[Federal Register Volume 77, Number 180 (Monday, September 17, 2012)]
[Proposed Rules]
[Pages 57451-57476]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-22838]
[[Page 57451]]
Vol. 77
Monday,
No. 180
September 17, 2012
Part V
Department of Treasury
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Internal Revenue Service
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26 CFR Part 1
Regulations Regarding the Application of Section 172(h) Including
Consolidated Groups; Proposed Rule
Federal Register / Vol. 77, No. 180 / Monday, September 17, 2012 /
Proposed Rules
[[Page 57452]]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG-140668-07]
RIN 1545-BH16
Regulations Regarding the Application of Section 172(h) Including
Consolidated Groups
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking.
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SUMMARY: This document contains proposed regulations under section
172(h) and section 1502 of the Internal Revenue Code. These proposed
regulations provide guidance regarding the treatment of corporate
equity reduction transactions (CERTs), including the treatment of
multiple step plans for the acquisition of stock and CERTs involving
members of a consolidated group. These proposed regulations also
provide guidance regarding certain elections relating to the carryback
of consolidated net operating losses (CNOLs) to separate return years.
These proposed regulations will affect C corporations and corporations
filing consolidated returns.
DATES: Written or electronic comments and requests for a public hearing
must be received by December 17, 2012.
ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-140668-07), Room
5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station,
Washington, DC 20044. Submissions may be hand-delivered Monday through
Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-
140668-07), Courier's Desk, Internal Revenue Service, 1111 Constitution
Avenue NW., Washington, DC, or sent electronically, via the Federal
eRulemaking Portal at www.regulations.gov (IRS REG-140668-07).
FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations,
Amie Colwell Breslow or Marie C. Milnes-Vasquez at (202) 622-7530;
concerning submissions of comments and request for public hearing,
Oluwafunmilayo Taylor at Oluwafunmilayo.P.Taylor@irscounsel.treas.gov
or (202) 622-7180 (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collection of information contained in this notice of proposed
rulemaking has been submitted to the Office of Management and Budget
for review in accordance with the Paperwork Reduction Act of 1995 (44
U.S.C. 3507(d)) under control number 1545-2171. Comments on the
collection of information should be sent to the Office of Management
and Budget, Attn: Desk Officer for the Department of the Treasury,
Office of Information and Regulatory Affairs, Washington, DC 20503,
with copies to the Internal Revenue Service, Attn: IRS Reports
Clearance Officer, SE:W:CAR:MP:T:T:SP, Washington, DC 20224. Comments
on the collection of information should be received by November 16,
2012. Comments are specifically requested concerning:
Whether the proposed collection of information is necessary for the
proper performance of the functions of the Internal Revenue Service,
including whether the information will have practical utility;
The accuracy of the estimated burden associated with the proposed
collection of information;
How the quality, utility and clarity of the information to be
collected may be enhanced;
How the burden of complying with the proposed collection of
information may be minimized, including through the application of
automated collection techniques or other forms of information
technology; and
Estimates of capital or start-up costs and costs of operation,
maintenance, and purchase of service to provide information.
The collection of information in these proposed regulations is in
Sec. Sec. 1.1502-21(b)(3)(ii)(B) and 1.1502-72(e).
The proposed regulations provide guidance regarding application of
section 172(b)(1)(E) and (h) and section 1502.
The collection of information is required in order to obtain a
benefit. The likely respondents are corporations that are members of
consolidated groups.
Estimated total annual reporting burden: 120,000 hours.
Estimated average annual burden hours per respondent: 15 hours.
Estimated number of respondents: 8,000.
Estimated frequency of responses: Once.
An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless it displays a valid
control number assigned by the Office of Management and Budget.
Books or records relating to a collection of information must be
retained as long as their contents may become material in the
administration of any internal revenue law. Generally, tax returns and
tax return information are confidential, as required by 26 U.S.C. 6103.
Background
Section 172 provides rules relating to net operating loss (NOL)
carrybacks and carryovers. Section 172(b)(1)(A) states that the NOL for
any taxable year generally is carried back to each of the 2 years
preceding the taxable year of the loss and carried over to each of the
20 years following the taxable year of the loss.
The corporate equity reduction transaction rules of section
172(b)(1)(E) and (h) were enacted in 1989 in response to the use of NOL
carrybacks to finance leveraged buyout transactions. Congress enacted
these rules to limit a corporation's ability to obtain tax refunds as
the result of the carryback of NOLs that were attributable to interest
deductions allocable to such transactions. See Explanation of Corporate
Tax Refund Restriction Bill, 135 Cong. Rec. S9936-01, at S9944 (1989);
1989 WL 193512.
Section 172(h)(3)(A) defines a corporate equity reduction
transaction (CERT) as a ``major stock acquisition'' (MSA) or an
``excess distribution'' (ED). Section 172(h)(3)(B) defines major stock
acquisition as the acquisition by a corporation, pursuant to a plan of
such corporation (or any group of persons acting in concert with such
corporation), of stock in another corporation representing 50 percent
or more (by vote or value) of the stock in such other corporation.
Section 172(h)(3)(C) defines excess distribution as the excess (if any)
of the aggregate distributions (including redemptions) made during a
taxable year by a corporation with respect to its stock over the
greater of: 150 percent of the average of such distributions during the
3 taxable years immediately preceding such taxable year, or 10 percent
of the fair market value of the stock of the corporation at the
beginning of such taxable year. Thus, the total of distributions that
may be treated as an ED is limited to the amount that exceeds the
greater of two baselines: One tied to a historical, three-year average
and the other based on the fair market value of the distributor.
If an MSA or ED occurs, section 172(b)(1)(E) and (h) limit the
carryback of the portion of an NOL that constitutes a ``corporate
equity reduction interest loss'' (CERIL) of an ``applicable
corporation'' in any ``loss limitation year.'' See section
172(b)(1)(E)(i).
[[Page 57453]]
Section 172(b)(1)(E)(iii) defines an applicable corporation as a C
corporation that acquires stock, or the stock of which is acquired, in
an MSA; a C corporation making distributions with respect to, or
redeeming, its stock in connection with an ED; or a C corporation that
is a successor to one of the other types of applicable corporations.
Section 172(b)(1)(E)(ii) defines loss limitation year as the taxable
year in which a CERT occurs and each of the two succeeding taxable
years. Section 172(h)(1) defines corporate equity reduction interest
loss as the excess of (1) the total NOL for a loss limitation year,
over (2) the NOL for the loss limitation year computed without regard
to the allocable interest deductions that are otherwise taken into
account in computing the NOL. Section 172(h)(2)(A) defines allocable
interest deductions as deductions allowed on the portion of any
indebtedness allocable to a CERT.
Under section 172(h)(2)(B), except as provided in regulations or
section 172(h)(2)(E), indebtedness is allocable to a CERT in the manner
prescribed under section 263A(f)(2)(A) without regard to paragraph (i)
thereof (relating to traced debt). Thus, a portion of the taxpayer's
total interest expense is allocable to the CERT. See H.R. Rep. No. 101-
247, at 1251 (Conf. Rep.). However, section 172(h)(2)(C) limits the
amount of allocable interest deductions for any loss limitation year to
(1) the amount allowable as a deduction for interest paid or accrued by
the taxpayer during the loss limitation year, less (2) the average of
deductions allowed for interest paid or accrued by the taxpayer for the
three taxable years preceding the taxable year in which the CERT
occurred. Therefore, the allocable interest deductions are limited to
the increase in interest deductions over a historical, three-year
baseline.
Section 172(h)(3)(C) and (E) sets forth specific rules for
determining whether an ED has occurred. For purposes of determining a
corporation's aggregate distributions for a taxable year under section
172(h)(3)(C)(i) and the average of such distributions during the three
taxable years preceding the relevant taxable year under section
172(h)(3)(C)(ii)(I), section 172(h)(3)(E)(ii) provides that the
distributions taken into account are reduced by the aggregate amount of
stock issued by the corporation during the applicable period in
exchange for money or property other than stock in the corporation.
However, section 172(h)(3)(E)(i) provides that stock described in
section 1504(a)(4) (certain preferred stock) and distributions
(including redemptions) with respect to such stock are disregarded.
For purposes of applying section 172(b)(1)(E) and (h), an
applicable corporation and all members of its consolidated group are
treated as a single taxpayer. See section 172(h)(4)(C).
Currently, there are no regulations under section 172(b)(1)(E) and
(h). Section 172(h)(5) grants the Secretary the authority to prescribe
such regulations as may be necessary to carry out the purposes of
section 172(h), including regulations: (A) For applying section 172(h)
to successor corporations and to cases in which a taxpayer becomes (or
ceases to be) a member of a consolidated group; (B) to prevent the
avoidance of section 172(h) through the use of related parties, pass-
through entities, and intermediaries; and (C) for applying section
172(h) when more than one corporation is involved in a CERT. In
addition, section 172(h)(2)(B) grants the Secretary authority to issue
regulations prescribing a method for allocating indebtedness to a CERT
other than the method contained in section 263A(f)(2)(A). Section 1502
provides the Secretary with broad authority to prescribe rules
applicable to corporations that file consolidated returns that are
different from the income tax provisions that would apply if those
corporations filed separate returns.
These proposed regulations provide general rules addressing whether
a CERT has occurred, the computation of a CERIL, and the treatment of
successors. The proposed regulations also address issues specific to
the application of section 172(b)(1)(E) and (h) to consolidated groups,
including: (1) Treatment of the consolidated group as a single
taxpayer; (2) determination of the group's three-year average that is
relevant to a particular consolidated return loss limitation year; (3)
application of these rules if the corporation participating in a CERT
becomes a member of a consolidated return group; (4) application of
these rules if a group member deconsolidates after the group has
participated in (or is treated as having participated in) a CERT; (5)
apportionment of a CERIL (and other special status CNOLs) to members of
a consolidated group for carryback or carryover to separate return
years; and (6) application of section 172(b)(1)(E) and (h) to a life-
nonlife group. The proposed regulations also provide rules that would
amend the loss carryback waivers available to deconsolidating group
members.
At this time, the Department of Treasury and the IRS are not
providing rules addressing the application of section 172(h) to related
parties, pass-through entities, or intermediaries. However, the
Department of Treasury and the IRS continue to study the circumstances
under which these persons should be subject to section 172(b)(1)(E) and
(h). For example, the purposes of the statute may be furthered if
section 172(b)(1)(E) and (h) apply to the acquisition of 100 percent of
the stock of a target by a partnership in which a corporation (or
consolidated group) holds a controlling interest. On the other hand,
the purposes of the statute may not be advanced if 100 percent of the
stock of a target is acquired in a single transaction, but the
percentage of target stock indirectly attributable to corporate
acquirers is relatively small. The Department of Treasury and the IRS
request comments regarding the parameters for applying section
172(b)(1)(E) and (h) to indirect corporate acquirers, and what special
computational rules, if any, would be needed to implement its
application.
The Department of Treasury and the IRS considered inclusion of an
anti-avoidance rule to prevent taxpayers from engaging in section 381
transactions to shorten loss limitation years. However, the Department
of Treasury and the IRS believe that the detrimental effects of
shortening tax years make it unlikely that taxpayers will attempt to
undertake such transactions as a planning technique. For example,
shortening a loss limitation year will reduce the income in that year,
and, accordingly, will limit the ability to carry back any losses to
that year. The Department of Treasury and the IRS continue to study
whether an anti-abuse rule is needed and request comments on this
issue.
In addition, the Department of Treasury and the IRS are not
providing rules addressing the application of section 172(b)(1)(E) and
(h) to transactions occurring before these rules are adopted as final
regulations (transitional issues). However, the Department of Treasury
and the IRS continue to study, and request comments on, transitional
issues. For example, the Department of Treasury and the IRS request
comments regarding the application of section 172(b)(1)(E) and (h) if a
taxable year constitutes a loss limitation year with regard to more
than one CERT, one occurring before and the other occurring after the
adoption of these proposed regulations as final regulations.
[[Page 57454]]
Explanation of Provisions
1. General CERT Rules
A. Determination of Existence of a CERT
As discussed, a CERT is either an MSA or an ED. The statute does
not exclude tax-free transactions from treatment as an MSA or an ED. In
addition, the concerns targeted by Congress in enacting section
172(b)(1)(E) and (h) can exist in the context of both taxable and tax-
free transactions. Accordingly, the proposed regulations provide that a
tax-free transaction that meets the statutory definition of an MSA or
an ED must be tested as a CERT under section 172(b)(1)(E) and (h) and
these proposed regulations (collectively, the ``CERT rules''). For
example, a section 355 transaction, a corporate organization under
section 351, or a stock acquisition that qualifies for reorganization
treatment under section 368(a)(1)(A) and (a)(2)(E) must be tested under
the CERT rules.
These proposed regulations also provide that an integrated plan of
stock acquisition including multiple steps will be tested as a single
potential MSA for purposes of determining the consequences of the
transaction under the CERT rules. This treatment applies even if a step
in the plan might separately constitute an ED, or might so qualify in
conjunction with other distributions in the same taxable year.
Section 172(h)(3)(C)(ii) limits the amount of distributions in a
taxable year that may be treated as an ED. Under one prong of this
limitation, the taxpayer's distributions are treated as an ED only to
the extent that they exceed 150 percent of the taxpayer's average of
distributions (three-year distribution average) made in the three
taxable years preceding the taxable year in which a potential ED occurs
(the distribution lookback period). These proposed regulations provide
that, to the extent that a distribution is part of an integrated plan
that is treated as an MSA, the distribution is excluded from the
computation of the taxpayer's three-year distribution average that is
relevant to any other potential ED. These proposed regulations provide
additional rules for calculating the taxpayer's three-year distribution
average under section 172(h)(3)(C)(ii)(I) relevant to potential EDs
that occur in taxable years that are not full 12-month years.
B. Loss Limitation Years
The proposed regulations generally provide that the taxable year in
which a CERT occurs and each of the two succeeding taxable years
constitute loss limitation years with regard to the CERT. The proposed
regulations also provide special rules addressing loss limitation years
of successors, consolidated groups, and former members of consolidated
groups.
C. Computation of a CERIL
Under section 172(h)(1), the term CERIL means, with respect to any
loss limitation year, the excess (if any) of (1) the NOL for such
taxable year, over (2) the NOL for such taxable year determined without
regard to any allocable interest deductions otherwise taken into
account in computing such loss. Section 172(h)(2)(A) defines allocable
interest deductions as deductions allowed for interest on any
indebtedness allocable to a CERT. Section 172(h)(2)(B) states that,
except as provided in regulations and section 172(h)(2)(E), the
indebtedness allocable to a CERT is determined under the avoided cost
methodology of section 263A(f)(2)(A), with certain adjustments.
Under section 263A(f)(2)(A) and the regulations thereunder,
allocable interest deductions are computed by multiplying the
``weighted average interest rate'' by ``average excess expenditures''
as those terms are defined in Sec. 1.263A-9(c)(5)(ii) and (iii).
Because section 263A contemplates transactions that are very different
in nature from CERTs, it is often difficult to identify the costs
associated with a CERT that are analogous to average excess
expenditures. To ameliorate this difficulty, these proposed regulations
provide MSA- and ED-specific rules for computing costs associated with
a CERT (CERT costs). Further, these proposed regulations identify
additional CERT costs by looking to the capitalization rules under
section 263(a). Specifically, the proposed regulations treat as CERT
costs amounts paid or incurred to facilitate an MSA or ED to the extent
that those amounts are required to be capitalized under section 263(a)
(with certain modifications), and any amounts disallowed under section
162(k). Because most CERTs occur under circumstances that already
require application of section 263(a), invoking those rules should
result in greater administrability. Once the CERT costs are identified,
the interest allocable to those costs is computed under the principles
of section 263A(f)(2)(A) and the regulations thereunder (with
adjustments). The avoided cost methodology of section 263A(f)(2)(A)
effectively allocates interest to a CERT to the extent that the
taxpayer's interest costs could have been reduced if the taxpayer had
not engaged in the CERT. For purposes of applying the avoided cost
rules of section 263A(f)(2)(A), all CERT costs are treated as if they
were cash expenditures.
Under the proposed regulations, CERT costs with regard to an MSA
include the fair market value of the stock acquired, whether that stock
is acquired in exchange for cash, stock of the acquirer, or other
property. The inclusion of the fair market value of stock acquired in
stock-for-stock exchanges ensures that such transactions are treated
similarly to an issuance of acquirer's stock for cash followed by an
MSA funded with the cash proceeds. Further, inclusion of the fair
market value of stock acquired is consistent with the avoided cost
methodology applied under section 172(h)(2) because the CERT statute
rejects tracing and assumes that debt is used to fund all CERT costs.
In addition, CERT costs of an MSA include the fair market value of
any distribution that is part of an integrated transaction constituting
the MSA. CERT costs also include amounts paid or incurred to facilitate
any step of the MSA to the extent that those amounts are required to be
capitalized under section 263(a), and any amounts disallowed under
section 162(k).
Under the proposed regulations, CERT costs associated with an ED
include the fair market value of distributions to shareholders that are
determined to be EDs during the year in which the CERT occurs. CERT
costs also include a portion of amounts paid or incurred to facilitate
the distributions to the extent that those amounts are required to be
capitalized under section 263(a), and any amounts disallowed under
section 162(k). However, if neither section 263(a) nor section 162(k)
applies or if only section 162(k) applies to a distribution included in
an ED, additional CERT costs associated with the distribution are
determined under the principles of Sec. 1.263(a)-4(e) (relating to the
capitalization of costs that facilitate the acquisition or creation of
intangibles), applied as if the ED were a transaction within the scope
of Sec. 1.263(a)-4.
As discussed, the rules of section 263(a) are applied in the CERT
context with certain modifications. For the purpose of identifying CERT
costs under these proposed regulations, modifications to the operation
of Sec. 1.263(a)-4 and -5 include treating certain borrowing costs as
facilitative of an MSA or ED. Therefore, CERT costs will include these
borrowing costs. Congress objected to the carryback of NOLs resulting
from leveraging that directly or indirectly enables CERTs; therefore,
the Department of Treasury
[[Page 57455]]
and the IRS believe that it is appropriate to include borrowing costs
in total CERT costs. However, the Department of Treasury and the IRS
request comments regarding the extent to which borrowing costs should
be included in CERT costs.
The computation of interest allocable to CERTs under the rules of
section 263A(f)(2)(A) involves the time-weighted average of costs
incurred as of various dates in the taxable year. Therefore, these
proposed regulations set forth rules for determining when CERT costs
should be taken into account. Under these proposed regulations,
accumulated CERT costs as of a particular date are the total CERT costs
that have been taken into account as of that date under the applicable
corporation's method of accounting. A special proration rule is
provided to determine accumulated CERT costs related to an ED. Finally,
CERT costs incurred in any year prior to the year in which the CERT
occurs are included in accumulated CERT costs beginning on the first
day of the year in which the CERT occurs.
Section 172(h)(2)(E) requires that the allocation of interest to a
CERT be reduced if an unforeseeable extraordinary adverse event occurs
during a loss limitation year but after the CERT. The proposed
regulations do not provide guidance with regard to unforeseeable
extraordinary adverse events. However, the Department of Treasury and
the IRS request comments regarding whether rules are necessary and, if
so, what type of events should constitute unforeseeable extraordinary
adverse events.
D. Limitation on Interest Deductions
The CERT rules generally provide that the portion of an NOL for any
loss limitation year that is attributable to the interest deductions
allocable to a CERT (that is, a CERIL) may not be carried back to any
year prior to the year in which the CERT occurred. As discussed,
section 172(h)(2)(C) limits the amount of interest treated as an
allocable interest deduction to the excess of the amount allowable as a
deduction for interest paid or accrued by the taxpayer during the loss
limitation year, over the average of amounts allowable as a deduction
for interest paid or accrued (the three-year average) during the three
taxable years preceding the taxable year in which the CERT occurred
(the lookback period). These proposed regulations provide special rules
for computing the three-year average in special situations, such as if
an applicable corporation is not in existence for the entire lookback
period. Further, the proposed regulations adjust the three-year average
if the relevant loss limitation year is not a full 12-month taxable
period. These proposed regulations also set forth special rules for any
taxable year that constitutes a loss limitation year with regard to
multiple CERTs.
The legislative history indicates that Congress expected the
Department of Treasury and the IRS to write rules that provide that
increases attributable solely to fluctuations in interest rates would
not be taken into account for purposes of applying the three-year
average. Out of concern that the additional complexities of such rules
would outweigh the benefit, these proposed regulations do not include
rules that factor out increases in interest deductions attributable
solely to fluctuations in interest rates. However, the Department of
Treasury and the IRS are studying a rule that, for purposes of applying
the three-year average, would factor out interest deductions that are
attributable to increases in a taxpayer's interest rate that occur
after the date of a CERT. Under the rule being considered, the
measurement of a baseline interest rate after the CERT occurs would
take into account the fact that CERT activity will often decrease a
taxpayer's creditworthiness and increase its average cost of borrowing,
and accordingly that the existence of the CERT, in and of itself, will
increase a taxpayer's borrowing expenses. The Department of Treasury
and the IRS request comments on whether such a baseline would
effectively account for fluctuations in interest rates or whether an
alternative measure would be more appropriate.
E. Predecessor and Successor
As discussed, the CERT rules apply only to applicable corporations.
Under section 172(b)(1)(E)(iii)(III), an applicable corporation
includes any corporation that is a successor of: a corporation that
acquires stock in an MSA; a corporation the stock of which is acquired
in an MSA; or a corporation making a distribution with respect to, or
redeeming, its stock in connection with an ED. For purposes of applying
the CERT rules, these proposed regulations define successor as a
transferee or distributee in a transaction to which section 381(a)
applies. Further, if a successor to a previous applicable corporation
with regard to a CERT itself transfers assets to a further successor,
the further successor corporation is treated as an applicable
corporation with regard to that CERT. In addition, these proposed
regulations set forth special rules for computing a successor's CERIL.
F. Operating Rules
The proposed regulations include special rules regarding the
prohibition on carryback of a CERIL. These rules provide that no CERIL
may be carried back to any taxable year that includes solely dates that
precede the date on which the CERT at issue occurred. In applying this
rule to multi-step MSAs and to EDs that include multiple distributions,
the date on which the CERT occurs is the earliest date on which the
requirements for CERT status have been satisfied. These proposed
regulations also provide that, for purposes of determining whether an
ED has occurred, the computation of any three-year distribution average
under section 172(h)(3)(C)(ii)(I) will be reduced by the average of the
stock issuances made by the applicable corporation during the three
years of the distribution lookback period.
The principles of the proposed regulations apply to the computation
of the alternative minimum tax net operating loss under section 56(d).
2. Special CERT Rules Applicable to Consolidated Groups
A. Single Entity Treatment
Section 172(h)(4)(C) states that, except as provided by regulation,
all members of a consolidated group are treated as a single taxpayer
for purposes of section 172(b)(1)(E) and (h). These proposed
regulations provide further guidance regarding the application of
single entity principles. These proposed regulations affirm that
transactions and expenditures undertaken by a particular member are not
separately tracked; rather, the entire group is treated as a single
applicable corporation. For example, if multiple members of a group
acquire in total 50 percent or more (by vote or value) of the stock of
another corporation, the group has engaged in an MSA. Likewise, the
computation of a group's CERIL under section 172(h)(1) for any loss
limitation year that is a consolidated return year includes the debt of
all members and all interest deductions that are allowed on the group's
consolidated return.
Intercompany transactions (including interest accruals and payments
on intercompany obligations) are generally disregarded under the
proposed regulations. However, these proposed regulations provide that
a transaction will not be disregarded if a party to the transaction
becomes a non-member as a part of the same plan or arrangement.
The most difficult issues in the CERT area arise from the
application of single entity concepts if different corporations join
and deconsolidate from a group
[[Page 57456]]
within the same three-year period. The fungibility of money and the
ease of moving cash and debt within a consolidated group may provide a
consolidated group with an unwarranted ability to manipulate the
application of the CERT rules, further complicating the analysis. After
considering different approaches, the Department of Treasury and the
IRS have determined that application of single entity principles, under
which corporations cease to be separately tracked for CERT purposes
after their inclusion in a group, will limit complexity and promote
administrability. Furthermore, single entity treatment is consistent
with the statutory default of treating the consolidated group as a
single taxpayer.
Consistent with single entity treatment, these proposed regulations
provide that, if an applicable corporation with regard to a CERT
occurring in a separate return year (pre-existing CERT member) joins a
consolidated group, the group is treated as a single applicable
corporation with regard to that CERT in the consolidated return year of
the acquisition and any relevant succeeding year. The pre-existing CERT
member will no longer have separate status as an applicable
corporation. Beginning on the day the pre-existing CERT member is first
included in the group, the only CERIL computation will be that of the
group.
These proposed regulations also provide that, in the consolidated
return context, both the debt of a new member acquired in a CERT and
the corresponding interest expenses are included in the group's CERIL
computation, even if the group would not have been in a position to pay
off the debt of the acquired corporation if the CERT had not occurred.
For example, if a target corporation acquired by a consolidated group
has debt outstanding prior to the acquisition, the group takes into
account interest incurred by the group that is attributable to the
target's pre-existing debt, despite the fact that the group would have
had no reason to satisfy the target's debt if the acquisition had not
occurred. If the acquisition had not occurred, the debt of the target
would not have become a liability of the applicable corporation (the
group), and the associated interest expense would not have been
deducted by the group. As will be discussed, the historical interest
expense of the target is also included in the group's computation of
the three-year average applied to limit the interest allocated to the
CERT.
B. Applicable Corporation Status and Allocation of CERT Costs Following
Deconsolidation From a Group
These proposed regulations provide that, if a member deconsolidates
from a group on or after (1) the date on which the group engages in a
CERT, or (2) the date on which the group acquires a pre-existing CERT
member, then, following the deconsolidation, both the deconsolidating
member and the group generally will be treated as applicable
corporations with regard to the CERT. The deconsolidating member will
be apportioned a pro rata share of the group's CERT costs incurred
through the date of the deconsolidation. The proration is based on the
relative fair market values of the deconsolidating corporation
(immediately after its deconsolidation) and the entire group
(immediately before the deconsolidation). This rule applies regardless
of whether any particular corporation would have constituted an
applicable corporation with regard to the CERT without the application
of the single entity treatment. The Department of Treasury and the IRS
request comments regarding alternatives for allocating CERT costs
following deconsolidation from a group.
The CERT costs that are allocated and apportioned to the
deconsolidating member are subtracted from the group's CERT costs and
will not attract allocable interest in any loss limitation year of the
group (or any separate return loss limitation year of another group
member) after the year of deconsolidation. Therefore, the group may
have less CERIL in the years following the deconsolidation.
Apportionment of CERT costs to the deconsolidating member may result in
that corporation having a CERIL in the period following its
deconsolidation.
Under these proposed regulations, the deconsolidating member (or
the common parent of any group that the deconsolidating member joins
immediately after deconsolidation) may elect out of the general rule of
apportionment. In making this election, the member or common parent
permanently waives all carrybacks of losses allocable to the
deconsolidating member to years of the former group and any preceding
taxable years. If this election is made, the deconsolidating member
will not be treated as an applicable corporation with regard to the
CERT, and it will not be allocated any CERT costs. Applicable
corporation status and CERT costs will remain with the former group.
This is true even if the deconsolidating member directly engaged in the
CERT. Further, none of the interest history of the group will be
allocated to the deconsolidating member for CERT purposes, including
determining the CERIL related to any future CERT. The resulting lack of
interest history may increase the amount of a CERIL in future taxable
years associated with other CERTs of the deconsolidating corporation.
This election is available to any deconsolidating member, even if the
former group is not an applicable corporation with regard to any CERT
at the time of the deconsolidation.
C. Loss Limitation Years
Because all members of a consolidated group are treated as a single
taxpayer under section 172(h)(4)(C), a consolidated group is treated as
the ``applicable corporation'' with regard to a CERT. These proposed
regulations provide special rules for determining loss limitation years
of consolidated groups and former members of consolidated groups. Under
these proposed regulations, the taxable year in which a CERT actually
occurs is a loss limitation year. Any other taxable year (potential
loss limitation year) of any applicable corporation (including a
consolidated group) will constitute a loss limitation year with regard
to the CERT only if, under the carryover rules of sections
172(b)(1)(A)(ii) and 381(c)(1), the potential loss limitation year
would constitute the first or second taxable year following the taxable
year of the corporation or consolidated group that actually engaged in
the CERT, which includes the date of the CERT. For purposes of tracking
taxable years, section 172 and 381 are applied as if the inclusion of
any corporation in a consolidated group or the deconsolidation of any
member from a group were a transaction described in section 381(a).
The proposed regulations provide that the separate return years of
a corporation that deconsolidates from a consolidated group may be loss
limitation years with regard to a CERT of the former group. This may
occur only if the consolidated return year of the deconsolidation is a
first or second loss limitation year with regard to that CERT. The
taxable years of more than one applicable corporation (including a
consolidated group) may be loss limitation years with regard to the
same CERT, even if those taxable years include the same dates.
The special rules for determining loss limitation years can be
illustrated as follows: T corporation maintains a calendar taxable year
and does not join in the filing of a consolidated return. The X group
holds 60 percent of the
[[Page 57457]]
only class of T stock. On July 1, Year 5, T engages in a CERT. The X
group, which includes member S, maintains a calendar taxable year. On
December 31, Year 5, the X group acquires all of the remaining T stock.
T is first included in the X group on January 1, Year 6. On June 30,
Year 6, S deconsolidates from the X group, and thereafter S maintains a
calendar taxable year. The first loss limitation year with respect to
the T CERT is T's calendar Year 5. Pursuant to these proposed
regulations, as a result of acquiring T, the X group is treated as an
applicable corporation with respect to the T CERT. The X group's loss
limitation years with respect to the T CERT are its calendar Years 6
and 7. Because no election is made with respect to the deconsolidation
of S, following the deconsolidation, S is also treated as an applicable
corporation with regard to the T CERT. Because consolidated return Year
6 (the year of the deconsolidation) is a second loss limitation year
with regard to the CERT, S's short year ending December 31, Year 6 will
be S's only loss limitation year with regard to the T CERT.
D. Determining the Three-Year Average of a Group
As discussed in section 1.D. of this preamble, under section
172(h)(2)(C), the interest deductions treated as allocable to a CERT
are limited to the difference between the interest paid or accrued in
the loss limitation year at issue and the average of the interest paid
or accrued in the three years preceding the year of the CERT (three-
year average). These proposed regulations adopt single entity concepts
intended, in part, to decrease the complexity of the computation of the
three-year average resulting from the entry of corporations into, and
the deconsolidation of corporations from, a consolidated group. Under
these proposed regulations, with regard to a corporation joining a
group, the interest history of that corporation is combined with that
of the acquiring group. For purposes of the CERT rules, this interest
is thereafter generally treated as having been paid or accrued by the
group and is no longer separately traced to the acquired corporation.
Similarly, with regard to the deconsolidation of a member from a group,
a portion of the group's entire interest history is generally
apportioned to the deconsolidating member for purposes of the CERT
rules. The apportionment is based on the relative fair market values of
the deconsolidating corporation (immediately after its deconsolidation)
and the entire group (immediately before the deconsolidation). Under
these proposed regulations, the allocated and apportioned history is
subtracted from the group's interest history solely for purposes of the
CERT rules and is unavailable to the group with regard to any loss
limitation year of the group (or any separate return loss limitation
year of another group member) after the year of deconsolidation.
Consistent with single entity treatment and rejection of a tracing
regime, the interest allocated to a particular deconsolidating member
is not tied to that member's actual interest history.
These proposed regulations also provide special rules relevant to
any loss limitation year during which a corporation (partial-year
member) becomes a member of, or ceases to be a member of, a group
(transitional year). For purposes of computing any three-year average
of a group that is relevant to a transitional year, these rules require
proration of the interest history that is attributable to the partial-
year member so that a group that includes a particular member for only
a portion of a loss limitation year includes only a pro rata portion of
that member's three-year interest history. These proposed regulations
also provide special rules for computing the three-year average if a
group is not in existence for three taxable years prior to the
consolidated return year in which the CERT occurs (the lookback period)
and for determining the lookback period if a group acquires a
corporation that previously engaged in a CERT.
E. Excess Distributions in Groups
These proposed regulations contain rules pertaining to the
computation of EDs of consolidated groups and of corporations that have
been consolidated group members. Consistent with single entity
treatment under section 172(h)(4)(C), the proposed regulations provide
that the distributions relevant for purposes of computing an ED of a
consolidated group generally include only non-intercompany
distributions. However, this general rule does not apply if a party to
the transaction deconsolidates as part of the same plan or arrangement.
Under those circumstances, the distribution will be tested on a
separate entity basis as a potential CERT.
As discussed in section 1.A. of this preamble, section
172(h)(3)(C)(ii) places a limitation on the amount of distributions in
a taxable year that may be treated as ED, and the limitation is based
in part on 150 percent of the taxpayer's average of distributions
(three-year distribution average) made in the three taxable years
preceding the taxable year of the potential ED. These proposed
regulations provide that single entity principles generally apply to
the computation of the three-year distribution average of a
consolidated group or a corporation that has been a consolidated group
member. That is, the only distributions taken into account are those
made to non-member shareholders. However, in computing the three-year
distribution average of a consolidated group that includes a member for
less than the entire consolidated return year of a potential ED, the
group takes into account only a pro rata portion of the actual
distribution history of that member. Further, a corporation that
deconsolidates from a group takes into account its actual history of
non-intercompany distributions for purposes of applying the CERT rules
in future separate return years. The corporation is not apportioned a
pro rata share of the total distribution history of the group.
Additional rules apply with regard to computation of stock
issuances and valuation of the group, which are intended to ensure that
the rules in those areas are applied on a single entity basis.
Specifically, the proposed regulations provide that, in applying
section 172(h)(3)(E)(ii) to determine the offset of stock issuances
against distributions, only stock that is issued to non-members is
taken into account. Further, the proposed regulations provide that the
value of the group, computed pursuant to section 172(h)(3)(C)(ii)(II),
equals the value of the stock of all members other than stock that is
owned directly or indirectly by another member.
F. Reverse Acquisitions
These proposed regulations address the application of the MSA rules
to reverse acquisitions, as defined in Sec. 1.1502-75(d)(3). The
proposed regulations provide that, if a reverse acquisition occurs, the
CERT rules will be applied by treating the acquirer in form as the
target corporation, and treating the target in form as the acquiring
corporation. They also provide special rules regarding the computation
of the CERT costs in a reverse acquisition.
G. Life-Nonlife Groups
These proposed regulations provide rules for applying the CERT
rules to a group that elects under section 1504(c)(2) to file a
consolidated return (life-nonlife group). As with consolidated groups
generally, the fungibility of money and the ease of moving cash and
debt within a life-nonlife group may provide an unwarranted ability to
manipulate the
[[Page 57458]]
application of the CERT rules. Accordingly, these proposed regulations
generally apply the CERT rules and the consolidated return CERT rules
to a life-nonlife group on a single entity basis, and not on a subgroup
basis. Under the proposed regulations, a single CERIL is computed with
regard to any loss limitation year of a life-nonlife group, which
includes all life-nonlife group members' CERT costs, debt, and interest
paid or accrued for that year. However, for purposes of determining the
CERIL of a life-nonlife group under section 172(h)(1) for any loss
limitation year, the sum of the nonlife consolidated net operating loss
(nonlife CNOL) (if any) and the life consolidated loss from operations
(LO) (if any) for that year is treated as a notional ``NOL'' of the
group. For this purpose, nonlife consolidated taxable income does not
offset any LO, and consolidated partial life insurance company taxable
income (as used in Sec. 1.1502-47(g)) does not offset any nonlife
CNOL.
If a CERIL exists for a loss limitation year of a life-nonlife
group, that CERIL is allocated on a pro rata basis between the nonlife
CNOL and the LO of the group, based on the relative sizes of the two
attributes.
3. Specialized CNOL Carryback Rules
These proposed regulations provide rules regarding the
apportionment of CNOLs that contain a component portion of special
status loss, such as a CERIL or a specified liability loss. See section
172(h)(1) and (f)(1). Under these rules, a special status loss is
apportioned to each group member, separately from the remainder of the
CNOL, under the method provided in Sec. 1.1502-21(b)(2)(iv). This
apportionment occurs without separate entity inquiry into whether a
particular member incurred the specific expenses or engaged in the
particular activities required by the provisions governing the special
status loss.
The proposed regulations also amend and expand the current election
under Sec. 1.1502-21(b)(3)(ii)(B), informally referred to as the
``split-waiver'' election. That election is currently available to any
group that acquires one or more members from another group. By making
the election, the acquiring group relinquishes, with respect to all
CNOLs attributable to the newly-acquired corporation, the portion of
the carryback period during which that corporation was a member of
another group. The current rule does not allow a group to waive the
portion of the carryback period for which a newly-acquired corporation
was not a member of a consolidated group. The current election is a
one-time election and must be made with the acquiring group's timely-
filed original return for the year of the acquisition.
The proposed regulations amend the split waiver election to make
the election available to any group that acquires a corporation,
regardless of whether such corporation was acquired from another group.
An election results in the waiver of the entire carryback period with
regard to CNOLs allocable to the acquired corporation, not only the
period during which the corporation was a member of another group.
Further, any election that is made with regard to a newly-acquired
member that had been a member of another group at the time of its
acquisition must include all members acquired from the same group
during the taxable year of the acquiring group.
In addition, the proposed regulations give the electing group a
choice of making the one-time election or making the split-waiver
election on an annual basis with regard to the CNOL of a particular
consolidated return year. Any annual split-waiver election must be
filed with the group's timely filed original return for the year of the
CNOL. The one-time election and the annual split-waiver election that
are available under proposed Sec. 1.1502-21(b)(3)(ii)(B) apply
generally with respect to losses attributable to the acquired
corporation. These split-waiver elections are in addition to the one-
time election available under the CERT rules to elect out of the
general rule of apportionment for CERT costs and interest history to a
deconsolidating member, which also results in the waiver of all
carrybacks of losses allocable to the deconsolidating member to any
prior taxable years. As a result, under these proposed regulations,
corporations may have three, mutually exclusive, irrevocable elections
to waive carryback of CNOLs to separate return years: An annual
election, a one-time election, and a special CERT election.
Proposed Effective Date
Sections 1.172(h)-1 through 1.172(h)-5 and Sec. 1.1502-72 (except
Sec. 1.1502-72(e)) are effective for CERTs occurring on or after the
date of publication of the Treasury decision adopting these rules as
final regulations in the Federal Register, except that they do not
apply to any CERTs occurring pursuant to a written agreement that is
binding prior to the date of publication of the Treasury decision
adopting these rules as final regulations in the Federal Register. The
amendments to Sec. 1.1502-21(b)(2) are effective for taxable years for
which the due date of the original return (without extensions) is on or
after the date of publication of the Treasury decision adopting these
rules as final regulations in the Federal Register. Section 1.1502-
72(e) and the amendments to Sec. 1.1502-21(b)(3) are effective for
acquisitions or deconsolidations, as appropriate, occurring on or after
the date of publication of the Treasury decision adopting these rules
as final regulations in the Federal Register, except that they do not
apply to any acquisition or deconsolidations, as appropriate, occurring
pursuant to a written agreement that is binding before the date of
publication of the Treasury decision adopting these rules as final
regulations in the Federal Register.
Special Analyses
It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in Executive Order
12866, as supplemented by Executive Order 13563. Therefore, a
regulatory assessment is not required. Pursuant to the Regulatory
Flexibility Act (5 U.S.C. chapter 6), it is hereby certified that these
proposed regulations will not have a significant economic impact on a
substantial number of small entities. This certification is based on
the fact that these proposed regulations will primarily affect C
corporations and members of consolidated groups, which tend to be large
corporations. Accordingly, a regulatory flexibility analysis is not
required. Pursuant to section 7805(f) of the Internal Revenue Code,
these regulations have been submitted to the Chief Counsel for Advocacy
of the Small Business Administration for comment on their impact on
small business.
Comments and Requests for Public Hearing
Before these proposed regulations are adopted as final regulations,
consideration will be given to any written (a signed original and eight
(8) copies) or electronic comments that are submitted timely to the
IRS. The Department of Treasury and the IRS request comments on all
aspects of the proposed regulations. All comments will be available for
public inspection and copying. A public hearing will be scheduled if
requested in writing by any person that timely submits written
comments. If a public hearing is scheduled, notice of the date, time,
and place for the public hearing will be published in the Federal
Register.
[[Page 57459]]
Drafting Information
The principal authors of these proposed regulations are Rebecca J.
Holtje and Marie C. Milnes-Vasquez of the Office of Associate Chief
Counsel (Corporate). However, other personnel from the Department of
Treasury and the IRS participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Proposed Amendments to the Regulations
Accordingly, 26 CFR part 1 is proposed to be amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 is amended by adding
entries in numerical order to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Sections 1.172(h)-1 through -5 are also issued under 26 U.S.C.
172. * * *
Section 1.1502-21(b)(2)(iv)(C) is also issued under 26 U.S.C.
1502. * * *
Section 1.1502-72 is also issued under 26 U.S.C. 1502. * * *
Par. 2. Sections 1.172(h)-0 through 1.172(h)-5 are added to read as
follows:
Sec. 1.172(h)-0 Table of Contents.
This section lists the paragraphs contained in Sec. Sec. 1.172(h)-
1 through 1.172(h)-5.
Sec. 1.172(h)-1 Existence of CERT and loss limitation years.
(a) In general.
(b) Applicable corporation.
(1) In general.
(2) Predecessor and successor.
(c) CERT defined.
(1) In general.
(2) MSA defined.
(3) ED defined.
(d) Transactions tested as CERTs.
(1) Tax-free transactions.
(2) Multiple step plan of acquisition.
(3) Examples.
(e) Loss limitation years.
(f) Computation of three-year distribution average relevant to a
potential ED.
(1) Integrated plan.
(2) Short taxable year.
(g) Effective/applicability date.
Sec. 1.172(h)-2 Computation of a CERIL.
(a) In general.
(1) Scope.
(2) CERIL defined.
(b) Computation of allocable interest deductions.
(1) In general.
(2) Operating rules.
(3) CERT costs defined.
(i) Major stock acquisition.
(ii) Excess distribution.
(iii) Borrowing costs included in CERT costs.
(4) Accumulated CERT costs.
(i) Major stock acquisition.
(ii) Excess distribution.
(iii) CERT costs incurred in a year prior to a CERT.
(iv) Year constitutes loss limitation year with regard to multiple
CERTs.
(5) No netting of interest income and deductions.
(6) Certain unforeseeable events.
(7) Examples.
(c) Effective/applicability date.
Sec. 1.172(h)-3 Limitation on allocable interest deductions.
(a) General rule.
(b) Three-year average for a short loss limitation year.
(1) General rule.
(2) Example.
(c) Computation of interest paid or accrued by corporation with
incomplete lookback period.
(1) Lookback period for corporation not in existence.
(2) Interest history of corporation not in existence.
(3) Example.
(d) Computation of a CERIL if single year constitutes loss
limitation year with regard to multiple CERTs.
(1) Single CERIL computation.
(2) Limitation on allocable interest deductions.
(3) Computation of three-year average if CERTs have different
lookback periods.
(i) In general.
(ii) Cumulative three-year average.
(4) Allocation of a CERIL among CERTs.
(5) Examples.
(e) Effective/applicability date.
Sec. 1.172(h)-4 Special rules for predecessor and successors.
(a) Scope.
(b) Loss limitation years.
(1) In general.
(2) Example.
(c) Computation of a CERIL.
(1) CERT costs.
(2) Limitation on allocable interest deductions.
(i) Lookback period.
(A) In general.
(B) Successor not in existence on date of CERT.
(ii) Computation of three-year average.
(A) In general.
(B) Year of successor transaction.
(3) Examples.
(d) Three-year distribution average.
(e) Effective/applicability date.
Sec. 1.172(h)-5 Operating rules.
(a) Date on which CERT occurs in a multi-step transaction.
(b) Prohibition on carryback.
(1) In general.
(2) Example.
(c) Stock issuances and computation of three-year distribution
average.
(1) In general.
(2) Example.
(d) Computation of the alternative minimum tax net operating loss
deduction.
(e) Effective/applicability date.
Sec. 1.172(h)-1 Existence of CERT and loss limitation years.
(a) In general. If there is a corporate equity reduction
transaction (CERT) and an applicable corporation has a corporate equity
reduction interest loss (CERIL) for any loss limitation year, section
172(b)(1)(E) and (h), this section, Sec. Sec. 1.172(h)-2 through
1.172(h)-5, and Sec. 1.1502-72 (collectively, the CERT rules) limit
the amount of net operating loss that can be carried back to any
taxable year preceding the taxable year in which the CERT occurs. This
section provides rules regarding the determination of whether a CERT
has occurred and whether a taxable year constitutes a loss limitation
year. See Sec. 1.172(h)-2 for rules regarding the computation of a
CERIL.
(b) Applicable corporation--(1) In general. The CERT rules apply
only to applicable corporations. The term applicable corporation means
a C corporation that acquires stock, or the stock of which is acquired,
in a major stock acquisition (MSA), a C corporation making
distributions with respect to, or redeeming, its stock in connection
with an excess distribution (ED), or a C corporation that is a
successor of any corporation described in this paragraph (b)(1). For
special rules regarding the definition of an applicable corporation
with regard to members that join and leave a consolidated group, see
Sec. 1.1502-72(a) and (b).
(2) Predecessor and successor. For purposes of the CERT rules, the
term predecessor means a transferor or distributor of assets to a
transferee or distributee (the successor) in a transaction to which
section 381(a) applies. A corporation is a successor to its
predecessor, and to all predecessors of that predecessor. If an
applicable corporation transfers or distributes its assets to a
successor, the successor is treated as an applicable corporation in the
successor's taxable year during which the transfer or distribution
occurs and any subsequent years.
(c) CERT defined--(1) In general. A CERT can be an MSA or an ED.
[[Page 57460]]
(2) MSA defined. An MSA is the acquisition by a corporation
pursuant to a plan of such corporation (or any group of persons acting
in concert with such corporation) of stock in another corporation
representing 50 percent or more (by vote or value) of the stock in such
other corporation.
(3) ED defined. An ED is any excess of the aggregate distributions
made during a taxable year by a corporation with respect to its stock,
over the greater of--
(i) 150 percent of the average of such distributions (the three-
year distribution average) during the three taxable years immediately
preceding such taxable year (the distribution lookback period); or
(ii) 10 percent of the fair market value of the stock of such
corporation as of the beginning of such taxable year. For purposes of
testing a potential ED, distributions include redemptions.
(d) Transactions tested as CERTs--(1) Tax-free transactions. A
transaction may constitute a CERT and must be tested under the CERT
rules regardless of whether gain or loss is recognized by any party.
For example, a distribution that qualifies for tax-free treatment under
section 355 is tested as a potential ED (or part of a potential ED).
Likewise, the acquisition by a corporation of 50 percent or more of the
stock of another corporation in a transaction meeting the requirements
of section 351, section 368(a)(1)(A) and (a)(2)(E), or section
368(a)(1)(B) constitutes an MSA.
(2) Multiple step plan of acquisition. Solely for purposes of
determining whether an MSA has occurred and determining the
consequences of an MSA, all steps of an integrated plan (including
redemptions and other distributions) are tested as a single potential
MSA. If an integrated plan qualifies as an MSA and includes one or more
distributions, then, for purposes of applying the CERT rules, the
distributions are treated solely as a part of the MSA, regardless of
whether such distributions would otherwise constitute an ED (or would
so qualify in conjunction with other distributions). Any distributions
during the year that are not part of the integrated plan qualifying as
an MSA are tested as a potential ED.
(3) Examples. The following examples illustrate the rules of this
paragraph (d). For purposes of these examples, unless otherwise stated,
assume that all entities are domestic C corporations that do not join
in the filing of a consolidated return and that the entities have no
history of paying dividends or otherwise making distributions:
Example 1. Spin-off. Distributing corporation (D) distributes
stock of controlled corporation (C) to its shareholders in a
transaction that satisfies the requirements of section 355. There is
no taxable ``boot'' associated with the distribution. Pursuant to
paragraph (d)(1) of this section, D's distribution of C stock is
tested as a potential ED (in conjunction with any other
distributions by D during the same taxable year). The same result
would obtain if D distributes boot to its shareholders in addition
to C stock.
Example 2. Bootstrap acquisition. (i) Facts. T is a publicly-
traded, widely-held corporation with a single class of stock
outstanding with a fair market value of $100. The following steps
occur as part of an integrated plan. Corporation A acquires 10
percent of the outstanding stock of T for $10. A forms a new
corporation, S, with a contribution of $25. S obtains a loan of $65
from an unrelated lender, and then merges with and into T, with T
surviving. In the merger, all shareholders of T except A receive
cash in exchange for their shares, and as a consequence, A owns all
of the outstanding stock of T. As a result of the merger, T becomes
liable for S's $65 loan. Assume that the $90 cash payment from T to
the T shareholders should be treated as a redemption to the extent
of the $65 loan assumed by T, and as a stock acquisition by A to the
extent of the remaining $25.
(ii) Analysis. A's direct acquisition of 10 percent of T's
outstanding stock and the steps culminating with the merger are part
of an integrated plan. Therefore, the multiple steps are tested
together as a potential MSA. Because the steps of the integrated
plan resulted in A's acquisition of 100 percent of T, the
transaction is treated as a single MSA. Furthermore, because the $65
redemption is part of an MSA, it is treated solely as part of the
MSA and is not tested as a potential ED. See paragraph (d)(2) of
this section.
(e) Loss limitation years. The taxable year in which a CERT occurs
and each of the two succeeding taxable years constitute loss limitation
years with regard to the CERT. See Sec. 1.172(h)-4(b) (addressing loss
limitation years of successors) and Sec. 1.1502-72(a)(3) (addressing
loss limitation years of consolidated groups and former members of
consolidated groups).
(f) Computation of three-year distribution average relevant to a
potential ED--(1) Integrated plan. Section 172(h)(3)(C)(ii)(I) and
paragraph (c)(3) of this section treat as an ED the excess of
distributions in a taxable year over the taxpayer's average
distributions (three-year distribution average) made in the three
taxable years preceding the taxable year in which a potential ED occurs
(distribution lookback period). The computation of a taxpayer's three-
year distribution average under this paragraph (f) excludes any
distribution during the distribution lookback period that is treated as
part of an integrated plan qualifying as an MSA pursuant to paragraph
(d)(2) of this section. See Sec. 1.1502-72(f)(2) and (3) for rules
relating to distributions (including intercompany distributions) made
during a consolidated return year.
(2) Short taxable year. For purposes of computing the three-year
distribution average under this paragraph (f), if the year of the
potential ED is less than a full 12-month year, the distribution
history with regard to any year of the taxpayer during a distribution
lookback period (distribution lookback period year) equals the amount
of distributions made during the distribution lookback period year
multiplied by a fraction, the numerator of which equals the number of
days in the short taxable year of the potential ED, and the denominator
of which equals the number of days in the distribution lookback period
year. The value of the fraction may not exceed 100 percent. No
distributions are deemed made (in excess of amounts actually
distributed) in a distribution lookback period year that is shorter
than the year of the potential ED.
(g) Effective/applicability date. This section is applicable to
CERTs occurring on or after the date of publication of the Treasury
decision adopting these rules as final regulations in the Federal
Register. This section is also applicable to the deconsolidation of a
member from, or the acquisition of a corporation by, a consolidated
group that occurs on or after the date of publication of the Treasury
decision adopting these rules as final regulations in the Federal
Register. However, in each case, this section does not apply to any
CERT, deconsolidation, or acquisition occurring pursuant to a written
agreement that is binding before the date of publication of the
Treasury decision adopting these rules as final regulations in the
Federal Register.
Sec. 1.172(h)-2 Computation of a CERIL.
(a) In general--(1) Scope. The portion of a net operating loss
(NOL) that is treated as a corporate equity reduction interest loss
(CERIL) (as defined in paragraph (a)(2) of this section) cannot be
carried back to a taxable year preceding the taxable year in which the
corporate equity reduction transaction (CERT) occurs. This section
provides rules for computing allocable interest deductions necessary to
compute a CERIL for purposes of applying section 172(b)(1)(E) and (h),
Sec. Sec. 1.172(h)-1 through 1.172(h)-5, and Sec. 1.1502-72 (the CERT
rules).
(2) CERIL defined. A CERIL means, with respect to any loss
limitation year, the excess (if any) of the NOL for such taxable year
over the NOL for such taxable year determined without regard
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to any allocable interest deductions otherwise taken into account in
computing such loss.
(b) Computation of allocable interest deductions--(1) In general.
Allocable interest deductions are deductions allowed for interest on
the portion of indebtedness allocable to a CERT. Except as provided in
section 172(h)(2)(E) (relating to adjustments for certain unforeseeable
events), indebtedness is allocated to a CERT in the manner prescribed
in section 263A(f)(2)(A), without regard to clause (i) thereof
(relating to traced debt). Generally, interest deductions are allocable
to a CERT if the interest expense could have been avoided if the CERT
had not been undertaken (for example, if the amount of CERT costs (as
defined in paragraph (b)(3)) had instead been used to pay down debt).
See section 263A(f)(2)(A)(ii) and Sec. 1.263A-9(a)(1). For purposes of
applying the avoided cost rules of section 263A(f)(2)(A)(ii), all CERT
costs are treated as if they were cash expenditures.
(2) Operating rules. This section provides a method for identifying
the pool of costs to be treated as arising from a CERT (CERT costs).
The interest allocable to those CERT costs is then computed under the
principles of the avoided cost rules under section 263A(f)(2)(A)
(without regard to paragraph (i) thereof) and the regulations
thereunder, but substituting ``CERT costs'' or ``accumulated CERT
costs'' (as defined in paragraph (b)(4)) for ``production
expenditures'' or ``accumulated production expenditures,'' where those
terms appear. In addition, for purposes of applying the avoided cost
rules to compute interest allocable to a CERT, the ``production
period'' is treated as beginning on the first date of the taxable year
in which the CERT occurs (year of the CERT) on which there are
accumulated CERT costs. Because the principles of section
263A(f)(2)(A)(i) are inapplicable to CERT computations, the principles
of Sec. 1.263A-9(b) (relating to traced debt) are also inapplicable.
Instead, accumulated CERT costs are treated in their entirety as
expenditures allocable to non-traced debt as that term is defined under
Sec. 1.263A-9(c)(5), and interest allocable to a CERT is calculated
without tracing debt under the provisions of Sec. 1.263A-9(d)(1).
Limitations apply to the amount of interest allocable to a CERT. See,
for example, section 172(h)(2)(C)(ii) and Sec. 1.172(h)-3 (generally
relating to three-year average interest history).
(3) CERT costs defined--(i) Major stock acquisition. CERT costs
with regard to a major stock acquisition (MSA) include the fair market
value of the stock acquired, whether that stock is acquired in exchange
for cash, for stock of the acquirer, or for other property. In
addition, CERT costs include the fair market value of any distributions
to shareholders that are treated as part of the MSA under Sec.
1.172(h)-1(d)(2). CERT costs also include the sum of amounts paid or
incurred to facilitate any step of the MSA to the extent that those
amounts are required to be capitalized under section 263(a), and any
amounts disallowed under section 162(k). See also Sec. 1.1502-72(a)(4)
for additional rules regarding CERT costs in the case of a reverse
acquisition.
(ii) Excess distribution. CERT costs with regard to an excess
distribution (ED) include the fair market value of any distributions to
shareholders during the year of the CERT. CERT costs also include the
sum of amounts paid or incurred to facilitate the distributions to the
extent that those amounts are required to be capitalized under section
263(a), and any amounts disallowed under section 162(k). To the extent
that neither section 263(a) nor section 162(k) applies or if only
section 162(k) applies to a distribution included in an ED, additional
CERT costs associated with the distribution are determined under the
principles of Sec. 1.263(a)-4(e) (relating to the capitalization of
certain costs incurred to acquire or create intangibles), applied as if
the distribution were a transaction within the scope of Sec. 1.263(a)-
4.
(iii) Borrowing costs included in CERT costs. For purposes of
identifying CERT costs with regard to an MSA or ED under this paragraph
(b)(3), the determination of whether costs facilitate an MSA or ED is
made without regard to Sec. Sec. 1.263(a)-5(c)(1) and 1.263(a)-
4(e)(1)(iv) (excluding borrowing costs). Therefore, certain costs of
debt financing are included in CERT costs.
(4) Accumulated CERT costs--(i) Major stock acquisition. Except as
otherwise provided in this paragraph (b)(4), accumulated CERT costs
with regard to an MSA as of a particular date are the total CERT costs
described in paragraph (b)(3) of this section that have been taken into
account as of that date under the applicable corporation's method of
accounting. For example, CERT costs incurred in the taxable year after
the year of the CERT are not included in accumulated CERT costs in the
year of the CERT, but are included in accumulated CERT costs during the
taxable year in which they are incurred and in any succeeding loss
limitation year. Similarly, CERT costs include costs incurred after the
date on which a CERT occurs if the CERT consists of multiple steps. See
Sec. 1.172(h)-5(a).
(ii) Excess distribution. Except as provided otherwise in this
paragraph (b)(4), accumulated CERT costs as of a particular date with
regard to an ED are the total CERT costs described in paragraph (b)(3)
of this section that have been taken into account as of that date under
the applicable corporation's method of accounting, multiplied by a
fraction, the numerator of which equals the amount of distributions
constituting an ED during the year of the CERT pursuant to Sec.
1.172(h)-1(c)(3), and the denominator of which equals the total amount
of distributions made during the year of the CERT. CERT costs include
costs incurred after date on which a CERT occurs if the CERT consists
of multiple steps. See Sec. 1.172(h)-5(a).
(iii) CERT costs incurred in a year prior to a CERT year. CERT
costs incurred in a year prior to the year of the CERT are treated as
incurred on the first day of the year of the CERT.
(iv) Year constitutes loss limitation year with regard to multiple
CERTs. If a single taxable year constitutes a loss limitation year with
regard to more than one CERT, the accumulated CERT costs on any
particular date during that year include accumulated CERT costs under
this paragraph (b)(4) with regard to all such CERTs. See Sec.
1.172(h)-3(d) for rules regarding computation of a CERIL if a year
constitutes a loss limitation year with regard to multiple CERTs.
(5) No netting of interest income and deductions. Allocable
interest deductions under paragraph (b)(1) of this section are the
deductions allowed for interest on any indebtedness allocable to a
CERT. Allocable interest deductions are not netted against a taxpayer's
interest income.
(6) Certain unforeseeable events. [Reserved].
(7) Examples. The following examples illustrate the rules of this
paragraph (b). Unless otherwise provided, assume that all entities are
domestic C corporations that do not join in the filing of consolidated
returns and are accrual method taxpayers. Assume that all applicable
corporations have substantial NOLs in their loss limitation years:
Example 1. CERT costs in MSA. (i) Facts. On February 1, Year 5,
Corporation A begins investigating the possible acquisition of
Corporation T. On March 1, Year 5, A enters into an exclusivity
agreement with T. On July 1, Year 5, A engages in an MSA when it
acquires all of the stock of T in exchange for cash. A incurs costs
for services rendered by its outside counsel and an investment
banker. A's outside counsel and the investment banker conduct due
diligence on T, determine the value of T, negotiate and
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structure the transaction with T, draft the purchase agreement,
secure shareholder approval, and prepare SEC filings. In addition,
the investment banker arranges borrowings to fund both the stock
acquisition and A's operations. A also pays a bonus to one of its
corporate officers, who negotiated the acquisition of T. Before and
after the acquisition is consummated, A incurs costs to relocate
personnel and equipment, and to integrate records and information
systems.
(ii) Analysis. The CERT costs taken into account by A in
computing interest allocable to the CERT include the fair market
value of the T stock. See paragraph (b)(3)(i) of this section. The
costs incurred on or after the date of the exclusivity agreement,
March 1, Year 5, (but not before) to conduct due diligence are also
included in A's CERT costs. See paragraph (b)(3)(i) of this section
and Sec. 1.263(a)-5(e)(1). A's CERT costs also include all amounts
incurred to determine the value of T, negotiate and structure the
transaction with T, draft the purchase agreement, secure shareholder
approval, and prepare SEC filings. See Sec. 1.263(a)-5(e)(2). In
addition, A's CERT costs include borrowing costs that facilitate the
CERT. See paragraph (b)(3)(iii) of this section. A's CERT costs do
not include any portion of the bonus paid to the corporate officer
or the costs incurred to relocate personnel and equipment, and to
integrate records and information systems. See Sec. 1.263(a)-
5(c)(6) and (d).
Example 2. CERT costs in ED. (i) Facts. X corporation is a
calendar-year taxpayer. On July 1, Year 5, X makes a distribution of
$80,000 to its shareholders, $60,000 of which constitutes an ED. X
makes no other distributions during Year 5. At previous regular
quarterly board of directors meetings, the directors discussed the
July 1, Year 5 distribution. On March 30, Year 5, X incurs $2,500 in
borrowing costs that constitute CERT costs under paragraph
(b)(3)(iii) of this section. In addition, on March 30 and April 15,
Year 5, X incurs $500 and $3,000, respectively, for work performed
by its outside counsel which facilitates the ED under the principles
of Sec. 1.263(a)-4(e). During Year 5, X pays its directors for
attendance at the regular quarterly board of directors meetings. No
additional CERT costs are incurred in Years 6 and 7.
(ii) CERT costs. X's CERT costs include the fair market value of
all distributions made during the year of the CERT ($80,000), as
well as the $2,500 of borrowing costs. See paragraph (b)(3)(ii) and
(iii) of this section. In addition, under the principles of section
Sec. 1.263(a)-4(e), X's CERT costs include the costs incurred for
work performed by A's outside counsel related to the ED. See
paragraph (b)(3)(ii) of this section and Sec. 1.263(a)-4(e)(1)(i).
X's CERT costs do not include amounts paid to X's board of directors
to attend the regular board of directors meetings. See Sec.
1.263(a)-4(e)(4)(ii)(B).
(iii) Accumulated CERT costs. Under paragraph (b)(4)(ii) of this
section, X's accumulated CERT costs as of a particular date with
regard to its ED are the total CERT costs that have been taken into
account as of that date multiplied by a fraction the numerator of
which equals the amount of distributions constituting ED during the
year of the CERT, and the denominator of which equals the total
amount of distributions made during the year of the CERT. Here
$60,000 is divided by $80,000, which equals \3/4\. The CERT occurs
during X's Year 5, and that year is a loss limitation year with
regard to the CERT. X's accumulated CERT costs on March 30, Year 5
are $2,250 (3,000 x \3/4\). X's accumulated CERT costs are $4,500
(6,000 x \3/4\) on April 15, Year 5 and $64,500 (86,000 x \3/4\) on
July 1, Year 5. X's Years 6 and 7 are also loss limitation years.
Because no additional CERT costs are incurred in Years 6 and 7,
throughout those years, X's accumulated CERT costs are $64,500.
Example 3. Accumulated CERT costs in an MSA. (i) All CERT costs
incurred in year of CERT. X corporation is a calendar-year taxpayer.
On March 1, Year 5, X acquires all of the stock of unrelated
corporation T in an MSA. X's loss limitation years are calendar
Years 5, 6, and 7. During Year 5, X incurs the following CERT costs:
$4,000 on January 30; $50,000 on March 1; and $9,000 on March 15.
During Year 5, X's accumulated CERT costs are: $4,000 as of January
30; $54,000 as of March 1; and $63,000 as of March 15. See paragraph
(b)(4)(i) of this section. No additional CERT costs are incurred in
Years 6 and 7. As a result, throughout Years 6 and 7, X's
accumulated CERT costs are $63,000.
(ii) Portion of CERT costs incurred prior to year of CERT. The
facts are the same as in paragraph (i) of this Example 3, except
during Year 4, X incurs $2,000 of CERT costs. During Year 5, X's
accumulated CERT costs are: $2,000 as of January 1 (reflecting costs
incurred during Year 4); $6,000 as of January 30; $56,000 as of
March 1; and $65,000 as of March 15. See paragraph (b)(4)(i) and
(iii) of this section. X is treated as having no accumulated CERT
costs during Year 4.
(c) Effective/applicability date. This section is applicable to
CERTs occurring on or after the date of publication of the Treasury
decision adopting these rules as final regulations in the Federal
Register. This section is also applicable to the deconsolidation of a
member from, or the acquisition of a corporation by, a consolidated
group that occurs on or after the date of publication of the Treasury
decision adopting these rules as final regulations in the Federal
Register. However, in each case, this section does not apply to any
CERT, deconsolidation, or acquisition occurring pursuant to a written
agreement that is binding before the date of publication of the
Treasury decision adopting these rules as final regulations in the
Federal Register.
Sec. 1.172(h)-3 Limitation on allocable interest deductions.
(a) General rule. The amount of allocable interest deductions
(determined under Sec. 1.172(h)-2(b)) for any loss limitation year is
limited to the excess (if any) of the amount allowable as a deduction
for interest paid or accrued by the taxpayer during the loss limitation
year, over the average of interest paid or accrued by the taxpayer (the
three-year average) for the three taxable years preceding the taxable
year in which the corporate equity reduction transaction (CERT)
occurred (the lookback period). This section provides additional rules
for computing the three-year average relevant to any loss limitation
year for purposes of applying section 172(b)(1)(E) and (h), Sec. Sec.
1.172(h)-1 through 1.172(h)-5, and Sec. 1.1502-72 (the CERT rules).
(b) Three-year average for a short loss limitation year--(1)
General rule. For purposes of computing the three-year average if the
relevant loss limitation year is less than a full 12-month year, the
interest paid or accrued with regard to any year of the taxpayer during
a lookback period (lookback period year) equals the amount of interest
treated as paid or accrued multiplied by a fraction, the numerator of
which equals the number of days in the short loss limitation year, and
the denominator of which equals the number of days in the lookback
period year. The value of the fraction may not exceed 100 percent. Zero
interest is deemed paid or accrued (in excess of amounts actually paid
or accrued) in a lookback period year that is shorter than the loss
limitation year.
(2) Example. The following example illustrates the short loss
limitation year rule of this paragraph (b):
Example. (i) Facts. T, a domestic C corporation, was organized
on July 1, Year 1. T's first taxable year is a short taxable year,
which includes July 1 through December 31, Year 1 (184 days). T's
next two taxable years are full calendar years: Calendar Year 2 and
Calendar Year 3. T's Year 4 ends on September 30 as a result of a
change in accounting period. T engages in a CERT during its taxable
Year 4, which includes January 1, Year 4, through September 30, Year
4 (273 days). T's next two taxable periods are full 12-month fiscal
years ending on September 30, Year 5, and September 30, Year 6.
(ii) Year 4 analysis. T's taxable Year 4 is a short loss
limitation year. Therefore, in computing its three-year average
applicable to loss limitation Year 4, T multiplies its interest
treated as paid or accrued during each of the three years of the
lookback period by the fraction specified in paragraph (b)(1) of
this section. The pertinent fraction with regard to Year 1 of the
lookback period is 273/184 (number of days in short loss limitation
year divided by the number of days in the lookback period year).
However, under paragraph (b)(1) of this section, the value of the
fraction cannot exceed 100 percent. As a result, T includes in the
computation of its three-year average its actual interest paid or
accrued in Year 1. As to Years 2 and 3, T includes in the
computation of its three-year average its actual interest paid or
accrued in each of
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those years, multiplied by a fraction equal to 273/365.
(iii) Year 5 and 6 analysis. Because T's taxable Years 5 and 6
are full 12-month loss limitation years, T includes in the
computation of its three-year average applicable to those loss
limitation years its actual interest paid or accrued in each year of
the lookback period, without adjustment.
(c) Computation of interest paid or accrued by corporation with
incomplete lookback period--(1) Lookback period for corporation not in
existence. If an applicable corporation was not in existence for three
taxable years preceding the taxable year in which the CERT occurred
(the lookback period), for purposes of determining the limitation on
allocable interest deductions under section 172(h)(2)(C) and paragraph
(a) of this section, the applicable corporation's lookback period is
deemed to have additional 12-month periods that end on the calendar
date that is one day prior to the date of the corporation's
organization. See Sec. 1.172(h)-4(c)(2)(i)(B) (regarding determination
of lookback period for successor applicable corporations not in
existence on date of CERT) and Sec. 1.1502-72(d)(4)(ii) (regarding
consolidated groups not in existence during the entire lookback
period).
(2) Interest history of corporation not in existence. If an
applicable corporation was not in existence for the entire lookback
period, it is treated as having paid or accrued zero interest during
periods deemed to exist under paragraph (c)(1) of this section in
computing any three-year average. However, if the applicable
corporation is a successor corporation pursuant to Sec. 1.172(h)-
1(b)(2), the computation of any three-year average for the successor
includes interest paid or accrued by any predecessor during the
lookback period. See Sec. 1.172(h)-4(c)(2)(ii)(A).
(3) Example. The following example illustrates the rules of this
paragraph (c):
Example. Corporation not in existence for entire lookback
period. C is a domestic C corporation that does not join in the
filing of a consolidated return and maintains a calendar taxable
year. C is formed on October 1, Year 3, and engages in a CERT during
Year 5. For purposes of computing any CERIL related to the CERT,
paragraph (a) of this section requires that C must measure its
interest deductions for the lookback period. However, C was not in
existence for three taxable years preceding the year in which the
CERT occurred. Rather, C was in existence for one full calendar
taxable year (Year 4) and one short taxable year (October 1 through
December 31, Year 3). Pursuant to paragraph (c)(1) of this section,
C's lookback period is deemed to include an additional taxable
period (October 1, Year 2, through September 30, Year 3). Further,
in computing any three-year average, C is treated as having paid or
accrued zero interest during the deemed additional period. See
paragraph (c)(2) of this section.
(d) Computation of a CERIL if single year constitutes loss
limitation year with regard to multiple CERTs--(1) Single CERIL
computation. This paragraph (d) applies if a taxable year constitutes a
loss limitation year of the taxpayer with regard to more than one CERT.
In that case, a single corporate equity reduction interest loss (CERIL)
is computed under section 172(h)(1) and Sec. 1.172(h)-2(a)(2) for that
year. This computation takes into account accumulated CERT costs for
every CERT, determined under Sec. 1.172(h)-2(b)(4)(iv) for the loss
limitation year.
(2) Limitation on allocable interest deductions. In computing the
single CERIL under this paragraph (d), section 172(h)(2)(C) and
paragraph (a) of this section are applied a single time to limit the
cumulative amount of interest allocable to all of the CERTs to the
excess (if any) of the amount allowable as a deduction for interest
paid or accrued by the taxpayer during the loss limitation year over
the three-year average for the lookback period. The limitation is not
applied separately with respect to interest allocable to a particular
CERT.
(3) Computation of three-year average if CERTs have different
lookback periods--(i) In general. If the lookback periods (as defined
in paragraph (a) of this section or in Sec. 1.1502-72(d)(4)) relevant
to all of the CERTs pertinent to a loss limitation year are not
identical, a cumulative three-year average is computed by applying the
rules of paragraph (d)(3)(ii) of this section. The cumulative three-
year average is treated as the three-year average relevant to the loss
limitation year, and is applied to determine the limitation on the
amount of interest allocable to all of the CERTs under section
172(h)(2)(C) and paragraph (a) of this section.
(ii) Cumulative three-year average. The cumulative three-year
average applicable to any loss limitation year is computed under this
paragraph (d)(3)(ii). With regard to each lookback period relevant to a
loss limitation year, a modified three-year average is computed. The
modified three-year average is the three-year average relevant to a
particular lookback period (determined under section 172(h)(2)(C) and
this section) multiplied by a fraction, the numerator of which equals
the accumulated CERT costs as of the close of the loss limitation year
that are attributable to the particular CERT or CERTs to which the
three-year average corresponds, and the denominator of which equals the
total accumulated CERT costs as of the close of the loss limitation
year that are attributable to all CERTs relevant to the loss limitation
year. See Sec. 1.172(h)-2(b)(4) defining accumulated CERT costs. The
sum of all modified three-year averages is the cumulative three-year
average for that year.
(4) Allocation of a CERIL among CERTS. After the computation of the
single CERIL for a loss limitation year that is attributable to all
CERTs, the total CERIL is allocated to particular CERTs, if CERILs
attributable to different CERTs are subject to different limitations on
carryback. See section 172(b)(1)(E)(i) and Sec. 1.172(h)-5(b)
(regarding prohibition on carrybacks). For purposes of this allocation,
the CERT costs attributable to each particular CERT are identified. The
total CERIL is then attributed to each CERT by multiplying the total
CERIL by a fraction, the numerator of which equals the accumulated CERT
costs as of the close of the loss limitation year that are attributable
to a particular CERT, and the denominator of which equals the total
accumulated CERT costs as of the close of the loss limitation year that
are attributable to all CERTs relevant to the loss limitation year. See
Sec. 1.172(h)-2(b)(4) defining accumulated CERT costs.
(5) Examples. The following examples illustrate the rules of this
paragraph (d). Unless otherwise provided, assume that all entities are
domestic C corporations that do not join in the filing of consolidated
returns and that maintain calendar taxable years. Assume that all
applicable corporations have substantial net operating losses in their
loss limitation years:
Example 1. Multiple CERTs with identical lookback period. (i)
Facts. Corporation A maintains a calendar taxable year. A engages in
two separate CERTs during its taxable Year 4. The lookback period
for both CERTs is January 1, Year 1, through December 31, Year 3.
The total amount of interest deductions allocable to CERT 1 and CERT
2 (before application of section 172(h)(2)(C) and paragraph (a) of
this section) is $50. A's total interest expense during Year 4 was
$150, and its three-year average interest for the lookback period
was $120.
(ii) Analysis. Year 4 constitutes a loss limitation year with
regard to both CERT 1 and CERT 2. A single CERIL is computed with
regard to Year 4, and the limitation on allocable interest under
section 172(h)(2)(C) and paragraph (a) of this section is applied a
single time. See paragraphs (d)(1) and (2) of this section. The
limitation under section 172(h)(2)(C) and paragraph (a) of this
section is applied to the cumulative amount of interest allocable to
the two CERTs ($50). See paragraph (d)(2) of this section. The
limitation under section 172(h)(2)(C) and paragraph (a) of this
section equals the excess
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of the amount of interest allowable in Year 4 ($150) over the three-
year average ($120), or $30. Therefore, the CERIL is limited to $30.
Example 2. Multiple CERTs with different lookback periods. (i)
Facts. Corporation A maintains a calendar taxable year. A engages in
CERT 1 during its taxable Year 4. The lookback period relevant to
CERT 1 is January 1, Year 1, through December 31, Year 3. A also
engages in CERT 2 during its taxable Year 5. The lookback period
relevant to CERT 2 is January 1, Year 2, through December 31, Year
4. The total amount of interest deductions allocable to CERT 1 and
CERT 2 (before application of section 172(h)(2)(C) and paragraph (a)
of this section) during taxable Year 5 is $50. A's total interest
expense during Year 5 is $126. A's three-year average interest that
is relevant to loss limitation Year 5 for the CERT 1 lookback period
is $100, and its three-year average interest that is relevant to
loss limitation Year 5 for the CERT 2 lookback period is $110. A's
accumulated CERT costs attributable to CERT 1 are $400. A's
accumulated CERT costs attributable to CERT 2 are $600.
(ii) Cumulative three-year average. Year 5 is a loss limitation
year with regard to both CERT 1 and CERT 2. A single CERIL is
computed with regard to Year 5, and the limitation on allocable
interest under section 172(h)(2)(C) and paragraph (a) of this
section is applied a single time. See paragraph (d)(1) and (2) of
this section. The limitation under section 172(h)(2)(C) and
paragraph (a) of this section is applied to the cumulative amount of
interest allocable to the two CERTs ($50). See paragraph (d)(2) of
this section. Because Year 5 constitutes a loss limitation year with
regard to CERTs with different lookback periods, the relevant three-
year average applied under section 172(h)(2)(C) and paragraph (a) of
this section is the cumulative three-year average, which is the sum
of all modified three-year averages. See paragraph (d)(3)(ii) of
this section. The modified three-year average with regard to CERT 1
is the three-year average for CERT 1 multiplied by $400/$1,000
(accumulated CERT costs attributable to CERT 1 divided by the total
accumulated CERT costs attributable to CERTs 1 and 2), or \2/5\.
Therefore, the modified three-year average with regard to CERT 1 is
$40 (100 x \2/5\). The modified three-year average with regard to
CERT 2 is the three-year average for CERT 2 multiplied by $600/
$1,000 (accumulated CERT costs attributable to CERT 2 divided by the
total accumulated CERT costs attributable to CERTs 1 and 2), or \3/
5\. Therefore, the modified three-year average with regard to CERT 2
is $66 (110 x \3/5\). Thus, the cumulative three-year average
interest for Year 5 is $106 ($40 + $66). See paragraph (d)(3) of
this section. The limitation under section 172(h)(2)(C) and
paragraph (a) of this section equals the excess of the amount of
interest allowable in Year 5 ($126) over the cumulative three-year
average interest ($106), or $20. Therefore, the CERIL for Year 5 is
limited to $20.
(iii) Allocation of a CERIL to different CERTs. Because Year 5
constitutes a loss limitation year with regard to more than one
CERT, and a CERIL associated with each CERT is subject to different
limitations on carryback, the total CERIL must be allocated between
CERT 1 and CERT 2. See paragraph (d)(4) of this section. The portion
of the total CERIL allocated to CERT 1 is the total CERIL multiplied
by $400/$1,000 (accumulated CERT costs attributable to CERT 1
divided by the total accumulated CERT costs attributable to CERTs 1
and 2), or \2/5\. Therefore, the portion of the total CERIL
allocated to CERT 1 is $8 ($20 x \2/5\). The portion of the total
CERIL allocated to CERT 2 is the total CERIL multiplied by $600/
$1,000 (accumulated CERT costs attributable to CERT 2 divided by the
total accumulated CERT costs attributable to CERTs 1 and 2), or \3/
5\. Therefore, the portion of the total CERIL allocated to CERT 2 is
$12 ($20 x \3/5\). See paragraph (d)(4) of this section. See also
section 172(b)(1)(E)(i) and Sec. 1.172(h)-5(b)(1) for rules
regarding the prohibition on carryback of a CERIL.
Example 3. CERTs of multiple corporations with identical
lookback period. (i) Facts. Corporation T maintains a taxable year
ending on June 30. On August 31, Year 5, T engages in CERT 1.
Unrelated P is the parent of a group that maintains a calendar
taxable year. On October 31, Year 5, P acquires all the stock of T
in an MSA (CERT 2). T is first included in the P group on November
1, Year 5. For its calendar Year 5, the P group is treated as an
applicable corporation with respect to CERT 1 and CERT 2. See Sec.
1.1502-72(a)(2)(iv)(A). The P group's lookback period for both CERTs
is January 1, Year 2, through December 31, Year 4. The total CERIL
of the group in Year 5 is $80. The P group's accumulated CERT costs
attributable to CERT 1 are $500. The P group's accumulated CERT
costs attributable to CERT 2 are $1,500. The P group has a
consolidated net operating loss (CNOL) in Year 5, a portion of which
is allocable to T under Sec. 1.1502-21(b)(2)(iv)(B).
(ii) Allocation of a CERIL to different CERTs. Year 5
constitutes a loss limitation year with regard to two CERTs that
share a common lookback period. However, the CERIL associated with
the different CERTs is subject to different limitations on carryback
under Sec. 1.172(h)-5(b)(1) (some CNOL will be carried back to the
group's consolidated return years and some will be carried back to
T's separate return years). Therefore, the total CERIL must be
allocated between CERT 1 and CERT 2. The portion of the total CERIL
allocated to CERT 1 is the total CERIL multiplied by $500/$2,000
(accumulated CERT costs attributable to CERT 1 divided by the total
accumulated CERT costs attributable to CERTs 1 and 2), or \1/4\. See
paragraph (d)(4) of this section. Therefore, the portion of the
total CERIL allocated to CERT 1 is $20 ($80 x \1/4\). The portion of
the total CERIL allocated to CERT 2 is the total CERIL multiplied by
$1,500/$2,000 (accumulated CERT costs attributable to CERT 2 divided
by the total accumulated CERT costs attributable to CERTs 1 and 2),
or \3/4\. Therefore, the portion of the total CERIL allocated to
CERT 2 is $60 ($80 x \3/4\).
(e) Effective/applicability date. This section is applicable to
CERTs occurring on or after the date of publication of the Treasury
decision adopting these rules as final regulations in the Federal
Register. This section is also applicable to the deconsolidation of a
member from, or the acquisition of a corporation by, a consolidated
group that occurs on or after the date of publication of the Treasury
decision adopting these rules as final regulations in the Federal
Register. However, in each case, this section does not apply to any
CERT, deconsolidation, or acquisition occurring pursuant to a written
agreement that is binding before the date of publication of the
Treasury decision adopting these rules as final regulations in the
Federal Register.
Sec. 1.172(h)-4 Special rules for predecessors and successors.
(a) Scope. This section provides guidance with regard to the
application of section 172(b)(1)(E) and (h), Sec. Sec. 1.172(h)-1
through 1.172(h)-5, and Sec. 1.1502-72 (the CERT rules) to
predecessors and successors (as defined in Sec. 1.172(h)-1(b)(2)).
(b) Loss limitation years--(1) In general. This paragraph (b)(1)
applies to identify loss limitation years of a successor. The taxable
year in which a corporate equity reduction transaction (CERT) actually
occurs is a loss limitation year. See Sec. 1.172(h)-1(e). Any taxable
year of a successor (potential loss limitation year) of any applicable
corporation is a loss limitation year with regard to the CERT if, under
the carryover rules of sections 172(b)(1)(A)(ii) and 381(c)(1), the
potential loss limitation year constitutes the first or second taxable
year following the taxable year of the corporation that actually
engaged in the CERT which includes the date on which the CERT occurred.
See Sec. 1.172(h)-5(a) (defining date on which CERT occurs in
multiple-step transaction); but see Sec. 1.1502-72(a)(3) (defining
loss limitation years of consolidated groups and corporations that were
previously members of a consolidated group).
(2) Example. The following example illustrates the rules of this
paragraph (b):
Example. Loss limitation years of successor. T is a domestic C
corporation that maintains a calendar taxable year and does not join
in the filing of a consolidated return. On March 31, Year 6, T
engages in a CERT. On June 30, Year 6, T merges into Corporation A,
a calendar-year taxpayer, in a transaction to which section 381(a)
applies. T's taxable Year 6 ends on the date of the merger, and A
succeeds to T's tax attributes. See section 381(a) and (b)(1). T's
only loss limitation year with respect to the Year 6 CERT is its
short taxable year ending June 30, Year 6. See section
172(b)(1)(E)(ii) and Sec. 1.172(h)-1(e). Following the merger, A is
the successor to T, and A is treated as an applicable corporation
with regard to the
[[Page 57465]]
Year 6 CERT. See Sec. 1.172(h)-1(b)(2). A's calendar Years 6 and 7
are the second and third loss limitation years with regard to the
Year 6 CERT. See section 172(b)(1)(E)(ii) and paragraph (b)(1) of
this section.
(c) Computation of a CERIL--(1) CERT costs. For purposes of
computing any corporate equity reduction interest loss (CERIL) under
section 172(h)(1) and Sec. 1.172(h)-2(a)(2), any CERT costs incurred
(or treated as incurred under this paragraph (c)) by a predecessor are
attributed to the successor. However, such costs are treated as having
been incurred by the successor only for purposes of applying the
avoided cost rules of section 263A(f)(2)(A) to any measurement date (as
defined in Sec. 1.263A-9(f)(2)) after the date of the section 381(a)
transaction.
(2) Limitation on allocable interest deductions--(i) Lookback
period--(A) In general. The lookback period with regard to a CERT is
the three taxable years preceding the taxable year in which the CERT
occurs. See Sec. 1.172(h)-3(a). The lookback period that is relevant
to the calculation of any CERIL of a successor (successor's lookback
period) is the three years preceding the taxable year of the successor
that includes the date on which the CERT occurred. See Sec. Sec.
1.172(h)-5(a) (defining the date on which a CERT occurs if the CERT
consists of multiple steps) and Sec. 1.172(h)-3(c) (regarding
corporations with insufficient lookback periods).
(B) Successor not in existence on date of CERT. If a successor was
not in existence on the date on which the CERT occurred, for purposes
of determining the lookback period, the successor is deemed to have
additional 12-month periods that end on the calendar date that is one
day prior to the date of the corporation's organization. The successor
is deemed to have a sufficient number of such additional periods such
that the successor is treated as having a year that includes the date
on which the CERT occurred and as having three years (the lookback
period) immediately preceding the deemed year that includes the date of
the CERT. See Sec. 1.172(h)-3(c)(1) regarding lookback period for
corporation lacking three-year history.
(ii) Computation of three-year average--(A) In general. Except as
otherwise provided in this paragraph (c)(2)(ii), for purposes of
determining any three-year average of a successor under section
172(h)(2)(C)(ii) and Sec. 1.172(h)-3, the interest paid or accrued by
a successor includes interest paid or accrued by all corporations that
are its predecessors as of the end of the successor's taxable year. If
the dates of any taxable year of a predecessor do not precisely
correspond to the dates of a taxable year of the successor, the
interest paid or accrued by the predecessor is apportioned equally to
each date of the predecessor's taxable year. The successor is treated
as having paid or accrued in any year during the lookback period all
predecessor interest that is apportioned to a date within that lookback
period year.
(B) Year of successor transaction. In computing the three-year
average that is relevant to the taxable year of a successor that
includes the date of the section 381(a) transaction that resulted in
successor status, the successor includes only a pro rata portion of the
predecessor's amount of interest paid or accrued during the successor's
lookback period. The pro rata amount equals the predecessor's interest
treated as paid or accrued for the dates of the successor's lookback
period, multiplied by a fraction, the numerator of which equals the
number of days in the loss limitation year of the successor that follow
the date of the transaction that resulted in successor status, and the
denominator of which equals the number of days in the successor's loss
limitation year. The predecessor's amount of interest treated as paid
or accrued that is subject to proration under this paragraph
(c)(2)(ii)(B) is the interest history of the predecessor that would
otherwise be fully combined with the interest history of the successor
under paragraph (c)(2)(ii)(A) of this section.
(3) Examples. The following examples illustrate the rules of this
paragraph (c). Unless otherwise provided, assume that all entities are
domestic C corporations that do not join in the filing of consolidated
returns and that maintain calendar taxable years. Assume that all
applicable corporations have substantial net operating losses in their
loss limitation years:
Example 1. Predecessor corporation engages in CERT. (i) Facts.
Corporation X is a calendar-year taxpayer. On February 1, Year 5, X
engages in a CERT. On August 1, Year 5, X merges into unrelated
corporation Y in a transaction to which section 381(a) applies. Y is
a calendar-year taxpayer and all of its taxable years are full
calendar years. All of X's taxable years prior to the year of the
merger are full calendar years.
(ii) Analysis. X's only loss limitation year is its short year
ending August 1, Year 5. X's lookback period relevant to the Year 5
CERT includes X's calendar Years 2, 3, and 4. See paragraph
(c)(2)(i)(A) of this section; see also Sec. 1.172(h)-3(b)(1)
(computation of three-year average for a short loss limitation
year). Following the merger, Y is the successor to X, and Y is
treated as an applicable corporation with regard to the Year 5 CERT.
See Sec. 1.172(h)-1(b)(2). Because Y's calendar Year 5 follows a
single loss limitation year of X with regard to the same CERT, Y's
calendar Years 5 and 6 are loss limitation years with regard to the
Year 5 CERT. See paragraph (b)(1) of this section and Sec.
1.381(c)(1)-1(e)(3). Y's lookback period for the Year 5 CERT is its
calendar Years 2, 3, and 4. See paragraph (c)(2)(i)(A) of this
section. The computations of Y's three-year averages relevant to its
loss limitation Years 5 and 6 include interest paid or accrued by Y
and by all of Y's predecessors, including X, during the lookback
period. See paragraph (c)(2)(ii)(A) of this section. However,
because Year 5 is Y's taxable year that includes the date of the
section 381(a) transaction that resulted in Y's successor status,
for purposes of computing Y's three-year average for Y's loss
limitation Year 5, Y includes only a pro rata portion of X's amount
of interest paid or accrued. In the proration, X's amount of
interest paid or accrued during the 3 year lookback period is
multiplied by 151/365 (the number of days in Y's loss limitation
Year 5 that follow the date of the section 381(a) transaction that
resulted in Y's successor status, divided by the number of days in
Y's loss limitation Year 5). See paragraph (c)(2)(ii)(B) of this
section.
(iii) Predecessor and successor have different taxable years.
The facts are the same as in paragraph (i) of this Example 1, except
that X maintained a taxable year ending June 30 before its merger
into Y. X's full taxable year ending June 30, Year 5, and its short
year ending August 1, Year 5, are its loss limitation years with
regard to its February 1, Year 5 CERT. See section 172(b)(1)(E)(ii)
and Sec. 1.172(h)-1(e). Following the merger of X into Y, Y is a
successor to X and is treated as an applicable corporation with
regard to the Year 5 CERT. Y's calendar Year 5 is the third loss
limitation year with regard to the CERT. See paragraph (b)(1) of
this section. Y's lookback period is Y's three taxable years
preceding Y's taxable year that includes the date of the CERT, which
are Years 2, 3, and 4. Further, because the dates of X's taxable
years do not precisely correspond to the dates of Y's taxable years,
X's interest paid or accrued is apportioned equally to each date
within each of X's taxable years. Y is treated as having paid or
accrued in any year during the lookback period all of X's interest
that is so apportioned. See paragraph (c)(2)(ii)(A) of this section.
However, because Y's taxable Year 5 includes the date of the section
381(a) transaction that resulted in Y's successor status, for
purposes of computing Y's three-year average for loss limitation
Year 5, Y includes only a pro rata portion of X's interest history.
See paragraphs (c)(2)(ii)(B) of this section.
Example 2. Successor corporation not in existence for entire
lookback period. (i) Facts. Corporation A is formed on October 1,
Year 3, and thereafter maintains a calendar taxable year.
Immediately after A is formed in Year 3, a second corporation, T,
merges into A in a transaction that meets the requirements of
section 368(a)(1)(A). During Year 5, A engages in a CERT.
(ii) Analysis. A's loss limitation years are its calendar Years
5, 6, and 7. See section 172(b)(1)(E)(ii). For purposes of computing
any CERIL related to the Year 5 CERT, section 172(h)(2)(C)(ii) and
Sec. 1.172(h)-3
[[Page 57466]]
require that A measure its interest deductions for the three years
preceding the taxable year of the CERT (three-year average).
However, A is in existence for only two taxable years before the
year in which the CERT occurs. Therefore, pursuant to Sec.
1.172(h)-3(c)(1), A is deemed to have an additional taxable period
(October 1, Year 2, through September 30, Year 3). Further, in
computing the three-year average, A is treated as having paid or
accrued zero interest during the deemed year. See Sec. 1.172(h)-
3(c)(2). However, because T is the predecessor of A, the computation
of A's three-year average relevant to its loss limitation Year 5
includes interest paid or accrued by T during the lookback period
(October 1,Year 2, through December 31, Year 4). See paragraph
(c)(2)(ii)(A) of this section and Sec. 1.172(h)-3(c)(2). Because T
merges into A in a year prior to any loss limitation year, there is
no proration of T's interest history under paragraph (c)(2)(ii)(B)
of this section.
(d) Three-year distribution average. For purposes of determining
any three-year distribution average of a successor under section
172(h)(3)(C)(ii)(I) and Sec. 1.172(h)-1(c)(3), the distributions made
by a successor include distributions made by all corporations that are
its predecessors as of the end of the successor's taxable year. If the
dates of any taxable year of a predecessor do not correspond to the
dates of a taxable year of the successor, the distributions made by the
predecessor are apportioned equally to each date of the predecessor's
taxable year. The successor is treated as having made in its taxable
years all predecessor distributions that are apportioned to a date
within those taxable years.
(e) Effective/applicability date. This section is applicable to
CERTs occurring on or after the date of publication of the Treasury
decision adopting these rules as final regulations in the Federal
Register. This section is also applicable to the deconsolidation of a
member from, or the acquisition of a corporation by, a consolidated
group that occurs on or after the date of publication of the Treasury
decision adopting these rules as final regulations in the Federal
Register. However, in each case, this section does not apply to any
CERT, deconsolidation, or acquisition occurring pursuant to a written
agreement that is binding before the date of publication of the
Treasury decision adopting these rules as final regulations in the
Federal Register.
Sec. 1.172(h)-5 Operating rules.
(a) Date on which CERT occurs in a multi-step transaction. For
purposes of applying section 172(b)(1)(E) and (h), Sec. Sec. 1.172(h)-
1 through 1.172(h)-4, and this section, and Sec. 1.1502-72 (the CERT
rules), if a corporate equity reduction transaction (CERT) consists of
multiple steps, the date on which the CERT occurs is the earliest date
on which the requirements for CERT status are satisfied. For example,
if multiple distributions are made in a single year, an excess
distribution (ED) is treated as occurring on the earliest date on which
the amount of distributions satisfies the greater of the two thresholds
contained in section 172(h)(3)(C)(ii) and Sec. 1.172(h)-1(c)(3). A
major stock acquisition (MSA) is treated as occurring on the earliest
date on which at least 50 percent of the stock of a corporation is
acquired, subject to the provisions of section 172(h)(3)(B) and Sec.
1.172(h)-1(c)(2).
(b) Prohibition on carryback--(1) In general. No corporate equity
reduction interest loss (CERIL) attributable to a CERT may be carried
back under section 172 or Sec. 1.1502-21(b) to any taxable year
(including a consolidated return year) that includes solely dates that
precede the date on which the CERT occurred. In addition, if a
corporation becomes a member of a consolidated group as a result of a
CERT, no CERIL allocable to that CERT may be carried back under section
172 or Sec. 1.1502-21(b) to the taxable year of the acquired
corporation that includes the date on which the CERT occurred, or to
any preceding taxable year. See Sec. 1.172(h)-3(d)(4) regarding
allocation of a CERIL among CERTs, and Sec. 1.1502-21(b)(2)(iv)(C)(1)
for the apportionment of a CERIL among consolidated group members.
(2) Example. The following example illustrates the rules of this
paragraph (b):
Example. Prohibition on carryback. (i) Facts. T corporation
maintains a taxable year ending June 30. X corporation is the parent
of a group that maintains a calendar taxable year. On March 31, Year
5, the X group acquires all of the T stock in a CERT, and T is first
included in the X group on April 1, Year 5. During its consolidated
return Year 5, the X group has a consolidated net operating loss
(CNOL), a portion of which constitutes a CERIL, pursuant to section
172(h)(1) and Sec. 1.172(h)-2(a)(2). Part of the CERIL is
apportioned to T, pursuant to Sec. 1.1502-21(b)(2)(iv)(C)(1).
(ii) Analysis. On the date of the acquisition, both the X group
and T constitute applicable corporations with regard to the Year 5
CERT. See section 172(b)(1)(E)(iii)(I) and Sec. 1.172(h)-1(b). T's
short taxable year ending on March 31, Year 5, was T's taxable year
in which the CERT occurred. The X group's year in which the CERT
occurred was its consolidated return Year 5. Section 172(b)(1)(E)(i)
and paragraph (b) of this section prohibit the carryback of a CERIL
to years preceding the taxable year in which the CERT occurs.
Pursuant to paragraph (b)(1) of this section, no portion of a CERIL
relating to the X group CNOL can be carried back to any taxable year
that includes solely dates that precede the date on which the CERT
occurred. As a result, no portion of the CERIL can be carried back
to the X group's Year 4, or any preceding year. Moreover, because T
becomes a member of the X group as a result of the CERT, no portion
of the CERIL can be carried back to T's short taxable year ending
March 31, Year 5, or any preceding taxable year. See paragraph
(b)(1) of this section.
(c) Stock issuances and computation of three-year distribution
average--(1) In general. In determining whether an ED has occurred,
aggregate distributions made during a taxable year are reduced by the
aggregate amount of stock issued by the applicable corporation during
the year in which the potential ED occurred in exchange for money or
property other than stock of the applicable corporation. Similarly, the
computation of any three-year distribution average under section
172(h)(3)(C)(ii)(I) and Sec. 1.172(h)-1(f) is reduced by the average
of the stock issuances described in section 172(h)(3)(E)(ii) and this
paragraph (c)(1) during the three years of the distribution lookback
period (three-year stock issuance average).
(2) Example. The following example illustrates the rules of this
paragraph (c):
Example. (i) Facts. C is a corporation that maintains a calendar
taxable year. During Year 5, C makes a large distribution to its
shareholders. During taxable Years 2, 3, and 4, C distributes an
average of $100,000 per year. In addition, during taxable Year 2, C
issued stock in exchange for $90,000 cash. During taxable Year 3, C
issued stock in exchange for $15,000 cash. C issued no stock during
taxable Year 4.
(ii) Analysis. C must test its Year 5 distribution as a
potential ED. C's three-year distribution average without respect to
any stock issued during the distribution lookback period is
$100,000. C's three-year distribution average is reduced by the
average of the stock issued by the corporation in exchange for money
or property other than stock in C during the years of the
distribution lookback period (three-year stock issuance average).
See paragraph (c)(1) of this section. C's three-year stock issuance
average is $35,000 [($90,000 + $15,000 + 0)/3]. Therefore, T's
three-year distribution average is $65,000 ($100,000-$35,000).
(d) Computation of the alternative minimum tax net operating loss
deduction. The CERT rules governing the carryback of net operating
losses following a CERT also apply to the carryback of an alternative
minimum tax net operating loss.
(e) Effective/applicability date. This section is applicable to
CERTs occurring on or after the date of publication of the Treasury
decision adopting these rules as final regulations in the Federal
Register. This section is also applicable to the deconsolidation of a
member from, or the acquisition of a corporation by, a consolidated
group that occurs on
[[Page 57467]]
or after the date of publication of the Treasury decision adopting
these rules as final regulations in the Federal Register. However, in
each case, this section does not apply to any CERT, deconsolidation, or
acquisition occurring pursuant to a written agreement that is binding
before the date of publication of the Treasury decision adopting these
rules as final regulations in the Federal Register.
Par. 3. Section 1.1502-21 is amended by adding paragraphs
(b)(2)(iv)(C) and (h)(1)(iv) and revising paragraphs (b)(3)(ii)(B) and
(h)(5) to read as follows:
Sec. 1.1502-21 Net operating losses.
* * * * *
(b) * * *
(2) * * *
(iv) * * *
(C) Apportionment of special status losses--(1) In general. The
amount of the group's CNOL that is determined to constitute a corporate
equity reduction interest loss (CERIL) (as defined in section 172(h)(1)
and Sec. 1.172(h)-2(a)(2)), specified liability loss (as defined in
section 172(f)(1)), or any other net operating loss (NOL) that is
subject to special carryback or carryover rules (special status loss),
is apportioned to each member separately from the remainder of the
CNOL, based on the percentage of CNOL attributable to the member as
determined under paragraph (b)(2)(iv)(B) of this section. This
apportionment is made without regard to whether a particular member
actually incurred specific expenses or engaged in specific activities
required by the special status loss provisions. If a consolidated group
must apply Sec. 1.172(h)-3(d)(4) to allocate its CERIL for a loss
limitation year between multiple corporate equity reduction
transactions (CERTs), then the portion of the CERIL allocable to each
CERT is treated as a separate CERIL for purposes of applying this
paragraph (b)(2)(iv)(C) to apportion special status losses among
members of the group.
(2) Example. The following example illustrates the rules of this
paragraph (b)(2)(iv)(C):
Example. (i) Facts. P is the parent of a group that includes S
and that maintains a calendar taxable year. S has been a member of
the group for all relevant years. In Year 3, the P group engages in
a CERT. T is included in the P group beginning on January 1, Year 4,
as a result of a transaction that does not constitute a CERT. In
Year 4, the P group has a CNOL of $1,200. Under the CERT rules (in
section 172(b)(1)(E) and (h), Sec. Sec. 1.172(h)-1 through
1.172(h)-5, and Sec. 1.1502-72), $300 of the CNOL (25%) constitutes
a CERIL. Assume that, absent application of this paragraph
(b)(2)(iv)(C), under paragraph (b)(2)(iv)(B) of this section, \2/3\
of the CNOL ($800) is attributable to T and the remaining \1/3\ of
the CNOL ($400) is attributable to S.
(ii) Analysis. Under this paragraph (b)(2)(iv)(C), the CNOL is
divided into its special status (CERIL) component, and its non-
special status component. Because T has separate return year
carryback years, each component of the CNOL (the non-special status
CNOL and the CERIL) is apportioned under paragraph (b)(2)(iv)(B) of
this section. Under that apportionment rule, \2/3\ of each amount is
apportioned to T, and the remainder of the CNOL is attributable to S
and can be carried back to prior P group years, subject to any
applicable limitations. Therefore, $200 of the $300 CERIL is
apportioned to T, and $600 of the $900 non-special status CNOL is
also apportioned to T. The $200 CERIL cannot be carried back to
certain taxable years of T under the CERT rules. Likewise, $100 of
the $300 CERIL is apportioned to S, and $300 of the $900 non-special
status CNOL is also apportioned to S. Under the CERT rules, the $100
CERIL cannot be carried back to certain taxable years.
* * * * *
(3) * * *
(ii) * * *
(B) Election on acquisition to waive carryback to separate return
years--(1) In general. A corporation may make one of three mutually
exclusive, irrevocable elections to waive carryback of CNOLs to
separate return years of acquired members. Any election that is made
with regard to an acquired corporation that was a member of a
consolidated group (the former group) immediately before becoming a
member of an acquiring group must include all other corporations that
were members of the former group and that joined the acquiring group
during the same consolidated return year of the acquiring group.
(2) Annual election. If a corporation becomes a member of an
acquiring group, the acquiring group may make an irrevocable election
to relinquish, with respect to the part of any CNOL attributable to the
member, the portion of the carryback period for which the member filed
a separate return. This is an annual election, applicable to the CNOL
of a single year. The election is made in a separate statement
entitled, ``THIS IS AN ELECTION UNDER Sec. 1.1502-21(b)(3)(ii)(B)(2)
TO WAIVE THE PRE- [insert the first taxable year in which the member(s)
joined the group] CARRYBACK PERIOD FOR THE PORTION OF THE [insert
taxable year] CNOL ATTRIBUTABLE TO [insert the name(s) and EIN(s) of
the corporation(s)].'' The statement must be filed with the acquiring
group's timely filed original return for the consolidated return year
of the particular CNOL.
(3) Single election. If a corporation becomes a member of an
acquiring group, the acquiring group may make an irrevocable election
to relinquish, with respect to all CNOLs attributable to the member,
the portion of the carryback period for which the member filed a
separate return. The election is not an annual election and applies to
all losses that would otherwise be subject to a carryback to separate
return years under section 172 or paragraph (b) of this section. The
election is made in a separate statement entitled, ``THIS IS AN
ELECTION UNDER Sec. 1.1502-21(b)(3)(ii)(B)(3) TO WAIVE THE PRE-
[insert the first taxable year in which the member(s) joined the group]
CARRYBACK PERIOD FOR THE PORTION FOR ALL NOLs (and ALL CNOLs)
ATTRIBUTABLE TO [insert the name(s) and EIN of the corporation(s)].''
The statement must be filed with the acquiring group's timely filed
original income tax return for the consolidated return year the
corporation (or corporations) became a member.
(4) Special one-time election for deconsolidating member. Section
1.1502-72(e)(1) makes available an election by a deconsolidating member
(or its new common parent immediately following deconsolidation) to
relinquish in whole the carryback of all NOLs to taxable years of the
former group and any preceding taxable year. An election under Sec.
1.1502-72(e)(1) will control whether the deconsolidating corporation is
treated as an applicable corporation under section 172(b)(1)(E)(iii)
and Sec. 1.172(h)-1(b)(1) following the deconsolidation with regard to
a CERT of the former group. See Sec. 1.1502-72(b). Further, an
election under Sec. 1.1502-72(e)(1) may affect the computation of the
CERIL under section 172(h)(1) and Sec. 1.172(h)-2(a)(2) with regard to
any CERT for which the deconsolidating corporation (or any group of
which the deconsolidating corporation is a member) is an applicable
corporation under section 172(b)(1)(E)(iii) and Sec. 1.172(h)-1(b)(1)
following the deconsolidation. See Sec. 1.1502-72(c)(4) and
(d)(3)(ii).
* * * * *
(h) * * *
(1) * * *
(iv) Paragraph (b)(2)(iv)(C) of this section applies to taxable
years for which the due date of the original return (without
extensions) is on or after the date of publication of the Treasury
decision adopting these rules as final regulations in the Federal
Register.
* * * * *
(5) Waiver of carrybacks. Paragraph (b)(3)(ii)(B) of this section
(relating to the waiver of carrybacks to separate return years) applies
to acquisitions
[[Page 57468]]
occurring on or after the date of publication of the Treasury decision
adopting these rules as final regulations in the Federal Register,
except that it does not apply to any acquisition occurring pursuant to
a written agreement that is binding before the date of publication of
the Treasury decision adopting these rules as final regulations in the
Federal Register. For original consolidated Federal income tax returns
due (without extensions) before the date of the publication of the
Treasury decision adopting these rules as final regulations in the
Federal Register, see paragraph (b)(3)(ii)(B) of this section as
contained in 26 CFR part 1 in effect on April 1, 1999.
* * * * *
Par. 4. Section 1.1502-72 is added to read as follows:
Sec. 1.1502-72 Corporate equity reduction transactions.
(a) In general--(1) Scope. Section 172(b)(1)(E) and (h), Sec. Sec.
1.172(h)-1 through 1.172(h)-5, and the rules of this section (the CERT
rules) apply to determine whether a corporate equity reduction
transaction (CERT) has occurred and to determine the consequences of
the CERT, including rules governing the carryback of losses following a
CERT, with respect to corporations that become, are, or cease to be
members of a consolidated group.
(2) Single entity treatment--(i) In general. All members of a group
are treated as a single taxpayer for purposes of the CERT rules. For
example, if multiple members of a group acquire in total 50 percent or
more (by vote or value) of the stock of another corporation, the group
has engaged in a major stock acquisition (MSA) as defined in section
172(h)(3)(B) and Sec. 1.172(h)-1(c)(2). The transactions and
expenditures undertaken by a particular group member are generally not
separately tracked; instead, the entire group is treated as a single
applicable corporation.
(ii) Debt and interest of group members--(A) In general. The
computation of a group's corporate equity reduction interest loss
(CERIL) under section 172(h)(1) and Sec. 1.172(h)-2(a)(2) for any loss
limitation year (as defined in paragraph (a)(3) of this section) that
is a consolidated return year includes the debt of all members and all
interest deductions that are allowed on the group's consolidated return
for that year. This rule applies regardless of whether any particular
debt or interest expense is directly related to the CERT, whether any
particular member was included in the group on the date of the CERT, or
whether any particular debt would not exist in the group if the group
had not engaged in the CERT. But see paragraph (a)(2)(iii) of this
section (providing that intercompany transactions are generally
disregarded).
(B) Debt of acquired corporation. With respect to a corporation
that joins a consolidated group (acquired corporation), in applying the
CERT rules to consolidated return years that are loss limitation years,
any debt of the acquired corporation is treated as debt of the
acquiring group for purposes of applying the avoided cost rules of
section 263A(f)(2)(A) on any measurement date after the inclusion of
the corporation in the group. See section 172(h)(2) and Sec. 1.172(h)-
2(b) (applying the principles of section 263A(f)(2)(A)(ii)); see also
Sec. 1.263A-9(f)(2) (defining measurement dates).
(iii) Intercompany transactions. In applying the CERT rules,
intercompany transactions as defined in Sec. 1.1502-13 are generally
disregarded. For example, interest expense attributable to an
intercompany obligation is not taken into account in computing the
CERIL or three-year average of a group. However, a transaction between
group members is not disregarded if a party to the transaction becomes
a non-member pursuant to the same plan or arrangement. In such case,
any transaction between group members, including a potential excess
distribution (ED) as defined in section 172(h)(3)(C), Sec. 1.172(h)-
1(c)(3), and paragraph (f)(1) of this section, is tested on a separate
entity basis under the CERT rules. It may also be tested as part of a
larger, multi-step MSA. See Sec. 1.172(h)-1(d)(2).
(iv) Applicable corporation status following inclusion of member
with pre-existing CERT--(A) Acquiring group treated as applicable
corporation. If a corporation that is an applicable corporation
(including by application of paragraph (b) of this section) with regard
to a CERT occurring in a separate return year (pre-existing CERT
member) joins a consolidated group, the group is treated as a single
applicable corporation with regard to that CERT in the consolidated
return year of the acquisition and any succeeding year. A corporation
is a pre-existing CERT member regardless of whether the transaction at
issue is an MSA that constitutes a CERT with respect to both a
consolidated return year of the acquiring group and a separate return
year of the acquired corporation.
(B) End of separate tracking of target. Beginning on the first day
on which a pre-existing CERT member is included in a consolidated
group, the member ceases to be separately tracked as an applicable
corporation. See paragraph (a)(2)(i) of this section. The CERT rules
thereafter apply to the group, rather than to the member, with regard
to any CERT for which the member had been an applicable corporation,
including an MSA in which the member was acquired by the group.
Therefore, beginning on the day on which the pre-existing CERT member
is included in the group, no CERIL is computed with regard to the
member, independent of the CERIL computed for the group. But see Sec.
1.1502-21(b)(2)(iv)(C) (providing for allocation and apportionment of a
group's CERIL to specific group members) and Sec. 1.172(h)-5(b)(1)
(relating to prohibition on carryback of a CERIL).
(3) Loss limitation years--(i) In general. This paragraph applies
to identify loss limitation years of a consolidated group and
corporations that have been members of a consolidated group. The
taxable year in which a CERT actually occurs is a loss limitation year.
Any other taxable year (potential loss limitation year) of any
applicable corporation (including a consolidated group) constitutes a
loss limitation year with regard to the CERT only if, under the
carryforward rules of sections 172(b)(1)(A)(ii) and 381(c)(1), the
potential loss limitation year would constitute the first or second
taxable year following the taxable year of the corporation or
consolidated group that actually engaged in the CERT that includes the
date on which the CERT occurred. Except as otherwise provided in
paragraph (a)(3)(ii) of this section, for purposes of this paragraph
(a)(3), sections 172 and 381 are applied as if the inclusion of any
corporation in a consolidated group or the deconsolidation of any
member from a group were a transaction listed in section 381(a).
(ii) Corporation joins group in an MSA. If a corporation joins a
group in an MSA, no separate return year of the acquired corporation
ending on or before it joined the acquiring group is treated as a loss
limitation year for the purpose of determining the loss limitation
years of the acquiring group or any corporation that deconsolidates
from that group that relate to the MSA.
(iii) Deconsolidating members. Under this paragraph (a)(3)(iii), a
corporation that deconsolidates (deconsolidating member) from a group
(former group) that is an applicable corporation may have loss
limitation years with regard to a CERT of its former group. See
paragraphs (b) (relating to post-deconsolidation status as applicable
corporation) and (e)(1) of this section (providing for an irrevocable
waiver of
[[Page 57469]]
carrybacks such that a deconsolidating member is not treated as an
applicable corporation). If the consolidated return year during which
the deconsolidation occurs (year of deconsolidation) is a first or
second loss limitation year with regard to the CERT, then certain
separate return years of a deconsolidating member that is treated as an
applicable corporation will constitute loss limitation years. If the
year of deconsolidation is a first loss limitation year with regard to
the CERT, the following two separate return years will constitute loss
limitation years. If the year of deconsolidation is a second loss
limitation year with regard to the CERT, the separate return year that
immediately follows the year of deconsolidation will constitute a loss
limitation year. If the deconsolidating member joins another
consolidated group, the consolidated return years of that group may
also constitute loss limitation years with regard to the CERT of the
former group. See paragraph (a)(2)(iv) of this section (relating to
inclusion of member with pre-existing CERT).
(4) Application of rules to reverse acquisitions. In the case of
any acquisition to which Sec. 1.1502-75(d)(3) applies (a reverse
acquisition), for purposes of applying the CERT rules, the first
corporation (as defined in Sec. 1.1502-75(d)(3)(i)) is treated as the
corporation the stock of which is acquired, and the second corporation
(as defined in Sec. 1.1502-75(d)(3)(i)) is treated as the corporation
that acquires stock. In addition, for purposes of Sec. 1.172(h)-
2(b)(3)(i) (identifying CERT costs of an MSA) in the case of a reverse
acquisition, the fair market value of the stock acquired equals the
fair market value of the stock of the first corporation that the
stockholders (immediately before the acquisition) of the first
corporation own immediately after the acquisition, rather than the fair
market value of the stock of the second corporation.
(b) Applicable corporation status following deconsolidation--(1) In
general. If a corporation deconsolidates in a loss limitation year from
a group that is treated as an applicable corporation with regard to a
CERT, the deconsolidating corporation and the former group are both
treated as applicable corporations following the deconsolidation. If
the corporation joins another consolidated group (acquiring group)
following the deconsolidation, the rules of this section apply to the
acquiring group, and this paragraph (b) applies with regard to the
deconsolidation of any member from the acquiring group during a loss
limitation year associated with the CERT. See paragraph (a)(2)(iv) of
this section regarding treatment of a group as a single applicable
corporation following an acquisition; see also paragraph (a)(3)(ii) of
this section for identification of loss limitation years following a
deconsolidation. This paragraph (b) applies without regard to whether
any particular corporation would on a separate entity basis have
constituted an applicable corporation with regard to the CERT under
section 172(b)(1)(E)(iii) and Sec. 1.172(h)-1(b), with or without the
application of section 172(h)(4)(C) and paragraph (a)(2) of this
section, or whether the CERT occurred in a consolidated return year.
However, under this paragraph (b), the deconsolidating corporation may
be treated as an applicable corporation with regard to a CERT of a
former group only if the group engages in the CERT on or before the
date of the deconsolidation, or if a pre-existing CERT member, as
described in paragraph (a)(2)(iv)(A) of this section, joins the group
on or before the date of the deconsolidation.
(2) Exception if waiver filed. In general, a corporation that
deconsolidates from a group (or the parent of a group acquiring the
deconsolidating member), may, pursuant to paragraph (e)(1) of this
section, make an irrevocable election to relinquish the carryback of
all net operating losses (NOLs) (and attributable portions of
consolidated net operating losses (CNOLs)) to taxable years of the
former group and any preceding years. If such an election is made, the
deconsolidating member is not treated as an applicable corporation with
regard to any CERT of the former group after the deconsolidation. Any
group that acquires the deconsolidating member is not treated as an
applicable corporation with regard to any CERT of the former group
solely as a result of the acquisition of that member. The former group
will continue to be treated as an applicable corporation with regard to
the CERT.
(3) Examples. The following examples illustrate the rules of
paragraph (a) of this section and this paragraph (b). For purposes of
these examples, assume that all entities are domestic C corporations
unless otherwise stated. Assume that all applicable corporations have
substantial NOLs in their loss limitation years:
Example 1. Single entity treatment of acquisition indebtedness.
(i) Facts. Corporation T is a calendar-year taxpayer that has
significant debt outstanding, which was incurred to fund operations.
Unrelated P is the common parent of a calendar-year consolidated
group. The following steps occur pursuant to an integrated plan. On
May 1, Year 5, P acquires 10 percent of the T stock for $100. On
June 30, Year 5, T borrows $700 and immediately thereafter uses the
money to redeem some of its shares from its shareholders. On the
same day, the P group acquires all of the remaining T stock in
exchange for $200. Assume that the $700 cash payment from T to the T
shareholders is treated as a redemption. T is first included in the
P group on July 1, Year 5. Under Sec. 1.172(h)-1(d)(2), the steps
of the integrated plan (including the redemption of the former T
shareholders) constitute a single MSA.
(ii) Analysis. T's short taxable year ending June 30, Year 5 is
T's year of the CERT. The P group's consolidated return Year 5 is
the taxable year of the CERT for the group. For purposes of
allocating to the single MSA interest paid or accrued during the P
group's loss limitation years (Years 5, 6, and 7) under Sec.
1.172(h)-2(b), the P group takes into account the debt of all
members, including the $700 loan and all of T's other debt. See
paragraph (a)(2)(ii)(B) of this section. The allocation of interest
also takes into account all deductions for interest paid or accrued
that are included in the consolidated return for the relevant loss
limitation year. See paragraph (a)(2)(ii)(A) of this section.
Example 2. Loss limitation years if a corporation joins group in
an MSA. Corporation T maintains a taxable year ending June 30.
Unrelated X is the common parent of a calendar-year consolidated
group. On March 31, Year 5, the X group acquires all of the T stock
in a CERT, and T is first included in the X group on April 1, Year
5. On the date of the acquisition, both the X group and T constitute
applicable corporations with regard to the Year 5 CERT. See Sec.
1.172(h)-1(b) and paragraph (a)(2) of this section. T's short
taxable year ending on March 31, Year 5, was T's taxable year in
which the CERT occurred. T's only loss limitation year with respect
to the Year 5 CERT is its short taxable year ending on March 31,
Year 5. See Sec. 1.172(h)-1(e) and paragraph (a)(3) of this
section. Beginning on April 1, Year 5, T ceases to be separately
tracked as an applicable corporation. See paragraph (a)(2)(i) and
(iv)(B) of this section. The X group's year in which the CERT
occurred is its consolidated return Year 5. The X group's loss
limitation years with respect to the Year 5 CERT are its full
taxable calendar Years 5, 6, and 7. See paragraph (a)(3)(i) and (ii)
of this section.
Example 3. Loss limitation years of a group and deconsolidating
member. (i) Facts. P is the common parent of a calendar-year
consolidated group that includes S. On June 30, Year 6, a member of
the P group engages in an acquisition that constitutes a CERT. S is
not a party to the acquisition. On September 30, Year 6, S
deconsolidates from the P group. No election under paragraph (e)(1)
of this section is made with respect to the deconsolidation of S.
Following its deconsolidation, S does not join in the filing of a
consolidated return with another group, and it maintains a calendar
taxable year.
(ii) Analysis. Because no election is made under paragraph
(e)(1) of this section, following the deconsolidation, both the P
group and S are treated as applicable
[[Page 57470]]
corporations with regard to the Year 6 CERT. See paragraph (b)(1) of
this section. The P group's loss limitation years with regard to the
CERT are its consolidated return Years 6, 7, and 8. See section
172(b)(1)(E)(ii) and paragraph (a)(3)(i) of this section. S
deconsolidates from the P group during consolidated return Year 6,
which is the first loss limitation year with regard to the CERT. See
paragraph (a)(3)(i) of this section. For purposes of applying
paragraph (a)(3) of this section to identify loss limitation years,
S is treated as deconsolidating from the P group in a transaction to
which section 381(a) applies. Therefore, S's two taxable years that
follow the deconsolidation, the short year ending December 31, Year
6, and the full taxable calendar Year 7, are its additional loss
limitation years with regard to the Year 6 CERT. See paragraph
(a)(3)(iii) of this section. See section 172(b)(1)(E)(i) and Sec.
1.172(h)-5(b)(1) for rules regarding the prohibition on carryback of
a CERIL.
Example 4. Loss limitation years if a pre-existing CERT member
joins the group. (i) Acquiring group has loss limitation years.
Corporation T maintains a calendar taxable year and does not join in
the filing of a consolidated return. On July 1, Year 5, T engages in
a CERT (Year 5 CERT). Unrelated X is the common parent of a
calendar-year consolidated group that includes S. On December 31,
Year 5, the X group acquires all of the outstanding T stock. T is
first included in the X group on January 1, Year 6. The first loss
limitation year with respect to the Year 5 CERT is T's calendar Year
5. See Sec. 1.172(h)-1(e). As a result of the X group's acquisition
of T, the X group is treated as a single applicable corporation with
respect to the Year 5 CERT. See paragraph (a)(2)(iv) of this
section. For purposes of applying paragraph (a)(3) of this section
to identify loss limitation years, T is treated as joining the X
group in a transaction to which section 381(a) applies. Because T
has one loss limitation year with regard to the CERT before it joins
the X group, the X group has two loss limitation years with respect
to the Year 5 CERT: Its calendar Years 6 and 7. See paragraph
(a)(3)(i) of this section. However, the X group must test its
acquisition of T under the CERT rules.
(ii) Acquiring group has no loss limitation years. The facts are
the same as in paragraph (i) of this Example 4, except that the X
group acquires T on January 31, Year 7. Because T has three loss
limitation years before it is included in the X group (calendar
Years 5 and 6, and a short taxable year ending on January 31, Year
7), none of the X group's consolidated return years are loss
limitation years with regard to the Year 5 CERT. See section
172(b)(1)(E)(ii) and paragraph (a)(3)(i) of this section.
(iii) Member deconsolidates from acquiring group. The facts are
the same as in paragraph (i) of this Example 4, except that S
deconsolidates from the X group on June 30, Year 6. No election
under paragraph (e)(1) of this section is made on the
deconsolidation of S. Following its deconsolidation from the X
group, S does not join in the filing of a consolidated return. T and
the X group's loss limitation years remain the same as in paragraph
(i) of this Example 4. Because no election is made under paragraph
(e)(1) of this section with respect to S's deconsolidation,
following the deconsolidation, S and the X group are both treated as
applicable corporations with regard to T's Year 5 CERT. See
paragraph (b)(1) of this section. S deconsolidates from the P group
during consolidated return Year 6, which is the second loss
limitation year with regard to the CERT. See paragraph (a)(3)(i) of
this section. Therefore, following its deconsolidation, S's only
loss limitation year with respect to the Year 5 CERT is its short
taxable year July 1, Year 6 through December 31, Year 6. See
paragraph (a)(3)(iii) of this section.
Example 5. Deconsolidation before group engages in CERT.
Corporation T is a member of the P group, which maintains a calendar
taxable year. On February 28, Year 4, T deconsolidates from the P
group due to T's acquisition by the X group, which also maintains a
calendar taxable year. T is included in the X group as of March 1,
Year 4. No election under paragraph (e)(1) of this section is made
on the deconsolidation of T from the P group. On March 31, Year 4,
the P group engages in a CERT. Because the P group engages in the
CERT after the date of the deconsolidation, T is not treated as an
applicable corporation following the deconsolidation. See paragraph
(b)(1) of this section. However, the X group must apply the CERT
rules to the X group's acquisition of T.
Example 6. Member that engages in CERT deconsolidates with a
waiver election. (i) Facts. P is the common parent of a calendar-
year consolidated group. On March 31, Year 4, the P group engages in
an MSA, when member T acquires all of the stock of T1. On June 30,
Year 4, T and its subsidiaries (including T1) deconsolidate from the
P group due to the acquisition of T by the X group. T and its
subsidiaries are first included in the X group as of July 1, Year 4.
The X group makes an election under paragraph (e)(1) of this section
on the deconsolidation.
(ii) Analysis. Because an election under paragraph (e)(1) of
this section is made on the deconsolidation of T and its
subsidiaries from the P group, following the deconsolidation, only
the P group is treated as an applicable corporation with regard to
the March 31, Year 4 CERT. Neither T, T1, nor the X group is treated
as an applicable corporation with regard to the March 31, Year 4
CERT, even though T directly engaged in the MSA, and T1 was the
acquired corporation in that MSA. See paragraph (b)(2) of this
section. However, the X group must apply the CERT rules to the X
group's acquisition of T.
(c) Identification and allocation of CERT costs--(1) In general.
The portion of an NOL that is treated as a CERIL is subject to
limitation on carryback. See section 172(b)(1)(E)(i) and Sec.
1.172(h)-5(b)(1). A CERIL is computed in part by identifying the
deductions allowed for interest allocable to the CERT. The computation
of interest allocable to a CERT under section 172(h)(2) and Sec.
1.172(h)-2(b) takes into account all CERT costs as defined in Sec.
1.172(h)-2(b)(3). This paragraph (c) contains rules applicable to the
identification and allocation of CERT costs of a consolidated group.
(2) Single entity treatment of CERT costs. The computation of
interest allocable to a CERT in any particular loss limitation year of
a consolidated group includes CERT costs incurred (including costs
deemed incurred under this paragraph (c)) with regard to the CERT by
all corporations that are members of a group during the loss limitation
year.
(3) CERT costs of acquired corporation. With respect to a
corporation that joins a consolidated group (acquired corporation), for
purposes of applying the CERT rules, any CERT costs incurred (or
treated as incurred under this paragraph (c)) by the acquired
corporation during separate return years prior to the acquired
corporation's inclusion in the group are attributed to the acquiring
group. Such costs are treated as having been incurred by the acquiring
group for purposes of applying the avoided cost rules of section
263A(f)(2)(A) to any measurement date after the acquisition of the
corporation. Those CERT costs are no longer separately identified as
CERT costs incurred by the acquired corporation.
(4) Allocation of CERT costs on deconsolidation--(i) In general.
This paragraph (c)(4) applies to determine the CERT costs allocable to
a corporation that deconsolidates in a loss limitation year from a
group that is treated as an applicable corporation with regard to a
CERT. Under this paragraph (c)(4), CERT costs may be allocated to a
deconsolidating corporation only if the group engages in the relevant
CERT on or before the date of the deconsolidation, or if a pre-existing
CERT member, as described in paragraph (a)(2)(iv)(A) of this section,
joins the group on or before the date of the deconsolidation. This
paragraph (c)(4) applies regardless of whether any particular
corporation would have constituted an applicable corporation under
section 172(b)(1)(E)(iii) and Sec. 1.172(h)-1(b) without the
application of section 172(h)(4)(C) and paragraph (a)(2) of this
section, whether the CERT occurred in a consolidated return year, or
whether any particular corporation actually incurred CERT costs.
(ii) No waiver election made. If no election under paragraph (e)(1)
of this section is made with regard to the deconsolidation, CERT costs
incurred by the group (including costs treated as incurred by the group
under this paragraph (c)) are allocated between the
[[Page 57471]]
deconsolidating corporation and the former group, solely for purposes
of computing allocable interest deductions of the deconsolidating
corporation and the continuing group with regard to the CERT under
section 172(h)(2) and Sec. 1.172(h)-2(b). For purposes of computing
interest allocable to the CERT under section 172(h)(2) and Sec.
1.172(h)-2(b) during the loss limitation year of the former group that
is the year of the deconsolidation, the CERT costs allocated to the
deconsolidating member are included in the group's accumulated CERT
costs on those measurement dates on which the deconsolidating
corporation was included in the group. The portion of the group's total
CERT costs that is allocated to a deconsolidating member equals the
group's total CERT costs multiplied by a fraction, the numerator of
which equals the value of the deconsolidating corporation immediately
after its deconsolidation, and the denominator of which equals the
value of the entire group immediately prior to the deconsolidation.
(iii) Waiver election made. If an election under paragraph (e)(1)
of this section is made with regard to a deconsolidation, no CERT costs
are allocated to the deconsolidating corporation. All CERT costs remain
with the former group for purposes of identifying its allocable
interest deductions under section 172(h)(2) and Sec. 1.172(h)-2(b)
with regard to the CERT.
(5) Examples. The following examples illustrate the rules of this
paragraph (c). For purposes of the examples in this paragraph (c)(5),
assume that all entities are domestic C corporations unless otherwise
stated. Assume that all applicable corporations have substantial NOLs
in their loss limitation years:
Example 1. Aggregation of CERT costs of consolidated group and
target. (i) Facts. P is the common parent of a calendar-year
consolidated group that includes S1 and S2. On June 30, Year 5, S1
acquires all of the stock of T for $10 million. P incurs CERT costs
of $100,000 and $250,000 for work performed by its outside counsel
and an investment banker, respectively, that facilitates the
acquisition. In addition, T incurs CERT costs of $175,000 for work
performed by its outside counsel that facilitates the acquisition.
All of these costs are incurred on or before the date of the
acquisition. In all relevant years preceding its acquisition, T does
not join in the filing of a consolidated return.
(ii) Analysis. For purposes of computing the P group's allocable
interest deductions under section 172(h)(2) and Sec. 1.172(h)-2(b),
the P group's CERT costs include CERT costs incurred by all members
of the P group. See paragraph (c)(2) of this section. In addition,
when T joins the P group, the CERT costs incurred by T prior to its
inclusion in the P group are attributed to the P group and are
treated as having been incurred by the P group for purposes of
applying the avoided cost rules of section 263A(f)(2)(A) to any
measurement date after the acquisition of T. See paragraph (c)(3) of
this section. As a result, the P group's accumulated CERT costs on
July 1, Year 5, are $10,525,000 [$10,000,000 + $100,000 + 250,000 +
175,000]. See Sec. 1.172(h)-2(b)(3) for rules defining CERT costs.
Example 2. Acquiring group treated as incurring CERT costs
associated with unrelated CERT of target. T is a calendar-year
taxpayer that does not join in the filing of a consolidated return.
P is the common parent of a calendar-year consolidated group. P also
owns 70 percent of the only class of T stock. During Year 4, T
engages in a CERT. On June 30, Year 5, P acquires the remainder of
the stock of T, and T is first included in the P group on July 1,
Year 5. Following the acquisition, the P group is treated as an
applicable corporation with regard to T's Year 4 CERT. See paragraph
(a)(2)(iv) of this section. The P group's consolidated return Year 5
is the third and final loss limitation year with regard to the Year
4 CERT. See paragraph (a)(3)(i) of this section. The P group is
treated as having incurred all of T's expenses allocable to the CERT
for purposes of computing any CERIL for consolidated return Year 5.
Because T was a member of the P group for less than the entire
calendar taxable Year 5, T's CERT costs are included in the P
group's accumulated CERT costs only on those measurement dates on
which T is included in the group (that is, measurement dates on or
after July 1, Year 5). See paragraph (c)(3) of this section and
Sec. 1.172(h)-2(b)(4). See also paragraph (d)(3)(iii) for rules
relating to the interest history of a partial-year member.
Example 3. Allocation of CERT costs to deconsolidating member.
(i) Facts. P is the common parent of a calendar-year consolidated
group. P owns 60 percent of the sole class of stock of T, a
calendar-year taxpayer. On January 31, Year 5, the P group engages
in a CERT. On March 31, Year 5, P acquires the remainder of the
stock of T, and T is first included in the P group on April 1, Year
5. On June 30, Year 6, T deconsolidates from the P group, with no
election made under paragraph (e)(1) of this section.
(ii) Analysis. T is not a member of the P group at the time of
the CERT. However, following its deconsolidation, T is treated as an
applicable corporation with regard to the Year 5 CERT because the P
group engages in the CERT before T deconsolidates, and no election
is made under paragraph (e)(1) of this section on the
deconsolidation. See paragraph (b)(1) of this section. Further, a
portion of the P group's CERT costs is allocated to T for purposes
of computing any CERIL of T (or of any group of which T becomes a
member following its deconsolidation from the P group) with regard
to the Year 5 CERT. See paragraphs (b)(1) and (c)(4)(ii) of this
section. However, the CERT costs of the group otherwise allocated to
T are included in the P group's accumulated CERT costs on those
measurement dates during which T is included in the group (that is,
measurement dates before July 1, Year 6). See paragraph (c)(4)(ii)
of this section and Sec. 1.172(h)-2(b)(4).
(d) Determining the three-year average of a group--(1) In general.
Section 172(h)(2)(C) and Sec. 1.172(h)-3(a) limit the amount of
allocable interest deductions to the excess (if any) of the amount
allowable as a deduction for interest paid or accrued by the taxpayer
during the loss limitation year, over the average of interest paid or
accrued by the taxpayer (the three-year average) for the three taxable
years preceding the taxable year in which the CERT occurred (the
lookback period). The computation under section 172(h)(2)(C)(ii) and
Sec. 1.172(h)-3(b) of a group's three-year average for the lookback
period that is relevant to any loss limitation year includes interest
paid or accrued (or treated as paid or accrued under this paragraph
(d)) during the lookback period by all corporations that are members of
the consolidated group during the loss limitation year.
(2) Varying group membership. If group membership varies from one
loss limitation year to another, a different three-year average is
computed with regard to each loss limitation year of the group.
(3) Interest history--(i) Combination of interest history of
acquired member with group history. With respect to a corporation that
joins a consolidated group (acquired corporation), for purposes of
applying the CERT rules, the interest paid or accrued (or treated as
paid or accrued under this paragraph (d)) by the acquired corporation
during each separate return year prior to its inclusion in the group is
apportioned equally to each day within each of its separate return
years. The interest apportioned to dates within the lookback period is
then combined with the interest paid or accrued by the acquiring group
and is treated as interest paid or accrued by the acquiring group
during the lookback period for purposes of computing the three-year
average that is relevant to any loss limitation year beginning with the
consolidated return year during which the acquired corporation is first
included in the group. For purposes of the CERT rules, the interest
from the separate return years is no longer separately traced as
interest paid or accrued by the acquired corporation. But see paragraph
(d)(3)(iii) of this section for rules requiring proration of interest
history attributable to corporations that are members of a group for
less than an entire loss
[[Page 57472]]
limitation year. The interest paid or accrued by a predecessor (as
defined in Sec. 1.172(h)-(1)(b)(2)) of a member of the group is
similarly combined with the interest paid or accrued by the group. See
Sec. 1.172(h)-4(c)(2)(ii)(A).
(ii) Interest treated as paid or accrued by a corporation that
deconsolidates--(A) In general. This paragraph (d)(3)(ii) provides
rules that apply for purposes of determining any three-year average of
a corporation that deconsolidates from a group (or a three-year average
of any other group of which it becomes a member) and any three-year
average of the group from which the corporation deconsolidates (former
group). These rules apply to the computation of any three-year average
with regard to a CERT of the former group or any other CERT.
(B) Waiver election made. If an election under paragraph (e)(1) of
this section is made with respect to the deconsolidation of a
corporation from a group, then, following the deconsolidation, the
deconsolidating member is treated as having paid or accrued zero
interest during the period of its inclusion in the former group and
preceding years. The group retains the interest history that would
otherwise be allocated and apportioned to the deconsolidating member
under this paragraph (d)(3)(ii).
(C) No waiver election made. If no election under paragraph (e)(1)
of this section is made with respect to the deconsolidation of a
corporation, a portion of the group's amount of interest treated as
paid or accrued during the period of the corporation's consolidation
and any preceding years is allocated and apportioned to the
deconsolidating corporation. The allocated and apportioned interest is
subtracted from the group's interest history and is unavailable to the
group (or any other group member) for purposes of computing a three-
year average with regard to any loss limitation year of the group (or
any other group member) after the year of deconsolidation. But see
paragraph (d)(3)(iii) of this section for rules requiring proration of
interest history attributable to corporations that are members of a
group for less than an entire loss limitation year.
(D) Method of allocation. If no election under paragraph (e)(1) of
this section is made when a corporation deconsolidates, solely for
purposes of the CERT rules, the corporation is treated as having paid
or accrued interest equal to the amount of interest paid or accrued by
the group in each consolidated return year through the date of the
deconsolidation (including any combination of interest history pursuant
to paragraph (d)(3)(i) of this section), multiplied by a fraction, the
numerator of which equals the value of the deconsolidating corporation
immediately after its deconsolidation, and the denominator of which
equals the value of the entire group immediately prior to the
deconsolidation.
(iii) Proration of lookback period interest for members that are
part of a group for less than the entire loss limitation year. If any
member is included in the group for less than an entire consolidated
return year that is a loss limitation year (partial-year member), then
the group takes into account a pro rata portion of the partial-year
member's amount of interest paid or accrued during the lookback period
for purposes of determining a group's three-year average relevant to
that loss limitation year. The amount of interest treated as paid or
accrued that is subject to proration under this paragraph (d)(3)(iii)
is the interest of the partial-year member that would otherwise be
fully combined with the interest history of the acquiring group under
paragraph (d)(3)(i) of this section (with regard to corporations
acquired during the loss limitation year) or the interest that is
otherwise allocated to a deconsolidating member under paragraph
(d)(3)(ii) of this section. The pro rata amount equals the partial-year
member's interest treated as paid or accrued for the dates of the
lookback period, multiplied by a fraction, the numerator of which
equals the number of days of the loss limitation year during which the
partial-year member was a member of the group, and the denominator of
which equals the number of days in the loss limitation year. This
proration applies to interest paid or accrued during the entire
lookback period, including portions of the lookback period during which
the partial-year member was a member of the group.
(4) Lookback period--(i) In general. The lookback period with
regard to a CERT is the three taxable years preceding the taxable year
in which the CERT occurs. See section 172(h)(2)(C)(ii) and Sec.
1.172(h)-3(a). The lookback period that is relevant to any CERIL of a
consolidated group is the three taxable years preceding the taxable
year of the group that includes the date on which the CERT occurred.
See Sec. 1.172(h)-5(a) (defining the date on which a CERT occurs if
the CERT consists of multiple steps). This rule applies whether the
group actually engaged in the CERT or is treated as an applicable
corporation with regard to a CERT solely by application of paragraph
(a)(2)(iv) of this section.
(ii) Group not in existence for entire lookback period. If a group
was not in existence for three taxable years prior to the consolidated
return year that includes the date of the CERT, the lookback period
includes the group's taxable years preceding the year of the CERT plus
the preceding taxable years of the corporation that was the common
parent of the group on the first day of the group's first consolidated
return year (original common parent). If the group and the original
common parent together have fewer than three taxable years that precede
the consolidated return year that includes the date of the CERT, the
lookback period will be deemed to include full 12-month periods that
end on the calendar date that is one day prior to the date of
organization of the original common parent.
(iii) Group not in existence on date of CERT. If a group was not in
existence on the date on which the CERT occurred, for purposes of
determining the lookback period, the group's taxable years will be
deemed to include the taxable years of the group's original common
parent. If the original common parent was not in existence on the date
of the CERT, or it does not have three taxable years that precede its
taxable year that includes the date of the CERT, the group will be
deemed to have additional 12-month taxable periods that end on the
calendar date that is one day prior to the date of the original common
parent's organization. From these deemed taxable periods, the group
will identify the deemed period that includes the date on which the
CERT occurred and the three immediately preceding deemed periods that
constitute the lookback period. See Sec. 1.172(h)-5(a) regarding date
on which CERT occurred in multi-step transaction.
(iv) Interest history of corporations not in existence. If any
member of a group is not in existence for the entire lookback period,
for purposes of the CERT rules, that member is treated as having paid
or accrued zero interest before its organization. But see Sec.
1.172(h)-4(c)(2)(ii) (regarding interest history of successors).
(5) Examples. The following examples illustrate the rules of this
paragraph (d). Unless otherwise stated, assume that all entities are
domestic C corporations that have full, 12-month taxable years. Assume
that all applicable corporations have substantial NOLs in their loss
limitation years:
[[Page 57473]]
Example 1. Acquired member's interest history combined with
interest history of group. (i) Facts. P is the common parent of a
calendar-year consolidated group that includes S on all relevant
dates. On December 31, Year 5, S acquires the stock of T in a CERT,
and T is first included in the P group on January 1, Year 6.
Membership in the P group is otherwise stable for all relevant
years. Prior to joining the P group, T does not join in the filing
of a consolidated return and maintains a calendar taxable year. T's
amounts of interest paid or accrued in Years 2, 3, and 4,
respectively, are $600, $200, and $400. The P group's amounts of
interest paid or accrued in Years 2, 3, and 4, respectively, are
$1,400, $1,000, and $1,200.
(ii) Analysis. The P group's loss limitation years are calendar
Years 5, 6, and 7. See paragraph (a)(3)(i) of this section. Year 5
is also a loss limitation year for T. The P group's lookback period
with regard to the CERT is calendar Years 2, 3, and 4. See paragraph
(d)(4)(i) of this section. For purposes of computing any three-year
average of the P group for its lookback period, on the acquisition
of T, the interest history of T is generally combined with the
interest history of the P group. See paragraph (d)(3)(i) of this
section. However, because T is not a member of the P group on any
date during consolidated return Year 5, the computation of the P
group's three-year average relevant to Year 5 will not include any
of T's interest paid or accrued during the lookback period. See
paragraph (d)(3)(iii) of this section. Thus, the P group's three-
year average for loss limitation Year 5 is $1,200 ([$1,400 + $1,000
+ 1,200]/3). Because T is a member of the P group during each day of
loss limitation Years 6 and 7, T's history of interest paid or
accrued during the lookback period is fully included in the P
group's computation of its three-year average relevant to loss
limitation Years 6 and 7. See paragraph (d)(3)(i) and (iii) of this
section. Thus, the P group's three-year average for loss limitation
Years 6 and 7 is $1,600 ([$1,400 + $1,000 + 1,200 + $600 + $200 +
$400]/3).
(iii) Interest combination if acquired member included in group
for part of loss limitation year. The facts are the same as in
paragraph (i) of this Example 1, except that S acquires the stock of
T on March 31, Year 5, and T is included in the P group for 275
days. Because T is a partial-year member of the P group during loss
limitation Year 5, the computation of the three-year average
relevant to loss limitation Year 5 includes the interest of T for
the lookback period, prorated as required under paragraph
(d)(3)(iii) of this section. Because T is in the P group for 275
days during Year 5, the computation of the P group's three-year
average relevant to Year 5 takes into account an amount of T's
interest history equal to T's actual amount of interest paid or
accrued for each year of the lookback period, multiplied by a
fraction equal to 275/365 (number of days of the loss limitation
year during which T is a member of the P group divided by the number
of days in the loss limitation year), or $452 ($600 x [275/365]),
$151 ($200 x [275/365]), and $301 ($400 x [275/365]) for Years 2, 3,
and 4, respectively.
Example 2. Lookback period if corporation with CERT history
joins group. (i) Facts. P is the common parent of a calendar-year
consolidated group. P also owns 55 percent of the sole class of
stock of Corporation T, which maintains a taxable year ending June
30. On September 30, Year 4, T engages in a CERT. On December 31,
Year 5, P acquires the remainder of the stock of T, and T is first
included in the P group on January 1, Year 6.
(ii) Analysis. T's full taxable year ending June 30, Year 5, and
its short year ending December 31, Year 5 are loss limitation years
with regard to the September Year 4 CERT. The lookback period for
the CERT relevant to these two loss limitation years is T's three
taxable years ending on June 30, Years 2, 3, and 4. See section
172(h)(2)(C)(ii) and Sec. 1.172(h)-3(a). The P group's calendar
Year 6 is its sole loss limitation year with regard to T's September
Year 4 CERT. See paragraph (a)(3)(i) of this section. In determining
any CERIL with regard to the P group's calendar Year 6, the lookback
period is the three taxable years prior to the taxable year of the
group that includes the date on which the CERT occurred. See
paragraph (d)(4)(i) of this section. Therefore, the lookback period
with regard to the P group's loss limitation Year 6 is calendar
consolidated return Years 1, 2, and 3.
Example 3. Interest history if no waiver election made on member
deconsolidation. (i) Facts. P is the common parent of a calendar-
year consolidated group that includes S. The P group engaged in a
CERT on December 27, Year 5. S deconsolidates from the P group on
December 31, Year 5. No election under paragraph (e)(1) of this
section is made on the deconsolidation of S. S's value immediately
after its deconsolidation is $4,000. The P group's value immediately
before S's deconsolidation is $10,000. The P group and its members
engaged in no prior CERTs.
(ii) Analysis. Because the CERT occurs during the P group's
calendar consolidated return Year 5, Years 5, 6, and 7 are the P
group's loss limitation years. Because no election is made under
paragraph (e)(1) of this section with regard to the deconsolidation
of S, S is treated as an applicable corporation with regard to the
Year 5 CERT under paragraph (b)(1) of this section and the interest
history of the P group during the period of S's consolidation and
any preceding years is allocated to S and the remaining members of
the P group. See paragraph (d)(3)(ii)(C) of this section. The amount
of the P group's interest for each year that is allocated to S is
the amount of interest paid or accrued by the P group in the
relevant consolidated return year multiplied by a fraction equal to
4,000 divided by 10,000 (the value of the deconsolidating
corporation immediately after its deconsolidation divided by the
value of the entire group immediately prior to the deconsolidation),
or \2/5\. See paragraph (d)(3)(ii)(D) of this section. The interest
allocated to S is subtracted from the interest history of the group
and is unavailable to the P group for purposes of computing a three-
year average with regard to any loss limitation year of the P group
after the year of the deconsolidation, including Years 6 and 7. The
interest history allocated to S will be maintained by S to be used
in the computation of any CERIL of S, or any CERIL of any group of
which S is later a member. See paragraph (d)(3)(ii)(C) of this
section.
(iii) Waiver election filed. The facts are the same as in
paragraph (i) of this Example 3, except that an election under
paragraph (e)(1) of this section is filed on the deconsolidation of
S. As a result of that election, S is not treated as an applicable
corporation with regard to the Year 5 CERT under paragraph (b)(2) of
this section and none of the interest history of the P group is
allocated to S under paragraph (d)(3)(ii)(B) of this section.
Therefore, in any post-deconsolidation year, for purposes of
computing a CERIL in connection with any CERT with regard to which S
(or of any group of which S is later a member) is an applicable
corporation, S is treated as having paid or accrued zero interest
for the period of its inclusion in the P group and preceding years.
The P group will retain the interest history that would otherwise be
allocated to S. See paragraph (d)(3)(ii)(B) of this section.
Example 4. Interest history if no waiver election made for
member that deconsolidates prior to CERT. (i) Facts. P is the parent
of a calendar-year consolidated group that includes S. On December
31, Year 4, S deconsolidates from the P group. No election is made
under paragraph (e)(1) of this section with regard to the
deconsolidation. On July 1, Year 5, the P group engages in a CERT.
The P group and its members engaged in no prior CERTs.
(ii) Analysis. Because no election is made under paragraph
(e)(1) of this section with regard to the deconsolidation of S, the
interest history of the P group is allocated between S and the
remaining members of the P group. See paragraph (d)(3)(ii)(C) of
this section. This allocation occurs despite the fact that, at the
time of the deconsolidation, the P group has not engaged in a CERT.
Therefore, for purposes of computing any three-year average for the
P group relevant to the Year 5 CERT, the portion of the interest
history allocated to S is unavailable to the P group for purposes of
computing a three-year average with regard to any loss limitation
year of the P group after the year of the deconsolidation. See
paragraph (d)(3)(ii)(C) of this section.
Example 5. Interest history if waiver election made for member
that deconsolidates and then engages in a CERT. (i) Facts. P is the
parent of a calendar-year consolidated group that includes X. On
December 31, Year 5, X deconsolidates from the P group and makes an
election under paragraph (e)(1) of this section. After its
deconsolidation, X maintains a calendar taxable year. During Year 7,
X engages in a CERT.
(ii) Analysis. X's loss limitation years with regard to the Year
7 CERT are Years 7, 8, and 9. X's lookback period with regard to the
CERT is comprised of its Years 4 and 5 in the P consolidated group,
and X's separate return Year 6. See section 172(h)(2)(C)(ii) and
paragraph (d)(4)(i) of this section. As a result of the filing of
the election under paragraph (e)(1) of this section, none of the
interest
[[Page 57474]]
history of the P group is allocated to X. Therefore, for purposes of
computing X's three-year average for loss limitation Years 7, 8, and
9, X is treated as having paid or accrued zero interest during Years
4 and 5 of the lookback period. See paragraph (d)(3)(ii)(B) of this
section.
Example 6. Interest history if member deconsolidates mid-year.
(i) Facts. P is the common parent of a calendar-year consolidated
group that includes S. S deconsolidates from the P group on June 30,
Year 5. No election under paragraph (e)(1) of this section is made
on the deconsolidation of S. During Year 5, but prior to the
deconsolidation, the P group engages in a CERT. S is not a party to
the CERT, and, throughout its history in the group, S paid or
accrued only nominal interest.
(ii) Analysis. The P group's lookback period is calendar Years
2, 3, and 4. Consolidated return Years 5, 6, and 7 are the P group's
loss limitation years. Because no election is made under paragraph
(e)(1) of this section with regard to the deconsolidation of S, the
interest history of the P group is allocated between S and the
remaining members of the P group. See paragraph (d)(3)(ii)(C) of
this section. This is true although S played no part in the CERT,
and it actually paid or accrued only nominal interest. In the
consolidated return year of the deconsolidation (here, the P group's
Year 5), S was a member for 181 days. Therefore, the P group
includes in the computation of its three-year average relevant to
Year 5 a pro rata portion of the interest history allocated to S.
See paragraph (d)(3)(ii)(C) and (iii) of this section. The pro rata
portion equals the group's interest history allocated to S under
paragraph (d)(3)(ii)(C) and (D) of this section, multiplied by a
fraction equal to 181/365 (number of days of the loss limitation
year during which S is a member divided by the number of days in the
loss limitation year). See paragraph (d)(3)(iii) of this section.
The portion of the interest history allocated to S is excluded in
its entirety from the computation of the group's three-year average
relevant to Years 6 and 7. The interest history allocated to S will
be used in the computation of any CERIL of S, and any CERIL of any
group of which S is later a member. See paragraph (d)(3)(ii)(C) of
this section.
Example 7. Group not in existence for the entire lookback
period. (i) Facts. Corporation P is formed on October 1, Year 3, and
maintains a calendar taxable year. On January 1, Year 4, P forms S
in a transaction meeting the requirements of section 351. Beginning
in Year 4, P files consolidated returns with S, its only subsidiary.
The P group maintains a calendar taxable year. During Year 5, the P
group engages in an ED.
(ii) Analysis. For purposes of limiting any CERIL related to the
Year 5 CERT, the P group must measure its interest deductions for
the three years preceding the taxable year in which the CERT occurs
(three-year average). See section 172(h)(2)(C)(ii) and Sec.
1.172(h)-3(a). However, the P group was not in existence for three
taxable years before the year that includes the date of the CERT
(calendar Year 5). Rather, the P group was in existence for one full
calendar taxable year (Year 4). Because the group does not have a
three-year history, the lookback period includes the common parent's
(P's) short taxable year (October 1 through December 31, Year 3),
and is also deemed to include an additional taxable period (October
1, Year 2 through September 30, Year 3). See paragraph (d)(4)(ii) of
this section. Further, in computing the three-year average, the P
group members are treated as having paid or accrued zero interest
for dates on which they did not exist. However, the P group is
treated as having paid any interest paid by P during its short
taxable year (October 1 through December 31, Year 3). See paragraph
(d)(4)(iv) of this section.
Example 8. Group not in existence prior to year of the CERT but
target in existence. (i) Facts. Corporation P is formed on January
1, Year 4. On the same day, P organizes wholly-owned, special-
purpose corporation S. T is an unrelated, calendar-year corporation
with a significant tax history. On February 1, Year 4, S merges into
T, with T surviving. In the merger, all of T's historic shareholders
receive cash in exchange for their shares. Following the merger, P
owns all of the outstanding stock of T, and P is treated as
acquiring all the stock of T in an MSA. The P group files
consolidated returns beginning in Year 4 and maintains a calendar
taxable year. T is first included in the P group on February 2, Year
4.
(ii) Analysis. Neither P (the original common parent) nor the P
group is in existence before the year that includes the date of the
CERT (calendar Year 4). Therefore, for purposes of applying the
interest allocation limitation of section 172(h)(2)(C) and Sec.
1.172(h)-3(a), the P group's lookback period is deemed to include
three additional taxable periods (January 1 through December 31 for
Years 1, 2, and 3). See paragraph (d)(4)(ii) of this section.
Further in computing the three-year average, P is treated as having
paid or accrued zero interest during the deemed years (January 1,
Year 1 through December 30, Year 3). See paragraph (d)(4)(iv) of
this section. However, with respect to the group's acquisition of T,
the interest history of T is combined with the interest history of
the P group. Because T is not a member of the P group for each day
of loss limitation Year 4, the computation of the three-year average
applicable to loss limitation Year 4 will include only a pro rata
portion of the interest of T for the lookback period. See paragraph
(d)(3)(i), (d)(3)(iii), and paragraph (iii) of Example 1 of
paragraph (d)(5) of this section.
(e) Election to waive carryback from all separate return years--(1)
In general. In addition to any other elections available under section
172(b)(3) and Sec. 1.1502-21(b)(3), if a member becomes a non-member
of a group (former group), the former member may make an irrevocable
election to relinquish the carryback of all NOLs (and attributable
portions of CNOLs) to taxable years of the former group and any
preceding years. If the former member becomes a member of another group
(acquiring group) immediately after its deconsolidation from the former
group, the election described in this paragraph (e)(1) is available
only to the common parent of the acquiring group. The election is not
an annual election and applies to all losses that would otherwise be
subject to carryback to years of the former group (or preceding years)
under section 172 or Sec. 1.1502-21(b). The election is binding on the
deconsolidating corporation and any group of which it may become a
member. Further, the election is available without regard to whether
the former group is treated as an applicable corporation with regard to
any CERT at the time of the deconsolidation. Any election under this
paragraph (e)(1) by the common parent of an acquiring group must
include all deconsolidating corporations that were members of the
former group and that joined the acquiring group during the same
consolidated return year of the acquiring group. The election is made
in a separate statement entitled, ``THIS IS AN ELECTION UNDER Sec.
1.1502-72(e)(1) TO WAIVE THE PRE- [insert the first taxable year
following the deconsolidation of the former member(s) from the former
group] CARRYBACK PERIOD FOR ALL NOLs AND ALL CNOLs ATTRIBUTABLE TO
[insert the name(s) and EIN(s) of the corporation(s)].'' The statement
must be filed with the timely filed original return of the former
member or the acquiring group for the first taxable year following the
deconsolidation of the former member from the former group. See
paragraphs (b)(2), (c)(4)(iii), and (d)(3)(ii)(B) of this section
relating to treatment of a deconsolidating member making an election
under this paragraph (e)(1).
(2) Example. The following example illustrates the rules of this
paragraph (e):
Example. P, a publicly-held corporation, is the common parent of
a calendar-year consolidated group that includes T. On July 30, Year
5, the P group engages in a CERT. On December 31, Year 5, T
deconsolidates from the P group, and it continues to maintain a
calendar taxable year. With respect to its deconsolidation, T makes
an election under paragraph (e)(1) of this section. As a result of
such election, T is not treated as an applicable corporation with
regard to the P group's Year 5 CERT and none of the CERT costs or
interest history of the P group are allocated to T. See paragraphs
(b)(2), (c)(4)(iii), and (d)(3)(ii)(B) of this section. On March 30,
Year 6, the X group acquires all of the stock of T. The X group
maintains a calendar taxable year. A portion of the X group's Year 6
CNOL is attributable to T under Sec. 1.1502-21(b)(2)(iv)(B).
Because T filed an election under paragraph (e)(1) of this section
with respect to its deconsolidation from the P group, no portion of
the X group's Year 6 CNOL attributable to
[[Page 57475]]
T can be carried back to any taxable years of T, of the P group, or
any preceding years.
(f) Excess distribution--(1) Defined. Section 172(h)(3)(C) and
Sec. 1.172(h)-1(c)(3) provide that an ED means the excess (if any) of
the aggregate distributions (including redemptions) made during a
taxable year by a corporation with respect to its stock, over the
greater of 150 percent of the average of such distributions (three-year
distribution average) for the three taxable years immediately preceding
such taxable year (distribution lookback period), or 10 percent of the
fair market value of the stock of such corporation as of the beginning
of such taxable year.
(2) Determination of an ED by a group--(i) Aggregation of
distributions to non-members. For purposes of determining whether a
group has made an ED during any consolidated return year (potential ED
year), distributions by all members of the group to non-members during
the potential ED year are aggregated and tested under section
172(h)(3)(C), Sec. 1.172(h)-1(c)(3), and paragraph (f)(1) of this
section.
(ii) Distributions between members of the same group. Distributions
between members of the same group are generally disregarded for
purposes of applying the CERT rules. However, the preceding sentence
does not apply if a party to the transaction is deconsolidated pursuant
to the same plan or arrangement. See paragraph (a)(2)(iii) of this
section.
(3) Computation of three-year distribution average--(i) In general.
The computation under section 172(h)(3)(C)(ii)(I) and Sec. 1.172(h)-
1(f) of the group's three-year distribution average includes
distributions made during the distribution lookback period to non-
members by each corporation that is a member of the consolidated group
during the potential ED year. Distributions made during the
distribution lookback period by predecessors of those members are also
included. See Sec. 1.172(h)-4(d). The computation includes
distributions made by corporations during separate return years,
subject to additional rules of this paragraph (f) and paragraph
(a)(2)(iii) of this section. If a corporation was a member of a prior
group during a portion of a distribution lookback period, the
distribution history of that corporation during taxable years of the
prior group includes only distributions made by that corporation to
non-members of the prior group.
(ii) Corporation deconsolidated from a group. If a corporation
deconsolidates from a group (former group), the corporation's actual
distribution history is subtracted from the group's distribution
history and is available to the deconsolidating corporation (or any
group of which it becomes a member) for purposes of computing any
three-year distribution average following the deconsolidation. The
deconsolidating member's distribution history will be unavailable to
the former group for purposes of computing its three-year distribution
average with regard to any potential ED year of the former group after
the year of deconsolidation. See Sec. 1.172(h)-1(f)(1) (excluding from
three-year distribution average those distributions treated as part of
an MSA).
(iii) Members included in group for less than entire loss
limitation year. If any member is included in the group for less than
an entire potential ED year (partial-year member), then a pro rata
portion of the partial-year member's distribution history is computed
under the principles of paragraph (d)(3)(iii) of this section and is
included for purposes of determining the group's three-year
distribution average relevant to that potential ED year.
(4) Stock value and stock issuances of a group--(i) Stock issuances
taken into account in computing distributions. Stock issued by a member
of a group is taken into account in applying section 172(h)(3)(E)(ii)
and Sec. 1.172(h)-5(c)(1) only if the stock is issued to a non-member.
Intercompany stock issuances are disregarded. This rule is applicable
whether the stock issuance occurred in the current group or a previous
group.
(ii) Value of stock of group. For purposes of applying section
172(h)(3)(C)(ii)(II), Sec. 1.172(h)-1(c)(3), and paragraph (f)(1) of
this section (relating to the fair market value of the stock of a
distributing corporation), the value of the stock of the group is the
value of the stock of all members, other than stock that is owned
directly or indirectly by another member. But see section
172(h)(3)(E)(i) for rules regarding the exclusion of certain preferred
stock for purposes of applying sections 172(h)(3)(C), Sec. 1.172(h)-
1(c)(3) and (f), and this paragraph (f). See also paragraphs
(a)(2)(iii) and (f)(2)(ii) of this section, requiring separate entity
analysis of certain transactions between members of a consolidated
group.
(5) Examples. The following examples illustrate the rules of this
paragraph (f). For purposes of these examples, assume that all entities
are domestic C corporations:
Example 1. Corporation deconsolidates from group. (i) Facts. P
is the common parent of a calendar-year consolidated group that
includes T. P owns 90 percent of the outstanding stock of T, and A
(an unrelated party) owns the remaining 10 percent of the
outstanding stock of T. T regularly makes distributions to its
shareholders, P and A. On December 31, Year 4, X, the common parent
of another calendar-year consolidated group, acquires all of the
outstanding stock of T, and T deconsolidates from the P group. T is
first included in the X group on January 1, Year 5. On March 31,
Year 5, X makes a large distribution to its non-member shareholders.
X makes no further distributions during its taxable year.
(ii) Analysis. The X group's distribution to its non-member
shareholders on March 31, Year 5, is tested as a potential ED under
section 172(h)(3)(C), Sec. 1.172(h)-1(c)(3) and (f), and paragraph
(f) of this section. The X group's distribution lookback period with
regard to the potential ED is January 1 through December 31, for
each of Years 2, 3, and 4. For purposes of computing the X group's
three-year distribution average, the computation includes any
distributions made by T to A, its former non-member shareholder,
during the distribution lookback period, because T is a member of
the X group during the year of the potential ED. See paragraph
(f)(3) of this section. Distributions between members of the X group
and between members of the P group are disregarded. See paragraph
(f)(2)(ii) of this section.
Example 2. Integrated plan to deconsolidate. T is a wholly-owned
subsidiary of P, and is a member of the P group. As part of a plan
that includes the deconsolidation of T from the P group, T makes a
distribution to P. Because T's distribution to P is part of an
integrated plan that results in the deconsolidation of T, T's
distribution to P is tested on a separate entity basis as a
potential ED under section 172(h)(3)(C) Sec. 1.172(h)-1(c)(3) and
(f), and paragraph (f) of this section. See paragraphs (a)(2)(iii)
and (f)(2)(ii) of this section. Therefore, the rules of section
172(h)(3)(C), Sec. 1.172(h)-1(c)(3) and (f), and paragraph (f) of
this section are applied based on the separate entity value and
distribution history of T. See Sec. 1.172(h)-1(d)(2) regarding
testing of the distribution as part of a plan of major stock
acquisition.
(g) Life-nonlife groups--(1) Scope. This paragraph (g) provides
rules for applying the CERT rules to a group that elects under section
1504(c)(2) to file a consolidated return (life-nonlife group). See
Sec. 1.1502-47 (rules regarding life-nonlife groups).
(2) Single entity treatment--(i) In general. All members of a life-
nonlife group are generally treated as a single taxpayer for purposes
of the CERT rules. Accordingly, the rules of paragraphs (a) through (f)
and (h) of this section and the rules of Sec. Sec. 1.172(h)-1 through
1.172(h)-5 are applied by treating the life-nonlife group as a single
taxpayer, and are not applied on a subgroup basis. For example, all
members of a life-nonlife group are treated as a single entity for
purposes of determining whether a CERT has occurred under sections
172(h)(3)(B) and (C) and
[[Page 57476]]
Sec. 1.172(h)-1. See paragraph (a)(2)(i) of this section. Furthermore,
all intercompany transactions between and within subgroups are
generally disregarded. In addition, if a pre-existing CERT member
becomes a member of a life-nonlife group, the life-nonlife group is
treated as a single applicable corporation with regard to that CERT in
the consolidated return year of the acquisition and any succeeding
year. See paragraph (a)(2)(iv) of this section. If it is determined
that a CERT exists, the amount of the CERIL is determined for the
entire life-nonlife consolidated group as described in paragraph
(g)(2)(ii)(A) of this section, and the CERIL is allocated to each
subgroup as described in paragraph (g)(3) of this section.
(ii) CERIL--(A) Single CERIL computation. For any loss limitation
year, a single CERIL is computed under section 172(h)(1) and Sec.
1.172(h)-2(a)(2) for the life-nonlife group. The computation of the
life-nonlife group's CERIL for any loss limitation year includes all
life-nonlife group members' CERT costs, debt, and interest paid or
accrued for that year.
(B) Net operating loss. For purposes of determining the CERIL of a
life-nonlife group under section 172(h)(1) and Sec. 1.172(h)-2(a)(2),
the net operating loss of the group in any loss limitation year is the
sum of the nonlife consolidated net operating loss (nonlife CNOL) (if
any) and the consolidated loss from operations (consolidated LO) (if
any) for that year. For this purpose, nonlife consolidated taxable
income does not offset any LO, and consolidated partial life insurance
company taxable income (as used in Sec. 1.1502-47(g)) does not offset
any nonlife CNOL.
(iii) Carryover to separate return years. If any nonlife CNOL or
consolidated LO that is attributable to a member of a subgroup may be
carried to a separate return year (as defined in Sec. 1.1502-
47(d)(10)), the CERIL that is associated with the nonlife CNOL or
consolidated LO is apportioned to each member, as relevant, under the
method provided by Sec. 1.1502-21(b)(2)(iv)(C)(1).
(iv) Deconsolidation. If a member deconsolidates from a life-
nonlife group without an election under paragraph (e)(1) of this
section, then paragraphs (b)(1), (c)(4)(i) and (ii), and (d)(3)(ii)(A)
and (C) of this section (relating to treatment of a deconsolidating
member) apply to allocate CERT status, CERT costs, and interest history
from the entire life-nonlife group to the deconsolidating member, and
not from a specific subgroup.
(3) Allocation of a CERIL. If a CERIL exists under paragraph
(g)(2)(ii)(A) of this section, that CERIL is allocated to each subgroup
that has a nonlife CNOL or consolidated LO. The amount of the nonlife
CNOL and consolidated LO in a loss limitation year that constitutes a
CERIL is equal to the total amount of the CERIL for the loss limitation
year multiplied by a fraction, the numerator of which equals the
nonlife CNOL or consolidated LO (as relevant), and the denominator of
which equals the nonlife CNOL plus the consolidated LO.
(h) Effective/applicability date--(1) In general. Other than
paragraph (e) of this section, the rules of this section apply to CERTs
occurring on or after the date of publication of the Treasury decision
adopting these rules as final regulations in the Federal Register. The
rules of this section also apply to the deconsolidation of a member
from, or the acquisition of a corporation by, a consolidated group that
occurs on or after the date of publication of the Treasury decision
adopting these rules as final regulations in the Federal Register.
However, in each case, this section does not apply to any CERT,
deconsolidation, or acquisition occurring pursuant to a written
agreement that is binding before the date of publication of the
Treasury decision adopting these rules as final regulations in the
Federal Register.
(2) Waiver election. Paragraph (e) of this section applies to the
deconsolidation of a member from a consolidated group that occurs on or
after the date of publication of the Treasury decision adopting these
rules as final regulations in the Federal Register, except that it does
not apply to any deconsolidation occurring pursuant to a written
agreement that is binding before the date of publication of the
Treasury decision adopting these rules as final regulations in the
Federal Register.
Steven T. Miller,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2012-22838 Filed 9-13-12; 4:15 pm]
BILLING CODE 4830-01-P