The Secret Is Out! Proposed Treasury Regulations Shed New Light on the Controlled Group Deferred Loss “Supersecret Rule,” Including Its Application to CFCs

by Eversheds Sutherland (US) LLP

On April 20, 2011, Treasury and the IRS issued proposed Treasury regulations (the Proposed Regulations) that would modify the so-called “supersecret rule” of Treas. Reg. § 1.267(f)-1(c)(1)(iv), a provision that has come to have an increasingly important role in international restructurings involving members of controlled groups, including CFCs. In brief, the supersecret rule generally defers losses from intercompany sales of stock within a controlled group even after the target company is dissolved in a taxable liquidation. The Proposed Regulations would modify the supersecret rule by (i) adopting a new aggregation rule similar to, but not as expansive as, the rule found in Treas. Reg. § 1.1502-34, (ii) extending the rule’s applicability to scenarios in which split ownership of the target company exists before the intercompany sale, and (iii) providing relief to the extent of offsetting gain. In so doing, the Proposed Regulations adhere to positions taken by the IRS in recent informal guidance—namely, Chief Counsel Advice (CCA) 200931043 (Apr. 13, 2009) and CCA 201025046 (Mar. 12, 2010). (Hence, the “supersecret rule” reference.)


Section 267(a)(1) provides that no deduction is allowed for any loss on the sale or exchange of property between certain related persons. Section 267(f)(2) contains an exception for a loss on the sale or exchange of property between members of a controlled group. For this purpose, the term “controlled group” has the meaning given to such term by section 1563(a), except that (i) “more than 50 percent” must be substituted for “at least 80 percent” each place that it appears in section 1563(a), and (ii) the determination must be made without regard to section 1563(a)(4) and (e)(3)(C). In the case of a sale or an exchange of loss property between members of a controlled group, the loss is deferred rather than disallowed. Under section 267(f)(2)(B), the loss is deferred until (i) the property is transferred outside of the controlled group and there would be recognition of the loss under consolidated return principles or (ii) such other time as may be prescribed in Treasury regulations.

The Treasury regulations under section 267(f) provide that the timing principles for intercompany sales or exchanges between members of a consolidated group, i.e., the rules of Treas. Reg. § 1.1502-13(c)(2), apply to sales or exchanges of property at a loss between members of a controlled group. The attribute redetermination rules applicable to transactions between members of a consolidated group, however, do not apply to sales or exchanges between members of a controlled group. For example, if a member of a consolidated group (S) holds land for investment and sells the land at a loss to another member of its consolidated group (B), and B develops the land and sells developed lots to unrelated customers, S’s intercompany loss will be taken into account when B sells the property to the unrelated person. Furthermore, S’s loss will be recharacterized as an ordinary loss, even though S’s loss otherwise would be a capital loss given its separate-entity status as holding the property for investment. If B and S were members of a controlled group but not a consolidated group, S’s loss also would be taken into account when B sells the parcel to an unrelated person, but S’s loss would retain its character as a capital loss.

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