[Federal Register Volume 69, Number 50 (Monday, March 15, 2004)]
[Rules and Regulations]
[Pages 12069-12072]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-5666]


=======================================================================
-----------------------------------------------------------------------

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9117]
RIN 1545-BC96


Guidance Under Section 1502; Application of Section 108 to 
Members of a Consolidated Group

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Temporary and final regulations.

-----------------------------------------------------------------------

SUMMARY: This document contains temporary regulations under section 
1502 that govern the application of section 108 when a member of a 
consolidated group realizes discharge of indebtedness income. These 
regulations affect corporations filing consolidated returns.

DATES: Effective Date: These regulations are effective March 15, 2004.
    Applicability Dates: For dates of applicability, see Sec. Sec.  
1.1502-13T(l) and 1.1502-28T(d).

FOR FURTHER INFORMATION CONTACT: Candace Ewell or Marie Milnes-Vasquez 
at (202) 622-7530 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background and Explanation of Provisions

    On September 4, 2003, the IRS and Treasury Department published in 
the Federal Register a notice of proposed rulemaking (REG-132760-03, 68 
FR 52542) and temporary regulations (TD 9089, 68 FR 52487) under 
section 1502 of the Internal Revenue Code. The temporary regulations 
added Sec.  1.1502-28T, which provides guidance regarding the 
determination of the attributes that are available for reduction when a 
member of a consolidated group realizes discharge of indebtedness 
income that is excluded from gross income (excluded COD income) and the 
method for reducing those attributes. Section 1.1502-28T reflects a 
consolidated approach that is intended to make available for reduction 
attributes that are available to the debtor member. The regulations 
contain a rule governing the order in which attributes are reduced and 
a look-through rule that provides that when the basis of stock of a 
member (the lower-tier member) that is owned by another member is 
reduced, the lower-tier member must reduce its attributes as if it had 
realized excluded COD income in the amount of the basis reduction.
    On December 11, 2003, the IRS and Treasury Department published in 
the Federal Register a notice of proposed rulemaking (REG-153319-03, 68 
FR 69062) and temporary regulations (TD 9098, 68 FR 69024) under 
section 1502 amending Sec.  1.1502-28T. Those regulations clarify that 
certain attributes that arise (or are treated as arising) in a separate 
return year are subject to reduction when no SRLY limitation applies to 
the use of such attributes.
    The IRS and Treasury Department have received comments regarding 
certain technical issues that arise under the regulations. The 
temporary regulations included in this document address certain issues 
related to the application of section 1245 and the matching rule of 
Sec.  1.1502-13, and certain issues related to the inclusion of excess 
loss accounts in cases in which excluded COD income is not fully 
applied to reduce attributes. The IRS and Treasury Department 
anticipate that there may be further changes to the regulations but 
believe that immediate guidance on these issues is desirable. The 
following sections describe these issues and the manner in which they 
are addressed in these temporary regulations.

A. Application of Section 1245

    Under section 108(b), asset basis is an attribute that is subject 
to reduction in respect of excluded COD income. Under section 
108(b)(5), the taxpayer may elect to apply any portion of excluded COD 
income to reduce basis in depreciable assets under the rules of section 
1017 prior to reducing other attributes.
    Section 1017 provides rules that apply in cases in which excluded 
COD income is applied to reduce the basis of property. Under section 
1017(d)(1), any property the basis of which is reduced and which is 
neither section 1245 property nor section 1250 property is treated as 
section 1245 property and the basis reduction is treated as a deduction 
allowed for depreciation. Under section 1017(b)(3)(D), if a corporation 
that has excluded COD income is a member of a consolidated group, it 
can elect to treat the stock of another member as depreciable property 
if that other member consents to a corresponding

[[Page 12070]]

reduction in the basis of its depreciable property.
    Generally, if section 1245 property is disposed of, the amount by 
which the lower of (1) the recomputed basis of the property, or (2) in 
the case of a sale, exchange or involuntary conversion, the amount 
realized, or (3) in the case of any other disposition, the fair market 
value of such property, exceeds the adjusted basis of such property is 
treated as ordinary income (the recapture amount). The recomputed basis 
is the adjusted basis of property increased by adjustments reflected in 
that basis that are attributable to deductions allowed or allowable for 
depreciation or amortization. Application of the recapture rule of 
section 1245 to property the basis of which has been reduced by reason 
of the realization of excluded COD income ensures that the character of 
the income deferred by reason of attribute reduction (i.e., the extra 
gain that may be recognized on the disposition of an asset the basis of 
which has been reduced) will be ordinary (even if the asset is held as 
a capital asset), which character the excluded COD income would have 
had if it had been included in income when realized.
    Commentators have noted that if the basis of subsidiary stock is 
reduced in respect of a member's excluded COD income and then the basis 
of the assets of that subsidiary are reduced pursuant to the look-
through rule, both the stock of the subsidiary as well as its assets 
would be treated as section 1245 property. As a result of that 
treatment, in certain cases, the group may be required to include in 
income an inappropriate amount of ordinary income. A similar result may 
obtain if a member consents under section 1017(b)(3)(D) to reduce the 
basis of its depreciable property when stock of the subsidiary is 
treated as depreciable property.
    For example, assume a member (a higher-tier member) realizes 
excluded COD income that is applied to reduce the higher-tier member's 
basis in the stock of another member (a lower-tier member) and, as a 
result, a corresponding reduction to the basis of property of the 
lower-tier member is made. The following year, the lower-tier member 
transfers all of its assets to the higher-tier member in a liquidation 
to which section 332 applies. Under section 1245, recapture on the 
lower-tier member's property that is treated as section 1245 property 
by reason of section 1017(d)(1) is limited to the amount of the gain 
recognized by the lower-tier member in the liquidation. However, no 
similar limitation applies to the stock of the lower-tier member that 
is also treated as section 1245 property. Therefore, the higher-tier 
member would be required to include as ordinary income the entire 
recapture amount with respect to the lower-tier member stock. In 
addition, when the higher-tier member sells the assets of the former 
lower-tier member the bases of which were reduced, the higher-tier 
member would be required to include as ordinary income the recapture 
amount with respect to such assets. In that case, the group may be 
required to include in consolidated taxable income the amounts 
representing the same excluded COD income more than once.
    The IRS and Treasury Department believe that it is appropriate for 
the group to include in income as ordinary income amounts reflecting 
previously excluded COD income only once. Therefore, to prevent a 
double inclusion of ordinary income amounts representing the same 
excluded COD income, these regulations provide that a reduction of the 
basis of subsidiary stock is treated as a deduction allowed for 
depreciation only to the extent that the amount by which the basis of 
the subsidiary stock is reduced exceeds the total amount of the 
attributes attributable to such subsidiary that are reduced pursuant to 
the subsidiary's consent under section 1017(b)(3)(D) or as a result of 
the application of the look-through rule. This rule has the effect of 
limiting the ordinary income recapture amount to the amount of the 
stock basis reduction that does not result in a corresponding reduction 
of the tax attributes attributable to the subsidiary.

B. Application of Matching Rule

    If the member that realizes excluded COD income is the creditor 
with respect to an intercompany obligation, it is possible that the 
basis of that intercompany obligation would be reduced under sections 
108 and 1017, and Sec.  1.1502-28T. Section 1.1502-13 provides rules 
relating to the treatment of transactions between members of a 
consolidated group. In general, in the case of a transaction between 
two members (S and B) of a consolidated group, the regulations operate 
to match the items of both members. In particular, under Sec.  1.1502-
13(c)(1)(i), the separate entity attributes of S's intercompany items 
and B's corresponding items are redetermined to the extent necessary 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. Under paragraph Sec.  1.1502-13(c)(6)(i), subject to 
certain limitations, S's intercompany item might be redetermined to be 
excluded from gross income or treated as a noncapital, nondeductible 
amount.
    Some commentators have asked whether the rule of Sec.  1.1502-
13(c)(6)(i) operates to exclude from gross income any income recognized 
that is attributable to the application of excluded COD income to 
reduce the basis of an intercompany obligation. The application of the 
rule of Sec.  1.1502-13(c)(6)(i) in this manner would render without 
consequence the reduction of the basis of the intercompany obligation. 
These temporary regulations, therefore, reflect the IRS's and Treasury 
Department's position that, if the basis of an intercompany obligation 
held by a creditor member is reduced in respect of excluded COD income, 
Sec.  1.1502-13(c)(6)(i) will not apply to exclude income of the 
creditor member attributable to the basis reduction in the intercompany 
obligation.

C. Taking Into Account of Excess Loss Account

    Under Sec. Sec.  1.1502-19 and 1.1502-19T, when an indebtedness of 
a subsidiary is discharged and any part of the amount discharged is not 
included in gross income and is not treated as tax-exempt income under 
Sec.  1.1502-32, if there is an excess loss account in the stock of the 
subsidiary, that excess loss account must be included in income to the 
extent of the amount discharged that is not treated as tax-exempt 
income. Questions have arisen regarding the timing of the taking into 
account of excess loss accounts required pursuant to Sec. Sec.  1.1502-
19 and 1.1502-19T.
    The IRS and Treasury Department have considered whether an excess 
loss account that is required to be included as a result of the 
application of Sec.  1.1502-19(c)(1)(iii)(B) is properly included in 
the group's consolidated taxable income for the taxable year that 
includes the date on which the member realizes the excluded COD income. 
Some have suggested that, because pursuant to section 108(b)(4)(A) 
attributes are reduced only after the computation of tax for the year 
of the excluded COD income and, therefore, whether an excess loss 
account must be included in income is determined only after the 
computation of tax, the inclusion of the excess loss account should not 
be required on the return for the taxable year that includes the date 
on which the excluded COD income was realized. Because the inclusion of 
the excess loss account is required in connection with the realization 
of the excluded COD income, the IRS and

[[Page 12071]]

Treasury Department believe that it is properly included on the return 
for the taxable year that includes the date on which the excluded COD 
income was realized.
    Some have suggested that inclusion of the excess loss account on 
the return for the taxable year that includes the date on which the 
excluded COD income was realized could result in circular calculations. 
That is, the inclusion of the excess loss account would be offset by 
losses that would have otherwise been subject to reduction, potentially 
increasing the amount of excluded COD income that is not applied to 
reduce attributes and, therefore, the amount of excess loss account 
required to be taken into account. To address this concern, 
contemporaneously with the issuance of these temporary regulations, the 
IRS and Treasury Department are proposing regulations that address 
these and other circular computations that would otherwise arise when 
there is an actual disposition of subsidiary stock, or an event that is 
treated as a disposition of subsidiary stock under Sec.  1.1502-19, in 
the year that a member of the group realizes excluded COD income. Those 
regulations are published elsewhere in the Rules and Regulations 
section of this issue of the Federal Register.

Special Analysis

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 12866. 
Therefore, a regulatory assessment is not required. These temporary 
regulations are necessary to provide taxpayers with immediate guidance 
regarding the application of section 108 when a member of a 
consolidated group realizes discharge of indebtedness income that is 
excluded from gross income and the consequences of such application. 
Accordingly, good cause is found for dispensing with notice and public 
procedure pursuant to 5 U.S.C. 553(b)(B) and with a delayed 
applicability date pursuant to 5 U.S.C. 553(d)(3). For applicability of 
the Regulatory Flexibility Act, please refer to the cross-reference 
notice of proposed rulemaking published elsewhere in this issue of the 
Federal Register. Pursuant to section 7805(f) of the Internal Revenue 
Code, these temporary regulations will be submitted to the Chief 
Counsel for Advocacy of the Small Business Administration for comment 
on their impact on small business.

Drafting Information

    The principal author of these regulations is Marie C. Milnes-
Vasquez of the Office of Associate Chief Counsel (Corporate). However, 
other personnel from the IRS and Treasury Department participated in 
their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

0
Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by adding an 
entry in numerical order to read in part as follows:

    Authority: 26 U.S.C. 7805. * * *
    Section 1.1502-13T also issued under 26 U.S.C. 1502. * * *


0
Par. 2. Paragraph (g)(3)(ii)(B) of Sec.  1.1502-13 is revised to read 
as follows:


Sec.  1.1502-13  Intercompany transactions.

* * * * *
    (g) * * *
    (3) * * *
    (ii) * * *
    (B) [Reserved]. For further guidance, see Sec.  1.1502-
13T(g)(3)(ii)(B).
* * * * *

0
Par. 3. Section 1.1502-13T is added to read as follows:


Sec.  1.1502-13T  Intercompany transactions (temporary).

    (a) through (g)(3)(ii)(A) [Reserved]. For further guidance, see 
Sec.  1.1502-13(a) through (g)(3)(ii)(B).
    (g)(3)(ii)(B) Timing and attributes. For purposes of applying the 
matching rule and the acceleration rule --
    (1) Paragraph (c)(6)(ii) 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;
    (2) Any gain or loss from an intercompany obligation is not subject 
to section 108(a), section 354 or section 1091;
    (3) The reduction of the basis of an intercompany obligation 
pursuant to sections 108 and 1017 and Sec.  1.1502-28T does not result 
in the realization of any amount with respect to such obligation; and
    (4) Paragraph (c)(6)(i) of this section (treatment of intercompany 
items if corresponding items are excluded or nondeductible) will not 
apply to exclude any amount of income or gain attributable to a 
reduction of the basis of an intercompany obligation pursuant to 
sections 108 and 1017 and Sec.  1.1502-28T.
    (g)(3)(iii) through (k) [Reserved]. For further guidance, see Sec.  
1.1502-13(g)(3)(iii) through (k).
    (l) Effective dates. Paragraph (g)(3)(ii)(B) of this section 
applies to transactions or events occurring during a taxable year the 
original return for which is due (without extensions) after March 12, 
2004.

0
Par. 4. Section 1.1502-28T is amended by:
0
1. Adding paragraphs (b)(4), (b)(5), and (b)(6).
0
2. Revising paragraph (d).
    The additions and revision read as follows:


Sec.  1.1502-28T  Consolidated section 108 (temporary).

* * * * *
    (b) * * *
    (4) Application of section 1245. Notwithstanding section 
1017(d)(1)(B), a reduction of the basis of subsidiary stock is treated 
as a deduction allowed for depreciation only to the extent that the 
amount by which the basis of the subsidiary stock is reduced exceeds 
the total amount of the attributes attributable to such subsidiary that 
are reduced pursuant to the subsidiary's consent under section 
1017(b)(3)(D) or as a result of the application of paragraph (a)(3)(ii) 
of this section.
    (5) Reduction of basis of intercompany obligations. See Sec.  
1.1502-13T(g)(3)(ii)(B)(3) and (4) for special rules related to the 
application of the matching and acceleration rules of Sec.  1.1502-13 
when the basis of an intercompany obligation is reduced pursuant to 
sections 108 and 1017 and paragraph (a)(2) or (3) of this section.
    (6) Taking into account of excess loss account--(i) Determination 
of inclusion. [Reserved.]
    (ii) Timing of inclusion. To the extent an excess loss account in a 
share of stock of a subsidiary that realizes excluded COD income is 
required to be taken into account as a result of the application of 
Sec.  1.1502-19(c)(1)(iii)(B), such amount shall be included on the 
group's tax return for the taxable year that includes the date on which 
the subsidiary realizes such excluded COD income.
* * * * *
    (d) Effective dates. (1) This section, other than paragraphs 
(a)(4), (b)(4), (b)(5), and (b)(6) of this section, applies to 
discharges of indebtedness that occur after August 29, 2003.
    (2) Paragraph (a)(4) of this section applies to discharges of 
indebtedness that occur after August 29, 2003, but only if the 
discharge occurs during a

[[Page 12072]]

taxable year the original return for which is due (without regard to 
extensions) after December 11, 2003. However, groups may apply 
paragraph (a)(4) of this section to discharges of indebtedness that 
occur after August 29, 2003, and during a taxable year the original 
return for which is due (without regard to extensions) on or before 
December 11, 2003. For discharges of indebtedness that occur after 
August 29, 2003, and during a taxable year the original return for 
which is due (without regard to extensions) on or before December 11, 
2003, paragraph (a)(4) of this section shall apply as in effect on 
August 29, 2003.
    (3) Paragraphs (b)(4), (b)(5), and (b)(6)(ii) of this section apply 
to discharges of indebtedness that occur after August 29, 2003, but 
only if the discharge occurs during a taxable year the original return 
for which is due (without regard to extensions) after March 12, 2004. 
However, groups may apply paragraphs (b)(4), (b)(5), and (b)(6) of this 
section to discharges of indebtedness that occur after August 29, 2003, 
and during a taxable year the original return for which is due (without 
regard to extensions) on or before March 12, 2004.

Mark E. Matthews,
Deputy Commissioner for Services and Enforcement.
    Approved: March 4, 2004.
Gregory F. Jenner,
Acting Assistant Secretary of the Treasury.
[FR Doc. 04-5666 Filed 3-12-04; 8:45 am]
BILLING CODE 4830-01-P