M&A tax recent guidance

This Month in M&A / Issue 21 / December 2014
Did you know…? p2 / Court Watch p4 / Treasury Regulations p4
M&A tax recent guidance
This month features:

CCA appears to apply a novel approach for the application of the step transaction doctrine in
the context of a retroactive check-the-box election (CCA 201446019)

Second Circuit affirms Tax Court decision that funds received through a controlled foreign
corporation in substance constituted dividend payments (Barnes Group)

Final regulations limit ability to choose tax attribute location following asset reorganizations
(T.D. 9700)

Final regulations address basis allocations in ‘All Cash D’ reorganizations (T.D. 9702)

Final GRA regulations address filing failures, other GRA administrative deficiencies (T.D.
9704)
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Did you know…?
A recently released Chief Counsel Advice applies a novel approach for application of
the step transaction doctrine in the context of a retroactive REIT election (CCA
201446019). While REIT elections are available only to a limited class of taxpayers,
the question arises whether this CCA could have broader application and might signal
potential IRS positions in other ‘retroactive election’ situations, such as a retroactive
check-the-box (CTB) election under Reg. sec. 301.7701-3. The new CCA,
supplementing a CCA issued June 20, 2014 (the June CCA), concludes that a deemed
contribution occurring pursuant to a retroactive election was a taxable exchange
rather than a tax-free section 351 transfer because the deemed contribution failed to
satisfy the section 351 control requirement.
Background
Section 351 generally provides that no gain or loss is recognized upon the transfer of
property to a corporation in exchange for stock in such corporation, if immediately
thereafter the transferors are in control of the transferee corporation (the section 351
control requirement). For this purpose, control is determined under section 368(c),
which requires ownership of at least 80 percent of the voting stock and at least 80
percent of each class of nonvoting stock of the corporation.
A section 351 exchange generally differs from a sale in that the transferors continue to
have a beneficial interest in the transferred property and retain dominion over the
property through their interest in the corporation. Generally, courts and the IRS have
stated that the purpose of section 351 is to allow nonrecognition when a taxpayer has
not economically ‘cashed in’ investments but merely has changed the form of its
ownership in such investments. See, for example, Portland Oil Company v.
Commissioner, 109 F.2d 479, 488 (1st Cir. 1940), and CCA 200840040.
Applying the step transaction doctrine in the section 351 context, courts and the IRS
generally have agreed that if at the time of engaging in a purported section 351
exchange, the transferor has a binding commitment to transfer the transferee’s shares
following the exchange, the section 351 control requirement may not be satisfied. See,
for example, Intermountain Lumber Co. v. Commissioner, 65 T.C. 1025 (1976), and
Rev. Rul. 79-70.
Reg. sec. 301.7701-3 provides that a retroactive CTB election can be made up to 75
days after the desired effective date of the election. However, the tax treatment of a
change in classification of an entity under the CTB regulations is determined under all
relevant provisions of the Code and general principles of tax law, including the step
transaction doctrine (see Reg. sec. 301.7701-3(g)(2)(i)). Similar to the REIT election
in the CCA that imposed a deemed contribution fiction, a disregarded entity (DE) that
elects to change its classification from a DE to a corporation is treated for US federal
income tax purposes as if the DE owner contributed all the assets and liabilities of the
DE to a newly formed corporation solely in exchange for its stock (see Reg. sec.
301.7701-3(g)(1)(iv)).
Facts in the CCA
As depicted in the timeline below, on Date 1 of Year 1 (Date 1) a financial institution
(Failed Institution) formed a single-member LLC (BankLLC) treated from its
formation as a disregarded entity (DE) for US federal tax purposes. On the same
date, Failed Institution transferred REMIC securities (qualifying REIT assets under
section 856) to BankLLC.
On Date 2 of Year 1 (Date 2), subsequent to Failed Institution’s failure as a bank, an
unrelated purchaser (Bank) acquired Failed Institution’s deposit liabilities and assets,
including the REMIC securities held by BankLLC, in a taxable acquisition (the
Acquisition). On Date 6 of Year 2 (Date 6), BankLLC elected to be treated as a REIT
for US federal income tax purposes effective as of Date 1 (the Retroactive REIT
Election).
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IRS analysis
The IRS stated that if the Retroactive REIT Election were respected as being effective
as of Date 1, then the following would be deemed to occur for US federal income tax
purposes: (1) BankLLC would be deemed to be treated as a corporation as of the start
of Date 1, and (2) consequently, Failed Institution would be deemed to have
contributed all of BankLLC’s assets and liabilities to BankLLC in exchange for
BankLLC units immediately before the close of the day prior to Date 1 (the Deemed
Contribution).
In the CCA, the IRS first acknowledged its prior conclusion in the June CCA that the
Deemed Contribution qualified as a section 351 transfer for US federal income tax
purposes. The IRS then, however, rejected its prior conclusion on the ground that the
IRS now viewed Failed Institution as having failed to meet the section 351 control
requirement.
In determining that the Deemed Contribution failed to satisfy the section 351 control
requirement, the IRS analogized to the body of well-developed case law, and its own
prior revenue rulings, which hold that the control requirement is not satisfied if the
transferor is under a binding commitment at the time of the exchange to transfer the
transferee corporation’s stock to another person in a taxable disposition. Specifically,
the IRS stated that because Failed Institution no longer owned BankLLC when
BankLLC made the Retroactive REIT Election, Failed Institution “should be viewed as
having irrevocably foregone or relinquished at the time of the Deemed Contribution
the legal right to determine whether to keep the BankLLC shares.”
As a result of the Retroactive REIT Election, the IRS viewed the circumstances of the
Deemed Contribution as ‘analogous’ to Failed Institution being under a binding
commitment to transfer the REMIC securities to BankLLC in a purported section 351
exchange, and then to sell the LLC units of BankLLC to Bank. Accordingly, the IRS
concluded that the Deemed Contribution failed to qualify as a section 351 exchange.
Observations
Although the IRS analogized the facts of the CCA to a binding commitment standard,
the CCA does not state that there was such a binding commitment to sell in place as of
Date 1. An alternative application of the binding commitment standard for a
retroactive CTB election would have been that the binding commitment must be
present at the effective date of the retroactive election and taxpayers could not use
hindsight to effectively create a ‘busted’ section 351 transaction for tax planning
purposes.
Thus, the approach taken in this CCA appears to create a new approach for
application of the step transaction doctrine in the context of a retroactive REIT
election (Note: Because REIT elections have to be made through filing a 1120-REIT
for the applicable period, they are always retroactive elections, see section 856(c)(1)).
While REIT elections are available only to a limited category of taxpayers, the
question arises whether this CCA could have broader application and might signal
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potential IRS positions in other ‘retroactive election’ situations, such as a retroactive
CTB election under Reg. sec. 301.7701-3.
Although a CCA cannot be used or cited as precedent, it can provide useful insight as
to how the IRS viewed the issues considered therein. This CCA seems to provide a
new or different line of reasoning by the IRS. Query whether the IRS will permit
taxpayers to obtain a single-issue private letter ruling applying the CCA’s rationale to
retroactive CTB elections.
For additional information, please contact Tim Lohnes, Henry Miyares, or Rob
Calabrese.
Court watch
Barnes Group, Inc. v. Commissioner, Second Circuit 13-4298
(November 5, 2014)
The Second Circuit Court of Appeals recently affirmed the Tax Court’s April 2013
decision in Barnes v. Commissioner that substance-over-form and step transaction
doctrine principles applied to a reinvestment plan such that the series of transactions
occurring under the plan in substance constituted a constructive dividend
distribution. See the May 2013 edition of This Month in M&A for discussion of the
steps comprising the reinvestment plan and a summary of the Tax Court decision.
The Second Circuit agreed with the Tax Court’s holding that the taxpayer did not
reasonably rely on Rev. Rul. 74-503, on the ground that the ruling was factually
inapplicable to the facts in Barnes.
Observations
The Second Circuit found Rev. Rul. 74-503 to be factually inapplicable to the
taxpayer’s circumstances in Barnes on the ground that because the steps of the
reinvestment plan occurred pursuant to an integrated plan, while the revenue ruling
addressed only an isolated exchange. Thus, the Second Circuit’s opinion does not
resolve a broader question raised by the Barnes’ Tax Court decision as to how close
the facts of a taxpayer’s transaction must be to the facts of an existing revenue ruling
in order to justify reliance on that ruling. Also, the opinion indicates that providing
additional business purposes for the steps of a transaction will not necessarily
preclude application of the step transaction doctrine. Most notably, the Second
Circuit’s affirmation of the Tax Court decision signifies the importance of executing
and implementing the transaction as planned and following through in a manner that
complies with all applicable legal and regulatory requirements.
For additional information, please contact Gary Wilcox, Tim Lohnes, or Rob
Calabrese.
Final Treasury Regulations
Final regulations under sections 381 and 312 (T.D. 9700)
The IRS on November 10 published final regulations under sections 381 and 312 (T.D.
9700) that limit the degree of electivity afforded to taxpayers regarding the location of
tax attributes inherited from a target corporation in an asset reorganization.
The final regulations apply to transactions occurring on or after November 10, 2014.
The preamble states that the final regulations adopt proposed section 312 regulations
published April 16, 2012 (REG-141268-11) and proposed section 381 regulations
published May 7, 2014 (REG-131239-13) without substantive change to either set of
proposed regulations. See the May 2012 and June 2014 editions of This Month in
M&A for a background discussion of section 381 and the interaction of the prior final
and proposed regulations under sections 381 and 312.
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Final rules
Under the final section 381 regulations, the definition of the acquiring corporation is
modified to mean the corporation that directly acquires the assets transferred by the
transferor corporation, even if that corporation ultimately retains none of the
transferred assets. The final section 312 regulations provide that in the case of an
asset reorganization, the acquiring corporation (and only the acquiring corporation)
as defined in the final section 381 regulations succeeds to the earnings and profits
(E&P) of the transferor corporation.
Thus, under the final regulations, if transferor corporation (T) merges into acquiring
corporation (A), A is treated as the acquiring corporation that succeeds to T’s tax
attributes (including T’s E&P) regardless of whether A subsequently transferred all of
T’s acquired assets to a wholly owned subsidiary (S) pursuant to the plan of
reorganization. Prior to these final regulations, if A had transferred all of T’s acquired
assets to S, S would have succeeded to all of T’s E&P. However, if A had transferred
all of T’s acquired assets among several wholly owned subsidiaries, it had been
unclear whether T’s E&P would be allocated among the wholly owned subsidiaries.
The preamble states that this rule is appropriate “because it generally maintains such
earnings and profits at the corporation closest to the transferor corporation’s former
shareholders in a manner that minimizes electivity and administrative burden.”
Observations
The final regulations provide clarity in adopting a ‘bright-line’ rule that can be applied
by taxpayers in evaluating the anticipated results of various structuring alternatives.
Taxpayers may seek to retain some measure of ability to choose the location of
inherited tax attributes through the form of the transaction itself, as techniques such
as downstream mergers and triangular reorganizations could prove viable alternatives
in appropriate situations resulting in a preferential location of tax attributes under
the bright-line rule.
For additional information, please contact Robert Black or Jon Lewbel.
Final basis allocation regulations in ‘All Cash D’ reorganizations (T.D.
9702)
The IRS on November 12 published final regulations under section 358 regarding
determination of the basis of stock or securities of the acquiring corporation in ‘All
Cash D’ reorganizations. The final regulations adopt temporary regulations issued in
November 2011 without substantive changes. See the December 2011 edition of This
Month in M&A for a detailed discussion of the temporary regulations.
Background
In general, the All Cash D regulations provide that a transaction is treated as
satisfying the distribution requirement of section 368(a)(1)(D) notwithstanding that
there is no actual issuance of stock and/or securities of the acquiring corporation so
long as the same person or persons own, directly or indirectly, all the stock of the
target and acquiring corporations in identical proportions.
In these situations, assuming a value-for-value exchange between the transferor and
acquiring corporations, the All Cash D regulations deem the acquiring corporation to
issue a nominal share of its stock in addition to the actual consideration exchanged
for the transferor corporation’s assets. In a non value-for-value exchange—i.e., a
situation where the acquiring corporation provides the transferor corporation with no
consideration or consideration having a value less than the transferor corporation’s
assets—the acquiring corporation is treated as issuing shares of its stock having a
value necessary to create a value-for-value exchange.
Temporary regulations
In a value-for-value exchange, the temporary regulations provided a special rule that
allowed a shareholder that was deemed to receive a nominal share of acquiring
corporation stock to designate a share of the acquiring corporation stock to which the
basis of the nominal share would attach (the nominal share basis designation rule).
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Prior to issuance of the temporary regulations, in the context of an All Cash D
reorganization with a lower-tier target corporation where the acquiring corporation
was in a different chain of ownership, some taxpayers had interpreted the earlier
regulations as allowing shareholders of the transferor corporation who did not
actually own stock of the acquiring corporation to designate a share of ‘actual’
acquiring corporation stock to which the basis in the nominal share would attach
prior to any deemed distribution/contribution of the nominal share. The IRS
considered this result inappropriate, prompting issuance of the temporary
regulations. The final regulations, which apply to exchanges and distributions of
stock occurring on or after November 12, 2014, reiterate this view of the IRS.
Final rules
The final regulations apply to value-for-value and non value-for-value (bargain
exchange) Cash D reorganizations. The final regulations clarify that the deemed
recapitalization under the second step of the ‘bargain exchange basis rule’ occurs only
after the stock treated as issued by the acquiring corporation pursuant to Reg. sec.
1.368-2(l) is held by a shareholder that actually owns stock of the acquiring
corporation. Similarly, the final regulations provide that the nominal share basis
designation rule applies only after an actual shareholder of the acquiring corporation
receives the nominal share pursuant to Reg. sec. 1.368-2(l), and that such shareholder
must attach the nominal share’s basis (even if the share’s basis is zero) to a share of
the acquiring corporation’s stock that the shareholder actually owns.
Observations
As noted in the December 2011 edition of This Month in M&A, taxpayers that want to
preserve the basis in lower-tier target corporations that otherwise would be
eliminated as a consequence of the mechanics of the All Cash D regulations should
cause the acquiring corporation to actually issue some shares in the reorganization.
For additional information, please contact Tim Lohnes or Brian Corrigan.
Final GRA regulations (T.D. 9704)
The IRS on November 19 published final and temporary regulations that apply to US
persons who fail to file gain recognition agreements (GRAs) and related documents,
or to satisfy other reporting obligations required for certain transfers of property to
foreign corporations in nonrecognition exchanges. These regulations generally apply
effective on that date (see regulations for specific effective date rules).
The new regulations generally incorporate the provisions of proposed regulations
issued January 31, 2013, with certain modifications. See the February 2013 edition of
This Month in M&A for a discussion of the proposed regulations and PwC Tax
Insight: New final GRA regulations: failures to file and deficiencies in GRAs and
other documents for additional discussion of the final and temporary regulations.
Under the final regulations, US persons who either fail to timely file a GRA or related
documents, or file such documents with material deficiencies, face rules for obtaining
relief that are similar to those in the 2013 proposed regulations. The final regulations
also address failures to file (and deficient filings of) certain documents required in the
sections 367(a) and 6038B regulations concerning outbound transfers, as well as
Form 926, and the section 367(e)(2) regulations for liquidations into foreign
corporations.
The final regulations require the US person to demonstrate that any failure was not
‘willful,’ a less burdensome standard than ‘reasonable cause’ standard in the
withdrawn regulations. At the same time, the final regulations continue to apply the
‘reasonable cause and not willful neglect’ standard to US persons seeking relief from
failure to report penalties under section 6038B.
Additional highlights of the final regulations include:

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The IRS directive put into place in 2010, which applies to timely filed but
deficient GRAs and related documents, is revoked effective November 19,
2014.
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Whether the failure to file a GRA or to comply in all material respects with
the GRA regulations was willful is to be determined based on all the relevant
facts and circumstances.

Application of the ‘willful’ standard is illustrated through a series of
examples.

The requirement that the IRS respond to requests for relief for missed and
deficient GRA filings within 120 days of receipt of the request is eliminated.

The requirement to file Form 926 is extended to outbound stock transfers
where the US transferor files a GRA.

Relief rules are provided similar to the proposed GRA relief rules for failures
to file statements required by Reg. secs. 1.367(a)-2T, 1.367(a)-3(c)(6),
1.367(a)-3(c)(7), 1.367(a)-3(d)(2)(vi)(B)(1)(ii), 1.367(a)-7, and 1.367(e)-2.
Observations
Because the final regulations set forth a less burdensome standard for failure to file a
GRA, taxpayers who were denied relief under the prior reasonable cause standard
may be able to resubmit for relief under the final regulations claiming that the failure
to timely file a GRA, or file a GRA with material deficiencies was not willful. Consult
with your tax advisors to determine whether it is advisable to resubmit based on all
the relevant facts and circumstances.
For additional information, please contact Marty Collins, Carl Dubert, or Sean
Mullaney.
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Let’s talk
For a deeper discussion of how this issue might affect your business, please contact:
Tim Lohnes, Washington, DC
Henry Miyares, Washington, DC
+1 (202) 414-1686
+1 (202) 312-7595
[email protected]
[email protected]
Marty Collins, Washington, DC
Gary Wilcox, Washington, DC
+1 (202) 414-1571
+1 (202) 312-7942
[email protected]
[email protected]
Sean Mullaney, Washington, DC
Carl Dubert, Washington, DC
+1 (202) 495-9545
+1 (202) 414-1873
[email protected]
[email protected]
Olivia Ley, Washington, DC
Robert Black, Washington, DC
+1 (202) 312-7699
+1 (202) 414-1870
[email protected]
[email protected]
Meryl Yelen, Los Angeles, CA
Jon Lewbel, Washington, DC
+1 (202) 346-5175
+1 (202) 312-7980
[email protected]
[email protected]
Brian Corrigan, Washington, DC
Rob Calabrese, Washington, DC
+1 (202) 414-1717
+1 (202) 346-5205
[email protected]
[email protected]
This document is for general information purposes only, and should not be used as a substitute for consultation with
professional advisors.
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© 2014 PricewaterhouseCoopers LLP. All rights reserved. In this document, ‘PwC’ refers to PricewaterhouseCoopers (a
Delaware limited liability partnership), which is a member firm of PricewaterhouseCoopers International Limited, each
member firm of which is a separate legal entity.