Final regulations effective January 15, 2008 (TD 9376), explain how the members of a consolidated group succeed to tax items, or “attributes,” of a subsidiary corporation when two or more members of the group own stock in the subsidiary and the subsidiary is liquidated on a tax-free basis. This issue is present only in the consolidated return area because, in the absence of a consolidated group, only one “parent” corporation can succeed to the tax attributes of the liquidated subsidiary.
Rules Under the Code
Where the requirements of each provision are satisfied, Sec. 332 provides tax-free treatment to the corporate shareholder’s gain or loss from the receipt of the subsidiary’s property in liquidation, and Sec. 337 provides tax-free treatment to the subsidiary’s gain or loss on the distribution of its property to the parent corporation. Sec. 332(b) provides for nonrecognition of gain or loss where the corporation receiving such property was, on the date of adoption of the plan of liquidation and at all times thereafter until the receipt of the property, the owner of stock meeting the requirements of Sec. 1504(a)(2) (generally 80% by voting power and value) and the distribution was made in complete cancellation or redemption of all the stock of the liquidating corporation.
Many of the consolidated return rules are premised on the goal of treating the various corporate members of the consolidated group as if they were divisions of a single corporation. To that end, Regs. Sec. 1.1502-34 permits shares of stock owned by two or more members of the group to be aggregated in order to determine whether the required stock ownership threshold has been satisfied. The rule specifically applies to the Sec. 332 stock ownership requirement, as well as other provisions of the Code not relevant to this discussion.
Sec. 337(a) generally provides that the liquidating corporation does not recognize gain or loss on the distribution to the 80% distributee of any property in a complete liquidation to which Sec. 332 applies. Sec. 337(c) provides that, for purposes of Sec. 337, the term “80% distributee” means only the corporation that meets the 80% stock ownership requirements of Sec. 332(b) without regard to the application of any consolidated return regulation, such as Regs. Sec. 1.1502-34. Thus, the subsidiary’s gain or loss is eligible for nonrecognition only to the extent that property is distributed to a direct 80% corporate shareholder, even in a consolidated return context.
To the extent that Sec. 337(a) does not apply, Sec. 336 provides that the liquidating corporation will generally recognize gain or loss on the distribution of property in complete liquidation as if such property were sold to the distributee at its fair market value (FMV). Thus, gain or loss would be recognized on property distributed to a minority shareholder of a subsidiary corporation even if Sec. 332 otherwise applied to the corporate parent. A complete liquidation to which Sec. 332 applies may therefore be taxable in whole or in part to the liquidating corporation, while remaining tax free to the distributee member(s).
As a consequence of these provisions, a liquidation of a corporate subsidiary might permit the members of the group to avail themselves of Sec. 332 in their capacity as corporate shareholders, even though the subsidiary might recognize gain or loss, in whole or in part. For example, assume that 80% of a subsidiary’s (T’s) stock is owned by P and the remaining 20% is owned by S. T distributes its assets pro rata to P and S. P and S are each entitled to Sec. 332 treatment upon the receipt of T’s assets. T, however, is entitled to Sec. 337 treatment with respect to the distribution of its assets to P, but not to S. If P and S each owned 50% of T’s stock, then T would be required to recognize gain or loss on the distribution of all its assets to both shareholders. In the latter case, the consolidated return intercompany transaction rules would defer the recognition of T’s gain or loss until a later time.
Because Sec. 332 liquidations generally are limited to a transfer of assets from one corporation to an 80% controlled corporation, the Code regards the parent as a successor to the subsidiary for many income tax purposes. Sec. 381(a)(1) provides that in the case of a Sec. 332 liquidation, the parent corporation succeeds to and takes into account 22 specific tax attributes as set forth in Sec. 381(c). These attributes include earnings and profits (E&P), net operating loss (NOL) carryovers, capital loss carryovers, unused tax credits, methods of depreciating assets, and other methods of accounting, including income that has been received by an accrual-method taxpayer for goods and subscriptions but not earned, and thus deferred under Secs. 451 and 455, and services under Rev. Proc. 2004-34.
Outside the consolidated return area, the application of Sec. 381 to a Sec. 332 liquidation is clear. Only the corporate parent succeeds to the tax attributes identified in Sec. 381(c). The minority shareholder cannot, under any circumstances, succeed to the subsidiary’s NOL or capital loss carryovers, unused tax credits, or methods of accounting. In contrast, within a consolidated group, two or more members may receive assets of the subsidiary on a tax-free basis under Sec. 332; thus, it may be appropriate for all members of the group owning stock in the subsidiary to succeed to the subsidiary’s tax attributes.
The Service issued proposed regulations in February 2005 that applied the single-entity principles of taxation for allocating the intercompany items of a liquidating subsidiary where multiple members acquire the assets of a liquidating subsidiary in a complete liquidation to which Sec. 332 applies (REG-131128-04). The proposed regulations allocated the items of the liquidating corporation to the various distributee members in a manner such that these items could be used to offset the income or tax liability of the group or to each distributee member to the extent that such items would have been reflected in investment adjustments to the stock of the liquidating corporation owned by such distributee member under Regs. Sec. 1.1502-32(c). The proposed regulations also provided specific allocation rules for the credits, E&P, and other items of the liquidating corporation, as well as guidance on the proper method for allocating the “intercompany” items of a liquidating subsidiary in these transactions.
Because of the perceived lack of clarity in the proposed regulations, and based on comments received by the IRS, the final regulations made certain revisions to the proposed regulations. The final regulations provide more definitive guidance in this area but specifically provide no rules regarding the application of the successor rules for “intercompany” items as outlined under Regs. Sec. 1.1502-13(j)(2). The final regulations provide rules for succession to the following attributes:
Earnings and profits: The E&P of the subsidiary is allocated proportionately to the distributee members based on the relative FMV of the liquidating corporation’s stock owned by each such member. If the subsidiary is also a member of the consolidated group, its E&P would already have been reflected, in whole or in part, in the E&P of the higher tier members. Adjustments to that E&P are necessary to prevent the E&P from being duplicated in the higher-tier members by reason of the liquidation.
Credits: All credits, including general business credits and the minimum tax credit under Sec. 53, will be allocated proportionately to the distributee members based on the FMV of the stock of the liquidating corporation owned by each such member.
Deferred income items of the liquidating corporation: All of the authorities that permit the use of a deferral method for unearned income require that the income be recognized if the taxpayer is relieved of its obligation to perform the services or provide the goods. However, in a transaction subject to Sec. 381(a), the IRS permits the income to continue to be deferred in the hands of the transferee. For these reasons, the Service believes that it is appropriate for any deferred income items of a liquidating corporation attributable to assets and/or liabilities transferred to a non-80% distributee to be taken into account under applicable principles of law as a result of the liquidation, despite the fact that the transaction is described in Sec. 381(a).
Sec. 332(a) does not apply in determining the recognition or nonrecog-nition of any income realized by the non-80% distributee attributable to its assumption of an obligation or liability related to the deferred income because such income is not gain or loss recognized with respect to the liquidating corporation’s stock. To the extent that the deferred income method may not be carried over to the distributee, taxpayers should consider eliminating or mitigating the income acceleration through the application of Rev. Rul. 68-112 (offsetting deduction to transferor for payments made by transferor to transferee) and Rev. Rul. 71-450 (income recognition by transferee in same transaction).Allocation of items specific to prop erty or a business: Taxpayers will be required to determine which of the distributees must account for the deferred income in order to apply the foregoing rules. The Service believes that it is appropriate to allocate the full amount of deferred income items or deferred deductions of the liquidating corporation that are attributable to specific property or a specific business to the distributee member that receives such property or business in the liquidation.
Notwithstanding the lack of guidance for deferred intercompany transactions, the final regulations provide more certainty with respect to certain Sec. 332 liquidations involving multiple distributees.
Lorin D. Luchs, Partner, Washington National Tax Office BDO Seidman, LLP, Bethesda, MD.
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