Editor: Annette B. Smith, CPA
Corporations & Shareholders
If a transaction satisfies the substantive tests for certain subchapter C nonrecognition provisions (e.g., Secs. 332, 351, and 368), can the taxpayer nonetheless achieve a taxable exchange by intentionally violating procedural requirements? In other words, can procedural requirements be viewed as, in effect, offering an election to create gain or loss? As discussed below, the authorities generally indicate that the answer is “no” and that nonrecognition is mandatory. The issue has arisen in connection with such substantive or procedural requirements as the need to issue shares to meet a statutory requirement (sometimes called a “meaningless gesture” but required under, e.g., Sec. 367(c)(2)); the requirement for a gain recognition agreement (GRA); and the requirement for a Sec. 367(b) notice.
Information Filing Required for Nonrecognition
The regulations associated with tax-free contributions, liquidations, and reorganizations require taxpayers to file certain information with the IRS. For example, every significant transferor and transferee corporation in a Sec. 351 exchange must include a Regs. Sec. 1.351-3(a) statement on its income tax return for the tax year of the Sec. 351 exchange. In the context of nontaxable corporate liquidations meeting the requirements of Sec. 332, Regs. Sec. 1.332-6 requires a parent corporation receiving distributions in complete liquidation from its 80%-or-more liquidating subsidiary corporation to include a statement on its tax return for that year stating that the corporation received a liquidating distribution and to provide the fair market value and basis of the distributed property immediately before the liquidation.
With respect to the corporate distributor in a Sec. 332 liquidation, Regs. Sec. 1.6043-1 requires that a liquidating corporation file Form 966, Corporate Dissolution or Liquidation, setting forth the terms of the resolution or plan and other information required by the IRS. A liquidating corporation also must file Form 1096, Annual Summary and Transmittal of U.S. Information Returns. In the context of reorganizations, Regs. Sec. 1.368-3 requires a corporate participant in a tax-free reorganization to file a complete statement with its tax return for the year of reorganization setting out specific information including the date of the reorganization; the aggregate fair market value and basis of the assets, stock, or securities of the target corporation transferred in the transaction; and the date and control number of any private letter rulings issued by the IRS in connection with this reorganization.
Court Authorities
In Burnside Veneer Co. , 167 F.2d 214 (6th Cir. 1948), the taxpayer unsuccessfully argued that although it owned 80% of the subsidiary stock and in all other respects fell within the nonrecognition provisions of Sec. 112 (a predecessor statute of Sec. 332), the liquidation did not fall within Sec. 112 because the taxpayer did not file the required statement showing the period during which the transfer of the property occurred. The Sixth Circuit found that a resolution ordering both that the corporation “be immediately dissolved” and that officers take the necessary steps to that end constituted evidence of the existence of a plan of liquidation such that the corporate shareholder could not claim a long-term capital loss after the dissolution.
Similarly, in Service Co., 165 F.2d 75 (8th Cir. 1948), a corporate parent’s intentional failure to meet procedural requirements of the regulations to claim a loss on a “one-year” liquidation of its subsidiary was unsuccessful. The Eighth Circuit held that “[r]egulations are matters of administrative procedure promulgated primarily for the protection of the revenue, not for the advantage of the taxpayer.” As with complete liquidations, the procedural requirements within the reorganization context generally are not viewed as strictly necessary for tax-free treatment. In J.E. Seagram Corp., 104 T.C. 75 (1995), the Tax Court concluded that “the concept of ‘plan of reorganization,’ as described in [Regs. Sec.] 1.368-2(g) … is one of substantial elasticity.”
IRS Position
The IRS has taken a similar position. For example, in Rev. Rul. 65-30 (subsequently declared obsolete by Rev. Rul. 95-71), the IRS concluded that a corporation would not be denied the benefits of Sec. 337 for failure to report the information required by former Regs. Sec. 1.337-6. Rev. Rul. 65-30 also discussed the effect of a corporation’s failure to report certain information that, pursuant to Regs. Sec. 1.337-6, was to be attached to the return of a liquidating corporation in cases to which Sec. 337(a) applied. The IRS reasoned that because Sec. 337 is not elective, its application is mandatory to any transaction fitting the facts described in Sec. 337(a) and that former Regs. Sec. 1.337-6 was not intended to impose a further condition on its applicability. However, Rev. Rul. 65-30 pointed out that under certain circumstances, failure to furnish information required by former Regs. Sec. 1.337-6 could subject the taxpayer to Sec. 7203, pertaining to criminal penalties for willful failure to supply information then required by the regulations. Further, under Rev. Rul. 65-80, failure to file Form 966, which also is required for Sec. 332 liquidations, did not nullify the liquidation but could subject the corporation to criminal penalties for willful failure to file.
The IRS also has taken the position in Technical Advice Memorandum (TAM) 8452004 that while failure to file the statement as prescribed in Regs. Sec. 1.368-3 may cause the IRS some problems in administration, failure to comply with the notice-giving provisions of the regulation will not disqualify a reorganization that otherwise qualifies as a tax-free reorganization. TAM 8216067 likewise stated that although failure to file the information statements required by Regs. Sec. 1.332-6 and former Regs. Sec. 1.337-6 for transactions under Sec. 332 and Sec. 337, respectively, may cause some administrative problems, that failure will not, by itself, nullify transactions under those Code sections. In addition, the TAMs provide that failure to file the required statements may cause the IRS some problems but will not nullify the transactions discussed, including whether a transaction qualifies for nonrecognition treatment under Sec. 351.
As discussed above, complete and even intentional noncompliance with procedural requirements may not prevent the IRS from imposing tax-free liquidation treatment under Sec. 332 or nonrecognition treatment under the reorganization regime. In fact, courts have rejected attempts by taxpayers to avoid Sec. 332 on the ground that a liquidating subsidiary or a controlling parent did not comply with regulatory procedural requirements. Similarly, the procedural requirements within the organization and reorganization context also are not viewed as strictly necessary conditions to tax-free qualification of such transactions. Thus, taxpayers wishing to avoid nonrecognition for a complete liquidation under Sec. 332, a tax-free contribution under Sec. 351, or a tax-free reorganization under Sec. 368 to use certain attributes or reach a specific tax result should not rely on intentional noncompliance with the procedural regulatory filings required in connection with the transactions.
Sec. 367(b) Notices and Gain Recognition Agreements
The consequences of failing to file a Sec. 367(b) notice are not entirely clear. The notice appears to be a procedural requirement that, if not satisfied, would not result in gain recognition, based on the authorities discussed above. Proposed regulations from the 1990s provided that if a Sec. 367(b) notice was not filed, the IRS could deny tax-free treatment. This statement later was removed when those regulations were finalized in 2000; the final regulations give no explicit indication that gain recognition can result.
However, the failure to properly file a GRA—a substantive requirement that has replaced, in part, the prior Sec. 367 letter ruling requirement—can result in gain recognition under Sec. 367(a)(1). For example, Field Attorney Advice 20074901F provides that where a taxpayer did not have a valid GRA as required by Regs. Sec. 1.367(a)-8, the substantial compliance doctrine did not apply where the preparer of the GRA knowingly reported an incorrect estimated fair market value and basis of transferred property. The memo recommended making an adjustment showing the transaction as taxable under Sec. 367(a)(1). See also TAM 200919032, which provides, “Taxpayer’s failure to file a gain recognition agreement after being notified one was due renders it ineligible for relief under [Regs. Sec.] 1.367(a)-8(c)(2). Thus, the Outbound Stock Transfer is described in [Sec.] 367(a)(1) and is a taxable exchange.”
EditorNotes
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.
