In addition to IRC Sec. 1504(A)(3)(A), Congress enacted IRC Sec. 1504(a)(3)(B), allowing the IRS to waive the application of IRC Sec. 1504(a)(3)(A). Such a waiver can be obtained through a written request to the IRS (i.e., private letter ruling). The ability to obtain a waiver is important because IRC Sec. 1504(a)(3)(A), on its face, applies to many transactions outside the anti-abuse purpose of the section.

While no proposed, temporary, or final regulations addressing obtaining a waiver have been promulgated, many private letter rulings relating to waivers have been issued. Generally, the IRS has ruled that reconsolidation would be permitted in situations where the disaffiliation/reconsolidation did not secure for the group or member the benefit of any deduction, credit, or allowance that otherwise would not have occurred.

The Reverse Acquisition

One common fact pattern which has generated a considerable number of ruling requests is the reverse acquisition. A reverse acquisition occurs when a common parent corporation ("X corporation") or a subsidiary of X corporation acquires stock or substantially all of the assets of another corporation ("Y corporation") resulting in affiliation with X corporation or its subsidiary, in exchange for stock of X corporation and the stockholders of Y corporation own after the acquisition more than 50% of the fair market value of the outstanding stock of X corporation. The group of which X corporation was the common parent immediately before the acquisition ceases to exist as of the date of the acquisition and any group of which Y corporation is the common parent is treated as remaining in existence, although X corporation nominally becomes the common parent of the continuing group.

Technically, IRC Sec. 1504(a)(3)(A) applies to every reverse acquisition since the acquiring company (X corporation) group ceases to exist as of the date of acquisition and the members of that group are now affiliated in a new group (Y corporation) with the same common parent (X corporation). Although the letter rulings evidence an IRS policy to grant the waiver, the rulings have binding effect only to the taxpayer requesting the ruling, therefore they are of no precedential value to other taxpayers. Consequently, taxpayers subject to IRC Sec. 1504(a)(3)(A) had to either request their own ruling or file on a separate basis. The IRS issued Rev. Proc. 90-53 purporting to solve this problem through an automatic waiver. Rev. Proc. 91-71 was issued clarifying and superseding Rev. Proc. 90-53 effective for any group for which the due date (including extensions of time) of its consolidated return for the taxable year of the group in which the corporation rejoins the group is on or after October 15, 1990 (the issue date of Rev. Proc. 90-53).

In certain situations, Rev. Proc. 91-71 eliminates the need for a waiver altogether. In other circumstances, it makes the waiver automatic, thus eliminating the necessity of administrative costs associated with filing a ruling request to obtain a waiver pursuant to IRC Sec. 1504(a)(3)(B). If the corporation is within the scope of the revenue procedure and it satisfies certain requirements, an automatic waiver is now available. Generally, the revenue procedure applies to a member corporation of a consolidated group that has ceased to be a member of the group and subsequently rejoined the same group (as defined under Reg. 1.1502- 75(d)) before the 61st month beginning after its first tax year in which it ceased to be group member.

Rev. Proc. 91-71 provides that a waiver is not necessary in the following situations where a subsidiary has been reconsolidated after disaffiliation with the same common parent:

Tax-free asset acquisitions from the common parent of the old group in a transaction qualifying under IRC Secs. 368(a)(1)(A), (C), or (D) if the common parent of the new group is the acquiring corporation;

Tax-free asset acquisitions from a member of the new group in a transaction qualifying under IRC Secs. 68(a)(1)(A), (C), or (D) if a member of the old group is the acquiring corporation; or

A reverse acquisition as described in Reg. 1.1502-75(d)(3).

For the rule to apply, the corporation must join in the filing of a consolidated return with the acquiring group if such a group has an election to file consolidated returns in effect. The above situations are described in Rev. Rul. 91-70 issued concurrently with Rev. Proc. 91- 71.

It's Automatic

Under Rev. Proc. 90-71, an automatic waiver is obtained by filing a statement (under penalties of perjury) with the consolidated return of the group. The statement's disclosure must include:

* The business purpose of the transactions that caused the disaffiliation and reconsolidation;

* A schedule which analyzes the effect of the disaffiliation and reconsolidation to the consolidated group and the subsidiary for the year prior to and subsequent to the taxable year in which the subsidiary left the consolidated group, as well as the taxable year in which the subsidiary rejoined the consolidated group for the following items: taxable income, deferred gains and losses, excess loss accounts, tax liability, net operating loss carryovers, capital loss carryovers, and investment and foreign tax credits;

* A representation that neither the consolidated group, the corporation, nor any other person will secure or has secured the benefit of a reduction in income, increase in loss, or any other deduction, credit or allowance that it would not otherwise secure or has secured had the disaffiliation and reconsolidation not occurred, including, but not limited to, the use of a net operating loss or credit that would have otherwise expired; and

* An analysis of the effect of the disaffiliation and reconsolidation on the U.S. taxation of any related party within the meaning of IRC Sec. 6038A(c)(2). The required analysis includes transfers of money or property occurring during the period of disaffiliation involving (directly or indirectly) the corporation seeking the waiver and any reporting corporation or related party, if such transfers are not in the ordinary course of business.

IRC Sec. 6038A(c)(2) defines related parties as foreign shareholders owning 25% of the corporation or any person related to the 25% foreign shareholder, or the corporation through the attribution rules of IRC Sec. 267(b) or IRC Sec. 707(b)(1), or any person related to the reporting corporation through the application of IRC Sec. 482. Although the revenue procedure purports to alleviate the unintended application of IRC Sec. 1504(a)(3)(A) to non-abusive type situations, the disclosure required to satisfy IRC Sec. 6038(A) may convert the well-intended automatic waiver procedure into a cumbersome, time consuming procedure.

The waiver is binding for all subsequent taxable years after the granting of the waiver unless permission is granted under Reg. 1.1502- 75(c)(3) for the entire group to cease filing a consolidated return. The waiver may not be revoked by the taxpayer. However, if it is determined that the information provided is incorrect, the IRS may revoke the waiver at any time beginning with the first taxable year for which the waiver was granted.

The desire to reconsolidate after disaffiliation is based on the premise that the benefits of filing consolidated tax returns outweigh those of separate tax returns. However, the benefit of reconsolidation must be analyzed in light of the potential detriment of the loss disallowance regulations ("LDR") under Reg. 1.1502-20(a), which generally disallows a loss recognized by a member of a consolidated group with respect to the disposition of stock of a subsidiary. Unfortunately, it is less than certain whether the LDR applies to former subsidiaries notwithstanding the absence of a waiver to reconsolidate. This result is due to the fact that when a nonaffiliated subsidiary for which no waiver is obtained is not included in the consolidated return, literally it is still a member of the affiliated group and, therefore, qualifies as a subsidiary under the LDR. |See Lerner, Federal Income Taxation of Corporations Filing Consolidated Returns (Matthew Bender & Co., Inc., 1991) 21.02|9(2)

An Annual Review

Many taxpayers and their advisors have shied away from filing combined returns. While the circumstances permitting the filing of a combined return are limited, it is advisable for taxpayers and their advisors to annually review operations to see if circumstances have changed that would permit the filing of a combined return.