This Month in M&A / Issue 17 / August 2014

This Month in M&A / Issue 17 / August 2014
Did you know…? p2 / Court watch p4 / Treasury regulations p5 / Private letter
rulings p6 / PwC’s M&A publications p7
M&A tax recent guidance
This month features:

Regulations will address ‘disposition rule’ under section 901(m) (Notices 2014-44, 2014-45)

Sixth Circuit decides ownership of federal tax refund received by consolidated group common
parent (FDIC. v. AmFin Financial Corp.)

IRS finalizes regulations to preclude accelerating deductions for partnership unamortized
organizational expenses and start-up expenditures (T.D. 9681)

Temporary regulations prevent section 382 ownership change when Treasury sells stock acquired
under 2008 law (T.D. 9682)

Section 355 active trade or business requirement ruled met with employees from non-affiliated
corporation (PLR 201429006)
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Did You Know…?
In Notice 2014-44, the IRS announced its intent to issue regulations addressing the socalled disposition rule under Section 901(m) related to covered asset acquisitions. The
regulations would explain when an event constitutes a ‘disposition’ of a relevant foreign
asset—perhaps narrowing interpretations of the current definition—and the effect of the
disposition on unamortized basis differences. According to the Notice, the final
regulations generally would apply to dispositions on or after July 21, 2014. Notice 201445 further expanded the effective date related to retroactive check the box elections.
Background
Covered asset acquisitions
Section 901(m) was enacted in 2010 to eliminate the foreign tax credit benefit a US
taxpayer could achieve from certain transactions that cause the basis of assets to differ
under US and foreign tax law. The statute refers to these transactions as covered asset
acquisitions (CAAs) and specifies four different categories:
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Qualified stock purchases to which Section 338(a) applies;
Transactions treated as asset acquisitions for US federal income
tax purposes and as stock acquisitions (or as disregarded) for
foreign income tax purposes;
Acquisitions of partnership interests for which a Section 754
election is in effect; and
Similar transactions to the extent provided in future guidance.
Basis differences
After a CAA, the basis of the assets transferred (or deemed transferred) in the CAA
generally is equal to fair market value for US federal income tax purposes, but typically
there is a carryover basis for foreign tax purposes. When US tax basis exceeds foreign tax
basis, this disparity can lower US taxable income relative to foreign income over time
(e.g., through increased amortization), thereby increasing the ratio of foreign taxes—and
foreign tax credits—to US taxable income.
Section 901(m)(3) limits this foreign tax credit benefit by disqualifying a portion of the
foreign income taxes. The disqualified portion for a taxable year is based on the ratio of
(1) the aggregate basis differences allocated to the taxable year with respect to all relevant
foreign assets (RFAs) to (2) the foreign income to which the foreign income taxes relate.
The basis difference with respect to an RFA is the excess of the adjusted basis of the asset
immediately after the CAA over the adjusted basis of the asset immediately before the
CAA.
RFA dispositions
Basis differences generally are allocated to taxable years under the applicable cost
recovery method (i.e., similar to depreciation). However, in the event of a disposition of
an RFA, the remaining basis difference with respect to the asset (the Unallocated Basis
Difference) is accelerated into the taxable year of the disposition (the disposition rule). In
the absence of a statutory definition of disposition for this purpose, the IRS has expressed
concern that taxpayers could apply the plain language of the disposition rule to
transactions that did not decrease the basis disparity with respect to an RFA or that did
not result in the recognition of gain or loss for US or foreign income tax purposes.
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Notice 2014-44 cites as one example of the IRS’s ‘significant policy concerns’ the situation
where a domestic corporation (USP) wholly owns a foreign corporation (FSub), which
acquires 100 percent of the stock of a foreign target corporation (FT) in a qualified stock
purchase with respect to which a Section 338(g) election is made. The acquisition of FT is
a CAA and FT’s assets are RFAs. Shortly after the acquisition, a check-the-box election is
made to treat FT as disregarded from FSub. To the extent taxpayers have treated the
deemed liquidation arising from the check-the-box regulations as a disposition of the
RFAs, the remaining Unallocated Basis Difference is allocated to FT’s final taxable year,
and none is allocated to any later taxable year. The IRS is concerned with such a result
because (i) the basis disparity continues to exist after the deemed liquidation and (ii) no
gain is recognized for foreign income tax purposes, meaning that there may be no foreign
income tax subject to disqualification under Section 901(m).
Forthcoming guidance
The regulations announced by Notice 2014-44 would narrow the definition of disposition
for purposes of Section 901(m) to include only those events that result in recognition of
gain or loss with respect to an RFA for US or foreign income tax purposes (or both).
Under these rules, an event—such as a deemed liquidation under the check-the-box
regulations—generally would not be a disposition provided that it is a nonrecognition
transaction for US federal income tax purposes and is disregarded for foreign income tax
purposes. On the other hand, an event that is fully taxable for both US and foreign tax
purposes would be a disposition and would result in the entire Unallocated Basis
Difference with respect to an RFA being taken into account in the year of the disposition.
An event that is taxable under US or foreign law (but not both) would constitute a
disposition for purposes of Section 901(m). However, Section 901(m) would continue to
disqualify foreign taxes associated with an RFA until the Unallocated Basis Difference is
fully reversed. The Unallocated Basis Difference is the excess of the RFA’s aggregate
basis difference over the amount of its aggregate basis difference that has been allocated
to all prior taxable years.
Under the forthcoming regulations, if US tax basis exceeds foreign tax basis, a positive
Unallocated Basis Difference is reduced only by the US tax amortization or depreciation
deductions associated with the RFAs or, in the case of a disposition, the US tax loss or
foreign tax gain on the disposition (the Disposition Amount). If foreign tax basis exceeds
US tax basis, the negative Unallocated Basis Difference is reduced, in the case of a
disposition, by the US tax gain or foreign tax loss on the disposition. Notice 2014-44
states that the IRS is continuing to consider whether and to what extent Section 901(m)
should apply to an asset received in exchange for an RFA in a transaction in which the
basis of the asset is determined by reference to the basis of the RFA transferred.
Observation: Under the announced regulations, Section 901(m) would continue to
apply to an RFA to the extent that a basis difference remains following a disposition—
even if the RFA is transferred to an unrelated third party. This rule ostensibly would
require a US acquirer of a foreign target to obtain information on the history of each
foreign asset in order to determine if a pre-acquisition CAA created a basis difference to
which the US acquirer could succeed.
Notice 2014-44 also would provide special rules related to CAAs arising when a
partnership has a Section 754 election in effect (Section 743(b) CAAs). Under these rules,
if an RFA is subject to a Section 743(b) CAA, the basis difference generally is the resulting
Section 743(b) basis adjustment that is allocated to the RFA under the rules of Section
755. The Notice provides that if there is a disposition of an RFA subject to a Section
743(b) CAA, the computation of the disposition amount only would take into account the
amount of gains and losses attributable to the partnership interest that was transferred in
the Section 743(b) CAA.
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Effective date
Notice 2014-44 states that the final regulations generally would apply to dispositions
occurring on or after July 21, 2014. The rules governing the annual determination of the
Unallocated Basis Difference with respect to an RFA (and the continuing application of
Section 901(m) until such amount is taken into account) would apply to any Unallocated
Basis Difference as of July 21, 2014 and to any Unallocated Basis Difference arising from
a CAA occurring on or after July 21, 2014.
The Notice also states that taxpayers may apply the rules related to Section 743(b) CAAs
consistently to all such transactions occurring on or after January 1, 2011. The IRS states
that no inference is intended as to the current-law treatment of transactions as to which
the Notice expresses concern, and that the IRS may challenge such transactions under
Code provisions or judicial doctrines.
In Notice 2014-45, issued just a week after Notice 2014-44, the IRS stated that the
regulations described in Notice 2014-44 would apply to check-the-box elections filed on
or after July 29, 2014, that are made effective on or before July 21, 2014.
Observations
When considering these new rules and the overall broad application of Section 901(m) to
common business transactions, taxpayers need to be aware of potential Section 901(m)
RFAs. The regulations described in the Notice raise concerns as to administrability and
compliance and should be reconsidered by the IRS. In particular, the survival of an
Unallocated Basis Difference in the context of third-party transactions could create a
significant compliance burden for acquisitive companies and an administration burden
for the government. To ease these burdens, the government should consider including an
exception in the forthcoming regulations that would eliminate the Unallocated Basis
Difference in third-party transactions.
For additional information, please contact Tim Lohnes, Marty Collins, or Wade Sutton.
Court watch
Federal Deposit Insurance Corp. v. AmFin Financial Corp. (6th Cir., No.
13-3669, July 8, 2014)
Yet another court examined whether the parent of a consolidated group owns the federal
tax refund it receives on behalf of the group or whether the refund belongs to the
consolidated subsidiary that generated it.
In this case, the US Court of Appeals for the Sixth Circuit recently concluded that the tax
sharing agreement (TSA) between the group’s members was silent on this issue and
remanded for the trial court to consider extrinsic evidence of the relationship between the
members. In a similar case last year, the Eleventh Circuit first determined a TSA to be
ambiguous and then considered extrinsic evidence to construe the TSA as creating an
agency relationship such that the refund belonged to the member that generated it rather
than the common parent. [See the January 2014 edition of This Month in M&A for the
discussion of In re Netbank, 729 F.3d 1344 (11th Cir. 2013).]
The taxpayer in AmFin Financial Corp. (AFC) was the common parent of a consolidated
group (the AFC Group). In 2009, AFC filed for bankruptcy. As a result of the
bankruptcy, one of its consolidated subsidiaries (AmTrust) was placed into FDIC
receivership. AFC subsequently received a federal tax refund for its 2008 consolidated
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tax year, a substantial portion of which was attributable to the carryback of AmTrust net
operating losses (NOLs) to offset AmTrust income in prior years.
According to the Sixth Circuit, the case rested on whether AFC and AmTrust had a
debtor-creditor relationship—so that AFC owned the refund but had to repay AmTrust—
or an agency or trust relationship—so that AmTrust owned the refund with AFC acting
merely as an agent or trustee on its behalf. The court noted that although the TSA spoke
to the allocation of liability in the event of an adjustment such as an NOL carryback
refund, it did not directly address the ownership of such a refund.
The court also concluded that the TSA did not create a debtor-creditor relationship
between AFC and AmTrust. Specifically, the Sixth Circuit emphasized that, despite using
terms such as “reimbursement” and “payment,” the TSA did not accord AmTrust any of
the protections that creditors typically enjoy, such as a fixed interest rate, a fixed maturity
date, or the ability to accelerate payment upon default. Accordingly, the Sixth Circuit
reversed the district court’s decision—which had found a debtor-creditor relationship
based on the terms of the TSA—and remanded with instructions to consider any extrinsic
evidence and analyze the specified trust and agency provisions.
Observations
The AmFin decision serves as a reminder to taxpayers with a TSA in place to analyze what
legal relationship they intend to exist between the parties and to confirm that the
language of the TSA creates that relationship. When reviewing the TSA, taxpayers
should ensure that the language makes clear the scope of its application and the goals it
seeks to accomplish, taking into account that a court may not view commonly used terms
as sufficient evidence of intent. As the Sixth Circuit’s decision indicates, a TSA that is not
completely clear may result in significant litigation expense and the risk of an adverse
outcome due to a court’s independent characterization of the relationship between the
parties. For additional information, please contact David Friedel or Jon Lewbel.
Treasury regulations
Final Section 708 regulations (T.D. 9681)
Partnerships generally must capitalize and, unless electing otherwise, amortize over 15
years organizational expenses (within the meaning of Section 709(b)(3)) and start-up
expenditures (within the meaning of Section 195(c)(1)). If a partnership is liquidated
before the end of the 15-year period, any unamortized portion generally is allowable as a
deduction under Section 165 (Sections 195(b)(2) and 709(b)(2)).
Some taxpayers have sought to accelerate the deduction of organizational expenses and
start-up expenditures by intentionally triggering a technical termination of a partnership
under Section 708(b)(1)(B). Specifically, as a result of a technical termination, the ‘old’
partnership is deemed to contribute all its assets in to a ‘new’ partnership in exchange for
an interest in the new partnership. Immediately thereafter, the old partnership
distributes interests in the new partnership to partners and terminates for tax purposes.
The IRS recently finalized regulations under the authority of Section 708 providing that
technical partnership terminations do not accelerate deductions, which it views as
contrary to the Congressional intent underlying Sections 195, 708, and 709. The final
regulations adopt proposed regulations published on December 9, 2013 (REG-12628512), with one clarification, namely that the amortization period does not restart upon a
technical termination. The ‘new’ partnership resulting from a technical termination
under Section 708(b)(1)(B) continues amortizing the organizational expenses and startup expenditures over the remaining portion of the amortization period adopted by the
terminated partnership.
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The final regulations are effective for technical terminations that occur on or after
December 9, 2013. For additional information, please contact Todd McArthur, John
Schmalz, Dianna Miosi, or Matthew Arndt.
Temporary Section 382 regulations (T.D. 9682)
The IRS recently issued temporary regulations under Section 382 affecting loss
corporations whose stock is or was purchased by the Department of the Treasury under
the Emergency Economic Stabilization Act of 2008 (EESA). The regulations protect such
a corporation from experiencing a Section 382 ownership change when Treasury sells
stock in the corporation. The regulations also were issued in proposed form.
Section 382 generally restricts a loss corporation’s utilization of its net operating losses
(NOLs) after the loss corporation undergoes an ownership change. An ownership change
occurs if one or more five-percent shareholders increase their ownership in the loss
corporation’s stock, in the aggregate, by more than 50 percentage points during a testing
period, which generally is the three-year period preceding a testing date. Shareholders
owning less than five percent of a loss corporation’s stock are aggregated into a public
group that is itself viewed as a five-percent shareholder.
Under the former Section 382 regulations, a new public group was created when a fivepercent shareholder sold shares to the public. In Notice 2010-2, the IRS provided that
when Treasury sold stock it had acquired under EESA, the new public group’s ownership
would not be considered to have increased solely as a result of such sale. As a result,
Treasury’s sale alone could not trigger an ownership change.
However, under the current Section 382 regulations, as amended in October 2013 (T.D.
9638), a new public group no longer is formed when a five-percent shareholder sells stock
to the public. Instead, each existing public group is treated as acquiring a proportionate
share of the stock. For a discussion of the former and final regulations, see the November
2013 edition of This Month in M&A.
In issuing the temporary regulations, the IRS acknowledged that the final regulations
unintentionally may have rendered Notice 2010-2 inoperative by preventing the creation
of a new public group. Accordingly, the IRS was concerned that a sale by Treasury
potentially could result in an ownership change. To prevent this result, the temporary
regulations treat the sale of stock held by Treasury under EESA as creating a new public
group, allowing the exception under Notice 2010-2 to apply.
Observations
The issuance of the temporary regulations restores the applicability of Notice 2010-2 after
the issuance of the final Section 382 regulations in October 2013. Going forward, loss
corporations should continue to follow Notice 2010-2 when Treasury sells stock acquired
under EESA. For additional information, please contact Rich McManus or Sarah
Remski.
Private letter rulings
PLR 201429006
The IRS ruled that a split-off by a closely held S corporation (Distributing) qualified as a
tax-free Section 355 distribution even though Distributing relied on the activities of
employees of a non-affiliated corporation owned by one of Distributing’s individual
shareholders to conduct its active trade or business (ATOB).
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Individuals A and B owned an equal interest in each of Distributing and a trust. The trust
was created for the benefit of A and B and owned the remaining interest in Distributing.
Distributing had no employees of its own, instead relying on the employees of a
corporation (RelatedCo 1) owned by A (and trusts for the benefit of A’s spouse and
descendants) to perform its operational activities and some management services.
Distributing and RelatedCo 1 conducted the same line of business.
Pursuant to an unwritten arrangement, RelatedCo 1 compensated the employees for their
work and provided their benefits, while Distributing reimbursed RelatedCo 1 for a portion
of the compensation and benefits intended to reflect the amount of time they spent
working on behalf of Distributing.
Distributing’s and RelatedCo 1’s remaining
management services were provided by A.
Under the proposed transaction, Distributing contributed a portion of its business assets
to a new corporation (Controlled) and distributed all the stock of Controlled to B in
exchange for all of B’s interest in Distributing.
Observations
Section 355 requires that both the distributing and controlled corporations be engaged in
an ATOB immediately after the distribution. The current ATOB regulations provide that
a corporation’s own employees or the employees of affiliated corporations (but not
independent contractors or employees of unaffiliated corporations) must perform
substantial management and operational functions. See Rev. Rul. 79-394.
Unlike Rev. Rul. 79-394, RelatedCo 1 was not within the same affiliated group of
corporations as Distributing. Nevertheless, it appears that the IRS attributed the
operational and management activities of RelatedCo 1’s employees to A and then to
Distributing. Such attribution is consistent with PLR 201426007 (see the July 2014 issue
of This Month in M&A), which signalled an IRS willingness to be flexible in applying the
ATOB regulations, particularly with respect to Distributing’s or Controlled’s reliance on
the employees of another entity in conducting its ATOB. For additional information,
please contact Rich McManus, Bruce Decker, or Brandon Fleming.
PwC’s M&A publications
In an article titled Uptick In Tax Exclusions Granted By The Commissioner Under Reg.
1.1502-13(c)(6)(ii)(D), published in Corporate Taxation (July/August 2014), PwC authors
Olivia Ley, Matt Lamorena, and Jon Lewbel examine the expansion of the gain exclusion
rule under the Commissioner’s discretionary rule.
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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
Karen Lohnes, Washington, DC
+1 (202) 414-1686
+1 (202) 414-1564
[email protected]
[email protected]
David Friedel, Washington, DC
Todd McArthur, Washington, DC
+1 (202) 414-1606
+1 (202) 312-7559
[email protected]
[email protected]
Julie Allen, Washington, DC
Marty Collins, Washington, DC
+1 (202) 414-1393
+1 (202) 414-1571
[email protected]
[email protected]
Rich McManus, Washington, DC
Jerry Towne, Washington, DC
+1 (202) 414-1447
+1 (202) 346-5153
[email protected]
[email protected]
Wade Sutton, Washington, DC
Dianna Miosi, Washington, DC
+1 (202) 346-5188
+1 (202) 414-4316
[email protected]
[email protected]
Bruce Decker, Washington, DC
Olivia Ley, Washington, DC
+1 (202) 414-1306
+1 (202) 312-7699
[email protected]
[email protected]
Matt Arndt, Washington, DC
Marty Hunter, Washington, DC
+1 (202) 312-7633
+1 (202) 312-7778
[email protected]
[email protected]
Sarah Remski, Washington, DC
Matt Lamorena, Washington, DC
+1 (202) 312-7936
+1 (202) 312-7626
[email protected]
[email protected]
Jon Lewbel, Washington, DC
Andrew Gottlieb, Washington, DC
+1 (202) 312-7980
+1 (202) 346-5079
[email protected]
[email protected]
Brandon Fleming, Washington, DC
+1 (202) 346-5254
[email protected]
© 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.
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