Significant recent corporate developments.

• Author: Hayes, Brandon L.

EXECUTIVE SUMMARY

* The IRS issued regulations under Sec. 1502 adopting a unified rule for determining the amount of loss that may be recognized on a transfer of stock of a member corporation.

* Temporary regulations provide guidance with respect to the "Killer B" and "Killer C" transactions described in Notice 2006-85 and Notice 2007-48.

* Long-awaited proposed regulations were issued under Secs. 367(a)(5) and 1248(f) providing certain exceptions to the gain recognition rules thereof.

* Proposed regulations were issued under Sec. 336(e) to permit inside basis adjustments on certain taxable stock dispositions.

* Notice 2008-111 established four required components for a transaction to be considered an intermediate transaction tax shelter within the scope of Notice 2001-16.

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This article summarizes selected U.S. federal income tax developments during 2008 affecting corporations, including those filing consolidated returns. Since the last update, there has not been any significant legislation specifically directed at corporations or consolidated taxpayers. However, Congress did enact several items of legislation, including the Housing and Economic Recovery Act of 2008 (the Housing Act) (1) and the Emergency Economic Stabilization Act of 2008 (EESA). (2) Treasury and the IRS have issued a number of notices providing short-term guidance about how certain provisions of EESA and the Housing Act may affect taxpayers. In addition, the Service and Treasury have issued several packages of final, temporary, and proposed regulations covering a broad spectrum of corporate and consolidated issues.

Final and Temporary Regs. The Unified Loss Rule

The Service finalized regulations (3) under Sec. 1502 that establish an integrated set of rules, commonly referred to as the unified loss rule (ULR), for determining the amount of loss, if any, that a consolidated group recognizes on the transfer of the stock of a member corporation. The ULR replaces the pre-Rite Aid (4) loss disallowance rules of Regs. Secs. 1.337(d)-1, 1.337(d)-2, and 1.1502-20. The ULR's principal purposes are:

1. To prevent the consolidated return rules from reducing a group's consolidated taxable income (CTI) through the creation and recognition of noneconomic losses; and

2. To prevent group members from duplicating the tax benefit of a single economic loss. (5)

   The ULR generally applies whenever a member (M) transfers a share of the stock of a subsidiary corporation (S) and the share is a loss share. For this purpose, the concept of a transfer is broader than a sale or disposition of the share. The regulations define a transfer as any event in which:

   * M ceases to own the S share in a taxable transaction;

   * M and S cease to be members of the same consolidated group;

   * A nonmember acquires the S share from M; or

   * The S share becomes worthless (taking into account the provisions of Regs. Sec. 1.1502-80(c)). (6)

   Certain nonrecognition transactions are excepted from this definition, and the regulations incorporate a special rule for intercompany transfers.

   If M transfers a loss share of S, then immediately before the transfer taxpayers must sequentially apply three rules to redetermine basis or attributes of S.

1. Under Regs. Sec. 1.1502-36(b), each member's basis in S shares is subject to redetermination (the redetermination rule).

2. If any member's basis in a transferred S share is still greater than that share's value, that basis is subject to reduction under Regs. Sec. 1.1502-36(c) (the basis reduction rule).

3. If any member's basis in a transferred S share exceeds that share's value after application of the prior rules, S's attributes are subject to reduction under Regs. Sec. 1.1502-36(d) (the attribute reduction rule).

   Under the redetermination rule, if M transfers a loss share of S stock, its basis in all shares of its S stock is redetermined first by reducing basis in the transferred loss common shares (but not below fair market value) by the amount of positive investment adjustments previously applied to the shares and reallocating such adjustments to other shares. If there is still loss in a transferred S share (either common or preferred), basis is reduced in such shares by reallocating negative basis adjustments from common shares that are not transferred loss shares. (7) The regulations provide specific rules as to how these allocations are to be made. However, the redetermination rule is not applied if the group disposes of all the S shares in a taxable transaction or the members have no gain or loss on S preferred stock and no disparity in their common stock bases. (8)

   In general, the basis reduction rule requires M to reduce its basis in the transferred share, but not below fair market value, by the lesser of (1) the share's net positive adjustment or (2) the share's "disconformity amount." (9) The regulations provide purely mechanical formulas for calculating a share's net positive adjustment and its disconformity amount--no tracing is permitted. (10) As a result, this rule reaches appropriate results in true "son of mirror" situations but may improperly allow or deny certain true economic losses. (11)

   Finally, if after the basis reductions described above the transferred S share is still a loss share, S's attributes are reduced (with certain exceptions) by S's attribute reduction amount as defined in Regs. Sec. 1.1502-36(d)(3). The reduction is applied to four separate categories of S's attributes in the following order: (1) capital loss carryovers; (2) net operating loss carryovers; (3) deferred deductions; and (4) basis of assets other than Class I assets as defined in Regs. Sec. 1.338-6(b)(1) (e.g., cash). (12)

   The regulations also establish rules for allocating the reduction among the fourth category of assets. Regs. Sec. 1.1502-36(d)(6) allows the common parent to make an election to avoid or limit attribute reduction by electing to otherwise reduce members' bases in the transferred S loss shares, to reattribute S's attributes to the common parent (if Sis leaving the group), or some combination thereof. A taxpayer may make this election protectively if it is uncertain whether any transferred S share is a loss share. Informed purchasers may require a protective election to be filed by the common parent of a selling group in order to preclude an unintended reduction in the tax attributes of a target corporation acquired from a consolidated group.

   The regulations also include certain exceptions to the application of these rules as well as an anti-avoidance provision. Under the anti-avoidance provision, appropriate adjustments will be made to effect the purposes of the regulations if a taxpayer acts with a view to avoid the purposes of Regs. Sec. 1.1502-36 or to apply the regulations to avoid the purposes of any other rule of law. (13)

   These regulations have been criticized as overly complex, particularly with respect to the application of the rules to lower-tier subsidiaries. In addition, much of the information required to perform the calculations, such as asset and stock basis, will not be readily available and must be separately determined. The regulations are generally effective as of September 17, 2008. (14)

   "Killer B" and "Killer C" Transactions

   On May 23, 2008, the Service issued temporary regulations (15) implementing the rules published in Notices 2006-85 (16) and 2007-48. (17) Temp. Regs. Sec. 1.367(b)-14T applies to triangular reorganizations (as described in Regs. Sec. 1.358-6(b)(2) or Secs. 368(a)(1)(G) and (a)(1)(D)) where either the parent (P) or the subsidiary (S) or both are foreign corporations, and S acquires, in exchange for property, all or a portion of the P stock that is used to acquire the stock or assets of the target corporation (T). Generally, if the regulation applies, adjustments will be made to have the effect of a deemed distribution of property from S to P under Sec. 301. The amount of the deemed distribution is equal to the amount of money plus the value of the other property transferred by S in exchange for the P stock used in the reorganization. This distribution is deemed to occur in an unrelated transaction immediately before the triangular reorganization. (18)

   Moreover, if S acquires the P stock from a person other than P, immediately following the deemed distribution P is treated as contributing to S the property deemed to be distributed by S to P. If at the time of the purchase P owns S stock satisfying the requirements of Sec. 368(c), the deemed distribution and contribution are treated as separate transactions occurring immediately before the purchase. If P does not have Sec. 368(c) control of S at the time of purchase, the deemed distribution and contribution are treated as occurring in separate transactions immediately after P acquires control of S. The regulations provide that the deemed distribution is treated as a distribution of property for all purposes of the Code and that the deemed contribution, if any, is treated as a contribution of property for all purposes of the Code. (19)

   The regulations also contain an anti-abuse rule under which appropriate adjustments shall be made if, in connection with a triangular reorganization, a transaction is undertaken with a view to avoiding the purpose of the regulations. (20) The temporary regulations are generally effective May 27, 2008, but have retroactive application to four enumerated types of transactions. Furthermore, each effective date is subject to a limited "binding commitment" exception. (21)

   Complete Liquidations into Multiple Members

   Sec. 332(a) generally provides that a corporation shall not recognize any gain or loss in connection with the receipt of property distributed in complete liquidation of another corporation. As a general rule, Sec. 332(b) provides that in order to qualify under Sec. 332(a), the recipient corporation must own stock of the liquidating corporation satisfying the...