Proposed section 1504(a) regulations relating to the treatment of certain options as exercised.

On November 3, 1992, Tax Executives Institute submitted the following comments to the Internal Revenue Service on proposed regulations under section 1504(a) of the Internal Revenue Code on the circumstances in which certain options with respect to a subsidiary's stock will be treated as exercised for purposes of determining whether the 80-percent voting power and value tests for affiliation under section 1504(a) are satisfied. The comments were prepared under the aegis of TEI's Federal Tax Committee, whose chair is David F. Nitschke of Amerada Hess Corporation. Contributing materially to the development of the Institute's position were William V. Meltzer and George Papazicos of the New York Chapter.

On February 28, 1992, the Internal Revenue Service issued proposed regulations under section 1504(a) of the Internal Revenue Code, concerning the circumstances in which certain options with respect to a subsidiary's stock will be treated as exercised for purposes of determining whether the 80-percent voting power and value tests for affiliation under section 1504(a) are satisfied. The proposed regulations treat an option as exercised (and the underlying stock as issued or transferred, as the case may be) if (1) the issuance or transfer of the option rather than the stock would result (but for the regulations) in the elimination of a substantial amount of federal income tax liability, and (2) a reasonable certainty exists on a measurement date (generally the issuance, notification, or transfer date of the option) that the option will be exercised.

The proposed regulations (CO-152-84) were published in the Federal Register on March 2, 1992 (57 Fed. Reg. 7340), and in the March 23, 1992, issue of the Internal Revenue Bulletin (1992-12 I.R.B. 37).(1) A public hearing on the proposed regulations that had been scheduled for April 14, 1992, was subsequently canceled. Tax Executives Institute is pleased to submit the following comments on the proposed regulations.

Effective Date

Prop. Reg. [section] 1.1504-4(i) provides that the regulations apply "to options with a measurement date on or after February 28, 1992." The preamble states that "[n]o inference is intended that options with no measurement date on or after February 28, 1992, are to be disregarded for purposes of determining affiliation." (1992-12 I.R.B. at 40.)

TEI believes that, for purposes of determining affiliation, the regulations should expressly permit taxpayers to disregard options issued prior to February 28, 1992 (regardless of whether there has been a measurement date after that date) to the extent such options do not have an abuse potential. Thus, taxpayers that, prior to the effective date of these regulations, have entered into arrangements involving, for example, publicly traded options, stock purchase agreements, employee stock options, security agreements, and options issued pursuant to a bonafide loan agreement should be permitted to apply the regulations (and their safe harbors) retroactively to prevent disaffiliation. Similarly, taxpayers should be allowed to apply the regulations retroactively to prevent disaffiliation where an option would have satisfied one of the safe harbors of the regulations or where it otherwise could be...