[Federal Register Volume 61, Number 51 (Thursday, March 14, 1996)]
[Rules and Regulations]
[Pages 10447-10450]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-6151]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 8660]
RIN 1545-AT51
Consolidated Groups--Intercompany Transactions and Related Rules
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
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SUMMARY: This document contains final regulations disallowing losses
and excluding gain for certain dispositions and other transactions
involving stock of the common parent of a consolidated group.
DATES: These regulations are effective March 14, 1996.
For dates of applicability, see the effective date provision of
these regulations.
FOR FURTHER INFORMATION CONTACT: Victor Penico or Richard Osborne of
the Office of Assistant Chief Counsel (Corporate), (202) 622-7750 or
(202) 622-7770 (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collections of information contained in these final regulations
have been reviewed and approved by the Office of Management and Budget
in accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under
control number 1545-1433. Responses to these collections of information
are required to obtain a benefit, the avoidance of a possible gain
because of basis adjustments relating to built-in loss.
An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless the collection of
information displays a valid control number.
The estimated average annual burden per respondent is 15 minutes.
Comments concerning the accuracy of this burden estimate and
suggestions for reducing this burden should be sent to the Internal
Revenue Service, Attn: IRS Reports Clearance Officer, T:FP, Washington,
DC 20224, and to the Office of Management and Budget, Attn: Desk
Officer for the Department of the Treasury, Office of Information and
[[Page 10448]]
Regulatory Affairs, Washington, D.C. 20503.
Books or records relating to this collection of information must be
retained as long as their contents may become material in the
administration of any internal revenue law. Generally, tax returns and
tax return information are confidential, as required by 26 U.S.C. 6103.
Background
On July 12, 1995, the IRS and Treasury issued proposed and
temporary regulations disallowing loss incurred by a member (M) of a
consolidated group with respect to the stock of the common parent (P
stock). The regulations also eliminate gain in certain transactions by
M with respect to P stock. The regulations are effective for
transactions occurring on or after July 12, 1995.
The IRS received comments on the proposed regulations and held a
public hearing on December 11, 1995. After consideration of the
comments and the statements made at the hearing, the IRS and Treasury
adopt the proposed regulations with revisions in this Treasury
decision. The significant comments and changes are discussed below.
Explanation of Provisions
Scope of the regulations
The proposed regulations disallow all losses on P stock and
eliminate gain in specified circumstances. Some commentators suggested
that the regulations should treat gain and loss more symmetrically.
Some suggested the regulations should achieve this goal by eliminating
gain in all circumstances. Others suggested the regulations should
disallow loss only in ``abusive'' circumstances.
Eliminating gain in all circumstances would effectively require
complete single entity treatment of P stock. Implementing such a system
would significantly increase the complexity of the consolidated return
regulations. Notice 94-49 (1994-1 C.B. 358), included a detailed
discussion of issues relating to the single entity treatment of P
stock.
Limiting the loss disallowance rule to ``abusive situations'' would
allow consolidated groups to rely on the separate-entity treatment of
stock to claim losses and single-entity treatment to avoid gains. For
example, taxpayers might plan to take advantage of separate entity
treatment by having M purchase P stock. If the value of the stock has
gone down at a time when the group wants to issue equity, M will sell
its P stock at a loss (and claim the loss). If the value of the stock
has gone up, the group can take advantage of single entity treatment by
having P sell the stock, and no gain would be recognized under section
1032. The same would hold true if instead P had acquired M already
owning P stock. Commentators did not suggest any generally applicable
method of distinguishing between transactions in which loss should be
allowed and those in which loss should not be allowed.
The IRS and Treasury have therefore concluded that the final
regulations should retain the general approach of the proposed
regulations.
Built-in Losses
Some commentators suggested that if M joins the group at a time
when it holds P stock with a built-in loss the loss should be allowed
because it accrued outside the group. The final regulations do not
allow this loss because doing so without ensuring that the built-in
gain is taxed would allow the same selectivity and inconsistencies that
the regulation is designed to prevent. In addition, allowing the loss
would require tracing, which is inconsistent with the approaches to
similar issues in Secs. 1.1502-20 and 1.1502-32.
Commentators further suggested that interactions between the
proposed regulations and Sec. 1.1502-32 could cause the group to
recognize an artificial gain from the purchase of a corporation owning
depreciated P stock. If M joins the group at a time when it holds P
stock with a built-in loss and M subsequently sells the stock, P will
have a downward basis adjustment in its M stock because of the
disallowed loss. See Sec. 1.1502-32(b)(3)(iii)(A). The commentators
asserted that this basis adjustment would be inappropriate if the group
has a cost basis in M stock because the basis of M will reflect the
value of the P stock at the time of acquisition (rather than M's basis
in the P stock). To address this problem, the final regulations allow
the built-in loss to be waived immediately before M joins the group.
The loss waiver is modeled after a similar provision in Sec. 1.1502-
32(b)(4). The election, however, is limited to direct acquisitions of a
corporation holding P stock in a cost basis transaction.
Gain Relief
Commentators suggested that the gain relief should be broadened.
Some suggested that the requirement that M receive the P stock in a
capital contribution or section 351(a) transaction be eliminated.
Others suggested elimination of the requirement that M dispose of the P
stock immediately. Commentators also suggested that the gain relief
should apply to options and warrants in P stock, and not merely to P
stock.
The final regulations retain the requirements for gain relief but
extend the relief to positions in P stock. Any further expansion of the
gain relief would require additional limitations and complexities.
For instance, if M were not required to dispose of the P stock
immediately, the regulations would have to require that M have no
minority shareholders. If M had minority shareholders, the gain relief
mechanism (treating cash as contributed to M followed by a purchase of
the stock by M) would allow P a full basis adjustment in M stock for
post-contribution appreciation rather than a pro rata adjustment as
required by Sec. 1.1502-32 in the case of minority shareholders.
Amending the mechanism to allow only pro rata adjustments (for example,
through a direct basis adjustment rather than a cash transaction) would
create further complexities, such as the interaction with Sec. 1.1502-
20.
Expanding gain relief would require further adjustments if M stock
were sold to another member of the group. For example, if B purchases
the stock of M from another member, B's basis in M will reflect the
value of any P stock held by M. Thus, an increase to B's basis in the
stock of M when M disposes of P stock would be unwarranted. Additional
special rules would be needed if M were permitted to acquire P stock by
purchase rather than through a capital contribution. Moreover, the IRS
and Treasury believe that in many cases gain on P stock is avoidable
without further expansion of the regulations. See, e.g., Sec. 1.1032-
2(b) (no gain or loss on M's use of certain P stock in triangular
reorganizations). Therefore, the final regulations retain the
requirements of the proposed regulations for gain relief.
In addition, commentators claimed that the relief when M is newly
formed was unclear. The final regulations clarify that M can be newly
formed as part of the plan to dispose of P stock.
Dealers in P Stock
Some commentators suggested that if a subsidiary is a dealer in P
stock, it should be allowed to recognize losses from its dealing
activity. They argued that dealing in P stock increases the liquidity
of the stock and that the proposed regulations would curtail this
activity by forcing the recognition of gain but disallowing loss with
respect to P stock.
[[Page 10449]]
In response to these comments, the final regulations include an
exception for dealers in P stock or positions in P stock. Under the
final regulations, a dealer in P stock or positions recognizes both
gain and loss on shares of the stock to the extent taken into account
because of section 475(a) (or 1256(a) in the case of dealer equity
options). To be eligible for this exception, M must regularly trade in
P stock (of the same class) in the ordinary course of its business as a
dealer. In addition, the gain or loss on a share is eligible only to
the extent it is taken into account under section 475(a) (or in the
case of dealer equity options, section 1256(a) to the extent that it
would be taken into account under the principles of section 475), and
the basis of the share of stock must not be adjusted by reference to
the basis of any other property (for example, under Sec. 1.302-2) or by
reference to income, gain, deduction or loss from other property. For
example, loss that is suspended under section 475(b)(3) and that is
recognized under section 1001 as the result of a disposition of the
security is not eligible for the relief, but loss taken into account
under section 475(a) immediately before a taxpayer ceases to be the
owner of the security is eligible for relief. Finally, relief is not
available if either M or any other member of the group has structured
or engaged in any transaction while a member (or in anticipation of
becoming a member) during the taxable year or in any year within the
preceding five taxable years that is open for assessment under section
6501 with a principal purpose of avoiding gain or creating loss on P
stock subject to section 475(a).
Positions in P Stock
In response to comments, the final regulations clarify that the
scope of loss disallowance is coextensive with the scope of section
1032. For example, cash-settled options are within the scope of loss
disallowance. See Rev. Rul. 88-31 (1988-1 C.B. 302). No inference is
intended as to the extent to which section 1032 and these regulations
apply to derivative positions in P stock other than options.
One commentator argued that the loss disallowance rule should not
apply to options in P stock because the selectivity available for stock
is not present with respect to options. The final regulations do not
adopt this approach. If M purchases an option to acquire P stock and
the option expires when it is worthless, M has a loss. If the option is
in the money, M can purchase the P stock and hold it indefinitely.
Thus, the group would have the ability to recognize losses while
avoiding gains.
Effective Dates
The final regulations apply to gain or loss taken into account on
or after July 12, 1995, and to transactions (such as a member leaving
the group) occurring on or after July 12, 1995. Thus, the regulations
are intended to cover the same gain, loss and transactions covered by
the rules published in 1995--32 I.R.B. 47. If, however, a taxpayer
takes a gain or loss into account, or engages in a transaction, on or
after July 12, 1995, during a tax year ending prior to December 31,
1995, the taxpayer may treat the gain, loss or transaction under the
rules of the temporary rules published in 1995--32 I.R.B. 47 instead of
under the rules of the final regulations.
Special Analysis
It has been determined that this Treasury decision is not a
significant regulatory action as defined in EO 12866. Therefore, a
regulatory assessment is not required. It is hereby certified that
these regulations do not have a significant economic impact on a
substantial number of small entities. This certification is based on
the fact that these regulations will primarily affect affiliated groups
of corporations that have elected to file consolidated returns, which
tend to be larger businesses. The regulations do not significantly
alter the reporting or recordkeeping duties of small entities.
Therefore, a Regulatory Flexibility Analysis under the Regulatory
Flexibility Act (5 U.S.C. chapter 6) is not required. Pursuant to
section 7805(f) of the Internal Revenue Code, the notice of proposed
rulemaking preceding these regulations was submitted to the Small
Business Administration for comment on its impact on small business.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
Accordingly, 26 CFR part 1 is amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 is amended by
revising the entry for Sec. 1.1502-13 to read as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.1502-13 also issued under 26 U.S.C. 1502. * * *
Par. 2. In Sec. 1.267(f)-1(k), the first sentence is amended by
removing the reference ``1.1502-13T(f)(6)'' and adding ``1.1502-
13(f)(6)'' in its place.
Par. 3. Section 1.1502-13(f)(6) is added to read as follows:
Sec. 1.1502-13 Intercompany transactions.
* * * * *
(f) * * *
(6) Stock of common parent. In addition to the general rules of
this section, this paragraph (f)(6) applies to parent stock (P stock)
and positions in P stock held or entered into by another member. For
this purpose, P stock is any stock of the common parent held by another
member or any stock of a member (the issuer) that was the common parent
if the stock was held by another member while the issuer was the common
parent.
(i) Loss stock--(A) Recognized loss. Any loss recognized, directly
or indirectly, by a member with respect to P stock is permanently
disallowed and does not reduce earnings and profits. See Sec. 1.1502-
32(b)(3)(iii)(A) for a corresponding reduction in the basis of the
member's stock.
(B) Other cases. If a member, M, owns P stock, the stock is
subsequently owned by a nonmember, and, immediately before the stock is
owned by the nonmember, M's basis in the share exceeds its fair market
value, then, to the extent paragraph (f)(6)(i)(A) of this section does
not apply, M's basis in the share is reduced to the share's fair market
value immediately before the share is held by the nonmember. For
example, if M owns shares of P stock with a $100x basis and M becomes a
nonmember at a time when the P shares have a value of $60x, M's basis
in the P shares is reduced to $60x immediately before M becomes a
nonmember. Similarly, if M contributes the P stock to a nonmember in a
transaction subject to section 351, M's basis in the shares is reduced
to $60x immediately before the contribution. See Sec. 1.1502-
32(b)(3)(iii)(B) for a corresponding reduction in the basis of M's
stock.
(C) Waiver of built-in loss on P stock--(1) In general. If a
nonmember that owns P stock with a basis in excess of its fair market
value becomes a member of the P consolidated group in a qualifying cost
basis transaction, the group may make an irrevocable election to reduce
the basis of the P stock to its fair market value immediately before
the nonmember becomes a member of the P group. If the nonmember was a
member of another consolidated group immediately before becoming a
member of the P group, the reduction in basis is treated as occurring
immediately after it ceases to be a member of the prior group. A
qualifying cost basis transaction is the purchase (i.e., a transaction
in which basis is determined
[[Page 10450]]
under section 1012) by members of the P consolidated group (while they
are members) in a 12-month period of an amount of the nonmember's stock
satisfying the requirements of section 1504(a)(2).
(2) Election. The election described in this paragraph (6)(i)(C)
must be made in a separate statement entitled ``ELECTION TO REDUCE
BASIS OF P STOCK UNDER Sec. 1.1502-13(f)(6).'' The statement must be
filed with the P consolidated group's return for the year in which the
nonmember becomes a member, and it must be signed by both P and the
nonmember. The statement must identify the fair market value of, and
the amount of the basis reduction in, the P stock.
(ii) Gain stock. If a member, M, would otherwise recognize gain on
a qualified disposition of P stock, then immediately before the
qualified disposition, M is treated as purchasing the P stock from P
for fair market value with cash contributed to M by P (or, if
necessary, through any intermediate members). A disposition is a
qualified disposition only if--
(A) The member acquires the P stock directly from the common parent
(P) through a contribution to capital or a transaction qualifying under
section 351(a) (or, if necessary, through a series of such transactions
involving only members);
(B) Pursuant to a plan, the member transfers the stock immediately
to a nonmember that is not related, within the meaning of section
267(b) or 707(b), to any member of the group;
(C) No nonmember receives a substituted basis in the stock within
the meaning of section 7701(a)(42);
(D) The P stock is not exchanged for P stock;
(E) P neither becomes nor ceases to be the common parent as part
of, or in contemplation of, the disposition or plan; and
(F) M is neither a nonmember that becomes a member nor a member
that becomes a nonmember as part of, or in contemplation of, the
disposition or plan.
(iii) Mark-to-market of P stock. Paragraphs (f)(6)(i) and (ii) of
this section shall not apply to any gain or loss from a share of P
stock held by a member, M, if--
(A) M regularly trades in P stock (of the same class) with
customers in the ordinary course of its business as a dealer;
(B) The gain or loss on the share is taken into account by M
pursuant to section 475(a);
(C) M's basis in the share is not adjusted by reference to the
basis of any other property or by reference to income, gain, deduction,
or loss from other property; and
(D) Neither M nor any other member of the group has structured or
engaged in any transaction while a member (or in anticipation of
becoming a member), during the taxable year or in any year within the
preceding five taxable years that is open for assessment under section
6501, with a principal purpose of avoiding gain or creating loss on P
stock subject to section 475(a).
(iv) Options, warrants, and other positions--(A) In general. This
paragraph (f)(6) applies with appropriate adjustments to positions in P
stock to the extent that P's gain or loss from an equivalent position
would not be recognized under section 1032. Thus, if M purchases an
option to buy or sell P stock and sells the option at a loss, the loss
is permanently disallowed under paragraph (f)(6)(i)(A) of this section.
Similarly, if M is the grantor of such an option and becomes a
nonmember, then the principles of paragraph (f)(6)(i)(B) of this
section apply to the extent that M would recognize loss from cash
settlement of the option at its fair market value immediately before M
becomes a nonmember, and proper adjustments must be made in the amount
of any gain or loss subsequently realized from the position by M. If P
grants M an option to acquire P stock in a transaction meeting the
requirements of paragraph (f)(6)(ii) of this section, M is treated as
having purchased the option from P for fair market value with cash
contributed to M by P.
(B) Mark-to-market of positions in P stock. For purposes of
paragraph (f)(6)(iii) of this section, gain or loss with respect to a
position taken into account under section 1256(a) is treated as taken
into account under section 475(a) to the extent that the gain or loss
would be taken into account under the principles of section 475. -
(v) Effective date. This paragraph (f)(6) applies to gain or loss
taken into account on or after July 12, 1995, and to transactions
occurring on or after July 12, 1995. For example, if S sells P stock to
B at a loss prior to July 12, 1995, and B sells the P stock to a
nonmember after July 12, 1995, S's loss is disallowed because it is
taken into account after July 12, 1995. If a taxpayer takes a gain or
loss into account or engages in a transaction on or after July 12,
1995, during a tax year ending prior to December 31, 1995, the taxpayer
may treat the gain or loss or the transaction under the rules published
in 1995-32 I.R.B. 47, instead of under the rules of this paragraph
(f)(6).
* * * * *
Par. 4. In Sec. 1.1502-13(g)(2)(i)(B), the last sentence is amended
by removing the language ``paragraph (f)(4) of this section and
Sec. 1.1502-13T(f)(6)'' and adding ``paragraphs (f)(4) and (6) of this
section.''
Margaret Milner Richardson,
Commissioner of Internal Revenue.
Approved: March 8, 1996.
Leslie Samuels,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 96-6151 Filed 3-13-96; 8:45 am]
BILLING CODE 4830-01-P