T.D. 9515, 03/03/2011; Reg. §1.1502-13
IRS has finalized, eased and otherwise modified temporary and proposed regs providing that intercompany gain with respect to consolidated group member stock may be permanently excluded from gross income following certain stock basis elimination transactions. The final regs apply for items taken into account after Mar. 3, 2011.
Observation: To an even greater extent than the temporary and proposed regs, the final regs prevent the effective duplication of gain within a consolidated group that would result from taking an intercompany gain into account without any corresponding tax basis (or other resulting tax benefit).
Background. Reg. §1.1502-13 provides rules governing the timing and characterization of items resulting from transactions between consolidated group members. Reg. §1.1502-13(c) provides general rules under which the timing and character of such items can be deferred or recharacterized to clearly reflect the taxable income (and tax liability) of the group as a whole. These rules generally apply a “matching” principle under which, in a property transaction, the seller's (S) timing is linked to the buyer's (B) use of its basis in the property, and S's and B's characterizations are subject to redetermination in order to effectuate single entity principles.
The proposed regs provide that intercompany gain with respect to member stock may be permanently excluded from gross income following certain stock basis elimination transactions, such as tax-free spin-offs and liquidations, if certain requirements are met. One requirement under the proposed regs is that, immediately before intercompany gain would otherwise be taken into account, the common parent (P) must be the member that holds the member stock with respect to which the intercompany gain was realized, and the gain must be P's intercompany item.
Final regs provide relief where member other than common parent holds the subject stock. IRS says that, given the other requirements of the reg—namely that (i) the group has not and will not derive any Federal income tax benefit from the intercompany transaction; and (ii) the excluded gain will not be treated as tax-exempt income for purposes of the investment adjustment regs—it is appropriate to provide relief where a member other than the common parent holds the subject stock. Accordingly, the final regs allow the exclusion of gain where a member holds the target member stock with respect to which the intercompany gain was realized, and the holding member is either (i) B or S, as a successor to the other party (either B or S); or (ii) a third member that is the successor to both B and S. (Reg. §1.1502-13(c)(6)(ii)(C)(1))
Final regs retain “Commissioner's Discretionary Rule.” Intercompany gain or income is redetermined to be excluded from gross income only to the extent that one of several conditions applies. Under Reg. §1.1502-13(c)(6)(ii)(D), one of these conditions is that IRS determines that treating S's intercompany item as excluded from gross income is consistent with the purposes of the intercompany transaction regs and other applicable provisions of the Code and regs (IRS refers to this as the “Commissioner's Discretionary Rule”). The proposed regs' preamble stated that IRS was considering eliminating the “Commissioner's Discretionary Rule” of the regs and sought comments on whether the rule should be retained. IRS now says that, upon further consideration, it believes there may be circumstances where application of such discretion is warranted. Thus, for example, the final regs do not provide automatic relief for transactions involving property other than member stock (such as the stock of nonmembers), but relief may be available after review by IRS under the Commissioner's Discretionary Rule. Accordingly, the final regs retain the Commissioner's Discretionary Rule in a form revised to describe the conditions to be satisfied for that discretion to be exercised, and to indicate that relief is available only through a request for a letter ruling. (Reg. §1.1502-13(c)(6)(ii)(D))
Other changes in final regs. The final regs also expressly provide that the excluded gain is not treated as tax-exempt income for purposes of Reg. §1.1502-32 (investment adjustment regs) and does not increase earnings and profits. (Reg. §1.1502-13(c)(6)(ii)(C)(2))
References: For intercompany transactions, see FTC 2d/FIN ¶E-8250; United States Tax Reporter ¶15,024.03; TaxDesk ¶604,501; TG ¶5716.