The IRS issued proposed regulations governing the availability of net operating loss (NOL) deductions that are attributable to corporate equity reduction transactions (CERTs) under Secs. 172(b)(1)(E) and (h) (REG-140668-07). The CERT rules were enacted in response to the use of NOL carrybacks to finance leveraged buyout transactions and are intended to limit corporations’ ability to obtain tax refunds that result from interest deductions from financing used to facilitate those transactions. The proposed regulations explain the application of the CERT rules generally and to consolidated groups specifically and provide three new elections that current and former members of consolidated groups can make.
A CERT is either a major stock acquisition or an excess distribution. A major stock acquisition is a corporation’s acquisition, under the corporation’s plan or any group operating in concert with the corporation’s plan, of 50% or more of a corporation’s stock (by vote or value). An excess distribution is the excess, if any, of the aggregate distributions (including redemptions) the corporation made during the tax year with respect to its stock over the greater of (1) 150% of the average of those distributions during the three tax years immediately preceding the tax year, or (2) 10% of the corporation’s stock value at the beginning of the tax year.
Once a major stock acquisition or excess distribution occurs, the CERT rules limit the carryback of the portion of an NOL that is a corporate equity reduction interest loss of an applicable corporation in any loss limitation year (the year in which the CERT occurs and the two succeeding tax years). An applicable corporation is a C corporation that acquires stock or whose stock is acquired in a major stock acquisition; a C corporation making distributions with respect to, or redeeming its stock in connection with, an excess distribution; or a C corporation that is a successor to one of these corporations. The corporate equity reduction interest loss is the excess of the total NOL for the loss limitation year over the NOL for the loss limitation year computed without regard to the allocable interest deductions.
The proposed regulations under Secs. 172(b) and (h) explain whether a CERT has occurred, how to compute a corporate equity reduction interest loss, and how to treat successor corporations. They also contain detailed rules for applying these regulations in the consolidated group context: (1) treating the group as one taxpayer; (2) determining the group’s three-year average for a loss limitation year; (3) applying the CERT rules when a corporation joins or leaves a consolidated group; (4) apportioning a corporate equity reduction interest loss to members of a group in separate return years; and (5) applying the rules to life insurance and non-life insurance groups. The proposed regulations also provide rules that would amend the loss carryback waivers available to deconsolidating group members.
The new rules will apply to CERTs occurring after the regulations are published as final in the Federal Register, except for CERTs occurring under a written agreement binding before that date. There are separate effective dates for the amendments to Regs. Secs. 1.1502-21(b)(2) and (3) and for Regs. Sec. 1.1502-72(e) (preamble to REG-140668-07).