Recent developments for using target's NOLs.

• Author: Maydew, Jeff
• Position: Target corporation's net operating losses

An acquired corporation's net operating losses (NOLs) are often subject to multiple restrictions that limit or prohibit their use by a corporate acquiror, including limitations under Secs. 382,384,269 and the separate return limitation year (SRLY) rules of Temp. Regs. Sec. 1.1502-21T. However, a recently released 1993 Field Service Advice (FSA) and expected revisions to the SRLY rules offer some hope to acquirors.

Sec. 382 Built-in Gain

Sec. 382 generally restricts use of NOLs by a loss corporation that has undergone an ownership change (a greater-than-50% change in ownership over a rolling three-year period), by limiting the annual amount of income that may be offset by pre-change loss carryforwards. This limit generally equals the product of (1) the loss corporation's value immediately before the ownership change multiplied by (2) the prevailing long-term tax-exempt interest rate. (When a corporation undergoes an ownership change, Sec. 383 imposes similar limits on the rate at which other pre-change attributes (such as capital losses and tax credits) may be absorbed.)

One somewhat pro-taxpayer aspect of this rule involves the treatment of built-in gain. Sec. 382(h)(1) provides that, if a loss corporation has a "net unrealized built-in gain" (NUBIG) on the change date, the Sec. 382 limitation may be increased by the built-in gain recognized during the five post-change years. To take advantage of this provision, the NUBIG must be greater than either (1) $10 million or (2) 15% of the gross value of the loss corporation's noncash or cash-equivalent assets.

For Sec. 382 purposes, built-in gain is recognized to the extent the loss corporation establishes that there has been a "disposition" of an asset held immediately before the change date, and the gain from the disposition does not exceed the amount of built-in gain on the change date. Sec. 382(h)(6) further provides that "any item of income which is properly taken into account during the recognition period but which is attributable to periods before the change date shall be treated as a recognized built-in gain for the taxable year in which it is properly taken into account." The legislative history to this provision gives only two examples of built-in income items: (1) pre-change accounts receivable of a cash-basis taxpayer and (2) post-change Sec. 481 adjustments attributable to pre-change periods.

1993 FSA

The IRS released FSA 1998-415, concluding that income from software licensing...