Clarification on use of sec. 381(c) (1) (b) in tax-free asset acquisition by a consolidated group.

• Position: Tax guidance

The 2001 Guidance Priority List should include a project to clarify the operation of Sec. 381(c)(1)(B) in tax-free asset acquisitions by a consolidated group. Such guidance is necessitated by the recent adoption of the "overlap rule" providing for the elimination of separate return limitation year (SRLY) limits in certain transactions also giving rise to a limit under Sec. 382.

Background

Under Sec. 381(c)(1)(B), the acquiring corporation (Acquiring) in a tax-free asset reorganization may use the target corporation's (Target's) net operating loss carryovers in Acquiring's tax year of the acquisition only up to an amount that bears the same ratio to Acquiring's taxable income for that year as the number of days in that year after the date of the acquisition bears to the total number of days in that year; see also Sec. 381(c)(3)(B) and Regs. Sec. 1.381(c)(23)-1 (e). Thus, if Acquiring acquires the Target assets on the 16th day before the end of Acquiring's year, the absorption of Target's loss carryovers is limited to 15/365 of Acquiring's taxable income for the year. The rule generally seeks to prevent the newly acquired loss carryovers from offsetting income generated prior to the acquisition date.

Prior to the recent promulgation of the overlap rule, when Acquiring was a member of a consolidated group that acquired the assets of a nonmember Target in a tax-free asset acquisition, the absorption of the Target losses was subject to a SRLY limit, computed with reference to Acquiring's contribution to consolidated taxable income. Because Target's loss carryovers could generally be used to offset only the income of its successor, Acquiring, it made sense to compute the Sec. 381(c)(1)(B) limit by taking into account only Acquiring's contribution to consolidated taxable income (and not the income of the group as a whole); see Rev. Rul. 75-378.

The recent adoption of the overlap rule, however, has eliminated the application of SRLY limits when SRLY loss carryovers are acquired by a consolidated group in certain transactions that also cause those loss carryovers to become subject to a Sec. 382 limit. In such cases, although utilization of the loss is limited by Sec. 382, the loss may be used to offset the income generated by any member of the group, and not just Acquiring's contribution to consolidated taxable income.

There is no guidance, however, indicating whether the reference to "taxable income" in the computation of the Sec. 381(c)(1)(B)...