Proposed Regs. Would Require E&P to Be Allocated to Acquiring Corporations in Corporate Reorganizations

The IRS has proposed amending existing regulations under Sec. 312 (effect on earnings and profits (E&P) of corporate distributions) and Sec. 381 (carryovers of tax attributes in certain corporate acquisitions) to clarify that in certain corporate reorganizations, the “acquiring corporation” succeeds to the full E&P account of the transferor corporation (REG-141268-11). 

The IRS has historically interpreted the regulations under Sec. 312 as providing that the E&P of the transferor corporation do not move to the transferee in whole or in part other than in a transfer described in Sec. 381 or, to the extent provided under Regs. Sec. 1.312-10, in a divisive reorganization. Furthermore, the IRS has interpreted the regulations to provide that in a corporate reorganization described in Sec. 381, the acquiring corporation, as defined in Regs. Sec. 1.381(a)-1(b)(2), succeeds to the full E&P account of the transferor corporation. According to the IRS, the E&P account is not divided if the acquiring corporation in an acquisitive asset reorganization subsequently transfers target assets to one or more controlled subsidiaries.

The IRS believes the proposed rule is appropriate because E&P measures a corporation’s capacity to pay dividends to its shareholders. Thus, the corporation that has an interest, directly or indirectly, in all of the target’s assets has the dividend-paying capacity that is most comparable to that of the target.

Some practitioners have suggested that this result was not clear under current law. In response, the IRS is clarifying its position in the proposed regulations by removing Regs. Sec. 1.381(c)(2)-1(d), which provides that the determination of how E&P is allocated in certain corporate acquisitions is made without regard to Sec. 381 and contains a cross-reference to Regs. Sec. 1.312-11. The proposed regulations would also amend Regs. Sec. 1.312-11 to require E&P to accrue to the acquiring corporation.

The proposed rules would apply to transactions occurring on or after the date the regulations are finalized.