Significant OID Test

Transcription

Corporate tax issues:
Interest expense
limitations and
consolidated group
continuation rules
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Original Publication Date: March 26, 2015
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Today's
Presenters
Amanda Oakley
Tax Business Leader
Corporate Tax
Houston, Texas
+1 832.476.3700
[email protected]
Bryan Keith
Managing Director
Washington National Tax Office
Washington D.C.
+1 202.861.4116
[email protected]
Jeff Borghino
Senior Manager
Washington National Tax
Office
Washington D.C.
+1 202.521.1532
[email protected]
Brian Angstadt
Manger
Office
Washington D.C.
+1 202.521.1535
5
Learning objectives
• Identify certain interest
expense deductibility
limitations for corporations
and discuss the scope of their
applicability
• Describe the consolidated
group continuation rules and
identify circumstances under
which a consolidated group
will terminate or continue
• Recognize factors to consider
for tax planning
6
Interest Expense Limitations
Interest Expense Limitations - Agenda
• Background
• Related Party Interest – Section
267
• Earnings Stripping – Section 163(j)
• AHYDO – Section 163(e)(5)
• Debt Payable in Equity - Section
163(l)
• Corporate Acquisition Indebtedness
– Section 279
8
Background
What is Interest?
– The "compensation for the use or forbearance of
money.” Deputy v. Dupont, 308 U.S. at 498
• The tax law provides for two types of interest:
(i) qualified stated interest (“QSI”); and
(ii) original issue discount (“OID”)
9
Background
• QSI is stated interest that is:
(i) “unconditionally payable” in cash or property, or
constructively received,
(ii) at least annually. Treas. Reg. § 1.1273-1(c)
• OID related to a debt instrument is equal to:
(i) the Stated Redemption Price at Maturity (“SRPM”);
less
(ii) the Issue Price. Treas. Reg. § 1.1273-1(b)
10
Background
Section 163(a)
• “There shall be allowed as a deduction all interest paid or
accrued within the taxable year on indebtedness." *
Section 163(e)(1)
• The aggregate of the daily portions of original issue
discount (OID) for any taxable year is allowable as a
deduction to the issuer.*
*Potentially subject to deductibility limitations.
11
Background
• QSI is taken into account by a taxpayer under the
taxpayer’s regular method of accounting (e.g., an
accrual method or a cash receipts method)
• OID must be accounted for under sections 1271
through 1275
• Some interest deductibility limitations distinguish
between QSI and OID
12
Related Party Interest
Related party interest
• A deduction for interest expense to a related party is
disallowed until the interest income is includible to such
related party. Section 267(a)(2)
• The definition of related person under section 267(b)
include:
– A corporation and an individual who owns more than 50 percent of the value
of the outstanding stock of such corporation directly or indirectly;*
– Two corporations which are members of the same controlled group;*
– A corporation and a partnership if the same persons own more than 50
percent of the value of the corporation's stock and more than 50 percent of
the capital interest or the profits interest in the partnership;*
– Two S corporations if the same persons own more than 50 percent of the
value of the stock of each corporation;* and
– An S corporation and a C corporation if the same persons own more than 50
percent of the stock of each corporation.*
*Section 267(c) for constructive ownership of stock
14
Related party interest – Example 1
•
X is a U.S. corporation with a
calendar year on the accrual
method
•
A is a U.S. individual with a calendar
year on the cash receipts method
•
A owns 100% of the stock of X
•
X owes a debt to A, which provides
for QSI equal to 10% per annum
payable semi-annually on February
1st and August 1st
•
Section 267(a)(2) will disallow X's
deduction for the amount of interest
accrued until it is includible to A
A
10%
QSI
X
15
Related party interest – Example 2
• Same facts except that X's debt to
A provides for 10% per annum of
OID to accrue to A
A
10%
OID
X
• The OID is includible to A under
the constant yield method in
Treas. Reg. § 1.1272-1(b)
• Section 267(a)(2) will not disallow
X's deduction for OID that would
otherwise be deductible. Treas.
Reg. § 1.267(a)-2T(b), Question
2
16
Related foreign person interest
• Sections 267(a)(3) and 163(e)(3) generally disallow an interest
deduction related to a debt instrument that is held by a related
foreign person until it is paid
• The term "related foreign person" means any person who is not
a United States person and is related to the issuer under
section 267(b)
• Exceptions apply for (i) interest that is effectively connected
income with a U.S. trade or business; (ii) certain interest
exempt from U.S. tax or subject to a reduced tax under a treaty;
and (iii) certain interest payable to FPHCs under section 552,
CFCs under section 957, and PFICs under section 1296
17
Related foreign person interest - Example
• X is a U.S. corporation with a
calendar year on the accrual
method
FP
OID
X
• FP is a non-U.S. foreign
corporation that does not have a
U.S. trade or business
• X owes a debt to FP, which
provides for OID to FP equal to
10% per annum
• Assuming no exceptions apply,
section 163(e)(3) disallows X's
deduction for the OID until it is paid
18
Earnings Stripping
Earnings stripping
• Section 163(j) applies to a corporation if such corporation:
– Has "excess interest expense"; and
– A debt-to-equity ratio exceeding 1.5 to 1
• "Excess Interest Expense" means that the corporation's
net interest expense exceeds 50 percent of its "adjusted
taxable income" plus excess limitation carryforward
• If section 163(j) applies, there is no deduction allowed for
"disqualified interest" paid or accrued to the extent of
Excess Interest Expense
20
Earnings stripping
• Disqualified interest means any interest paid or accrued by
the taxpayer:
– Directly or indirectly to a related person if "no tax is imposed"
with respect to such person;
– With respect to any debt to a person who is not related if
there is a disqualified guarantee of such debt and no gross
basis tax is imposed with respect to such interest; and
– Directly or indirectly by a taxable REIT subsidiary to the
REIT. Section 163(j)(3)
• A "disqualified guarantee" is any guarantee by a related
foreign or tax-exempt person except guarantees by 80
percent subsidiaries. Section 163(j)(6)(D)
21
Earnings stripping
• Any amount that is disallowed is treated as disqualified
interest in the succeeding taxable year. Section
163(j)(1)(B)
• Special rules in determining:
– Whether a partnership is treated as a related person. Section
163(j)(4);
– Whether interest is "subject to tax." Section 163(j)(5);
– Whether a partnership's debt is subject to section 163(j) to
the extent of corporate partners. Section 163(j)(8); and
– All members of the same affiliated group are treated as one
taxpayer. Section 163(j)(6)(C)
22
Earnings stripping – Example 1
Bank
Debt
FP
Loan
to X
•
FP is a foreign corporation, which
directly wholly owns a U.S. corporation X
•
FP is able to borrow at more favorable
terms than X so FP borrows from Bank
and loans the proceeds to X
•
X's debt to FP provides for OID to FP,
which is "not subject to tax" for purposes
of section 163(j)
•
X pays a portion of the OID to FP on the
last day of its taxable year
•
Even if section 163(e)(3) does not apply,
section 163(j) may still apply to disallow
the deduction of the paid portion
OID
X
23
Earnings stripping – Example 2
FP
Bank Debt with
FP Guaranty
• Same facts except that Bank is
willing to loan to X if FP
provides a guaranty on X's
payment to Bank
• Section 163(j) may apply to
any interest that X pays or
accrues to Bank because of
FP's guaranty
X
24
AHYDO
AHYDO
• Section 163(e)(5) disallows the deduction of OID to C
Corporations related to an Applicable High Yield
Discount Obligation (AHYDO)
• The "disqualified portion" of OID is permanently
disallowed if the yield of the AHYDO yield is greater
than 6% plus the applicable federal rate (AFR)
• Any other OID related to an AHYDO is temporarily
disallowed as a deduction until paid
26
AHYDO
• Section 163(i) defines an AHYDO as a debt instrument
that has:
1. A C Corporation issuer;
2. A maturity term greater than 5 years;
3. A yield to maturity greater than the AFR plus 5 percent
(today’s AFR ≈ 1.46%); and
4. “Significant OID."
•
A debt instrument has Significant OID if the terms of the
debt permit more than 1 year’s yield to be accrued and
unpaid for any accrual period ending after 5 years
27
AHYDO – Example 1
• X is a C corporation
• X issued a debt instrument with a stated principal of $1000 on
August 1, 2014 for $1000
• The debt provides for interest equal to 10%, which compounds
on a quarterly accrual period each calendar quarter
• The outstanding principal and interest is required to be paid no
later than July 31, 2020
• The AFR for August 2014 was equal to 1.88%
The debt instrument meets the first 3 tests for AHYDO because: (i) the
issuer is a C corporation; (ii) the maturity term is greater than 5 years;
and (iii) the yield-to-maturity is greater than 5% plus the AFR, which is
6.88%
28
AHYDO – Example 1
Year
Beg.
Issue
Price
8/1/2014
1000
8/1/2015
1000
104
0
1104
104
8/1/2016
1104
115
0
1219
219
8/1/2017
1219
126
0
1345
345
8/1/2018
1345
140
0
1485
485
8/1/2019
1485
154
0
1639
639
9/30/2019
1639
27
0
1666
666
12/31/2019
1666
41
0
1707
707
3/31/2020
1707
43
0
1750
750
6/30/2020
1750
44
0
1794
794
7/31/2020
1794
15
1809
0
0
10%
Yield
Pmt.
Ending
Issue
Price
Accrued
Unpaid
•
The first accrual period after
the 5th anniversary ends on
September 30, 2019
•
The amount of accrued and
unpaid OID permitted at the
end of the accrual period
ending September 30, 2019 is
$667
•
Thus, the Significant OID Test
is met
29
AHYDO
Accrual Periods - Treas. Reg. § 1.1272-1(b)(1)(ii)
•
An accrual period is an interval of time over which the
accrual of OID is measured
•
Accrual periods may be of any length and may vary over
the term of the debt instrument provided that:
–
–
Each accrual period is no longer than 1 year; and
Each scheduled payment of principal or interest occurs
either: (i) on the final day of an accrual period; or (ii) on
the first day of an accrual period
30
AHYDO – Example 2
Year
Beg.
Issue
Price
Yield
Pmt.
Ending
Issue
Price
8/1/2014
1000
8/1/2015
1000
104
0
1104
104
8/1/2016
1104
115
0
1219
219
8/1/2017
1219
126
0
1345
345
8/1/2018
1345
140
0
1485
485
8/1/2019
1485
154
0
1639
639
7/31/2020
1639
170
1809
0
0
10.4%
Accrued
Unpaid •
Same facts except that the
taxpayer elected an annual accrual
period and the first accrual period
after the 5th anniversary ends on
July 31, 2020
•
The amount of accrued and unpaid
OID permitted at the end of the
accrual period ending July 31,
2020 is $0 because the loan will
mature on July 31, 2020
•
Thus, the Significant OID Test is
not met
31
AHYDO – Example 3
Year
Beg.
Issue
Price
8/1/2014
1000
8/1/2015
1000
101
81
1020
20
8/1/2016
1020
103
82
1041
41
8/1/2017
1041
105
84
1062
62
8/1/2018
1062
107
86
1083
83
8/1/2019
1083
109
87
1105
105
9/30/2019
1105
18
14
1109
109
12/31/2019
1109
28
22
1115
115
3/31/2020
1115
27
22
1120
120
6/30/2020
1120
28
22
1126
126
7/31/2020
1126
10
1136
0
0
10%
Yield
Pmt.
Ending
Issue
Price
Accrued
Unpaid
•
Same facts except the debt provides
–
For quarterly interest payments equal to
8% per annum due at the end of each
calendar quarter, and
–
2% payment-in-kind compounded
quarterly
•
The first accrual period after the 5th
anniversary ends on September 30,
2019
•
OID permitted at the end of the
accrual period ending September
30, 2019 is $109
•
Thus, the Significant OID Test is met
32
AHYDO – Example 4
Year
Beg.
Issue
Price
8/1/2014
1000
8/1/2015
1000
101
81
1020
20
8/1/2016
1020
103
82
1041
41
8/1/2017
1041
105
84
1062
62
8/1/2018
1062
107
86
1083
83
8/1/2019
1083
109
87
1105
105
9/30/2019
1105
18
24
1099
99
12/31/2019
1099
27
27
1099
99
3/31/2020
1099
27
27
1099
99
6/30/2020
1099
27
27
1099
99
7/31/2020
1099
10
1109
0
0
10%
Yield
Pmt.
Ending
Issue
Price
Accrued
Unpaid •
Same facts that the debt provides
–
For quarterly interest payments equal to
8% per annum due at the end of each
calendar quarter, and
–
2% payment-in-kind compounded
quarterly
•
However, the debt also requires an
"AHYDO Catchup" payment on the last
day of each accrual period after the 5th
anniversary
•
OID permitted at the end of each
accrual period ending after the 5th
anniversary is $99
•
Thus, the Significant OID Test is not
met
33
AHYDO
Trap for the Unwary: Subordinated Debt
• For an "AHYDO Catch-up Payment" provision to be
effective, the payments must be required
• Senior creditors may restrict the debtor's ability to make
an AHYDO Catch-up Payment or restrict the subordinated
creditors' rights if the payment is not made
34
AHYDO – Example 5
X
•
Corporation X and Corporation Y are
partners in a business partnership,
PRS
•
As part of the business, PRS issues
debt to an unrelated third party
•
If the PRS debt was issued by X
and/or Y directly, section 163(e)(5)
would disallow the interest deduction
of X and Y
•
For the purposes of the AHYDO
rules, PRS is treated as an
aggregate of its partners, X and Y.
See Treas. Reg. § 1.701-2(f), ex. 1
Y
AHYDO
Debt
PRS
35
Debt Payable in Equity
Debt payable in equity
• No interest deduction is allowed for interest related to a
“Disqualified Debt Instrument” under section 163(l)
• A Disqualified Debt Instrument under section 163(l)(2) is
any debt that is payable in:
– Equity of the issuer (or a related party to the issuer);
or
– Equity held by the issuer (or a related party)
• Interest is permanently disallowed if payable in the equity
of the issuer or a related party
37
• Debt is treated as “payable in equity” of the issuer if a
substantial amount of the principal or interest is:
– Required to be paid or converted into such equity;
– Payable or convertible into such equity at the option of the issuer
(or a related party);
– Required to be determined by reference to the value of such
equity;
– Determined by reference to the value of such equity at the option
of the issuer (or a related party); or
– Part of an arrangement that is “reasonably expected” to result in
the above. Section 163(l)(3)
• Whether section 163(l) applies is generally assessed on the
issue date of the debt
38
Debt payable in equity – Example 1
• On January 1, 2010, X
issues a one-year Note with
a $1000 face amount and 10
percent interest
Convertible Note
Lender
X
$1000
• X may elect to convert the
principal of the Note into X
stock at maturity
• Section 163(l) appears to
apply because X has the
option to convert the principal
of the Note into X stock
39
39
• On January 1, 2010, X issues
a one-year Note with a $1000
face amount and 10 percent
interest
Convertible Note
Lender
X
$1000
• The Note automatically
converts into X Preferred
Shares if X issues Preferred
Shares to other investors in
exchange for cash before the
Note's maturity
• Query whether Section 163(l)
will apply if it is “reasonably
expected” that the Note will
convert into X Preferred
Shares
40
40
Holder Options to Convert into Equity under Section
163(l)(3)
• Principal or interest is treated as required to be paid,
converted, or determined by such equity if:
– The holder (or a related party to the holder) has an
option; and
– There is a “substantial certainty” the option will be
exercised
• There is currently no definition in the Code and
regulations for the standard of "substantial certainty" in
this context
41
• Lender and X are not related
under section 267(b)
• On January 1, 2010, X issues a
one-year note with a $1000 face
amount and 10 percent interest
Convertible Note
Lender
X
$1000
• Lender may elect to convert the
principal of the Note into X stock
at any time
• Query whether there is a
substantial certainty the Note
will be converted by Lender into
X stock
42
42
Debt Payable in Equity – Example 4
• PRS and X are related under
section 267(b)
PRS
$1000
Note
X
• On January 1, 2010, X issues a
one-year note to PRS with a $1000
face amount and 10 percent interest
• PRS may elect to convert the
principal of the Note into X stock at
any time
• Section 163(l) appears to apply
because PRS, as a related party to
X, has the option to convert the
principal of the Note into X stock
43
Corporate Acquisition
Indebtedness
Corporate acquisition indebtedness
• No deduction is allowed for interest in excess of a specified
amount related to a Corporate Acquisition Indebtedness ("CAI")
under section 279. Section 279(a)
• Section 279(b) provides that CAI is debt that has:
– Purpose: issued to provide consideration for certain stock or asset
acquisitions;
– Subordination: subordinated to claims of trade creditors or expressly
subordinate to a substantial amount of unsecured debt;
– Convertibility: convertible into stock of the issuing corporation or part
of an investment unit which includes an option to acquire such stock;
and
– Met the Section 279(b)(4) Test: issuing corporation's DE ratio exceeds
2 to 1 or projected earnings do not exceed 3 times the annual interest
to be paid or incurred on the obligation
45
• General Rule: No interest disallowed until Section
279(b)(4) Test, but then the obligation is CAI all
subsequent taxable years. Section 279(d)(1) and (2)
• Exceptions: (i) Redetermination where control is acquired.
Section 279(d)(3); (ii) Special 3-year rule. Section
279(d)(4); (iii) 5-percent stock rule. Section 279(d)(5)
• If the issuing corporation is a member of an affiliated
group, all members of the affiliated group are treated as
the issuing corporation. Section 279(g)
46
• Any extension, renewal, or refinancing of an
obligation is not deemed to be the issuance of a
new obligation for section 279 purposes. Section
279(h)(1)
• Any obligation which is CAI of the issuing
corporation is also CAI for any corporation that
becomes liable as a guarantor, endorser, or
indemnitor. Section 279(h)(2)
47
Corporate acquisition indebtedness – Example
1
$
$
P
Convertible
Note
T Stock
T
• P issues a convertible note to a
third party for cash, and uses
the proceeds to acquire T stock
• The Note is expressly
subordinate to all of P's other
unsecured debt
• Section 279 may apply to
disallow P's deduction for
interest related to the
Convertible Note
48
Corporate acquisition indebtedness – Example
2
$
• P and S are members of an
affiliated group
$
P
Convertible
Note
T Stock
• S has a substantial amount of
unsecured debt owed to third-party
lenders
• P issues a convertible note to a
third party for cash, and uses the
proceeds to acquire T stock
S
T
• The Note is not expressly
subordinate any other debt owed by
P and S
• Section 279 may apply to disallow
P's deduction for interest related to
the Convertible Note
49
Affiliated Groups
Stock Ownership
Requirement
Affiliated groups
consolidated federal income tax return
Electing to file a Consolidated Return:
• For federal income tax purposes, members of an "Affiliated Group"
may, generally, consent to file a consolidated return. See Treas.
Reg. § 1.1504-1
• Members of an Affiliated Group consent to file a consolidated return
by filing a Form 1122 for the first consolidated return year for the
group. Treas. Reg. § 1.1502-75(h)(2)
• If an Affiliated Group elects to file a consolidated return, all members
of the affiliated group, generally, must be included in the consolidated
federal income tax return. See § 1501
51
Affiliated groups
consolidated federal income tax return
Electing to file a Consolidated Return (continued):
•
Members who enter the Affiliated Group after the election is made, generally,
are automatically included in the consolidated return (but, consider whether
the new member should still file a Form 1122)
•
If member(s) fails to timely file a Form 1122, Rev. Proc. 2014-24 may treat
the member(s) as filing a timely Form 1122 if certain requirements are met
•
Determining whether there is an affiliated group and which corporations are
included in the group is a question of fact that must be assessed on a day-today basis. See for example TAM 9714002
•
If a transaction is structured with a principal purpose of avoiding the inclusion
of the corporation(s) in the affiliated group, the corporation(s) may still be
treated as a member for certain purposes. See anti-avoidance rules under
Treas. Reg. § 1.1502-13(h)
52
Affiliated groups
definition of an affiliated group
§1504(a): "affiliated group" means:
• 1 or more chains of includible corporations connected through stock
ownership with a common parent corporation that is an includible
corporation, but only if –
– The common parent "owns directly" stock meeting the "80-80 Test"
(defined below) in 1 other includible corporation, and
– Stock meeting the "80-80 Test" in each includable corporation (except
the common parent) is "owned directly" by 1 or more of the other
includable corporations
• "Includable corporation" does not include certain corporations such
as S corporations and foreign corporations. See Treas. Reg.
§1504(b) – (f)
53
Affiliated groups
definition of an affiliated group
§1504(a): "affiliated group" means (continued):
• "Stock" does not include certain nonvoting,
nonparticipating preferred stock that is not convertible
into another class of stock ("plain vanilla preferred
stock"). See Treas. Reg. §1504(a)(4)
• "Direct Ownership" means, generally, the beneficial
owner
– Generally, does not include stock held by non-includable
corporation, partnership, or irrevocable voting trust
– May include stock of corporation that is in bankruptcy or stock
held in escrow. See for example Rev. Rul. 63-104 and Rev. Rul.
55-458
54
Affiliated groups
the 80 / 80 test
• 80-80 Test
– The ownership of stock that: (i) possesses at least 80 percent of
the total voting power of the corporation's stock, and (ii) has a
value equal to at least 80 percent of the value of the corporation's
stock
• Voting Power Test: at least 80 percent of total voting
power of corporation's stock
– Generally, a mechanical test based on ability to elect Board. See
Rev. Rul. 69-126
– Mechanical test, however, may not be sufficient if Board's
authority is restricted in favor of other shareholders. See for
example Alumax Inc. v. Commissioner, 165 F3d 822 (11th Cir.
1999)
55
Affiliated groups
the 80 / 80 test (continued)
• Value Test: value equal to at least 80 percent of the
value of the corporation's stock
– Corporation may need to get an appraisal to determine
whether the Value Test is met
– Corporation may need to include the value of certain
options when performing the value test. See Treas.
Reg. § 1.1504-4
– Notice 2004-37 provides relief from failure to satisfy
the Value Test in certain circumstances, when the
relative value between different classes of stock have
fluctuated
56
Affiliated groups
hook stock problem
• Top-Down Approach – P
Affiliated Group includes only
P and S1
P
100%
75%
S1
S2
100%
S3
25%
• Aggregate Approach – P
Affiliated Group includes P,
S1, S2, and S3. See PLR
201240017
• Other Concerns:
– Creation of Hook Stock
– Elimination of Hook Stock
– "No Rule" Area under Rev.
Proc. 2015-3
57
Affiliated Groups
Group Continuation Rules
Affiliated groups
effect of losing consolidated status
•
If an affiliated group files a consolidated return in the prior year and
the group ceases to file a consolidated return in the taxable year, the
member(s) of the group may incur certain adverse effects including
the following:
– Losing the benefit of deferring intercompany items, and possibly triggering
previously deferred intercompany items, under Treas. Reg. § 1.1502-13;
– Recognizing income or gain on excess loss accounts under Treas. Reg. §
1.1502-19;
– Creating SRLY limitations in tax years that the corporation(s) ceases to be
member(s), unless overlaps with § 382 limit;
– Causing member(s) to have two tax years in one 12-month period, which
may effect certain tax adjustment such as § 481(a); and
– Causing certain elections of member(s) to terminate
59
Affiliated groups
continued filing requirement – General rule
• If: (i) an affiliated group filed a consolidated return for the
immediately preceding taxable year, and (ii) the affiliated group
remained in existence in the current taxable year, then the affiliated
group is required to file a consolidated return for the current tax
year, unless it has an election to discontinue filing the consolidated
return. See Treas. Reg. §1.1502-75(a)(2)
• "Remains in Existence" – An affiliated group remains in existence
for a tax year if: (i) the common parent remains the common
parent, and (ii) at least one subsidiary that was affiliated with the
common parent at the end of the prior year remains affiliated with
the common parent at the beginning of the year. See Treas. Reg.
§1.1502-75(d)(1)
60
Affiliated groups
continued filing requirement – General rule
(continued)
•
Election to Discontinue Filing a Consolidated Return – Under Treas. Reg.
§1.1502-75(c), the IRS may grant permission to discontinue if: (i) the taxpayer
applies to the IRS and establishes "Good Cause," or (ii) the IRS issues a
"Blanket Permission."
– "Good Cause"
• Taxpayer must establish that the net result of all amendments to the Code or
regulations with effective dates commencing within the taxable year has a
"substantial adverse effect" on the consolidated tax liability of the group for
such year relative to what the aggregate tax liability would be if the members
of the group filed separate returns for such year
• Taxpayers have, generally, not been able to establish "Good Cause." But
see PLR 7750017
– "Blanket Permission"
• IRS, in its discretion, may grant all groups permission to discontinue if a
provision of the Code or regulations has been amended and such
amendment could have a "substantial adverse effect" on filing a consolidated
return, relative to filing separate returns
• IRS has not issued many "Blanket Permissions" in recent years. But see
Rev. Proc. 95-11
61
Affiliated groups
continued filing illustration # 1
Disposition of subsidiary
A
A
S1
P
S1
$
P
X
100%
S2
Stock
–
–
Y
100%
S1
Stock
S2
S1
–
–
–
A
A
$
P
12/31/X2
07/01/X2
05/01/X2
12/31/X1
P
S2
S2
On 05/01/X2, P acquired 100% of the S2 stock from X
On 07/01/X2, P sold 100% of the S1 stock to Y
Assume P group had a calendar year-end, filed a consolidated return in Year 1, and did not elect to
discontinue in Year 2
Did the P group remain in existence in Year 2?
What about Year 3?
62
Affiliated groups
continued filing requirement – Special rules
• Group Continuation Special Rules:
– F Reorganization – Common parent remains in existence
irrespective of a mere change in identity, form, or place of
reorganization of such common parent. See Treas. Reg. §1.150275(d)(2)(i)
– Downstream Merger – The group, generally, remains in existence
if: (i) the former common parent is no longer in existence; (ii)
members of affiliated group succeed to and become owners of
substantially all the assets of the former common parent; (iii) there
remains one or more chains of includible corporations connected
through stock ownership with a new common parent corporation;
(iv) the new common parent is an includable corporation; and (v)
the new common parent was a member of the group prior to the
date such former common parent ceased to exist. See Treas.
Reg. §1.1502-75(d)(2)(ii)
63
Affiliated groups
continued filing requirement – Special Rules
(continued)
• Group Continuation Special Rules (continued):
– Reverse Acquisition – The Target group, generally, remains in
existence (and the Buyer group ceases to exist) if: (i) Target
becomes a member of Buyer group, or Buyer acquires
substantially all the assets of Target; and (ii) the shareholders of
Target own more than 50 percent of the FMV of the Buyer
stock, as a result of owning the Target stock. See Treas. Reg.
§1.1502-75(d)(3)
– Rev. Rul. 82-152 – The group may remain in existence if there
is no "substantial change in the composition of the group."
64
Affiliated groups
F Reorganization
12/31/X1
06/30/X2
07/01/X2
12/31/X2
A
A
A
A
P
Newco
P
Newco
S1
S1
S1
S2
S2
S2
P
Newco
S1
S2
–
–
–
–
S1
S2
On 06/30/X2, A formed Newco
On 07/01/X2, P merged with and into Newco, with Newco surviving
Assume P group had a calendar year-end, filed a consolidated return in Year 1, and that Newco
was a newly formed includable corporation with no assets and liabilities prior to 07/01/X2
65
Affiliated groups
Downstream merger
–
–
–
12/31/X1
07/01/X2
12/31/X2
A
A
A
P
P
S1
S1
S1
S2
S2
S2
S3
S3
S3
On 07/01/X2, P merged with and into S1, with S1 surviving
Assume P group had a calendar year-end and filed a consolidated return in Year 1
66
Affiliated groups
Reverse acquisition
12/31/X2
12/31/X3
07/01/X3
A
A
A
100% of P1
stock
P2
P1
P2
P1
P2
S1
S2
S1
S2
P1
S2
S1
–
–
–
–
–
On 07/01/X3, A contributed 100% of the P1 stock to P2
Assume the P1 group and P2 group each had a calendar year-end, and each filed a consolidated
return in Year 2
Did the P1 group remain in existence in Year 3?
What if the FMV of the P1 Group was more than the FMV of the P2 Group on 07/01/X3?
What if P1 was formerly a member of the P2 Group in Year 1 (i.e., reaffiliation problem)?
67
Affiliated groups
Rev. Rul. 82-152 illustration
12/31/X1
07/01/X2
12/31/X2
A
A
A
P
P
S
S
S
P
T
T
–
–
Facts:
• P was common parent of an affiliated group (the "P Group"), and P Group filed a consolidated
return
• Pursuant to a plan of reorganization, T merged into P, with P surviving, and the shareholders of P
exchanged all of their P stock for S stock
Issue:
• Did merger cause the termination of the P group in Year 2?
68
Affiliated groups
rev. rul. 82-152 analysis
• Law and Analysis:
– Treas. Reg. § 1.1502-75(d)(2)(ii) (i.e., Downstream Merger) was inapplicable
because P did not cease to exist
– Treas. Reg. § 1.1502-75(d)(3) (i.e., Reverse Acquisition) was inapplicable
because P and S were affiliated prior to the Transaction
– The function of Treas. Reg. § 1.1502-75(d)(2)(ii) is recognizing the continuity of
an affiliated group after a transaction that, even though formally restructuring the
group, did not effect any substantial change in the composition of the group
(judged by reference to the underlying assets of the group)
– For purposes of determining the continuity of the P Group, there is no significant
difference, other than in form, between a transaction in which T survives and
one in which P survives
• Holding:
– The merger did not cause the termination of the P group
69
Affiliated groups
PLR 200905001 – Extending rev. Rul. 82-152
PreTransaction
Step # 1
Public
Public
D
(NonUS)
C
(US)
Public
D
(NonUS)
Newco
(US)
C
(US)
Merger
Sub
Subs
PostTransaction
Step # 2
Newco
(US)
D
(NonUS)
C
(US)
Subs
Public
100%
of C
stock
Newco
(US)
D
(NonUS)
C
(US)
Subs
Subs
–
Facts:
•
•
•
C was common parent of an affiliated group (the "C Group"), and C Group filed a consolidated return
In Step 1, Public formed Newco and Merger Sub; and Merger Sub merged with and into D, with D
Surviving, in a transaction that qualified as a B Reorganization
In Step 2, D distributed 100% of the C stock to Newco in a transaction qualifying as a spin-off under §
355
70
Affiliated groups
PLR 200905001 analysis
•
Law and Analysis:
– Treas. Reg. § 1.1502-75(d)(2)(ii) (i.e., Downstream Merger) was inapplicable
because C did not cease to exist
– Treas. Reg. § 1.1502-75(d)(3) (i.e., Reverse Acquisition) was inapplicable
because shareholders of C did not receive stock in Acquiring (i.e., Newco)
– Transaction did not meet basic facts of Rev. Rul. 82-152
•
Holding:
– Provided that Newco and C are members of the same affiliated group after the
proposed steps, the consolidated group of which C was the common parent
immediately before the proposed steps will remain in existence after
consummation of the proposed steps, with Newco becoming the common
parent
•
Question:
– Must C account for a certain % of Newco's assets? Greater than 50%?
– Can Newco be an existing entity? If so, can Newco be the parent company of
another affiliated group, or can Newco be a former member of C?
71
Affiliated Groups
Five-Year Lapse before
Reconsolidation
Affiliated groups
Five-year lapse before reconsolidation
•
§ 1504(a)(3)(A) provides that if (i) a corporation is included (or required to be
included) in a consolidated return filed by an affiliated group, and (ii) such corporation
ceases to be a member of such group, then:
–
–
•
Such corporation (and any successor of such corporation) may not be included in any
consolidated return filed by the affiliated group (or by another affiliated group with the same
common parent or a successor of such common parent)
Before the 61st month beginning after its first taxable year in which it ceased to be a member
of such affiliated group
"Successor" is not defined in § 1504(a)(3) or under the regulations.
–
Treas. Reg. § 1.1502-1(f)(4) – The term predecessor means a transferor or distributor of
assets to a member (the "successor") in a transaction –
• To which § 381(a) applies, or
• In which the successor's basis for the assets is determined, directly or indirectly, in whole
or in part, by reference to the basis of the assets of the transferor or distributor
–
See also Treas. Reg. § 1.1502-13(j)(2); 1.1502-19(f); 1.1502-28(b)(10); 1.1502-31(f); 1.150233(h); 1.1502-35(d)(5); and 1.1502-77(a)(1)(iii)
73
Affiliated groups
Five-year lapse application # 1
Departing subsidiary
06/01/X3
06/01/X2
$
12/31/X1
A
A
P
P
A
A
P
P
$
$
S1
S2
–
–
–
–
S1
S2
X
100%
S2
Stock
12/31/X3
X
S1
100%
S2
Stock
S2
S1
S2
On 06/01/X2, S1 sold 100% of the S2 stock to X
On 06/01/X3, S1 purchased 100% of the S2 stock from X
Assume P group had a calendar year-end and filed a consolidated return in Year 1 and Year 2
Can S2 be included in P group's consolidated return in Year 3?
74
Affiliated groups
Five-year lapse application #2
Acquisition of parent
06/01/X2
$$
12/31/X2
A
06/01/X3
$
X
A
100% P
Stock
12/31/X3
X
B
100% P
Stock
B
P
P
S1
S1
S1
S1
S2
S2
S2
S2
–
–
–
–
P
P
On 06/01/X2, A sold 100% of the P stock to X
On 06/01/X3, X sold 100% of the P stock to B
Assume P group had a calendar year-end and filed a consolidated return in Year 1. In addition,
assume X was common parent of X group, had a calendar year-end and filed a consolidated return
in Year 2
Can P file a consolidated return in Year 3?
75
Affiliated groups
Waiver of five-year period
• § 1504(a)(3)(B) states that the Secretary may waive the
application of § 1504(a)(3)(A) to any corporation for any
period subject to such conditions as the Secretary may
prescribe
• Rev. Proc. 2002-32 modified by Rev. Proc. 2006-21
provides rules for: (i) Automatic Waiver, and (ii) Private
Letter Ruling
76
Affiliated groups
Waiver of five-year period (continued)
• "Automatic Waiver" – To qualify, taxpayer must attach a statement,
under penalties of perjury, that includes certain information including:
– Common parent of affiliated group which became disaffiliated was not an
S corporation, a disregard, REIT, or RIC during period of disaffiliation;
– Disaffiliation and subsequent consolidated has not and will not provide a
benefit of a reduction in income, increase in loss, or any other deduction,
credit, or allowance (a federal tax savings) that would not otherwise be
secured or have been secured had the disaffiliation and subsequent
consolidated not occurred, including, but not limited to, the use of a net
operating loss or credit that would have otherwise expired, or the use of
a loss recognized on a disposition of stock of the deconsolidated
corporation or a predecessor of such corporation
• Must take into account the time value of money
77
Affiliated groups
Waiver of five-year period (continued)
• "Private Letter Ruling" – If taxpayer cannot obtain a waiver under the
Automatic Waiver procedures, the taxpayer may only obtain a waiver
through Private Letter Ruling
• The letter ruling request must:
– Contain information establishing that federal tax savings was not a
purposes of the disaffiliation,
– Contain information that the amount of any federal tax savings
attributable to the disaffiliation or a subsequent consolidation is not
significant; and
– State whether the deconsolidated corporation or a predecessor of such
corporation was, at any time during the period of disaffiliation, in the
effective control of any member (or successor of any member) of the
current group or the former group
78
Comments?
Questions?
79
Today's
Presenters
Amanda Oakley
Tax Business Leader
Corporate Tax
Houston, Texas
+1 832.476.3700
[email protected]
Bryan Keith
Manager Director
Washington National Tax Office
Washington D.C.
+1 202.861.4116
[email protected]
Jeff Borghino
Senior Manager
Office
Washington D.C.
+1 202.521.1532
[email protected]
Brian Angstadt
Manger
Office
Washington D.C.
+1 202.521.1535
80
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analysis of the subject matters covered and may include
proposed guidance that is subject to change before it is issued
in final form. All relevant facts and circumstances, including the
pertinent authoritative literature, need to be considered to arrive
at conclusions that comply with matters addressed in this
presentation. The views and interpretations expressed in the
presentation are those of the presenters and the presentation is
not intended to provide accounting or other advice or guidance
with respect to the matters covered.
For additional information on matters covered in this
presentation, contact your Grant Thornton, LLP adviser.
81
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Significant OID Test

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