When are the final consolidated E&P regulations retroactive?

• Author: Friedel, David
• Position: Earnings and profits

Computing a corporation's earnings and profits (E&P) sometimes can be complicated, particularly when the corporation is the parent of a consolidated group. Several additional adjustments are required under the consolidated return regulations, such as "tiering up" the proper amount of low-tier members' earnings (or deficits) and exceptions and transition rules.

The existing consolidated return E&P regulations were issued in 1994 and generally took effect in 1995. While these rules generally apply retroactively, prior law cannot be ignored completely. There are some significant areas in which prior law still makes a difference.

Fact Pattern

Example: Foreign corporation FX has owned all the stock of domestic corporation Z since Z's inception many years ago. Z never had lower-tier domestic subsidiaries and filed separate returns every year until 1984. During that prior period, Z operated profitably and had $10 million of accumulated E&P coming into 1984. In 1984, FX restructured its U.S. operations by positioning Z below a U.S. holding company. FX formed a new domestic corporation, P, and contributed all the Z stock to P on Jan. 1, 1984. P and Z elected to file a consolidated return in 1984 and have done so every year since.

P now is planning to distribute $8 million to FX. That distribution will be subject to 5% U.S. withholding tax under the applicable treaty to the extent it constitutes a dividend (i.e., to the extent of P's E&P). Since 1984, P and Z have had no net profit or loss; if P has any E&P today, therefore, it is attributable entirely to the $10 million E&P that Z generated through 1983. The P group made a deemed dividend election in connection with its first consolidated return in 1984 and Z has made no actual distributions to P.

Analysis Ignoring Prior Law

If prior law could be ignored, the analysis of these facts would be quite straightforward. The 1984 contribution of Z stock to P was a "reverse acquisition" under Regs. Sec. 1.1502-75(d)(3); that transaction therefore also qualified as a "group structure change" as that term is now defined under Regs. Sec. 1.1502-33(f). (A group structure change generally occurs when a corporation succeeds another corporation as the new common parent of a group in a downstream merger or a reverse acquisition and the group of the old common parent is treated as continuing in existence.) As a result, Z's $10 million of E&P would have replicated automatically in P's hands, and P would have $10...