- Unified Loss Rule Finalized - Buyers May Benefit from a Protective Election
- October 25, 2008 | Author: R.D. David Young
- Law Firm: Pepper Hamilton LLP - Washington Office
On September 17, 2008, the IRS and the Treasury Department finalized regulations establishing a Unified Loss Rule applicable to corporations filing consolidated returns that transfer a share of subsidiary stock at a loss.1 The Unified Loss Rule generally requires a reduction in the basis of the transferred share or the reduction of the tax attributes of the subsidiary in order to prevent the group2 from recognizing a noneconomic stock loss and obtaining more than one tax loss from a single economic loss.3 This Unified Loss Rule is designed to provide an integrated approach to address both of these concerns while preserving the result of the Rite Aid decision.4
The Unified Loss Rule consists of three principal rules that apply when a member5 transfers a share of subsidiary stock with a basis in excess of its value (a “loss share”): the “basis redetermination rule;” the “basis reduction rule;” and the “attribute reduction rule.” Each rule is applied sequentially but only to the extent that the transferred share continues to be a loss share after the application of the prior rule.6 These rules apply to all transfers on or after September 17, 2008, unless the transfer was made pursuant to a binding agreement that was in effect prior to September 17, 2008 and at all times thereafter.7
Definition of Transfer
A transfer generally occurs when the member ceases to own the share of subsidiary stock in a taxable transaction, the member and the subsidiary cease to be members of the same group, a nonmember acquires the share from the member, or the share becomes worthless.8 However, a transfer generally does not occur when the member ceases to own the share as a result of a tax-free intra-group transaction to which section 381(a) applies, and in the case of a Section 332 liquidation, the member is the only member that owns shares of subsidiary stock.9 A transfer also generally does not occur when the member ceases to own the share as a result of a distribution of the share to a nonmember in a tax free spin-off or split-off.10
If a member transfers a share of subsidiary stock in an intercompany transaction in which the member’s intercompany item is deferred under Treas. Reg. §1.1502-13, the Unified Loss Rule will apply as of the time the member’s intercompany item is taken into account and all transferor-members will be treated as divisions of a single corporation.11
The first rule, referred to as the “basis redetermination rule,” reallocates consolidated return investment adjustments, to the greatest extent possible, to reduce basis disparity among members’ bases in preferred shares of subsidiary stock and among members’ bases in common shares of subsidiary stock.12 This rule is designed to address both noneconomic and duplicated stock loss when members hold subsidiary shares with disparate bases and to “bring members’ bases closer into alignment with the assumptions underlying the investment adjustment system.”13 However, the basis redetermination rule does not apply if the group disposes of its entire interest in the subsidiary in a taxable transaction, there is no disparity among members’ bases in shares of common stock, and no member owns a share of S preferred stock with respect to which there is unrecognized gain or loss.14
In general, the member’s basis in each of its transferred loss shares of subsidiary common stock is first reduced, but not below value, by removing positive investment adjustments previously applied to the basis of the share.15 If a transferred share is still a loss share, the member’s basis in the share is reduced, but not below value, by reallocating negative investment adjustments to the transferred loss share from other shares of subsidiary common stock held by such members.16 The positive investment adjustments removed from transferred loss shares of subsidiary common stock in the first step are reallocated and applied first to increase, but not above value, members’ bases in shares of subsidiary preferred stock in a manner that reduces the disparity among members’ bases in all shares of subsidiary preferred stock,17 and second to increase members’ bases in shares of subsidiary common stock in a manner that reduces the disparity among members’ bases in all shares of subsidiary common stock.18
The final regulations modify the basis redetermination rule to omit the reallocation of positive investment adjustments applied to preferred shares under §1.1502-32.19 The reason is that such positive adjustments are allocated to preferred shares solely to account for the right to receive distributions. Because such adjustments are based on economic changes in the shareholder’s investment, the IRS and Treasury believe that they should have no correlation to unrecognized loss reflected in the bases of the shares and so should not be subject to this rule.
The second rule, referred to as the “basis reduction rule,” reduces the basis of each transferred loss share, but not below value, by the lesser of the share’s “net positive adjustment” and its “disconformity amount.”20 This rule is intended to prevent noneconomic stock loss and thus promote the clear reflection of the group’s income.21
A share’s “net positive adjustment” is generally the greater of zero or the sum of all investment adjustments reflected in the basis of the share, including those made under the “basis redetermination rule.”22 This amount reflects the extent to which a share’s basis has been increased by the investment adjustment provisions.23
A share’s “disconformity amount” is the excess of its basis over its allocable portion of the subsidiary’s “net inside attribute amount” at the time of the transfer.24 The subsidiary’s “net inside attribute amount” generally is the sum of the subsidiary’s cash, asset basis, net operating and capital loss carryovers, and deferred deductions immediately before the transfer.25 The subsidiary’s “net inside attribute amount” does not include the subsidiary’s credits.26 In computing the “net inside attribute amount” the basis reduction rule includes a special rule applicable to shares in lower-tier subsidiaries.27 The rationale behind limiting the amount of basis reduction to the share’s “disconformity amount” is that such amount identifies the minimum amount of unrecognized appreciation actually reflected in the basis of such share at the relevant time.28
The third rule, referred to as the “attribute reduction rule,” reduces the subsidiary’s attributes by the lesser of the “net stock loss” and the “subsidiary’s aggregate inside loss.”29 This rule is intended to prevent a subsidiary from using deductions and losses to the extent that the group or its members (including former members) have either used, or preserved for later use, a corresponding loss in the subsidiary’s shares.30
The “net stock loss” is the excess of the sum of the basis (after application of the above rules) of all subsidiary shares transferred by members in the same transaction over the value of such shares.31 The “aggregate inside loss” is the excess of the subsidiary’s “net inside attribute amount” over the value of all of the subsidiaries shares.32 For this purpose “net inside attribute amount” is similar to the amount computed for purposes of the “basis reduction rule” but with different rules for lower-tier subsidiaries.33
The attribute reduction rule generally applies first to reduce capital loss carryovers, net operating loss carryovers, and deferred deductions in the order specified by the selling group.34 If such attributes are reduced in full, the attribute reduction rule then generally applies to reduce the subsidiary’s asset basis under a reverse residual allocation method under Section 1060, with a special rule applicable to shares in lower-tier subsidiaries.35
If the total attribute reduction amount is less than 5 percent of the aggregate value of the transferred shares, the attribute reduction rule does not apply, unless the selling group elects to apply the rule.36 The attribute reduction rule also allows the common parent of a group to elect (and it may do so protectively) to reduce stock basis, reattribute attributes,37 or do some combination of basis reduction and attribute reattribution, if the subsidiary ceases to be a member of the group, in order to prevent the reduction of attributes otherwise required under these rules.38
Special rules are provided to determine application in the case of transfers of stock of multiple subsidiaries.39 Additionally, the rules contain safe-harbor provisions that call off application in certain situations.40 Further, a general “anti-abuse and anti-avoidance” provision provides that “appropriate adjustments” will be made if a taxpayer attempts to avoid the application of these rules.41
While these regulations are final, the IRS and Treasury have requested and will consider comments on numerous issues arising under these regulations.
These regulations are the result of extensive study by the IRS and Treasury and represent an attempt to address both the circumvention of General Utilities repeal and the duplication of losses by consolidated groups. The IRS and Treasury Department indicated that the complexity of the rules is a result of the balancing of benefits and burdens arising from the presumptions on which the rules are based. The results of these presumptions are not always intuitive and occasionally lead to anomalous results.
These regulations clearly have significant implications to a corporation selling stock of a subsidiary after September 17, 2008. These regulations also may have a hidden trap for buyers of stock of a subsidiary if the attributes of the subsidiary are reduced because of the application of the attribute reduction rule. Buyers should seriously consider including a provision in all stock purchase agreements requiring the common parent of the selling group to protectively elect to reduce subsidiary stock basis in event the seller has a loss on the sale. Without such an election, a buyer may purchase a subsidiary from a group and unknowingly allow the subsidiary’s attributes to be reduced if the seller has a loss on the sale and such loss is not eliminated by the basis redetermination and basis reduction rules.
1 T.D. 9424. Unified Rule for Loss on Subsidiary Stock, 73 Fed. Reg. 53,934 (Sept. 17, 2008).
2 The term “group” means an affiliated group of corporations filing (or required to file) consolidated returns for the tax year.
3 Id. at 53,937.
4 See, Rite Aid Corp. v. U.S., 88 AFTR 2d 2001-5058; 255 F.3d 1357 (July 6, 2001). IRS and Treasury Department interpret the preservation of the result of Rite Aid to mean that regulations addressing loss duplication by consolidated groups must not disallow a deduction for an economic loss on subsidiary stock solely because the stock loss duplicates unrecognized or unabsorbed losses that later could be used outside the group.
5 The term “member” means a corporation (including the common parent) that is included in the group.
6 T.D. 9424, 73 Fed. Reg. at 53,935.
7 Treas. Reg. § 1.1502-36(h).
8 Treas. Reg. § 1.1502-36(f)(10)(i).
9 Treas. Reg. § 1.1502-36(f)(10)(ii)(A).
10 Treas. Reg. § 1.1502-36(f)(10)(ii)(B).
11 Treas. Reg. § 1.1502-36(e)(3).
12 T.D. 9424, 73 Fed. Reg. at 53,939.
13 Unified Rule for Loss on Subsidiary Stock, 72 Fed. Reg. 2963 (January 23, 2007).
14 Treas. Reg. § 1.1502-36(b)(1)(ii).
15 Treas. Reg. § 1.1502-36(b)(2)(i)(A).
16 Treas. Reg. § 1.1502-36(b)(2)(i)(B).
17 Treas. Reg. § 1.1502-36(b)(2)(ii)(A).
18 Treas. Reg. § 1.1502-36(b)(2)(ii)(B).
19 T.D. 9424, 73 Fed. Reg. at 53,938.
20 Treas. Reg. § 1.1502-36(c)(2).
21 Treas. Reg. § 1.1502-36(c)(1).
22 Treas. Reg. § 1.1502-36(c)(3).
23 Unified Rule for Loss on Subsidiary Stock, 72 Fed. Reg. 2963 (January 23, 2007).
24 Treas. Reg. § 1.1502-36(c)(4).
25 Treas. Reg. § 1.1502-36(c)(5).
26 T.D. 9424, 73 Fed. Reg. at 53,937.
27 Treas. Reg. § 1.1502-36(c)(6).
28 Unified Rule for Loss on Subsidiary Stock, 72 Fed. Reg. 2963 (January 23, 2007).
29 Treas. Reg. § 1.1502-36(d)(3)(i).
30 Treas. Reg. § 1.1502-36(d)(1).
31 Treas. Reg. § 1.1502-36(d)(3)(ii).
32 Treas. Reg. § 1.1502-36(d)(3)(iii)(A).
33 Treas. Reg. § 1.1502-36(d)(3)(iii)(B).
34 Treas. Reg. § 1.1502-36(d)(4).
36 Treas. Reg. § 1.1502-36(d)(2)(ii).
37 The final regulations revise the provisions regarding the election to reattribute tax attributes to provide for the reattribution of a section 382 limitation that may be associated with the subject tax attributes as well.
38 Treas. Reg. § 1.1502-36(d)(6).
39 Id at 53,953.
40 Unified Rule for Loss on Subsidiary Stock, 72 Fed. Reg. 2963 (January 23, 2007)
41 T.D. 9424, 73 Fed. Reg. at 53,946.