Complexities in the consolidated return reverse acquisition rules.

• Author: Prettyman, James
• Position: Taxation

The determination of whether a transaction is a reverse acquisition under the consolidated return regulations has a large impact on a number of consolidated return issues, such as the application of the separate return limitation year rules under Temp. Regs. Sec. 1.1502-21T, stock basis adjustments under Regs. Sec. 1.1502-31, earnings and profits adjustments under Regs. Sec. 1.1502-33(f) and certain consolidated return filings (such as short-period returns or consolidated return elections). The reverse acquisition rule of Regs. Sec. 1.150275(d)(3), while mechanical in its approach, has been rather broadly applied in IRS rulings. Examples of the Service's broad interpretation of the reverse acquisition rule can be found in GCM 39528 and Letter Ruling 8834013. The IRS's broad interpretation makes the application of the reverse acquisition rule to complex transactions even more difficult.

Substance-Over-Form Approach

Generally under Regs. Sec. 1.150275(d)(3), a reverse acquisition occurs when:

1. A corporation acquires the stock or substantially all of the assets of a second corporation;

2. The second corporation becomes a member of the first corporation's group; and

3. The shareholders of the second corporation end up owning more than 50% of the first corporation's outstanding stock.

If an acquisition is treated as a reverse acquisition, the second corporation's group continues in existence, with the first corporation as the parent. Provided that consolidated returns are filed after the acquisition, the tax year of the first corporation and any consolidated subsidiaries ends on the acquisition date.

The reverse acquisition rule is intended to prevent taxpayers from altering the consolidated tax return consequences of a transaction merely by changing its form. Therefore, the reverse acquisition rule looks to the transaction's substance rather than its form. For example, a consolidated group could be terminated at the taxpayer's choosing by altering the structure of the transaction, by which the common parent of one consolidated group is merged into the common parent of another consolidated group. Barring the application of the reverse acquisition rule, either consolidated group could be terminated, depending on which common parent the taxpayers choose to survive the merger.

Regardless of the form of the acquisition, the reverse acquisition rule requires the consolidated group whose former shareholders own more than 50% of the new parent...