On May 7, Treasury and the IRS published proposed regulations addressing which corporation succeeds to the tax attributes of another corporation that transfers assets in an acquisitive asset reorganization described in IRC §§ 368(a) and 381(a)(2) (the Proposed Regulations). In brief, the Proposed Regulations provide that the corporation that directly acquires the assets transferred in the reorganization succeeds to the tax attributes of the transferor corporation, even if the direct acquirer subsequently transfers all of the acquired assets to a single controlled subsidiary pursuant to the plan of reorganization. In providing for this result, the Proposed Regulations affirm and extend the approach of the 2012 proposed regulations under IRC § 312, which address the allocation of earnings and profits of a transferor corporation in an IRC § 381 transaction.
Sutherland Observation: Simplicity and the removal of any potential for electivity with respect to the location of the transferor corporation’s tax attributes following an acquisitive asset reorganization appear to be the motivating factors behind this proposed change to the long-standing regulations under IRC § 381. For example, the Proposed Regulations eliminate the “facts and circumstances” test currently used to determine whether “all” of the assets of the transferor corporation have been disposed of by the direct acquirer. That test has resulted in complex factual determinations for taxpayers and the IRS, with inconsistent results in various instances.
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Background
IRC § 381(a) generally provides that, in the case of the acquisition of the assets of a corporation in an IRC § 332 liquidation or in an acquisitive asset reorganization under IRC § 368(a), the acquiring corporation succeeds to and takes into account, as of the close of the day of transfer, the tax attributes of the transferor corporation that are described in IRC § 381(c). Those tax attributes include earnings and profits, net operating losses, and net capital losses.
Treas. Reg. § 1.381(a)-1(b)(2)(i) provides that only a single corporation may be an acquiring corporation for purposes of IRC § 381. That regulation also provides that the acquiring corporation in an acquisitive asset reorganization is the corporation that, pursuant to a plan of reorganization, ultimately acquires, directly or indirectly, all of the assets transferred by the transferor corporation. Thus, if a corporation (P) acquires all of the assets of another corporation (T) in a reorganization described in IRC § 368(a)(1)(A), and, as part of the same plan, P transfers all of T’s assets to P’s wholly owned subsidiary (S), S will be treated as the “acquiring corporation” for purposes of IRC § 381. Treas. Reg. § 1.381(a)-1(b)(2)(i) directs that the determination of whether S has acquired all of T’s assets is a question of fact to be determined on the basis of all of the facts and circumstances.
Sutherland Observations
1. In applying the facts and circumstances test of Treas. Reg. § 1.381(a)-1(b)(2)(i), many practitioners have questioned whether “all” really means “all.” For example, if P acquires all of T’s assets in a reorganization described in IRC §§ 368(a) and 381(a)(2), uses $5 of those assets to satisfy a pre-existing liability of T, and then transfers the remaining assets of T to a wholly owned subsidiary (S), it is unclear whether P has transferred “all” of T’s assets to S under the facts and circumstances test. In this instance, P arguably has transferred all of T’s assets on a net basis (because T’s assets have the same net value upon contribution to S), but not on a gross basis (because P transferred $5 of T’s assets in satisfaction of the pre-existing liability of T). These issues have proven particularly vexing for practitioners where, as in this example, the T asset at issue is a fungible asset like cash.
2. The current regulations under IRC § 381 effectively permit the elective placement of the tax attributes of the transferor corporation following an acquisitive asset reorganization. For example, by retaining a portion of the assets of the transferor corporation, or by splitting those assets between multiple controlled subsidiaries, a direct acquirer may retain the tax attributes of the transferor corporation. Alternatively, where the direct acquirer transfers all of the transferor corporation’s assets to a single controlled subsidiary, the subsidiary may be treated as succeeding to the transferor corporation’s tax attributes.
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In April 2012, Treasury and the IRS published proposed regulations that reject attempts to allocate earnings and profits between a “direct” and a “subsequent” acquirer of the transferor corporation’s assets and provide that only a single acquiring corporation may succeed to the earnings and profits of a transferor corporation in an IRC § 381 transaction (the 2012 Proposed Regulations). (For an analysis of the 2012 Proposed Regulations, see Sutherland’s Legal Alert dated April 17, 2012.) In support of this approach, the preamble to the 2012 Proposed Regulations states that the new rule with respect to earnings and profits is appropriate because earnings and profits measures the capacity of a corporation to pay dividends to its shareholders, and the corporation that has an interest, directly or indirectly, in all of the transferor corporation’s assets has the dividend-paying capacity that is most comparable to that of the transferor corporation.
Sutherland Observation: Some practitioners have argued (and continue to argue) that the IRC § 381 rules conflict with the current regulations under IRC § 312 dealing with the allocation of earnings and profits, and that, in appropriate cases, the earnings and profits of a transferor corporation should be allocated among multiple corporations. Thus, in a situation where the direct acquirer of a transferor corporation’s assets subsequently transfers those assets to three controlled subsidiaries, the argument that follows is that it is appropriate to split the transferor corporation’s earnings and profits in some manner (e.g., between the direct acquirer and one or more of the controlled subsidiaries). The Proposed Regulations reject such an approach.
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The Proposed Regulations
The Proposed Regulations provide that the corporation that directly acquires the assets transferred in an acquisitive asset reorganization described in IRC §§ 368(a) and 381(a)(2) succeeds to the tax attributes of the transferor corporation, regardless of whether the direct acquirer subsequently transfers all of the acquired assets to a single controlled subsidiary pursuant to the plan of reorganization. This result differs from the result under the current regulations in that the direct acquirer retains its status as the acquiring corporation for purposes of IRC § 381, even if it transfers all of the acquired assets to a single controlled subsidiary. Correspondingly, the Proposed Regulations eliminate the facts and circumstances test of the current regulations.
Sutherland Observations
1. The Proposed Regulations affirm and extend the approach of the 2012 Proposed Regulations, which now are expected to be finalized concurrently with the finalization of the Proposed Regulations.
2. The Proposed Regulations remove any perceived uncertainty associated with the determination of whether “all” of the assets of a transferor corporation have been transferred by the direct acquirer to a single controlled subsidiary, as well as the electivity of the current regulations with respect to the location of the transferor corporation’s tax attributes following an acquisitive asset reorganization.
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The modifications made by the Proposed Regulations will apply to transactions occurring on or after the date of publication in the Federal Register of the Treasury Decision adopting these modifications as final regulations. Before the Proposed Regulations are adopted as final regulations, however, Treasury and the IRS have indicated that they will consider any written or electronic comments that are submitted timely to the IRS.
