common mistakes the average corporate tax practitioner makes when dealing with consolidated returns

1. Common Mistakes the Average Corporate Tax Practitioner Makes When Dealing With Consolidated Returns American Bar Association Affiliated & Related Corporations Committee San Antonio, Texas January 22, 2010

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3. Reverse Acquisitions - §1.1502-75(d)(3) Definitional requirements If a corporation (‘first corporation”) acquires the stock or substantially all of the assets of another corporation (“second corporation”) in a taxable or nontaxable transaction (it is easier to think of the “first corporation” as the “acquiring corporation” and the “second corporation” as the “target corporation”), and As a result of their ownership in the second corporation/target, shareholders of the second corporation/target own more than 50% of the stock of the first corporation/acquiring corporation. Notes:Notes:

4. Reverse Acquisitions - §1.1502-75(d)(3) Certain Tax consequences of a reverse acquisition §1.1502-75(d)(3)(i) -- Acquiring corporation’s group goes out of existence §1.1502-75(d)(3)(v)(a) -- Acquiring corporation’s group must close its taxable year and change to the taxable year of the Acquired corporation §1.1502-75(d)(3)(v)(b) – If the transaction is a subject to section 381, all taxable years of the Acquiring corporation will be treated for that purpose as taxable years of the transferor corporation (see section 381(b)(3) regarding NOL carrybacks) Acquiring corporation’s NOLs may be subject to SRLY Notes:Notes:

5. Group Structure Changes -- (§§1.1502-33(f) and -31) Definition of “Group Structure Change” -- If P succeeds another corporation as the common parent under §1.1502-75(d)(2) or §1.1502-75(d)(3) Consequences of Group Structure Change The E&P of P are adjusted to reflect the E&P of the former common parent P’s basis in the former common parent is adjusted to reflect the net inside asset basis of the former common parent Notes:Notes:

6. §1.1502-31 -- Stock Basis After Group Structure Change If “T” succeeds “P” as the common parent of a consolidated group under the principles of -75(d)(2) or (3), the basis of members in the stock of the former common parent is determined as follows: Asset acquisitions (e.g., corporation acquires the former common parent’s assets) -- the basis of members in the stock of the acquiring corporation … reflects the acquiring corporation’s allocable share of . . . the former common parent’s net asset basis … or Stock Acquisitions (e.g., a corporation acquires stock of the former common parent ) -- the basis of the members in the former common parent’s stock immediately after the group structure change that is, or would otherwise be, transferred basis property is redetermined in accordance with the results for an asset acquisition

7. Reverse Acquisition/Group Structure Change - §§1.1502-75(d)(3)/-31 7 Notes:Notes:

8. Reverse Acquisition/Group Structure Change - §§1.1502-75(d)(3)/-31 8 Notes:Notes:

9. Reverse Acquisition/Group Structure Change - §§1.1502-75(d)(3)/-31 9 Notes:Notes:

10. Group Structure Change -33(f) and -31 -- Taxable Stock Acquisition 10

11. Reverse Acquisition/Group Structure Change - §§1.1502-75(d)(3)/-31 11 Notes:Notes:

12. “Stand Alone” Reverse Acquisitions 12

13. Excess Loss Accounts - Reg. § 1.1502-19 Excess loss account is “negative basis” in the stock of a member (§1.1502-19(a)(2) and -32(a)(3)(ii)). Immediately before the “disposition” of stock with an ELA, the ELA must be taken into income (§1.1502-19(b)(1)). Events which trigger recognition of excess loss account Parent sells stock of subsidiary (ELA on sold shares taken into income) Parent transfers the stock of the subsidiary to a nonmember (or otherwise ceases to own the subsidiary stock), even if otherwise no gain or loss to Parent Parent leaves the consolidated group Subsidiary leaves the consolidated group Subsidiary’s stock becomes “worthless, within the meaning of § 1.1502-19” No subgroup exception Notes:Notes:

14. 14 Intercompany Transaction Regulations -- Acceleration Rule Acceleration Rules (§1.1502-13(d)) General Rule S’s and B’s items are taken into account to the extent they cannot be taken into account to produce the effect of treating S and B as divisions of a single corporation, such as: S or B leave the group, discontinue filing consolidated returns, etc, or A non-member reflects any aspect of an intercompany transaction (e.g., contribution of asset to a partnership) Exception for Intercompany Debt in §1.1502-13(g)(8). Notes:Notes:

15. ELA and DIT Recapture on Tax-Free Transaction 15 Notes:Notes:

16. 16 Reg. § 1.1502-11(b) Circular Basis Rule P is planning to sell the stock of S1 and S2 and will recognize $100 gain on each. S1 and S2 both have NOLs. What issues are present with this transaction? Notes:Notes:

17. The “Offspring Rule” (§1.1502-21(b)(2)(ii)(B)) Applies to a subsidiary member if it has been a member of the group continuously since its organization (determined without regard to successor/predecessor determination) NOLs of an eligible subsidiary generally may be carried back to years prior to its existence to the common parent’s equivalent consolidated or separate return year No carrybacks permitted to a year in which common parent was a member of another consolidated group or affiliated group filing separate returns Offspring Rule

18. Offspring Rule – Reverse Merger 18

19. Offspring Rule – Forward Merger 19

20. 20 Adjustments to Earnings & Profits (E&P) -- § 1.1502-33 §1.1502-33(a)(1) – Adjust P’s E&P to reflect S’s E&P for the period that S is a member of the group Purpose – To treat P and S as a single entity §1.1502-33(a)(2) – Rules are in addition to other rules of law and adjustments must not have the effect of duplicating E&P Where the stock of the common parent of the consolidated group is acquired, there is no special treatment (or elimination) of the accumulated E&P of the acquired group. Notes:Notes:

21. P, a newly formed corporation, acquires all of the stock of T for cash. At the time of the acquisition, P has $0 E&P and T has E&P of $100. T distributes $100 to P and P distributes the $100 to its shareholder, B. What is the amount of P’s dividend to B? Earnings and Profits -- Taxable Purchase 21 Notes:Notes:

22. Earnings and Profits -- Taxable Purchase P’s E&P of $0 is not adjusted by reason of P’s purchase of T stock. Year of S’s $100 dividend to P. S’s E&P decreased by $100 because of dividend to $0 (section 312 P’s E&P increased by $100 for dividend from S to $100 (section 312) and decreased by $100 to 0 because of decrease in T’s E&P. §1.1502-33(b)(1); special rule of §1.1502-33(b)(2) not applicable because T’s E&P is separate return limitation year (“SRLY”) E&P, not separate return year non-SRLY E&P See §1.1502-1(e) and (f); §1.1502 -33(b)(3)(ii), ex 1(d)) No dividend to A because P’s E&P = 0. (section 316) Notes:Notes:

23. Section 351(e) in Consolidation

24. 24 Consolidated Tax Attribute Rules CNOL apportionment rules: If CNOL that is attributable to a member would be carried over to a separate return year (e.g., the member leaves the consolidated group), the CNOL must be apportioned to the member (§1.1502-21(b)(2)) The apportionment of the CNOL to the departing member occurs at the end of the year (§1.1502-21(b)(2)(ii)(A))

25. Loss Apportionment -- §1.1502-21(b) P is the parent of a calendar year group. On January 2, Year 1, P sells all of the stock of S1 to A. On December 30, Year 1, S generates $6,000 of taxable income and S1 generates $1,000 of taxable income. How much of the $2,500 CNOL that S1 generated in the P group is available to S1 following A’s acquisition of the S1 stock? Suppose that, rather than S generating $6,000 of taxable income in Year 1, P recognizes excluded COD of $10,000 on December 30, Year 1, and the P Group has tax attributes to reduce of only $3,000 (disregarding the S1 losses).

26. 26 Subsidiary stock basis must be reduced by “Noncapital, Nondeductible Expenses” (§ 1.1502-32(b)(3)(iii)(A)) Defined as “Expense or loss that is taken into account but permanently disallowed” Examples include: Federal taxes Reduction of tax attributes upon discharge of indebtedness Disallowed loss on sale of subsidiary stock Expiring NOLs Bribes, Penalties Basis Adjustments to Subsidiary Stock - § 1.1502-32 Notes:Notes:

27. Expiring Losses -- §1.1502-32(b)(3)(iii)(A) P purchases all of the stock of T for $1 million and T joins the P consolidated group. During negotiations, P and X agree that P will pay no consideration for T’s losses because of the significant limitations to which they will be subject following the sale. T’s $1 billion NOL expires. P sells T for its purchase price of $1 million to A. What result? Can P alter this result by making an election? 27 Notes:Notes:

28. Overall Foreign Losses (“OFLs”) in Acquisitions P purchases all of the stock of T for cash and T joins the P consolidated group. At the time of the acquisition (and subsequent disposition), T has $99,000 non-U.S. assets, and P has a $1 billion OFL and $1,000 non-U.S. assets. How much of the OFL is allocated to T when it departs from the P group? See §1.1502-9T(c)(1). 28 Notes:Notes:

29. Consolidated Section 382- NUBIG/NUBIL The regulations extend the section 382 rules dealing with built-in losses to consolidated groups If the loss group (or subgroup) has a NUBIG on the date of an ownership change, RBIG will increase the section 382 limitation if it is recognized within 5 years If the loss group (or subgroup) has a NUBIL on the date of an ownership change, it will be subject to the section 382 limitation if it is recognized within 5 years Consolidated rules provide that a loss group (or subgroup) can have BOTH a NUBIG and a NUBIL

30. Consolidated Section 382- NUBIG/NUBIL Determination is made based on members of the loss group (or loss subgroup) For determining NUBIG, the loss group (or loss subgroup) includes all of the members of the consolidated group on the day that the determination is made (§1.1502-91(g)(2)(i))

31. Definition of “Loss Group” for Built-in Losses (§1.1502-91(g)(2)(ii)): The common parent and all of the members that have been affiliated with the common parent for 5 years; Any member(s) that has a NUBIL on the determination date that is not a new loss member with a NUBIL nor a member of a NUBIL loss subgroup; and Any member(s) that joined the group with a NUBIL but a has NUBIG on the determination date. Note: Non-5-year members are included only because NUBIL or NUBIG arose when member was a group member. In addition, stock of members of the loss group are ignored in this determination. Consolidated Section 382-Built-in Losses

32. Consolidated Section 382-NUBIG/NUBIL 32

33. Section 382-Built-In Losses (“BILs”) P, S and S1 are included in the P Group. In Year 1, when S has a $40 million built-in loss inherent in its assets and S1 has a $100 million built-in loss inherent in certain assets and a $110 million built-in gain inherent in other assets, the P group undergoes an ownership change. In Year 2, A acquires all of the stock of S1 (the amount of S1’s gross built-in items remains constant). What is the result if S1 subsequently disposes of equal amounts of gain and loss assets? 33 Notes:Notes:

34. The Overlap Rule 34 Notes:Notes:

35. Built-In Losses (“BILs”) 35 Notes:Notes:

36. 36 Application of Section 382 to Consolidated Groups Apportioning Section 382 Limitation When Loss Group Member Leaves the Consolidated Group (1.1502-95) Parent of the group (not parent of the subgroup) makes the election to apportion the limitation (1.1502-95(a)(2)) Any portion of the limitation may be apportioned to the subsidiary at the parent corporation’s election (1.1502-95(c)) Value Element Adjustment Element (Unused Limitation) Built-in Gain Adjustment Element Built-in Loss (Special Rules)

37. 37 Application of Section 382 to Consolidated Groups Apportionment (Cont.) An apportionment of either element reduces the consolidated Section 382 limitation for the remaining members of the group. Failure to apportion any limitation results in the departing member taking a zero section 382 limitation on its NOLs The apportionment rules apply to departing subgroups and member of departing subgroups. Special Rules may apply to departing subgroups (e.g., if a subgroup parent election is made) (1.1502-95(d))

38. §1.1502-76(c) provides rules for determining the time for making a separate return for a member corporation’s taxable year not included in a consolidated return If the consolidated group to which the corporation becomes or ceases to become a member has filed a consolidated return on or before the due date for the filing of the corporation's separate return , then the separate return for any portion of the corporation's taxable year for which its income is not included in the consolidated return of the group must be filed no later than the due date of such consolidated return (including extensions of time) If the consolidated group to which the corporation becomes or ceases to become a member has not filed a consolidated return on or before the due date for the filing of the corporation's separate return, then the corporation is required to file on or before such due date, a separate return either for the portion of its taxable year for which its income would not be included in the consolidated return if such a return were filed, or for its complete taxable year §1.1502-76(b)(4) provides that, in applying §1.1502-76(c), the due date for the filing of the corporation's separate return shall also be determined without regard to: the ending of the tax year under §1.1502-76(b)(1)(ii); or the deemed cessation of its existence under §1.1502-76(b)(2)(i) Section 381(b)(1) provides that, except in the case of an acquisition in connection with a reorganization described in section 368(a)(1)(F), the taxable year of the distributor or transferor corporation shall end on the date of the distribution or transfer (described in section 381(a)) Tax Return for Consolidated Groups 38

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41. Section 1504(a)(3) provides that if a corporation which is a member of a consolidated group ceases to be a member of such group such corporation (and any successor of such corporation) may not be included in any consolidated return filed by the affiliated group (or by another affiliated group with the same common parent or a successor of such common parent) before the 61st month beginning after its first taxable year in which it ceased to be a member of such affiliated group “Successor” is not defined in section 1504 Under § 1.1502-1(f)(4) (dealing with the SRLY rules) a “successor” is a member who receives, in a transfer or distribution, assets in a transaction (i) to which section 381(a) applies; or (ii) in which the successor's basis for the assets is determined, directly or indirectly, in whole or in part, by reference to the basis of the assets of the transferor or distributor. (e.g., a section 361 transfer) Section 1504(a)(3) and Successor Entities 41

42. Section 1504(a)(3) and Successor Entities 42

43. Section 1504(a)(3) and Successor Entities 43

44. Buyer Concerns from Attribute Reduction under §1.1502-36 Attribute reduction might arise any time the purchase price of S stock is less than the total net attributes of S, and the selling group has a loss on the S stock A potential buyer of S will generally want P to elect to reduce stock basis instead of acquiring S with reduced attributes The attribute reduction amount may not be known at closing S’s attributes may be subject to audit adjustment Purchase price may be subject to adjustment Buyer normally would not know or care about the selling group’s stock basis, or whether the selling group has a tax loss on the sale, and would want to be protected regardless of that basis P can make a “protective election” to reduce stock basis at the time of sale in order to prevent any future attribute reduction to the buyer, even though the amount of the potential attribute reduction may not be known at that time 44