Recognizing Loss Across Borders: More than Meets the Eye

[Pages:24]Recognizing Loss Across Borders: More than Meets the Eye

Daniel C. White Philip B. Wright

April 23, 2015 (updated)

St. Louis International Tax Group, Inc.

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Overview

I. Overview II. Loss Recognition Transactions

A. Insolvent Subsidiary Liquidations ? Rev. Rul. 2003-125 B. Sale or Exchange Transactions ? Granite Trust III. General Loss Tax Consequences IV. Collateral Loss Tax Consequences V. Examples

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II.A Loss Recognition Transactions and Rev. Rul 2003-125

A. Insolvent Subsidiaries and Rev. Rul. 2003-125

? Section 332 liquidation "only applies [when] the [controlling corporate shareholder] receives at least partial payment for the stock which it owns in the liquidating corporation."

? Section 332 will not apply and transaction will be taxable under Section 1001 if:

? Subsidiary is "balance sheet" insolvent. Morton v. Comm'r, 38 B.T.A. 1279 (1938), aff'd 112 F.2d 320 (7th Cir. 1940); or

? Subsidiary has multiple classes of stock and not all classes held by controlling corporate shareholder receives proceeds in liquidation. Spaulding Bakeries Inc., 27 T.C. 684 (1957), aff'd 252 F.2d 693(2nd Cir. 1958); H. K. Porter, 87 T.C. 689 (1986)

? Liquidation of corporation, including by classification election, is identifiable event. Rev. Rul. 2003-125

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II.B Loss Recognition Transactions and Granite Trust

? Section 331 and 336 apply to solvent corporate liquidations not described in Section 332. If a corporation is solvent but does not have one corporate shareholder "controlling" the subsidiary, Section 332 will not apply. This generally requires full recognition of gain or loss at the corporate and shareholder level.

? Section 1504(a)(2) defines "control," generally 80% voting power and 80% value ? Control may be broken in contemplation of the liquidation transaction. Granite Trust Co., 238

F.2d 670 (1st Cir. 1956) ? Pre-liquidation transfers of subsidiary stock may be taxable or tax-free. Compare Sections

1001, 304 with Sections 170, 351(a) ? Nature of the transfer may alter the availability of the loss on the transferred portion. See

Section 267(f)

? Transaction could be a tax-free C reorganization if one corporation acquires "substantially all properties" of the insolvent corporation, limiting loss recognition. See Rev. Rul. 69-617 (upstream C reorganization); Treas. Reg. 1.368-2(d)(4)(antiBausch & Lomb regulations); Norman Scott, 48 T.C. 598 (1967)(permitting insolvent reorganization with affiliated shareholder/creditor)

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A.M. 2011-003 Illustrated

US-X

US-X

Debt

FS-Y 80%

20% FS-Z

Debt

FS-Y

80%

20% FS-Z

FS-Z is balance sheet insolvent FS-Z changes its entity classification by election (deemed liquidation) FS-Z is deemed to distribute its assets subject to its liabilities in liquidation, which are deemed contributed to a new partnership

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After the election, FS-Z is classified as a partnership for US tax purposes.

Collateral Loss Tax Consequences: Insolvent Subsidiary - Multiple Owners

? AM 2011-003 addresses many of the consequences of an insolvent liquidation of a first tier CFC with multiple owners.

? Debt of CFC is not necessarily worthless. Since CFC becomes partnership, the consolidated return rules do not apply to the FSZ debt. no deemed satisfaction and reissuance (DSR).

? Under Treas. Reg. 1.1001-3, no transfer has occurred since payment expectations of creditors are not altered by classification change.

? Shareholder takes a cost basis in the assets; but see Est. of Franklin, 544 F.2d 1045 (9th Cir. 1976)(acquisition of assets for non-recourse debt far in excess of value).

? Liabilities assumed by new partnership limited to the value of the assets. Section 752(c).

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Granite Trust Illustrated

US-X

2 FS-Y

1

Trust

US-X 79%

FS-Y Debt

Trust

21%

FS-Y is balance sheet solvent but US-X has a loss in FS-Y stock. 1. US-X transfers 21% of FS-Y stock to Trust. 2. FS-Y elects to be changes its classification by election.

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After the election, FS-Y is taxed as a

partnership.

III. General Loss Tax Consequences

? Section 1001(a) ? "loss shall be the excess of the adjusted basis ...over the amount realized"

? Section 165(a) ? "There shall be allowed as a deduction any loss sustained during the taxable year and not compensated for by insurance or otherwise"

? Closed, completed transaction; fixed by identifiable event. Treas. Reg 1.165-1(b)

? Section 165(f) ? "Losses from sales...of capital assets shall be allowed only to the extent allowed in sections 1211 and 1212"

? Section 267 may limit any loss on a sale or exchange transaction

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