CERTs and consolidated groups: where avoided cost means avoided benefit.

• Author: Winsko, David A.
• Position: Corporate rate equity transaction

The significant number of highly leveraged transactions in recent years, coupled with the more recent economic recession, may place many once profitable corporations in a net operating loss (NOL) position. Unfortunately, some may find NOL carryback claims jeopardized by the corporate equity reduction transaction (CERT) provisions enacted in the Omnibus Budget Reconciliation Act of 1989 (OBRA) and included in Sec. 172(b)(1)(E) and (h).

The CERT provisions were enacted to stop profitable corporations from obtaining tax refunds by carrying back NOLs created by certain debt-financed transactions occurring after Aug. 2, 1989. While Sec. 382 does keep profitable corporations from using acquired NOLs, the CERT rules prevent highly leveraged transactions from being financed, in part, by tax refunds from carrying back postacquisition NOLs.

Although this objective is easily understood, a lack of regulatory guidance, coupled with sparse legislative history, provides traps for the unwary, particularly when consolidated groups are involved. Use of an "avoided cost" method to allocate interest to a CERT widens the trap for leveraged taxpayers. However, statutory language, committee reports and modifications made by the Revenue Reconciliation Act of 1990 (RRA) may provide certain opportunities to lessen the negative impact of the CERT provisions. Definition of a CERT A CERT occurs when there is a major stock acquisition or an excess distribution. A major stock acquisition is defined as the acquisition by a corporation (or a group of persons acting in concert with the corporation)of 50% or more (by vote or value) of the stock of another corporation within a 24-month period, except for qualified stock purchases for which a Sec. 338 election has been made (Sec. 172(h)(3)(B)and (D)(ii)). An excess distribution is any distribution to shareholders during the tax year (including a redemption) that exceeds the greater of 150% of the average of distributions made during the three preceding tax years or 10% of the stock's fair market value (Sec. 172(h)(3)(C)). Furthermore, all members of an affiliated group filing a consolidated return are to be treated as one taxpayer for purposes of applying the CERT provisions (Sec. 172(h)(4)(C)).

Once a CERT has occurred, any portion of an NOL attributable to "excess interest loss" incurred in the year of the CERT or the two succeeding tax years (the "limitation years") is not permitted to be carried back to a year preceding...