Corporate Liquidations Selected Issues

1
Corporate LiquidationsSelected Issues

• CORPORATE TAX COMMITTEE
• ABA SECTION OF TAXATION
• MIDYEAR MEETING
• February 4, 2006
• San Diego, California

Panelists Bob Woodward, King Spalding LLP,
Atlanta, GA Brett Enzor, Ernst Young LLP,
Transactions Advisory Services, New York,
NY Philip B. Wright, Bryan Cave LLP, St. Louis,
MO Mark A. Schneider, Deputy Associate Chief
Counsel (Corporate), Internal Revenue Service
2

• Liquidations Introduction and Background

3
Liquidations Introduction and Background

• Section 331. Gain or loss to shareholders in
  corporate liquidations.
• Distributions in complete liquidation treated as
  exchanges.Amounts received by a shareholder in a
  distribution in complete liquidation of a
  corporation shall be treated as in full payment
  in exchange for the stock.
• Section 336. Gain or loss recognized on property
  distributed in complete liquidation.
• General rule.Except as otherwise provided in
  this section or section 337, gain or loss shall
  be recognized to a liquidating corporation on the
  distribution of property in complete liquidation
  as if such property were sold to the distributee
  at its fair market value.
• Treatment of liabilities.If any property
  distributed in the liquidation is subject to a
  liability or the shareholder assumes a liability
  of the liquidating corporation in connection with
  the distribution, for purposes of subsection (a)
  and section 337, the fair market value of such
  property shall be treated as not less than the
  amount of such liability.
• Limitations on recognition of loss.
• No loss recognized in certain distributions to
  related persons.
• In general. No loss recognized by liquidating
  corporation on distribution to related person if
  non pro rata or disqualified property.
• Disqualified property. Defined to include
  property acquired in section 351 transaction
  within last 5 years.

4
Liquidations Introduction and Background

• Section 332. Complete liquidations of
  subsidiaries.
• General rule.No gain or loss shall be recognized
  on the receipt by a corporation of property
  distributed in complete liquidation of another
  corporation.
• Liquidations to which section applies.For
  purposes of this section, a distribution shall be
  considered to be in complete liquidation only
  if--
• the corporation receiving such property was, on
  the date of the adoption of the plan of
  liquidation, and has continued to be at all times
  until the receipt of the property, the owner of
  stock (in such other corporation) meeting the
  requirements of section 1504(a)(2) and either
• the distribution is by such other corporation in
  complete cancellation or redemption of all its
  stock, . . . or
• such distribution is one of a series . . . in
  complete cancellation or redemption of all its
  stock . . .

5
Liquidations Introduction and Background

• Section 334(b) Basis of property received in
  liquidations as amended by Gulf Opportunity Zone
  Act of 2005.
• (1) In General.
• If Property is received by a corporate
  distributee in a distribution in a complete
  liquidation to which section 332 applies (or in a
  transfer described in section 337(b)(1)), the
  basis of such property in the hands of such
  distributee shall be the same as it would be in
  the hands of the transferor except that--
• (A) The basis of such property shall be the
  fair market value of the property at the time of
  the distribution in any case in which gain or
  loss is recognized by the liquidating
  corporation with respect to such property, and
• (B) The basis of any property described in
  section 362(e)(1)(B) shall be the fair market
  value of the property at the time of the
  distribution in any case in which such
  distributees aggregate adjusted basis of such
  property would (but for this subparagraph)
  exceed the fair market value of such property
  immediately after such liquidation.

6
Liquidations Introduction and Background

• Section 337. Nonrecognition for Property
  Distributed to Parent in Complete Liquidation of
  Subsidiary.
• In General.
• No gain or loss shall be recognized to the
  liquidating corporation on the distribution to
  the 80-percent distributee of any property in a
  complete liquidation to which section 332
  applies.
• Treatment of Indebtedness of Subsidiary, etc.
• Indebtedness of subsidiary to parent. If--
• a corporation is liquidated in a liquidation to
  which section 332 applies, and
• on the date of the adoption of the plan of
  liquidation, such corporation was indebted to the
  80-percent distributee,
• for purposes of this section and section 336,
  any transfer of property to the 80-percent
  distributee in satisfaction of such indebtedness
  shall be treated as a distribution to such
  distributee in such liquidation.

7
Liquidations Introduction and BackgroundSection
331 Liquidations

• Requirements.
• Section 331 applies to any distribution in
  complete liquidation of a corporation that does
  not meet the requirements of Section 332.
• Conversion to LLC. A liquidation frequently is
  accomplished for tax purposes by converting or
  merging a corporation into a limited liability
  company that is treated as a partnership or
  disregarded entity.
• In Revenue Ruling 2003-125, however, the IRS
  stated that neither Section 331 nor Section 332
  applies, if a shareholder receives no payment
  for its stock in a liquidation of the
  corporation. In the ruling, the stock held by
  the shareholder was worthless at the time of the
  liquidation.
• Corporation must not be reincorporated. Section
  368(a)(1)(D).

8
Liquidations Introduction and BackgroundSection
331 Liquidations

• 2. Tax Consequences.
• Gain or loss is recognized to the shareholders by
  treating the liquidating distribution as payment
  in exchange for stock.
• Gain or loss is recognized to the liquidating
  corporation as if distributed property were sold
  for fmv, subject to the section 336(d) limitation
  on loss recognition for assets distributed to a
  related person (i) in non-pro rata distribution
  or (ii) if contributed in section 351 transaction
  within last 5 years. Section 336(a), (d).
• Fmv of distributed property is treated as not
  less than the amount of any liability to which
  the distributed property is subject. Section
  336(b).
• Distributee Shareholder takes tax basis in
  distributed property equal to fmv. Section
  334(a).
• All tax attributes of liquidated corporation are
  extinguished.

9
Liquidations Introduction and BackgroundSection
332 Liquidations

• Requirements.
• On the date of adoption of the liquidation plan,
  the parent corporation must own stock in the
  subsidiary meeting the requirements of section
  1504(a)(2) (1) at least 80 of the total
  combined voting power and (2) at least 80 of
  the total value of all classes of stock
  (excluding certain section 1504(a)(4) preferred
  stock). Section 332(b)(1).
• Subsidiary must distribute to its shareholders
  assets in complete cancellation or redemption of
  its stock. Section 332(b)(2). Note Some part
  of the distribution must be made with respect to
  common stock rather than solely with respect to
  intercompany debt or preferred stock. See H.K.
  Porter Co. v. Commissioner, 87 TC 689 (1986).
• Distribution within one taxable year, or within
  three years from the close of the taxable year in
  which the first distribution is made. Section
  332(b)(2), (3).
• Subsidiary must be solvent. Treas. Reg.
  1.332-2(b).
• Subsidiary must not be reincorporated. Section
  368(a)(1)(D).

10
Liquidations Introduction and BackgroundSection
332 Liquidations (contd)

• Tax Consequences.
• In general, no gain or loss is recognized to 80
  corporate distributee. Section 332(a). Thus, the
  corporate shareholders tax basis in the stock of
  its subsidiary disappears. Special rules apply
  to foreign corporation liquidations. See Treas.
  Reg. 1.367(b)-3.
• No gain or loss is recognized to liquidated
  corporation on the distribution to its 80
  corporate distributee. Section 337(a).
• Property received by the 80 corporate
  distributee generally has a carryover basis from
  the liquidated corporation. Section 334(b).
  However, where a foreign sub liquidates into a
  U.S. parent under section 332 and the aggregate
  adjusted bases of the foreign subs assets not
  previously subject to U.S. tax exceed their fmv,
  the U.S. parent takes a fmv basis in each
  distributed asset. See Section 334(b)(1)(B) (as
  amended by Gulf Opportunity Zone Act in December
  2005) Section 362(e)(1)(B).
• In general, the liquidated subsidiarys tax
  attributes are transferred to the 80 corporate
  distributee. Section 381(a). Special rules apply
  to foreign corporations. See e.g., Revenue
  Ruling 72-421, 1972-2 C.B. 166.
• If the subsidiary is a member of an affiliated
  group filing a consolidated return, any excess
  loss account inherent in the stock of the
  liquidated subsidiary is eliminated. See Treas.
  Reg. 1.1502-19(b)(2).
• In the case of a consolidated group, if the
  shareholder of the liquidated subsidiary has a
  intercompany gain in respect of the subsidiarys
  shares, the liquidation will accelerate this
  gain. See Treas. Reg. 1.1502-13(f)(5).
• Where a subsidiary merges into an 80 corporate
  distributee in a statutory merger and the
  requirements of section 332 are met, section 332
  liquidation treatment applies with respect to the
  distribution to the 80 corporate distributee.
  See Treas. Reg. 1.332-2(d),(e). The
  reorganization rules may apply to distributions
  to any other shareholders if the applicable
  requirements of sections 368 and 354 apply but
  if not the distributions to other shareholders
  will cause gain or loss recognition at the
  corporate and shareholder levels. Sections
  336(a) 331(a).

11

• The Electivity of Section 332

12
Section 332 Elective?Revenue Ruling 70-106

Minority Shareholders
1
2
Y
Y
25
Liquidation
75
100
X
Redemption of stock
X

• Y desired to liquidate X and did not want to
  recognize any gain.
• The Minority Shareholders agreed to have their
  stock redeemed.
• Following the redemption of the Minority
  Shareholders, Y owned 100 of X.
• Y then adopted a plan of liquidation pursuant to
  which X was liquidated.

• The ruling held that the liquidation of the
  subsidiary failed to meet the 80 control
  requirement under Section 332(b)(1) because the
  plan of liquidation was adopted when Y reached an
  agreement with the Minority Shareholders to have
  their stock redeemed.
• Would the result have been different if Y had
  purchased the X stock from the Minority
  Shareholders instead of having X redeem their
  stock? See Revenue Ruling 75-521.

13
Section 332 Elective?Revenue Ruling 68-602
Contribution of Debt by P Does Not Achieve
Solvency
1
2
P
P
Cancellation of debt
Assets
100
S
S

• S sustained operating losses in prior years that
  resulted in a net operating loss carryover.
• S was indebted to P in an amount greater than the
  fair market value of Ss assets.
• P wanted to avail itself of Ss NOLS.
• P cancelled the indebtedness owed to it by S and
  then caused S to liquidate.

• The IRS said the cancellation of Ss debt was
  transitory and had no independent significance
  other than to secure tax benefits, and therefore
  that the liquidation did not qualify under
  Section 332.
• Compare Revenue Ruling 78-330 (Ps cancellation
  of S1 debt immediately before S1s merger into S2
  respected).

14
Section 332 Elective?Commissioner v. Day
Zimmerman, Inc., 151 F.2d 517 (3rd Cir. 1945).
P
DavidKatz
1
2
23.6 M liability
P
85 common and 90 preferred
75 vote
75 vote
88.8 common and 100 preferred
Victor
Red Star
Victor
Red Star

• Victor and Red Star experienced financial
  downturns.
• Management decided to liquidate both
  subsidiaries.
• P did not want non-recognition treatment. It
  wanted to recognize a long-term capital loss in
  the stock of both subs.
• In order to fall below the 80 threshold, P
  retained a public auctioneer to sell a portion of
  the Victor and Red Star preferred and common
  stock. David Katz, the treasurer of P purchased
  the stock.
• Victor and Red Star subsequently liquidated.

• The Court held that P did not hold the requisite
  80 ownership as was required by the predecessor
  of Section 332 and that the liquidation was a
  taxable event. Hence, Ps capital losses in the
  Victor and Red Star stock were allowed.

15
Section 332 Elective?Granite Trust Co. v.
U.S., 238 F.2d 670 (1st Cir. 1956)
P
Unrelated parties
Sold and gifted greater than 20 of voting stock
S

• S was formed for the purpose of acquiring land
  and constructing a building.
• The building substantially declined in value.
• Bank regulators demanded a write down of Ss
  stock.
• P subsequently decided to liquidate S.
• P did not want non-recognition treatment and
  decided to sell some of its S stock to reduce its
  ownership interest below 80.

• In order to have a taxable liquidation P sold and
  gifted Ss stock to unrelated parties parties.
• The stock transfers reduced Ps ownership
  interest in S below the 80 threshold.

16
Section 332 Elective?Granite Trust (contd)

• Once Ps ownership was below 80, S sold its
  assets to P in return for 550,000 in cash, after
  which S liquidated.
• The Court held that the liquidation was a taxable
  event, relying heavily on a Senate Finance
  Committee report discussing the elective
  features of Section 332.
• Citing the Senate Finance Committee Report on the
  reenactment of Section 332 as part of the 1954
  Code, the Court stated, the elective features
  of the subsection seems inescapably to reflect a
  legislative understandingthat taxpayers can, by
  taking appropriate steps, render the subsection
  applicable or inapplicable as they choose.

P
Assets
550,000 cash
79.06 of vote
S
17

• Outbound Liquidations Section 332(d)

18
Outbound Liquidations Section 332(d)

• Requirements
• Section 332(d), as enacted in the AJCA of 2004,
  generally applies to the liquidation of a
  domestic corporation that is the parent of an
  affiliated group where the domestic parent
  corporation has been in existence for less than
  five years and substantially all of its assets
  are stock in other group members.
• Effect of Section 332(d)
• Section 332(d) treats any distribution of
  earnings by a U.S. holding company to a foreign
  corporation in a complete liquidation as a
  Section 301 distribution.
• Underlying Policy
• Congress was concerned that a foreign corporation
  could establish a U.S. holding company to receive
  dividends from U.S. operating companies,
  liquidate the U.S. holding company to distribute
  the U.S.-source earnings free of U.S. withholding
  taxes, and then reestablish another U.S. holding
  company with the intention of escaping future
  U.S. withholding taxes. Congress believed that
  this perceived abuse could be curtailed by
  treating as a distribution to which section 301
  applies certain liquidating distributions to
  foreign corporate shareholders of earnings and
  profits of a U.S. holding company created within
  5 years of the liquidation.
• Query
• Does Section 332(d) have the effect of turning
  off Section 337 at the corporate level?

19
Outbound Liquidations Section 332(d)Example

• Consequences

Foreign Parent

• Section 332(d) provides that Section 332(a) does
  not apply
• Outbound liquidation treated as a Section 301
  distribution (potentially subject to withholding
  tax)
• Does Section 337 get turned off to create
  corporate-level gain within New U.S. Parent?
  Section 337 requires a liquidation to which
  Section 332 applies
• 4. Since Section 332(d) disengages only
  Section 332(a), and the outbound liquidation is
  still described in Section 332(b) (subject to
  applicable Section 367 requirements), an outbound
  liquidation arguably does not create
  corporate-level Section 336 gain.

Outbound Liquidation
New U.S. Parent Formed 1/1/05
Significant EP
Old U.S. Parent
U.S. Sub 1
U.S. Sub 2
Value 100 Basis 0
Value 100 Basis 0
20
Section 332 and Consolidated Groups
21
Section 332 and Consolidated Groups
P
S1
S2
80
20
S3

• S1 and S2 want to liquidate S3.
• This raises two important issues

1. Does the liquidation of S3 qualify as a
Section 332 liquidation? 2. Will S3 incur
corporate level gain due to the liquidation?
22
Section 332 and Consolidated Groups

• Does the liquidation of S3 qualify as a Section
  332 liquidation?
• According to Treas. Reg. 1.1502-34, In
  determining the stock ownership of a member of
  the group in another corporation, for purposes of
  determining the application of Section
  332(b)(1)there shall be included stock owned by
  all other members of the group.

23
Section 332 and Consolidated Groups
P
S1
S2
80
20
S3

• S1 and S2 shall each be treated as meeting the
  ownership requirement for purposes of Section 332
  even though S2 does not own the requisite 80
  individually.
• Therefore, no gain or loss will be recognized by
  either S1 or S2 with respect to the S3 stock when
  S3 distributes its assets to S1 and S2 in
  liquidation.

24
Section 332 and Consolidated Groups

• Will S3 incur corporate level gain due to the
  liquidation?
• Treas. Reg. 1.1502-13(j)(9), examples 6 and 7
  indicate that S3 must recognize corporate level
  gain under Section 337 to the extent any
  distributee is treated as an 80 distributee for
  purposes of Section 332 solely by reason of the
  application of Treas. Reg. 1.1502-34.

25
Section 332 and Consolidated Groups

P

• S3 distributes all of its assets to S1 and S2 in
  complete liquidation.
• Under Section 337, S3 has no gain or loss from
  its liquidating distribution to S1.
• Under Sections 336 and 337(c), S3 has a 40 gain
  from its liquidating distribution to S2 because
  S2 is an 80
• distributee only by reason of the application of
  Treas. Reg. 1.1502-34. The gain is deferred and
  succeeded to by S1 under the consolidated return
  regulations.
• See Treas. Reg. 1.1502-13(j)(9), example 6.
• See also Prop. Reg. 1.1502-13(j)(2)(ii) (both
  S1 and S2 succeed to their respective shares of
  S3 gain (and other S3 intercompany items)).

S2
S1
60 Value
40 Value
Common stock
Section 1504(a)(4) preferred stock
S3
Assets
100 value 0 basis
26
Section 332 and Consolidated Groups
P

• S3 has only common stock outstanding.
• S3 distributes all of its assets to S1 and S2 in
  a complete liquidation.
• Under Treas. Reg. 1.1502-34, Section 332
  applies to both S1 and S2, such that neither
  recognize gain on the liquidation.
• Under Sections 336 and 337(c), S3 has a 100 gain
  from its liquidating distribution to S1 and S2,
  because both S1 and S2 are 80 distributees only
  by reason of the application of Treas. Reg.
  1.1502-34. The gain is deferred and succeeded to
  by S1 and S2 under the consolidated return
  regulations.
• See Treas. Reg. 1.1502-13(j)(9), example 7.
• See also Prop. Reg. 1.1502-13(j)(2)(ii) (both
  S1 and S2 succeed to their respective shares of
  S3s gain (and other intercompany items)).

S1
S2
60 Common Stock
40 Common Stock
S3
Assets
100 value 0 basis
27

• Proposed Regulations Requiring An Exchange of
  Net Value

28
Proposed Regulations Overview

• Net Value Requirement In general, the proposed
  regulations provide that property with a net
  value must be exchanged in certain
  non-recognition transactions. The proposed
  regulations make the net value requirement
  applicable to
• Section 332 Liquidations
• Section 351 Exchanges and
• Section 368 Reorganizations
• Net Value Requirement Does Not Apply to
• Section 368(a)(1)(E) Recapitalizations
• Section 368(a)(1)(F) Mere change in identity,
  form or place of organization and
• Section 368(a)(1)(D) Transactions Certain
  acquisitive D reorganizations involving solvent
  corporations.

29
Proposed Regulations Net Value Requirement

• Net Value
• Section 332 Liquidations partial payment rule
  (a distribution of value in cancellation/redemptio
  n of all or a portion of each class of stock)
• Section 351 Exchanges must be a surrender and
  receipt of net value and
• Section 368 Reorganizations surrender and
  receipt.
• Purpose of Proposed Regs
• A distribution of net value has been consistently
  required by the authorities in regard to Section
  332 liquidations
• The IRS and Treasury believe that to resolve
  uncertainties and bring consistency, the same
  requirement should be applied throughout
  Subchapter C and
• The IRS and Treasury believe that transfers
  failing the net value requirement (e.g. transfers
  of property solely in exchange for the assumption
  of liabilities or in satisfaction of liabilities)
  resemble sales and thus should not receive
  non-recognition treatment.

30
Proposed Regulations Net Value Requirement

• Liabilities
• The Proposed Regs adopt the principles of Section
  357(d) for the determination of whether a
  liability is assumed by the acquiring or
  transferee corporation.
• The Proposed Regs provide that a transfer of
  property in satisfaction of a liability owed to
  the acquiring or transferee corporation should be
  viewed as an assumption of that liability for
  purposes of the net value requirement.
• No specific guidance on determining the amount of
  a liability.
• The IRS and Treasury are currently studying the
  appropriate treatment of the assumption of
  non-recourse liabilities, considering a similar
  rule to the one in Revenue Ruling 92-53 (i.e.,
  the excess of NR liability over the fmv of
  asset(s) securing the liability is to be
  disregarded).

31
Proposed Regulations Net Value Requirement
Section 332 Liquidations

• The Proposed Regs preserve (and clarify/expand)
  the current partial payment rule of Treas. Reg.
  1.332-2(b) which, as clarified/expanded, would
  provide
• A transfer of assets of a subsidiary (S) to a
  parent (P) does not qualify as a Section 332
  liquidation unless P receives at least partial
  payment for each class of stock it owns in S.
• The Preamble to the Proposed Regs provides that
  the substance over form doctrine does not allow
  P to make a capital contribution of S debt to
  achieve solvency of S prior to liquidation in
  order to receive Section 332 treatment. See
  Revenue Ruling 68-602.

32
Proposed Regulations Net Value Requirement
Illustration of Example 2 in Proposed Reg.
1.332-2(e)
Q liquidates and distributes all assets (subject
to liabilities) to P. P receives partial payment
for preferred stock and nothing for its common
stock
P
P
All outstanding Preferred (not Section
1504(a)(4)) and Common
Q assets and liabilities
Q
Q

• Receipt by P of properties of Q is not a
  distribution in complete liquidation within the
  meaning of Section 332 because the partial
  payment rule is not met.
• Under Section 165(g), P entitled to a worthless
  stock deduction for its Q common stock.
• Transaction may qualify as a reorganization,
  otherwise P will recognize loss on its preferred
  stock under Section 331.
• What results if P contributed the Q preferred
  stock to Q (or the Q preferred was cancelled)
  prior to the liquidation?

FMV of Qs assets exceeds its liabilities but
does not exceed the sum of its liabilities and
the liquidation preference of Qs preferred stock.
33

• Upstream Reorganizations

34
Upstream ReorganizationsRevenue Ruling 69-617

• The issue presented is whether the transfer of
  the assets of S1 to P may qualify as a
  reorganization inasmuch as the transfer is
  literally within the language of Section 332.
• The Revenue Ruling provides that this is a good
  Type A and Type C upstream reorganization, even
  if the transaction would not have qualified as a
  good Section 332 liquidation (because of the
  reincorporation of assets transferred to S2).

Shareholders
P
Retain 50
Merge
50 of assets
S1
S2
35
Complete Liquidation Asset Drop-Down and
Spin-Off
P Shareholders
P Shareholders
Drop-Down
P
P
S-1
S-2
S-1
S-2
Liquidation
Spin-Off

• Step 1 S-1 Liquidates into P.
• Step 2 S-1 assets related to S-2 business
  dropped into S-2.
• Step 3 S-2 distributed to P shareholders in
  transaction qualifying under Section 355.

• P desires to distribute S-2 to its shareholders
  in a transaction qualifying under section 355.
• Certain assts related to the S-2 business are
  held by S-1.

36
Complete Liquidation Asset Drop-Down Tax
Consequences

• Is the liquidation of S-1 into P followed by the
  drop-down of part of the S-1 assets a
  distribution in complete liquidation of S-1?
• See Revenue Ruling 76-429, 1976-2 CB 97
  Telephone Answering Service Co. v. Commissioner,
  63 TC 423 (1974) Revenue Procedure 90-52, 1990-2
  CB 626.
• What is the proper characterization of the
  transaction (if not a Section 332 liquidation)?
• Does it alter the tax consequences if the
  liquidation is accomplished by merger?
• See Revenue Ruling 69-617, 1969-2 CB 57.
• Is gain recognized with respect to the S-1
  assets?
• Is the Section 368(a)(2)(C) control requirement
  satisfied with respect to shares attributable to
  the S-1 assets contributed to S-2?
• See PLR 200532011 PLR 200310005.

37

• Section 336(a) Loss Recognition for Retained
  Assets

38
Section 336(a) Loss Recognition for Retained
Assets
Individual Shareholder
Holdco
Asset A FMV 200 AB 100
Asset BFMV 100 AB 200

• Shareholder wishes to have Holdco sell Asset A
  and retain Asset B.
• Neither Asset A nor Asset B were acquired via a
  Section 351 transaction or capital contribution.
• Holdco sells Asset A and converts into an LLC.
• The aggregate value of Holdcos assets exceeds
  the amount of Holdcos liabilities.

39

• Section 336(a) Loss Recognition for Retained
  Assets
• Tax Consequences
• Holdco recognizes loss in Asset B that offsets
  gain on sale of Asset A.
• See Section 336(a) but see Section 336(d) (no
  loss recognized on liquidating distribution of
  certain property acquired in Section 351
  transaction or capital contribution).
• No loss disallowance under Section
  267(a)(1)(second sentence).
• Wash sale rule of Section 1091 should not
  apply.
• Section 1091 loss disallowance applies only if
  substantially identical stock or securities are
  purchased within the 61-day period by the
  taxpayer.
• Section 336(a) loss recognition applies except
  as otherwise provided in this Section or Section
  337.

40

• Section 334(b)(1)(B)
• Section 332 Liquidation of Foreign Sub with NBIL

41
Section 334(b)(1)(B) --Section 332 Liquidation
of Foreign Sub with NBIL
P
FS
Asset A FMV 100 AB 50
Asset B FMV 100 AB 151

• Neither Asset A nor Asset B is subject to U.S.
  tax if disposed of by FS.
• FS liquidates via check-the-box election to be
  treated as a disregarded entity.

42
Section 334(b)(1)(B) -- Section 332 Liquidation
of Foreign Sub with NBIL Tax Consequences

• Because the aggregate adjusted bases of FSs
  assets (201) exceed their fmv (200), the basis
  of Asset A and Asset B is marked to market.
• FMV Basis
• Asset A 100 100 Asset B 100 100
• 200 200
• See Sections 334(b)(1)(B), 362(e)(1)(B).
• This results, in effect, in a transfer of 50
  of FSs basis in Asset B to Asset A.
• If the aggregate fmv of FSs assets were 200 or
  less, Section 334(b)(1)(B) would not apply and
  the basis of Asset A and Asset B would carry over
  to P under the general rule of Section 334(b)(1).
  

43
Section 332 Liquidation Section 355 Overlap
44
Section 332 Liquidation Section 355 Overlap
P
P
Public
Liquidation
Cash
S
S
S-2 Stock
S-1
S-2
S-1
S-2

• S liquidates distributing S-1 and S-2 to P.
• Both S-1 and S-2 would satisfy the requirements
  of Section 355.

• Step 1 S liquidates into P.
• Step 2 S-2 sells 50.1 to the public in an IPO

45
Section 332 Liquidation Section 355 Overlap
Tax Consequences

• Is the liquidation of S into P a distribution in
  complete liquidation governed by Section 332 or a
  Section 355 distribution?
• See Treas. Reg. 1.332-2(d) Treas. Reg.
  1.332-2(e) Section 355(c).
• What is the basis to P in the stock of S-1 and
  S-2?
• See Section 358(b),(c) versus Section 334 (b)
• Are Ss tax attributes eliminated?
• See Section 381 Cf General Housewares Corp. v.
  US, 615 F.2d 1056 (5th Cir. 1980) FEC
  Liquidating Corp. v. U.S., 548 F.2d 924 (Ct. Cl.
  1977)
• Does Section 355(e) apply to the planned IPO of
  50.1 of S-2?

46
Capital Contribution/Sale of Insolvent Subsidiary
47
Capital Contribution/Sale of Insolvent
SubsidiaryCapital Contribution - Intercompany
Debt
FC
FC
Year 5 FC contributes US S debt to US P.
Year 1 US P buys US S for 300.
US P
US P
B
US S
Year 2 FC Loans 200 to US S.
Year 5 US P contributes US S debt to US S.
100
US S
US S
Year 5 US P sells US S to B for 100.
Assets FMV 100 AB
50 Liabilities 200 NOL (200)

• Year 1 US P purchases US S for 300.
• U.S. S assets FMV 300 tax basis 50.
• Year 2 FC loans 200 to US S to fund
• US S net operating loses of 200.

• Year 5 US P enters into agreement to sell
• US S to B for 100 excluding FC debt. US assets
  have declined to 100. Prior to sale FC
  contributes debt to US P and U.S. P contributes
  debt to US S.

48
Capital Contribution/Sale of Insolvent Subsidiary
Capital Contribution - Intercompany Debt Tax
Consequences

• Assume US S Debt to FC is Debt for federal income
  tax purposes.
• Is FCs contribution of debt to US P subject to
  Section 362(e)(1) causing US P to take a fair
  market value basis of 100 in US S debt?
• If section 362(e) applies the contribution by US
  P to US S creates 100 of COD income. Sections
  61(a)(12) and 108(e)(6). (Face 200 less US P
  adjusted basis 100). Insolvency exception
  applicable to the extent of US Ss insolvency
  after contribution in the amount of 100. Income
  offset by NOLs.
• US P recognizes a capital loss of 300 on sale
  (amount realized (100) less adjusted basis
  (400)).
• No step-up in US S assets. US S NOL (100)
  subject to Section 382 limitations. Sections
  382(a) and 382(l)(1).

49
Capital Contribution/Sale of Insolvent Subsidiary
Intercompany Debt S Liquidates
FC
Year 5 US S converts to LLC.
FC
Year 5 FC contributes US S - LLC debt to US P.
Year 1 US P buys US S for 300.
US P
US P
B
US S
Year 2 FC Loans 200 to US S.
100
US S
Year 5 US P contributes US S - LLC debt to US
S - LLC.
US S - LLC
Year 5 US P sells US S - LLC to B for 100.
Assets FMV 100 AB
50 Liabilities 200 NOL (200)

• Year 5 US P enters into agreement to sell US S
  to B for 100 excluding FC debt. US assets have
  declined to 100. Prior to sale US S converts to
  US S - LLC. FC contributes debt to US P and US P
  contributes debt to US S - LLC.

• Year 1 US P purchases US S for 300.
• US S assets FMV 300 tax basis 50.
• Year 2 FC loans 200 to US S to fund
• US S net operating loses of 200.

50
Capital Contribution/Sale of Insolvent Subsidiary
Intercompany Debt S Liquidates Tax
Consequences

• Assume US S Debt to FC is Debt for federal income
  tax purposes.
• Conversion of US S to US S - LLC is a liquidation
  of US S.
• Cf Treas. Reg. 301.7701-3(g).
• US P recognizes Section 165(g)(3) loss with
  respect to 300 basis in US S.
• Revenue Ruling 2003-125, 2003-2 C.B. 1243.
• Liquidation of US S results in taxable asset
  transfer to US P.
• Query whether transfer is a distribution in
  liquidation of US S subject to sections 331/336
  or Section 1001? See Revenue Ruling 2003-125.
• Is gain recognized based on assets fair market
  value (100) or debt (200).
• Treas. Reg. 1.1001-2(a) Section 336(b).
• Does US S recognize COD income on conversion -
  debt is neither cancelled nor discharged?
• Query whether assets are deemed distributed to FC
  in satisfaction of debt and deemed contributed to
  US P.
• No gain or loss on FC contribution of debt to US
  P.
• Section 108(e)(6).
• Buyer takes a fair value tax basis in acquired
  assets (100). NOLs absorb any gain on
  liquidation (further reduced to the extent COD
  income is excluded under insolvency exception).

51
Capital Contribution/Sale of Insolvent Subsidiary
Intercompany Debt S Liquidates Tax
Consequences

• Assume US S Debt to FC is equity for federal
  income tax purposes.
• Conversion of US S to US S - LLC is a liquidation
  of US S.
• Cf Treas. Reg. 301.7701-3(g).
• Does US P recognize loss with respect to 300
  basis in US S.
• See Prop. Treas. Reg. 1.332-2(b) H.K Porter
  Co. v. Commissioner, 87 T.C. 689 Spaulding
  Bakeries, Inc. v. Commissioner, 27 T.C. 684
  (1957).
• Query whether transfer is a distribution in
  liquidation of US S subject to sections 331/336
  or a C reorganization (followed by drop-down)?
  
• See Prop. Treas. Reg. 1.332-2(b).
• If a reorganization what is the effect on US S
  tax attributes?
• No gain or loss on contribution of equity to US
  P.
• Buyer takes a fair value tax basis in acquired
  assets (100). NOLs (reduced by interest
  deductions claimed with respect to equity)
  absorb gain on liquidation to the extent thereof.