Enacted As Part of the Repeal of the General Utilities Doctrine in the Tax Reform Act of 1986
Section 336(e) of the Code authorizes the issuance of regulations whereby a domestic corporation which owns a controlling interest, per §1504(a)(2), in the stock of another domestic corporation, is permitting to treat the taxable disposition of its stock as a deemed asset sale of the target-subsidiary’s assets. While §336(e) was enacted into law as part of the Tax Reform Act of 1986, among the set of corporate tax provisions under Part II of Suchapter C which repealed the General Utilities Doctrine, the provision was not operative under final regulations were issued. H.R. Conf. Rep. No. 8411, 99th Cong., 2d Sess., Vol 11, 198, 204 (1986), 1986-3 C.B., Vol. 4, 198-207.
Enabling Regulations Issued Last Year
In T.D. 9619 (5/15/2013), the Service issued enabling elections for certain transactions under §336(e). Proposed regulations were issued in 2008 (REG-143544-04).
While a §336(e) election results in a deemed sale of the target’s assets as with the sale of target stock in a §338(g) or §338(h)(10) transaction, the scope of a §336(e) is broader and can extend to other types of stock transfers of stock in a controlled domestic corporation. Moreover, unlike the limitation set forth for a “qualified stock purchase” under §338(d)(3) which can only be made by a purchasing corporation, the acquirers or purchasers of subsidiary stock can include individuals and noncorporate entities as well. The regulations also permit S corporations to take advantage of a §336(e) election which will yield similar results to a §338(h)(10) election as to the sale of 80% or more of the stock of an S corporation provided all shareholders of the target S corporation consent.
In order to make an § 336(e) election, the seller(s), or in the case of an S corporation target, all of the S corporation shareholders, and the target must enter into a written, binding agreement to make an § 336(e) election. An § 336(e) election statement must be attached to the relevant income tax or informational return. Where the seller(s) and the target are members of a consolidated group, the election statement is filed on a timely filed consolidated return, and the common parent of the consolidated group must provide a copy of the § 336(e) election statement to the target on or before the due date (including extensions) of the group’s consolidated Federal income tax return.
Where the target is an S corporation, the election statement is filed on the S corporation’s timely filed return. If the seller and the target are members of an affiliated group but do not join in the filing of a consolidated return, the election statement is filed with both the seller’s and the target’s timely filed returns. By (1) requiring the seller(s) or all of the S corporation shareholders and target to enter into a written, binding agreement, (2) in the case of a consolidated group, requiring the common parent of the group to provide a copy of the election statement to the target, and (3) in the case where the seller and the target are members of an affiliated group but do not join in the filing of a consolidated return, requiring both the seller and the target to file the election statement on their respective returns, the IRS and the Treasury Department indicated in the preamble the belief that the final regulations significantly reduce the potential for unwanted results or unfair surprise.
Unlike an election under section 338(h)(10), which is available only if target stock is acquired by a corporate purchaser, the proposed and final regulations do not require an acquirer of target stock to be a corporation, or even necessarily a purchaser. Also unlike § 338(h)(10), which generally requires that a single purchasing corporation acquire the stock of a target, the proposed (and final) regulations permit the aggregation of all stock of a target that is sold, exchanged, and distributed by a seller to different acquirers for purposes of determining whether there has been a qualified stock disposition of a target.
Two Different Models for Treating Deemed Transactions Under Section 336(e)
The proposed regulations provided two models for the deemed transactions where a §336(e) election is made; (i) the Basic Model; and (ii) the Sale-to-Self Model.
The Basic Model: Seller Realizes Gain/Loss From Sale
The first or “basic” model generally follows the same structure used for the deemed transactions resulting from the making of a § 338(h)(10) election (basic model) and applies to all qualified stock dispositions (including taxable distributions of target stock) other than distributions described in §§355(d)(2) or 355(e)(2).Under the basic model, target, while owned by the seller (old target), is treated as selling all of its assets to an unrelated person and new target is treated as acquiring all of its assets from an unrelated person at the close of the date on which the threshold amount of target stock is disposed (deemed asset disposition).
The party recognizing the gain is the deemed seller of asset. Therefore, “old” target recognizes the Federal income tax consequences from the deemed asset disposition before the close of the date on which its stock was disposed. Then, after taking into account the gain or loss realized from the deemed asset disposition, old target is generally treated as liquidating into the seller. In addition, to the extent that the qualified stock disposition consisted of one or more distributions (rather than sales or exchanges) of the stock of a target (other than in §§355(d)(2) and (e)(2) transactions), the seller is treated as acquiring directly from new target an amount of new target stock equal to the amount of target stock distributed. The tax consequences of the purchaser(s) generally are unaffected by the section 336(e) election.
Basic Model for Non-Section 355(d)(2) or (e)(2) Transactions
The final regulations generally follow the rules contained in the proposed regulations with respect to the deemed transactions under the basic model. The final regulations modify the proposed regulations by providing that in a distribution of target stock (and also with respect to stock in target that seller retains after the distribution date) seller is deemed to purchase the new target stock that is distributed or retained not from new target but from an unrelated person in a taxable transaction. Seller will not recognize any gain or loss on the deemed distribution of new target stock and purchaser will have a fair market value basis in new target stock received without any possible application of § 351.
The Sale-to-Self Model: Sale by Old Target to New Target; Retention of Tax Attributes
The second model adopted by the proposed (and final) regulations for the deemed sale transactions resulting from a § 336(e) election applies to §§355(d)(2) and (e)(2) transactions is the “sale-to-self” model. Under the sale-to-self model, old target (the controlled corporation) is deemed to remain in existence; old target is treated as if it sold its assets to an unrelated person and then repurchased those assets. Following the deemed asset disposition, old target (the controlled corporation) is not deemed to liquidate into seller (the distributing corporation). Instead, after old target’s deemed repurchase of its own assets, seller is treated as distributing the stock of old target to its shareholders, with seller recognizing no gain or loss. Because no liquidation of old target into seller is deemed to occur, old target will generally retain the tax attributes it would have had if the section 336(e) election had not been made, adjusted for the creation or absorption of attributes resulting from the election.
In the Preamble to the final regulations noted some conceptual problems with the sale-to-self model but decided that the sale-to-self model should be retained. While the deemed transactions resulting from the making of § 336(e) elections with respect to taxable sales, exchanges, or distributions of target stock could actually be undertaken in a transaction involving the sale, exchange, or distribution of the assets of target, a transaction that included an actual sale or distribution of all the assets of target could not qualify under §355. In as much as a deemed sale of assets to a new target cannot actually be undertaken in a §§ 355(d)(2) or (e)(2) transactions, and Service views the predominant feature of the §336(e) election with respect to a §§ 355(d)(2) or (e)(2) transaction is the § 355 transaction, the final regulations adopt the sale-to-self model and treat the transaction as the distribution of old target stock.
The Preamble to the final regulations further notes that the Service and Treasury Department, in responding to other criticisms with the “sale-to-self” model, do not believe that adoption of the sale-to-self model should cause the anti-churning rules in § 197(f)(9) or wash sale rule in §1091 to apply to a §336(e) election with respect to a section 355(d)(2) or (e)(2) transaction. Therefore, the final regulations provide that for purposes of § 197(f)(9), § 1091, and any other provision designated in the Internal Revenue Bulletin by the IRS, old target, in its capacity as seller of assets in the deemed asset disposition, is treated as a separate and distinct taxpayer from, and unrelated to, old target in its capacity as acquirer of assets in the subsequent deemed purchase and for subsequent periods.
The Disallowed Loss Rule: Application to “Net Losses”
The proposed regulations disallowed the recognition of losses resulting from the deemed asset disposition to the extent the qualified stock disposition consisted of one or more distributions of target stock (disallowed loss rule). The rationale for this rule was conformity with §311 and §355(c). The Service and Treasury received many complaints on the loss disallowance rule and that the policy reasons under §336(e) for permitting loss recognition were valid. In response, the final regulations generally permit target’s realized losses in the deemed asset disposition to offset sthe amount of target’s realized gains. Thus, the regulations disallow a net loss of target (that is, losses realized in excess of target’s realized gains) recognized on a deemed asset disposition, but only in proportion to the portion of target stock that was disposed of by seller in one or more distributions.
The loss disallowance rule in the proposed regulations only applied to distributions that were taken into account as part of the qualified stock disposition on or before the disposition date. Thus, stock distributions that occurred after 80 percent of target was disposed of were not subject to the loss disallowance rule. The final regulations modify the disallowed loss rule of the proposed regulations to take into account (1) target stock distributed at any time within the 12-month disposition period, and (2) target stock distributed within the 12-month disposition period that is not part of the qualified stock disposition, such as stock distributed to a related person. Accordingly, under the disallowed loss rule of the final regulations, if a §336(e) election is made and any stock of target is distributed during the 12-month disposition period, whether or not as part of the qualified stock disposition, any net loss attributable to such stock distribution is disallowed.
While some had suggested that any non-recognized net loss be applied to increase the target’s asset basis after the deemed asset disposition, the final regulations rejected this thought as falling outside of the purpose of §336(e), i.e., to avoid two levels of taxation rather than to also preserve the use of built-in losses.
Time and Manner of Making a Section 336(e) Election
The time and manner of making § 336(e) election provided in the proposed regulations also differed from those for making an election under §338(h)(10). Noting that a joint election may be burdensome in cases with multiple purchasers, the proposed regulations provide that a §336(e) election is unilaterally made by a seller attaching a statement to its timely filed Federal income tax return for the taxable year that includes the disposition date.
The final regulations provide, however, that order to make a § 336(e) election, seller(s), or in the case of an S corporation target, all of the S corporation shareholders, and target must enter into a written, binding agreement to make a §336(e) election and a §336(e) election statement must be attached to the relevant return. If seller(s) and target are members of a consolidated group, the election statement is filed on a timely filed consolidated return and the common parent of the consolidated group must provide a copy of the §336(e) election statement to target on or before the due date (including extensions) of the consolidated group’s consolidated Federal income tax return. If target is an S corporation, the election statement is filed on the S corporation’s timely filed return. If seller and target are members of an affiliated group but do not join in the filing of a consolidated return, the election statement is filed with both seller’s and target’s timely filed returns. By (1) requiring seller(s), or all the S corporation shareholders, and target to enter into a written, binding agreement, (2) in the case of a consolidated group, requiring the common parent of the consolidated group to provide a copy of the election statement to target, and (3) in the case in which seller and target are members of an affiliated group but do not join in the filing of a consolidated return, requiring both seller and target to file the election statement on their respective returns, the IRS and Treasury Department believe that the final regulations significantly reduce the potential for unwanted results or unfair surprise.
The final regulations retain the rule that the election must be made by the due date of the relevant tax return. The IRS and Treasury Department believe that a due date of the 15th day of the ninth month after the disposition date will add administrative burden to both taxpayers and the IRS. Such due date would generally require that the election be made prior to the filing of the tax return, rather than on a tax return. The government’s stated experience in administering §338 has shown that some taxpayers miss the due date for making a § 338 election because they wrongly believe that the election is due with the income tax return of the taxpayer. Further, except with respect to the election statement filed by seller if seller and target are members of the same affiliated group but do not join in the filing of a consolidated return, the due date for filing the election statement now coincides with the due date of the return that includes the deemed disposition tax consequences.
The final regulations provide detailed requirements to assist taxpayers in making a § 336(e) election for an eligible subsidiary of target (target subsidiary). See Treas. Regs. §§ 1.336-2(h)(4) and (5). Some of these requirements also differ from those for making a section 338 election for target subsidiaries on Form 8023, which treats the purchasing corporation(s) of the directly purchased target as the purchasing corporation(s) of any target subsidiary for purposes of completing and signing a Form 8023 for a target subsidiary that is filed outside of any return. For example, if seller and target are members of the seller consolidated group but target subsidiary is not, a § 336(e) election for target subsidiary now requires that target subsidiary be a party to either the agreement entered into by seller and target, or that target and target subsidiary enter into a separate agreement to make such election. Because target subsidiary is not a member of the same consolidated group as target, the § 336(e) election for target subsidiary requires that a § 336(e) election statement be attached to both seller’s timely filed consolidated Federal income tax return and the timely filed Federal income tax return of the target subsidiary.
Modifications to Form 8883 (“Asset Allocation Statement Under Section 338”) or a new form will accommodate the §336 election. Form 8883 should continue to be filed until a special form fir §336(e) events is issued. See also Form 8023.
D. Intragroup Sales, Exchanges, or Distributions Prior to External Sales, Exchanges, or Distributions and Section 355(f)
Where the stock of a corporation is sold or distributed within an affiliated group and then is transferred outside the affiliated group, a §336(e) election is not available for the intragroup transaction because the buyer and seller in the intragroup transaction are related persons after the disposition of target outside the affiliated group. While a § 336(e) election may be available for the external transfer, the election could result in the affiliated group immediately recognizing multiple levels of gain, both on target’s stock from the intragroup transaction and on target’s assets from the deemed asset disposition. Treas. Reg. § 1.1502- 13(f)(5)(ii)(C) provides an election (a ”§ 1.1502-13(f)(5) election”) in the case of §338(h)(10) and comparable transactions. A § 1.1502-13(f)(5) election allows taxpayers to treat the deemed liquidation as the result of a §338(h)(10) election or an actual liquidation as a taxable liquidation in order to provide the consolidated group with a stock loss to offset some, if not all, of the intragroup seller’s stock gain from the intragroup transaction. The final regulations allow a taxpayer to make a § 1.1502-13(f)(5) election to treat the deemed liquidation of target into seller as a result of a § 336(e) election as a taxable liquidation. Treas. Reg. § 1.1502-13(f)(5)(ii)(C).
The final regulations further provide that in the case of a §§355(d)(2) or (e)(2) transaction that is preceded by an intragroup transaction, for the limited purpose of a § 1.1502-13(f)(5) election, immediately after the deemed asset disposition of target’s assets, target is deemed to liquidate into seller, thus providing seller with a stock loss that can offset some or all of the group’s intercompany gain with respect to the intragroup transfer of target stock.
Elections for S Corporations
Consistent with the legislative history under the TRA ’86, the final regulations permit a §336(e) election to be made for S corporation targets and provide additional and special rules to allow §336(e) elections to be made with respect to S corporation targets.
Where a § 338(h)(10) election is made with respect to an S corporation target, all of the S corporation shareholders, including those who do not sell their S corporation target stock, must consent to the election. With respect to a § 336(e) election, the final regulations provide the same requirement for purposes of making a §336(e) election. While S corporation shareholders consent to a section 338(h)(10) election by signing Form 8023, to make a § 336(e) election, the S corporation shareholders do not file a §336(e) election statement. Instead, consent to make a §336(e) election is established by all the S corporation shareholders, including those who do not dispose of their stock in the transaction, and target entering into a written, binding agreement to make the election, on or before the due date (including extensions) of the S corporation target’s income tax return. The §336(e) election statement for an S corporation target is filed with the income tax return of the S corporation target. If a §336(e) election is made for an S corporation target, old target’s S election continues in effect through the close of the disposition date (including the time of the deemed asset disposition and the deemed liquidation) at which time old target’s S election terminates, and old target ceases to exist. If new target qualifies as a small business corporation within the meaning of § 1361(b) and wants to be an S corporation, a new election for new target under § 1362(a) must be made. This rule poses a trap for the unwary no doubt.
Determination of AGUB (Adjusted Gross-Up Basis) and ADADP (Aggregate Deemed Asset Disposition Price)
The final regulations continue to adhere to the position that sellers selling costs or purchaser acquisitions costs do not reduce old targets ADADP or buyer’s AGUB. With regard to grossing up the selling costs and acquisition costs over all target stock, this issue was specifically addressed in the preamble to the proposed section 338 regulations in 1999 (”Grossing-up the selling shareholders’ selling costs or the purchasing corporation’s acquisition costs would result in costs not actually incurred reducing old target’s amount realized for the assets or increasing new target’s cost basis in the assets. . . . [T]here is no evidence that the purchasing corporation’s costs to acquire an amount of target stock sufficient for there to be a qualified stock purchase would increase proportionately if it acquired all of the target stock . . .”). See REG-107069-97, 1999-2 CB 346, 353. Accordingly, the final regulations retain the rule of the proposed regulations.
With regard to the preferred stock issue, the determination of grossed-up basis in §338 is specifically provided for in the Code, and Congress included preferred stock in determining the percentage of stock attributable to recently purchased stock. The regulations under § 338 apply the same rule in determining grossed-up amount realized. The IRS and the Treasury Department believe that it is appropriate to use the same computation for purposes of a section 336(e) election. Accordingly, the final regulations retain the rule of the proposed regulations.
Gain Recognition Elections
The proposed §336(e) regulations provided that the holder of nonrecently disposed stock may make a gain recognition election, similar to the gain recognition election under § 338, which treats nonrecently disposed stock as being sold as of the disposition date. The gain recognition election is mandatory if a purchaser owns (after the application of the rules of §318(a), other than §318(a)(4)), 80-percent or more of the voting power or value of target stock. Once made, a gain recognition election is irrevocable. This rule was retained in the final regulations.
Anti-Related Party Rule
The proposed regulations provided that a transaction is not a disposition (and therefore is ineligible to count towards a qualified stock disposition) if target stock is sold, exchanged, or distributed to a related person. The proposed regulations, like the §338 regulations, treat persons as related if stock in a corporation owned by one of the persons would be attributed to the other person under §318(a), other than § 318(a)(4). In the Preamble to the final regulations, after reviewing many comments that were submitted on the related party aspects, that the anti-related party rule should not be prohibited if cross ownership is minimal. The best manner for addressing the commenters’ concerns is to modify the definition of related persons as pertaining to partnerships by providing that, solely for purposes of determining whether purchaser and seller are related for purposes of §336(e), the attribution rules of §318(a)(2)(A) and 318(a)(3)(A) will not apply to attribute stock ownership from a partnership to a partner, or from a partner to a partnership if such partner owns, directly or indirectly, less than five percent of the value of the partnership. A five-percent threshold is within the range suggested by comments for limiting upstream and downstream attribution under § 318(a) between partners and partnerships, and is consistent with the five-percent threshold of constructive ownership rules under §§267(e)(3) and 1562(e)(2) relevant to partners and partnerships.
Scope of Regulations: Application to Non-recognition Transactions
The final regulations do not permit an election to be made in non-taxable transfers of target stock. However, the IRS and Treasury Department will continue to study this issue and may address the issue in future guidance.
International Provisions: Application to Acquisitions of Foreign Targets
The final regulations retain the requirement that the seller and the target both must be domestic corporations. However, the IRS and Treasury stated it will continue to study the issue.
Allocation of Foreign Taxes Paid
The proposed regulations provide that if a §336(e) election is made and target’s taxable year under foreign law (if any) does not close at the end of the disposition date, foreign income taxes paid by new target attributable to the foreign taxable income earned by target during such foreign taxable year are allocated to old target and new target under the principles of Treas. Reg. § 1.1502-76(b). See Treas. Reg. §1.338-9(d) for allocating foreign tax paid by a target that is acquired in a transaction that is treated as an asset acquisition pursuant to an election under § 338 if the foreign taxable year of target does not close at the end of the acquisition date. In addition, regulations under §901, which were published on February 14, 2012, provide foreign tax allocation rules, consistent with § 1.338-9(d), for certain changes in ownership of a partnership or disregarded entity during the entity’s foreign taxable year. See Treas. Reg. § 1.901-2(f)(4). The final regulations at § 1.336-2(g)(3)(ii) reflect modifications made to achieve consistency with Treas. Reg. § 1.901-2(f)(4). The regulations also provide that if target holds an interest in a disregarded entity or partnership, the rules of Treas. Reg. § 1.901-2(f)(4) apply with respect to foreign tax imposed at the entity level on the income of such entities. The IRS and Treasury Department intend to issue future guidance that will make similar modifications to Treas. Reg. § 1.338-9(d).
Covered Asset Acquisition Rules: Section 901(m)
Section 901(m)(1), enacted into law as part of the Education Jobs and Medicaid Assistance Act of 2010, P.L. 111-226 (8/10/2010), provides, in part, that in the case of a covered asset acquisition, the disqualified portion of any foreign income taxes determined with respect to the income or gain attributable to a relevant foreign asset shall not be taken into account in determining the foreign tax credit allowed under §901(a). Section 901(m)(2)(B) defines a covered asset acquisition to include any transaction that is treated as an acquisition of assets for U.S. income tax purposes and as the acquisition of stock of a corporation (or is disregarded) for purposes of a foreign income tax. Since a §336(e) election for target is treated as an acquisition of assets for U.S. income tax purposes, and is treated as the acquisition of stock of a corporation (or is disregarded in the case of tiered § 336(e) elections) for foreign tax purposes, a §336(e) election for a target corporation is a covered asset acquisition. Accordingly, the final regulations contain a cross-reference to the rules under section 901(m), which, for example, could apply if target has foreign branch operations.
The proposed regulations to §336(e) provided that where the seller retains any stock in target after the 12-month disposition period, seller is treated as purchasing the stock so retained on the day after the disposition date. The proposed regulations provide the holding period and purchase price (and thus the basis) of the retained stock. The regulations under Treas. Reg. § 1.338(h)(10)-1 provide a similar rule concerning retained stock, with the exception that the Treas. Reg. § 1.338(h)(10)-1 rule only requires that the stock be retained after the acquisition date. Under the proposed regulations, if seller sells, exchanges, or distributes less than all of its stock prior to the disposition date, but sells, exchanges, or distributes additional stock after the disposition date but before the end of the 12-month disposition period, the regulations are silent as to holding period and purchase price (and thus the basis) of such stock. If the later transaction is part of the qualified stock disposition, the basis and holding period may not be relevant, because no gain or loss is recognized on that transaction. However, if the stock is transferred in a transaction not part of the qualified stock disposition, such as a sale to a related person, the basis and holding period will be relevant. In the Preamble to the final regulations, it was announced that the rule in the Treas.Reg. § 1.338(h)(10)-1, providing that stock is retained if seller owns the stock after the acquisition date, should be adopted by the regulations under ¶336(e). Accordingly, the final regulations modify the rule of the proposed regulations, so that stock is retained if owned by seller after the disposition date.
The proposed regulations generally follow the structure and policies of §338(h)(10), including the application of the consistency rules of Treas. Reg. § 1.338-8. In general, Treas. Reg. § 1.338-8 provides that if (1) a purchasing corporation (or an affiliate) acquires an asset meeting certain requirements from target (or a subsidiary of target) in a sale during the target consistency period, (2) gain from the sale is reflected in the basis of target stock as of the target acquisition date, and (3) the purchasing corporation acquires stock of target in a qualified stock purchase (but does not make a § 338 election), then the purchasing corporation is required to take a carryover basis in the acquired asset. The final regulations, in response to comments made during the proposed rule-making period, provide that for purposes of §336(e), consistency rules apply to an asset only if the asset is owned, immediately after its acquisition and on the disposition date, by a person (or by a related person to such a person) that acquires five percent or more, by value, of the stock of target in a qualified stock disposition.