[Federal Register Volume 59, Number 73 (Friday, April 15, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-8488]
[[Page Unknown]]
[Federal Register: April 15, 1994]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[CO-11-91]
RIN 1545-AL63
Consolidated Groups and Controlled Groups--Intercompany
Transactions and Related Rules
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking.
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SUMMARY: This document proposes regulations revising the intercompany
transaction system of the consolidated return regulations to more
clearly reflect consolidated taxable income. The proposed regulations
also revise the regulations under section 267(f), limiting losses and
deductions from comparable transactions between members of a controlled
group. Amendments to other related regulations are also proposed in
this document.
DATES: Comments must be received by July 18, 1994. Because the proposed
regulations affect a broad range of transactions, two public hearings
will be held. A preliminary hearing to respond to general comments and
questions by speakers will be held on May 4, 1994, beginning at 10
a.m., and a second hearing to receive comments will be held on August
8, 1994, beginning at 10 a.m. Requests to speak at the first hearing
must be received by April 20, 1994. Outlines of topics to be discussed
at the second hearing must be received by July 18, 1994. See the notice
of public hearings on proposed rulemaking published elsewhere in this
issue of the Federal Register.
ADDRESSES: Send submissions to: CC:DOM:CORP:T:R (CO-11-91), room 5228,
Internal Revenue Service, POB 7604, Ben Franklin Station, Washington,
DC 20044. In the alternative, submissions may be delivered to:
CC:DOM:CORP:T:R (CO-11-91), room 5228, Internal Revenue Service, 1111
Constitution Avenue NW., Washington, DC. The first public hearing will
be held in room 2615 of the Internal Revenue Building, 1111
Constitution Avenue NW, Washington, DC. The second public hearing will
be held in the Internal Revenue Building Auditorium, Seventh Floor,
7400 Corridor, Internal Revenue Service Building, 1111 Constitution
Avenue NW., Washington, DC.
FOR FURTHER INFORMATION CONTACT: Concerning the hearings, Carol
Savage of the Regulations Unit, Assistant Chief Counsel
(Corporate), (202) 622-8452 or (202) 622-7180; concerning the
regulations relating to consolidated groups generally, Roy
Hirschhorn or David Kessler of the Office of Assistant Chief
Counsel (Corporate), (202) 622-7770; concerning stock of members of
consolidated groups, Rose Williams of the Office of Assistant Chief
Counsel (Corporate), (202) 622-7550; concerning obligations of
members of consolidated groups, Victor Penico of the Office of
Assistant Chief Counsel (Corporate), (202) 622-7750; concerning
insurance issues, Gary Geisler of the Office of Assistant Chief
Counsel (Financial Institutions and Products), (202) 622-3970;
concerning international issues relating to members of consolidated
groups, Philip Tretiak of the Office of Associate Chief Counsel
(International), (202) 622-3860; and concerning controlled groups,
Martin Scully, Jr. of the Office of Assistant Chief Counsel (Income
Tax and Accounting), (202) 622-4960. (These numbers are not toll-
free numbers.)
SUPPLEMENTARY INFORMATION:
A. Paperwork Reduction Act
The collections of information contained in this notice of proposed
rulemaking has been submitted to the Office of Management and Budget
for review in accordance with the Paperwork Reduction Act of 1980 (44
U.S.C. 3504(h)). Comments on the collection of information should be
sent to the Office of Management and Budget, Attn: Desk Officer for the
Department of the Treasury, Office of Information and Regulatory
Affairs, Washington, DC 20503, with copies to the Internal Revenue
Service, Attn: IRS Reports Clearance Officer, PC:FP, Washington, DC
20224.
The collections of information are found in Sec. 1.1502-13 (e)(3),
(f)(5)(v), and (j)(5). This information is required by the IRS to
comply with section 1502 and the regulations thereunder, and to
simplify the operation of the proposed regulations. This information
will be used to assure that the amount, location, timing, character,
source, and other attributes of intercompany items and corresponding
items are properly determined. The respondents are members of
consolidated groups.
The estimated total annual reporting burden is 2,500 hours.
The estimated annual reporting burden per respondent is .50 hour.
The estimated number of respondents is 5,000.
The estimated annual frequency of responses is once per year, if
necessary.
B. Background
This document proposes amendments to the regulations under section
1502 of the Internal Revenue Code of 1986 (Code) that are applicable to
transactions between members of a consolidated group (intercompany
transactions). Sections 1.1502-13, 1.1502-13T, 1.1502-14, 1.1502-14T,
and 1.1502-31 contain most of the rules of the current intercompany
transaction system. Amendments are also proposed to related
regulations, including the regulations under section 267(f), which are
applicable to transactions between members of a controlled group.
The current consolidated return regulations use a deferred sale
approach that treats the members of a group as separate entities for
some purposes and as a single entity for other purposes. In general,
the amount, location, character, and source of items from an
intercompany transaction are determined as if separate returns were
filed (separate entity treatment), but the timing of items is
determined more like the timing that would apply if the participants
were divisions of a single corporation (single entity treatment).
For a discussion of the issues considered in developing the
proposed regulations, see the notice of hearings on the proposed
regulations that appears elsewhere in this issue of the Federal
Register. The topics discussed in the notice of hearings include:
1. Separate and single entity treatment.
2. Location of items within the group (and alternative
comprehensive single entity treatment).
3. Mechanical rules.
4. Matching and acceleration rules (including nonrecognition
transactions, subgroups, and possible simplifying rules).
5. Stock of members.
6. Obligations of members.
No inference is intended by the proposed regulations as to the
operation of the current regulations or other rules.
C. Explanation of Proposed Intercompany Transaction Rules
1. In General
The purpose of the proposed intercompany transaction regulations is
to clearly reflect the taxable income (and tax liability) of the group
as a whole by preventing intercompany transactions from creating,
accelerating, avoiding, or deferring consolidated taxable income (or
consolidated tax liability).
The proposed regulations retain the basic approach of the current
regulations by accounting for intercompany transactions through a
deferred sale system. The principal focus of single entity treatment
under the current regulations is on the timing of items from
intercompany transactions. The proposed regulations expand this focus
by redetermining the character, source, and other attributes of the
items on a single entity basis. Only the amount and location of items
remain on a separate entity basis.
The proposed regulations eliminate many inconsistent combinations
of single and separate entity treatment under the current regulations
that lead to inappropriate results. Nevertheless, the rules of the
proposed regulations reflect the basic principles underlying the
current regulations. Accordingly, the results of most common
intercompany transactions are not affected by the proposed regulations
even though the analysis is changed.
The proposed regulations replace the mechanical rules of the
current regulations with a matching rule and an acceleration rule.
These rules apply uniformly to ``period'' transactions (e.g., payment
of currently deducted interest), sales of property and performance of
capitalized services, and transactions involving the stock or
obligations of members. Because the proposed regulations generally
unify the rules for all intercompany transactions, many of the
distinctions drawn by the current regulations between intercompany
transactions, deferred intercompany transactions, and transactions
involving stock or obligations of members, are eliminated as no longer
necessary.
The proposed regulations include numerous examples, but the first
few examples under the matching and acceleration rules provide the
guidance necessary for most common intercompany transactions.
Additional examples illustrate the application of the proposed rules to
less common transactions.
The proposed regulations are a method of accounting to the extent
they determine the timing of items. An item taken into account under
these rules can be deferred, disallowed, or eliminated under other
applicable law.
A group's ability to change its manner of applying the final
intercompany transaction regulations will be subject to the generally
applicable rules for accounting method changes. Whether a change in
method will be applied with an adjustment under section 481(a) or
applied on a cut-off approach will be determined by the IRS. See also
``Proposed effective dates,'' discussed at F. of this preamble for the
application of the final intercompany transaction regulations on a cut-
off basis.
2. Definitions: Intercompany Transaction, Intercompany Item, and
Corresponding Item
In general, an intercompany transaction is a transaction between
corporations that are members of the same consolidated group
immediately after the transaction. The proposed regulations provide
further guidance largely through examples. S is the member transferring
property or providing services, and B is the member receiving the
property or services.
Each party to an intercompany transaction can have items of income,
gain, deduction, and loss from the transaction (or from property
acquired in the transaction). S's items are referred to as intercompany
items and B's items are referred to as corresponding items. These items
are generally taken into account under the matching and acceleration
rules.
For most transactions, S's intercompany items and B's corresponding
items are their items from the intercompany transaction (or from
property acquired in the intercompany transaction) determined on a
separate entity basis. Issues arise under the current regulations
regarding the effect of certain costs and expenses on the determination
of intercompany items and corresponding items. For example, if S
performs services for B, the extent to which S's costs are included in
determining its intercompany income may not always be clear. The
proposed regulations retain the approach of the current regulations by
providing guidance largely through examples.
The proposed regulations also continue the current approach of
treating certain amounts as S's intercompany items even though S has
not yet recognized or incurred them under its own method of accounting.
Thus, in certain situations the rules can accelerate as well as defer
intercompany items. S generally is not required, however, to take into
account amounts that it will never recognize under its method of
accounting merely to match B's corresponding items. Additional
adjustments are made to the extent necessary to clearly reflect the
group's income, including treating certain basis adjustments under the
Code as items required to be taken into account.
The matching rule of the proposed regulations generally focuses on
B to redetermine the time S's intercompany items are taken into
account. This approach is similar to the approach of the current
regulations for deferred intercompany transactions. However, the
matching rule applies to a wider range of transactions, and the roles
of the parties might vary. For example, a single business arrangement
may be composed of related transactions, with one member being S for
one transaction and B for another. The proposed regulations require
each transaction to be separately analyzed, and provide examples to
identify which member is B and which is S in a transaction.
The roles of the parties might also vary over time. For example, if
two members engage in an interest rate notional principal contract, the
member that is obligated to make the net payment in each period under
the contract will vary depending on changes in interest rates. Because
the net payment for each period is treated as a separate transaction, a
member may be B in one period (as the payor) and S in another period
(as the payee).
3. Matching Rule
Under the proposed regulations, the matching rule is the principal
rule for redetermining the timing and attributes of S's intercompany
items and B's corresponding items on a single entity basis. In general,
S's intercompany items and B's corresponding items are taken into
account to produce the same effect on consolidated taxable income as if
S and B were divisions of a single corporation.
For purposes of treating S and B as divisions under the matching
rule, S and B are treated as engaging in their actual transaction and
owning any actual property in the transaction, operating separate
trades or businesses, and having any special status (e.g., as a bank or
insurance company) that they have under the Code.
In addition to timing, the matching rule conforms the character and
other attributes of S's intercompany items and B's corresponding items.
For example, S might sell investment property to B, and B might hold
the property for sale to customers in the ordinary course of business.
S and B redetermine the attributes of their intercompany items and
corresponding items to produce the same effect on consolidated taxable
income as if they were divisions of a single corporation. Thus, the
redetermination of character is based on the activities of both S and B
and may require both S's items and B's items to be ordinary or capital.
Because the attributes are redetermined by treating S and B as
divisions, the matching rule also generally aggregates the holding
periods of S and B with respect to property transferred in an
intercompany transaction.
For each consolidated return year, the matching rule requires S to
take into account its intercompany items to reflect the difference
between the corresponding items B takes into account and B's recomputed
items (the corresponding items B would have taken into account if S and
B were divisions of a single corporation). Comparing B's corresponding
items and its recomputed items ordinarily will not be difficult.
For example, if S sells property with a $70 basis to B for $100,
and B later resells the property to a nonmember for $90, S's $30 gain
is not taken into account until the resale. At that time, S's gain is
taken into account to reflect the $30 difference between the $10 loss B
takes into account and the recomputed $20 gain B would take into
account if B had succeeded to S's $70 basis in a transfer between
divisions of a single corporation. The character of S's $30 gain and
B's $10 loss (and their holding period for the property) are
redetermined by taking into account the activities of both S and B with
respect to the property.
Treatment as divisions of a single corporation applies only to S
and B as the parties to the intercompany transaction. The activities of
other members are generally not taken into account. Moreover, because
treatment as divisions is solely for purposes of taking into account
items from intercompany transactions, the treatment generally does not
affect determinations by S and B with respect to items or holding
periods in other transactions.
The matching rule continues the trend of recent amendments to the
intercompany transaction system by reducing the reliance on particular
events and transactions to take items into account. Compare current
Sec. 1.1502-13(l) with current Sec. 1.1502-13 (d) through (f). Because
the matching rule focuses on B's items, if S sells land to B at a gain
and B transfers the land outside the group in an exchange to which
section 1031 applies, S's gain is not taken into account under the
matching rule, even though the property is disposed of outside the
group, if there is no difference between B's actual and recomputed
items resulting from the exchange. Instead, S's gain remains deferred
and is taken into account based on B's items with respect to the
replacement property.
The current regulations redetermine timing on a single entity
basis, but generally determine character on a separate entity basis.
This dual approach may result in conflicts because timing and character
cannot always be separately analyzed under the Code. The current
regulations only partially resolve these conflicts. See, e.g.,
Secs. 1.1502-13(c)(4)(ii) and (d)(3) (the character of S's deferred
gain or loss taken into account as a result of B's depreciation is
redetermined), and 1.1502-13(m)(1) (S is treated as disposing of
property at the same time and in the same manner as B disposes of the
property outside the group).
The proposed regulations generally eliminate potential conflicts
between timing and character by redetermining both the timing and the
attributes of items on a single entity basis. This approach eliminates
the need for the special rules under the current regulations. For
example, if S sells depreciable property to B at a gain, B depreciates
the property for a period, and B then resells it to a nonmember, no
special rules are needed to redetermine the recapture income of S or B.
Instead, the recapture income is redetermined as if S and B were
divisions of a single corporation. This prevents the intercompany
transaction from affecting consolidated taxable income, but preserves
the location of each member's items. Redetermining attributes on a
single entity basis is not expected to affect most intercompany
transactions.
Preserving the location of S's items, but redetermining their
attributes on a single entity basis, may in certain cases require S's
intercompany income or gain to be treated as excluded from gross income
(or its intercompany deductions or losses to be treated as noncapital,
nondeductible amounts). For example, if S has intercompany interest
income from B, but B's corresponding interest deduction is disallowed
under section 265, S's intercompany income must be excluded from gross
income.
This approach prevents an intercompany transaction from having an
effect on consolidated taxable income, but preserves the location of
items for stock basis and earnings and profits adjustments under
Secs. 1.1502-32 and 1.1502-33. However, because of administrability
concerns, S's intercompany income or gain generally can be treated as
excluded from gross income only if B's corresponding item is a
deduction or loss that, in the taxable year the item is taken into
account, is permanently disallowed directly under another provision of
the Code or regulations.
Because it has the same effect as a deduction or loss that is
permanently disallowed, exclusion is also permitted if B has a
corresponding loss that is not recognized under section 311. For
example, if S has property with a $70 basis and sells it to B for $100,
and the property is subsequently distributed to a nonmember when it has
a value of $90, B's $10 loss is not recognized under section 311(a).
B's distribution results in all of S's $30 gain being taken into
account, but $10 of the gain is excluded from gross income. Additional
corresponding items that permit S's intercompany income or gain to be
excluded from gross income may be identified by the Commissioner in
future guidance, to the extent consistent with administrability
concerns.
Under the proposed regulations, the special asset basis rules of
current Sec. 1.1502-31(a) are not needed. These rules originally were
adopted to contrast with the intercompany transaction system applicable
to pre-1966 consolidated return years. They are now encompassed by the
general approach of the proposed regulations to use the provisions of
the Code where possible. Consequently, the special asset basis rules
were not included in recently proposed revisions to Sec. 1.1502-31. See
CO-30-92 [1992-2 C.B. 627].
4. Acceleration Rule
The acceleration rule takes items into account immediately to the
extent that they cannot be taken into account under the matching rule
to produce the effect of treating S and B as divisions of a single
corporation. The effect cannot be produced to the extent either the
matching rule will not fully account for the items from an intercompany
transaction in consolidated taxable income, or the intercompany
transaction will be reflected by a nonmember.
For example, if S or B becomes a nonmember, any remaining
intercompany items and corresponding items can no longer be matched in
the determination of consolidated taxable income. Moreover, S or B
would reflect the intercompany transaction as a nonmember. The
intercompany items are therefore taken into account immediately before
S or B becomes a nonmember.
Similar results would be required if B purchases property from S
and transfers it to a partnership in a transaction to which section 721
applies (or to nonmember corporation in a transaction to which section
351 applies), because the partnership reflects the intercompany
transaction by succeeding to B's cost basis in the property. If S and B
had been divisions of a single corporation, S's transfer to B generally
could not have created a cost basis to be reflected by the partnership
in the property. The acceleration rule requires S to take its
intercompany items into account immediately before the event rendering
single entity treatment impossible. (If B had disposed of the property
in an exchange with a nonmember to which section 1031 applies, the
intercompany items would not be taken into account under the
acceleration rule because the nonmember would not succeed to B's cost
basis.)
In limited circumstances, the acceleration rule will apply without
the occurrence of an event separate from the intercompany transaction.
This might occur if S's gain or loss from the sale of property to B
exceeds the effect of the intercompany transaction on the basis of the
property. For example, if B owns a building that is destroyed by fire
and B uses its insurance proceeds to buy a replacement building from S,
S's gain or loss will not conform to B's basis in the building because
B's basis is determined under section 1033. If the amount of S's gain
or loss exceeds the effect of the intercompany sale on the building's
basis, S's gain or loss will not be fully taken into account under the
matching rule because there will not be a sufficient difference between
the corresponding items B takes into account and its recomputed items.
Consequently, the acceleration rule applies at the time of the
intercompany sale to take the excess amount into account. S's gain or
loss is accelerated because it is not possible to treat S and B as
divisions of a single corporation, and acceleration is the only
administrable alternative.
The acceleration rule has two provisions for determining the
attributes of S's intercompany items. For intercompany transactions
involving property, the attributes are redetermined under the
principles of the matching rule by deeming B to resell the property to
a nonmember affiliate (a transaction comparable to S's intercompany
transaction). Thus, the attributes of S's intercompany items reflect
B's activities with respect to the property. For example, if S was an
investor in land sold to B, and B holds the land for sale to customers
in the ordinary course of business at the time B becomes a nonmember,
S's gain or loss taken into account under the acceleration rule may be
ordinary. Because B is deemed to sell to a nonmember affiliate, any
rules applicable to related party transactions apply to determine the
attributes of S's items. See, e.g., section 1239 (relating to
depreciable property).
For intercompany transactions involving services or rentals, or
other nonproperty transactions, the attributes of S's accelerated items
are determined on a separate entity basis. For example, if S performs
services that are capitalized by B, there is no deemed sale by B for
purposes of determining the attributes of S's items. Instead, S's
accelerated items remain ordinary items from its performance of
services. The proposed regulations do not deem a sale to occur because
S did not engage in a property transaction and B may never engage in
the sale or exchange of property that would require S's items to be
recharacterized as items from a property transaction.
Like the current regulations, and consistent with the treatment
under the intercompany transaction system of a consolidated group as a
single entity, the proposed regulations do not accelerate items if the
entire consolidated group is acquired by another consolidated group.
5. Simplifying Rules
a. Inventory
The current regulations generally treat intercompany transactions
involving inventory like intercompany transactions involving other
property. But see Secs. 1.1502-13(f)(1) (iv) and (viii) (a deferred
amount attributable to stock in trade or inventory is taken into
account as the result of a separate return year or a value write-down),
and 1.1502-18 (special inventory adjustment).
The proposed regulations continue to generally treat inventory
transactions like other intercompany transactions. However, if S or B
uses a dollar-value LIFO method of inventory accounting, the matching
rule might be unadministrable because dollar-value LIFO measures
aggregate inventory changes in terms of base-year dollars, and does not
separately identify the items from particular transactions. For
example, B is not able to determine when corresponding items with
respect to each separate intercompany transaction are taken into
account because of the substitution of inventory units and costs within
the dollar-value LIFO method.
Intercompany inventory transactions are typically routine
transactions that occur in the normal course of business. Applying the
matching and acceleration rules to dollar-value LIFO methods may be
burdensome because of the potential for numerous additional
computations and the inconsistencies with financial reporting of
intercompany transactions. For example, S may compute intercompany
inventory income and corresponding elimination for financial reporting
purposes using a FIFO cost-flow assumption even though S and B use
dollar-value LIFO for Federal income tax purposes.
To simplify the matching computations, the proposed regulations
permit S or B to use any reasonable method to take into account their
items from intercompany inventory transactions. However, adjustments
are required if the cumulative amount of intercompany items not taken
into account by S under the method used significantly exceeds the
cumulative amount that would not be taken into account by S under
methods specifically provided in the proposed regulations. For example,
a group may be able to use its current accounting methods or develop
other simplified methods. However, the use of a FIFO cost-flow
assumption could result in deferral that significantly exceeds the
deferral that would be achieved under a LIFO cost-flow assumption. If a
method is expected to be reasonable, but in fact produces a significant
cumulative excessive deferral in any year, S must take into account an
amount for that year which will eliminate the excess and make
appropriate adjustments thereafter to reflect the amount taken into
account.
The proposed regulations specifically provide an ``increment
averaging method'' and an ``increment valuation method.'' Under the
increment averaging method, B determines the portion of its total
inventory costs for the current year that are included in a layer of
increment under its LIFO inventory method, and S defers a comparable
portion of its intercompany inventory items from sales to B for the
year. B computes the ratio of current-year costs of its layer of
increment over total inventory costs incurred for the year. B's
current-year costs are computed in a manner consistent with its method
for valuing LIFO increments (e.g., earliest, latest, or average costs).
If B uses a simplified method to allocate section 263A costs to
inventory and does not allocate additional section 263A costs to
specific items of LIFO inventory, B may compute the portion of its
costs included in an increment without including section 263A costs in
either the total costs or the costs included in a layer. B must compute
its costs separately for each LIFO pool that receives intercompany
purchases, and if more than one selling member transfers inventory into
that pool in intercompany transactions, each selling member must take
into account a comparable portion of its intercompany items.
To the extent S defers its intercompany inventory items under the
increment averaging method, S layers the items based on the
corresponding layers of B's costs. S takes the deferred items into
account under the matching rule as B takes into account its
corresponding layers through subsequent decrements.
The increment valuation method is similar to the increment
averaging method. Under the increment valuation method, a ratio is
determined based on the current-year costs of the layer of increment
over the total costs incurred in the appropriate period used to value
the increment. The appropriate period is the period of B's year used to
determine current-year costs. This ratio is applied to S's intercompany
inventory items computed with respect to intercompany inventory sales
during the appropriate period. For example, if B determines current-
year costs by reference to its earliest costs, and only the inventory
costs incurred in B's first inventory turn are included for this
purpose, the appropriate period is the period of B's year that includes
its first inventory turn.
S determines the amount of its total intercompany inventory items
for a year under any reasonable method for allocating its inventory
costs to intercompany transactions. If S uses a dollar-value LIFO
inventory method and a decrement occurs for the year, S must reasonably
take into account the costs of prior layers of increment. For example,
S may compute its intercompany inventory income using its most recent
costs incurred if S has an increment for the year and S uses the
earliest acquisitions cost method to value increments. Similarly, S may
use an average of its costs incurred during the year if S uses this
method to value increments or if S does not experience a significant
increment or decrement for the year.
The current regulations determine whether inventory is disposed of
outside the group by reference to B's method of inventory
identification (e.g., FIFO, LIFO, or specific identification). Because
the current regulations require B to consider the effect of its use of
dollar-value LIFO, it is not anticipated that the proposed regulations
will result in a significant change. Taxpayers can continue to use
their current methods after the final intercompany transactions
regulations apply if the current methods are reasonable.
b. Reserve Accounting
Reserve accounting is permitted only for special status members,
and it is inappropriate to apply some aspects of reserve accounting on
a single entity basis (e.g., where both parties to an intercompany
transaction do not have the same special status). To the extent that
reserve accounting should apply to intercompany transactions, the
necessary adjustments to produce single entity results may be complex.
The proposed regulations provide that a member's addition to, or
reduction of, a reserve for bad debts that is maintained under section
585 or 593 is generally taken into account on a separate entity basis.
But see ``Obligations of members,'' discussed at C.7. of this preamble
(special rules for reserve deductions with respect to intercompany
obligations). Similarly, if a member provides insurance to another
member in an intercompany transaction, the transaction is taken into
account by both members on a separate entity basis.
c. Elections
Section 1.1502-13(c)(3) of the current regulations provides that a
group may elect with the consent of the Commissioner not to defer
intercompany gain or loss from deferred intercompany transactions with
respect to all or any classes of property. See also Rev. Proc. 82-36,
1982-1 C.B. 490 (a checklist and guidelines for requests under
Sec. 1.1502-13(c)(3)).
The proposed regulations continue to permit groups to request that
items from intercompany transactions (other than transactions with
respect to stock or obligations of members), be taken into account on a
separate entity basis rather than under the intercompany transaction
system. Any election under current Sec. 1.1502-13(c)(3) will remain in
effect. As under current law, an election to take items into account on
a separate entity basis does not apply for purposes of taking losses
into account under section 267(f).
Current Sec. 1.1502-13(f)(3) provides that the IRS may enter into a
closing agreement with a group required to divest itself of a member by
order of law. The closing agreement generally allows the group to take
into account deferred gain or loss as if it had not disposed of the
member (but not over more than 10 years). Closing agreements generally
will not be entered into where the divestiture is occasioned by an
acquisition after August 31, 1966. Consequently, this provision is
eliminated under the proposed regulations as deadwood.
Current Sec. 1.1502-13(j) provides that the IRS may enter into a
closing agreement providing special treatment for public utilities. The
proposed regulations also eliminate this provision as deadwood, because
a request for a closing agreement must have been made on or before
November 15, 1966.
Any groups currently subject to a closing agreement under a
deadwood provision eliminated by the proposed regulations will remain
subject to the terms of the closing agreement.
6. Stock of Members
Sections 1.1502-14 and 1.1502-31(b) of the current regulations
provide special rules for distributions and other transactions with
respect to stock of members. These stock rules combine single and
separate entity treatment.
The current regulations eliminate intercompany dividends from the
gross income of the distributee. Section 301 distributions (whether or
not dividends) first reduce the distributee member's basis in the
distributing member's stock to zero, and then create an excess loss
account in the stock.
If appreciated property is distributed in a distribution to which
section 301 applies, the current regulations provide that the
distributing member recognizes gain under section 311 that is deferred
and taken into account in the same manner as if it were recognized in a
deferred intercompany transaction. The distributee's basis in the
property received is generally its fair market value.
No special rules are provided under the current regulations for
reorganization transactions and transactions to which section 355
applies.
Liquidating distributions are governed by either section 331 or 332
as to the distributee, and section 336 or 337 as to the distributing
member. Under Sec. 1.1502-34, the stock ownership of all members is
aggregated to determine whether section 332 applies to the distributee.
Under section 337(c), however, the ownership is not aggregated to
determine whether section 337 applies to the distributing member. Gain
or loss recognized by the distributing member under section 336 is
deferred under the current regulations and taken into account as if it
were recognized in an intercompany transaction. If the distributee
member would recognize gain or loss from the liquidation under section
331, the distributee's gain or loss is limited under the current
regulations, but preserved by determining the distributee's basis in
the distributed property by reference to the distributee's basis in the
stock surrendered.
Other recent consolidated return regulation projects address
aspects of intercompany distributions and other transactions with
respect to stock of members. See, e.g., Sec. 1.1502-80(b) (non-
applicability of section 304 to transactions between members), proposed
Sec. 1.1502-80(c) (deferral of section 165(g)), and proposed
Sec. 1.1502-80(d) (replacing current Sec. 1.1502-14(a)(2), and
providing for the non-applicability of section 301(c)(3) to transfers
between members).
The proposed regulations generally apply the rules of the Code and
the matching and acceleration rules to transactions with respect to
stock of members. For example, if S sells to B the stock of another
member (T) at a gain, S's gain is taken into account under the matching
and acceleration rules.
The proposed regulations provide that intercompany distributions
are generally not included in the gross income of the distributee
member. However, this exclusion applies to a distribution from a
subsidiary only to the extent there is a corresponding negative
adjustment reflected under Sec. 1.1502-32 in the distributee's basis in
the distributing member's stock. By conditioning the exclusion on a
negative adjustment, the concerns with dividend stripping transactions
illustrated by current Sec. 1.1502-32(k) are minimized. Intercompany
distributions are taken into account for all Federal income tax
purposes when the members become entitled to them (generally the record
date) or, if earlier, when they are taken into account under the Code
(e.g., under section 305(c)).
Excluding intercompany dividends from gross income is intended to
have the same effect as eliminating them under the current regulations,
but it conforms to the terminology generally used under the Code. For
example, the holdings in Revenue Ruling 72-230, 1972-1 C.B. 209 (the
effect of dividend elimination on the source of dividends paid for
purposes of section 861(a)(2)) and Revenue Ruling 79-60, 1979-1 C.B.
211 (the effect of dividend elimination on personal holding company
status), and the application of section 1059, are not affected.
The matching and acceleration rules apply to the distributing
member's gain under section 311(b) from intercompany distributions of
property. The proposed regulations provide that the distributing
member's loss from an intercompany distribution of property is also
recognized under the principles of section 311(b) and is taken into
account under the matching and acceleration rules. In effect,
intercompany distributions are equated with intercompany sales.
The recognition of loss from distributions applies only to
intercompany distributions. For example, S's loss from distributing
property to B is recognized, but S's loss from distributing the
property to a nonmember is not recognized. Under the matching rule, a
buying member's nonrecognition of loss from the distribution of
property to a nonmember may result in prior intercompany gain (or loss)
from the property being recharacterized as excluded from gross income
(or as a noncapital, nondeductible amount). For example, if S sells
property to B at a loss, and B later distributes it to a nonmember at
no gain or loss, S's intercompany loss is recharacaterized as a
noncapital, nondeductible amount. In effect, a group is treated as a
single entity with respect to the nonrecognition of loss under section
311 on distributions to nonmembers.
The proposed regulations provide special rules to minimize the
effect on consolidated taxable income of boot in intercompany
reorganizations. Boot received by a member as a shareholder in an
intercompany reorganization is treated as received in a separate
transaction. Thus, consolidated taxable income is generally the same
whether the boot is distributed as part of the reorganization, before
it, or after it.
The proposed boot rules do not apply to a reorganization if any
participant becomes a member or becomes a nonmember as part of the same
plan or arrangement. The proposed rules do not reflect any decisions
about boot received in other reorganizations such as those involving
unrelated corporations or affiliated corporations filing separate
returns. The tax results of reorganizations straddling consolidation
remain under study because of the significant differences between boot
transferred between members of a consolidated group and boot
transferred between separate return corporations.
The proposed regulations provide that if a member acquires its own
stock in an intercompany transaction, its basis in that stock is
treated as eliminated for purposes of taking intercompany items into
account with respect to the stock. Thus, if S distributes B stock to B,
S's gain or loss from the distribution is taken into account
immediately to reflect the elimination of basis. Compare Gen. Coun.
Mem. 39,608 (March 5, 1987) (S's gain from the distribution of B stock
to B is deferred until, for example, B sold the same shares to a
nonmember). On the other hand, if S transfers to B the stock of T, and
B subsequently transfers the stock to T in exchange for new T stock in
a recapitalization to which section 368(a)(1)(E) applies, S's
intercompany gain or loss remains deferred and is taken into account by
reference to the replacement stock. See ``Successor corporations and
property,'' discussed at C.9. of this preamble.
Under the current regulations, intercompany gain or loss from
transferring the stock of a member is taken into account when that
member liquidates under section 332. For example, if S sells all of the
stock of T to B at a gain, and T later liquidates in an unrelated
transaction to which section 332 applies, S's gain is taken into
account. If the basis of T's assets conformed to the basis of its stock
before S's sale, S's gain from the T stock will be duplicated by gain
that the group later recognizes from the former T assets (because B
succeeds to T's basis in the assets).
The proposed regulations provide relief from this duplication in
limited circumstances. Under the first rule, if section 332 applies to
T's liquidation and B transfers substantially all of T's assets to a
new member (new T), the transfer to new T is treated as pursuant to the
same plan or arrangement as the liquidation and S's gain generally will
not be taken into account. Instead, S's gain is taken into account by
reference to the stock of new T. New T must be formed and the relief
elected by the group within specified time periods. Similar principles
apply if B's basis in the T stock is eliminated in a transaction
comparable to the section 332 liquidation (e.g., a downstream merger).
Under the second rule, if T's liquidation is deemed to occur under
section 338(h)(10) as a result of a qualified stock purchase of T, B is
treated, subject to certain limitations, as recognizing any loss or
deduction it would recognize (determined after adjusting stock basis
under Sec. 1.1502-32) if section 331 applied to the deemed liquidation.
In effect, S's income or gain is offset by B's deduction or loss in
determining consolidated taxable income (although S and B must take
into account their separate items). Similar principles apply if T
transfers all of its assets to a nonmember and completely liquidates in
a transaction comparable to a section 338(h)(10) transaction.
The third rule applies if member stock is transferred in an
intercompany transaction and subsequently distributed in a second
intercompany transaction to which section 355 applies. S's gain or loss
might otherwise be taken into account under the proposed regulations
because the basis adjustments to the T stock under section 358 may
result in an inability to match the T stock basis with S's gain. Relief
is provided by permitting the group to elect to treat B's distribution
as subject to sections 301 and 311 rather than section 355, so that
matching with S's gain remains possible. This prevents S's gain from
being taken into account immediately if matching remains possible, but
B's gain or loss from its distribution will also be taken into account
under the matching and acceleration rules.
7. Obligations of Members
Current Sec. 1.1502-13 provides that the general rules for
intercompany transactions apply to the payment of interest and premium
on intercompany obligations. Current Sec. 1.1502-14(d) provides for the
deferral of a member's gain or loss from the disposition of another
member's obligation. Similar rules apply to a member's deduction for
the worthlessness of an obligation and the deduction for an addition to
a reserve for bad debts with respect to an obligation.
If a member's obligation is transferred to a nonmember (or the
holding member becomes a nonmember), the deferred amount is generally
taken into account ratably over the remaining term of the obligation.
In effect, the deferred amount is reflected in consolidated taxable
income under rules similar to the rules that existed under the Code in
1966 for original issue discount or amortizable bond premium. If the
obligation remains within the group, the deferred amount is generally
not taken into account until the obligation is redeemed. Thus, the
gains and losses of the members with respect to the obligation
generally offset each other in determining consolidated taxable income.
Section 108(e)(4) adopts a limited single entity approach by
treating the acquisition of debt by a person related to the debtor as
comparable to the debtor's acquisition of its own debt. The regulations
implementing section 108(e)(4) include some circumstances in which the
holder of the debt becomes a person related to the debtor.
Under the proposed regulations, the matching and acceleration rules
apply to intercompany obligations. An obligation is defined to include
securities described in section 475(c)(2) (D) and (E), and comparable
securities with respect to commodities. For example, an interest rate
notional principal contract between members is an obligation between
the counterparties. An obligation is an intercompany obligation during
the period its parties are members.
The proposed regulations continue to treat each payment or accrual
of interest (and each payment or accrual of premium) on an intercompany
debt as a separate intercompany transaction, and the income is matched
with the deduction. Similarly, each periodic and nonperiodic payment
with respect to an intercompany notional principal contract is a
separate intercompany transaction.
Special rules are proposed for two categories of transactions: (1)
Transactions in which an intercompany obligation becomes a
nonintercompany obligation (or remains an intercompany obligation but
gain or loss is realized with respect to it); and (2) transactions in
which a nonintercompany obligation becomes an intercompany obligation.
In both categories, an obligation is generally deemed to be satisfied
and, if it remains outstanding, reissued. There are, however,
significant differences as to how the transactions are deemed to occur.
Under the first category, if S holds a note of B with a $100 basis
and stated redemption price at maturity, and S sells the note to a
nonmember for $75, B is treated as satisfying its obligation to S for
$75 immediately before S's sale, and issuing a new note directly to the
nonmember for $75 with a $100 stated redemption price at maturity. The
proposed regulations match both the timing and the attributes of S's
items and B's items resulting from the deemed satisfaction. Similar
principles apply if the note is transferred by S to another member in
an intercompany transaction, the note is marked to market under section
475, or if S or B becomes a nonmember (i.e., the note is deemed to be
satisfied by B and reissued). Similar principles also apply if the
obligation is a notional principal contract or other nondebt
intercompany obligation.
The effect on consolidated taxable income for transactions in the
first category is similar to the effect under current Sec. 1.1502-
14(d). In both cases, reflection of the net gain or loss on
consolidated taxable income is deferred in a manner consistent with
time value of money principles. Under the proposed regulations,
however, if S sells B's obligation to a nonmember at a loss, S's loss
and B's gain from the deemed satisfaction are taken into account
immediately and offset each other, and the discount from the deemed
reissuance is taken into account over time by B (as the issuer) rather
than by S. This approach more accurately adjusts the stock basis of S
and B each year, and is closer to the results under common law
principles for debtors and creditors in a parent-subsidiary
relationship. The approach of the proposed regulations in many respects
treats B's obligation as first existing only after it is sold by S to
the nonmember. Thus, if a nonmember buys B's note from S at a discount,
the nonmember will hold the note with original issue discount to which
section 1272 applies, rather than market discount to which sections
1276 through 1278 apply.
Under the second category, if a nonmember (X) holds B's note with a
$100 basis and stated redemption price at maturity, and X sells the
note to S for $75, B is treated as satisfying its obligation to S for
$75 immediately after S's purchase, and issuing a new note to S for $75
with a $100 stated redemption price at maturity.
The treatment for transactions under the second category is similar
in many respects to the treatment of B under section 108(e)(4). Because
the focus of section 108(e)(4) is to prevent avoidance of discharge of
indebtedness income, however, that section does not adequately address
the single entity treatment of consolidated groups. Consequently, the
proposed regulations apply to cases beyond the scope of section
108(e)(4), such as to the acquisition of debt at a premium and to all
cases in which a corporation holding B's debt becomes a member (whether
or not there is an avoidance view, and whether or not the holder is
already a related party).
The deemed satisfaction and reissuance under the proposed
regulations applies to both the issuer and the holder, and the
character of their respective items under the Code is not modified (and
therefore may not match). Nevertheless, the amount at which an
obligation is satisfied under Sec. 1.108-2 represents a compromise that
is incorporated into the proposed regulations. In addition, the
proposed regulations adopt the exceptions to section 108(e)(4) for
special cases, such as securities dealers.
Because a member's adjustments to a reserve for bad debts under
section 585 or 593 reflect its general bad debt experience, rather than
the value of any particular intercompany obligation that it holds, the
proposed regulations provide special rules. Reserve deductions with
respect to intercompany obligations are deferred in a manner similar to
the treatment of reserves under current Sec. 1.1502-14(d). This
approach prevents the reserve accounting method of one member from
affecting the income of another member (or affecting consolidated
taxable income) through a bad debt reserve deduction with respect to an
intercompany debt.
Section 163(e)(5) provides special rules for original issue
discount on an applicable high yield discount obligation (AHYDO). The
concerns reflected in the AHYDO rules do not apply to intercompany
debt, and the Code provides only a partial recast for the dividend
equivalent portion of the disqualified portion of the original issue
discount. Consequently, to simplify the applicable rules, the proposed
regulations exclude intercompany obligations from the application of
section 163(e)(5).
8. Anti-Avoidance Rules
Although the proposed regulations shift the emphasis of the
intercompany transaction system toward single entity treatment, tension
remains between the single entity and separate entity treatment of
consolidated groups. The proposed regulations do not address every
interaction with other consolidated return regulations and other rules
of law. To ensure that the proposed regulations achieve neutrality in
the overall determination of consolidated taxable income, adjustments
may be required. For example, if the approach of the proposed
regulations in matching the attributes of S's intercompany items and
B's corresponding items facilitates ``mirror subsidiary'' transactions
determined by Congress to be inappropriate, adjustments must be made.
See H.R. Rep. No. 391, 100th Cong., 1st Sess. 1081-84 (1987).
Adjustments must be made under the proposed regulations if a
transaction is engaged in or structured with a principal purpose to
avoid treatment as an intercompany transaction, or to avoid the
purposes of the proposed regulations. For example, in the case of a
``mirror subsidiary'' transaction, the adjustments would generally
conform to the intent of the mirror legislation to ``require the
recognition of corporate-level gain whenever an appreciated subsidiary
is sold or distributed outside the economic unit of [a consolidated]
group.'' Id.
In addition to these adjustments, the Code (e.g., sections 337(d),
446, and 482) and general principles of tax law (e.g., the substance-
over-form doctrine, and the tax benefit rule) can apply to require
proper measurement of taxable income (and tax liability).
9. Successor Corporations and Property
Under the current regulations, if S's assets are acquired in a
transaction to which section 381(a) applies, its deferred gains and
losses are inherited by the member that receives the ``greatest portion
of the assets (measured by fair market value).'' Commentators have
suggested that this rule can be used to facilitate the breakup of
acquired corporations without corporate-level tax, contrary to the
intent of the ``mirror'' subsidiary legislation. Moreover, they have
raised questions as to the operation of this rule in many
circumstances. For example, the reference to fair market value does not
identify whether liabilities are to be taken into account to determine
the value on a net basis.
The proposed regulations generally incorporate successor asset and
successor person principles. References under the proposed regulations
to an asset or to a member include, as the context may require,
references to a successor asset or person.
The proposed regulations provide that, if there is more than one
successor, the successors take into account the predecessor's
intercompany items in a manner that is consistently applied and
reasonably carries out the purposes of the proposed regulations and
applicable provisions of law. No inference is intended by this rule as
to the application of section 381 or other successor principles to
attributes other than intercompany items and corresponding items.
The proposed regulations retain the basic approach of the current
regulations by not requiring acceleration solely because a group
terminates from its acquisition by another consolidated group. Unlike
the current regulations, however, the proposed regulations do not
require all of the members immediately before the acquisition to become
members of the surviving consolidated group. Instead, the proposed
regulations accelerate only the items from transactions involving
corporations that do not become members of the surviving consolidated
group.
D. Explanation of Proposed Section 267(f) Rules
Section 267(a) disallows loss on certain sales or exchanges of
property between related parties. Section 267(f) provides for deferral
of loss on the sale or exchange of property between members of a
controlled group, rather than disallowance of the loss under section
267(a). The section 267(f) rules are generally intended to conform to
the intercompany transaction rules applicable to consolidated groups
even though the definition of a controlled group is broader than that
of a consolidated group.
The legislative history indicates that exceptions to deferral might
be provided to properly reflect the amount of net income from a
transaction. For example, if an accrual method member of a controlled
group takes into account income with respect to the face amount of a
note receivable, and later recognizes loss from the sale of that note
to another member of the controlled group at a discount, the loss would
not be deferred to the extent it does not exceed the income taken into
account. See H.R. Rep. No. 861, 98th Cong., 2d Sess. 1032-34 (1984).
The current regulations applicable to controlled groups generally
conform to the basic intercompany transaction rules applicable to
consolidated groups. See Secs. 1.267(f)-1T and 1.267(f)-2T.
Modifications are made to reflect the broader application of section
267(f).
For example, although there are no subgroup rules for intercompany
transactions between members of a consolidated group, deferral of loss
continues under section 267(f) as long as S and B remain in a
controlled group relationship with each other. The current regulations
also provide that if S sells property to B at a loss, and the property
is still owned by B when S ceases to be a member of the same controlled
group, S never takes the loss into account. Instead, B's basis in the
property is increased by an amount equal to S's unrestored loss.
The proposed regulations retain the basic approach of the current
regulations but simplify their operation by more generally
incorporating the consolidated return rules.
The proposed regulations eliminate the rule that transforms S's
loss into additional basis in the transferred property when S ceases to
be a member of the controlled group. Instead, the proposed regulations
generally allow S's loss immediately before it ceases to be a member.
This conforms to the consolidated return rules, and eliminates the need
for special rules. An anti-avoidance rule is adopted, however, to
prevent the purposes of section 267(f) from being circumvented, for
example, by using the proposed rule to accelerate S's loss.
E. Other Applicable Rules
1. Methods of Accounting
Under current Sec. 1.1502-17(a), each member is generally permitted
to determine its own method of accounting as if separate returns were
filed. Thus, the members may have different methods for similar trades
or businesses. If, however, B acquires assets from S in a transaction
to which section 381 applies, B might be required to use the same
method of accounting as S. See, e.g., section 381(c)(4).
The matching rule proposed in Sec. 1.1502-13 relies on the
accounting methods of B to determine the timing of S's intercompany
items. Because B's accounting methods generally control S's timing, a
group might be able to frustrate the principles of single entity
treatment under Sec. 1.1502-13 by rearranging its activities to use an
accounting method that would not be available if S and B were divisions
of a single corporation.
Under the proposed regulations, if B directly or indirectly
acquires an activity of S or undertakes S's activity, with the
principal purpose to avail the group of an accounting method that would
be unavailable without securing the Commissioner's consent if S and B
were treated as divisions of a single corporation, B may be required to
use S's accounting method for the acquired or undertaken activity or
secure consent from the Commissioner for a different method.
2. Special Inventory Adjustment
Current Sec. 1.1502-18 requires a special adjustment relating to
intercompany profit from inventory transactions if an affiliated group
filing separate returns elects to file consolidated returns. This
adjustment has historically been included in the consolidated return
regulations. It is intended to prevent the members' income from being
reduced when the group switches from separate to consolidated returns.
For example, if S and B are affiliated but file separate returns
for Year 1 and S manufactures inventory for $75 that is sold to B for
$100, S's $25 intercompany profit is taken into account in Year 1 and B
has a $100 cost basis in the inventory. If S recognizes another $25 of
intercompany profit in Year 2, and B sells the inventory purchased from
S in Year 1, S's additional $25 profit is taken into account in Year 2
and B recovers its cost basis in the inventory purchased in Year 1. If,
however, the group shifts to consolidated returns for Year 2, S's
additional $25 profit is deferred under Sec. 1.1502-13 but B still
recovers its cost basis. Thus, the shift to consolidated returns
reduces the group's aggregate income in Year 2. If S and B continue the
same intercompany activity year after year, the one-time reduction is
effectively a permanent reduction.
To prevent a reduction in taxable income, the current regulations
provide for a special inventory adjustment to increase the group's
consolidated taxable income for Year 2 by S's $25 intercompany profit
from Year 1, to the extent that it is reflected in B's opening
inventory for Year 2. The adjustment might ultimately be reversed in
later years if, for example, B's ending inventory purchased from S is
reduced or the group ceases to file consolidated returns.
Commentators argue that Sec. 1.1502-18 reaches an inappropriate
result, and that its effect can be avoided, for example, by causing S
to transfer its assets to a lower-tier member in a transaction to which
section 351 applies (or otherwise to cease its intercompany sales).
To simplify the intercompany transaction system, the proposed
regulations eliminate the special inventory adjustment. Any remaining
unrecovered inventory amount under Sec. 1.1502-18(c) (or its equivalent
under Sec. 1.1502-18(f)) is recovered under the principles of those
rules in the first taxable year ending on or after the date final
regulations are filed with the Federal Register. The unrecovered
inventory amount can be recovered only to the extent it was previously
included in taxable income.
3. Attribute Reduction (Section 108(b))
The proposed regulations provide rules to prevent avoidance of the
attribute reduction required under section 108(b). Several issues
regarding the application of section 108 to consolidated groups are
under study. For example, single entity treatment for consolidated
group attribute reduction under section 108(b) is being considered in
connection with regulations being developed. The proposed regulations
are not intended to affect any other aspects of the application of
section 108.
4. Applicability of Section 1031
The current regulations do not provide special rules for
intercompany transactions to which section 1031 applies.
Section 1031 treatment for intercompany transactions is
inconsistent with the general approach of the proposed regulations. If
the members had been divisions of a single corporation, the basis of
one property could not be substituted as the basis for another
property. Although section 1031(f) limits the planning opportunities
from certain basis shifts, the limitations do not adequately address
the single entity treatment of consolidated groups under the proposed
regulations.
To conform the treatment of like-kind exchanges more closely to the
general treatment of intercompany transactions under the proposed
regulations, the proposed regulations provide that section 1031 does
not apply to intercompany transactions. Any gain or loss of the members
will be taken into account under the matching and acceleration rules.
F. Proposed Effective Dates
The proposed intercompany transaction regulations generally apply
to intercompany transactions occurring in years beginning on or after
the date the final regulations are filed with the Federal Register.
Prior intercompany transactions will generally continue to be subject
to the prior regulations under section 1502 as in effect with respect
to the transaction.
Because an intercompany transaction can occur in part under the
current regulations and in part under the proposed regulations, the
current regulations (rather than the proposed regulations) will
continue to apply to take into account transactions that have already
been taken into account in part under the current regulations. This
approach prevents duplication or omission of items from a transaction,
and treats items consistently.
To prevent manipulation, the final regulations (and not prior law)
apply to certain transactions engaged in or structured on or after
April 8, 1994. The final regulations apply if the transaction is
engaged in or structured with a principal purpose to avoid the final
regulations, to duplicate, omit, or eliminate an item in determining
taxable income (or tax liability), or to treat items inconsistently. In
these cases, appropriate adjustments must be made in years beginning on
or after [the date the final regulations are filed with the Federal
Register], to prevent the avoidance, duplication, omission,
elimination, or inconsistency.
The methods of accounting provided in the final regulations will be
required of all groups. If the final regulations are adopted on the
proposed ``cut-off'' basis, no request for permission to make the
change, or to make an adjustment under section 481(a), will be
necessary.
Special Analyses
It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in EO 12866. Therefore,
a regulatory assessment is not required. It has also been determined
that section 553(b) of the Administrative Procedure Act (5 U.S.C.
chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do
not apply to these regulations, and, therefore, a Regulatory
Flexibility Analysis is not required. Pursuant to section 7805(f) of
the Code, this notice of proposed rulemaking will be submitted to the
Chief Counsel for Advocacy of the Small Business Administration for
comment on its impact on small business.
Comments and Public Hearing
Before these proposed regulations are adopted, consideration will
be given to any written comments that are submitted timely (preferably
a signed original and eight copies) to the IRS. All comments will be
available for public inspection and copying in their entirety. Two
public hearings on the proposed regulations will be held. See the
notice of public hearings on proposed rulemaking published elsewhere in
this issue of the Federal Register.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Proposed Amendments to the Regulations
Accordingly, 26 CFR part 1 is proposed to be amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 is amended by
removing the entries for sections ``1.469-1, 1.469-1T, 1.469-2, 1.469-
2T, 1.469-3, 1.469-3T, 1.469-5, 1.469-5T and 1.469-11'', ``1.1502-13'',
``1.1502-13T'', ``1.1502-14'', and ``1.1502-14T'' and adding the
following:
Authority: 26 U.S.C. 7805 * * * Section 1.108-3 also issued
under 26 U.S.C. 108, 267, and 1502. * * * Section 1.267(f)-1 also
issued under 26 U.S.C. 267 and 1502. * * * Section 1.460-4 also
issued under 26 U.S.C. 460 and 1502. * * * Section 1.469-1, 1.469-
1T, 1.469-2, 1.469-2T, 1.469-3, 1.469-3T, 1.469-5, 1.469-5T, and
1.469-11 also issued under 26 U.S.C. 469. * * * Section 1.1502-13
also issued under 26 U.S.C. 108, 337, 446, 1275, 1502 and 1503. * *
* Section 1.1502-17 also issued under 26 U.S.C. 446 and 1502.
Section 1.1502-18 also issued under 26 U.S.C. 1502. * * * Section
1.1502-26 also issued under 26 U.S.C. 1502. * * * Section 1.1502-33
also issued under 26 U.S.C. 1502. * * *
Par. 2. In the list below, for each location indicated in the left
column, remove the language in the middle column from that section, and
add the language in the right column.
------------------------------------------------------------------------
Affected section Remove Add
------------------------------------------------------------------------
1.167(a)-(11)(d)(3)(v)(b) Paragraph (c) of........
, 1st sentence.
1.263A-1T(b)(2)(vi)(B), A deferred intercompany An intercompany
2nd sentence. transaction. transaction.
1.263A-1T(e)(1)(ii), 1st A deferred intercompany An intercompany
sentence. transaction. transaction.
1.263A-1T(e)(1)(ii), 4th 1.1502-13(c)(2)......... 1.1502-13.
sentence.
1.263A-1T(e)(1)(ii), 4th Deferred.
sentence.
1.263A-1T(e)(1)(ii), 7th Deferred intercompany Intercompany
sentence. transaction. transaction.
1.263A-1T(e)(1)(ii), 7th Defined................. As used.
sentence.
1.263A-1T(e)(1)(iii)(A) 1.1502-13(c)............ 1.1502-13.
Example, 2nd sentence.
1.263A-1T(e)(1)(iii)(A) 1.1502-13(c)............ 1.1502-13.
Example, 4th sentence.
1.338-4(f)(4) Example (2) 1.1502-13(f)............ 1.1502-13.
(a).
1.341-7(e)(10)........... Paragraph (c)(1) of Sec. Sec. 1.1502-13.
1.1502-14.
1.861-8T(d)(2)(i), 1.1502-13(c)(2)......... 1.1502-13.
concluding text.
1.861-8T(d)(2)(i), Deferred.
concluding text.
1.861-8T(d)(2)(i), 1.1502-13(a)(2)......... 1.1502-13.
concluding text.
1.861-9T(g)(2)(iv), Deferred.
paragraph heading.
1.861-9T(g)(2)(iv), 1st Deferred intercompany Intercompany
sentence. transactions transactions.
1.1502-3(a)(2)........... 1.1502-13(a)(1)......... 1.1502-13(b).
1.1502-4(j) Example (1), Paragraph (d), (e), or 1.1502-13.
8th sentence. (f) of Sec. 1.1502-13.
1.1502-4(j) Example (1), Paragraph (d), (e), or 1.1502-13.
2nd sentence after chart. (f) of Sec. 1.1502-13.
1.1502-9(f) Example (6).. 1.1502-13(f)............ 1.1502-13.
1.1502-12(a)............. Secs. 1.1502-13 and Sec. 1.1502-13.
1.1502-14.
1.1502-12(g)(2).......... A deferred intercompany An intercompany
transaction as defined transaction as
in Sec. 1.1502-13(a)(2). defined in Sec.
1.1502-13.
1.1502-22(a)(3).......... 1.1502-14,.............. ...................
1.1502-22(a)(5) Example Paragraph (d), (e), or Sec. 1.1502-13.
(i). (f) of Sec. 1.1502-13.
1.1502-26(b)............. Paragraph (a)(1) of Sec. Sec. 1.1502-13.
1.1502-14.
1.1502-47(e)(4)(iii)..... Secs. 1.1502-13(f), Secs. 1.1502-13,
1.1502-14, 1.1502-18,. 1.1502-18.
1.1502-47(e)(4)(iv) Deferred intercompany Intercompany
Example 4, 3d sentence. transactions (see Sec. transactions (see
1.1502-13(a)(2)). Sec. 1.1502-13).
1.1502-47(e)(4)(iv) 1.1502-13(f)(1)(iv)..... 1.1502-13.
Example 4, 4th sentence.
1.1502-47(e)(4)(iv) Deferred intercompany Intercompany
Example 4, chart header. transactions between. transactions
between.
1.1502-47(e)(4)(iv) 1.1502-13(f)(1)(iv)..... 1.1502-13.
Example 4, chart header.
1.1502-47(f)(3).......... 1.1502-14.
1.1502-47(r), 2nd Deferred.
sentence.
1.1503-2(d)(4) Example 1 Deferred.
(iii), 4th sentence.
1.1503-2(d)(4) Example 1 1.1502-13(a)(2)......... 1.1502-13.
(iii), 4th sentence.
------------------------------------------------------------------------
Par. 3. Section 1.108-3 is added to read as follows:
Sec. 1.108-3 Intercompany losses and deductions.
(a) General rule. This section applies to certain losses and
deductions from the sale, exchange, or other transfer of property
between corporations that are members of a consolidated group or a
controlled group (an intercompany transaction). See section 267(f)
(controlled groups) and Sec. 1.1502-13 (consolidated groups) for
applicable definitions. For purposes of determining the attributes to
which section 108(b) applies, a loss or deduction not yet taken into
account under section 267(f) or Sec. 1.1502-13 (an intercompany loss or
deduction) is treated as basis described in section 108(b) that the
transferor retains in property. For example, if S and B are
corporations filing a consolidated return, and S sells land with a $100
basis to B for $90 and the $10 loss is deferred under section 267(f)
and Sec. 1.1502-13, the deferred loss is treated for purposes of
section 108(b) as $10 of basis that S has in land (even though S has no
remaining interest in the land sold to B) and is subject to reduction
under section 108(b)(2)(E). To the extent S's loss is reduced, it can
not thereafter be taken into account under section 267(f) or
Sec. 1.1502-13. Similar principles apply, with appropriate adjustments,
if S and B are members of a controlled group and S's loss is deferred
only under section 267(f).
(b) Effective date. This section applies with respect to discharges
of indebtedness occurring on or after [the date that is 60 days after
final regulations are filed with the Federal Register.
Sec. 1.167(a)-11 [Amended]
Par. 4. Section 1.167(a)-11(d)(3)(v)(e) is amended by removing the
second sentence of Example (3).
Par. 5. Section 1.267(f)-1 is revised to read as follows:
Sec. 1.267(f)-1 Controlled groups.
(a) In general--(1) Purpose. This section provides rules under
section 267(f) to defer losses and deductions from certain transactions
between members of a controlled group (intercompany sales). The purpose
of the deferral is to prevent tax avoidance from allowing the loss or
deduction of the selling member (S) without the corresponding inclusion
of the buying member (B).
(2) Application of consolidated return principles. Under this
section, S's loss or deduction from an intercompany sale is taken into
account under the timing principles of Sec. 1.1502-13 (intercompany
transactions between members of a consolidated group), treating the
intercompany sale as an intercompany transaction. For this purpose:
(i) The matching and acceleration rules of Sec. 1.1502-13(c) and
(d), the definitions and operating rules of Sec. 1.1502-13(b) and (j),
and the simplifying rules of Sec. 1.1502-13(e)(1) apply with the
adjustments in paragraphs (b) and (c) of this section to reflect that
this section--
(A) Applies on a controlled group basis rather than consolidated
group basis; and
(B) Generally affects only the timing of a loss or deduction, and
not its attributes (e.g., its source and character) or the holding
period of property.
(ii) The special rules under Sec. 1.1502-13(f) (stock of members)
and (g) (obligations of members) apply under this section only to the
extent that the transaction is also an intercompany transaction to
which Sec. 1.1502-13 applies.
(iii) Any election under Sec. 1.1502-13 to take items into account
on a separate entity basis does not apply under this section. See
Sec. 1.1502-13(e)(3).
(3) Other law. The rules of this section apply in addition to other
applicable law. For example, to the extent a loss or deduction deferred
under this section is from a transaction that is also an intercompany
transaction under Sec. 1.1502-13(b)(1), the loss or deduction is also
subject to recharacterization under Sec. 1.1502-13. See also sections
269 (acquisitions to evade or avoid income tax) and 482 (allocations
among commonly controlled taxpayers). Any loss or deduction taken into
account under this section can be deferred, disallowed, or eliminated
under other applicable law. See, e.g., section 1091 (loss eliminated on
wash sale).
(4) Construction. The rules of this section must be applied in a
consistent manner that reasonably carries out their purposes, taking
into account all of the facts and circumstances, the underlying
economic arrangement, and applicable Federal income tax accounting
principles. For example, the rules must not be applied to accelerate or
duplicate S's losses or deductions.
(b) Definitions and operating rules. The definitions in
Sec. 1.1502-13(b) and the operating rules of Sec. 1.1502-13(j) apply
under this section with appropriate adjustments, including the
following:
(1) Intercompany sale. An intercompany sale is a sale, exchange, or
other transfer of property between members of a controlled group, if it
would be an intercompany transaction under the principles of
Sec. 1.1502-13, determined by treating the references to a consolidated
group as references to a controlled group and by disregarding whether
any of the members join in filing consolidated returns.
(2) S's losses or deductions. Unless the intercompany sale is also
an intercompany transaction to which Sec. 1.1502-13 applies, S's losses
or deductions subject to this section are determined on a separate
entity basis. For example, the principles of Sec. 1.1502-13(b)(2)(i)(C)
(treating certain amounts not yet recognized as items to be taken into
account) do not apply. A loss or deduction is from an intercompany sale
whether it is directly or indirectly from the intercompany sale.
(3) Controlled group; member. For purposes of this section, a
controlled group is defined in section 267(f). Thus, a controlled group
includes a FSC (as defined in section 922) and excluded members under
section 1563(b)(2), but does not include a DISC (as defined in section
992). Because corporations may be controlled group members without
joining in the filing of consolidated returns or being owned through a
common parent, corporations remain members of a controlled group as
long as they remain in a controlled group relationship with each other.
For example, corporations become nonmembers with respect to each other
when they cease to be in a controlled group relationship with each
other, rather than by having a separate return year (described in
Sec. 1.1502-13(j)(4)). Further, the principles of Sec. 1.1502-13(j)(3)
(former common parent treated as continuation of group) apply to any
corporation if, immediately before it becomes a nonmember, it is both
the selling member and the owner of property with respect to which a
loss or deduction is deferred (whether or not it becomes a member of a
different controlled group filing consolidated or separate returns).
(4) Consolidated taxable income. References to consolidated taxable
income (and consolidated tax liability) include references to the
combined taxable income of the members (and their combined tax
liability). For corporations filing separate returns, it ordinarily
will not be necessary to actually combine their taxable incomes (and
tax liabilities) because the taxable income (and tax liability) of one
corporation does not affect the taxable income (or tax liability) of
another corporation.
(c) Matching and acceleration principles of Sec. 1.1502-13--(1)
General rule. Under this section, S's losses and deductions are
deferred until they are taken into account under the timing principles
of the matching and acceleration rules of Sec. 1.1502-13 (c) and (d),
with appropriate adjustments. For example, if S sells depreciable
property to B at a loss, S's loss is deferred and taken into account
under the principles of the matching rule of Sec. 1.1502-13(c) to
reflect the difference between B's depreciation taken into account with
respect to the property and the depreciation that B would take into
account if S and B were divisions of a single corporation; if S and B
subsequently cease to be in a controlled group relationship with each
other, S's remaining loss is taken into account under the principles of
the acceleration rule of Sec. 1.1502-13(d). The matching and
acceleration rules are not applied under this section to affect the
attributes of an item, or cause it to be taken into account before it
is taken into account under the member's method of accounting on a
separate entity basis. Similarly, the matching and acceleration rules
are not applied under this section to affect the timing or attributes
of B's items.
(2) Adjustments to the timing principles of Sec. 1.1502-13 (c) and
(d). For purposes of this section, the adjustments to Sec. 1.1502-13
(c) and (d) include the following:
(i) Different taxable years. If S and B have different taxable
years, the taxable years that include a December 31 are treated as the
same taxable years. If S or B has a short taxable year that does not
include a December 31, the short year is treated as part of the
succeeding taxable year that does include a December 31.
(ii) Transfer to a section 267(b) related person. To the extent S's
loss or deduction is taken into account under this section as a result
of B's transfer to a nonmember that is a person related to any member
under section 267(b), the loss or deduction is taken into account but
allowed only to the extent of any income or gain taken into account as
a result of the transfer. The balance not allowed is treated as a loss
referred to in section 267(d) if it is from a sale or exchange by B
(rather than from a distribution).
(iii) Circularity of references. References to deferral or
elimination under the Internal Revenue Code or regulations do not
include references to section 267(f) or this section. See, e.g.,
Sec. 1.1502-13(a)(3) (applicability of other law).
(d) Intercompany sales of inventory involving foreign persons--(1)
General rule. Section 267(a)(1) and this section do not apply to an
intercompany sale of property that is inventory (within the meaning of
section 1221(1)) in the hands of both S and B, if--
(i) The intercompany sale is in the ordinary course of S's trade or
business; and
(ii) S or B is a foreign corporation, any income or loss realized
on the intercompany sale by S or B is not income or loss that is
recognized as effectively connected with the conduct of a trade or
business within the United States within the meaning of section 864
(unless the income is exempt from taxation pursuant to a treaty
obligation of the United States).
(2) Intercompany sales involving related partnerships. For purposes
of paragraph (d)(1) of this section, a partnership and a foreign
corporation described in section 267(b)(10) are treated as members,
provided the foreign corporation is described in paragraph (d)(1)(ii)
of this section.
(3) Intercompany sales in ordinary course. For purposes of this
paragraph (d), whether an intercompany sale is in the ordinary course
of business is determined under all the facts and circumstances.
(e) Treatment of a creditor with respect to a loan in nonfunctional
currency. Sections 267(a)(1) and this section do not apply to an
exchange loss realized with respect to a loan of nonfunctional currency
if--
(1) The loss is realized by a member with respect to nonfunctional
currency loaned to another member;
(2) The loan is described in Sec. 1.988-1(a)(2)(i);
(3) The loan is not in a hyperinflationary currency as defined in
Sec. 1.988-1(f); and
(4) The transaction does not have as a significant purpose the
avoidance of Federal income tax.
(f) Receivables. If S has income or gain from a receivable acquired
as a result of selling goods or services to a nonmember, and S sells
the receivable at fair market value to B, any loss or deduction of S
from its sale to B is not deferred under this section to the extent it
does not exceed S's income or gain from the sale to the nonmember.
(g) Earnings and profits. A loss or deduction deferred under this
section is not reflected in S's earnings and profits before it is taken
into account under this section. See, e.g., Secs. 1.312-6(a), 1.312-7,
and 1.1502-33(c)(2).
(h) Anti-avoidance rule. If a transaction is engaged in or
structured with a principal purpose to avoid the application of this
section, or to affect the timing of losses or deductions (or tax
liability) under this section, adjustments must be made to carry out
the purposes of this section.
(i) [Reserved]
(j) Examples. For purposes of the examples in this paragraph (j),
unless otherwise stated, corporation P owns 75% of the only class of
stock of subsidiaries S and B, X is a person unrelated to any member of
the P controlled group, the taxable year of all persons is the calendar
year, all persons use the accrual method of accounting, tax liabilities
are disregarded, the facts set forth the only activity, and no member
has a special status. If a member acts as both a selling member and a
buying member (e.g., with respect to different aspects of a single
transaction, or with respect to related transactions), the member is
referred as to M (rather than as S or B). This section is illustrated
by the following examples.
Example 1. Matching and acceleration rules. (a) Facts. S holds
land for investment with a basis of $130. On January 1 of Year 1, S
sells the land to B for $100. On a separate entity basis, S's loss
is long-term capital loss. B holds the land for sale to customers in
the ordinary course of business. On July 1 of Year 3, B sells the
land to X for $110.
(b) Matching rule. Under paragraph (b)(1) of this section, S's
sale of land to B is an intercompany sale. Under paragraph (c)(1) of
this section, S's $30 loss is taken into account under the timing
principles of the matching rule of Sec. 1.1502-13(c) to reflect the
difference for the year between B's corresponding items taken into
account and B's recomputed corresponding items (the corresponding
items that B would take into account for the year if S and B were
divisions of a single corporation). If S and B were divisions of a
single corporation and the intercompany sale were a transfer between
the divisions, B would succeed to S's $130 basis in the land and
would have a $20 loss from the sale to X. Consequently, S takes no
loss into account in Years 1 and 2, and takes the entire $30 loss
into account in Year 3 to reflect the $30 difference in that year
between the $10 gain B takes into account and its $20 recomputed
loss. The attributes of S's intercompany items and B's corresponding
items are determined on a separate entity basis. Thus, S's $30 loss
is long-term capital loss and B's $10 gain is ordinary income.
(c) Acceleration resulting from sale of B stock. The facts are
the same as in paragraph (a) of this Example 1, except that on July
1 of Year 3 P sells all of its B stock to X (rather than B's selling
the land to X). Under paragraph (c)(1) of this section, S's $30 loss
is taken into account under the timing principles of the
acceleration rule of Sec. 1.1502-13(d) immediately before the effect
of treating S and B as divisions of a single corporation cannot be
produced. Because the effect cannot be produced once B becomes a
nonmember, S takes its $30 loss into account in Year 3 immediately
before B becomes a nonmember. S's loss is long-term capital loss.
(d) Subgroup principles applicable to sale of S and B stock. The
facts are the same as in paragraph (a) of this Example 1, except
that on July 1 of Year 3 P sells all of its S and B stock to X
(rather than B's selling the land to X). Under paragraph (b)(3) of
this section, S and B are considered to remain members of a
controlled group as long as they remain in a controlled group
relationship with each other (whether or not in the original
controlled group). P's sale of their stock does not affect the
controlled group relationship of S and B with each other. Thus, S's
loss is not taken into account as a result of P's sale of the stock.
Instead, S's loss is taken into account based on subsequent events
(e.g., B's sale of the land to a nonmember).
Example 2. Distribution of loss property. (a) Facts. S holds
land with a basis of $130 and value of $100. On January 1 of Year 1,
S distributes the land to P in a transaction to which section 311
applies. On July 1 of Year 3, P sells the land to X for $110.
(b) No loss taken into account. Under paragraph (b)(2) of this
section, because P and S are not members of a consolidated group,
Sec. 1.1502-13(f)(2)(iii) does not apply to cause S to recognize a
$30 loss under the principles of section 311(b). Thus, S has no loss
to be taken into account under this section. (If P and S were
members of a consolidated group, Sec. 1.1502-13(f)(2)(iii) would
apply to S's loss in addition to the rules of this section, and the
loss would be taken into account in Year 3 as a result of P's sale
to X.)
Example 3. Loss not yet taken into account under separate entity
accounting method. (a) Facts. S holds land with a basis of $130. On
January 1 of Year 1, S sells the land to B at a $30 loss but does
not take into account the loss under its separate entity method of
accounting until Year 4. On July 1 of Year 3, B sells the land to X
for $110.
(b) Timing. Under paragraph (b)(2) of this section, the
determination S's loss is made on a separate entity basis. Under
paragraph (c)(1) of this section, S's loss is not taken into account
before it is taken into account under S's separate entity method of
accounting. Thus, although B takes its corresponding gain into
account in Year 3, S has no loss to take into account until Year 4.
Once S's loss is taken into account in Year 4, it is not deferred
under this section because B's corresponding gain has already been
taken into account. (If S and B were members of a consolidated
group, S would be treated under Sec. 1.1502-13(b)(2)(i)(C) as taking
the loss into account in Year 3.)
Example 4. Consolidated groups. (a) Facts. P owns all of the
stock of S and B, and the P group is a consolidated group. S holds
land for investment with a basis of $130. On January 1 of Year 1, S
sells the land to B for $100. B holds the land for sale to customers
in the ordinary course of business. On July 1 of Year 3, P sells 25%
of B's stock to X. As a result of P's sale, B becomes a nonmember of
the P consolidated group but S and B remain in a controlled group
relationship with each other for purposes of section 267(f). Assume
that if S and B were divisions of a single corporation, the items of
S and B from the land would be ordinary by reason of B's activities.
(b) Timing and attributes. Under paragraph (a)(3) of this
section, S's sale to B is subject to both Sec. 1.1502-13 and this
section. Under Sec. 1.1502-13, S's loss is recharacterized as an
ordinary loss by reason of B's activities. Under paragraph (b)(3) of
this section, because S and B remain in a controlled group
relationship with each other, the loss is not taken into account
under the acceleration rule of Sec. 1.1502-13(d) as modified by
paragraph (c) of this section. See Sec. 1.1502-13(a)(3).
Nevertheless, S's loss is recharacterized by Sec. 1.1502-13 as an
ordinary loss, and the character of the loss is not further
redetermined under this section. Thus, the loss continues to be
deferred under this section, and will be taken into account as
ordinary loss based on subsequent events (e.g., B's sale of the land
to a nonmember).
(c) Resale to controlled group member. The facts are the same as
in paragraph (a) of this Example 4, except that P owns 75% of X's
stock, and B resells the land to X (rather than P's selling any B
stock). The results for S's loss are the same as in paragraph (b) of
this Example 4. Under paragraph (b) of this section, X is also in a
controlled group relationship, and B's sale to X is a second
intercompany sale. Thus, S's loss continues to be deferred and is
taken into account under this section as ordinary loss based on
subsequent events (e.g., X's sale of the land to a nonmember).
Example 5. Intercompany sale followed by installment sale. (a)
Facts. S holds land for investment with a basis of $130x. On January
1 of Year 1, S sells the land to B for $100x. B holds the land for
investment. On July 1 of Year 3, B sells the land to X in exchange
for X's $110x note. The note bears a market rate of interest in
excess of the applicable Federal rate, and provides for principal
payments of $55x in Year 4 and $55x in Year 5. Section 453A applies
to X's note.
(b) Timing and attributes. Under paragraph (c) of this section,
S's $30x loss is taken into account under the timing principles of
the matching rule of Sec. 1.1502-13(c) to reflect the difference in
each year between B's gain taken into account and its recomputed
loss. Under section 453, B takes into account $5x of gain in Year 4
and in Year 5. Therefore, S takes $20x of its loss into account in
Year 3 to reflect the $20x difference in that year between B's $0
loss taken into account and its $20x recomputed loss. In addition, S
takes $5x of its loss into account in Year 4 and in Year 5 to
reflect the $5x difference in each year between B's $5x gain taken
into account and its $0 recomputed gain. Although S takes into
account a loss and B takes into account a gain, the attributes of
B's $10x gain are determined on a separate entity basis, and
therefore the interest charge under section 453A(c) applies to B's
$10x gain on the installment sale beginning in Year 3.
Example 6. Section 721 transfer to a section 267(b) nonmember.
(a) Facts. S owns land with a basis of $130. On January 1 of Year 1,
S sells the land to B for $100. On July 1 of Year 3, B transfers the
land to a partnership in exchange for a 40% interest in capital and
profits in a transaction to which section 721 applies. P also owns a
25% interest in the capital and profits of the partnership.
(b) Timing. Under paragraph (c)(2)(ii) of this section, S's $30
loss is taken into account in Year 3 but disallowed because the
partnership is a nonmember that is a related person under section
267(b). In addition, any subsequent gain recognized by the
partnership with respect to the property is limited under section
267(d). (The results would be the same if the P group were a
consolidated group, and S's sale to B were also subject to
Sec. 1.1502-13.)
Example 7. Receivables. (a) Controlled group. S owns goods with
a $60 basis. In Year 1, S sells the goods to X for X's $100 note.
The note bears a market rate of interest in excess of the applicable
Federal rate, and provides for payment of principal in Year 5. S
takes into account $40 of income in Year 1 under its method of
accounting. In Year 2, the fair market value of X's note falls to
$90 due to an increase in prevailing market interest rates, and S
sells the note to B for its $90 fair market value.
(b) Loss not deferred. Under paragraph (f) of this section, S
takes its $10 loss into account in Year 2. (If the sale were not at
fair market value, paragraph (f) of this section would not apply and
none of S's $10 loss would be taken into account in Year 2.)
(c) Consolidated group. Assume instead that P owns all of the
stock of S and B, and the P group is a consolidated group. In Year
1, S sells to X goods having a basis of $90 for X's $100 note
(bearing a market rate of interest in excess of the applicable
Federal rate, and providing for payment of principal in Year 5), and
S takes into account $10 of income in Year 1. In Year 2, S sells the
receivable to B for its $85 fair market value. In Year 3, P sells
25% of B's stock to X. Although paragraph (f) of this section
provides that $10 of S's loss (i.e., the extent to which S's $15
loss does not exceed its $10 of income) is not deferred under this
section, S's entire $15 loss is subject to Sec. 1.1502-13 and none
of the loss is taken into account in Year 2 under the matching rule
of Sec. 1.1502-13(c). See paragraph (a)(3) of this section
(continued deferral under Sec. 1.1502-13). P's sale of B stock
results in B becoming a nonmember of the P consolidated group in
Year 3. Thus, S's $15 loss is taken into account in Year 3 under the
acceleration rule of Sec. 1.1502-13(d). Nevertheless, B remains in a
controlled group relationship with S and paragraph (f) of this
section permits only $10 of S's loss to be taken into account in
Year 3. See Sec. 1.1502-13(a)(3) (continued deferral under section
267). The remaining $5 of S's loss continues to be deferred under
this section and taken into account under this section based on
subsequent events (e.g., B's collection of the note or P's sale of
the remaining B stock to a nonmember).
Example 8. Selling member ceases to be a member. (a) Facts. P
owns all of the stock of S and B, and the P group is a consolidated
group. S has several historic assets, including land with a basis of
$130 and value of $100. The land is not essential to the operation
of S's business. On January 1 of Year 1, S sells the land to B for
$100. On July 1 of Year 3, P transfers all of S's stock to newly
formed X in exchange for a 20% interest in X stock as part of a
transaction to which section 351 applies. Although X holds many
other assets, a principal purpose for P's transfer is to accelerate
taking S's $30 loss into account. P has no plan or intention to
dispose of the X stock.
(b) Timing. Under paragraph (c) of this section, S's $30 loss
ordinarily is taken into account immediately before P's transfer of
the S stock, under the timing principles of the acceleration rule of
Sec. 1.1502-13(d). Although taking S's loss into account results in
a $30 negative stock basis adjustment under Sec. 1.1502-32, because
P has no plan or intention to dispose of its X stock, the negative
adjustment will not immediately affect taxable income. P's transfer
accelerates a loss that otherwise would be deferred, and an
adjustment under paragraph (h) of this section is required. Thus,
S's loss is never taken into account, and S's stock basis and
earnings and profits are reduced by $30 under Secs. 1.1502-32 and
1.1502-33 immediately before P's transfer of the S stock.
(c) Nonhistoric assets. Assume instead that, with a principal
purpose to accelerate taking loss into account, P forms M with a
$100 contribution on January 1 of Year 1 and S sells the land to M
for $100. On December 1 of Year 1, M sells the land to B for $90. On
July 1 of Year 3, while B still owns the land, P sells all of M's
stock to X and M becomes a nonmember. Under paragraph (c) of this
section, M's $10 loss ordinarily is taken into account under the
timing principles of the acceleration rule of Sec. 1.1502-13(d)
immediately before M becomes a nonmember. (S's $30 loss is not taken
into account under the timing principles of Sec. 1.1502-13(c) or
Sec. 1.1502-13(d) as a result of M becoming a nonmember, but is
taken into account based on subsequent events such as B's sale of
the land to a nonmember or P's sale of the stock of S or B to a
nonmember.) The land is not an historic asset of M and, although
taking M's loss into account reduces P's basis in the M stock under
Sec. 1.1502-32, the negative adjustment only eliminates the $10
duplicate stock loss. Under paragraph (h) of this section, M's loss
is never taken into account. M's stock basis, and the earnings and
profits of M and P, are reduced by $10 under Secs. 1.1502-32 and
1.1502-33 immediately before P's sale of the M stock.
(k) Cross-reference. For additional rules applicable to the
disposition or deconsolidation of the stock of members of consolidated
groups, see Secs. 1.337(d)-1, 1.337(d)-2, and 1.1502-20.
(l) Effective dates--(1) In general. This section applies with
respect to transactions occurring in S's years beginning on or after
[the date the final regulations are filed with the Federal Register].
If both this section and prior law apply to a transaction, or neither
applies, with the result that items are duplicated, omitted, or
eliminated in determining taxable income (or tax liability), or items
are treated inconsistently, prior law (and not this section) applies to
the transaction.
(2) Avoidance transactions. This paragraph (l)(2) applies if a
transaction is engaged in or structured on or after April 8, 1994, with
a principal purpose to avoid the rules of this section applicable to
transactions occurring in years beginning on or after [the date the
final regulations are filed with the Federal Register], to duplicate,
omit, or eliminate an item in determining taxable income (or tax
liability), or to treat items inconsistently. If this paragraph (l)(2)
applies, appropriate adjustments must be made in years beginning on or
after [the date the final regulations are filed with the Federal
Register], to prevent the avoidance, duplication, omission,
elimination, or inconsistency.
(3) Prior law. For transactions occuring in S's years beginning
before [the date the final regulations are filed with the Federal
Register] see the applicable regulations issued under sections 267 and
1502. See, e.g., Secs. 1.267(f)-1, 1.267(f)-1T, 1.267(f)-2T, 1.267(f)-
3, 1.1502-13, 1.1502-13T, 1.1502-14, 1.1502-14T, and 1.1502-31 (as
contained in the 26 CFR part 1 edition revised as of April 1, 1994).
Secs. 1.267(f)-1T, 1.267(f)-2T, and 1.267(f)-3 [Removed]
Par. 6. Sections 1.267(f)-1T, 1.267(f)-2T, and 1.267(f)-3 are
removed.
Par. 7. Section 1.460-0 is amended in the table of contents by
revising the section heading for Sec. 1.460-4, and adding entries for
that section to read as follows:
Sec. 1.460-0 Outline of regulations under section 460.
* * * * *
Sec. 1.460-4 Methods of accounting for long-term contracts.
(a) through (i) [Reserved]
(j) Consolidated groups and controlled groups.
(1) Intercompany transactions.
(i) In general.
(ii) Definitions and nomenclature.
(2) Example.
(3) Effective date.
(i) In general.
(ii) Prior law.
* * * * *
Par. 8. Section 1.460-4 is amended by revising the section heading,
adding and reserving paragraphs (a) through (i), and adding paragraph
(j) to read as follows:
Sec. 1.460-4 Methods of accounting for long-term contracts.
(a) through (i) [Reserved]
(j) Consolidated groups and controlled groups--(1) Intercompany
transactions--(i) In general. Section 1.1502-13 does not apply to the
income, gain, deduction, or loss from an intercompany transaction
between members of a consolidated group, and section 267(f) does not
apply to these items from an intercompany sale between members of a
controlled group, to the extent--
(A) The transaction or sale directly or indirectly benefits, or is
intended to benefit, another member's long-term contract with a
nonmember;
(B) The selling member is required under section 460 to determine
any part of its gross income from the transaction or sale under the
percentage-of-completion method (PCM); and
(C) The member with the long-term contract is required under
section 460 to determine any part of its gross income from the long-
term contract under the PCM.
(ii) Definitions and nomenclature. The definitions and nomenclature
under Sec. 1.1502-13 and Sec. 1.267(f)-1 apply for purposes of this
paragraph (j).
(2) Example. The following example illustrates the principles of
paragraph (j)(1) of this section.
Example. Corporations P, S, and B file consolidated returns on a
calendar-year basis. In 1996, B enters into a long-term contract
with X, a nonmember, to manufacture 5 airplanes for $500 million,
with delivery scheduled for 1999. Section 460 requires B to
determine the gross income from its contract with X under the PCM. S
enters into a contract with B to manufacture for $50 million the
engines that B will install on X's airplanes. Section 460 requires S
to determine the gross income from its contract with B under the
PCM. S estimates that it will incur $40 million of total contract
costs during 1997 and 1998 to manufacture the engines. S incurs $10
million of contract costs in 1997 and $30 million in 1998. Under
paragraph (j) of this section, S determines its gross income from
the long-term contract under the PCM rather than under section
267(f) or Sec. 1.1502-13. Thus, S includes $12.5 million of gross
receipts and $10 million of contract costs in gross income in 1997
and includes $37.5 million of gross receipts and $30 million of
contract costs in gross income in 1998.
(3) Effective date--(i) In general. This paragraph (j) applies with
respect to transactions and sales occurring in years beginning on or
after [the date the final regulations are filed with the Federal
Register].
(ii) Prior law. For transactions and sales occurring in years
beginning before [the date final regulations are filed with the Federal
Register], see the applicable regulations issued under sections 267(f)
and 1502, including Secs. 1.267(f)-1T, 1.267(f)-2T, and 1.1502-13(n)
(as contained in the 26 CFR part 1 edition revised as of April 1,
1994).
Par. 9. Section 1.469-0 is amended in the table of contents by
revising entries for paragraphs (a) through (d)(1), (g)(5) through
(h)(3), and (h)(5) through (k) under Sec. 1.469-1 and revising entries
for paragraphs (c)(8), (h)(1), (h)(2), and (h)(6) under Sec. 1.469-1T
to read as follows:
Sec. 1.469-0 Table of contents.
* * * * *
Sec. 1.469-1 General rules.
(a) through (c)(7) [Reserved]
(c)(8) Consolidated groups.
(c)(9) through (d)(1) [Reserved]
* * * * *
(g)(5) [Reserved]
(h)(1) In general.
(h)(2) Definitions.
(h)(3) [Reserved]
* * * * *
(h)(5) [Reserved]
(h)(6) Intercompany transactions.
(i) In general.
(ii) Example.
(iii) Effective dates.
(h)(7) through (k) [Reserved]
Sec. 1.469-1T General rules (temporary).
* * * * *
(c)(8) [Reserved]
* * * * *
(h)(1) [Reserved]
(h)(2) [Reserved]
* * * * *
(h)(6) [Reserved]
* * * * *
Par. 10. Section 1.469-1 is amended by revising paragraphs (a)
through (d)(1), (g)(5) through (h)(3), and (h)(5) through (k) to read
as follows:
Sec. 1.469-1 General rules.
(a) through (c)(7) [Reserved]
(c)(8) Consolidated groups. Rules relating to the application of
section 469 to consolidated groups are contained in paragraph (h) of
this section.
(c)(9) through (d)(1) [Reserved]
* * * * *
(g)(5) [Reserved]
(h)(1) In general. This paragraph (h) provides rules for applying
section 469 in computing a consolidated group's consolidated taxable
income and consolidated tax liability (and the separate taxable income
and tax liability of each member).
(2) Definitions. The definitions and nomenclature in the
regulations under section 1502 apply for purposes of this paragraph
(h). See, e.g., Secs. 1.1502-1 (definitions of group, consolidated
group, member, subsidiary, and consolidated return year), 1.1502-2
(consolidated tax liability), 1.1502-11 (consolidated taxable income),
1.1502-12 (separate taxable income), 1.1502-13 (intercompany
transactions), 1.1502-21 (consolidated net operating loss), and 1.1502-
22 (consolidated net capital gain or loss).
(3) [Reserved]
* * * * *
(5) [Reserved]
(6) Intercompany transactions--(i) In general. Section 1.1502-13
applies to determine the treatment under section 469 of intercompany
items and corresponding items from intercompany transactions between
members of a consolidated group. For example, the matching rule of
Sec. 1.1502-13(c) treats the selling member (S) and the buying member
(B) as divisions of a single corporation for purposes of determining
whether S's intercompany items and B's corresponding items are from a
passive activity. Thus, for purposes of applying Sec. 1.469-
2(c)(2)(iii) and Sec. 1.469-- 2T(d)(5)(ii) to property sold by S to B
in an intercompany transaction--
(A) S and B are treated as divisions of a single corporation for
determining the uses of the property during the 12-month period
preceding its disposition to a nonmember, and generally have an
aggregate holding period for the property; and
(B) Section 1.469-2(c)(2)(iv) does not apply.
(ii) Example. The following example illustrates the application of
this paragraph (h)(6).
Example. (i) P, a closely held corporation, is the common parent
of the P consolidated group. P owns all of the stock of S and B. X
is a person unrelated to any member of the P group. S owns and
operates equipment that is not used in a passive activity. On
January 1 of Year 1, S sells the equipment to B at a gain. B uses
the equipment in a passive activity and does not dispose of the
equipment before it has been fully depreciated. Assume that if S and
B were divisions of a single corporation, S's gain would be passive
income attributable to a passive activity.
(ii) Under the matching rule of Sec. 1.1502-13(c), S's gain
taken into account as a result of B's depreciation is treated as
gain from a passive activity even though S used the equipment in a
nonpassive activity.
(iii) The facts are the same as in paragraph (a) of this
Example, except that B sells the equipment to X on December 1 of
Year 3 at a further gain. To the extent of B's depreciation before
the sale, the results are the same as in paragraph (ii) of this
Example. S's remaining gain taken into account as a result of B's
sale is treated as attributable to a passive activity.
(iv) The facts are the same as in paragraph (iii) of this
Example, except that B recognizes a loss on the sale to X. As in
paragraph (iii) of this Example, S's gain taken into account as a
result of B's sale is treated as attributable to a passive activity.
(iii) Effective dates. This paragraph (h)(6) applies with respect
to transactions occurring in years beginning on or after [the date the
final regulations are filed with the Federal Register]. For
transactions occurring in years beginning before [the date the final
regulations are filed with the Federal Register], see Sec. 1.469-
1T(h)(6) (as contained in the 26 CFR part 1 edition revised as of April
1, 1994).
(h)(7) through (k) [Reserved]
Sec. 1.469-1T [Amended]
Par. 11. Section 1.469-1T is amended by removing and reserving
paragraphs (c)(8), (h)(1), (h)(2), and (h)(6).
Par. 12. Section 1.1502-13 is revised to read as follows:
Sec. 1.1502-13 Intercompany transactions.
(a) In general--(1) Purpose. This section provides rules for taking
into account the items of income, gain, deduction, and loss of members
from intercompany transactions. The purpose of this section is to
provide rules to clearly reflect the taxable income (and tax liability)
of the group as a whole by preventing intercompany transactions from
creating, accelerating, avoiding, or deferring consolidated taxable
income (or consolidated tax liability).
(2) Separate entity and single entity treatment. Under this
section, the selling member (S) and the buying member (B) are treated
as separate entities for some purposes but as divisions of a single
corporation for other purposes. The amount and location of S's
intercompany items and B's corresponding items are determined on a
separate entity basis (separate entity treatment). For example, S
determines its gain or loss from a sale of property to B on a separate
entity basis, and B has a cost basis in the property. The timing,
character, source, and other attributes of the intercompany items and
corresponding items, although initially determined on a separate entity
basis, are redetermined under this section to produce the effect of
transactions between divisions of a single corporation (single entity
treatment). For example, if S sells land to B at a gain and B resells
the land to a nonmember, S does not take its gain into account until
the resale.
(3) Other law. The rules of this section apply in addition to other
applicable law, such as sections 269 (acquisitions to evade or avoid
income tax), 482 (allocations among commonly controlled taxpayers), and
7701(f) (use of related persons). The timing rules of this section are
a method of accounting that overrides otherwise applicable accounting
methods. For example, if S sells property to B in exchange for B's
note, the rules of this section apply instead of the installment sale
rules of section 453. However, an item taken into account under this
section can be deferred, disallowed, or eliminated under other
applicable law such as section 267 (losses from transactions between
related persons).
(4) Construction. The rules of this section must be applied in a
consistent manner that reasonably carries out their purposes, taking
into account all of the facts and circumstances, the underlying
economic arrangement, and applicable Federal income tax accounting
principles. For example, the rules of this section must not be applied
to take S's intercompany items into account more than once.
(5) Overview--(i) In general. The principal rules of this section
that implement single entity treatment are the matching rule and the
acceleration rule of paragraphs (c) and (d) of this section. Under the
matching rule of paragraph (c) of this section, S and B are generally
treated as divisions of a single corporation for purposes of taking
into account their items from intercompany transactions. The
acceleration rule of paragraph (d) of this section provides additional
rules for taking the items into account if the effect of treating S and
B as divisions cannot be achieved (e.g., if S or B becomes a
nonmember). Paragraph (b) of this section provides definitions,
including the definitions of intercompany transaction, intercompany
item, and corresponding item. Paragraph (e) of this section provides
simplifying rules for certain transactions. Paragraphs (f) and (g) of
this section provide additional rules for stock and obligations of
members. Paragraphs (h) and (j) of this section provide anti-avoidance
rules and miscellaneous operating rules.
(ii) Table of examples. Set forth below is a table of the examples
contained in this section.
Matching rule. (Sec. 1.1502-13(c)(4)(ii))
Example 1. Intercompany sale of land followed by resale;
intercompany sale followed by section 1031 exchange with nonmember;
intercompany sale followed by section 351 transfer to nonmember.
Example 2. Dealer activities.
Example 3. Intercompany section 351 transfer.
Example 4. Depreciable property.
Example 5. Intercompany sale followed by installment sale.
Example 6. Intercompany sale of installment obligation.
Example 7. Performance of services.
Example 8. Rental of property.
Example 9. Back-to-back intercompany sales.
Example 10. Intercompany sale of a partnership interest.
Example 11. Net operating losses subject to section 382 or the
SRLY rules.
Example 12. Special inventory accounting election.
Example 13. Section 475.
Example 14. Section 1092.
Example 15. Manufacturer rebates.
Example 16. Cancellation of debt and attribute reduction under
section 108(b).
Example 17. Source of items from a section 863 sale.
Example 18. Section 1248.
Acceleration rule. (Sec. 1.1502-13(d)(3))
Example 1. Becoming a nonmember--timing.
Example 2. Becoming a nonmember--attributes.
Example 3. Back-to-back intercompany transactions.
Example 4. Selling member's disposition of proceeds.
Example 5. Section 481.
Simplifying rules--inventory. (Sec. 1.1502-13(e)(1)(v))
Example 1. Increment averaging method.
Example 2. Increment valuation method.
Example 3. Other reasonable inventory methods.
Stock of members. (Sec. 1.1502-13(f)(6))
Example 1. Dividend exclusion and property distribution.
Example 2. Excess loss accounts.
Example 3. Intercompany reorganization.
Example 4. Stock redemptions and distributions.
Example 5. Intercompany stock sale followed by section 332
liquidation.
Obligations of members. (Sec. 1.1502-13(g)(6))
Example 1. Interest and premium on intercompany debt.
Example 2. Intercompany debt becomes nonintercompany debt.
Example 3. Bad debt deduction or loss with respect to
intercompany debt.
Example 4. Nonintercompany debt becomes intercompany debt.
Example 5. Notional principal contracts.
Anti-avoidance rules. (Sec. 1.1502-13(h)(2))
Example 1. Sale of a partnership interest.
Example 2. Sale to a related party.
Example 3. Sale and leaseback.
Example 4. Transitory status as an intercompany obligation.
Miscellaneous operating rules. (Sec. 1.1502-13(j)(6))
Example 1. Intercompany sale followed by section 351 transfer to
member.
Example 2. Intercompany sale of member stock followed by
recapitalization.
Example 3. Successor group.
Example 4. Liquidation--80% distributee.
Example 5. Liquidation--no 80% distributee.
(b) Definitions. For purposes of this section--
(1) Intercompany transactions--(i) In general. An intercompany
transaction is a transaction between corporations that are members of
the same consolidated group immediately after the transaction. S is the
member transferring property or providing services, and B is the member
receiving the property or services. Intercompany transactions include--
(A) S's sale of property (or other transfer, such as an exchange or
contribution) to B, whether or not gain or loss is recognized;
(B) S's performance of services for B, and B's payment or accrual
of its expenditure for S's performance;
(C) S's licensing of technology, rental of property, or loan of
money to B, and B's payment or accrual of its expenditure; and
(D) S's distribution to B with respect to S stock.
(ii) Time of transaction. If a transaction occurs in part while S
and B are members and in part while they are not members, the
transaction is treated as occurring when performance by either S or B
takes place, or when payment for performance would be taken into
account under the rules of this section if it were an intercompany
transaction, whichever is earliest. Appropriate adjustments must be
made in such cases by, for example, dividing the transaction into two
separate transactions reflecting the extent to which S or B has
performed.
(iii) Separate transactions. Each transaction is analyzed
separately. For example, if S simultaneously sells two properties to B,
one at a gain and the other at a loss, each property is sold in a
separate transaction. Similarly, each payment or accrual of interest
with respect to a loan is a separate transaction. If two members
exchange property, each member is S with respect to the property it
transfers and B with respect to the property it receives.
(2) Intercompany items and corresponding items--(i) Intercompany
items--(A) In general. S's income, gain, deduction, and loss from an
intercompany transaction are its intercompany items. For example, S's
gain from the sale of property to B is intercompany gain and, if the
sale results in both ordinary income and capital gain (or other
attribute disparities), each is treated as a separate intercompany
item. An item is an intercompany item whether it is directly or
indirectly from an intercompany transaction.
(B) Related costs or expenses. S's costs or expenses related to an
intercompany transaction are included in determining its intercompany
items. For example, if S sells inventory to B, S's direct and indirect
costs properly includible under section 263A are included in
determining its intercompany income. Similarly, in addition to other
related costs, deductions for employee wages are included in
determining S's income from performing services for B, and depreciation
deductions are included in determining S's income from renting property
to B.
(C) Amounts not yet recognized or incurred. S's items from
intercompany transactions are taken into account under this section
even if S has not yet taken them into account under its separate entity
method of accounting. For example, if S is a cash method taxpayer, S's
intercompany income is taken into account under this section even if
the cash is not yet received.
(ii) Corresponding items--(A) In general. B's income, gain,
deduction, and loss from an intercompany transaction, or from property
acquired in an intercompany transaction, are its corresponding items.
For example, if B pays rent to S, B's deduction for the rent is a
corresponding deduction. If B buys property from S and resells it to a
nonmember, B's gain or loss from the resale is a corresponding gain or
loss; alternatively, if B recovers the cost of the property through
depreciation, B's depreciation deductions are corresponding deductions.
An item is a corresponding item whether it is directly or indirectly
from an intercompany transaction (or from property acquired in an
intercompany transaction).
(B) Disallowed or eliminated amounts. B's corresponding items
include amounts that are permanently disallowed or permanently
eliminated, whether directly or indirectly. For example, corresponding
items include amounts disallowed under section 265 (expenses relating
to tax-exempt income), amounts offset under section 171(e) (amortizable
bond premium offset), and amounts not recognized under section 311
(nonrecognition of loss on distributions) or 332 (nonrecognition on
liquidating distributions). (See paragraph (c)(3)(iv) of this section,
under which certain of these amounts may cause S's intercompany income
or gain to be treated as excluded from gross income.)
(iii) Effect of basis adjustments. This paragraph (b)(2)(iii)
provides additional rules for intercompany items and corresponding
items.
(A) Deemed intercompany items. An adjustment reflected in basis (or
to an amount equivalent to basis, such as a loss carryover or an excess
loss account) that is a substitute for an intercompany item is treated
as an intercompany item. For example, a reduction in S's basis in
property that preserves S's income for a later period and relates to
B's corresponding deduction is treated as intercompany income of S.
However, if the adjustment is made pursuant to a nonrecognition
provision of the Code or regulations unrelated to S's method of
accounting, the adjustment is not treated as an intercompany item.
(B) Deemed corresponding items. An adjustment reflected in basis
(or in an amount equivalent to basis, such as a loss carryover or an
excess loss account) that is a substitute for a corresponding item is
treated as a corresponding item for purposes of taking S's intercompany
items into account. However, an adjustment is not treated as a
corresponding item to the extent that the adjustment reflects a
comparable amount not recognized by S, or to the extent that the only
effect of the adjustment is to preserve B's items for a later period
(rather than, for example, affecting the overall amount of items taken
into account or to be taken into account).
(C) Amounts deemed not to be items. A deduction or loss is not
treated as an intercompany item or corresponding item to the extent it
does not reduce basis (or have an equivalent effect, such as decreasing
a loss carryover or increasing an excess loss account). For example, if
B has percentage depletion in excess of basis under section 613 or 613A
with respect to mineral property purchased from S, the depletion in
excess of basis is not treated as a corresponding item for purposes of
this section. Similar principles apply to income or gain that does not
increase basis (or have an equivalent effect).
(3) Treatment as a separate entity. Treatment as a separate entity
means treatment without application of the rules of this section, but
with the application of the other consolidated return regulations. For
example, if S sells the stock of another member to B, S's gain or loss
on a separate entity basis is determined with the application of
Sec. 1.1502-80(b) (nonapplicability of section 304), but without
redetermination under paragraph (c) or (d) of this section.
(4) Attributes. The attributes of an intercompany item or
corresponding item are all of the item's characteristics necessary to
determine its effect on taxable income (and tax liability) except
amount, location, and timing. For example, attributes include
character, source, treatment as excluded from gross income or as a
noncapital, nondeductible amount, and treatment as built-in gain or
loss under section 382(h) or 384. A member's holding period in
property, or the fact that property is included in the inventory of a
member, is not an attribute of an item, but these factors do affect the
determination of the attributes of items from the property.
(c) Matching rule. S's intercompany items and B's corresponding
items are taken into account for each consolidated return year under
the following rules:
(1) Attributes and holding periods--(i) General rule. The
attributes of S's intercompany items and B's corresponding items are
redetermined to produce the same effect on consolidated taxable income
(and consolidated tax liability) as if S and B were divisions of a
single corporation, and the intercompany transaction were a transaction
between divisions. Thus, the activities of both S and B affect the
attributes of both intercompany items and corresponding items. For
example, if S holds property for sale to unrelated customers in the
ordinary course of its trade or business and sells the property to B,
S's intercompany items and B's corresponding items may be ordinary
items solely by reason of S's activities. Similar principles apply if S
performs services, rents property, or engages in any other intercompany
transaction.
(ii) Holding periods. The holding period of property transferred in
an intercompany transaction is the aggregate of the holding periods of
S and B. However, if the basis of the property is determined by
reference to the basis of other property, the property's holding period
is determined by reference to the holding period of the other property.
For example, the holding period of stock distributed in an intercompany
distribution to which section 355 applies is determined by reference to
the holding period of the distributing member's stock.
(2) Timing--(i) B's items. B takes its corresponding items into
account under its accounting method. However, the redetermination of
the attributes of a corresponding item may affect its timing. For
example, if B's resale of property acquired from S is treated as a
dealer disposition solely by reason of S's activities, section 453(b)
prevents any corresponding income of B from being taken into account
under the installment method.
(ii) S's items. S takes its intercompany items into account to
reflect the difference for the year between B's corresponding items
taken into account and B's recomputed corresponding items (the
corresponding items that B would take into account for the year if S
and B were divisions of a single corporation). For example, if S sells
property with a $70 basis to B for $100, and B later resells the
property to a nonmember for $90, B's corresponding item taken into
account is its $10 loss, B's recomputed corresponding item is a $20
recomputed gain, and the $30 difference is the amount of S's
intercompany gain that is taken into account for the year of the
resale. Although B does not actually take the recomputed corresponding
items into account, they are computed as if they were taken into
account (based on reasonable and consistently applied assumptions,
including any provision of the Internal Revenue Code (Code) or
regulations that would affect their timing or attributes).
(3) Operating rules for single entity adjustments. For purposes of
this paragraph (c)--
(i) Divisions of a single corporation. As divisions of a single
corporation, S and B are treated as engaging in their actual
transaction and owning any actual property in the transaction (rather
than treating the transaction as not occurring). For example, S's sale
of property to B for cash is not disregarded, but is treated as an
exchange of property for cash between divisions (and B therefore
ordinarily does not have a cost basis). Similarly, if S transfers
property to B in exchange for B's stock, S is treated as owning the
stock it receives in the exchange. Although treated as divisions, S and
B nevertheless are treated as:
(A) Operating separate trades or businesses. See, e.g., Sec. 1.446-
1(d) (accounting methods for a taxpayer engaged in more than one
business).
(B) Having any special status that they have under the Internal
Revenue Code. For example, a bank defined in section 581, a domestic
building and loan association defined in section 7701(a)(19), and an
insurance company to which section 801 or 831 applies are treated as
divisions having separate special status. On the other hand, the fact
that a member holds property for sale to customers in the ordinary
course of its trade or business is not a special status.
(ii) Multiple intercompany items or corresponding items--(A)
Multiple triggers. If more than one corresponding item can cause an
intercompany item to be taken into account under this paragraph (c),
the intercompany item is taken into account in connection with the
corresponding item most consistent with the treatment of members as
divisions of a single corporation. For example, if S sells a truck to
B, its intercompany gain from the sale is not taken into account by
reference to B's depreciation if the depreciation is capitalized under
section 263 as part of B's cost for a building; instead, S's gain
relating to the capitalized depreciation is taken into account when the
building is sold or as it is depreciated. If B purchases appreciated
land from S and transfers the land to a lower-tier member in exchange
for stock, thereby duplicating the basis of the land in the basis of
the stock, items with respect to both the stock and the land can cause
S's intercompany gain to be taken into account; if the lower-tier
member becomes a nonmember as a result of the sale of its stock, the
attributes of S's intercompany gain are determined with respect to the
land rather than the stock.
(B) Aggregation of transactions. If a member's intercompany item or
corresponding item affects the accounting for more than one
intercompany transaction, appropriate adjustments are made to treat all
of the intercompany transactions as transactions between divisions of a
single corporation. For example, if land is transferred in successive
intercompany transactions, all of the participating members are treated
as divisions of a single corporation for purposes of determining the
timing and attributes of each of the items from the land. Similar
principles apply with respect to intercompany transactions that are
part of the same plan or arrangement. For example, if S sells separate
properties to different members as part of the same plan or
arrangement, all of the participating members are treated as divisions
of a single corporation for purposes of determining the timing and
attributes of the intercompany items and corresponding items from each
of the properties.
(iii) Conflict of attributes or allocation--(A) In general. If it
is not possible to determine the attributes of an item, or the
allocation of attributes between S and B, by treating S and B as
divisions of a single corporation, the determination or allocation is
made as follows--
(1) The attributes of B's corresponding items on a separate entity
basis control the attributes of offsetting intercompany items of S
(e.g., B's interest expense controls S's interest income); and
(2) If the corresponding items and intercompany items do not offset
(e.g., both S and B have gain from the same property), their attributes
are determined on a separate entity basis to the extent not
inconsistent with the purposes of this section.
(B) Special status. To the extent an item's attributes determined
under this section are permitted or not permitted to a member under the
Internal Revenue Code or regulations by reason of the member's special
status, the attributes required under the Internal Revenue Code or
regulations apply to that member (but not the other member). For
example, if S is a bank to which section 582(c) applies, and sells debt
securities at a gain to B, a nonbank, the character of S's intercompany
gain is ordinary as required under section 582(c), but the character of
B's corresponding items as capital or ordinary is determined under
paragraph (c)(1) of this section without the application of section
582(c). For other special status issues, see, e.g., sections 595(b)
(foreclosure on property securing loans), 818(b) (life insurance
company treatment of capital gains and losses), 1032 (nonrecognition
with respect to an issuer's stock) and 1503(c) (limitation on
absorption of certain losses).
(iv) Limitation on treatment of intercompany income or gain as
excluded from gross income--(A) In general. Redetermining the
attributes of intercompany items and corresponding items under this
paragraph (c) may result in S's intercompany items being treated as
excluded from gross income or as noncapital, nondeductible amounts. For
example, S's intercompany loss from the sale of property to B is
treated as a noncapital, nondeductible amount if B distributes the
property to a nonmember shareholder at no further gain or loss (because
of the nonrecognition of loss under section 311(a)). See also
Secs. 1.1502-32 and 1.1502-33 (adjustments to S's stock basis and
earnings and profits to reflect amounts so treated).
(B) Limitation. S's intercompany income or gain may be treated
under this paragraph (c) as excluded from gross income only to the
extent one of the following applies:
(1) Disallowed amounts. B's corresponding item is a deduction or
loss that, in the taxable year the item is taken into account under
this section, is permanently disallowed directly under another
provision of the Internal Revenue Code or regulations. An amount is not
permanently disallowed for this purpose if, for example--
(i) The disallowance or elimination is not permanent because an
equivalent amount might be taken into account by B, such as under
section 280B (demolition costs recoverable as capitalized amounts), or
by another taxpayer, such as under section 267(d) (disallowed loss
under section 267(a) may result in nonrecognition of gain for a related
person);
(ii) The amount is realized but not recognized under section 332;
(iii) The amount is a deemed item under paragraph (b)(2)(iii) of
this section; or
(iv) The amount is a loss that is part of a carryforward that
expires in a later year.
(2) Section 311. The corresponding item is a loss that is realized,
but not recognized under section 311(a).
(3) Other amounts. The corresponding item is otherwise limited,
eliminated, offset, or has no effect on the computation of taxable
income under any provision identified by the Commissioner.
(4) Examples--(i) In general. For purposes of the examples in this
section, unless otherwise stated, P is the common parent of the P
consolidated group, P owns all of the only class of stock of
subsidiaries S and B, X is a person unrelated to any member of the P
group, the taxable year of all persons is the calendar year, all
persons use the accrual method of accounting, tax liabilities are
disregarded, the facts set forth the only corporate activity, and no
member has any special status. If a member acts as both a selling
member and a buying member (e.g., with respect to different aspects of
a single transaction, or with respect to related transactions), the
member is referred to as M (rather than as S or B).
(ii) Matching rule. The matching rule of this paragraph (c) is
illustrated by the following examples.
Example 1. Intercompany sale of land followed by resale;
intercompany sale followed by section 1031 exchange with nonmember;
intercompany sale followed by section 351 transfer to nonmember. (a)
Facts. S holds land for investment with a basis of $70. On January 1
of Year 1, S sells the land to B for $100. B also holds the land for
investment. On July 1 of Year 3, B sells the land to X for $110.
(b) Definitions. Under paragraph (b)(1) of this section, S's
sale of the land to B is an intercompany transaction, S is the
selling member, and B is the buying member. Under paragraph (b)(2)
of this section, S's $30 gain from the sale to B is its intercompany
gain, and B's $10 gain from the sale to X is its corresponding gain.
(c) Timing. Under the matching rule of paragraph (c) of this
section, S takes its intercompany items into account to reflect the
difference for the year between B's corresponding items taken into
account and B's recomputed corresponding items (the corresponding
items that B would take into account for the year if S and B were
divisions of a single corporation). If S and B were divisions of a
single corporation and the intercompany sale were a transfer between
the divisions, B would succeed to S's $70 basis in the land and
would have a $40 gain from the sale to X instead of a $10 gain.
Consequently, S takes no gain into account in Years 1 and 2, and
takes the entire $30 gain into account in Year 3 to reflect the $30
difference in that year between the $10 gain B takes into account
and its $40 recomputed gain (B's recomputed corresponding item).
Under Secs. 1.1502-32 and 1.1502-33, P's basis in its S stock and
the earnings and profits of S and P do not reflect S's $30 gain
until the gain is taken into account in Year 3. (Under paragraph
(b)(2)(i)(C) of this section, the results would be the same if S
sold the land to B in an installment sale to which section 453 would
otherwise apply, because S must take its intercompany gain into
account under this section.)
(d) Attributes. Under the matching rule, S's $30 intercompany
gain and B's $10 corresponding gain are taken into account to
produce the same effect on consolidated taxable income (and
consolidated tax liability) as if S and B were divisions of a single
corporation. In addition, the holding periods of S and B for the
land are aggregated. Thus, both are long-term capital gain.
(e) Intercompany loss and resale gain. The facts are the same as
in paragraph (a) of this Example 1, except that S's basis in the
land is $130 (rather than $70). The timing and attributes of S's
intercompany loss and B's corresponding gain are determined in the
manner provided in paragraphs (c) and (d) of this Example 1. If S
and B were divisions of a single corporation and the intercompany
sale were a transfer between the divisions, B would succeed to S's
$130 basis in the land and would have a $20 loss from the sale to X
instead of a $10 gain. Thus, S takes its entire $30 loss into
account in Year 3 to reflect the $30 difference between B's $10 gain
taken into account and its $20 recomputed loss. (The results are the
same under section 267(f).) S's $30 loss is long-term capital loss,
and B's $10 gain remains long-term capital gain.
(f) Intercompany gain and resale loss. The facts are the same as
in paragraph (a) of this Example 1, except that B sells the land to
X for $90 (rather than $110). The timing and attributes of S's
intercompany gain and B's corresponding loss are determined in the
manner provided in paragraphs (c) and (d) of this Example 1. If S
and B were divisions of a single corporation and the intercompany
sale were a transfer between the divisions, B would succeed to S's
$70 basis in the land and would have a $20 gain from the sale to X
instead of a $10 loss. Thus, S takes its entire $30 gain into
account in Year 3 to reflect the $30 difference between B's $10 loss
taken into account and its $20 recomputed gain. S's $30 gain is
long-term capital gain, and B's $10 loss is long-term capital loss.
(g) Intercompany sale followed by section 1031 exchange with
nonmember. The facts are the same as in paragraph (a) of this
Example 1, except that, instead of selling the land to X, B
exchanges the land for land owned by X in a transaction to which
section 1031 applies. There is no difference in Year 3 between B's
corresponding items taken into account and its recomputed items.
Thus, none of S's intercompany gain is taken into account under the
matching rule as a result of the section 1031 exchange. Instead, B's
gain is preserved in the land received from X and, under the
successor asset rule of paragraph (j)(1)(i) of this section, S's
intercompany gain is taken into account by reference to the
replacement property. (If B takes gain into account as a result of
boot received in the exchange, S's intercompany gain would be taken
into account under the matching rule to the extent the boot causes a
difference between B's gain taken into account and its recomputed
gain.)
(h) Intercompany sale followed by section 351 transfer to
nonmember. The facts are the same as in paragraph (a) of this
Example 1, except that, instead of selling the land to X, B
transfers the land to X in a transaction to which section 351
applies and X remains a nonmember. There is no difference in Year 3
between B's corresponding items taken into account and its
recomputed items. Thus, none of S's intercompany gain is taken into
account under the matching rule as a result of the section 351
transfer. However, S's entire gain is taken into account in Year 3
under the acceleration rule of paragraph (d) of this section
(because X reflects B's $100 cost basis in the land under section
362).
Example 2. Dealer activities. (a) Facts. S holds land for
investment with a basis of $70. On January 1 of Year 1, S sells the
land to B for $100. B develops the land as residential real estate,
and sells developed lots to customers during Year 3 for an aggregate
amount of $110.
(b) Attributes. S and B are treated under the matching rule as
divisions of a single corporation for purposes of determining the
attributes of B's corresponding items and S's intercompany items.
Thus, although S held the land for investment, whether the land is
property described in section 1221(1) is based on the activities of
both S and B. If the land is described in section 1221(1), both S's
gain and B's gain are ordinary income.
Example 3. Intercompany section 351 transfer. (a) Facts. S holds
land with a $70 basis for sale to customers in the ordinary course
of business. On January 1 of Year 1, S transfers the land to B in
exchange for B stock and $10 cash in a transaction to which section
351 applies. See Sec. 1.1502-34 (aggregate stock ownership rules). S
has a $10 gain under section 351(b), and its basis in the B stock is
$70 under section 358. Under section 362, B's basis in the land is
$80. B holds the land for investment. On July 1 of Year 3, B sells
the land to X for $100. Assume that if S and B were divisions of a
single corporation, B's gain from the sale would be ordinary income
by reason of S's activities.
(b) Timing and attributes. Under paragraph (c)(3)(i) of this
section, S is treated as transferring the land for B's stock even
though, as divisions, S could not own stock of B. S takes its $10
gain into account in Year 3 to reflect the $10 difference between
B's $20 gain taken into account and its $30 recomputed gain. Both
S's $10 gain and B's $20 gain are ordinary income.
(c) Partial disposition. The facts are the same as in paragraph
(a) of this Example 3, except B sells only a one-half, undivided
interest in the land to X for $50. The timing and attributes are
determined in the manner provided in paragraph (b) of this Example
3, except that S takes only $5 of its gain into account in Year 3 to
reflect the $5 difference between B's $10 gain taken into account
and its $15 recomputed gain.
(d) No boot. The facts are the same as in paragraph (a) of this
Example 3, except that there is no boot in the section 351
transaction. Under paragraph (b)(1) of this section, S's transfer to
B is an intercompany transaction. Under paragraph (b)(2) of this
section, S has no intercompany items, but B's $30 gain from its sale
of the land to X is a corresponding item because the land was
acquired in an intercompany transaction. B's $30 gain is ordinary
income.
Example 4. Depreciable property. (a) Facts. During Year 1, S
buys 10-year recovery property for $80 and depreciates it under the
straight-line method with the half- year convention. On July 1 of
Year 6, S sells the property to B for $100. Under section 168(i)(7),
B is treated as S for purposes of section 168 to the extent that B's
$100 basis does not exceed S's adjusted basis at the time of the
sale. B's additional basis is treated as new 10-year recovery
property subject to the half-year convention, for which B elects the
straight-line method of recovery.
(b) Depreciation in Year 6 and intercompany gain. S takes into
account $4 of depreciation for Year 6, and S has a $40 basis at the
time of the sale to B ($80 minus $36 of prior years' depreciation
and $4 of Year 6 depreciation). Thus, S has a $60 intercompany gain
from its sale to B. For Year 6, B has the remaining $4 of
depreciation with respect to $40 of its basis (the portion of its
$100 basis not exceeding S's adjusted basis). In addition, B has
another $3 of depreciation with respect to the $60 of its additional
basis that exceeds S's adjusted basis (under the half-year
convention). For purposes of treating S and B as divisions of a
single corporation under the matching rule, the $8 of recomputed
depreciation for Year 6 is also allocated $4 to S and $4 to B.
(c) Timing. S's $60 gain is taken into account to reflect the
difference for each consolidated return year between B's
depreciation taken into account with respect to the property and its
recomputed depreciation. For Year 6, B takes $7 of depreciation into
account. If the intercompany transaction had been a transfer between
divisions of a single corporation, B would have succeeded to S's
adjusted basis in the property and taken into account only its $4
allocable share of the property's $8 of depreciation for Year 6.
Thus, S takes $3 of gain into account in Year 6. In each subsequent
year that B operates the property and takes into account $14 of
depreciation ($8 with respect to $40 of basis, and $6 with respect
to $60 of basis), S takes into account $6 of gain to reflect the $6
difference between B's $14 of depreciation taken into account and
its recomputed $8 of depreciation (the depreciation that B would
take into account if the intercompany sale were a transfer between
divisions).
(d) Attributes. S's gain taken into account as a result of B's
depreciation is ordinary income.
(e) Resale of property. The facts are the same as in paragraph
(a) of this Example 4, except that B sells the property to X at the
beginning of Year 10 for an amount equal to its $44 adjusted basis
(applying the half-year convention). To the extent of B's $56 of
depreciation before the sale ($32 with respect to the $40 of basis
corresponding to S's adjusted basis, and $24 with respect to the $60
of additional basis), the timing and attributes of S's gain are
determined in the manner provided in paragraphs (c) and (d) of this
Example 4, and S takes into account $24 of gain in Years 6 through
10 as ordinary income. The $36 balance of S's gain is taken into
account in Year 10 as a result of B's sale to X, to reflect the $36
difference between B's $0 gain taken into account and its $36
recomputed gain ($44 sale proceeds minus the $8 basis B would have
if the intercompany sale were a transfer between divisions of a
single corporation). The attributes of the remaining $36 of S's gain
are determined by treating S and B as divisions of a single
corporation. Thus, the entire $36 of gain is recapture income under
section 1245.
Example 5. Intercompany sale followed by installment sale. (a)
Facts. S holds land for investment with a basis of $70x. On January
1 of Year 1, S sells the land to B for $100x. B also holds the land
for investment. On July 1 of Year 3, B sells the land to X in
exchange for X's $110x note. The note bears a market rate of
interest in excess of the applicable Federal rate, and provides for
principal payments of $55x in Year 4 and $55x in Year 5. The
interest charge under section 453A(c) applies to X's note.
(b) Timing and attributes. S takes its $30x gain into account in
each consolidated return year to reflect the difference between B's
gain taken into account for the year and its recomputed gain. Under
section 453, B takes into account $5x of gain in Year 4 and $5x of
gain in Year 5. Thus, S takes into account $15x of gain in Year 4
and $15x of gain in Year 5. This reflects the $15x difference in
Year 4 and in Year 5 between B's $5x gain taken into account and its
$20x recomputed gain. Both S's $30x gain and B's $10x gain are
subject to the section 453A(c) interest charge beginning in Year 3.
(c) Election out under section 453(d). If, under the facts in
paragraph (a) of this Example 5, the P group wishes to elect not to
apply section 453 with respect to S's gain, an election under
section 453(d) must be made for Year 3 with respect to B's gain.
This election will cause B's $10x gain to be taken into account in
Year 3. Under the matching rule, this in turn will result in S's $30
gain being taken into account in Year 3. (An election by the P group
solely with respect to S's gain has no effect because the gain from
S's sale to B is taken into account under the matching rule, and
therefore must reflect the difference between B's gain taken into
account and its recomputed gain.)
(d) Resale loss, but overall gain. The facts are the same as in
paragraph (a) of this Example 5, except that B sells the land to X
in exchange for X's $90x note (rather than $110x note). B's $10x
loss is taken into account in Year 3 and is not subject to
installment reporting under section 453 (only gain may be reported
on the installment method). There is an aggregate $30x difference
between B's $10x loss taken into account and its $20x recomputed
gain. Under paragraph (c)(2)(ii) of this section, however, B's $20x
recomputed gain is treated as taken into account in Years 4 and 5
under the installment method. Thus, S takes $10x of gain into
account in Year 3 to reflect the $10x difference between B's $10x
loss taken into account and its $0 recomputed gain for Year 3. (None
of B's $20 recomputed gain is treated as taken into account in Year
3 under the installment method). S takes $10x of gain into account
in each of Years 4 and 5 to reflect the difference in those years
between B's $0 gain taken into account and B's $10x recomputed gain
under the installment method. Only the $20x of S's gain taken into
account in Years 4 and 5 is subject to the interest charge under
section 453A(c) beginning in Year 3. (If the P group elects under
section 453(d) for Year 3 to not apply section 453 with respect to
S's gain, the election will be given effect under paragraph
(c)(2)(ii) of this section.)
(e) Intercompany loss, installment gain. The facts are the same
as in paragraph (a) of this Example 5, except that S has a $130x
(rather than $70x) basis in the land. S takes $20x of its loss into
account in Year 3 to reflect the $20x difference between B's $0 loss
taken into account (under section 453) and its $20x recomputed loss.
Of the $10x remaining balance of S's loss, $5x is taken into account
in each of Years 4 and 5 to reflect the $5x difference between B's
$5x gain taken into account and its $0 recomputed gain. (The results
are the same under section 267(f).) S's $20x loss taken into account
in Year 3 is treated like the $20x recomputed loss B would have
taken into account if S and B were divisions of a single
corporation, and S's remaining $5x loss in each of Years 4 and 5
offsets B's gain taken into account. Because B's $5x of gain in each
of Years 4 and 5, and S's $5x of loss in each of Years 4 and 5, are
taken into account at the same time and offset in determining
consolidated taxable income, the gain is not subject to the interest
charge under section 453A(c) for Years 4 and 5. (If B had sold the
land to X for more than $130x, B's gain in excess of S's $30x loss
would be subject to the interest charge under section 453A(c).)
(f) Recapture income. The facts are the same as in paragraph (a)
of this Example 5, except that S bought depreciable property for
$100x and its depreciation deductions reduced the property's basis
to $70x before Year 1, S sells the depreciable property (rather than
land) to B for $100x on January 1 of Year 1, and S's $30x of gain is
recapture income on a separate entity basis under section 1245. S's
gain is treated as recapture income that is ineligible under section
453(i) for installment reporting. Thus, S takes $30x ordinary income
into account in Year 3. B takes its $10 gain into account in Years 4
and 5, and the gain is subject to the interest charge under section
453A(c). (If S has bought the depreciable property for $110x and its
recomputed basis under section 1245 had been $110x (rather than
$100x), B's $10x gain and S's $30x gain would both be recapture
income ineligible under section 453(i) for installment reporting.)
Example 6. Intercompany sale of installment obligation. (a)
Facts. S holds land for investment with a basis of $70x. On January
1 of Year 1, S sells the land to X in exchange for X's $100x note,
and S reports its gain on the installment method under section 453.
X's note bears interest at a market rate of interest in excess of
the applicable Federal rate, and provides for principal payments of
$50x in Year 5 and $50x in Year 6. Section 453A applies to X's note.
On July 1 of Year 3, S sells X's note to B for $100x, and under
section 453B(a) S is considered to recognize the $30x gain from its
prior sale of the land to X.
(b) Timing and attributes. S's sale of X's note to B is an
intercompany transaction, and S's $30x gain is intercompany gain. S
takes $15x of the gain into account in each of Years 5 and 6 to
reflect the $15x difference in each year between B's $0 gain taken
into account and its $15x recomputed gain. S's gain continues to be
treated as its gain from the sale to X, and the deferred tax
liability remains subject to the interest charge under section
453A(c).
(c) Worthlessness. The facts are the same as in paragraph (a) of
this Example 6, except that X's note becomes worthless on December 1
of Year 3 and B has a $100x short-term capital loss under section
165(g) on a separate entity basis. Under the matching rule, B's loss
is a long-term capital loss because B's holding period for X's note
is aggregated with S's holding period. In addition, S takes its $30x
gain into account in Year 3 to reflect the $30x difference between
B's $100x loss taken into account and its $70x recomputed loss. S's
gain is long-term capital gain.
(d) Pledge. The facts are the same as in paragraph (a) of this
Example 6, except that, on December 1 of Year 3, B borrows $100x
from an unrelated bank and secures the indebtedness with X's note.
X's note remains subject to section 453A(d) following the sale to B.
Under section 453A(d), B's $100x of proceeds from the secured
indebtedness is treated as an amount received on December 1 of Year
3 by B on X's note. Thus, S takes its entire $30x gain into account
in Year 3.
Example 7. Performance of services. (a) Facts. S is a driller of
water wells. B operates a ranch in a remote location, and B's
taxable income from the ranch is not subject to section 447. B's
ranch requires water to maintain its cattle. During Year 1, S drills
an artesian well on B's ranch in exchange for $100 from B, and S
incurs $80 of expenses (e.g., for employees and equipment). B
capitalizes its $100 cost for the well under section 263, and takes
into account $10 of cost recovery deductions in each of Years 2
through 11. Under its separate entity method of accounting, S would
take its income and expenses into account in Year 1.
(b) Definitions. Under paragraph (b)(1) of this section, the
service transaction is an intercompany transaction, S is the selling
member, and B is the buying member. S has $100 of income and $80 of
related expenses. Under paragraph (b)(2)(i)(B) of this section, S's
income and expense are both included in determining its intercompany
income of $20.
(c) Timing and attributes. S's $20 of income is taken into
account under the matching rule to reflect the $20 difference
between B's items to be taken into account (based on its $100 cost
basis in the well) and B's recomputed items (based on the $80 basis
B would have if S and B were divisions of a single corporation and
B's basis were determined by reference to S's $80 of expenses). In
Year 1, S takes into account $80 of its income and the $80 of
expenses. In each of Years 2 though 11, S takes $2 of its remaining
$20 of income into account to reflect the annual $2 difference
between B's $10 of cost recovery deductions taken into account and
its $8 of recomputed cost recovery deductions. S's intercompany
income and related expenses, and B's cost recovery deductions, are
ordinary items.
(d) Sale of capitalized services. The facts are the same as in
paragraph (a) of this Example 7, except that B sells the ranch
before Year 11 and recognizes gain attributable to the well. To the
extent of the offsetting $80 income and expense and S's income taken
into account as a result of B's cost recovery deductions, the timing
and attributes are determined in the manner provided in paragraph
(c) of this Example 7. The remainder of S's $20 of income is treated
like the recomputed gain B would have taken into account if S and B
were divisions of a single corporation (recapture income or section
1231 gain, even though it is from S's performance of services).
Example 8. Rental of property. B operates a ranch that requires
grazing land for its cattle. S owns undeveloped land adjoining B's
ranch. On January 1 of Year 1, S leases grazing rights to B for Year
1. B's $100 rent expense is deductible for Year 1 under its separate
entity accounting method. Under paragraph (b)(1) of this section,
the rental transaction is an intercompany transaction, S is the
selling member, and B is the buying member. S takes its $100 of
income into account in Year 1 to reflect the $100 difference between
B's rental deduction taken into account and its $0 recomputed rent
deduction. S's income and B's deduction are ordinary items.
Example 9. Back-to-back intercompany sales. (a) Facts. S holds
land for investment with a basis of $70. On January 1 of Year 1, S
sells the land to M for $90. M also holds the land for investment.
On July 1 of Year 3, M sells the land for $100 to B, and B holds the
land for sale to customers in the ordinary course of business.
During Year 5, B sells all of the land to customers for $105.
(b) Timing. Under paragraph (b)(1) of this section, S's sale of
the land to M and M's sale of the land to B are both intercompany
transactions. S is the selling member and M is the buying member in
the first intercompany transaction, and M is the selling member and
B is the buying member in the second intercompany transaction. Under
paragraph (c)(3)(ii)(B) of this section, S, M and B are treated as
divisions of a single corporation for purposes of determining the
timing of their items from the intercompany transactions. See also
paragraph (j)(1)(ii) of this section (B is treated as a successor to
M for purposes of taking S's intercompany gain into account). Thus,
S's $20 gain and M's $10 gain are both taken into account in Year 5
to reflect the difference between B's $5 gain taken into account
with respect to the land and its $35 recomputed gain (i.e., the gain
that B would have taken into account if the intercompany sales had
been transfers between divisions of a single corporation, and B
succeeded to S's $70 basis).
(c) Attributes. Under paragraphs (c)(3)(ii)(B) of this section,
the attributes of the intercompany items and corresponding items of
S, M, and B are also determined by treating S, M, and B as divisions
of a single corporation. For example, S and M must take B's
activities into account in determining the character of their gains.
Example 10. Intercompany sale of a partnership interest. (a)
Facts. S owns a 20% interest in the capital and profits of a general
partnership. The partnership holds land for investment with an equal
basis and value, and operates depreciable assets which have value in
excess of basis. S's basis in its partnership interest equals its
share of the adjusted basis of the partnership's land and
depreciable assets. The partnership has an election under section
754 in effect. On January 1 of Year 1, S sells its partnership
interest to B at a gain. During Years 1 through 10, the partnership
depreciates the operating assets, and B's depreciation deductions
from the partnership reflect the increase in the basis of the
depreciable assets under section 743(b).
(b) Timing and attributes. S's gain is taken into account during
Years 1 though 10 to reflect the difference in each year between B's
depreciation deductions from the partnership taken into account and
B's recomputed depreciation deductions from the partnership. S's
gain taken into account is ordinary income. (The acceleration rule
of paragraph (d) of this section does not apply to S's gain as a
result of the section 743(b) adjustment, because the adjustment is
solely with respect to B and therefore no nonmember reflects any
part of the intercompany transaction.)
(c) Partnership sale of assets. The facts are the same as in
paragraph (a) of this Example 10, and the partnership sells some of
its depreciable assets to X at a gain on December 31 of Year 4. In
addition to the intercompany gain taken into account as a result of
the partnership's depreciation, S takes intercompany gain into
account in Year 4 to reflect the difference between B's partnership
items taken into account from the sale (which reflect the basis
increase under section 743(b)) and B's recomputed partnership items.
S's additional gain is treated like the recomputed gain B would have
taken into account if S and B were divisions of a single corporation
(recapture income or section 1231 gain).
(d) B's sale of partnership interest. The facts are the same as
in paragraph (a) of this Example 10, and on December 31 of Year 4, B
sells its partnership interest to X at no gain or loss. In addition
to the intercompany gain taken into account as a result of the
partnership's depreciation, the remaining balance of S's
intercompany gain is taken into account in Year 4 to reflect the
difference between B's $0 gain taken into account from the sale of
the partnership interest and its recomputed gain. Whether any of S's
remaining balance is treated as ordinary income depends on the
application of section 751 at the time of B's sale.
(e) No section 754 election. The facts are the same as in
paragraph (a) of this Example 10, except that the partnership does
not have a section 754 election in effect, and B recognizes a
capital loss from its sale of the partnership interest to X on
December 31 of Year 4 (B initially had a cost basis in the
partnership interest equal to its value, but the partnership's
built-in income and gain increased B's basis in excess of the
value). Because there is no difference between B's depreciation
deductions from the partnership taken into account and its
recomputed depreciation deductions, S does not take any of its gain
into account during Years 1 through 4 as a result of B's
partnership's items. Instead, S's entire intercompany gain is taken
into account in Year 4 to reflect the difference between B's loss
taken into account from the sale to X and its recomputed gain or
loss.
Example 11. Net operating losses subject to section 382 or the
SRLY rules. (a) Facts. On January 1 of Year 1, P buys all of S's
stock. S has net operating loss carryovers from prior years. P's
acquisition results in an ownership change under section 382 with
respect to S's loss carryovers, and S has a net unrealized built-in
gain (within the meaning of section 382(h)(3)). S owns
nondepreciable property with a $70 basis and $100 value. On July 1
of Year 3, S sells the property to B for $100, and its $30 gain is
recognized built-in gain (within the meaning of section 382(h)(2))
on a separate entity basis. On December 1 of Year 5, B sells the
property to X for $90.
(b) Timing and attributes. S's $30 gain is taken into account in
Year 5 to reflect the $30 difference between B's $10 loss taken into
account and its recomputed $20 gain. Treating S and B as divisions
of a single corporation for purposes of determining the attributes
of B's loss and S's gain, the single corporation has losses subject
to limitation under section 382, and this limitation may be
increased under section 382(h) if the single corporation has
recognized built-in gain with respect to those losses from either of
its divisions. Of S's $30 of gain, $20 is treated as recognized
built-in gain, and the remaining $10 that is offset by B's loss is
treated as not being recognized built-in gain. Thus, $10 of S's gain
does not increase the section 382 limitation applicable to S's
losses.
(c) B's recognized built-in gain. The facts are the same as in
paragraph (a) of this Example 11, except that the property declines
in value after S becomes a member of the P group, S sells the
property to B for its $70 basis, and B sells the property to X for
$90 during Year 5. Treating S and B as divisions of a single
corporation, S's sale to B does not cause the property to cease to
be built-in gain property. Thus, B's $20 gain from its sale to X is
recognized built-in gain that increases the section 382 limitation
applicable to S's losses.
(d) Depreciable property. The facts are the same as in paragraph
(a) of this Example 11, except that S's property is depreciable
property, and S's $30 gain is taken into account as a result of B's
depreciation of the property. Treating S and B as divisions of a
single corporation, both B's depreciation and S's gain taken into
account as a result of B's depreciation are treated as not being
recognized built-in amounts. Thus, S's gain taken into account as a
result of the depreciation does not increase the section 382
limitation applicable to S's losses.
(e) SRLY limitation. The facts are the same as in paragraph (a)
of this Example 11, except that S's net operating loss carryovers
are subject to the separate return limitation year (SRLY) rules. See
Sec. 1.1502-21(c). Although the matching rule redetermines the
timing and attributes of items, the amount and location of items are
not redetermined. Because S's SRLY limitation is determined solely
by its contribution to consolidated taxable income (as determined
under Sec. 1.1502-21(c)), S's SRLY limitation in Year 5 includes its
entire $30 gain taken into account.
Example 12. Special inventory accounting election. (a) Facts. S
operates a farming business (within the meaning of section
263A(e)(4)) of growing and selling grapes to customers, including B.
S is not required to use an inventory method, and uses the cash
method of accounting. See sections 446 to 448 and 471, and
Sec. 1.1502-17. On a separate entity basis, S does not capitalize
its employee costs for the production of grapes pursuant to an
election under section 263A(d)(3). B uses grapes purchased from S to
produce wine for sale to customers. B uses the accrual method of
accounting, and includes the cost of S's grapes in inventory under
its inventory method. During Year 1, S sells grapes to B, incurring
employee production costs. During Year 2, B converts the grapes into
wine. In December of Year 3, based on its inventory method, B sells
the wine produced with S's grapes and recognizes ordinary income.
(b) Related costs and expenses. Under paragraph (b)(2)(i)(B) of
this section, S costs related to its sale of grapes to B are
included in the determination of its intercompany items. Because the
timing of S's costs may differ from the timing of S's income, it is
necessary to determine whether S's costs are to be accounted for
separate from, rather than combined with, S's income from B in
determining its intercompany income or loss deferred until Year 3.
The determination depends on whether S's election under section
263A(d)(3) would continue to permit deduction of the costs if S were
engaged in a separate farming business as part of a single
corporation that includes B. See, e.g., sections 447 and 448. If the
costs are separately accounted for, they are taken into account in
Year 1 rather than deferred until Year 3.
Example 13. Section 475. (a) Facts. S, a dealer in securities
within the meaning of section 475(c), purchases a security for $100.
The security is held for sale to customers and is not identified
under section 475(b) as within an exception to marking to market,
and S recognizes $30 of net mark-to-market decreases before Year 1.
On July 1 of Year 1, S sells the security to B for $100. B is not a
dealer and holds the security for investment. On December 31 of Year
1, the fair market value of the security is $100. On July 1 of Year
2, B sells the security to X for $110.
(b) Treatment as a single corporation. Under section 475, a
dealer in securities can treat a security as within an exception to
marking to market under section 475(b) only if it identifies the
security on the day of its acquisition. S's intercompany gain is
taken into account by treating section 475 as applying to S and B as
a single corporation that is a dealer with respect to securities as
a result of S's activities. Thus, B's recomputed items are
determined by B's continuing to treat the security as not within an
exception to marking to market. However, under section 475(d)(3), it
is possible for the character of S's intercompany items to differ
from the character of B's corresponding items.
(c) Timing and attributes. S has a $30 gain when it disposes of
the security by selling it to B. This gain is intercompany gain that
is taken into account in Year 1 to reflect the $30 difference
between B's $0 gain taken into account and its recomputed $30 gain
that would be taken into account as a result of marking to market
under section 475. Under section 475(d)(3), S's gain is ordinary
income. B has a $10 gain as a result of its sale to X, and this gain
is taken into account in Year 2. Under section 475(d)(3), B's gain
is capital gain.
(d) Nondealer to dealer. The facts are the same as in paragraph
(a) of this Example 13, except that S is not a dealer and holds the
security for investment with a $70 basis, B is a dealer to which
section 475 applies and, immediately after acquiring the security
from S for $100, B holds the security for sale to customers in the
ordinary course of its trade or business. Treating S and B as
divisions of a single corporation, the security is treated as
properly identified as held for investment under section 475(b)(1)
until it is sold to B. Under section 475(b)(3), the security
thereafter ceases to be described in section 475(b)(1) because B
holds the security for sale to customers, and the mark-to-market
requirement applies only to changes in the value of the security
after B's acquisition. None of S's gain is taken into account in
Year 1 as a result of B's marking the security to market in Year 1.
B's mark-to-market gain taken into account and its recomputed mark-
to-market gain are both determined based on changes from the $100
value of the security at the time of B's acquisition. There is no
difference between B's $0 mark-to-market gain taken into account in
Year 1 and its $0 recomputed mark-to-market gain. In Year 2, B has a
$10 gain when it disposes of the security by selling it to X, but
would have had a $40 gain if S and B were divisions of a single
corporation. Thus, S takes its $30 gain into account in Year 2 under
the matching rule. Under section 475(d)(3), S's gain is capital gain
even though B's subsequent gain or loss from marking to market or
disposing of the security is ordinary gain or loss. (If B had held
the security for investment, and had so identified the security
under section 475(b)(1), the security would continue to be excepted
from marking to market.)
Example 14. Section 1092. (a) Facts. On July 1 of Year 1, S
enters into offsetting long and short positions with respect to
actively traded personal property. The positions are not section
1256 contracts, and they are the only positions taken into account
for purposes of applying section 1092. On August 1 of Year 1, S
sells the long position to B at an $11 loss, and there is $11 of
unrealized gain in the offsetting short position. On December 1 of
Year 1, B sells the long position to X at no gain or loss. On
December 31 of Year 1, there is still $11 of unrealized gain in the
short position. On February 1 of Year 2, S closes the short position
at an $11 gain.
(b) Timing and attributes. S's $11 loss is taken into account in
Year 1 under the matching rule to reflect the difference between B's
corresponding items taken into account and B's recomputed items.
Under paragraph (a)(3) of this section, however, an item taken into
account under this section can be deferred, disallowed, or
eliminated under other applicable law. Under section 1092, S's loss
continues to be deferred until Year 2 notwithstanding this section.
(The results are the same under section 267(f).)
Example 15. Manufacturer rebates. (a) Facts. B is a manufacturer
that sells its products to independent dealers for resale. S is a
credit company that offers financing, including financing to
customers of the dealers. S also purchases the product from dealers
for lease to customers of the dealers. During Year 1, B initiates a
program of rebates to the dealers' customers. Under B's program, S
buys a $100 product from a dealer and leases it to another. S pays
$90 to the dealer for the product, and assigns to the dealer its $10
rebate from B. Under their separate entity accounting methods, B
deducts the $10 rebate in Year 1 and S takes a $90 basis in the
product.
(b) Timing and attributes. Under paragraph (b)(1) of this
section, the rebate transaction is an intercompany transaction. S's
$90 basis in the product reflects a $10 adjustment for the rebate
from B. Under paragraph (b)(2)(iii)(A) of this section, S is treated
as having $10 of intercompany income that is to be taken into
account under this section. S's income is taken into account in Year
1 to reflect the $10 difference between B's $10 deduction taken into
account and its $0 recomputed deduction. S's $10 of income and B's
$10 deduction are ordinary items. Because the rebate is treated as
income to S, S's basis in the product is $100 rather than $90. S's
additional $10 of basis in the product is recovered based on
subsequent events (e.g., S's cost recovery deductions or its sale of
the product).
Example 16. Cancellation of debt and attribute reduction under
section 108(b). (a) Facts. S holds land for investment with a basis
of $0. On January 1 of Year 1, S sells the land to B for $100. B
also holds the land for investment. During Year 3, due to the
declining value of B's assets, B's nonmember creditors discharge $60
of B's indebtedness. Because of insolvency, B's $60 discharge is
excluded from B's gross income under section 108(a). B's elimination
of $60 of basis in the land under sections 108(b) and 1017 preserves
$60 of other attributes.
(b) Matching rule. Under paragraph (b)(2)(iii)(B) of this
section, B's $60 basis reduction under section 108(b) is an
adjustment that is a substitute for a corresponding item and is
therefore treated as a corresponding item for purposes of taking S's
intercompany gain into account. Although the basis reduction in
effect preserves $60 of B's discharge of indebtedness income, the
reduction also preserves other attributes that subsequently may be
taken into account and therefore affects the overall amount of items
to be taken into account. Thus, S takes $60 of its gain into account
as a result of the basis reduction. The $60 gain is treated as
ordinary income because the basis reduction has the effect of
offsetting ordinary income from the discharge of indebtedness.
(c) Purchase price adjustment. Assume instead that S sells the
land to B in exchange for B's $100 purchase money note, B remains
solvent, and S subsequently agrees to discharge $60 of the note as a
purchase price adjustment to which section 108(e)(5) applies. A
purchase price adjustment is not equivalent to a deduction or loss
that offsets discharge of indebtedness income. Instead, under
applicable principles of tax law, $60 of S's gain and $60 of B's
basis in the land are eliminated and never taken into account.
Example 17. Source of items from a section 863 sale. (a) Facts.
S manufactures inventory in the United States that it sells to
distributors for resale to customers. B is a distributor with a
foreign branch in country Y that purchases and resells the inventory
outside the United States. During Year 1, S manufactures inventory,
sells it to B's country Y branch at an arm's length price, and has
$75 of income. There is no independent factory or production price
for the sale. Also during Year 1, B's country Y branch resells the
inventory to X, an unrelated foreign person, with title passing
abroad. B recognizes $25 of income. S's United States manufacturing
assets have a value of $900, and B's country Y branch assets have a
value of $100.
(b) Timing. S's $75 of intercompany income is taken into account
in Year 1 to reflect the difference between B's $25 of corresponding
income taken into account and its $100 of recomputed income.
(c) Attributes. The attributes of S's intercompany income and
B's corresponding income are determined as if S and B were divisions
of a single corporation. Thus, section 863 applies to S's
intercompany sale as if S and B were divisions of a corporation
manufacturing in the United States and selling in country Y. Two
steps are required to source S's $75 of income and B's $25 of
income. First, the $100 of combined income must be divided into
foreign and U.S. source income portions. Of the combined income, $50
is sourced based on the aggregate asset values of S and B, with $45
of the $50 treated as United States source income ($50 multiplied by
$900/$1,000) and $5 treated as foreign source income ($50 multiplied
by $100/$1,000). The remaining $50 of combined income is treated as
foreign source income, based on the passage of title to X outside
the United States. See Sec. 1.863-3T(b), Example 2. Thus, $55 of the
$100 of combined income is treated as foreign source income and $45
is treated as United States source income. Second, consistent with
the treatment of S and B as divisions of a single corporation, the
foreign and United States source income is allocated between S and B
based on their intercompany income and corresponding income. Because
S earned $75 and B earned $25, $41.25 of the $55 of foreign source
income is allocated to S ($55 multiplied by 75/100), and $13.75 is
allocated to B ($55 multiplied by 25/100). Similarly, $33.75 of the
$45 of United States source income is allocated to S ($45 multiplied
by 75/100), and $11.25 is allocated to B ($45 multiplied by 25/100).
Example 18. Section 1248. (a) Facts. On January 1 of Year 1, S
forms FT, a wholly owned foreign subsidiary, with a $10
contribution. During Years 1 through 3, FT has earnings and profits
of $40. None of the earnings and profits is taxed as subpart F
income under section 951, and FT distributes no dividends to S
during this period. On January 1 of Year 4, S sells its FT stock to
B for $50. While B owns FT, FT has a deficit in earnings and profits
of $10. On July 1 of Year 6, B sells its FT stock for $70 to X, an
unrelated foreign corporation.
(b) Timing. S's $40 of intercompany gain is taken into account
in Year 6 to reflect the difference between B's $20 of gain taken
into account and its $60 recomputed gain.
(c) Attributes. Section 1248 applies to determine the attributes
of S's intercompany gain and B's corresponding gain as if S and B
were divisions of a single corporation. The portions of S's gain and
B's gain characterized as dividends under section 1248 is determined
on the basis of FT's $30 of earnings and profits at the time of B's
sale to X. Treating S and B as divisions of a single corporation,
this $30 amount is allocated between S and B based on their
respective gains. Because S has a $40 gain and B has a $20 gain, S
is allocated $20 of the $30 section 1248 amount ($30 multiplied by
$40/$60), and B is allocated the remaining $10 of the section 1248
amount ($30 multiplied by $20/$60). S's $20 of gain in excess of its
$20 section 1248 amount, and B's $10 of gain in excess of its $10
section 1248 amount, are each treated as gain from the sale or
exchange of a capital asset. Thus, $20 of S's intercompany gain is
treated as a dividend and the remaining $20 is treated as capital
gain, and $10 of B's corresponding gain is treated as a dividend and
the remaining $10 is treated as capital gain.
(d) No deficit in earnings and profits. The facts are the same
as in paragraph (a) of this Example 18, except that FT has no
earnings and profits or deficit in earnings and profits while B owns
FT, and B sells the FT stock to X for $40. Because S has gain from
its sale of the FT stock to B, and B has loss from its sale of the
FT stock to X, none of FT's $40 section 1248 amount is allocated to
B. Moreover, because FT's $40 section 1248 amount exceeds the $30
net gain of S and B (the sum of S's $40 gain and B's $10 loss), the
section 1248 amount allocated to S is limited to $30. See section
1248(a). Thus, $30 of S's intercompany gain is treated as a
dividend. The remaining $10 of S's gain and all of B's $10 loss are
treated as a capital gain and loss.
(d) Acceleration rule. S's intercompany items and B's
corresponding items are taken into account under this paragraph (d)
to the extent they cannot be taken into account to produce the
effect of treating S and B as divisions of a single corporation. For
this purpose, the following rules apply:
(1) S's items--(i) Timing. S takes its intercompany items into
account to the extent they cannot be taken into account to produce the
effect of treating S and B as divisions of a single corporation. The
items are taken into account immediately before it first becomes
impossible to achieve this effect. For this purpose, the effect cannot
be achieved--
(A) To the extent an intercompany item or corresponding item will
not be taken into account in determining the group's consolidated
taxable income (or consolidated tax liability) under the matching rule
of paragraph (c) of this section (e.g., if S or B becomes a nonmember);
or
(B) To the extent a nonmember reflects, directly or indirectly, any
aspect of the intercompany transaction (e.g., if B's cost basis in
property purchased from S is reflected by a nonmember under section 362
following a section 351 transaction).
(ii) Attributes. The attributes of S's intercompany items taken
into account under this paragraph (d)(1) are determined as follows:
(A) If the item is from a sale, exchange, or distribution of
property, its attributes are determined under the principles of the
matching rule of paragraph (c) of this section as if B resold the
property to a nonmember affiliate at the time the item is taken into
account, for a cash payment equal to B's adjusted basis in the
property.
(B) If the item is from an intercompany transaction other than a
sale, exchange, or distribution of property (e.g., income from S's
services capitalized by B), its attributes are determined on a separate
entity basis.
(2) B's items--(i) Timing. If paragraph (d)(1) of this section
applies to S, B nevertheless continues to take its corresponding items
into account under its accounting method. However, the redetermination
of the attributes of a corresponding item under this paragraph (d)(2)
may affect its timing.
(ii) Attributes. The attributes of B's corresponding items continue
to be redetermined under the principles of the matching rule of
paragraph (c) of this section, with the following adjustments:
(A) If S and B continue to join with each other in the filing of
consolidated returns, the attributes of B's corresponding items (and
any applicable holding periods) are determined by continuing to treat S
and B as divisions of a single corporation.
(B) Once S and B no longer join with each other in the filing of
consolidated returns, the attributes of B's corresponding items are
determined as if the S division (but not the B division) were
transferred by the single corporation to an unrelated person. Thus, S's
activities (and any applicable holding period) before the intercompany
transaction continue to affect the attributes of the corresponding
items (and any applicable holding period).
(3) Examples. The acceleration rule of this paragraph (d) is
illustrated by the following examples.
Example 1. Becoming a nonmember--timing. (a) Facts. S owns land
with a basis of $70. On January 1 of Year 1, S sells the land to B
for $100. On July 1 of Year 3, P sells 60% of S's stock to X for $60
and, as a result, S becomes a nonmember.
(b) Matching rule. Under the matching rule of paragraph (c) of
this section, none of S's $30 gain is taken into account in Years 1
through 3 because there is no difference between B's $0 gain or loss
taken into account and its recomputed gain or loss.
(c) Acceleration of S's intercompany items. Under the
acceleration rule of paragraph (d) of this section, S's $30 gain is
taken into account in computing consolidated taxable income (and
consolidated tax liability) immediately before the effect of
treating S and B as divisions of a single corporation cannot be
produced. Because the effect cannot be produced once S becomes a
nonmember, S takes its $30 gain into account in Year 3 immediately
before becoming a nonmember. S's gain is reflected under
Sec. 1.1502-32 in P's basis in the S stock immediately before P's
sale of the stock. Under Sec. 1.1502-32, P's gain is reduced (or
loss is increased) by $18 (60% of $30). See also Secs. 1.1502-33 and
1.1502-76(b). (The results would be the same if S sold the land to B
in an installment sale to which section 453 would otherwise apply,
because S must take its intercompany gain into account under this
section.)
(d) B's corresponding items. Notwithstanding the acceleration of
S's gain, B continues to take its corresponding items into account
under its accounting method. Thus, B's items from the land are taken
into account based on subsequent events (e.g., its sale of the
land).
(e) Sale of B's stock. The facts are the same as in paragraph
(a) of this Example 1, except that P sells 60% of B's stock (rather
than S stock) to X for $60 and, as a result, B becomes a nonmember.
Because the effect of treating S and B as divisions of a single
corporation cannot be produced once B becomes a nonmember, S takes
its $30 gain into account under the acceleration rule immediately
before B becomes a nonmember. (The results would be the same if S
sold the land to B in an installment sale to which section 453 would
otherwise apply, because S must take its intercompany gain into
account under this section.)
(f) Discontinue filing consolidated returns. The facts are the
same as in paragraph (a) of this Example 1, except that the P group
receives permission under Sec. 1.1502-75(c) to discontinue filing
consolidated returns beginning in Year 3. Under the acceleration
rule, S takes its $30 gain into account on December 31 of Year 2.
(g) No subgroups. The facts are the same as in paragraph (a) of
this Example 1, except that P simultaneously sells all of the stock
of both S and B to X (rather than 60% of S's stock), and S and B
become members of the X consolidated group. Because the effect of
treating S and B as divisions of a single corporation in the P group
cannot be produced once S and B become nonmembers, S takes its $30
gain into account under the acceleration rule immediately before S
and B become nonmembers. (Paragraph (j)(2) of this section does not
apply to treat the X consolidated group as succeeding to the P group
because the X group acquired only the stock of S and B.) However, so
long as S and B continue to join with each other in the filing of
consolidated returns, B continues to treat S and B as divisions of a
single corporation for purposes of taking its corresponding items
from the land into account.
Example 2. Becoming a nonmember--attributes. (a) Facts. S holds
land for investment with a basis of $70. On January 1 of Year 1, S
sells the land to B for $100. B holds the land for sale to customers
in the ordinary course of business, and expends substantial
resources over a two-year period subdividing, developing, and
marketing the land. On July 1 of Year 3, before B has sold any of
the land, P sells 60% of S's stock to X for $60 and, as a result, S
becomes a nonmember.
(b) Attributes. Under the acceleration rule, the attributes of
S's gain are redetermined under the principles of the matching rule
as if B resold the land to a nonmember affiliate for a cash payment
equal to B's adjusted basis in the land. (The deemed resale is
solely for purposes of determining attributes, and therefore does
not apply for purposes of determining timing.) Thus, whether S's
gain is capital gain or ordinary income depends on the activities of
both S and B. Because S and B no longer join with each other in the
filing of consolidated returns, the attributes of B's corresponding
items (e.g., from its subsequent sale of the land) are redetermined
under the principles of the matching rule of paragraph (c) of this
section as if the S division (but not the B division) were
transferred by the single corporation to an unrelated person at the
time of P's sale of the S stock. Thus, B continues to take into
account the activities of S with respect to the land before the
intercompany transaction.
(c) Depreciable property. The facts are the same as in paragraph
(a) of this Example 2, except that the property sold by S to B is
depreciable property. Section 1239 applies to treat all of S's gain
as ordinary income because it is taken into account as a result of
B's deemed resale of the property to a nonmember affiliate (a
related person within the meaning of section 1239(b)). (The results
would be the same if P sells 60% of B's stock (rather than S's
stock) to X.)
Example 3. Back-to-back intercompany transactions. (a) Facts.
During Year 1, S performs services for M in exchange for $10 from M.
M capitalizes the $10 cost of S's services under section 263 as part
of M's cost to acquire real property from X. S incurs $8 of employee
expenses that would be taken into account in Year 1 under its
separate entity method of accounting. M holds the real property for
investment and, on July 1 of Year 5, M sells it to B at a gain. B
also holds the real property for investment. On December 1 of Year
8, while B still owns the real property, P sells all of M's stock to
X and M becomes a nonmember.
(b) M's items. M takes its gain into account immediately before
it becomes a nonmember. The acceleration rule redetermines the
attributes of M's gain under the principles of the matching rule as
if B resold the real property to a nonmember affiliate for a cash
payment equal to B's adjusted basis in real property, and S, M, and
B were divisions of a single corporation. Thus, M's gain is capital
gain.
(c) S's items. Under paragraph (b)(2) of this section, S
includes the $8 of expenses in determining its intercompany income.
In Year 1, S takes into account $8 of its income and the $8 of
expenses. Under paragraph (c)(3)(ii)(B) of this section, appropriate
adjustments must be made to treat both S's performance of services
for M and M's sale to B as occurring between divisions of a single
corporation. Thus, S's remaining $2 of intercompany income is not
taken into account as a result of M becoming a nonmember, but
instead will be taken into account based on subsequent events (e.g.,
under the matching rule based on B's sale of the real property to a
nonmember, or under the acceleration rule based on P's sale of the
stock of S or B to a nonmember). See the successor person rules of
paragraph (j)(1)(ii) of this section (B is treated as a successor to
M for purposes of taking S's intercompany income into account).
(d) Sale of S's stock. The facts are the same as in paragraph
(a) of this Example 3, except that P sells all of S's stock (rather
than M's stock) and S becomes a nonmember on July 1 of Year 5. S's
remaining $2 of intercompany income is taken into account
immediately before S becomes a nonmember. Because S's intercompany
income is not from an intercompany sale, exchange, or distribution
of property, the attributes of the intercompany income are
determined on a separate entity basis. Thus, S's $2 of intercompany
income is ordinary income. M does not take any of its intercompany
gain into account as a result of S becoming a nonmember.
(e) Intercompany income followed by intercompany loss. The facts
are the same as in paragraph (a) of this Example 3, except that M
sells the real property to B at a $1 loss (rather than a gain). M
takes its $1 loss into account under the acceleration rule
immediately before M becomes a nonmember. But see Sec. 1.267(f)-1.
Under paragraph (c)(3)(ii)(B) of this section, P's sale of M stock
also results in S taking into account $1 of intercompany income as
capital gain to offset M's $1 of corresponding capital loss. The
remaining $1 of S's intercompany income is taken into account based
on subsequent events.
Example 4. Selling member's disposition of proceeds. (a) Facts.
S owns land with a basis of $70. On January 1 of Year 1, S sells the
land to B in exchange for B's $110 note. The note bears a market
rate of interest in excess of the applicable Federal rate, and
provides for principal payments of $55 in Year 4 and $55 in Year 5.
On July 1 of Year 3, S sells B's note to X for $110.
(b) Timing. S's intercompany gain is taken into account under
this section, and not under the rules of section 453. Consequently,
S's sale of B's note does not result in its intercompany gain being
taken into account (e.g., under section 453B). The sale does not
prevent S's intercompany items and B's corresponding items from
being taken into account in determining the group's consolidated
taxable income under the matching rule, and X does not reflect any
aspect of the intercompany transaction (X has its own cost basis in
the note). S will take the intercompany gain into account under the
matching rule or acceleration rule based on subsequent events (e.g.,
B's sale of the land). See also paragraph (g) of this section for
additional rules applicable to B's note as an intercompany
obligation.
Example 5. Section 481. (a) Facts. S operates several trades or
businesses, including a manufacturing business. S receives
permission to change its method of accounting for valuing inventory
for its manufacturing business. S increases the basis of its ending
inventory by $100, and the related $100 positive section 481(a)
adjustment is to be taken into account ratably over six taxable
years, beginning in Year 1. During Year 3, S sells all of the assets
used in its manufacturing business to B at a gain. Immediately after
the transfer, B adopts and uses the same inventory valuation method
as S. On a separate entity basis, S's sale results in an
acceleration of the balance of the section 481(a) adjustment to Year
3.
(b) Timing and attributes. Under paragraph (b)(2)(i) of this
section, the balance of S's section 481(a) adjustment accelerated to
Year 3 is intercompany income. However, S's $100 basis increase
before the intercompany transaction eliminates the related
difference between B's corresponding items taken into account and
its recomputed items in subsequent periods. Because the accelerated
section 481(a) adjustment will not be taken into account in
determining the group's consolidated taxable income (and
consolidated tax liability) under the matching rule, the balance of
S's section 481 adjustment is taken into account under the
acceleration rule as ordinary income at the time of the intercompany
transaction. (If S's sale had not resulted in accelerating S's
section 481(a) adjustment on a separate entity basis, S would have
no intercompany income to be taken into account under this section.)
(e) Simplifying rules--(1) Dollar-value LIFO inventory methods--(i)
In general. This paragraph (e)(1) applies if either S or B uses a
dollar-value LIFO inventory method to account for intercompany
transactions. Rather than applying the matching rule of paragraph (c)
of this section separately to each intercompany inventory transaction,
this paragraph (e)(1) provides methods to apply an aggregate approach
that is based on dollar-value LIFO inventory accounting. Any method
selected under this paragraph (e)(1) must be applied consistently.
(ii) B uses dollar-value LIFO--(A) In general. If B uses a dollar-
value LIFO inventory method to account for its intercompany inventory
purchases, and includes all of its inventory costs incurred for a year
in its cost of goods sold for the year, S takes into account all of its
intercompany inventory items for the year. If B does not include all of
its inventory costs incurred for the year in its cost of goods sold for
the year, S does not take into account a percentage of its net
intercompany inventory income or loss. The percentage not taken into
account is determined under either the increment averaging method or
the increment valuation method. Separate computations are made for each
pool of B that receives intercompany purchases from S.
(B) Increment averaging method. The percentage not taken into
account equals B's current-year costs of its layer of increment,
divided by B's total inventory costs incurred for the year under its
LIFO inventory method. S's amount not taken into account is layered
based on B's LIFO inventory layers. If B includes more than its
inventory costs incurred during any subsequent year in its cost of
goods sold (a decrement), S takes into account the intercompany
inventory income or loss layers in the same manner and proportion as B
takes into account its inventory decrements.
(C) Increment valuation method. The percentage not taken into
account equals B's current-year costs of its layer of increment,
divided by B's total inventory costs incurred in the appropriate period
under its LIFO inventory method. The principles of paragraph
(e)(1)(ii)(B) of this section otherwise apply. The appropriate period
is the period of B's year used to determine its current-year costs.
(iii) S uses dollar-value LIFO. If S uses a dollar-value LIFO
inventory method to account for its intercompany inventory sales, S can
use any reasonable method of allocating its LIFO inventory costs to
intercompany transactions. LIFO inventory costs include costs of prior
layers if a decrement occurs. For example, a reasonable allocation of
most recent costs incurred during the consolidated return year can be
used to compute S's net intercompany inventory income or loss for the
year if S has an inventory increment and uses the earliest acquisitions
costs method, but S must apportion costs from the most recent
appropriate layers of increment if an inventory decrement occurs for
the year.
(iv) Other reasonable methods. S or B can use a method not
specifically provided in this paragraph (e)(1) that is expected to
reasonably take into account intercompany items and corresponding items
from intercompany inventory transactions. However, if the method used
results, for any year, in a cumulative amount of intercompany inventory
items not taken into account by S that significantly exceeds the
cumulative amount that would not be taken into account under paragraph
(e)(1) (ii) or (iii) of this section, S must take into account for that
year the amount necessary to eliminate the excess. The method is
thereafter applied with appropriate adjustments to reflect the amount
taken into account.
(v) Examples. The inventory rules of this paragraph (e)(1) are
illustrated by the following examples.
Example 1. Increment averaging method. (a) Facts. Both S and B
use a double-extension, dollar-value LIFO inventory method, and both
value inventory increments using the earliest acquisitions cost
valuation method. During Year 2, S sells 25 units of product Q to B
on January 15 at $10/unit, and another 25 units on September 15 at
$12/unit. S's earliest cost of product Q is $7.50/unit and S's most
recent cost of product Q is $8.00/unit. B's total inventory costs
incurred during Year 2 are $3,333. The S and B inventory
computations for Year 2 and prior years are as follows:
(i)(A) S's Year 2 computations:
----------------------------------------------------------------------------------------------------------------
(2) base- (3) current-
Item (1) ending year cost/ (1)x(2) year cost/ (1)x(3)
quantity unit total unit total
----------------------------------------------------------------------------------------------------------------
Q.............................................. 50 $5 $250 $7.50 $375
Y.............................................. 150 2 300 3.00 450
----------------------------------------------------------------
xl............................................. xl xl $550 xl $825
----------------------------------------------------------------------------------------------------------------
Year 1--Ending inventory at base-year cost=$500.
Year 2--Price index = $825/$550=1.5.
(B) S's $7.50 current-year cost/unit of product Q is based on
its earliest acquisitions cost of 50 units.
------------------------------------------------------------------------
Base-
year Price LIFO
cost index cost
------------------------------------------------------------------------
Base layer................................ $450 1.000 $450
Year 1 layer.............................. 50 1.200 60
Year 2 layer.............................. 50 1.500 75
-----------------------------
585
------------------------------------------------------------------------
(ii)(A) B's Year 2 computations:
----------------------------------------------------------------------------------------------------------------
(2) Base- (3) Current-
Item (1) Ending year cost/ (1)x(2) year cost/ (1)x(3)
quantity unit total unit total
----------------------------------------------------------------------------------------------------------------
Q.............................................. 50 $8 $400 $11 $550
Z.............................................. 50 10 500 13 650
----------------------------------------------------------------
$900 $1,200
----------------------------------------------------------------------------------------------------------------
Year 1--Ending inventory at base-year cost=$650
Year 2--Price index=$1,200/$900=1.333.
(B) B's $11 current-year cost/unit of product Q is based on its
earliest acquisitions cost (25 units purchased from S at $10/unit,
and 25 units from X at $12/unit).
------------------------------------------------------------------------
Base-
year Price LIFO
cost index cost
------------------------------------------------------------------------
Base layer................................ $400 1.000 $400
Year 1 layer.............................. 250 1.100 275
Year 2 layer.............................. 250 1.333 333
---------
1,008
------------------------------------------------------------------------
(b) Intercompany inventory income. Under paragraph (e)(1)(iii)
of this section, S must use a reasonable method of allocating its
LIFO inventory costs to intercompany transactions. Because S has an
inventory increment for Year 2 and uses the earliest acquisitions
cost method, a reasonable method of determining its intercompany
cost of goods sold for product Q is to use its most recent costs.
Thus, its intercompany cost of goods sold is $400 ($8.00 most recent
cost, multiplied by 50 units sold to B), and its intercompany income
is $150 ($550 sale proceeds from B minus $400 cost).
(c) Timing. (i) Under the increment averaging method of
paragraph (e)(1)(ii)(B) of this section, $15 of S's $150 of
intercompany inventory income is not taken into account in Year 2,
computed as follows:
TP15AP94.001
(ii) Thus, $135 of S's intercompany inventory income is taken
into account in Year 2 ($150 of total intercompany inventory income
minus $15 not taken into account).
(d) S incurs a decrement. The facts are the same as in paragraph
(a) of this Example 1, except that S's Year 2 ending inventory at
base-year cost is $475, and therefore S incurs a $25 decrement (50%
of the Year 1 layer in terms of base-year cost) in its inventory for
Year 2. Under paragraph (e)(1)(iii) of this section, S must
reasonably allocate the LIFO cost of the decrement (50% of $60, or
$30) to the cost of goods sold to B to determine S's intercompany
income.
(e) B incurs a decrement. The facts are the same as in paragraph
(a) of this Example 1, except that B incurs a decrement in Year 2 of
$50 in base-year costs. S must take into account the entire $150 of
Year 2 intercompany inventory income because all 50 units of product
Q are deemed sold by B in Year 2.
Example 2. Increment valuation method. (a) Facts. Both S and B
use a dollar-value LIFO inventory method. Under B's LIFO method,
layers of increment are valued with respect to earliest costs. For
Year 2, B has a layer of increment in its pool that receives
intercompany purchases from S. To compute its increment valuation
index, B values its year-end inventory mix using costs incurred from
January through March. B values its increment at $250. B's costs
incurred from January through March and from April through December
are $750 and $3,300, respectively. For the period from January
through March and from April through December, S's intercompany
inventory income is $100 and $500, respectively.
(b) Timing. (i) Under the increment valuation method of
paragraph (e)(1)(ii)(C) of this section, $33 of S's $600 of
intercompany inventory income is not taken into account in Year 2,
computed as follows:
TP15AP94.002
(ii) Thus, $567 of S's intercompany inventory income is taken
into account in Year 2 ($600 of total intercompany inventory income
minus $33 not taken into account).
(c) B incurs a subsequent decrement. Assume that, in Year 3, B
experiences a decrement in its pool that receives intercompany
purchases from S. B's decrement equals 20% of the base-year costs
for its Year 2 layer, or $50 in terms of LIFO value (20% of $250).
S's intercompany inventory income from its Year 3 sales is $400.
Because B includes all of its inventory costs incurred for Year 3 in
its cost of goods sold for the year, S takes into account its entire
$400 of intercompany income from its Year 3 sales. In addition, S
takes into account $6.60 of its Year 2 layer of intercompany
inventory income not already taken into account (20% of $33).
Example 3. Other reasonable inventory methods. (a) Facts. Both S
and B use a dollar-value LIFO inventory method for their inventory
transactions. During Year 1, S sells inventory to B and to X. Under
paragraph (e)(1)(iv) of the section, to compute its intercompany
inventory income and the amount of this income not taken into
account, S computes its intercompany inventory income using the
transfer price of the inventory items less a FIFO cost for the
goods, takes into account these items based on a FIFO cost flow
assumption for B's corresponding items, and the LIFO methods used by
S and B are ignored for these computations. These computations are
comparable to the methods used by S and B for financial reporting
purposes, and the book methods and results are used for tax
purposes. S adjusts the amount of intercompany inventory items not
taken into account as required by section 263A.
(b) Reasonable method. The method used by S is a reasonable
method under paragraph (e)(1)(iv) of this section if the cumulative
amount of intercompany inventory items not taken into account by S
is not significantly greater than the cumulative amount that would
not be taken into account under the methods specifically described
in paragraph (e)(1) of this section. If, for any year, the method
results in a cumulative amount of intercompany inventory items not
taken into account by S that significantly exceeds the cumulative
amount that would not be taken into account under the methods
specifically provided, S must take into account for that year the
amount necessary to eliminate the excess. The method is thereafter
applied with appropriate adjustments to reflect the amount taken
into account (e.g., to prevent the amount from being taken into
account more than once).
(2) Reserve accounting--(i) Bad debts. Except as provided in
paragraph (g)(5) of this section (deferral of items from an
intercompany obligation), a member's addition to, or reduction of, a
reserve for bad debts that is maintained under section 585 or 593 is
taken into account on a separate entity basis. For example, if S makes
a loan to a nonmember and subsequently sells the loan to B, any
deduction for an addition to a bad debt reserve under section 585 and
any recapture income (or reduced deductions) are taken into account on
a separate entity basis rather than as intercompany items or
corresponding items taken into account under this section. Any gain or
loss of S from its sale of the loan to B is taken into account under
this section, however, to the extent it is not attributable to
recapture of the reserve.
(ii) Insurance companies--(A) Direct insurance. If a member
provides insurance to another member in an intercompany transaction,
the transaction is taken into account by both members on a separate
entity basis. For example, if one member provides life insurance
coverage for another member with respect to its employees, the
premiums, reserve increases and decreases, and death benefit payments
are determined and taken into account by both members on a separate
entity basis rather than taken into account under this section as
intercompany items and corresponding items.
(B) Reinsurance--(1) In general. Paragraph (e)(2)(ii)(A) of this
section does not apply to a reinsurance transaction that is an
intercompany transaction. For example, if a member assumes all or a
portion of the risk on an insurance contract written by another member,
the amounts transferred as reinsurance premiums, expense allowances,
benefit reimbursements, reimbursed policyholder dividends, experience
rating adjustments, and other similar items are taken into account
under the matching rule of paragraph (c) of this section.
(2) Reserves determined on a separate entity basis. For purposes of
determining the amount of a member's increase or decrease in reserves,
the amount of any reserve item listed in section 807(c) or 832(b)(5)
resulting from a reinsurance transaction that is an intercompany
transaction is determined on a separate entity basis. But see section
845, under which the Commissioner may allocate between or among the
members any items, recharacterize any such items, or make any other
adjustments necessary to clearly reflect the separate taxable income of
a member.
(3) De minimis or ordinary course intercompany transactions--(i)
General rule. The common parent may request consent to take items from
intercompany transactions into account on a separate entity basis,
other than intercompany transactions with respect to stock or
obligations of members. Consent may be granted for all items, or for
items from a class or classes of transactions. The consent has no
effect unless granted in writing by the Internal Revenue Service.
Unless revoked with the written consent of the Internal Revenue
Service, the separate entity treatment applies to all applicable
intercompany transactions in the consolidated return year for which
consent is granted and in all subsequent consolidated return years.
Consent under this paragraph (e)(3) will not apply for purposes of
deferring losses and deductions under section 267(f).
(ii) Time and manner for requesting consent. The request for
consent described in paragraph (e)(3)(i) of this section must be made
in the form of a ruling request. The request must be signed by the
common parent, include any information required by the Internal Revenue
Service, and be filed on or before the due date of the consolidated
return (not including extensions of time) for the first consolidated
return year to which the consent is to apply. The Internal Revenue
Service may impose terms and conditions for granting consent. A copy of
the consent must be attached to the consolidated returns (or amended
returns) as required by the terms of the consent.
(f) Stock of members--(1) In general. In addition to the general
rules of this section, the rules of this paragraph (f) apply to stock
of members.
(2) Intercompany distributions to which section 301 applies--(i) In
general. This paragraph (f)(2) provides rules for intercompany
transactions to which section 301 applies (intercompany distributions).
For purposes of determining whether a distribution is an intercompany
distribution, it is treated as occurring under the principles of the
entitlement rule of paragraph (f)(2)(iv) of this section. A
distribution is not an intercompany distribution to the extent it is
deducted by the distributing member. See, e.g., section 1382(c)(1).
(ii) Distributee member. An intercompany distribution is not
included in the gross income of the distributee member. However, this
exclusion applies to a distribution from a subsidiary only to the
extent there is a corresponding negative adjustment reflected under
Sec. 1.1502-32 in the distributee member's basis in the distributing
member's stock. See Secs. 1.1502-26(b) (applicability of the dividends
received deduction to distributions not excluded from gross income) and
1.1502-80(d) (non-applicability of section 301(c)(3)).
(iii) Distributing member. The principles of section 311(b) apply
to the distributing member's loss, as well as gain, from an
intercompany distribution of property. Thus, the distributing member's
loss is taken into account, for example, under the matching rule of
paragraph (c) of this section if the property is subsequently sold to a
nonmember. However, section 311(a) continues to apply to distributions
to nonmembers (e.g., the distributing member's loss is not recognized).
(iv) Entitlement rule. For all Federal income tax purposes, an
intercompany distribution is treated as taken into account when the
shareholding member becomes entitled to it (generally on the record
date) or, if earlier, when it is taken into account under the Internal
Revenue Code (e.g., under section 305(c)). For example, if the
distributee member becomes entitled to a cash distribution before it is
made, the distribution is treated as made when the distributee member
becomes entitled to it. Appropriate adjustments must be made (e.g., to
determine the earnings and profits of the distributing corporation) if
nonmembers own stock of the distributing corporation at the time the
distribution is treated as occurring. If it is later established, based
on all of the facts and circumstances, that the distribution will not
be made (or will be made only in part), the initial taking into account
of the distribution is reversed as of the date the distribution was
taken into account.
(3) Boot in an intercompany reorganization--(i) Application. This
paragraph (f)(3) provides additional rules for an intercompany
transaction in which money or other property (nonqualifying property)
is received that results in the application of section 356. For
example, the distribution of stock of a lower-tier member to a higher
tier member in an intercompany transaction to which section 355 would
otherwise apply but for the receipt of nonqualifying property, is an
intercompany reorganization to which this paragraph (f)(3) applies. For
this purpose, a transaction is not an intercompany reorganization if a
party to the transaction becomes a member or nonmember as part of the
same plan or arrangement. For example, if S merges into a nonmember in
a transaction described in section 368(a)(1)(A), this paragraph (f)(3)
does not apply (under paragraph (j)(1) of this section, the nonmember
is a successor to S).
(ii) General rule. Nonqualifying property received as part of an
intercompany reorganization is treated as received by the shareholder
in a separate transaction rather than as part of the intercompany
reorganization. See, e.g., sections 302 and 311 (rather than sections
356 and 361). The nonqualifying property is treated as taken into
account immediately after the intercompany reorganization if it is
received in a transaction to which section 354 would otherwise apply
but for the fact that nonqualifying property is received. It is treated
as taken into account immediately before the intercompany
reorganization if it is received in a transaction to which section 355
would otherwise apply but for the fact that nonqualifying property is
received. The treatment under this paragraph (f)(3)(ii) applies for all
Federal income tax purposes.
(4) Acquisition by issuer of its own stock. If a member acquires
its own stock in an intercompany transaction, the member's basis in
that stock is treated as eliminated, and the elimination is taken into
account for purposes of applying the rules of this section. For
example, S's intercompany items from the stock of B are taken into
account under this section if B acquires the stock in an intercompany
transaction (unless, for example, B acquires the stock in exchange for
successor property within the meaning of paragraph (j)(1) of this
section in a nonrecognition transaction).
(5) Relief for certain liquidations and distributions--(i) Scope.
S's intercompany items from an intercompany transfer to B of the stock
of another member (T) are taken into account under this section in
certain circumstances even though the T stock is never held by a
nonmember after the intercompany transaction. For example, if S sells
all of T's stock to B at a gain, and T subsequently liquidates into B
in a separate transaction to which section 332 applies, S's gain is
taken into account under this section. If the rules of this paragraph
(f)(5) are elected, certain transactions that are (in whole or in part)
nonrecognition transactions will not result in S's items being taken
into account. This paragraph (f)(5) applies only if, throughout the
period beginning as of S's transfer and ending as of the completion of
the nonrecognition transaction, no T stock is owned by a nonmember and
T does not become a nonmember.
(ii) Section 332--(A) In general. If section 332 applies to T's
liquidation into B, and B transfers T's assets to a new member (new T)
in a transaction not otherwise pursuant to the same plan or arrangement
as the liquidation, the transfer is nevertheless treated for all
Federal income tax purposes as pursuant to the same plan or arrangement
as the liquidation. For example, if T liquidates into B, but B forms
new T by transferring substantially all of T's former assets to new T,
S's intercompany gain or loss generally is not taken into account
solely as a result of the liquidation if the liquidation and transfer
would qualify as a reorganization described in section 368(a). (Under
paragraph (j)(1) of this section, B's stock in new T would be a
successor asset to B's stock in T, and S's gain would be taken into
account based on the new T stock.)
(B) Time limitation and adjustments. The transfer of an asset to
new T not otherwise pursuant to the same plan or arrangement as the
liquidation is treated under this paragraph (f)(5)(ii) as pursuant to
the same plan or arrangement only if B transfers it to new T on or
before the timely filing (including extensions of time) of the group's
return for the year of T's liquidation. Appropriate adjustments are
made for any assets not transferred to new T as part of the same plan
or arrangement. See, e.g., paragraph (f)(3) of this section (if B
retains an asset in the reorganization, the asset is treated as
acquired by new T but distributed to B immediately after the
reorganization).
(C) Downstream merger, etc. The principles of this paragraph
(f)(5)(ii) apply, with appropriate adjustments, if B's basis in the T
stock is eliminated in a transaction comparable to the section 332
liquidation described in paragraph (f)(5)(ii)(A) of this section. For
example, if S and B are subsidiaries, and S sells all of T's stock to B
at a gain followed by B's merger into T in a separate transaction
described in section 368(a), S's gain is not taken into account solely
as a result of the merger if the group forms new B with substantially
all of B's former assets (including all of the stock of T). The merger
is not treated as a comparable transaction if, for example, any B stock
is owned by nonmembers immediately before the merger, or any new B
stock is owned by nonmembers immediately after the merger.
(iii) Section 338(h)(10)--(A) In general. This paragraph
(f)(5)(iii) applies to a deemed liquidation of T under section 332 as
the result of an election under section 338(h)(10). This paragraph
(f)(5)(iii) does not apply if T has made substantial noncash
distributions during the 12-month period ending on the date of the
qualified stock purchase, or if paragraph (f)(5)(ii) of this section is
applied to the deemed liquidation. B is treated with respect to each
share of its T stock as recognizing as a corresponding item any loss or
deduction it would recognize (determined after adjusting stock basis
under Sec. 1.1502-32) if section 331 applied to the deemed liquidation.
For all other Federal income tax purposes, the deemed liquidation
remains subject to section 332.
(B) Noncash distribution. For purposes of this paragraph
(f)(5)(iii), a noncash distribution is a distribution of anything other
than cash or a cash item, any marketable stock or security, or any debt
of the distributor or distributee member.
(C) Limitation on amount of loss. The amount of B's loss or
deduction under this paragraph (f)(5)(iii) is limited as follows--
(1) The amount taken into account with respect to each T share
cannot exceed the net amount of intercompany income or gain with
respect to the share from all intercompany transactions before T's
deemed liquidation that is taken into account as a result of the deemed
liquidation; and
(2) The aggregate amount taken into account under this paragraph
(f)(5)(iii) from T's deemed liquidation cannot exceed the net amount of
deduction or loss (if any) that would be taken into account from the
deemed liquidation if section 331 applied with respect to all T shares.
(D) Asset sale, etc. The principles of this paragraph (f)(5)(iii)
apply, with appropriate adjustments, if T transfers all of its assets
to a nonmember and completely liquidates in a transaction comparable to
the section 338(h)(10) transaction described in paragraph
(f)(5)(iii)(A) of this section. For example, if S sells all of T's
stock to B at a gain followed by T's merger into a nonmember in
exchange for a cash payment to B in a transaction treated for Federal
income tax purposes as T's sale of its assets to the nonmember and
complete liquidation, the merger is ordinarily treated as a comparable
transaction. The merger is not treated as a comparable transaction if,
for example, T makes substantial noncash distributions during the 12-
month period ending on the date of the merger.
(iv) Section 355. If, instead of T liquidating into B, B
distributes the T stock in an intercompany transaction to which section
355 applies (including an intercompany transaction to which 355 applies
because of the application of paragraph (f)(3) of this section), the
redetermination of the basis of the T stock under section 358 could
cause S's gain or loss to be taken into account under this section.
This paragraph (f)(5)(iv) applies to treat B's distribution as subject
to section 301 and 311 (as modified by this paragraph (f)), rather than
section 355. The election will avoid S's gain or loss being taken into
account immediately if matching remains possible, but B's gain or loss
from the distribution will also be taken into account under this
section.
(v) Election. An election to apply this paragraph (f)(5) is made in
a separate statement entitled ``[Insert Name and Employer
Identification Number of Common Parent] HEREBY ELECTS THE APPLICATION
OF Sec. 1.1502-13(f)(5).'' The election must include a description of
S's intercompany transaction and T's liquidation (or other
transaction). It must specify which application of Sec. 1.1502-13(f)(5)
applies and how it alters the otherwise applicable results under this
section (including, for example, the amount of S's intercompany items
and the amount deferred or offset as a result of this Sec. 1.1502-
13(f)(5)). A separate election must be made for each application of
this paragraph (f)(5). The election must be signed by the common parent
and filed with the group's income tax return for the year of T's
liquidation (or other transaction). The Commissioner may impose
reasonable terms and conditions to the application of this paragraph
(f)(5) that are consistent with the purposes of this section.
(6) Examples. The application of this section to intercompany
transactions with respect to stock of members is illustrated by the
following examples.
Example 1. Dividend exclusion and property distribution. (a)
Facts. S owns land with a $70 basis and $100 value. On January 1 of
Year 1, P's basis in S's stock is $100. During Year 1, S declares
and makes a dividend distribution of the land to P. Under section
311(b), S has a $30 gain. Under section 301(d), P's basis in the
land is $100. On July 1 of Year 3, P sells the land to X for $110.
(b) Dividend elimination and stock basis adjustments. Under
paragraph (b)(1) of this section, S's distribution to P is an
intercompany distribution. Under paragraph (f)(2)(ii) of this
section, P's $100 of dividend income is not included in gross
income. Under Sec. 1.1502-32, P's basis in S's stock is reduced from
$100 to $0 in Year 1.
(c) Matching rule and stock basis adjustments. Under the
matching rule of paragraph (c) of this section (treating P as the
buying member and S as the selling member), S takes its $30 gain
into account in Year 3 to reflect the $30 difference between P's $10
gain taken into account and its $40 recomputed gain. Under
Sec. 1.1502-32, P's basis in S's stock is increased from $0 to $30
in Year 3.
(d) Loss property. The facts are the same as in paragraph (a) of
this Example 1, except that S has a $130 (rather than $70) basis in
the land. Under paragraph (f)(2)(iii) of this section, the
principles of section 311(b) apply to S's loss from the intercompany
distribution. Thus, S has a $30 loss that is taken into account
under the matching rule in Year 3 to reflect the $30 difference
between P's $10 gain taken into account and its $20 recomputed loss.
(The results are the same under section 267(f).) Under Sec. 1.1502-
32, P's basis in S's stock is reduced from $100 to $0 in Year 1, and
from $0 to a $30 excess loss account in Year 3. (If P had
distributed the land to its shareholders, rather than selling the
land to X, P would take its $10 gain under section 311(b) into
account, and S would take its $30 loss into account under the
matching rule with $10 offsetting P's gain and $20 recharacterized
as a noncapital, nondeductible amount.)
(e) Entitlement rule. The facts are the same as in paragraph (a)
of this Example 1, except that, after P becomes entitled to the
distribution but before the distribution is made, S issues
additional stock to the public and becomes a nonmember. Under
paragraph (f)(2)(i) of this section, the determination of whether a
distribution is an intercompany distribution is made under the
entitlement rule of paragraph (f)(2)(iv) of this section. Treating
S's distribution as made when P becomes entitled to it results in
the distribution being an intercompany distribution. Under paragraph
(f)(2)(ii) of this section, the distribution is not included in P's
gross income. S's $30 gain from the distribution is intercompany
gain that is taken into account under the acceleration rule of
paragraph (d) of this section immediately before S becomes a
nonmember. Thus, there is a net $70 decrease in P's basis in its S
stock under Sec. 1.1502-32 ($100 decrease for the distribution and a
$30 increase for S's $30 gain). See also Sec. 1.1502-20(b)
(additional stock basis reductions applicable to certain
deconsolidations). Under paragraph (a)(4) of this section, P does
not take the distribution into account again under separate return
rules when received, and P is not entitled to a dividends received
deduction.
Example 2. Excess loss accounts. (a) Facts. S owns all of T's
only class of stock with a $10 basis and $100 value. S has
substantial earnings and profits, and T has $10 of earnings and
profits (all of which are from pre-affiliation years). On January 1
of Year 1, S declares and distributes a dividend of all of the T
stock to P. Under section 311(b), S has a $90 gain. Under section
301(d), P's basis in the T stock is $100. During Year 3, T borrows
$90 and declares and makes a $90 distribution to P to which section
301 applies, and P's basis in the T stock is reduced under
Sec. 1.1502-32 from $100 to $10. During Year 6, T has $5 of earnings
that increase P's basis in the T stock under Sec. 1.1502-32 from $10
to $15. On December 1 of Year 9, T issues additional stock to X and,
as a result, T becomes a nonmember.
(b) Dividend exclusion. Under paragraph (f)(2)(ii) of this
section, P's $100 of dividend income from S's distribution of the T
stock, and its $10 of dividend income from T's $90 distribution, are
not included in gross income.
(c) Matching and acceleration rules. Under the matching rule, S
takes $75 of its $90 gain into account in Year 9 as a result of T
becoming a nonmember, to reflect the difference between P's $0 gain
taken into account and its $75 recomputed gain. If S's distribution
to P were a transfer between the divisions, P would succeed to S's
$10 basis in the T stock, and the adjustments under Sec. 1.1502-32
for T's $90 distribution and $5 of earnings would have resulted in a
$75 excess loss account. Thus, T's becoming a nonmember would have
resulted in P taking into account the $75 excess loss account. See
Sec. 1.1502-19 (excess loss accounts). S's remaining $15 of gain is
taken into account under the matching and acceleration rules based
on subsequent events (e.g., under the matching rule if P
subsequently sells its T stock, or under the acceleration rule if S
becomes a nonmember).
(d) Reverse sequence. The facts are the same as in paragraph (a)
of this Example 2, except that T borrows $90 and makes its $90
distribution to S before S distributes T's stock to P. Under section
301(d) P's initial basis in the T stock is $10 (the stock's fair
market value), and the basis increases to $15 under Sec. 1.1502-32
as a result of T's earnings in Year 6. Under paragraph (f)(2)(ii) of
this section, T's $90 distribution to S ($10 of which is a dividend)
is not included in S's gross income. The corresponding negative
adjustment under Sec. 1.1502-32 reduces S's basis in the T stock
from $10 to an $80 excess loss account. Under section 311(b), S has
a $90 gain from the distribution of T stock to P. The timing and
attributes of S's gain are determined in the manner provided in
paragraph (c) of this Example 2. Thus, $75 of S's gain is taken into
account under the matching rule in Year 9 as a result of T becoming
a nonmember, and the remaining $15 is taken into account under the
matching and acceleration rules based on subsequent events.
(e) Partial stock sale. The facts are the same as in paragraph
(a) of this Example 2, except that P sells 10% of T's stock to X on
December 1 of Year 9 for $1.50 (rather than T's issuing additional
stock and becoming a nonmember). Under the matching rule, S takes $9
of its gain into account to reflect the difference between P's $0
gain taken into account ($1.50 sale proceeds minus $1.50 basis) and
its $9 recomputed gain ($1.50 sale proceeds plus $7.50 excess loss
account).
(f) Loss, rather than cash distribution. The facts are the same
as in paragraph (a) of this Example 2, except that T retains the
loan proceeds and incurs a $90 loss in Year 3 that is absorbed by
the group. The timing and attributes of S's gain are determined in
the same manner provided in paragraph (c) of this Example 2. Under
Sec. 1.1502-32, the loss in Year 3 reduces P's basis in the T stock
from $100 to $10, and T's $5 of earnings in Year 6 increase the
basis to $15. Thus, $75 of S's gain is taken into account under the
matching rule in Year 9 as a result of T becoming a nonmember, and
the remaining $15 is taken into account under the matching and
acceleration rules based on subsequent events. (The timing and
attributes of S's gain would be determined in the same manner
provided in paragraph (d) of this Example 2 if T incurred the $90
loss before S's distribution of the T stock to P.)
(g) Stock sale, rather than stock distribution. The facts are
the same as in paragraph (a) of this Example 2, except that S sells
the T stock to P for $100 (rather than distributing the stock). The
timing and attributes of S's gain are determined in the same manner
provided in paragraph (c) of this Example 2. Thus, $75 of S's gain
is taken into account under the matching rule in Year 9 as a result
of T becoming a nonmember, and the remaining $15 is taken into
account under the matching and acceleration rules based on
subsequent events.
Example 3. Intercompany reorganization. (a) Facts. P forms S and
B by contributing $200 to the capital of each. During Years 1
through 4, S and B each earn $50, and under Sec. 1.1502-32 P adjusts
its basis in the stock of each to $250. (See Sec. 1.1502-33 for
adjustments to earnings and profits.) On January 1 of Year 5, the
fair market value of S's assets and its stock is $500, and S merges
into B in a tax-free reorganization. Pursuant to the plan of
reorganization, P receives B stock with a fair market value of $350
and $150 of cash.
(b) Treatment as a section 301 distribution. The merger of S
into B is an intercompany reorganization to which paragraph (f)(3)
of this section applies. P is treated as receiving additional B
stock with a fair market value of $500 and, under section 358, a
basis of $250. Immediately after the merger, $150 of the stock
received is treated as redeemed, and the redemption is treated under
section 302(d) as a distribution to which section 301 applies.
Because the $150 distribution is treated as not received as part of
the merger, section 356 does not apply and no basis adjustments are
required under section 358(a)(1)(A) and (B). Because B is treated
under section 381(c)(2) as receiving S's earnings and profits and
the redemption is treated as occurring after the merger, $100 of the
distribution is treated as a dividend under section 301 and P's
basis in the B stock is reduced correspondingly under Sec. 1.1502-
32. The remaining $50 of the distribution reduces P's basis in the B
stock. Section 301(c)(2) and Sec. 1.1502-32. Under paragraph
(f)(2)(ii) of this section, P's $100 of dividend income is not
included in gross income. Under Sec. 1.302-2(c), appropriate
adjustments are made to P's basis in its B stock to reflect its
basis in the B stock redeemed, with the result that P's basis in the
B stock is reduced by the entire $150 distribution.
(c) Depreciated property. The facts are the same as in paragraph
(a) of this Example 3, except that property of S with a $200 basis
and $150 fair market value is distributed to P (rather than cash of
B). As in paragraph (b) of this Example 3, P is treated as receiving
additional B stock in the merger and a $150 distribution to which
section 301 applies immediately after the merger. Under paragraph
(f)(2)(iii) of this section, the principles of section 311(b) apply
to B's $50 loss and the loss is taken into account under the
matching and acceleration rules based on subsequent events (e.g.,
under the matching rule if P subsequently sells the property, or
under the acceleration rule if B becomes a nonmember). The results
are the same under section 267(f).
(d) Divisive transaction. Assume instead that, pursuant to a
plan, S distributes the stock of a lower-tier subsidiary in a spin-
off transaction to which section 355 applies together with $150 of
cash. The distribution of stock is an intercompany reorganization to
which paragraph (f)(3) of this section applies. P is treated as
receiving the $150 of cash immediately before the section 355
distribution, as a distribution to which section 301 applies.
Section 356(b) does not apply and no basis adjustments are required
under section 358(a)(1)(A) and (B). Because the $150 distribution is
treated as made before the section 355 distribution, the
distribution reduces P's basis in the S stock under Sec. 1.1502-32,
and the basis allocated under section 358(c) between the S stock and
the lower-tier subsidiary stock received reflects this basis
reduction.
Example 4. Stock redemptions and distributions. (a) Facts.
Before becoming a member of the P group, S owns P stock with a $30
basis. On January 1 of Year 1, P buys all of S's stock. On July 1 of
Year 3, P redeems the P stock held by S for $100 in a transaction to
which section 302(a) applies.
(b) Gain under section 302. Under paragraph (f)(4) of this
section, P's basis in the P stock acquired from S is treated as
eliminated. Thus, S's $70 gain is taken into account in Year 3. S's
gain is taken into account as capital gain. (Under paragraph
(c)(3)(iv) of this section, S's gain cannot be excluded from gross
income.)
(c) Gain under section 311. The facts are the same as in
paragraph (a) of this Example 4, except that S distributes the P
stock to P in a transaction to which section 301 applies (rather
than the stock being redeemed), and S has a $70 gain under section
311(b). The timing and attributes of S's gain are determined in the
manner provided in paragraph (b) of this Example 4.
(d) Loss stock. The facts are the same as in paragraph (a) of
this Example 4, except that S has a $130 (rather than $30) basis in
the P stock and has a $30 loss under section 302(a). The limitation
under paragraph (c)(3)(iv) of this section on recharacterization of
items does not apply to intercompany losses. Thus, S's loss is taken
into account in Year 3 as a noncapital, nondeductible amount.
Example 5. Intercompany stock sale followed by section 332
liquidation. (a) Facts. S owns all of the stock of T, with a $70
basis and $100 value, and T's assets have a $10 basis and $100
value. On January 1 of Year 1, S sells all of T's stock to B for
$100. On July 1 of Year 3, T distributes all of its assets to B in
an unrelated complete liquidation to which section 332 applies.
(b) Timing and attributes. Under paragraph (b)(2)(ii)(B) of this
section, B's unrecognized gain or loss under section 332 is a
corresponding item for purposes of applying the matching rule. Thus,
S's $30 gain is taken into account in Year 3 as a result of T's
liquidation. Under paragraph (c)(1)(i) of this section, the
attributes of S's gain and B's corresponding item are redetermined
as if they were divisions of a single corporation. Although S's gain
ordinarily would be treated as excluded from gross income to reflect
the nonrecognition of B's gain or loss under section 332, the gain
remains capital gain. Paragraph (c)(3)(iv) of this section permits
S's gain to be excluded from gross income only if B has a
corresponding deduction or loss disallowed directly under a
provision of the Code or regulations. B's corresponding items from
the liquidation do not satisfy this requirement. However, relief may
be elected under paragraph (f)(5) of this section.
(c) Intercompany sale at a loss. The facts are the same as in
paragraph (a) of this Example 5, except that S has a $130 (rather
than $70) basis in the T stock. The limitation under paragraph
(c)(3)(iv) of this section on recharacterization of items does not
apply to intercompany losses. Thus, S's intercompany loss is taken
into account in Year 3 as a noncapital, nondeductible amount.
However, relief may be elected under paragraph (f)(5) of this
section.
(g) Obligations of members--(1) In general. In addition to the
general rules of this section, the rules of this paragraph (g) apply to
intercompany obligations.
(2) Definitions. For purposes of this section--
(i) Obligation of a member. An obligation of a member is--
(A) Any obligation of that member constituting indebtedness under
general principles of Federal income tax law (for example, under
section 108, section 163, section 171, or section 1275, but not an
executory obligation to purchase or provide goods or services); and
(B) Any security of the member described in section 475(c)(2)(D) or
(E), and any comparable security with respect to commodities.
(ii) Intercompany obligations. An intercompany obligation is an
obligation between members, but only for the period during which both
parties are members.
(3) Deemed satisfaction and reissuance of intercompany
obligations--(i) Application--(A) In general. If a member realizes an
amount (other than zero) of income, gain, deduction, or loss, directly
or indirectly, from the assignment or extinguishment of all or part of
its remaining rights or obligations under an intercompany obligation,
the intercompany obligation is treated for all Federal income tax
purposes as satisfied under paragraph (g)(3)(ii) of this section and,
if it remains outstanding, reissued under paragraph (g)(3)(iii) of this
section. Similar principles apply under this paragraph (g)(3) if a
member realizes any such amount, directly or indirectly, from a
comparable transaction (e.g., a marking-to-market of an obligation or a
bad debt deduction), or if an intercompany obligation becomes an
obligation that is not an intercompany obligation.
(B) Exceptions. This paragraph (g)(3) does not apply to an
obligation if any of the following applies:
(1) The obligation became an intercompany obligation by reason of
an event described in paragraph (g)(4)(i)(B) of this section
(exceptions to the application of section 108(e)(4)).
(2) The amount realized is from reserve accounting under section
585 or 593 (see paragraph (g)(5) of this section for special rules).
(3) Treating the obligation as satisfied and reissued will not have
a significant effect on any person's Federal income tax liability for
any year. For this purpose, obligations issued in connection with the
same transaction or related transactions are treated as a single
obligation. However, this paragraph (g)(3)(i)(B)(3) does not apply to
any obligation if its aggregate effect for all obligations in a year
would be significant.
(ii) Satisfaction--(A) General rule. If a creditor member sells
intercompany debt to a nonmember for cash, the debt is treated as
satisfied by the debtor immediately before the sale for the amount of
the cash. For other transactions, similar principles apply to treat the
intercompany obligation as satisfied immediately before the
transaction. Thus, if the obligation is transferred for property, it is
treated as satisfied for an amount consistent with the amount of the
reissuance under paragraph (g)(3)(iii) of this section, and the basis
of the property is also adjusted to reflect that amount. If this
paragraph (g)(3) applies because the obligor or obligee becomes a
nonmember, the obligation is treated as satisfied for cash in an amount
equal to its fair market value immediately before the obligor or
obligee becomes a nonmember. Similar principles apply to intercompany
obligations other than debt.
(B) Timing and attributes. For purposes of applying the matching
rule of paragraph (c) of this section and the acceleration rule of
paragraph (d) of this section--
(1) Paragraph (c)(3)(iv) of this section (limitation on treatment
of intercompany income or gain as excluded from gross income) does not
apply to prevent any intercompany income or gain from being excluded
from gross income; and
(2) Any intercompany gain or loss is not subject to section 354 or
1091.
(iii) Reissuance. If a creditor member sells intercompany debt to a
nonmember for cash, the debt is treated as a new debt (with a new
holding period) issued by the debtor immediately after the sale for the
amount of cash. For other transactions, if the intercompany obligation
remains outstanding, similar principles apply to treat the obligation
as reissued immediately after the transaction. Thus, if the obligation
is transferred for property, it is treated as a new obligation issued
to the nonmember for the property. If this paragraph (g)(3) applies
because the debtor or creditor becomes a nonmember, the obligation is
treated as a new obligation issued for an amount of cash equal to its
fair market value immediately after the debtor or creditor becomes a
nonmember. Similar principles apply to intercompany obligations other
than debt.
(4) Deemed satisfaction and reissuance of obligations becoming
intercompany obligations--(i) Application--(A) In general. This
paragraph (g)(4) applies if an obligation that is not an intercompany
obligation becomes an intercompany obligation.
(B) Exceptions. This paragraph (g)(4) does not apply to an
obligation if--
(1) The obligation becomes an intercompany obligation by reason of
an event described in Sec. 1.108-2(e) (exceptions to the application of
section 108(e)(4)); or
(2) Treating the obligation as satisfied and reissued will not have
a significant effect on any person's Federal income tax liability for
any year. For this purpose, obligations issued in connection with the
same transaction or related transactions are treated as a single
obligation. However, this paragraph (g)(4)(i)(B)(2) does not apply to
any obligation if its aggregate effect for all obligations in a year
would be significant.
(ii) Intercompany debt. If this paragraph (g)(4) applies to an
intercompany debt--
(A) Section 108(e)(4) does not apply;
(B) The debt is treated for all Federal income tax purposes,
immediately after it becomes an intercompany debt, as satisfied and a
new debt issued to the holder (with a new holding period) in an amount
determined under the principles of Sec. 1.108-2(f);
(C) The attributes of all items taken into account from the
satisfaction are determined on a separate entity basis, rather than by
treating S and B as divisions of a single corporation; and
(D) Any intercompany gain or loss taken into account is treated as
not subject to section 354 or 1091.
(iii) Other intercompany obligations. If this paragraph (g)(4)
applies to an intercompany obligation other than debt, the principles
of paragraph (g)(4)(ii) of this section apply to treat the intercompany
obligation as satisfied and reissued for an amount of cash equal to its
fair market value immediately after the obligation becomes an
intercompany obligation.
(5) Bad debt reserve. A member's deduction under section 585 or 593
for an addition to its reserve for bad debts with respect to an
intercompany obligation is not taken into account, and is not treated
as realized under paragraph (g)(3) of this section, until the
intercompany obligation becomes an obligation that is not an
intercompany obligation, or, if earlier, the redemption or collection
of less than the recorded amount of the intercompany obligation (and
the corresponding charge off against the reserve). For purposes of this
paragraph (g)(5) an addition to a reserve that results from charging
off an intercompany obligation is treated as with respect to the
intercompany obligation.
(6) Examples. The application of this section to obligations of
members is illustrated by the following examples.
Example 1. Interest and premium on intercompany debt. (a) Facts.
On January 1 of Year 1, M2 borrows $100 from M1 in return for M2's
note providing for $10 of interest annually at the end of each year,
and repayment of $100 at the end of Year 5. M2 fully performs its
obligations. Under their separate entity methods of accounting, M2
accrues a $10 interest deduction annually under section 163, and M1
accrues $10 of interest income annually under section 61(a)(4).
(b) Matching rule. Under paragraph (b)(1) of this section, the
accrual of interest on M2's note is an intercompany transaction, M1
is the selling member, and M2 is the buying member. Under the
matching rule of paragraph (c) of this section, M1 takes its $10 of
income into account in each of Years 1 through 5 to reflect the $10
difference between M2's $10 of interest expense taken into account
and its $0 recomputed expense.
(c) Original issue discount. The facts are the same as in
paragraph (a) of this Example 1, except that M2 borrows $90 (rather
than $100) from M1 in return for M2's note providing for $10 of
interest annually and repayment of $100 at the end of Year 5. The
principles described in paragraph (b) of this Example 1 for stated
interest also apply to the $10 of original issue discount. Thus, as
M2 takes into account its corresponding expense under section
163(e), M1 takes into account its intercompany income.
(d) Premium. The facts are the same as in paragraph (a) of this
Example 1, except that M2 borrows $110 from M1 (rather than $100),
and M1 elects under section 171 to amortize the $10 premium. Under
section 171(e), M1's premium deduction is allocated to its interest
income and applied to reduce the amount of the income. Although
there is no separate item of premium deduction to be taken into
account, paragraph (b)(2)(ii)(B) of this section provides that M1's
corresponding items include the premium even though it offsets
interest income rather than being separately taken into account.
Although M1 is the selling member with respect to the interest
(i.e., the recipient member), M1 is the buying member with respect
to the premium (i.e., the payor member). Thus, M2's intercompany
premium income is taken into account under the matching rule to
reflect the difference between M1's corresponding premium deduction
taken into account and its recomputed premium deduction.
Consequently, M2 takes its premium income into account in each of
Years 1 through 5 based on M1's amortization and offset of allocable
interest income. (If M1 does not make an election under section 171,
but instead takes the premium into account when the debt is retired
at the end of Year 5, M2 also does not take the premium into account
until the debt is retired at the end of Year 5.)
(e) Tax-exempt income. The facts are the same as in paragraph
(a) of this Example 1, except that M2's borrowing from M1 is
allocable under section 265 to M2's purchase of state and local
bonds to which section 103 applies. The timing of M1's income is the
same as in paragraph (b) of this Example 1, but that M1's income is
treated under the matching rule as excluded from gross income
because M2's corresponding expense is nondeductible under section
265. See paragraph (c)(3)(iv) of this section.
Example 2. Intercompany debt becomes nonintercompany debt. (a)
Facts. On January 1 of Year 1, B borrows $100 from S in return for
B's note providing for $10 of interest annually at the end of each
year, and repayment of $100 at the end of Year 20. As of January 1
of Year 3, B has paid the interest accruing under the note and S
sells B's note to X for $70, reflecting a change in the value of the
note as a result of increases in prevailing market interest rates. B
is never insolvent within the meaning of section 108(d)(3).
(b) Deemed satisfaction. Under paragraph (g)(3) of this section,
B's note is treated as satisfied for $70 immediately before S's sale
to X. Under the matching rule, B takes into account $30 of discharge
of indebtedness income under section 61(a)(12). Although S
ordinarily would take into account a $30 capital loss under section
1271(a)(1), S's loss is treated as ordinary loss to conform to B's
corresponding $30 of discharge of indebtedness income.
(c) Deemed reissuance. Under paragraph (g)(3) of this section, B
is also treated as reissuing, directly to X, a new note with a $70
issue price and a $100 stated redemption price at maturity. The new
note is not an intercompany obligation, it has a $70 issue price and
$100 stated redemption price at maturity, and the $30 of original
issue discount will be taken into account by B and X under sections
163(e) and 1272.
(d) Creditor deconsolidation. The facts are the same as in
paragraph (a) of this Example 2, except that P sells S's stock to X
(rather than S's selling the note of B). Under paragraph (g)(3) of
this section, the note is treated as satisfied by B for its $70 fair
market value immediately before S becomes a nonmember, and B is
treated as reissuing a new note to S immediately after S becomes a
nonmember. The results for S's $30 of loss and B's discharge of
indebtedness income are the same as in paragraph (b) of this Example
2. The new note is not an intercompany obligation, it has a $70
issue price and $100 stated redemption price at maturity, and the
$30 of original issue discount will be taken into account by B and S
under sections 163(e) and 1272.
(e) Debtor deconsolidation. The facts are the same as in
paragraph (a) of this Example 2, except that P sells B's stock to X
(rather than S's selling the note of B). The results are the same as
in paragraph (d) of this Example 2.
(f) Appreciated note. The facts are the same as in paragraph (a)
of this Example 2, except that S sells B's note to X for $130
(rather than $70), reflecting a decline in prevailing market
interest rates. Under paragraph (g)(3) of this section, B's note is
treated as satisfied for $130 immediately before S's sale of the
note to X. Under the matching rule, B takes into account $30 of
repurchase premium. Although S ordinarily would take into account a
$30 capital gain under section 1271(a)(1), the attributes of S's
capital gain conform to B's corresponding premium under the matching
rule. Thus, S's gain is treated as ordinary income to conform to B's
corresponding $30 premium. B is also treated as reissuing a new note
directly to X which is not an intercompany obligation. The new note
has a $130 issue price and a $100 stated redemption price at
maturity. Under Sec. 1.61-12(c), B's $30 premium income under the
new note is taken into account over the life of the new note. Under
section 171, X may elect to amortize its $30 of bond premium over
the life of the note (with corresponding reductions in its basis),
however, the election would have no effect on B's premium income.
Example 3. Bad debt deduction or loss with respect to
intercompany debt. (a) Facts. On January 1 of Year 1, B borrows $100
from S in return for B's note providing for $10 of interest annually
at the end of each year, and repayment of $100 at the end of Year 5.
For Year 3, S claims a $40 partial bad debt deduction under section
166(a)(2) on a separate entity basis. B is never insolvent within
the meaning of section 108(d)(3).
(b) Deemed satisfaction and reissuance. Under paragraph (g)(3)
of this section, B is treated as satisfying its note for $60
immediately before S's bad debt deduction, and reissuing a new note
to S with a $60 issue price and a $100 stated redemption price at
maturity. Thus, B takes into account $40 of discharge of
indebtedness income, and S takes into account $40 of loss as an
ordinary loss.
(c) Loss sale. The facts are the same as in paragraph (a) of
this Example 3, except that S sells B's note to P for $60 (rather
than claiming a partial bad debt deduction). The results are the
same as in paragraph (b) of this Example 3. B's note is treated as
satisfied immediately before the sale, and a new note reissued
directly to P immediately after the sale. B takes into account $40
of discharge of indebtedness income, and S takes into account $40 of
loss as an ordinary loss.
Example 4. Nonintercompany debt becomes intercompany debt. (a)
Facts. On January 1 of Year 1, B borrows $100 from X in return for
B's note providing for $10 of interest annually at the end of each
year, and repayment of $100 at the end of Year 5. As of January 1 of
Year 3, B has fully performed its obligations, but the note's fair
market value is $70. On January 1 of Year 3, P buys all of X's
stock. B is solvent within the meaning of section 108(d)(3).
(b) Deemed satisfied and reissuance. Under paragraph (g)(4) of
this section, B is treated as satisfying its indebtedness for $70
(determined under the principles of Sec. 1.108-2(f)(2)) immediately
after X becomes a member. Both X's $30 capital loss under section
1271(a)(1) and B's $30 of discharge of indebtedness income under
section 61(a)(12) are taken into account in determining consolidated
taxable income for Year 3. Under paragraph (g)(4)(ii)(C) of this
section, the attributes of items resulting from the satisfaction are
determined on a separate entity basis. But see section 382 and
Sec. 1.1502-15 (limitations on the absorption of built-in losses). B
is also treated as reissuing a new note. The new note is an
intercompany obligation, it has a $70 issue price and $100 stated
redemption price at maturity, and the $30 of original issue discount
will be taken into account by B and X.
(c) Election to file consolidated returns. Assume instead that B
borrows $100 from S during Year 1, but the P group does not file
consolidated returns until Year 3. Under paragraph (g)(4) of this
section, B's indebtedness is treated as satisfied and a new note
reissued immediately after the debt becomes intercompany debt. The
satisfaction and reissuance are on January 1 of Year 3, at the fair
market value of the note (determined under the principles of
Sec. 1.108-2(f)(2)) at that time.
Example 5. Notional principal contracts. (a) Facts. On April 1
of Year 1, M1 enters into a contract with counterparty M2 under
which, for a term of five years, M1 is obligated to make a payment
to M2 each April 1, beginning in Year 2, in an amount equal to the
London Interbank Offered Rate (LIBOR), as determined on the
immediately preceding April 1, multiplied by a $1,000 notional
principal amount. M2 is obligated to make a payment to M1 each April
1, beginning in Year 2, in an amount equal to 8% multiplied by the
same notional principal amount. LIBOR is 7.80% on April 1 of Year 1.
On April 1 of Year 2, M1 owes $78 to M2, and M2 owes $80 to M1.
(b) Matching rule. Under Sec. 1.446-3(d), the net income (or net
deduction) from a notional principal contract for a taxable year is
included in (or deducted from) gross income. Under Sec. 1.446-3(e),
the ratable daily portion of M2's fixed obligation to M1 as of
December 31 of Year 1 is $60.27 ($80 multiplied by 275/365), and the
ratable daily portion of M1's floating obligation as of December 31
of Year 1 is $58.77 ($78 multiplied by 275/365). Under the matching
rule, M1's net income for Year 1 of $1.50 is taken into account to
reflect the difference between M2's net deduction of $1.50 taken
into account and its $0 recomputed net deduction. Similarly, the
$.50 balance of the $2.00 of net periodic payments made on April 1
of Year 2 is taken into account for Year 2 in M1's and M2's net
income and net deduction from the contract. (Note that although M1
is the selling member with respect to the payment on April 1 of Year
2, it may be the buying member in a subsequent period if it owes the
net payment.)
(c) Dealer. The facts are the same as in paragraph (a) of this
Example 5, except that M2 is a dealer in securities, the contract
with M1 is not inventory in the hands of M2, and on December 31 of
Year 1 the fair market value of the contract to M2 is ($100). Under
section 475, M2 has a $100 loss as if the contract were sold on
December 31 for its fair market value. Under paragraph (g)(3) of
this section, M2 is treated as making a $100 payment to M1 to
terminate the contract immediately before section 475 is applied.
Under the matching rule, the net periodic payment in Year 1 is taken
into account as described in paragraph (b) of this Example 5. In
addition, M1's $100 of income from the termination payment is taken
into account to reflect the timing of M2's deduction (as described
in Sec. 1.446-3(h)), and the character and other attributes of the
income is conformed to the character and other attributes of the
deduction. Paragraph (g)(3) of this section also provides that,
immediately after section 475 would apply, a new contract is treated
as reissued with an up front payment of $100. Under Sec. 1.446-3(f),
the deemed $100 payment by M2 to M1 is taken into account over the
term of the new contract in a manner reflecting the economic
substance of the contract (e.g., allocating a portion of the $100 to
the periodic payment expected to be made by M2 on April 1 of Year 2,
and the balance under the level payment constant yield to maturity
method). (The results would be the same if M1, rather than M2, is
the dealer subject to section 475.)
(h) Anti-avoidance rules--(1) In general. If a transaction is
engaged in or structured with a principal purpose to avoid treatment as
an intercompany transaction, or to avoid the purposes of this section,
adjustments must be made to carry out the purposes of this section.
(2) Examples. The anti-avoidance rules of this paragraph (h) are
illustrated by the following examples.
Example 1. Sale of a partnership interest. (a) Facts. S owns
land with a $10 basis and $100 value. B has net operating losses
from separate return limitation years (SRLYs) subject to limitation
under Sec. 1.1502-21(c). Pursuant to a plan to absorb the losses
without limitation by the SRLY rules, S transfers the land to an
unrelated, calendar- year partnership in exchange for a 10% interest
in the capital and profits of the partnership in a transaction to
which section 721 applies. The partnership does not have a section
754 election in effect. S later sells its partnership interest to B
for $100. In the following year, the partnership sells the land to X
for $100. Because the partnership does not have a section 754
election in effect, its $10 basis in the land does not reflect B's
$100 basis in the partnership interest. Under section 704(c), the
partnership's $90 built-in gain is allocated to B, and B's basis in
the partnership interest increases to $190 under section 705. In a
later year, B sells the partnership interest to X for $100.
(b) Adjustments. Under Sec. 1.1502-21(c), the partnership's $90
built-in gain allocated to B ordinarily increases the amount of B's
SRLY limitation, and B's $90 loss from its sale of the partnership
interest ordinarily is not subject to limitation under the SRLY
rules. Under paragraph (h)(1) of this section, however, B's
allocable share of the partnership's gain from its sale of the land
is treated as not increasing the amount of B's SRLY limitation.
Example 2. Sale to a related party. (a) Facts. S and B
manufacture complimentary products that are sold in similar markets.
On January 1 of Year 1, S and B enter into a partnership agreement
to engage in common distribution. The partnership is formed and
operated for substantial nontax, business reasons and is treated as
a general partnership for Federal income tax purposes. S has loss
carryovers from separate return years subject to limitation under
section 382 as a result of an ownership change on January 1 of Year
1. S also has a net unrealized built-in gain (NUBIG) within the
meaning of section 382(h), and S owns land with $30 of unrealized
built-in gain that is included in the NUBIG. Pursuant to a plan to
take into account $30 of recognized built-in gain before the end of
the section 382(h)(7) recognition period without disposing of an
interest in the land, the partnership buys S's land on July 1 of
Year 3. On December 1 of Year 7, the partnership sells the land to
X.
(b) Adjustments. Under paragraph (b)(1) of this section, S's
sale to the partnership ordinarily would not be an intercompany
transaction. Under paragraph (h)(1) of this section, however, the
transaction is treated as an intercompany transaction. Thus, S's
gain is not taken into account until Year 7, as a result of the
partnership's sale to X. Because the gain is not recognized during
the section 382(h)(7) recognition period, it is not recognized
built-in gain under section 382(h).
Example 3. Transitory status as an intercompany obligation. (a)
Facts. P historically has owned 70% of X's stock and the remaining
30% is owned by unrelated shareholders. On January 1 of Year 1, S
borrows $100 from X in return for S's note requiring $10 of interest
annually at the end of each year, and repayment of $100 at the end
of Year 20. As of January 1 of Year 3, the P group has substantial
net operating loss carryovers, and the fair market value of S's note
falls to $70 due to an increase in prevailing market interest rates.
X is not permitted under section 166(a)(2) to take into account a
$30 loss with respect to the note. Pursuant to a plan to permit X to
take into account its $30 loss without disposing of the note, P
acquires an additional 10% of X's stock, causing X to become a
member, and P subsequently resells the 10% interest. X's $30 loss
with respect to the note is a net unrealized built-in loss within
the meaning of Sec. 1.1502-15.
(b) Adjustments. Under paragraph (g)(4) of this section, X
ordinarily would take into account its $30 loss as a result of the
note becoming an intercompany obligation, and S would take into
account $30 of discharge of indebtedness income. Under Sec. 1.1502-
22(c), X's loss is not combined with items of the other members and
the loss would be carried to X's separate return years as a result
of X becoming a nonmember. However, the transitory status of S's
indebtedness to X as an intercompany obligation is structured with a
principal purpose to accelerate the recognition of X's loss. Thus,
S's note is treated under paragraph (h)(1) of this section as not
becoming an intercompany obligation.
Example 4. Sale and leaseback. (a) Facts. S operates a factory
with a $70 basis and $100 value, and has loss carryovers from SRLYs.
Pursuant to a plan to take into account the $30 unrealized gain
while continuing to operate the factory, S sells the factory to X
for $100 and leases it back on a long-term basis. The sale and
leaseback are not recharacterized under general principles of
Federal income tax law. As a result of S's sale to X, the $30 gain
is taken into account and increases S's SRLY limitation.
(b) No adjustments. Although S's sale was pursuant to a plan to
accelerate the $30 gain, it is not subject to adjustment under
paragraph (h)(1) of this section. Because S has transferred
substantial interests in the factory to an unrelated person for
Federal income tax purposes, the sale is not treated as engaged in
or structured with a principal purpose to avoid treatment as an
intercompany transaction, or to avoid the single and separate entity
treatment that is the purpose of this section.
(i) [Reserved]
(j) Miscellaneous operating rules. For purposes of this section--
(1) Successors--(i) Assets. Any reference to an asset includes, as
the context may require, a reference to any other asset the basis of
which is determined, directly or indirectly, in whole or in part, by
reference to the first asset.
(ii) Persons--(A) In general. Any reference to a person includes,
as the context may require, a reference to a predecessor or successor.
For this purpose, a predecessor is a transferor of assets to a
transferee (the successor) in a transaction--
(1) To which section 381(a) applies;
(2) In which substantially all of the assets of the transferor are
transferred to members in a complete liquidation;
(3) In which the successor's basis in assets is determined
(directly or indirectly, in whole or in part) by reference to the basis
of the transferor, but the transferee is a successor only with respect
to the assets so determined; or
(4) Which is an intercompany transaction, but only with respect to
assets that are being accounted for by the transferor in a prior
intercompany transaction.
(B) Intercompany items. If the assets of a predecessor are acquired
by a successor member, the successor succeeds to, and takes into
account (under the rules of this section), the predecessor's
intercompany items. If two or more successor members acquire assets of
the predecessor, the successors take into account the predecessor's
intercompany items in a manner that is consistently applied and
reasonably carries out the purposes of this section and applicable
provisions of law.
(2) Acquisition of group--(i) Application. This paragraph (j)(2)
applies only if a consolidated group (the terminating group) ceases to
exist as a result of--
(A) The acquisition by a member of another consolidated group of
either the assets of the common parent of the terminating group in a
reorganization described in section 381(a)(2), or the stock of the
common parent of the terminating group; or
(B) The application of the principles of Sec. 1.1502-75 (d)(2) or
(d)(3).
(ii) General rule. The group that does not cease to exist (the
surviving group) is treated as the terminating group for purposes of
applying this section to the terminating group. For example,
intercompany items and corresponding items from intercompany
transactions between members of the terminating group are treated as
continuing to be reflected in the terminating group's consolidated
taxable income. This paragraph (j)(2) does not apply to members of the
terminating group that are not members of the surviving consolidated
group immediately after the terminating group ceases to exist (e.g.,
under section 1504(a)(3) relating to reconsolidation, or section
1504(c) relating to includible insurance companies).
(3) Former common parent treated as continuation of group. If a
group terminates because the common parent is the only remaining
member, the common parent succeeds to the treatment of the terminating
group for purposes of applying this section so long as it is not a
member of an affiliated group filing separate returns and does not
become a corporation described in section 1504(b). For example, if the
only subsidiary of the group liquidates into the common parent in a
complete liquidation to which section 332 applies, or the common parent
merges into the subsidiary and the subsidiary is treated as the common
parent's successor under paragraph (j)(1)(ii)(A) of this section, the
taxable income of the surviving corporation is treated as the group's
consolidated taxable income in which the intercompany and corresponding
items must be included. See Sec. 1.267(f)-1 for additional rules
applicable to intercompany losses or deductions.
(4) Becoming a nonmember. For purposes of this section, a member is
treated as becoming a nonmember if it has a separate return year
(including another group's consolidated return year). A member is not
treated as having a separate return year if its items are treated as
taken into account in computing the group's consolidated taxable income
under paragraph (j) (2) or (3) of this section.
(5) Recordkeeping. Intercompany and corresponding items must be
reflected on permanent records (including work papers). See also
section 6001, requiring records to be maintained. From such permanent
records the group must be able to identify the amount, location,
timing, and attributes of the items, so as to permit the application of
the rules of this section for each year.
(6) Examples. The operating rules of this paragraph (j) are
illustrated generally throughout this section, and by the following
examples.
Example 1. Intercompany sale followed by section 351 transfer to
member. (a) Facts. S holds land for investment with a basis of $70.
On January 1 of Year 1, S sells the land to M for $100. M also holds
the land for investment. On July 1 of Year 3, M transfers the land
to B in exchange for all of B's stock in a transaction to which
section 351 applies. Under section 358, M's basis in the B stock is
$100. B holds the land for sale to customers in the ordinary course
of business and, under section 362(b), B's basis in the land is
$100. On December 1 of Year 5, M sells 20% of the B stock to X for
$22. In an unrelated transaction on July 1 of Year 8, B sells 20% of
the land for $22.
(b) Definitions. Under paragraph (b)(1) of this section, S's
sale of the land to M and M's transfer of the land to B are both
intercompany transactions. S is the selling member and M is the
buying member in the first intercompany transaction, and M is the
selling member and B is the buying member in the second intercompany
transaction. M has no intercompany items under paragraph (b)(2) of
this section. Because B acquired the land in an intercompany
transaction, B's items from the land are corresponding items to be
taken into account under this section. Under the successor asset
rule of paragraph (j)(1)(i) of this section, references to the land
include references to M's B stock. Under the successor person rule
of paragraph (j)(1)(ii) of this section, references to M include
references to B with respect to the land.
(c) Timing and attributes resulting from the stock sale. Under
paragraph (c)(3)(i) of this section, M is treated as owning and
selling B's stock for purposes of the matching rule even though, as
divisions, M could not own and sell stock in B. Under paragraph
(c)(3)(ii)(A) of this section, both M's B stock and B's land can
cause S's intercompany gain to be taken into account under the
matching rule of paragraph (c) of this section. Thus, S takes $6 of
its gain into account in Year 5 to reflect the $6 difference between
M's $2 gain taken into account from its sale of B stock and its $8
recomputed gain. Under paragraph (c)(3)(ii)(B) of this section, the
attributes of this gain are determined by treating S, M, and B as
divisions of a single corporation. Under paragraph (c)(3)(iii)(A) of
this section, S's $6 gain and M's $2 gain are treated as long-term
capital gain. The gain would be capital on a separate entity basis
(assuming that section 341 does not apply), and this treatment is
not inconsistent with treating S, M, and B as divisions of a single
corporation because the stock sale and subsequent land sale are
unrelated transactions and B remains a member following the sale.
(d) Timing and attributes resulting from the land sale. Under
paragraph (c)(3)(ii)(A) of this section, S takes $6 of its gain into
account in Year 8 under the matching rule to reflect the $6
difference between B's $2 gain taken into account from its sale of
an interest in the land and its $8 recomputed gain. Under paragraph
(c)(3)(ii)(B) of this section, the attributes of this gain are
determined by treating S, M, and B as divisions of a single
corporation and taking into account the activities of S, M, and B
with respect to the land. Thus, both S's gain and B's gain might be
ordinary income as a result of B's activities. (If B subsequently
sells the balance of the land, paragraph (a)(4) of this section
limits S's gain taken into account to its remaining $18 of
intercompany gain.)
(e) Sale of successor stock resulting in deconsolidation. The
facts are the same as in paragraph (a) of this Example 1, except
that M sells 60% of the B stock to X for $66 on December 1 of Year 5
and B becomes a nonmember. Under the matching rule, M's sale of B
stock results in $18 of S's gain being taken into account (to
reflect the difference between M's $6 gain taken into account and
its $24 recomputed gain). Under the acceleration rule of paragraph
(d) of this section, however, the entire $30 gain is taken into
account (to reflect B becoming a nonmember, because its basis in the
land reflects M's $100 cost basis from the prior intercompany
transaction). Under paragraph (c)(3)(ii)(A) of this section, S's
entire $30 intercompany gain is taken into account under the
acceleration rule of paragraph (d) of this section. Under paragraph
(c)(3)(ii)(B) of this section, the attributes of S's gain are
determined by treating S, M, and B as divisions of a single
corporation. Because M's cost basis in the land will be reflected by
B as a nonmember, all of S's gain is treated as from the land
(rather than a portion being from B's stock), and B's activities
with respect to the land may therefore result in S's gain being
ordinary income.
Example 2. Intercompany sale of member stock followed by
recapitalization. (a) Facts. Before becoming a member of the P
group, S owns P stock with a basis of $70. On January 1 of Year 1, P
buys all of S's stock. On July 1 of Year 3, S sells the P stock to M
for $100. On December 1 of Year 5, P acquires M's original P stock
in exchange for new P stock in a recapitalization described in
section 368(a)(1)(E).
(b) Timing and attributes. Although paragraph (f)(4) of this
section eliminates P's basis in the stock acquired from M, the new P
stock received by M is exchanged basis property (within the meaning
of section 7701(a)(44)) having a basis under section 358 equal to
M's basis in the original P stock. Under the successor asset rule of
paragraph (j)(1)(i) of this section, references to M's original P
stock include references to M's new P stock. Under paragraph
(c)(3)(ii)(A) of this section, if more than one corresponding item
can cause S's intercompany gain to be taken into account under the
matching rule, the gain is taken into account in connection with the
corresponding item most consistent with the treatment of S, M, and P
as divisions of a single corporation. S's gain is not taken into
account as a result of the basis elimination under paragraph (f)(4)
of this section. Instead, the gain is taken into account based on
subsequent events with respect to M's new P stock (e.g., a
subsequent distribution or redemption of the new stock).
Example 3. Successor group. (a) Facts. On January 1 of Year 1, B
borrows $100 from S in return for B's note providing for $10 of
interest annually at the end of each year, and repayment of $100 at
the end of Year 20. As of January 1 of Year 3, B has paid the
interest accruing under the note. On that date, X acquires all of
P's stock and the former P group members become members of the X
consolidated group.
(b) Successor. Under paragraph (j)(2) of this section, although
B's note ceases to be an intercompany obligation of the P group, the
note is not treated as satisfied and reissued under paragraph (g) of
this section as a result of X's acquisition of P stock. Instead, the
X consolidated group succeeds to the treatment of the P group for
purposes of paragraph (g) of this section, and B's note is treated
as an intercompany obligation of the X consolidated group.
(c) No subgroups. The facts are the same as in paragraph (a) of
this Example 3, except that X simultaneously acquires the stock of S
and B from P (rather than X's acquiring all of P's stock). Paragraph
(j)(2) of this section does not apply to X's acquisitions. Unless
the exception in paragraph (g)(3)(i)(B) applies, B's note is treated
as satisfied immediately before S and B become nonmembers, and
reissued immediately after they become members of the X consolidated
group. The amount at which the note is satisfied and reissued under
paragraph (g)(3) of this section is based on the fair market value
of the note at the time of P's sales to X. Paragraph (g)(4) of this
section does not apply to the reissued B note in the X consolidated
group, because the new note is always an intercompany obligation of
the X consolidated group.
Example 4. Liquidation--80% distributee. (a) Facts. X has had
preferred stock described in section 1504(a)(4) outstanding for
several years. On January 1 of Year 1, S buys all of X's common
stock for $60, and B buys all of X's preferred stock for $40. X's
assets have a $0 basis and $100 value. On July 1 of Year 3, X
distributes all of its assets to S and B in a complete liquidation.
Under Sec. 1.1502-34, section 332 applies to both S and B. Under
section 337, X has no gain or loss from its liquidating distribution
to S. Under sections 336 and 337(c), X has a $40 gain from its
liquidating distribution to B. B has a $40 basis under section
334(a) in the assets received from X, and S has a $0 basis under
section 334(b) in the assets received from X.
(b) Intercompany items from the liquidation. Under the matching
rule, X's $40 gain from its liquidating distribution to B is not
taken into account under this section as a result of the liquidation
(and therefore is not yet reflected under Secs. 1.1502-32 and
1.1502-33). Under the successor person rule of paragraph
(j)(1)(ii)(A) of this section, S and B are both successors to X. S
is the only successor to X under section 381(a). Under paragraph
(j)(1)(ii)(B) of this section, to be consistent with the anti-
avoidance rules of paragraph (h)(1) of this section, S succeeds to
X's $40 intercompany gain. The gain will be taken into account by S
under the matching and acceleration rules of this section based on
subsequent events. (The allocation of the intercompany gain to S
does not govern the allocation of any other attributes.)
Example 5. Liquidation--no 80% distributee. (a) Facts. X has
only common stock outstanding. On January 1 of Year 1, S buys 60% of
X's stock for $60, and B buys 40% of X's stock for $40. X's assets
have a $0 basis and $100 value. On July 1 of Year 3, X distributes
all of its assets to S and B in a complete liquidation. Under
Sec. 1.1502-34, section 332 applies to both S and B. Under sections
336 and 337(c), X has a $100 gain from its liquidating distributions
to S and B. Under section 334(b), S has a $60 basis in the assets
received from X and B has a $40 basis in the assets received from X.
(b) Intercompany items from the liquidation. Under the matching
rule, X's $100 intercompany gain from its liquidating distributions
to S and B is not taken into account under this section as a result
of the liquidation (and therefore is not yet reflected under
Secs. 1.1502-32 and 1.1502-33). Under the successor person rule of
paragraph (j)(1)(ii)(A) of this section, S and B are both successors
to X. Under paragraph (j)(1)(ii)(B) of this section, to be
consistent with the anti-avoidance rules of paragraph (h)(1) of this
section, S succeeds to X's $40 intercompany gain with respect to the
assets distributed to B, and B succeeds to X's $60 intercompany gain
with respect to the assets distributed to S. The gain will be taken
into account by S and B under the matching and acceleration rules of
this section based on subsequent events. (The allocation of the
intercompany gain does not govern the allocation of any other
attributes.)
(k) Cross references--(1) Section 108. See Sec. 1.108-3 for the
treatment of intercompany deductions and losses as subject to attribute
reduction under section 108(b).
(2) Section 263A(f). See section 263A(f) for special rules
regarding interest from intercompany transactions.
(3) Section 267(f). See section 267(f) for special rules applicable
to certain losses and deductions transactions between members of a
controlled group.
(4) Section 382. See Sec. 1.1502-91(g) and (h) for the treatment of
intercompany items as built-in amounts under section 382.
(5) Section 460. See Sec. 1.460-4(j) for special rules regarding
the application of section 460 to intercompany transactions.
(6) Section 469. See Sec. 1.469-1(h) for special rules regarding
the application of section 469 to intercompany transactions.
(7) Sec. 1.1502-80. See Sec. 1.1502-80 for the nonapplication of
certain Internal Revenue Code rules.
(l) Effective dates--(1) In general. This section applies with
respect to transactions occurring in years beginning on or after [the
date the final regulations are filed with the Federal Register]. If
both this section and prior law apply to a transaction, or neither
applies, with the result that items are duplicated, omitted, or
eliminated in determining taxable income (or tax liability), or items
are treated inconsistently, prior law (and not this section) applies to
the transaction. For example, an intercompany dividend to which a
shareholder becomes entitled before [the date the final regulations are
filed with the Federal Register] but which is distributed after that
date is taken into account under prior law (generally when
distributed), because this section generally takes dividends into
account when the shareholder becomes entitled to them but this section
does not apply at that time.
(2) Avoidance transactions. This paragraph (l)(2) applies if a
transaction is engaged in or structured on or after April 8, 1994, with
a principal purpose to avoid the rules of this section applicable to
transactions occurring in years beginning on or after [the date the
final regulations are filed with the Federal Register], to duplicate,
omit, or eliminate an item in determining taxable income (or tax
liability), or to treat items inconsistently. If this paragraph (l)(2)
applies, appropriate adjustments must be made in years beginning on or
after [the date the final regulations are filed with the Federal
Register], to prevent the avoidance, duplication, omission,
elimination, or inconsistency.
(3) Prior law. For transactions occuring in S's years beginning
before [the date the final regulations are filed with the Federal
Register], see the applicable regulations issued under section 1502.
See Secs. 1.1502-13, 1.1502-13T, 1.1502-14, 1.1502-14T, 1.1502-31, and
1.1502-32 (as contained in the 26 CFR part 1 edition revised as of
April 1, 1994).
Secs. 1.1502-13T, 1.1502-14, and 1.1502-14T [Removed]
Par. 13. Sections 1.1502-13T, 1.1502-14, and 1.1502-14T are
removed.
Par. 14. Section 1.1502-17 is amended as follows:
1. Paragraph (c) is redesignated as paragraph (d).
2. New paragraph (c) is added.
3. Newly designated paragraph (d) is amended by:
a. Revising the paragraph heading.
b. Revising the introductory text.
c. Designating the existing example as Example 1 and revising the
heading.
d. Adding Example 2, and 3.
5. The added and revised provisions read as follows:
Sec. 1.1502-17 Methods of accounting.
* * * * *
(c) Anti-avoidance rules--(1) General rule. If one member (B)
directly or indirectly acquires an activity of another member (S) or
undertakes S's activity, with the principal purpose to avail the group
of an accounting method that would be unavailable without securing
consent from the Commissioner if S and B were treated as divisions of a
single corporation, B must use the accounting method for the acquired
or undertaken activity determined under paragraph (c)(2) of this
section or secure consent from the Commissioner for a different method.
(2) Treatment as divisions of a single corporation. B must use the
method of accounting that would be required if B acquired or undertook
the activity in a transaction to which section 381 applies. Thus, the
principles of section 381(c)(4) and (c)(5) apply to resolve any
conflicts between the accounting methods of S and B, and the acquired
or undertaken activity is treated as having the accounting method used
by S. Appropriate adjustments are made to treat all acquisitions or
undertakings that are part of the same plan or arrangement as a single
acquisition or undertaking.
(3) Effective date. This paragraph (c) applies with respect to
acquisitions or undertakings occurring in years beginning on or after
[the date the final regulations are filed with the Federal Register].
(d) Examples. The provisions of this section are illustrated by the
following examples:
Example 1. Separate return treatment generally. * * *
Example 2. Adopting methods. (a) Corporation P is a member of a
consolidated group. P is a service provider with substantial parts
and supplies on hand for use in its repair service business. P
capitalizes its cost for the parts and supplies and deducts the cost
under Sec. 1.162-3. P is unable to adopt a LIFO inventory method
under section 472 because the parts and supplies are used solely in
its service business. With the principal purpose to avail of a LIFO
inventory method, P forms corporation S, and S begins to purchase
and maintain all of the parts and supplies using a LIFO inventory
method. P purchases the parts and supplies that it needs from S, and
S's only customer is P.
(b) Under paragraph (c) of this section, S must account for the
parts and supplies under Sec. 1.162-3 rather than adopting a LIFO
inventory method.
Example 3. Changing inventory sub-method. (a) Corporation P is a
member of a consolidated group. P operates a manufacturing business
that uses dollar-value LIFO, and has built up a substantial LIFO
reserve. P has historically manufactured all its inventory and has
used one natural business unit pool. P begins purchasing goods
identical to its own finished goods from a foreign supplier, and is
concerned that it must establish a separate resale pool under
Sec. 1.472-8(c). P anticipates that it will begin to purchase,
rather than manufacture, a substantial portion of its inventory,
resulting in a recapture of most of its LIFO reserve because of
decrements in its manufacturing pool. With the principal purpose to
avoid the decrements, P forms corporation S in Year 1. S operates as
a distributor to nonmembers, and P sells all of its existing
inventories to S. S adopts LIFO, and elects dollar-value LIFO with
one resale pool. Thereafter, P continues to manufacture and purchase
inventory, and to sell it to S for resale to nonmembers. P's
intercompany gain from sales to S is taken into account under
Sec. 1.1502-13. S maintains its Year 1 base dollar value of
inventory to prevent the recognition of the intercompany items by P
that include the LIFO reserve.
(b) Under paragraph (c) of this section, S must maintain two
pools (manufacturing and resale) in the manner that P would be
required to maintain under Sec. 1.472-8.
Par. 15. Section 1.1502-18 is amended by revising the heading for
paragraph (f) and adding paragraph (g) to read as follows:
Sec. 1.1502-18 Inventory adjustment.
* * * * *
(f) Transitional rules for years before 1966. * * *
(g) Transitional rules for years beginning on or after [the date
the final regulations are filed with the Federal Register]. Paragraphs
(a) through (f) of this section do not apply for taxable years
beginning on or after [the date the final regulations are filed with
the Federal Register]. Any remaining unrecovered inventory amount of a
member under paragraph (c) of this section is recovered in the first
taxable year beginning on or after [the date the final regulations are
filed with the Federal Register], under the principles of paragraph
(c)(3) of this section by treating the first taxable year as the first
separate return year of the member. The unrecovered inventory amount
can be recovered only to the extent it was previously included in
taxable income. The principles of this section apply, with appropriate
adjustments, to comparable amounts under paragraph (f) of this section.
Par. 16. Section 1.1502-20 is amended as follows:
1. Paragraph (a)(5) Example (6) is amended as follows:
a. The fifth sentence of paragraph (i) is revised.
b. Paragraphs (ii) and (iii) are revised.
c. Paragraph (iv) is added.
2. Paragraph (b)(6) Example (5) is amended as follows:
a. The fifth sentence of paragraph (i) is revised.
b. A sentence is added at the beginning of paragraph (ii).
c. Paragraph (iii) is revised.
d. Paragraph (iv) is removed.
3. Paragraph (b)(6) Example (7) is amended as follows:
a. The fourth sentence of paragraph (i) is revised.
b. The first sentence of paragraph (iii) is revised.
4. Paragraph (c)(4) is amended as follows:
a. Example (3) is amended by removing paragraph (iii).
b. Example (9) is added.
5. Paragraph (e)(3) is amended as follows:
a. Example (2) is removed.
b. Example (3) through Example (8) are redesignated as Example (2)
through Example (7).
c. Newly designated Example (5) is revised.
d. Newly designated Example (7) is removed.
6. In paragraph (h)(1), the second sentence is revised.
7. The revised and added provisions read as follows:
Sec. 1.1502-20 Disposition or deconsolidation of subsidiary stock.
(a) * * *
(5) * * *
Example (6). * * *
(i) * * * S sells its T stock to P for $100 in an intercompany
transaction, recognizing a $60 intercompany loss that is deferred
under section 267(f) and Sec. 1.1502-13. * * *
(ii) Under paragraph (a)(3)(i) of this section, the application
of paragraph (a)(1) of this section to S's $60 intercompany loss on
the sale of its T stock to P is deferred, because S's intercompany
loss is deferred under section 267(f) and Sec. 1.1502-13. P's sale
of the T stock to X ordinarily would result in S's intercompany loss
being taken into account under the matching rule of Sec. 1.1502-
13(c). The deferred loss is not taken into account under
Sec. 1.267(f)-1, however, because P's sale to X (a member of the
same controlled group as P) is a second intercompany transaction for
purposes of section 267(f). Nevertheless, paragraph (a)(3)(ii) of
this section provides that paragraph (a)(1) of this section applies
to the intercompany loss as a result of P's sale to X because the T
stock ceases to be owned by a member of the P consolidated group.
Thus, the loss is disallowed under paragraph (a)(1) of this section
immediately before P's sale and is therefore never taken into
account under section 267(f).
(iii) The facts are the same as in (i) of this Example, except
that S is liquidated after its sale of the T stock to P, but before
P's sale of the T stock to X, and P sells the T stock to X for $110.
Under Secs. 1.1502-13(j) and 1.267(f)-1(b), P succeeds to S's
intercompany loss as a result of S's liquidation. Thus, paragraph
(a)(3)(i) of this section continues to defer the application of
paragraph (a)(1) of this section until P's sale to X. Under
paragraph (a)(4) of this section, the amount of S's $60 intercompany
loss disallowed under paragraph (a)(1) of this section is limited to
$50 because P's $10 gain on the disposition of the T stock is taken
into account as a consequence of the same plan or arrangement.
(iv) The facts are the same as in (i) of this Example, except
that P sells the T stock to A, a person related to P within the
meaning of section 267(b)(2). Although S's intercompany loss is
ordinarily taken into account under the matching rule of
Sec. 1.1502-13(c) as a result of P's sale, Sec. 1.267(f)-1(c)(2)(ii)
provides that none of the intercompany loss is taken into account
because A is a nonmember that is related to P under section 267(b).
Under paragraph (a)(3)(i) of this section, paragraph (a)(1) of this
section does not apply to loss that is disallowed under any other
provision. Because Sec. 1.267(f)-1(c)(2)(ii) and section 267(d)
provide that the benefit of the intercompany loss is retained by A
if the property is later disposed of at a gain, the intercompany
loss is not disallowed for purposes of paragraph (a)(3)(i) of this
section. Thus, the intercompany loss is disallowed under paragraph
(a)(1) of this section immediately before P's sale and is therefore
never taken into account under section 267(d).
(b) * * *
(6) * * *
Example (5). * * *
(i) * * * S sells its T stock to P for $100 in an intercompany
transaction, recognizing a $60 intercompany loss that is deferred
under section 267(f) and Sec. 1.1502-13. * * *
(ii) Under paragraph (a)(3)(i) of this section, the application
of paragraph (a)(1) of this section to S's intercompany loss on the
sale of its T stock to P is deferred because S's loss is deferred
under section 267(f) and Sec. 1.1502-13. * * *
(iii) T's issuance of the additional shares to the public does
not result in S's intercompany loss being taken into account under
the matching or acceleration rules of Sec. 1.1502-13 (c) and (d), or
under the application of the principles of those rules in section
267(f). However, the deconsolidation of T is an overriding event
under paragraph (a)(3)(ii) of this section, and paragraph (a)(1) of
this section disallows the intercompany loss immediately before the
deconsolidation even though the intercompany loss is not taken into
account at that time.
Example (7). * * *
(i) * * * S recently purchased its T stock from S1, a lower tier
subsidiary, in an intercompany transaction in which S1 recognized a
$30 intercompany gain that was deferred under Sec. 1.1502-13. * * *
* * * * *
(iii) Under the matching rule of Sec. 1.1502-13, S's sale of its
T stock results in S1's $30 intercompany gain being taken into
account. * * *
* * * * *
(c) * * *
(4) * * *
Example (9). Intercompany stock sales.
(i) P is the common parent of a consolidated group, S is a
wholly owned subsidiary of P, and T is a wholly owned recently
purchased subsidiary of S. S has a $100 basis in the T stock, and T
has a capital asset with a basis of $0 and a value of $100. T's
asset declines in value to $60. Before T has any positive investment
adjustments or extraordinary gain dispositions, S sells its T stock
to P for $60. T's asset reappreciates and is sold for $100, and T
recognizes $100 of gain. Under the investment adjustment system, P's
basis in the T stock increases to $160. P then sells all of the T
stock for $100 and recognizes a loss of $60.
(ii) S's sale of the T stock to P is an intercompany
transaction. Thus, S's $40 loss is deferred under section 267(f) and
Sec. 1.1502-13. Under paragraph (a)(3) of this section, the
application of paragraph (a)(1) of this section to S's $40 loss is
deferred until the loss is taken into account. Under the matching
rule of Sec. 1.1502-13(c), the loss is taken into account to reflect
the difference for each year between P's corresponding items taken
into account and P's recomputed corresponding items (the
corresponding items that P would take into account for the year if S
and P were divisions of a single corporation). If S and P were
divisions of a single corporation and the intercompany sale were a
transfer between the divisions, P would succeed to S's $100 basis
and would have a $200 basis in the T stock at the time it sells the
T stock ($100 of initial basis plus $100 under the investment
adjustment system). S's $40 loss is taken into account at the time
of P's sale of the T stock to reflect the $40 difference between the
$60 loss P takes into account and P's recomputed $100 loss.
(iv) Under the matching rule of Sec. 1.1502-13(c), the
attributes of S's $40 loss and P's $60 loss are redetermined to
produce the same effect on consolidated taxable income (and
consolidated tax liability) as if S and P were divisions of a single
corporation. Under Sec. 1.1502-13(b)(4), attributes of the losses
include whether they are disallowed under this section. Because the
amount described in paragraph (c)(1) of this section is $100, both
S's $40 loss and P's $60 loss are disallowed.
* * * * *
(e) * * *
(3) * * *
Example (5). Absence of a view.
(i) In Year 1, P buys all the stock of T for $100, and T becomes
a member of the P group. T has 2 historic assets, asset 1 with a
basis of $40 and value of $90, and asset 2 with a basis of $60 and
value of $10. In Year 2, T sells asset 1 for $90. Under the
investment adjustment system, P's basis in the T stock increases
from $100 to $150. Asset 2 is not essential to the operation of T's
business, and T distributes asset 2 to P in Year 5 with a view to
having the group retain its $50 loss inherent in the asset. Under
Sec. 1.1502-13(f)(2), and the application of the principles of this
rule in section 267(f), T has a $50 intercompany loss that is
deferred. Under Sec. 1.1502-32(b)(3)(iv), the distribution reduces
P's basis in the T stock by $10 to $140 in Year 5. In Year 6, P
sells all the T stock for $90. Under the acceleration rule of
Sec. 1.1502-13(d), and the application of the principles of this
rule in section 267(f), T's intercompany loss is ordinarily taken
into account immediately before P's sale of the T stock. Assuming
that the loss is absorbed by the group, P's basis in T's stock would
be reduced from $140 to $90 under Sec. 1.1502-32(b)(3)(i), and there
would be no gain or loss from the stock disposition. (Alternatively,
if the loss is not absorbed and the loss is reattributed to P under
paragraph (g) of this section, the reattribution would reduce P's
basis in T's stock from $140 to $90.)
(ii) A $50 loss is reflected both in T's basis in asset 2 and in
P's basis in the T stock. Because the distribution results in the
loss with respect to asset 2 being taken into account before the
corresponding loss reflected in the T stock, and asset 2 is an
historic asset of T, the distribution is not with the view described
in paragraph (e)(2) of this section.
* * * * *
(h) * * *
(1) * * * For this purpose, dispositions deferred under
Sec. 1.1502-13 are deemed to occur at the time the deferred gain or
loss is taken into account unless the stock was deconsolidated before
February 1, 1991. * * *
* * * * *
Par. 17. Section 1.1502-26 is amended by revising paragraph (b) to
read as follows:
Sec. 1.1502-26 Consolidated dividends received deduction.
* * * * *
(b) Intercompany dividends. The deduction determined under
paragraph (a) of this section is determined without taking into account
intercompany dividends to the extent that, under Sec. 1.1502-13(f)(2),
they are not included in gross income. See Sec. 1.1502-13 for
additional rules relating to intercompany dividends.
* * * * *
Par. 18. Section 1.1502-33, as proposed to be revised at 57 FR
53663, published November 12, 1992, is further amended by revising
paragraph (c)(2) to read as follows:
Sec. 1.1502-33 Earnings and profits.
* * * * *
(c) * * *
(2) Intercompany transactions. Intercompany items and corresponding
items are not reflected in earnings and profits before they are taken
into account under Sec. 1.1502-13. See Sec. 1.1502-13 for the
applicable rules and definitions.
* * * * *
Sec. 1.1502-79 [Amended]
Par. 19. Section 1.1502-79 is amended by removing paragraph (f).
Par. 20. Section 1.1502-80, as proposed to be amended at 57 FR
53670, published November 12, 1992, is further amended by adding
paragraphs (f) and (g) to read as follows:
Sec. 1.1502-80 Applicability of other provisions of law.
* * * * *
(f) Non-applicability of section 163(e)(5). Section 163(e)(5) does
not apply to any intercompany obligation (within the meaning of
Sec. 1.1502-13(g)) issued in a consolidated return year beginning on or
after [the date the final regulations are filed with the Federal
Register].
(g) Non-applicability of section 1031. Section 1031 does not apply
to any intercompany transaction occurring in consolidated return years
beginning on or after [the date the final regulations are filed with
the Federal Register].
Margaret Milner Richardson,
Commissioner of Internal Revenue.
[FR Doc. 94-8488 Filed 4-8-94; 1:03 pm]
BILLING CODE 4830-01-U