[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