted, created
discontinuity between stock and asset
sales to the extent that L's NOL
carryovers are prevented from
offsetting section 338 gain. In an
asset sale, the gain generated from
such sale could be fully offset by L's
NOL carryovers.
(2)
In addition, the apparent policy goal
of section 382 is to allow the buyer to
use the NOL carryovers to the same
extent that the seller could have used
them. In this case, the seller could
have sold the assets directly to the
buyer and utilized the NOL carryovers.
However, original section 382(h)(1)(C)
did not afford the same freedom to the
buyer electing section 338. This fact
violated the neutrality concept by
445
making NOL carryovers less valuable to
the buyer than to the seller.
f.
g.
TAMRA amended section 382(h)(1)(C) to
clarify that if a section 338 election is
made, and the loss corporation's net
unrealized built-in gain is zero due to the
threshold test in section 382(h)(3)(B), then
the section 382 limitation will be increased
by the lesser of: (1) net unrealized builtin gain -- determined without regard to the
threshold limitation, or (2) the recognized
built-in gain resulting from the election.
See P.L. 100-647, § 1006(d)(3)(A). Where
the threshold is exceeded, present section
382(h)(1)(C) will not apply. The usual
rules would apply so that section 338 gain
would be treated as recognized built-in gain
to the same extent as in an actual asset
sale by L.
(1)
Thus, under original section
338(h)(1)(C), the entire section 338
gain could increase the section 382
limitation (assuming the threshold was
exceeded)
(2)
However, under the TAMRA version of
section 382(h)(1)(C), only the section
338 gain that constitutes recognized
built-in gain will increase the section
382 limitation amount.
(3)
Accordingly, any gain accrued after the
change date but before the acquisition
date (i.e., the gain accrued between
January 2 and July 1, 1988 in the
example) will not increase the section
382 limitation because such gain cannot
constitute recognized built-in gain.
An interesting case arises if the option
attribution rule causes the change date to
precede the acquisition date, and the
parties make a section 338(h)(10) election.
Since such an election is treated as an
asset sale, the option (i.e., the contract
446
for the sale of stock) should be treated as
lapsing. As a result, section 382 should
not apply, as discussed in Part VII.B.1.,
above.
D.
Section 381 -- Impact of Subsequent Events
Apparently, even though not reflected in section 381,
the section 382 limitation will be treated as a tax
attribute which follows the related NOL carryover.
1.
Fact pattern
A owns all of the stock of L. L, in turn, owns
all of the stock of L-1 and L-2. On January 1,
1988, P acquires all of the L stock in a
transaction which constitutes an ownership
change. On January 1, 1989, P merges L-1 and L-2
into L.
2.
3.
As a result of the merger, under section 381 L
inherits the NOL carryovers of L-1 and L-2. The
pre-change losses of L-1 and L-2 retain their
character as such following the merger.
a.
Section 382(d)(1) defines a "pre-change
loss" as including NOL carryovers of the old
loss corporation to the taxable year in
which an ownership change occurs. In this
case, this would include NOL carryovers of
L-1 and L-2 from the years 1987 and earlier.
b.
The limitations of section 382(a) apply to
such pre-change losses during any post
change year. A post change year is any year
ending after the change date. Section
382(d)(2).
c.
This would include years of the new loss
corporations (L-1 and L-2) and any years of
their successor (L).
However, the conference report indicates that L
also inherits the section 382 limitation amount
as a tax attribute. That is, L must separately
account for NOL carryovers from a predecessor
loss corporation and separately apply the
applicable section 382 limitation from each
447
predecessor to those NOL carryovers.
Rep. at II-186.
E.
See Conf.
a.
In the above example, the section 382
limitation must be separately calculated, at
the change date, for L, L-1 and L-2.
b.
Following the subsequent combination the NOL
carryovers from L-1, for example, may only
offset L's income to the extent of the
section 382 limitation computed for L-1.
c.
The regulations follow this approach.
Treas. Reg. § 1.382-2(a)(1)(iii).
See
Section 383
1.
The Act also amends section 383 to apply
principles similar to present section 382 to
other specified tax attributes which are carried
over from pre-change years. See Act § 621(b).
2.
On September 19, 1989, the Treasury and the
Service issued temporary regulations under
section 383, as well as conforming the section
382 temporary regulations with section 383. See
T.D. 8264, 1989-2 C.B. 73.
3.
In June 1991, the regulations under section 383
were finalized. See T.D. 8352, 1991-28 I.R.B. 4.
4.
In General
a.
Section 383 will apply after an ownership
change has occurred. See section 383(a),
(b) and (c). In general, the same section
382 definitions apply for section 383
purposes. See section 383(e). In addition,
the same rules and principles applicable to
the section 382 regulations will also apply
to section 383. Treas. Reg. § 1.383-1(g).
b.
The attributes covered by section 383 are
the following:
(1)
Unused general business credits
(section 39);
448
c.
5.
6.
(2)
Unused minimum tax credits (section
53);
(3)
Net capital loss carryover (section
1212);
(4)
Unused foreign tax credits (section
904(c)).
In addition, the conference report states
that passive activity losses and credits
will also be covered by section 383. See
Conf. Rep. at II-194.
Excess Credits
a.
In general, under section 383(a)(1), the
amount of any excess credit which may be
used in a post-change year is limited to the
tax liability attributable to the taxable
income that does not exceed the section 382
limitation.
b.
However, if the loss corporation has NOL
carryovers or other attributes described
above, the section 382 limitation must be
adjusted before applying section 383(a)(1).
Ordering Rules
a.
Section 383 contains certain ordering rules
which apply if a loss corporation possesses
more than one of the covered attributes.
b.
Under section 383, the section 382
limitation is utilized as follows.
(1)
Net capital loss carryovers first
reduce the section 382 limitation to
the extent provided in regulations.
See section 383(b).
(2)
NOL carryovers may then offset income
to the extent of the section 382
limitation remaining after the
application of paragraph (1), above.
See section 383(b).
449
c.
7.
(3)
Excess foreign tax credits might be
used to the extent provided in
regulations. See section 383(a)(1) and
(c).
(4)
Finally, other excess credits covered
by section 383 may be utilized to the
extent of the tax on the section 382
limitation, after taking into account
the above adjustments. See section
383(a)(1).
The regulations provide more specific
ordering rules. Attributes are utilized in
the following order. See Treas. Reg.
§ 1.383-1(d)(2).
(1)
built-in capital losses recognized
during such year;
(2)
capital loss carryovers;
(3)
built-in ordinary losses recognized
during such year;
(4)
net operating loss carryforwards;
(5)
excess foreign taxes carried over under
section 904(e);
(6)
unused general business credits carried
over under section 39;
(7)
unused minimum tax credits under
section 53.
Example
a.
L, a calendar year taxpayer, undergoes an
ownership change on December 31, 1987. L
has $750,000 ordinary taxable income (prior
to pre-change carryovers) and a section 382
limitation of $1,500,000 for 1988. L's
carryovers from pre-1987 taxable years
consist of a $500,000 NOL and a $200,000
foreign tax credit carryover.
450
XI.
(1)
Because the section 382 limitation
exceeds L's NOL carryover, all $500,000
is applied to reduce L's taxable income
to $250,000. L's remaining section 382
limitation is $1,000,000.
(2)
L's remaining section 382 limitation
exceeds its taxable income. Therefore,
if it has sufficient credit carryovers,
L may then apply its foreign tax
credits to offset the remainder of its
tax liability attributable to its
$250,000 taxable income. The regular
tax liability on $250,000 is $80,750.
(3)
L would carryover to its 1989 taxable
year an NOL of zero, $119,250 of
foreign tax credits ($200,000 less
$80,750) and excess section 382
limitation of $750,000 ($1,500,000 less
$500,000 less $250,000). See Treas.
Reg. § 1.383-1(f) (Ex. (2)).
PLANNING TRANSACTIONS
A.
Avoiding Ownership Changes
1.
Issuing Debt Instruments
a.
Fact pattern
In 1987, L makes an initial public offering.
In the offering, 45 percent of the
outstanding L stock is issued to the public.
In 1988, L needs to raise additional funds.
However, an additional stock offering will
trigger an ownership change.
b.
L may have to raise capital either in the
bond markets or through bank lending.
c.
However, if the bank requires, as a
condition for the loan, that L shareholders
pledge their L stock, the pledge may be
treated as an option which could trigger
section 382. Also, a subsequent foreclosure
by the bank may trigger an ownership change.
451
d.
2.
An ownership change would reduce the value
of the L stock and adversely affect the
ability of L to repay the loan.
Sale or Lease of L's Assets
a.
Fact pattern
P is interested in acquiring L's business.
However, if P acquires the L stock, an
ownership change will occur.
b.
3.
L may sell or lease its assets to P without
impairing its NOL carryover. A sale or
lease by L will not cause an ownership
change since no stock of L has changed
hands.
Subsidiary Tracking Stock
a.
Fact pattern
P owns all of the stock of L. P is worth
$100 million; L is worth $10 million.
Individual A plans to invest $15 million in
L in exchange for a 60 percent of the L
stock following the investment.
b.
If A makes an investment directly in L, an
ownership change would occur. In addition,
any excess loss account P may have with
respect to the L stock would be triggered
into income.
c.
Therefore, P and A agree to structure A's
investment as follows. A will use the $15
million to acquire a special class of P
stock that is designed to pay dividends
based on L's income. This class represents
13 percent ($15MM/$115MM) of the value of P.
P contributes the $15 million received from
A to the capital of L. L uses the funds to
invest in a new business.
(1)
Under the attribution rules, A is
considered to own only 13 percent of L.
Therefore, no ownership change occurs
with respect to L.
452
(2)
B.
However, if A's class of P stock is
treated as L stock, an ownership change
would occur.
Increasing the Section 382 Limitation
1.
Corporate Combinations Prior to the Ownership
Change
a.
Fact pattern
H has two wholly owned subsidiaries -- L and
P. L has large NOL carryovers but little
value. P has no NOL carryovers but high
value. H also is not a loss corporation.
X wishes to acquire H and its subsidiaries.
2.
b.
If X acquires H, an ownership change will
occur with respect to L. However, with
respect to L, since its value prior to the
change date was so low, the section 382
limitations will similarly be low.
c.
If H merges L into P prior to X's
acquisition, P will become a loss
corporation (since it is entitled to use L's
NOL carryovers). Because of the common
control exception, the merger is not an
ownership change.
d.
When X subsequently purchases H, the section
382 limitation will be computed using P's
increased value, unless the combination is
viewed as an indirect capital contribution.
See Blue Book at 318.
Leveraged Buyout Transactions
a.
Fact pattern
P wishes to acquire L stock using borrowed
funds. L is worth $100 million. P forms N
and contributes $10 million. N borrows $90
million and contributes $100 million to N-1.
N-1 is merged into L with L surviving. L's
shareholders receive the $100 million. The
bank requires that N and L be combined
shortly after the merger.
453
b.
If N is merged into L, the transaction will
likely by viewed as a redemption by L of $90
million worth of its stock. See Rev. Rul.
78-250, 1978-1 C.B. 83; LTR 8546110; LTR
8542020; LTR 8539056.
(1)
In computing the section 382
limitation, the loss corporation's
value must be reduced if a redemption
occurs in connection with an ownership
change.
(2)
Therefore, L's section 382 amount must
be computed using $10 million as
opposed to $100 million.
c.
However, if L is merged into N, with N
surviving, the transaction may be viewed as
a purchase of the L stock by N. See LTR
8634066. Since a redemption does not occur
in connection with L's ownership change, its
value prior to the transaction is not
reduced. Thus, the full $100 million is
used to compute the section 382 limitation.
d.
Note, however, that the legislative history
to TAMRA states that the fact that a
transaction does not constitute a redemption
for other tax purposes does not preclude
such treatment for section 382 purposes.
See TAMRA Gen. Expl. at 44.
(1)
The rule for redemptions was intended
to apply to transactions that effect
similar results without regard to
formal differences in structure or
order of events.
(2)
For example, a bootstrap acquisition
such as the leveraged buyout above,
will be treated as a redemption because
the value of the loss corporation is
directly or indirectly burdened or
reduced by debt used to provide funds
to the shareholders.
(3)
This treatment could also apply to
acquisitions using the holding company
454
format, even if the debt remains at the
parent level.
C.
General Planning
1.
L Purchases Assets of P
a.
Fact pattern
L is owned by A, B and C. L corporation
sustained losses in prior years while
engaged in business X. L's shareholders
decide to enter into business Y by
purchasing the assets of P. A, B and C
contribute cash to L, and L uses the money
to acquire the P assets. L subsequently
terminates its business Y.
b.
(1)
Section 269(a) does not apply to this
transaction. See section 269.
(2)
Section 382 does not apply since the
stock of L has not changed. See
section 382(g)(1).
(3)
The Libson Shops doctrine does not
apply to transactions subject to the
provisions of the Act. See Conf. Rep.
at II-194.
Fact pattern
Same facts as above, except that L buys all
of the P stock, elects section 338 and
liquidates P under section 332.
(1)
If L first attempted to acquire P's
assets, but failed, the subsequent
purchase should not trigger section
269(a)(1) so long as L's stock
ownership remains stable. See Rev.
Rul. 63-40, 1963-1 C.B. 46, as modified
by TIR 773 (October 13, 1965).
(2)
Section 269(b) does not apply.
Section 269(b).
455
See
(3)
2.
Section 382 does not apply since the
stock ownership of L did not change.
L Acquires P Stock
a.
Fact pattern
The facts are the same as above except that,
instead of acquiring P assets, L acquires
all of the P stock. L and P then file a
consolidated return. P has no NOL
carryovers.
b.
In general, section 269(a)(1) may apply to
disallow the use of consolidated returns.
See Briarcliff Candy Corporation v.
Commissioner, 54 T.C.M. 667 (1987); Hall
Paving Company v. U.S., 471 F.2d 261 (5th
Cir. 1973); Treas. Reg. § 1.1502-80.
However, on these facts, it should not
apply.
(1)
This transaction achieves results
similar to the asset acquisitions
described in paragraph 1., above.
(2)
Thus, if on the same facts L could
acquire assets without triggering
section 269(a)(1), such section should
not apply where only the form differs.
See Rev. Rul. 63-40, supra. See also
Cromwell Corporation v. Commissioner,
43 T.C. 313 (1964).
c.
Section 382 does not apply since P was not a
loss corporation. See section 382(g)(1).
Libson Shops should not apply.
d.
L's NOL carryover are not subject to SRLY
limitation. See Treas. Reg. § 1.15021(f)(2)(i) (common parent exception).
e.
If L liquidated P without making a section
338 election, section 269(b) could apply.
However, on these facts, it should not apply
given L's option of acquiring P's assets
directly.
456
f.
D.
Importantly, OBRA 87 added section 384 to,
in general, prevent a loss corporation from
offsetting its losses with a target's builtin gains that are recognized during the
recognition period. Section 384 also covers
tax-free asset acquisitions.
Monitoring Stock Ownership
1.
L Corp. may wish to restrict trading in its stock
in order to preclude an ownership change that
would restrict use of its NOLs. This would be
especially important, for example, if L had
previously avoided an ownership change by using
the section 382(1)(5) bankruptcy rules. If
another ownership change occurs within 2 years,
the section 382 limitation becomes zero. Section
382(1)(5)(D).
2.
A stock escrow arrangement is one effective
device, although as a practical matter this would
be difficult to adopt.
3.
The Service has approved enforceable restrictions
on the sale of stock to a person who would become
a 4.5 percent or more shareholder, i.e., the
prohibited acquirer will not be considered the
owner of the stock pending its acquisition and
sale in the open market by the corporation's
agent. See LTR 8949040.
4.
This device would not be effective, however, in
preventing owner shifts of first tier and higher
tier entities. Effective restrictions would have
to be in place at each entity level to insure
against an ownership change.
457