"g" Reorganizations: Tax Planning for Corporate Insolvency
| Publication year | 1982 |
| Pages | 2375 |
1982, September, Pg. 2375. "G" Reorganizations: Tax Planning for Corporate Insolvency
The Bankruptcy Tax Act of 1980 ("Act")(fn1) was the last anticipated step in an effort begun in 1965 to reform the bankruptcy laws. The reform movement previously produced, in the commercial context, the Bankruptcy Reform Act of 1978 ("Bankruptcy Act"),(fn2) which among other things changed the name of the Bankruptcy Act to the Bankruptcy Code. The Act made significant changes in the concepts of discharge of indebtedness income under § 108 of the Internal Revenue Code of 1954, as amended ("IRC"), individual bankruptcies, tax procedure and tax effects of insolvency reorganizations. This article concerns some of the tax effects of insolvency reorganizations. It describes changes made in that area of the law, identifies ambiguities and remaining problem areas and provides some suggestions as to practical applications.
In reorganizations under Chapter X of the Bankruptcy Act and insolvency,(fn3) an insolvent corporation did not recognize gain or loss on the sale of its assets to another corporation organized as part of the plan of reorganization in exchange for stock or securities of the latter.(fn4) Similarly, holders of the corporation's securities recognized no gain or loss on the exchange of the securities of the reorganized corporation for those of the new corporation organized to effectuate the court-approved plan.(fn5) Loss could not be recognized upon the receipt of boot.(fn6) IRC § 381 did not provide for carryovers in reorganizations under IRC § 371, so in order to retain net operating loss carryovers and other tax characteristics of the insolvent corporation, tax counsel often sought to characterize such transactions as IRC § 351 exchanges to avoid nonrecognition under IRC § 371.
The Act repealed IRC § 371 effective for bankruptcy cases commencing after December 31, 1980,(fn7) and substituted for it new subsection "G" of IRC § 368(a)(1).(fn8) The Act was intended to correct six problems present under. IRC § 371, four of which are discussed in the following section.(fn9) Under new IRC § 368(a)(1)(G), a transfer by a corporation of all or part of its assets to another corporation in a Title 11 "or similar case" is treated as a reorganization eligible for nonrecognition treatment if, pursuant to the plan, stock or securities of the acquiring corporation are distributed in a transaction qualifying under IRC §§ 354, 355 or 356.
A Title 11 "or similar case" under IRC §§ 368(a)(1)(G) appears to have the same meaning as the "receivership, foreclosure, or similar proceeding or under Chapter X of the Bankruptcy Act" language in IRC § 371.(fn10) Thus, the new statute should be construed to apply only to an exchange consummated as part of a corporate debt or equity restructuring through a bona fide plan approved by a federal or state court which has jurisdiction of the proceedings.(fn11)
Prior to the passage of the Act, IRC § 381 provided for the transfer of operating losses upon exchanges incident to "A," "C" and non-divisive "D" reorganizations.(fn12) The application of IRC § 381 to reorganizations outside of IRC § 368 was unclear, however. In Lisbon Shops, Inc. v. Koehler,(fn13) the Supreme Court ruled against such carryovers in the context of a statutory merger on the ground that the successor corporation was not in the same line of business as the merged corporations. The rule of Libson Shops was held applicable to bankruptcy or insolvency proceedings in Willingham v. United States,(fn14) where the court stated that new stock ownership and a new corporate structure resulting from a bankruptcy:
does not fit into the scheme which Congress had in mind when it passed the carryover "designed," as the Supreme Court said in Libson, to "permit a taxpayer to set off its lean years against its lush years, and to strike something like an average taxable income computed over a period longer than one year."... This loss taxpayer
"set off against its lean years" by having them wiped out in reorganization proceedings.(fn15)
The Act was intended to make it clear that net operating losses incurred prior to reorganization are available to a successor corporation.(fn16) The method by which this change was made, however, may prove to be less than ideal in most bankruptcy or insolvency proceedings. IRC § 381(a) was amended to provide that net operating losses are carried over in "G" reorganizations and divisive "D" reorganizations, but only if the requirements of IRC § 354(b)(1) are met.(fn17) This section requires that (1) a corporate transferee acquire substantially all of the assets of...
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