Opportunity to Eliminate Certain Intercompany Gain

By Patricia W. Pellervo, J.D., and Charmaine Y. Lee, J.D., San Francisco

Editor: Annette B. Smith, CPA

Consolidated Returns

Sales or distributions of assets within a consolidated group may result in gain recognition that is deferred under Regs. Sec. 1.1502-13. If the intercompany gain relates to stock of a subsidiary member, Regs. Sec. 1.1502-13 generally requires the taxpayer to take into account the intercompany gain if the transferred entity is liquidated in a Sec. 332 transaction. Before 2008, taxpayers had to include the intercompany gain in their gross income without exception when the intercompany gain was triggered.

Previously dormant intercompany gain often caught unwary taxpayers off guard during business planning and restructuring. However, recent IRS developments may provide an opportunity for groups to effectively eliminate the intercompany gain in certain circumstances, thereby reducing the possibility of inadvertently triggering intercompany gain and freeing taxpayers from the need to plan transactions so as to avoid a trigger.


Prior to the issuance of temporary regulations in 2008, an intercompany gain that was recognized and deferred under Regs. Sec. 1.1502-13 generally would be taken into account if the transferred entity subsequently was liquidated under Sec. 332. While the buying member’s gain or loss on the liquidation would be subject to nonrecognition under Sec. 332, the selling member’s gain would be taken into account. This result is intended to prevent consolidated groups from using intercompany transactions to dispose of assets without recognition of gain that would be taxable at the corporate level.

Although the regulations prior to 2008 allowed the IRS to issue rulings to exclude a selling member’s gain from gross income, the principles set out in the rules allowing this exercise of discretion were not clear and relief was limited. This was especially true when the regulations had specifically contemplated possible gain duplication in situations involving a Sec. 332 transaction.

Example 1: S, T, and B are members of the same consolidated group. B owns all the stock of S, and S owns all the stock of T. S sells all its appreciated stock of T to B and has an intercompany gain from its T stock that will be deferred under Regs. Sec. 1.1502-13. B subsequently liquidates T and triggers S’s intercompany gain. S’s intercompany gain is taken into account and not redetermined to be treated as excluded or nontaxable because B’s unrecognized gain or loss on the transferred stock is not a permanent and explicit disallowance under the Code.

The IRS recognized that the application of Regs. Sec. 1.1502-13 may result in the effective duplication of gain within a consolidated group when the intercompany gain is not reflected in basis after the transaction and does not provide the taxpayer with some other tax benefit. Accordingly, in 2008, the IRS issued temporary regulations (Temp. Regs. Sec. 1.1502-13T(c)(6)(ii)(C), in T.D. 9383) that provided an exception to recognition if five requirements were met (the automatic relief rule, or ARR). The IRS retained the then-existing rule (the commissioner’s discretionary rule, or CDR) allowing a taxpayer to seek a letter ruling granting an exception from the income inclusion, but it noted in the preamble that it did not believe the rule would be necessary any longer, and it asked for comments on whether it would be appropriate to eliminate the CDR.

In 2011, the IRS finalized the regulations (T.D. 9515). The ARR remains the same under the final regulations. If a group can meet the five enumerated requirements of Regs. Sec. 1.1502-13(c)(6)(ii)(C)(1), the gain triggered will be nontaxable. Based on comments it received, the IRS decided not to eliminate the CDR and included it in Regs. Sec. 1.1502-13(c)(6)(ii)(D). Under the CDR, if a taxpayer cannot meet one of the first three of the ARR criteria with respect to the gain but does meet the last two criteria, the IRS may still determine the intercompany gain should be excluded from gross income. The final regulations apply to intercompany items taken into account on or after March 4, 2011. The temporary regulations (which included the prior versions of the ARR and the CDR) apply to items taken into account on or after March 7, 2008, and before March 4, 2011.

Example 2: Assume the same facts as Example 1, except that before B liquidates T, S liquidates or merges into B, with B as the successor member to S’s assets and intercompany gain. When B subsequently liquidates T, the transaction triggers S’s intercompany gain. Immediately prior to the liquidation of T, B is the T stock’s owner and is also a successor to S. Because T’s stock is eliminated and B is not afforded any other tax benefits, the ARR applies, and the gain triggered will be nontaxable under the ARR. However, if the ending result is the same—in other words, a single entity remains and the T stock is eliminated—but the sequence of steps differs, the ARR may not apply, and the gain triggered will be taxable. However, the group should consider whether the gain may be excludable from gross income through exercise of the CDR.


The ARR and CDR may provide an opportunity for taxpayers to eliminate intercompany gain that otherwise could interfere with business planning and restructuring. This opportunity may offer a means to eliminate intercompany gains on stock when to do so would not frustrate the purposes of the intercompany transaction rules by permitting circumvention of corporate-level tax. Since the CDR’s finalization in 2011, the IRS has issued two letter rulings exercising its authority provided by the CDR for taxpayers that could not meet the ARR’s requirements.

In Letter Ruling 201210018, the IRS exercised its authority to exclude intercompany gain with respect to a member stock that otherwise would have been taken into account as a result of a proposed downstream merger. The taxpayer did not meet one of the ARR’s enumerated requirements, namely, the selling member was not a successor to the buying member prior to execution of the proposed transaction. However, because the basis in the stock was eliminated and not reflected in any other asset and the intercompany transaction did not otherwise provide the taxpayer with a tax benefit, the IRS redetermined the intercompany gain to be excluded from gross income.

Similarly, in Letter Ruling 201312027, the IRS exercised its authority to exclude intercompany gain with respect to multiple member stocks that otherwise would have been taken into account as a result of multiple proposed upstream reorganizations or liquidations. The taxpayer did not meet at least one of the enumerated requirements of the ARR. Because the transferred stock’s basis was eliminated as a result of the proposed transactions, one entity remained as the successor to the selling and buying members, and the transaction otherwise did not afford the taxpayer with any tax benefits, the IRS redetermined the intercompany gain to be excluded from gross income.

In each favorable letter ruling, the IRS allowed the taxpayer to eliminate intercompany gain that was deferred but that otherwise could have been triggered, possibly inadvertently, upon subsequent intragroup restructurings. The IRS’s focus in each instance appears to be whether the taxpayer reflected the intercompany gain in the basis of any other stock or assets, or whether the transaction provided the taxpayer with any other tax benefits.


While previously, taxpayers with deferred intercompany gain had to remain vigilant to plan around a liability that did not provide any tax benefit to the taxpayer, the ARR and CDR now offer taxpayers an opportunity to plan for elimination of the intercompany gain. If used properly during business planning and restructuring, these relief provisions may serve as a useful tool in efficient tax planning.


Annette Smith is a partner with PwC, Washington National Tax Services, in Washington, D.C.

For additional information about these items, contact Ms. Smith at 202-414-1048 or annette.smith@us.pwc.com.

Unless otherwise noted, contributors are members of or associated with PricewaterhouseCoopers LLP.

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