The CPA Journal

Consolidated Return Developments

By Mary McLaughlin, Tax Manager, Moody’s Investors Service, Inc.

The loss disallowance rule (LDR) of Treasury Regulations section 1.1502-20 generally prohibits a loss deduction by a consolidated group member on the disposition of subsidiary stock. The LDR was adopted in 1991 in order to prevent the investment adjustment system of the consolidated return regulations from circumventing the repeal of the General Utilities doctrine. The LDR was also meant to prevent the losses of a subsidiary from being duplicated in the form of a parent’s investment losses.

Loss Disallowance Rule Developments

There were several significant developments regarding LDRs during the past year:

In Rite Aid Corp. (Fed Cl 2000-1 USTC 50,429), a case of first impression, the claims court upheld the validity of the loss disallowance rules of Regulations section 1.1502-20. Rite Aid, parent of a consolidated group, incurred a $22 million loss on the sale of stock of its subsidiary. Rite Aid also calculated a $28.6 million duplicated loss under Regulations section 1.1502-20. Because the duplicated loss exceeded the claimed economic loss, no loss deduction was allowed. According to the court, the duplicated loss rule prevents an affiliated group from recognizing a loss on a sale of stock of a subsidiary while allowing the purchaser to recognize the same loss. Moreover, the taxpayer could have structured the sale in a way that would have allowed it to recognize the disallowed losses, but failed to do so. For example, the taxpayer could have structured the transaction as a sale of assets or a sale of stock with a section 338(h)(10) election.

Technical advice memorandum (TAM) 2000-06014 applied the loss disallowance rules to a “capital loss generator.” In this case, the company Parent was the common parent of Sub 1, Sub 2, and Benefits, a second-tier subsidiary. Parent exchanged a note for repayment of a loan to Sub 2 for the outstanding preferred shares of Benefits. Parent failed to include the note’s basis in the assets of Benefits when it calculated its loss on the sale of Benefits preferred stock. The IRS disallowed Parent’s loss deduction. By excluding the note’s basis, Parent did not correctly apply the provisions of Regulations section 1.1502-13 and miscalculated the duplicated loss under Regulations section 1.1502-20(c). In addition, the IRS also relied upon Regulations section 1.1502-20(c)(1) and 1.1502-13(h)(1) with regard to the lack of business purpose for the note issuance, its tax avoidance purpose, and the transaction’s lack of economic substance.

Capital Loss Denied

In Textron Inc. and Subsidiary Companies (115 TC No. 6), the parent of a consolidated group was denied a capital loss on the redemption of a note by one of its subsidiaries under Regulations section 1.1502-14(d) (in effect for tax years beginning prior to July 12, 1995). In 1985, Textron Inc. acquired the Avco affiliated group, of which Paul Revere Corp. was a member. In 1977, Paul Revere had received a promissory note and other property from Avco in exchange for Avco stock held by Paul Revere. Paul Revere realized a loss on the stock redemption but did not recognize it. Instead, under Regulations section 1.1502-31(b)(2)(ii) (in effect for tax years beginning before July 12, 1995), Paul Revere’s basis in the Avco stock was allocated to the property and note distributed in the stock redemption. In 1987, while a member of the Textron group, Avco redeemed the note from Paul Revere and Paul Revere was liquidated into Avco under IRC section 332. Textron claimed a long-term capital loss on the note redemption. The loss was not allowed but rather deferred under Regulations section 1.1502-14(d)(4) because, among other factors, the basis in the note was determined by the basis in the stock and a nonmember had never held the note. The court determined that Paul Revere was a member of the Textron group at the time of redemption of the note.

SRLY Overlap Rule Applies to Credits

Issued on June 12, 2000, Treasury decision (TD) 8884 adopted the 1998 temporary regulations, which extended the separate return limitation year (SRLY) subgroup and cumulative principles to business credits and minimum tax credits. TD 8884 also applies the overlap rule introduced as part of the final SRLY regulations [under section 1.1502-21(g)] to these credits. Rules that eliminated SRLY restrictions on the use of foreign tax credits and that repealed the consolidated change of ownership provisions pertaining to those credits were made final. Although there are some special effective dates, the final regulations of TD 8884 generally apply to consolidated return years for which the due date of the income tax return without extensions is after March 13, 1998. Application of the overlap principle is generally effective for consolidated return years for which the return without extension is due after May 25, 2000. (For a detailed discussion of the SRLY rules see “Recent Changes to the SRLY Rules,” by Mary McLaughlin, The CPA Journal, August 1999.)

Product Liability Loss Developments

Two court cases dealt with the 10-year carryback provision for product liability losses in the context of a consolidated return. In United Dominion Industries, Inc. (CA-4, 2000-1 USTC #50,310), a parent corporation’s carryback of a group member’s product liability loss was limited by the member’s separate net operating loss (NOL). The group’s loss was the aggregate of each member’s product liability loss, which could not exceed that member’s separate NOL, regardless of its product liability expenses. In Intermet Corp. v Comm’r (CA-6, April 20, 2000), however, the court held that specified liability expenses incurred by an affiliate of a consolidated group may be carried back when the affiliate has positive separate taxable income for the year in which the expenses were incurred. The court found nothing in the consolidated return regulations to support the position that an affiliate’s specified liability expenses are eliminated when the affiliate has positive separate taxable income.

Editors:

Edwin B. Morris, CPA
Rosenberg, Neuwirth & Kuchner

Robert H. Colson, PhD, CPA
The CPA Journal

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