[Federal Register Volume 60, Number 137 (Tuesday, July 18, 1995)]
[Rules and Regulations]
[Pages 36671-36710]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-16973]
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DEPARTMENT OF THE TREASURY
26 CFR Parts 1 and 602
[TD 8597]
RIN 1545-AT58
Consolidated Groups and Controlled Groups--Intercompany
Transactions and Related Rules
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
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SUMMARY: This document contains final regulations amending the
intercompany transaction system of the consolidated return regulations.
The final regulations also revise the regulations under section 267(f),
limiting losses and deductions from transactions between members of a
controlled group. Amendments to other related regulations are also
included in this document.
DATES: These regulations are effective July 18, 1995.
For dates of applicability, see the Effective dates section under
the SUPPLEMENTARY INFORMATION portion of the preamble and the effective
date provisions of the new or revised regulations.
FOR FURTHER INFORMATION CONTACT: Concerning the regulations relating to
consolidated groups generally, Roy Hirschhorn of the Office of
Assistant Chief Counsel (Corporate), (202) 622-7770; concerning stock
and obligations of members of consolidated groups, Victor Penico of the
Office of Assistant Chief Counsel (Corporate), (202) 622-7750;
concerning insurance issues, Gary Geisler of the Office of Assistant
Chief Counsel (Financial Institutions and Products), (202) 622-3970;
concerning international issues, Philip Tretiak of the Office of
Associate Chief Counsel (International), (202) 622-3860; and concerning
controlled groups, Martin Scully, Jr. of the Office of Assistant Chief
Counsel (Income Tax and Accounting), (202) 622-4960. (These numbers are
not toll-free numbers.)
SUPPLEMENTARY INFORMATION:
A. Paperwork Reduction Act
The collections of information contained in these final regulations
have been reviewed and approved by the Office of Management and Budget
in accordance with the requirements of the Paperwork Reduction Act (44
U.S.C. 3504(h)) under control number 1545-1433. The estimated average
annual burden per respondent is .5 hours.
Comments concerning the accuracy of this burden estimate and
suggestions for reducing this burden should be sent to the Internal
Revenue Service, Attn: IRS Reports Clearance Officer, PC:FP,
Washington, DC 20224, and 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.
B. Background
This document contains final regulations under section 1502 of the
Internal Revenue Code of 1986 (Code) that comprehensively revise the
intercompany transaction system of the consolidated return regulations.
Amendments are also made to related regulations, including the
regulations under section 267(f), which apply to transactions between
members of a controlled group.
The proposed regulations were published in the Federal Register on
April 15, 1994 (59 FR 18011). The notice of hearing on the proposed
regulations, Notice 94-49, 1994-1 C.B. 358, 59 FR 18048, contains an
extensive discussion of the issues considered in developing the
proposed regulations. The IRS received many comments on the proposed
regulations and held public hearings on May 4, 1994 and August 8, 1994.
After consideration of the comments and the statements made at the
hearings, the proposed regulations are adopted as revised by this
Treasury decision. The principal comments and revisions are discussed
below. However, a number of other changes have been made to the
proposed regulations. References in the preamble to P, S, and B are
references to the common parent, the selling member, and the buying
member, respectively. No inference is intended as to the operation of
the prior regulations or other rules.
[[Page 36672]]
C. Principal Issues Considered in Adopting the Final Regulations
1. Retention and modification of the deferred sale approach
The proposed regulations generally retain the deferred sale
approach of prior law but comprehensively revise the manner in which
deferral is achieved to eliminate many of the inconsistent combinations
of single and separate entity treatment under prior law.
Notwithstanding these revisions, the results for most common
intercompany transactions remain unchanged.
Commentators uniformly supported the retention of the deferred sale
approach. Some comments, however, suggested that the rules of prior law
should be retained, with modifications only where necessary to address
a specific problem. Since the adoption of the prior regulations in
1966, however, developments in business practice and the tax law have
greatly increased the problems of accounting for intercompany
transactions. Although additional amendments could have been made to
the prior regulations, further amendments would risk raising additional
inconsistencies or uncertainties without providing a unified regime. By
comprehensively revising the intercompany transaction system, the
proposed regulations provide a unified regime and eliminate many of the
inconsistencies of prior law, without changing the results of most
common transactions. The final regulations therefore generally retain
the approach of the proposed regulations.
2. General v. Mechanical Rules
The prior intercompany transaction regulations were generally
mechanical in operation. The proposed regulations rely less on
mechanical rules and, instead, provide broad rules of general
application based on the underlying principles of the regulations. To
supplement the broad rules, the proposed regulations provide examples
illustrating the application of the rules to many common intercompany
transactions.
Some commentators supported the proposed regulations' use of broad
rules based on principles. Others suggested that the final regulations
should retain the mechanical rules of prior law. Mechanical rules
provide more certainty for transactions clearly covered by those rules.
For transactions that are not clearly covered, however, mechanical
rules provide much less guidance.
The final regulations retain the approach of the proposed
regulations. This approach is flexible enough to apply to the wide
range of transactions that can be intercompany transactions. For
example, the final regulations do not require special rules to
coordinate with the depreciation rules under section 168, the
installment reporting rules under sections 453 through 453B, and the
limitations under sections 267, 382, and 469. Flexible rules adapt to
changes in the tax law and reduce the need for continuous updating of
the regulations.
3. Timing Rules of Sec. 1.1502-13 as a Method of Accounting
The proposed regulations provide that ``the timing rules of this
section are a method of accounting that overrides otherwise applicable
accounting methods.'' A group's ability to change the manner of
applying the intercompany transaction regulations is therefore subject
to the generally applicable rules for accounting method changes.
Several comments objected to this treatment.
Commentators pointed out that treating the timing provisions of
these regulations as a group's method of accounting may increase the
burden and complexity of correcting improper applications of the
regulations (for example, necessitating requests for accounting method
changes for the treatment of intercompany transactions). This treatment
also raises questions about members coming into a group and leaving a
group (for example, whether requests to change a method of accounting
are required when a taxpayer becomes, or ceases to be, a member).
Various technical points were also raised as to the effect of a shared
accounting method on each member of a group, the propriety of applying
accounting method rules only to certain transactions or classes of
transactions, the interaction of the intercompany transaction rules
with separate entity accounting methods of members, and the linkage of
the selling member's method of accounting for its intercompany items
with the buying member's method of accounting for its corresponding
items.
The intercompany transaction regulations provide guidance on the
appropriate time for taking into account items of income, deduction,
gain, and loss from intercompany transactions to clearly reflect the
consolidated taxable income of the group. Clear reflection of income is
the central principle of section 446. Under section 446, any treatment
that does or could change the taxable year in which taxable income is
reported is a method of accounting. See Rev. Proc. 92-20, 1992-1 C.B.
685. The timing rules of the intercompany transaction regulations
affect the taxable year in which items from intercompany transactions
are taken into account in the computation of consolidated taxable
income. Accordingly, the timing rules of these regulations are properly
viewed as a method of accounting. Moreover, treating the timing rules
as a method of accounting assures that the provisions will be applied
consistently from year to year under the principles of section 446.
The final regulations retain the general approach of the proposed
regulations, treating the timing rules of Sec. 1.1502-13 as a method of
accounting under section 446. The regulations also contain several
provisions intended to reduce the administrative burden that
commentators believe might result from this treatment. The final
regulations treat the timing rules as an accounting method for
intercompany transactions, to be applied by each member, and not as an
accounting method of the group as a whole. However, an application of
the timing rules of this section to an intercompany transaction will be
considered to clearly reflect income only if the effect of the
transaction on consolidated taxable income is clearly reflected. This
treatment more closely conforms to the general practice of separate
taxpayers having their own methods of accounting, thereby alleviating
technical and administrative issues that were raised with respect to
characterization of the method as the method of the group as a whole,
rather than as the method of each member.
To reduce potential administrative burdens further, the final
regulations generally provide automatic consent under section 446(e) to
the extent changes in method are required when a member enters or
leaves a group. In addition, for the first taxable year of the group to
which the final regulations apply, consent is granted for any changes
in method that are necessary to comply with the final regulations. For
other years, members must obtain the Commissioner's consent to change
their methods of accounting for intercompany transactions under
applicable administrative procedures of section 446(e), currently Rev.
Proc. 92-20. The regulations provide that changes will generally be
effected on a cut-off basis (that is, the new method will apply to
intercompany transactions occurring on or after the first day of the
consolidated return year for which the change is effective). Changes in
methods of accounting for intercompany transactions generally will
otherwise be subject to the terms and conditions of applicable
administrative procedures. The IRS may determine, however, that other
terms and conditions are
[[Page 36673]]
appropriate in the interest of sound tax administration (for example,
if a taxpayer misapplies the regulations to avoid matching S's
intercompany item with B's corresponding item). See section 10 of Rev.
Proc. 92-20.
Paragraph (e)(3) of the final regulations continues the procedure
whereby the common parent may request consent from the IRS to report
intercompany transactions on a separate entity basis. Rev. Proc. 82-36
(1982-1 C.B. 490), which provides procedures for obtaining consent
under the prior regulations, will be updated and revised. Until new
procedures are provided, taxpayers may rely on the principles of Rev.
Proc. 82-36 in making applications under these final regulations.
If consent under paragraph (e)(3) of these regulations is obtained
or revoked, the final regulations provide the Commissioner's consent
under section 446(e) for each member to make any changes in methods of
accounting necessary to conform members' methods of accounting to the
consent or revocation. Any change in method under this provision must
be made as of the beginning of the first year for which the consent (or
revocation of consent) under paragraph (e)(3) is effective.
A group that has received consent under the prior intercompany
transaction regulations not to defer items from deferred intercompany
transactions will be considered to have obtained the consent of the
Commissioner to take items from the same class (or classes) of
intercompany transactions into account on a separate entity basis under
these regulations.
4. Single Entity Treatment of Attributes
a. In General
The prior intercompany transaction system used a deferred sale
approach that treated the members of a consolidated group as separate
entities for some purposes and as a single entity for other purposes.
In general, the amount, location, character, and source of items from
an intercompany transaction were given separate entity treatment, but
the timing of items was determined under rules that produced a single
entity effect.
The matching rule of the proposed regulations expands single entity
treatment by requiring the redetermination of the attributes (such as
character and source) of items to produce a single entity effect.
Several comments supported the broader single entity approach taken by
the proposed regulations. Other comments asked that separate entity
treatment of attributes be retained.
The commentators arguing for retention of separate entity treatment
claimed that single entity treatment does not always result in more
rational tax treatment, and may not reflect the economic results of a
group's activities as accurately as separate entity treatment. They
also argued that taxpayers should have the ability to avoid arbitrary
results or administrative burdens by separately incorporating business
operations. The Treasury and the IRS believe that single entity
treatment of both timing and attributes generally results in a clear
reflection of consolidated taxable income. In particular, single entity
treatment minimizes the effect of an intercompany transaction on
consolidated taxable income. In addition, single entity treatment
minimizes the tax differences between a business structured
divisionally and one structured with separate subsidiaries. The final
regulations therefore retain the approach of the proposed regulations
and generally adopt single entity treatment of attributes.
Nevertheless, in certain situations it may be appropriate to
provide separate entity treatment. The Treasury and the IRS believe
that these situations are relatively rare, and that any exceptions from
single entity treatment should be specifically provided in regulations.
For example, a separate entity election is permitted under Prop. Reg.
Sec. 1.1221-2(d) (published in the Federal Register on July 18, 1994,
59 FR 36394) in the case of certain hedging transactions. See also
Sec. 1.263A-9(g)(5). The Treasury and the IRS welcome comments on other
situations in which this type of relief might be appropriate.
b. Conflict or Allocation of Attributes
The proposed regulations provide specific rules for certain cases
in which separate entity attributes are redetermined under the matching
rule. Some commentators believe that the proposed regulations do not
provide sufficient guidance as to the manner in which these rules are
to be applied. In response to these comments, the attribute
redetermination provisions of the matching rule have been revised.
For example, the regulations have been revised to clarify that the
separate entity attributes of S's intercompany item and B's
corresponding item are redetermined under the matching rule only to the
extent necessary to produce the same effect on consolidated taxable
income as if the intercompany transaction had been between divisions.
Thus, the redetermination is required only to the extent the separate
entity attributes differ from the single entity attributes.
The final regulations generally retain the rule of the proposed
regulations under which the attributes of B's corresponding item
control the attributes of S's intercompany items to the extent the
corresponding and intercompany items offset in amount. However, the
final regulations provide an exception to this rule to the extent its
application would lead to a result that is inconsistent with treating S
and B as divisions of a single corporation. To the extent B's
corresponding item on a separate entity basis is excluded from gross
income or is a noncapital, nondeductible amount (such as a deduction
disallowed under section 265), however, the attribute of B's item will
always control. This assures the proper operation of attribute
limitation provisions contained elsewhere in the regulations.
To the extent B's corresponding item and S's intercompany item do
not offset in amount, the final regulations provide that redetermined
attributes are allocated to S's intercompany item and B's corresponding
item using a method that is reasonable in light of all of the facts and
circumstances, including the purposes of these regulations and any
other rule affected by the attributes of S's items or B's items. This
rule provides taxpayers considerable flexibility to allocate
attributes, but the regulations also provide that an allocation method
will be treated as unreasonable if it is not used consistently by all
members of the group from year to year.
c. Source of Income
Several commentators opposed single entity treatment for
determining the source of income or loss from an intercompany
transaction, arguing that the separate entity treatment under prior law
more accurately measures the source of income of the members of the
group. The final regulations, however, retain the single entity
treatment of source for the same reasons that the single entity
treatment of other attributes is retained. The final regulations modify
the example in the proposed regulations to reflect the changes made to
the attribute allocation rules.
Some comments suggested that a single entity approach would
inappropriately reduce the foreign source income of consolidated groups
that produce a natural resource abroad and sell it to customers within
the United States. For example, assume that one member extracts a
commodity
[[Page 36674]]
abroad and sells it to a second member, with title passing within a
foreign country. The second member sells the commodity to unrelated
customers with title passing in the United States. Assume that the
first member's income is 80 percent of the group's income and would be
treated solely as foreign source income under a separate entity
approach. Under a single entity approach, the intercompany transaction
is treated as occurring between divisions of a single corporation. If
the special sourcing rule for production and sale of natural resources
under the section 863 regulations does not apply because of ``peculiar
circumstances,'' the income of the group will be subject to the so-
called 50/50 rule of the section 863 regulations, and a portion of the
group's foreign source income could be recharacterized as domestic
source. Revisions to the section 863 regulations are being considered
to address these issues. The Treasury and the IRS welcome comments
regarding possible revisions to the section 863 regulations.
Another commentator noted that under the single entity approach, a
pro rata allocation of the group's foreign and U.S. source income (as
illustrated in Example 17 of paragraph (c) of the proposed regulations)
could cause a member that qualified as an ``80/20'' company under
section 861(a)(1)(A) to lose that status. As a result, the member could
be required to withhold Federal income tax on interest payments to a
foreign lender. As indicated above, the final regulations revise the
attribute rules to clarify that a redetermination is made only to the
extent it is necessary to achieve the effect of treating S and B as
divisions of a single corporation and to provide that redetermined
attributes are allocated to S and B using a method that is reasonable
in light of the purposes of Sec. 1.1502-13 and any other affected rule.
Thus, the group is not required to allocate U.S. and foreign source
income on a pro rata basis, and a member that qualifies as an 80/20
company under current law generally need not lose that status solely as
the result of the allocation from a transaction similar to that
described in the example.
Commentators also suggested that the pro rata allocation
methodology of the proposed regulations could be inconsistent with U.S.
income tax treaties that require the United States to treat income that
may be taxed by the treaty partner as derived from sources within the
treaty partner. As revised, the attribute rules do not require the
group to allocate U.S. and foreign source income on a pro rata basis.
Thus, the regulations will generally be consistent with any source
rules contained in U.S. income tax treaties. To the extent, however,
that a U.S. income tax treaty provides benefits to a taxpayer, these
regulations do not prevent a taxpayer from claiming those benefits.
The final regulations expand the example to illustrate the
determination of source if an independent factory or production price
exists, and also for a sale of mixed source property within the group
that is subsequently sold outside the group if, incident to the sale,
services are performed by one member for another member or intangibles
are licensed from one member to another member. Example 18 of paragraph
(c) of the proposed regulations (Example 15 of the final regulations)
addresses the application of section 1248 to intercompany transactions
and has been revised to reflect the changes made to the attribute
allocation provisions. Issue 3 of Rev. Rul. 87-96 (1987-2 C.B. 709)
will no longer be applicable to the extent it is inconsistent with
Example 15 and these regulations.
d. Limitation on attribute redetermination
The proposed regulations contain a provision limiting the treatment
of S's intercompany income or gain as excluded from gross income under
the matching rule to situations in which B's corresponding item is a
deduction or loss that is permanently disallowed directly under other
provisions of the Code or regulations. The final regulations clarify
that the Code or regulations must explicitly provide for the
disallowance of B's deduction or loss. Thus, B's amount that is
realized but not recognized under any provision of the Code or
regulations, such as in a liquidation under section 332, is not
permanently and explicitly disallowed, notwithstanding that the amount
may be considered a corresponding item because it is a ``disallowed or
eliminated amount.''
5. Deemed Items
The proposed regulations provide rules under which certain basis
adjustments are deemed to be items, and certain amounts are deemed not
to be items. Under the proposed regulations an adjustment reflected in
S's basis that is a substitute for an intercompany item is generally
treated as an intercompany item (the ``deemed intercompany item
rule''). An adjustment reflected in B's basis that is a substitute for
a corresponding item is generally treated as a corresponding item (the
``deemed corresponding item rule''). In addition, a deduction or loss
is not treated as an intercompany item or a corresponding item to the
extent it does not reduce basis (the ``amounts not deemed to be items
rule''). Commentators found these rules to be confusing. In addition,
the rules generally overlap with other rules of the proposed
regulations.
For example, the deemed intercompany item rule overlaps with the
rule of the proposed regulations under which S's items must be taken
into account even if they have not yet been taken into account under
S's separate entity accounting method. If, under its method of
accounting, S's income from an intercompany transaction is treated as a
basis reduction, both rules could apply.
Similarly, the deemed corresponding item rule overlaps with the
acceleration rule. S's intercompany item is taken into account under
the acceleration rule to the extent it will not be taken into account
under the matching rule. Thus, an adjustment to B's basis may result in
accelerating S's intercompany item, to the extent the intercompany item
is not reflected in B's basis following the adjustment. Because this is
the same result that would occur under the deemed corresponding item
rule, it is not necessary to treat the basis adjustment as a
corresponding item under the matching rule. For example, B's reduction
in the basis of property acquired from S under section 108(b) will
cause S's intercompany gain to be accelerated to the extent the basis
reduction exceeds S's basis in the property prior to the intercompany
transaction.
The amounts deemed not to be items rule treats certain amounts that
are within the definition of intercompany items as not being
intercompany items to achieve a result consistent with these
regulations and other Code provisions. Commentators indicated that this
rule has limited application, does not achieve its desired effect in
all cases, and is confusing to readers.
For these reasons, the deemed item rules and the amounts deemed not
be items rule have been eliminated in the final regulations. Because
the deemed item rules overlap with other provisions, their effects have
been retained in the final regulations. In addition, to achieve the
intended effect of the amounts deemed not be items rule, the attribute
provisions of the final regulations have been modified to permit the
Commissioner to treat intercompany gain as excluded from gross income
when that treatment is consistent with these regulations and other
applicable provisions of the Code.
[[Page 36675]]
6. The Acceleration Rule
The acceleration rule requires S and B to take into account their
items from an intercompany transaction to the extent the items cannot
be taken into account to produce the effect of treating S and B as
divisions of a single corporation. The acceleration rule applies, for
example, when either S or B leaves the group. Under the proposed
regulations, the attributes of S's items from intercompany property
transactions are determined under the principles of the matching rule
``as if B resold the property to a nonmember affiliate.'' Under this
rule, S's gain from the sale of depreciable property is always treated
as ordinary income under section 1239. This treatment is appropriate if
the property remains in the group, as it would, for example, if the
acceleration rule applies because S leaves the group. Many commentators
objected to this treatment of S's attributes in other situations,
arguing, for example, that if B leaves the group while it still owns
the property, the rules should treat the property as sold to a person
whose relationship to the group is the same as B's relationship to the
group after it becomes a nonmember. The commentators argued that
section 1239 should not apply if B is unrelated.
In response to these comments, the final regulations revise the
acceleration rule to provide that if the property is owned by a
nonmember immediately after the event causing acceleration occurs, S's
attributes are determined under the principles of the matching rule as
if B had sold the property to that nonmember. In applying this rule, if
the nonmember is related for purposes of any provision of the Code or
regulations to any party to the intercompany transaction (or any
related transaction) or to P, the nonmember is treated as related to B
for purposes of that provision. Accordingly, that relationship may
affect the attributes of S's intercompany item.
Under both the prior regulations and the proposed regulations, if S
sells an asset to B at a gain and B then transfers the asset to a
partnership, S's gain is taken into account under the acceleration
rule. Some commentators argued that gain should not be taken into
account, at least to the extent of the member's share of the asset
owned through the partnership, treating the partnership, in effect, as
an aggregate of its partners, rather than as an entity. One commentator
argued that continued deferral would be similar to the treatment
currently available under the remedial allocation method under
Sec. 1.704-3 if appreciated property is transferred to the partnership
without a prior intercompany transfer.
The final regulations retain the rule of the proposed regulations.
One of the purposes of the acceleration rule is to prevent basis
created in an intercompany transaction from affecting nonmembers prior
to the time the group takes into account the transaction that created
the basis. Allowing property that B purchased from S at a gain to be
contributed to a partnership without acceleration would allow the basis
created in the intercompany transaction to be reflected by the
partnership prior to the group taking into account the gain. While
rules could be developed to prevent this basis from affecting
nonmembers in most circumstances, the rules would be unduly complex.
For example, the rules would have to take into account the allocation
of liabilities under section 752 and basis adjustments under section
755. Moreover, these rules would not resemble the remedial allocation
method under Sec. 1.704-3 but instead would more closely resemble the
deferred sale method under the proposed regulations under section
704(c). However, this method was explicitly rejected when final
regulations were issued. See Sec. 1.704-3(a)(1).
7. Transactions Involving Stock of Members
a. Single Entity Treatment of Stock
In contrast to their predominantly single entity approach, the
proposed regulations generally retain separate entity treatment of
stock of members. For example, section 1032, which enables a member to
sell its own stock without recognition of gain or loss, is not extended
to sales of the stock of other members. Notice 94-49 (1994-1 C.B. 358)
discusses the difficulties of extending single entity treatment to
stock.
Several comments recommended greater single entity treatment of
stock. Some recommended a limited approach under which single entity
treatment would apply only to stock of the common parent. Under this
approach section 1032 treatment would be expanded so that any member
could sell stock of the common parent without recognizing any gain or
loss. As a corollary, gain or loss would be recognized when a
corporation owning stock of the common parent joined the group,
treating the stock, in effect, as redeemed.
This suggestion was generally not adopted in the final regulations,
because single entity treatment of P stock would significantly increase
the complexity of the regulations and would require significant
additional guidance dealing with the effect of this treatment on other
provisions of the Code. For example, the regulations would have to
coordinate single entity treatment of P stock with the reorganization
provisions of the Code and applicable case law. Similarly, the
regulations would have to address situations in which the common parent
of the group changes, as well as a variety of collateral consequences.
Nevertheless, the Treasury and the IRS believe that limited single
entity treatment of stock is needed to prevent disparities caused by
separate entity treatment. Therefore, temporary regulations published
elsewhere in this issue of the Federal Register provide a limited
single entity approach to P stock that generally limits the ability of
a group to create loss with respect to P stock and eliminates gain in
certain circumstances. The feasibility of expanding single entity
treatment for stock of members will continue to be studied. Comments
and suggestions on this subject are welcome.
b. Liquidations
The proposed regulations provide that if S sells stock of a
corporation (T) to B and T later liquidates into B in a transaction to
which section 332 applies, S's intercompany gain is taken into account
under the matching rule, even though the T stock is never held by a
nonmember after the intercompany transaction. This treatment is similar
to the treatment under prior regulations and has applied to
liquidations under section 332 since 1966 and to deemed liquidations
under 338(h)(10) since 1986, although the proposed regulations provide
relief not previously available for these transactions.
Some commentators suggested that this rule should be eliminated
because it could lead to two layers of tax inside the consolidated
group. The final regulations, however, retain the rule (with the
elective relief as described below). As more fully explained in Notice
94-49, the location of items within a group is a core principle
underlying the operation of these regulations, which like the prior
regulations, adopt a deferred sale approach, not a carryover basis
approach. Taking intercompany gain into account in the event of a
subsequent nonrecognition transaction is necessary to prevent the
transfer and liquidation of subsidiaries from being used to affect
consolidated taxable income or tax liability by changing the location
of items within a group (a result that would be equivalent to a
[[Page 36676]]
carryover basis system). For example, assume that S has an asset with a
zero basis and a $100 value. The group would like to shift this built-
in gain to B. To do so, S could transfer the asset to T, a newly formed
subsidiary. After the transfer, S has a zero basis in the T stock under
section 358, and T has a zero basis in the asset under section 362. S
then sells the T stock to B for $100 and realizes a $100 gain, which is
not taken into account. T later liquidates into B, which receives the
asset with a zero basis under section 334. If the transaction is not
recharacterized as a direct transfer of assets or is not subject to
adjustment under section 482, and S's gain on the sale of the T stock
is treated as tax-exempt (or if it is indefinitely deferred), the
series of transactions has the effect of a transfer of the asset by S
to B in a carryover basis transaction.
The Treasury and the IRS rejected a carryover basis system for the
reasons detailed in Notice 94-49. While a carryover basis system might
be feasible in limited circumstances, extensive rules to prevent
avoidance transactions would be required. The result would be to burden
the consolidated return regulations with an unworkable combination of
rules for both a deferred sale approach and a carryover basis approach.
Accordingly, the rule of the proposed regulations has been retained.
The regulations have been modified, however, to permit S to determine
the amount of its taxable gain by offsetting intercompany gain with
intercompany loss on shares of stock having the same material terms.
c. Liquidation Relief
The proposed regulations provide elective relief that, in certain
circumstances, eliminates or offsets gain taken into account under the
matching rule as a result of a section 332 liquidation (or a comparable
nonrecognition transaction, such as a downstream merger). In response
to comments, the final regulations broaden the circumstances under
which this relief is available by eliminating the requirements that T
have no minority shareholders and that T not have made substantial
noncash distributions during the previous 12-month period.
The available relief depends on the form of the transaction that
causes S's intercompany gain to be taken into account. In the case of a
liquidation of T under section 332, relief is provided by treating the
formation by B of a new subsidiary (new T) as if it were pursuant to
the same plan or arrangement as the liquidation (thus allowing
treatment as a reorganization if other applicable requirements are
met). The final regulations expand the scope of this relief over that
provided in the proposed regulations by allowing the transfer of assets
to new T to be completed up to 12 months after the timely filing
(including extensions) of the group's return for the year of T's
liquidation, so long as the transaction occurs pursuant to a written
plan, a copy of which is attached to the return. In the case of a
deemed liquidation of T as the result of an election under section
338(h)(10) in connection with B's sale of the T stock to a nonmember,
relief is provided by treating the deemed liquidation as if it were
governed by section 331 instead of section 332. The amount of loss
taken into account on the deemed liquidation is limited to the amount
of the intercompany gain with respect to the T stock that is taken into
account as a result of the deemed liquidation.
Some commentators requested that the relief applicable for a deemed
liquidation resulting from a section 338(h)(10) election be extended to
actual liquidations under section 332--that is, the liquidation would
be a taxable event both to T and to B (with T's gain or loss not
deferred, and B's basis in the T stock adjusted under Sec. 1.1502-32 to
reflect T's gain or loss from the taxable liquidation). This suggestion
was not adopted. The suggestion would result in the group currently
taking into account gain from, and increasing the basis of, property
that continues to be held within the group. Adopting the commentators'
suggestion could give groups the ability to selectively avoid the
deferral of gain on intercompany transactions by instead engaging in
stock sales and liquidations. Such selectivity would be contrary to the
purpose of these regulations and could create the potential for abusive
transactions.
d. Effective Date of Relief Provisions
As proposed, the effective date of the relief provisions follows
the general effective date of the regulations, applying only if both
the intercompany transaction and the triggering event occur in years
beginning after the final regulations are filed with the Federal
Register. Commentators requested retroactive application of the relief
provisions to varying degrees. For example, some commentators suggested
that the relief should extend to transactions after the date the
regulations are finalized. Others suggested that the relief should
apply for any open year.
In response to these comments, the final regulations adopt an
effective date that allows groups to elect to apply the relief
provisions to certain transactions that occur on or after July 12,
1995, regardless of whether the sale of the T stock from S to B
occurred prior to July 12, 1995.
The final regulations neither provide relief for duplicated gains
nor preclude losses taken into account under the prior regulations in
periods prior to the effective date of the regulations. Broader
retroactivity would result in significant additional administrative
burdens for the IRS. In addition to an increase in amended returns,
taxpayers that made elections to avoid triggering S's gain (for
example, under section 338) might seek to revoke these elections.
Revocation of these elections could raise difficult valuation issues
for assets that were disposed of long ago, as well as questions with
respect to other rules that have since been amended. In addition,
relief for prior years would be somewhat arbitrary. For example, many
taxpayers, such as those whose gain was taken into account from a
liquidation of T into B, would be unable to benefit from the relief
(because the relief requires T to be reformed within a limited time
period). By allowing elective relief only for transactions occurring
after the date the regulations are filed, the final regulations provide
the most relief possible without creating these problems.
8. Obligations of Members
a. Deemed Satisfaction and Reissuance
In addition to the general matching provisions, the proposed
regulations provide rules applicable to intercompany obligations that
generally operate to match an obligor's items with an obligee's items
from intercompany obligations. This matching results from a deemed
satisfaction and reissuance of an intercompany obligation when either
member realizes income or loss with respect to the intercompany
obligation from the assignment or extinguishment of all or part of the
remaining rights or obligations under the intercompany obligation, or
from a comparable transaction, such as marking to market. For example,
if one member is a dealer in securities that holds a security issued by
another member, the dealer might be required to market the security
issued by the other member at year-end under section 475. Under the
proposed regulations, to market the other member's security will result
in a deemed satisfaction and reissuance of the security, so that the
marking member and the issuing member take offsetting gain and loss
into account.
Commentators objected to the deemed satisfaction and reissuance
provision as requiring significant recordkeeping and
[[Page 36677]]
burdensome computations that are not required for financial statement
or internal management reporting purposes. Commentators suggested that
Prop. Reg. Sec. 1.446-4(e)(9) (published in the Federal Register on
July 18, 1994, 59 FR 36394), which permits separate entity treatment
for certain hedging transactions between members, should be extended
beyond hedging transactions to other intercompany obligations, provided
one party to the transaction marks its position to market. Separate
entity treatment would avoid the deemed satisfaction and reissuance
rule if one member is a dealer in securities required to mark its
securities to market.
The final regulations do not adopt this suggestion. The rules of
Sec. 1.446-4 limit the nonmarking member's ability to selectively
recognize gain or loss on its position in the intercompany obligation.
Without a limitation of this type, separate entity treatment would
allow taxpayers to achieve results that are contrary to the purposes of
these regulations (for example, by allowing a member to mark a loss
position in an intercompany obligation while the other member defers
realization of the associated gain). Accordingly, separate entity
treatment is not made available in the final regulations to other types
of intercompany obligations.
The Treasury and the IRS recognize that Prop. Reg. Sec. 1.446-
4(e)(9) provides an important exception to the general single entity
treatment of these final regulations. The Treasury and the IRS
anticipate that the proposed section 446 regulations will be finalized
shortly.
b. Cancellation of Intercompany Indebtedness
The proposed regulations do not affect the application of section
108 to the cancellation of intercompany indebtedness. For example,
under the proposed regulations if S loans money to B, a cancellation of
the loan subject to section 108(a) may result in: (i) excluded income
to B; (ii) a noncapital, nondeductible expense to S (under the matching
rule); and (iii) a reduction of B's tax attributes (such as its basis
in depreciable property). As a result, B's tax attributes are reduced
even though the group has not excluded any income on a net basis.
Accordingly, the final regulations provide that section 108(a) does not
apply to the cancellation of intercompany indebtedness. As a result of
this change, the general principles of the matching rule will prevent
transactions to which section 108(a) would otherwise apply from having
inappropriate effects on basis and consolidated taxable income. In the
preceding example, S and B will have offsetting ordinary income and
ordinary loss, and B's tax attributes will not be reduced. However, no
inference is intended as to whether the extinguishment of a loan
between S and B would be properly characterized as a transaction giving
rise to cancellation of indebtedness income within the meaning of
sections 61(a)(12) and 108, or as a contribution to capital, a dividend
or other transaction.
c. Obligations Becoming Intercompany Obligations
Under the proposed regulations, if an obligation becomes an
intercompany obligation, it is treated as satisfied and reissued
immediately after the obligation becomes an intercompany obligation.
This treatment applies to both the issuer and the holder. The
attributes of the issuer's items and the holder's items are separately
determined, and thus may not match. Commentators requested that the
rules be revised to allow for single entity treatment of attributes, to
avoid the mismatch of ordinary income with capital loss.
This suggestion was not adopted. The use of separate return
attributes for gain and loss assures that the attributes of gain or
loss will be the same whether the obligation is retired immediately
before the transaction in which the obligation becomes an intercompany
obligation, or is deemed retired as a result of that transaction.
Providing for the use of single entity attributes would result in undue
selectivity. In addition, the separate entity treatment of attributes
in these circumstances best reflects the fact that the income and loss
taken into account accrued before the issuer and the holder joined in
filing a consolidated return.
Commentators also noted that, under Sec. 1.1502-32, downward stock
basis adjustments would be required upon the expiration of any capital
losses created by the deemed satisfaction if a member joins the group
while holding an obligation of another member. Because the proposed
regulations provide that the deemed satisfaction and reissuance is
treated as occurring immediately after the obligation becomes an
intercompany obligation, these losses could not be waived under
Sec. 1.1502-32(b)(4). In response to this comment, the final
regulations provide that, solely for purposes of Sec. 1.1502-32(b)(4)
and the effect of any elections under that provision, the joining
member's loss from the deemed satisfaction and reissuance is treated as
a loss carryover from a separate return limitation year. Thus, the
group may elect to waive the capital losses and avoid the downward
basis adjustment.
d. Warrants and Similar Instruments
The proposed regulations do not provide special rules for the
treatment of warrants to acquire a member's stock. The proposed
regulations could, however, be read to include warrants within the
definition of intercompany obligations.
Under section 1032, warrants and other positions in stock of the
issuer are treated like stock. See, for example, Rev. Rul. 88-31, 1988-
1 C.B. 302. The treatment of warrants as intercompany obligations
subject to a single entity regime is inconsistent with the general
separate entity treatment of stock under these regulations.
Accordingly, the final regulations provide that warrants and other
positions with respect to a member's stock are not treated as
obligations of that member. Instead, these instruments are governed by
the rules generally applicable to stock of a member. In addition, the
final regulations provide that the deemed satisfaction and reissuance
rule for intercompany obligations will not apply to the conversion of
an intercompany obligation into the stock of the obligor.
9. Anti-avoidance Rule
The purpose of the intercompany transaction regulations is to
clearly reflect the taxable income (and tax liability) of the group as
a whole by preventing intercompany transactions from creating,
accelerating, avoiding, or deferring consolidated taxable income (or
consolidated tax liability). The proposed regulations provide that
transactions which are engaged in or structured with a principal
purpose to achieve a contrary result are subject to adjustment under
the anti-avoidance rule, notwithstanding compliance with other
applicable authorities. Some commentators criticized this rule as being
overly broad, unnecessary, and more appropriately placed in other
regulations, such as Sec. 1.701-2 (the partnership anti-abuse
regulation). Other commentators supported the use of anti-avoidance
rules but criticized the particular examples. The Treasury and the IRS
continue to believe that the anti-avoidance rule is necessary to
prevent transactions that are designed to achieve results inconsistent
with the purpose of the regulations and therefore the final regulations
retain the rule. Routine intercompany transactions that are undertaken
for legitimate business purposes generally will be unaffected by the
anti-avoidance rule.
The anti-avoidance provision can apply to transactions that are
structured
[[Page 36678]]
to avoid treatment as intercompany transactions. For example, if
property is indirectly transferred from one member to another using a
nonmember intermediary to achieve a result that could not be achieved
by a direct transfer within the group, the anti-avoidance rule might
apply. Thus, transactions that take place indirectly between members
but are not intercompany transactions (including, for example,
transactions involving the use of fungible property, trusts,
partnerships, and intermediaries) will be analyzed to determine whether
they are substantially similar (in whole or in part) to an intercompany
transaction, in which case the anti-avoidance rule might apply.
The examples from the proposed regulations have been revised to
better illustrate the effect of the anti-avoidance rule. Example 2 of
the proposed regulations, which involved a transfer outside of the
group to a partnership, has been eliminated. However, the transaction
described in that example, as with any other transaction, is subject to
challenge under other authorities. See, for example, Sec. 1.701-2.
10. Transitional Anti-avoidance Rule
To prevent manipulation, the proposed regulations provide that if a
transaction is engaged in or structured on or after April 8, 1994, with
a principal purpose to avoid the final regulations, to duplicate, omit,
or eliminate an item in determining taxable income (or tax liability),
or to treat items inconsistently, appropriate adjustments must be made
in years to which the final regulations apply to prevent the avoidance,
duplication, omission, elimination, or inconsistency.
Commentators objected to this rule, arguing that it had the effect
of treating the proposed regulation as an immediately effective
temporary regulation. These commentators also raised questions as to
when the rule applies and what ``appropriate adjustments'' will be
necessary.
Because of the prospective application of the regulations, and
particularly because members could otherwise engage in transactions
entirely within the group with a principal purpose to avoid the
application of the final regulations with almost no transaction costs,
this rule is retained in the final regulations, with minor
clarifications.
11. Dealers in Securities
If S is a dealer in securities under section 475 and sells
securities to B, a nondealer, the proposed regulations require S to
treat any gain or loss on the sale as an intercompany item.
Furthermore, under the single entity approach of the matching rule, B
must continue to mark to market securities acquired from S.
Several commentators argued that this approach is inconsistent with
proposed regulations under section 475, which require S to mark to
market the security immediately before the transfer, and take any gain
or loss into account immediately (that is, the gain or loss is not
subject to deferral under the prior intercompany transaction
regulations).
Although the rules applicable to these types of transactions under
the proposed regulations and the proposed section 475 regulations
differ, the effects of these transactions on consolidated taxable
income are generally the same. That is, the dealer's gain or loss is
taken into account in the taxable year of the transfer.
The approach of the proposed intercompany transaction regulations
is consistent with the general single entity principle, and has been
retained in the final regulations. Nevertheless, the Treasury and the
IRS will continue to consider the most appropriate treatment of these
transactions, in view of the underlying purposes of these regulations
and section 475. The Treasury and the IRS anticipate that upcoming
regulations under section 475 will address any remaining
inconsistencies in the approach, and will provide exceptions to the
single entity approach if appropriate. Comments and suggestions on this
subject are welcome.
12. Changes to Section 267 Regulations
The proposed regulations under section 267(f) generally provide
that losses from sales or exchanges of property between related parties
are taken into account in the same manner as is provided in the timing
provisions of the regulations under Sec. 1.1502-13. Several technical
changes have been incorporated into the final regulations under section
267.
For example, the regulations clarify that to the extent S's loss
would have been treated as a noncapital, nondeductible amount under the
attribute rules of the regulations under Sec. 1.1502-13, the loss is
deferred under section 267(f) until S and B are no longer in a
controlled group relationship with each other. Section 267 is intended
to prevent a taxpayer from taking a loss into account from the sale or
exchange of property when the property continues to be held by a member
of the same controlled group. Under Sec. 1.1502-13, S's loss might be
taken into account but redetermined to be noncapital or nondeductible,
permanently preventing the loss from being taken into account. It could
be argued that this is the result of the attribute provisions of
Sec. 1.1502-13, which do not apply under section 267(f), not a result
of the timing provisions of Sec. 1.1502-13, and thus, a controlled
group member could take its loss into account. The change made in the
final regulations assures that the purpose of section 267 is not
defeated as a result of the non-application of the attribute
redetermination rules of Sec. 1.1502-13 for purposes of section 267(f).
The proposed regulations also require loss deferral similar to
section 267(d) when B transfers property acquired at a loss from S to a
nonmember related party. This provision has been modified in the final
regulations to include parties described in section 707(b) as related
parties to prevent avoidance of the rules of section 267 through the
use of related partnerships.
13. Election to Deconsolidate
Section 1.1502-75 authorizes the Commissioner to grant all groups,
or groups in a particular class, permission to discontinue filing
consolidated returns if any provision of the Code or regulations has
been amended and the amendment could have a substantial adverse effect
relative to the filing of separate returns. The Commissioner has
determined that it is generally appropriate to grant permission to
discontinue filing consolidated returns as a result of the amendments
made in these regulations. To lessen taxpayer burden and ease
administrability, permission will be granted without requiring the
group to demonstrate any adverse effect. The Treasury and the IRS
intend to issue, prior to January 1, 1996, a revenue procedure pursuant
to which groups may receive permission to deconsolidate effective for
their first taxable year to which these regulations apply. Permission
for a group to deconsolidate will be granted under terms and conditions
similar to those prescribed in Rev. Proc. 95-11 (1995-4 I.R.B. 48).
D. Effective Dates
The regulations are effective in years beginning on or after July
12, 1995. For dates of applicability, see Sec. 1.1502-13(l).
E. Special Analyses
It has been determined that this Treasury Decision is not a
significant regulatory action as defined in EO 12866. Therefore, a
regulatory assessment is not required. It is hereby certified that
these regulations do not have a significant economic impact on
[[Page 36679]]
a substantial number of small entities. This certification is based on
the fact that these regulations will primarily affect affiliated groups
of corporations that have elected to file consolidated returns, which
tend to be larger businesses. The regulations also govern certain
transactions between members of controlled groups of corporations, but
generally produce the same results for such transactions as current
law. The regulations do not significantly alter the reporting or
recordkeeping duties of small entities. Therefore, a Regulatory
Flexibility Analysis under the Regulatory Flexibility Act (5 U.S.C.
chapter 6) is not required. Pursuant to section 7805(f) of the Internal
Revenue Code, the notice of proposed rulemaking preceding these
regulations was submitted to the Small Business Administration for
comment on its impact on small business.
List of Subjects
26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
26 CFR Part 602
Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
Accordingly, 26 CFR parts 1 and 602 are amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 is amended by
revising the entries for Secs. 1.1502-13, 1.1502-33, and 1.1502-80, as
set forth below; by removing the entries for sections ``1.469-1'',
``1.469-1T'', ``1.1502-13T'', ``1.1502-14'', and ``1.1502-14T''; and
adding the remaining entries in numerical order to read as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.108-3 also issued under 26 U.S.C. 108, 267, and 1502. * *
*
Section 1.267(f)-1 also issued under 26 U.S.C. 267 and 1502. * * *
Section 1.460-4 also issued under 26 U.S.C. 460 and 1502. * * *
Section 1.469-1 also issued under 26 U.S.C. 469. * * *
Section 1.469-1T also issued under 26 U.S.C. 469. * * *
Section 1.1502-13 also issued under 26 U.S.C. 108, 337, 446, 1275,
1502 and 1503. * * *
Section 1.1502-17 also issued under 26 U.S.C. 446 and 1502.
Section 1.1502-18 also issued under 26 U.S.C. 1502. * * *
Section 1.1502-26 also issued under 26 U.S.C. 1502. * * *
Section 1.1502-33 also issued under 26 U.S.C. 1502. * * *
Section 1.1502-79 also issued under 26 U.S.C. 1502. * * *
Section 1.1502-80 also issued under 26 U.S.C. 1502. * * *
Par. 2. In the list below, for each location indicated in the left
column, remove the language in the middle column from that section, and
add the language in the right column.
------------------------------------------------------------------------
Affected section Remove Add
------------------------------------------------------------------------
1.167(a)-(11)(d)(3)(v)( which results in
b), 1st sentence. ``deferred gain or
loss'' within the
meaning of paragraph
(c) of 1.1502-13.
1.167(c)-1(a)(5)....... , 1.1502-13, and 1.1502- and 1.1502-13
14.
1.263A-1T(b)(2)(vi)(B), a deferred intercompany an intercompany
2nd sentence. transaction. transaction
1.263A-1T(e)(1)(ii), a deferred intercompany an intercompany
1st sentence. transaction. transaction
1.263A-1T(e)(1)(ii), 1.1502-13(c)(2)........ 1.1502-13
4th sentence.
1.263A-1T(e)(1)(ii), deferred...............
4th sentence.
1.263A-1T(e)(1)(ii), ''deferred intercompany ``intercompany
7th sentence. transaction''. transaction''
1.263A-1T(e)(1)(ii), defined................ as used
7th sentence.
1.263A-1T(e)(1)(iii)(A) 1.1502-13(c)........... 1.1502-13
Example, 2nd sentence.
1.263A-1T(e)(1)(iii)(A) 1.1502-13(c)........... 1.1502-13
Example, 4th sentence.
1.279-6(b)(4).......... , Sec. 1.1502-13T,
Sec. 1.1502-14, or
Sec. 1.1502-14T.
1.337(d)-1(a)(5) 1.1502-13(c)........... 1.1502-13
Example 8(i), 5th
sentence.
1.337(d)-1(a)(5) 1.1502-13(c)........... 1.1502-13
Example 8(ii), 1st
sentence.
1.337(d)-1(a)(5) 1.1502-13(f)(1)(i), 1.1502-13, 1.267(f)-1
Example 8(ii), 2nd 1.267(f)-2T(e)(1).
sentence.
1.337(d)-2(g)(1), 2nd 1.1502-13T, 1.1502-14, and 1.1502-14 (as
sentence. and 1.1502-14T. contained in the 26
CFR part 1 edition
revised as of April
1, 1995)
1.338-4(f)(4) Example 1.1502-13(f)........... 1.1502-13
(2)(a).
1.341-7(e)(10)......... paragraph (c)(1) of Sec. 1.1502-13 for
Sec. 1.1502-14 for the treatment
the deferral.
1.861-8T(d)(2)(i), 1.1502-13(c)(2)........ 1.1502-13
concluding text.
1.861-8T(d)(2)(i), deferred...............
concluding text.
1.861-8T(d)(2)(i), 1.1502-13(a)(2)........ 1.1502-13
concluding text.
1.861-9T(g)(2)(iv), deferred...............
paragraph heading.
1.861-9T(g)(2)(iv), 1st deferred intercompany intercompany
sentence. transactions. transactions
1.1502-3(a)(2)......... 1.1502-13(a)(1)........ 1.1502-13(b)
1.1502-4(j) Example Under Sec. 1.1502-13.. Under Sec. 1.1502-13
(1), 8th sentence. (as contained in the
26 CFR part 1 edition
revised as of April
1, 1995)
1.1502-9(f) Example (6) a restoration event the intercompany gain
under section 1.1502- is taken into account
13(f) occurs. under Sec. 1.1502-13
1.1502-12(a)........... Secs. 1.1502-13 and Sec. 1.1502-13
1.1502-14.
1.1502-12(g)(2)........ a deferred intercompany an intercompany
transaction as defined transaction as
in Sec. 1.1502- defined in Sec.
13(a)(2). 1.1502-13
1.1502-22(a)(3)........ 1.1502-14,.............
1.1502-22(a)(5) Example paragraph (d), (e), or Sec. 1.1502-13
(i). (f) of Sec. 1.1502-13.
1.1502-26(b), second paragraph (a)(1) of Sec. 1.1502-13
sentence. Sec. 1.1502-14.
1.1502-47(e)(4)(iii), Secs. 1.1502-13(f), Secs. 1.1502-13,
first sentence. 1.1502-14,.
1.1502-47(e)(4)(iv) deferred intercompany intercompany
Example 4, third transactions (see Sec. transactions (see
sentence. 1.1502-13(a)(2)). Sec. 1.1502-13)
1.1502-47(e)(4)(iv) 1.1502-13(f)(1)(iv).... 1.1502-13
Example 4, fourth
sentence.
1.1502-47(e)(4)(iv) Deferred intercompany Intercompany
Example 4, chart transactions between. transactions between
header.
[[Page 36680]]
1.1502-47(e)(4)(iv) 1.1502-13(f)(1)(iv).... 1.1502-13
Example 4, chart
header.
1.1502-47(f)(3), first 1.1502-14,.............
sentence.
1.1502-47(r), second deferred...............
sentence.
1.1503-2(d)(4) Example deferred...............
1 (iii), fourth
sentence.
1.1503-2(d)(4) Example 1.1502-13(a)(2)........ 1.1502-13
1 (iii), fourth
sentence.
1.1552-1(a)(2)(ii)(c).. 1.1502-14.............. 1.1502-13 (f) and (g)
------------------------------------------------------------------------
Par. 3. Section 1.108-3 is added to read as follows:
Sec. 1.108-3 Intercompany losses and deductions.
(a) General rule. This section applies to certain losses and
deductions from the sale, exchange, or other transfer of property
between corporations that are members of a consolidated group or a
controlled group (an intercompany transaction). See section 267(f)
(controlled groups) and Sec. 1.1502-13 (consolidated groups) for
applicable definitions. For purposes of determining the attributes to
which section 108(b) applies, a loss or deduction not yet taken into
account under section 267(f) or Sec. 1.1502-13 (an intercompany loss or
deduction) is treated as basis described in section 108(b) that the
transferor retains in property. To the extent a loss not yet taken into
account is reduced under this section, it cannot subsequently be taken
into account under section 267(f) or Sec. 1.1502-13. For example, if S
and B are corporations filing a consolidated return, and S sells land
with a $100 basis to B for $90 and the $10 loss is deferred under
section 267(f) and Sec. 1.1502-13, the deferred loss is treated for
purposes of section 108(b) as $10 of basis that S has in land (even
though S has no remaining interest in the land sold to B) and is
subject to reduction under section 108(b)(2)(E). Similar principles
apply, with appropriate adjustments, if S and B are members of a
controlled group and S's loss is deferred only under section 267(f).
(b) Effective date. This section applies with respect to discharges
of indebtedness occurring on or after September 11, 1995.
Sec. 1.167(a)-11 [Amended]
Par. 4. Section 1.167(a)-11(d)(3)(v)(e) is amended by removing the
second sentence of Example (3).
Par. 5. In Sec. 1.263A-1, paragraph (j)(1)(ii)(B), the last
sentence is revised to read as follows:
Sec. 1.263A-1 Uniform capitalization of costs.
* * * * *
(j) * * *
(1) * * *
(ii) * * *
(B) * * * See Sec. 1.1502-13.
* * * * *
Par. 6. Section 1.267(f)-1 is revised to read as follows:
Sec. 1.267(f)-1 Controlled groups.
(a) In general--(1) Purpose. This section provides rules under
section 267(f) to defer losses and deductions from certain transactions
between members of a controlled group (intercompany sales). The purpose
of this section is to prevent members of a controlled group from taking
into account a loss or deduction solely as the result of a transfer of
property between a selling member (S) and a buying member (B).
(2) Application of consolidated return principles. Under this
section, S's loss or deduction from an intercompany sale is taken into
account under the timing principles of Sec. 1.1502-13 (intercompany
transactions between members of a consolidated group), treating the
intercompany sale as an intercompany transaction. For this purpose:
(i) The matching and acceleration rules of Sec. 1.1502-13 (c) and
(d), the definitions and operating rules of Sec. 1.1502-13 (b) and (j),
and the simplifying rules of Sec. 1.1502-13(e)(1) apply with the
adjustments in paragraphs (b) and (c) of this section to reflect that
this section--
(A) Applies on a controlled group basis rather than consolidated
group basis; and
(B) Generally affects only the timing of a loss or deduction, and
not it's attributes (e.g., its source and character) or the holding
period of property.
(ii) The special rules under Sec. 1.1502-13(f) (stock of members)
and (g) (obligations of members) apply under this section only to the
extent the transaction is also an intercompany transaction to which
Sec. 1.1502-13 applies.
(iii) Any election under Sec. 1.1502-13 to take items into account
on a separate entity basis does not apply under this section. See
Sec. 1.1502-13(e)(3).
(3) Other law. The rules of this section apply in addition to other
applicable law (including nonstatutory authorities). For example, to
the extent a loss or deduction deferred under this section is from a
transaction that is also an intercompany transaction under Sec. 1.1502-
13(b)(1), attributes of the loss or deduction are also subject to
recharacterization under Sec. 1.1502-13. See also, sections 269
(acquisitions to evade or avoid income tax) and 482 (allocations among
commonly controlled taxpayers). Any loss or deduction taken into
account under this section can be deferred, disallowed, or eliminated
under other applicable law. See, for example, section 1091 (loss
eliminated on wash sale).
(b) Definitions and operating rules. The definitions in
Sec. 1.1502-13(b) and the operating rules of Sec. 1.1502-13(j) apply
under this section with appropriate adjustments, including the
following:
(1) Intercompany sale. An intercompany sale is a sale, exchange, or
other transfer of property between members of a controlled group, if it
would be an intercompany transaction under the principles of
Sec. 1.1502-13, determined by treating the references to a consolidated
group as references to a controlled group and by disregarding whether
any of the members join in filing consolidated returns.
(2) S's losses or deductions. Except to the extent the intercompany
sale is also an intercompany transaction to which Sec. 1.1502-13
applies, S's losses or deductions subject to this section are
determined on a separate entity basis. For example, the principles of
Sec. 1.1502-13(b)(2)(iii) (treating certain amounts not yet recognized
as items to be taken into account) do not apply. A loss or deduction is
from an intercompany sale whether it is directly or indirectly from the
intercompany sale.
(3) Controlled group; member. For purposes of this section, a
controlled group is defined in section 267(f). Thus, a controlled group
includes a FSC (as defined in section 922) and excluded members under
section 1563(b)(2), but does not include a DISC (as defined in section
992). Corporations remain members of a controlled group as long as they
remain in a controlled group relationship with each other. For example,
corporations become nonmembers with respect to each other when they
cease to be in a controlled group relationship with each other, rather
than by having a separate return year (described in Sec. 1.1502-
13(j)(7)).
[[Page 36681]]
Further, the principles of Sec. 1.1502-13(j)(6) (former common parent
treated as continuation of group) apply to any corporation if,
immediately before it becomes a nonmember, it is both the selling
member and the owner of property with respect to which a loss or
deduction is deferred (whether or not it becomes a member of a
different controlled group filing consolidated or separate returns).
Thus, for example, if S and B merge together in a transaction described
in section 368(a)(1)(A), the surviving corporation is treated as the
successor to the other corporation, and the controlled group
relationship is treated as continuing.
(4) Consolidated taxable income. References to consolidated taxable
income (and consolidated tax liability) include references to the
combined taxable income of the members (and their combined tax
liability). For corporations filing separate returns, it ordinarily
will not be necessary to actually combine their taxable incomes (and
tax liabilities) because the taxable income (and tax liability) of one
corporation does not affect the taxable income (or tax liability) of
another corporation.
(c) Matching and acceleration principles of Sec. 1.1502-13--(1)
Adjustments to the timing rules. Under this section, S's losses and
deductions are deferred until they are taken into account under the
timing principles of the matching and acceleration rules of
Sec. 1.1502-13(c) and (d) with appropriate adjustments. For example, if
S sells depreciable property to B at a loss, S's loss is deferred and
taken into account under the principles of the matching rule of
Sec. 1.1502-13(c) to reflect the difference between B's depreciation
taken into account with respect to the property and the depreciation
that B would take into account if S and B were divisions of a single
corporation; if S and B subsequently cease to be in a controlled group
relationship with each other, S's remaining loss is taken into account
under the principles of the acceleration rule of Sec. 1.1502-13(d). For
purposes of this section, the adjustments to Sec. 1.1502-13 (c) and (d)
include the following:
(i) Application on controlled group basis. The matching and
acceleration rules apply on a controlled group basis, rather than a
consolidated group basis. Thus if S and B are wholly-owned members of a
consolidated group and 21% of the stock of S is sold to an unrelated
person, S's loss continues to be deferred under this section because S
and B continue to be members of a controlled group even though S is no
longer a member of the consolidated group. Similarly, S's loss would
continue to be deferred if S and B remain in a controlled group
relationship after both corporations become nonmembers of their former
consolidated group.
(ii) Different taxable years. If S and B have different taxable
years, the taxable years that include a December 31 are treated as the
same taxable years. If S or B has a short taxable year that does not
include a December 31, the short year is treated as part of the
succeeding taxable year that does include a December 31.
(iii) Transfer to a section 267(b) or 707(b) related person. To the
extent S's loss or deduction from an intercompany sale of property is
taken into account under this section as a result of B's transfer of
the property to a nonmember that is a person related to any member,
immediately after the transfer, under sections 267(b) or 707(b), or as
a result of S or B becoming a nonmember that is related to any member
under section 267(b) (for example, if S or B becomes an S corporation),
the loss or deduction is taken into account but allowed only to the
extent of any income or gain taken into account as a result of the
transfer. The balance not allowed is treated as a loss referred to in
section 267(d) if it is from a sale or exchange by B (rather than from
a distribution).
(iv) B's item is excluded from gross income or noncapital and
nondeductible. To the extent S's loss would be redetermined to be a
noncapital, nondeductible amount under the principles of Sec. 1.1502-13
but is not redetermined because of paragraph (c)(2) of this section,
then, if paragraph (c)(1)(iii) of this section does not apply, S's loss
continues to be deferred and is not taken into account until S and B
are no longer in a controlled group relationship. For example, if S
sells all of the stock of corporation T to B at a loss and T
subsequently liquidates into B in a transaction qualifying under
section 332, S's loss is deferred until S and B (including their
successors) are no longer in a controlled group relationship. See
Sec. 1.1502-13(c)(6)(ii).
(v) Circularity of references. References to deferral or
elimination under the Internal Revenue Code or regulations do not
include references to section 267(f) or this section. See, e.g.,
Sec. 1.1502-13(a)(4) (applicability of other law).
(2) Attributes generally not affected. The matching and
acceleration rules are not applied under this section to affect the
attributes of S's intercompany item, or cause it to be taken into
account before it is taken into account under S's separate entity
method of accounting. However, the attributes of S's intercompany item
may be redetermined, or an item may be taken into account earlier than
under S's separate entity method of accounting, to the extent the
transaction is also an intercompany transaction to which Sec. 1.1502-13
applies. Similarly, except to the extent the transaction is also an
intercompany transaction to which Sec. 1.1502-13 applies, the matching
and acceleration rules do not apply to affect the timing or attributes
of B's corresponding items.
(d) Intercompany sales of inventory involving foreign persons--(1)
General rule. Section 267(a)(1) and this section do not apply to an
intercompany sale of property that is inventory (within the meaning of
section 1221(1)) in the hands of both S and B, if--
(i) The intercompany sale is in the ordinary course of S's trade or
business;
(ii) S or B is a foreign corporation; and
(iii) Any income or loss realized on the intercompany sale by S or
B is not income or loss that is recognized as effectively connected
with the conduct of a trade or business within the United States within
the meaning of section 864 (unless the income is exempt from taxation
pursuant to a treaty obligation of the United States).
(2) Intercompany sales involving related partnerships. For purposes
of paragraph (d)(1) of this section, a partnership and a foreign
corporation described in section 267(b)(10) are treated as members,
provided that the income or loss of the foreign corporation is
described in paragraph (d)(1)(iii) of this section.
(3) Intercompany sales in ordinary course. For purposes of this
paragraph (d), whether an intercompany sale is in the ordinary course
of business is determined under all the facts and circumstances.
(e) Treatment of a creditor with respect to a loan in nonfunctional
currency. Sections 267(a)(1) and this section do not apply to an
exchange loss realized with respect to a loan of nonfunctional currency
if--
(1) The loss is realized by a member with respect to nonfunctional
currency loaned to another member;
(2) The loan is described in Sec. 1.988-1(a)(2)(i);
(3) The loan is not in a hyperinflationary currency as defined in
Sec. 1.988-1(f); and
(4) The transaction does not have as a significant purpose the
avoidance of Federal income tax.
(f) Receivables. If S acquires a receivable from the sale of goods
or services to a nonmember at a gain, and S sells the receivable at
fair market
[[Page 36682]]
value to B, any loss or deduction of S from its sale to B is not
deferred under this section to the extent it does not exceed S's income
or gain from the sale to the nonmember that has been taken into account
at the time the receivable is sold to B.
(g) Earnings and profits. A loss or deduction deferred under this
section is not reflected in S's earnings and profits before it is taken
into account under this section. See, e.g., Secs. 1.312-6(a), 1.312-7,
and 1.1502-33(c)(2).
(h) Anti-avoidance rule. If a transaction is engaged in or
structured with a principal purpose to avoid the purposes of this
section (including, for example, by avoiding treatment as an
intercompany sale or by distorting the timing of losses or deductions),
adjustments must be made to carry out the purposes of this section.
(i) [Reserved]
(j) Examples. For purposes of the examples in this paragraph (j),
unless otherwise stated, corporation P owns 75% of the only class of
stock of subsidiaries S and B, X is a person unrelated to any member of
the P controlled group, the taxable year of all persons is the calendar
year, all persons use the accrual method of accounting, tax liabilities
are disregarded, the facts set forth the only activity, and no member
has a special status. If a member acts as both a selling member and a
buying member (e.g., with respect to different aspects of a single
transaction, or with respect to related transactions), the member is
referred as to M (rather than as S or B). This section is illustrated
by the following examples.
Example 1. Matching and acceleration rules. (a) Facts. S holds
land for investment with a basis of $130. On January 1 of Year 1, S
sells the land to B for $100. On a separate entity basis, S's loss
is long-term capital loss. B holds the land for sale to customers in
the ordinary course of business. On July 1 of Year 3, B sells the
land to X for $110.
(b) Matching rule. Under paragraph (b)(1) of this section, S's
sale of land to B is an intercompany sale. Under paragraph (c)(1) of
this section, S's $30 loss is taken into account under the timing
principles of the matching rule of Sec. 1.1502-13(c) to reflect the
difference for the year between B's corresponding items taken into
account and the recomputed corresponding items. If S and B were
divisions of a single corporation and the intercompany sale were a
transfer between the divisions, B would succeed to S's $130 basis in
the land and would have a $20 loss from the sale to X in Year 3.
Consequently, S takes no loss into account in Years 1 and 2, and
takes the entire $30 loss into account in Year 3 to reflect the $30
difference in that year between the $10 gain B takes into account
and its $20 recomputed loss. The attributes of S's intercompany
items and B's corresponding items are determined on a separate
entity basis. Thus, S's $30 loss is long-term capital loss and B's
$10 gain is ordinary income.
(c) Acceleration resulting from sale of B stock. The facts are
the same as in paragraph (a) of this Example 1, except that on July
1 of Year 3 P sells all of its B stock to X (rather than B's selling
the land to X). Under paragraph (c)(1) of this section, S's $30 loss
is taken into account under the timing principles of the
acceleration rule of Sec. 1.1502-13(d) immediately before the effect
of treating S and B as divisions of a single corporation cannot be
produced. Because the effect cannot be produced once B becomes a
nonmember, S takes its $30 loss into account in Year 3 immediately
before B becomes a nonmember. S's loss is long-term capital loss.
(d) Subgroup principles applicable to sale of S and B stock. The
facts are the same as in paragraph (a) of this Example 1, except
that on July 1 of Year 3 P sells all of its S and B stock to X
(rather than B's selling the land to X). Under paragraph (b)(3) of
this section, S and B are considered to remain members of a
controlled group as long as they remain in a controlled group
relationship with each other (whether or not in the original
controlled group). P's sale of their stock does not affect the
controlled group relationship of S and B with each other. Thus, S's
loss is not taken into account as a result of P's sale of the stock.
Instead, S's loss is taken into account based on subsequent events
(e.g., B's sale of the land to a nonmember).
Example 2. Distribution of loss property. (a) Facts. S holds
land with a basis of $130 and value of $100. On January 1 of Year 1,
S distributes the land to P in a transaction to which section 311
applies. On July 1 of Year 3, P sells the land to X for $110.
(b) No loss taken into account. Under paragraph (b)(2) of this
section, because P and S are not members of a consolidated group,
Sec. 1.1502-13(f)(2)(iii) does not apply to cause S to recognize a
$30 loss under the principles of section 311(b). Thus, S has no loss
to be taken into account under this section. (If P and S were
members of a consolidated group, Sec. 1.1502-13(f)(2)(iii) would
apply to S's loss in addition to the rules of this section, and the
loss would be taken into account in Year 3 as a result of P's sale
to X.)
Example 3. Loss not yet taken into account under separate entity
accounting method. (a) Facts. S holds land with a basis of $130. On
January 1 of Year 1, S sells the land to B at a $30 loss but does
not take into account the loss under its separate entity method of
accounting until Year 4. On July 1 of Year 3, B sells the land to X
for $110.
(b) Timing. Under paragraph (b)(2) of this section, S's loss is
determined on a separate entity basis. Under paragraph (c)(1) of
this section, S's loss is not taken into account before it is taken
into account under S's separate entity method of accounting. Thus,
although B takes its corresponding gain into account in Year 3, S
has no loss to take into account until Year 4. Once S's loss is
taken into account in Year 4, it is not deferred under this section
because B's corresponding gain has already been taken into account.
(If S and B were members of a consolidated group, S would be treated
under Sec. 1.1502-13(b)(2)(iii) as taking the loss into account in
Year 3.)
Example 4. Consolidated groups. (a) Facts. P owns all of the
stock of S and B, and the P group is a consolidated group. S holds
land for investment with a basis of $130. On January 1 of Year 1, S
sells the land to B for $100. B holds the land for sale to customers
in the ordinary course of business. On July 1 of Year 3, P sells 25%
of B's stock to X. As a result of P's sale, B becomes a nonmember of
the P consolidated group but S and B remain in a controlled group
relationship with each other for purposes of section 267(f). Assume
that if S and B were divisions of a single corporation, the items of
S and B from the land would be ordinary by reason of B's activities.
(b) Timing and attributes. Under paragraph (a)(3) of this
section, S's sale to B is subject to both Sec. 1.1502-13 and this
section. Under Sec. 1.1502-13, S's loss is redetermined to be an
ordinary loss by reason of B's activities. Under paragraph (b)(3) of
this section, because S and B remain in a controlled group
relationship with each other, the loss is not taken into account
under the acceleration rule of Sec. 1.1502-13(d) as modified by
paragraph (c) of this section. See Sec. 1.1502-13(a)(4).
Nevertheless, S's loss is redetermined by Sec. 1.1502-13 to be an
ordinary loss, and the character of the loss is not further
redetermined under this section. Thus, the loss continues to be
deferred under this section, and will be taken into account as
ordinary loss based on subsequent events (e.g., B's sale of the land
to a nonmember).
(c) Resale to controlled group member. The facts are the same as
in paragraph (a) of this Example 4, except that P owns 75% of X's
stock, and B resells the land to X (rather than P's selling any B
stock). The results for S's loss are the same as in paragraph (b) of
this Example 4. Under paragraph (b) of this section, X is also in a
controlled group relationship, and B's sale to X is a second
intercompany sale. Thus, S's loss continues to be deferred and is
taken into account under this section as ordinary loss based on
subsequent events (e.g., X's sale of the land to a nonmember).
Example 5. Intercompany sale followed by installment sale. (a)
Facts. S holds land for investment with a basis of $130x. On January
1 of Year 1, S sells the land to B for $100x. B holds the land for
investment. On July 1 of Year 3, B sells the land to X in exchange
for X's $110x note. The note bears a market rate of interest in
excess of the applicable Federal rate, and provides for principal
payments of $55x in Year 4 and $55x in Year 5. Section 453A applies
to X's note.
(b) Timing and attributes. Under paragraph (c) of this section,
S's $30x loss is taken into account under the timing principles of
the matching rule of Sec. 1.1502-13(c) to reflect the difference in
each year between B's gain taken into account and its recomputed
loss. Under section 453, B takes into account $5x of gain in Year 4
and in Year 5. Therefore, S takes $20x of its loss into account in
Year 3 to reflect the $20x difference in that year between B's $0
loss taken into account and its $20x recomputed loss. In addition, S
takes
[[Page 36683]]
$5x of its loss into account in Year 4 and in Year 5 to reflect the $5x
difference in each year between B's $5x gain taken into account and
its $0 recomputed gain. Although S takes into account a loss and B
takes into account a gain, the attributes of B's $10x gain are
determined on a separate entity basis, and therefore the interest
charge under section 453A(c) applies to B's $10x gain on the
installment sale beginning in Year 3.
Example 6. Section 721 transfer to a related nonmember. (a)
Facts. S owns land with a basis of $130. On January 1 of Year 1, S
sells the land to B for $100. On July 1 of Year 3, B transfers the
land to a partnership in exchange for a 40% interest in capital and
profits in a transaction to which section 721 applies. P also owns a
25% interest in the capital and profits of the partnership.
(b) Timing. Under paragraph (c)(1)(iii) of this section, because
the partnership is a nonmember that is a related person under
sections 267(b) and 707(b), S's $30 loss is taken into account in
Year 3, but only to the extent of any income or gain taken into
account as a result of the transfer. Under section 721, no gain or
loss is taken into account as a result of the transfer to the
partnership, and thus none of S's loss is taken into account. Any
subsequent gain recognized by the partnership with respect to the
property is limited under section 267(d). (The results would be the
same if the P group were a consolidated group, and S's sale to B
were also subject to Sec. 1.1502-13.)
Example 7. Receivables. (a) Controlled group. S owns goods with
a $60 basis. In Year 1, S sells the goods to X for X's $100 note.
The note bears a market rate of interest in excess of the applicable
Federal rate, and provides for payment of principal in Year 5. S
takes into account $40 of income in Year 1 under its method of
accounting. In Year 2, the fair market value of X's note falls to
$90 due to an increase in prevailing market interest rates, and S
sells the note to B for its $90 fair market value.
(b) Loss not deferred. Under paragraph (f) of this section, S
takes its $10 loss into account in Year 2. (If the sale were not at
fair market value, paragraph (f) of this section would not apply and
none of S's $10 loss would be taken into account in Year 2.)
(c) Consolidated group. Assume instead that P owns all of the
stock of S and B, and the P group is a consolidated group. In Year
1, S sells to X goods having a basis of $90 for X's $100 note
(bearing a market rate of interest in excess of the applicable
Federal rate, and providing for payment of principal in Year 5), and
S takes into account $10 of income in Year 1. In Year 2, S sells the
receivable to B for its $85 fair market value. In Year 3, P sells
25% of B's stock to X. Although paragraph (f) of this section
provides that $10 of S's loss (i.e., the extent to which S's $15
loss does not exceed its $10 of income) is not deferred under this
section, S's entire $15 loss is subject to Sec. 1.1502-13 and none
of the loss is taken into account in Year 2 under the matching rule
of Sec. 1.1502-13(c). See paragraph (a)(3) of this section
(continued deferral under Sec. 1.1502-13). P's sale of B stock
results in B becoming a nonmember of the P consolidated group in
Year 3. Thus, S's $15 loss is taken into account in Year 3 under the
acceleration rule of Sec. 1.1502-13(d). Nevertheless, B remains in a
controlled group relationship with S and paragraph (f) of this
section permits only $10 of S's loss to be taken into account in
Year 3. See Sec. 1.1502-13(a)(4) (continued deferral under section
267). The remaining $5 of S's loss continues to be deferred under
this section and taken into account under this section based on
subsequent events (e.g., B's collection of the note or P's sale of
the remaining B stock to a nonmember).
Example 8. Selling member ceases to be a member. (a) Facts. P
owns all of the stock of S and B, and the P group is a consolidated
group. S has several historic assets, including land with a basis of
$130 and value of $100. The land is not essential to the operation
of S's business. On January 1 of Year 1, S sells the land to B for
$100. On July 1 of Year 3, P transfers all of S's stock to newly
formed X in exchange for a 20% interest in X stock as part of a
transaction to which section 351 applies. Although X holds many
other assets, a principal purpose for P's transfer is to accelerate
taking S's $30 loss into account. P has no plan or intention to
dispose of the X stock.
(b) Timing. Under paragraph (c) of this section, S's $30 loss
ordinarily is taken into account immediately before P's transfer of
the S stock, under the timing principles of the acceleration rule of
Sec. 1.1502-13(d). Although taking S's loss into account results in
a $30 negative stock basis adjustment under Sec. 1.1502-32, because
P has no plan or intention to dispose of its X stock, the negative
adjustment will not immediately affect taxable income. P's transfer
accelerates a loss that otherwise would be deferred, and an
adjustment under paragraph (h) of this section is required. Thus,
S's loss is never taken into account, and S's stock basis and
earnings and profits are reduced by $30 under Secs. 1.1502-32 and
1.1502-33 immediately before P's transfer of the S stock.
(c) Nonhistoric assets. Assume instead that, with a principal
purpose to accelerate taking into account any further loss that may
accrue in the value of the land without disposing of the land
outside of the controlled group, P forms M with a $100 contribution
on January 1 of Year 1 and S sells the land to M for $100. On
December 1 of Year 1, when the value of the land has decreased to
$90, M sells the land to B for $90. On July 1 of Year 3, while B
still owns the land, P sells all of M's stock to X and M becomes a
nonmember. Under paragraph (c) of this section, M's $10 loss
ordinarily is taken into account under the timing principles of the
acceleration rule of Sec. 1.1502-13(d) immediately before M becomes
a nonmember. (S's $30 loss is not taken into account under the
timing principles of Sec. 1.1502-13(c) or Sec. 1.1502-13(d) as a
result of M becoming a nonmember, but is taken into account based on
subsequent events such as B's sale of the land to a nonmember or P's
sale of the stock of S or B to a nonmember.) The land is not an
historic asset of M and, although taking M's loss into account
reduces P's basis in the M stock under Sec. 1.1502-32, the negative
adjustment only eliminates the $10 duplicate stock loss. Under
paragraph (h) of this section, M's loss is never taken into account.
M's stock basis, and the earnings and profits of M and P, are
reduced by $10 under Secs. 1.1502-32 and 1.1502-33 immediately
before P's sale of the M stock.
(k) Cross-reference. For additional rules applicable to the
disposition or deconsolidation of the stock of members of consolidated
groups, see Secs. 1.337(d)-1, 1.337(d)-2, 1.1502-13T(f)(6), and 1.1502-
20.
(l) Effective dates--(1) In general. This section applies with
respect to transactions occurring in S's years beginning on or after
July 12, 1995. If both this section and prior law apply to a
transaction, or neither applies, with the result that items are
duplicated, omitted, or eliminated in determining taxable income (or
tax liability), or items are treated inconsistently, prior law (and not
this section) applies to the transaction.
(2) Avoidance transactions. This paragraph (l)(2) applies if a
transaction is engaged in or structured on or after April 8, 1994, with
a principal purpose to avoid the rules of this section applicable to
transactions occurring in years beginning on or after July 12, 1995, to
duplicate, omit, or eliminate an item in determining taxable income (or
tax liability), or to treat items inconsistently. If this paragraph
(l)(2) applies, appropriate adjustments must be made in years beginning
on or after July 12, 1995, to prevent the avoidance, duplication,
omission, elimination, or inconsistency.
(3) Prior law. For transactions occurring in S's years beginning
before July 12, 1995 see the applicable regulations issued under
sections 267 and 1502. See, e.g., Secs. 1.267(f)-1, 1.267(f)-1T,
1.267(f)-2T, 1.267(f)-3, 1.1502-13, 1.1502-13T, 1.1502-14, 1.1502-14T,
and 1.1502-31 (as contained in the 26 CFR part 1 edition revised as of
April 1, 1995).
Secs. 1.267(f)-1T, 1.267(f)-2T, and 1.267(f)-3 [Removed]
Par. 7. Sections 1.267(f)-1T, 1.267(f)-2T, and 1.267(f)-3 are
removed.
Par. 8. Section 1.460-0 is amended in the table of contents by
revising the entries for Sec. 1.460-4 to read as follows:
Sec. 1.460-0 Outline of regulations under section 460.
* * * * *
Sec. 1.460-4 Methods of accounting for long-term contracts.
(a) through (i) [Reserved]
(j) Consolidated groups and controlled groups.
(1) Intercompany transactions.
(i) In general.
(ii) Definitions and nomenclature.
[[Page 36684]]
(2) Example.
(3) Effective dates.
(i) In general.
(ii) Prior law.
(4) Consent to change method of accounting.
* * * * *
Par. 9. Section 1.460-4 is amended by:
1. Revising the section heading.
2. Adding and reserving paragraphs (a) through (i).
3. Adding paragraph (j).
The revisions and additions read as follows:
Sec. 1.460-4 Methods of accounting for long-term contracts.
(a) through (i) [Reserved]
(j) Consolidated groups and controlled groups--(1) Intercompany
transactions--(i) In general. Section 1.1502-13 does not apply to the
income, gain, deduction, or loss from an intercompany transaction
between members of a consolidated group, and section 267(f) does not
apply to these items from an intercompany sale between members of a
controlled group, to the extent--
(A) The transaction or sale directly or indirectly benefits, or is
intended to benefit, another member's long-term contract with a
nonmember;
(B) The selling member is required under section 460 to determine
any part of its gross income from the transaction or sale under the
percentage-of-completion method (PCM); and
(C) The member with the long-term contract is required under
section 460 to determine any part of its gross income from the long-
term contract under the PCM.
(ii) Definitions and nomenclature. The definitions and nomenclature
under Sec. 1.1502-13 and Sec. 1.267(f)-1 apply for purposes of this
paragraph (j).
(2) Example. The following example illustrates the principles of
paragraph (j)(1) of this section.
Example. Corporations P, S, and B file consolidated returns on a
calendar-year basis. In 1996, B enters into a long-term contract
with X, a nonmember, to manufacture 5 airplanes for $500 million,
with delivery scheduled for 1999. Section 460 requires B to
determine the gross income from its contract with X under the PCM. S
enters into a contract with B to manufacture for $50 million the
engines that B will install on X's airplanes. Section 460 requires S
to determine the gross income from its contract with B under the
PCM. S estimates that it will incur $40 million of total contract
costs during 1997 and 1998 to manufacture the engines. S incurs $10
million of contract costs in 1997 and $30 million in 1998. Under
paragraph (j) of this section, S determines its gross income from
the long-term contract under the PCM rather than taking its income
or loss into account under section 267(f) or Sec. 1.1502-13. Thus, S
includes $12.5 million of gross receipts and $10 million of contract
costs in gross income in 1997 and includes $37.5 million of gross
receipts and $30 million of contract costs in gross income in 1998.
(3) Effective dates--(i) In general. This paragraph (j) applies
with respect to transactions and sales occurring pursuant to contracts
entered into in years beginning on or after July 12, 1995.
(ii) Prior law. For transactions and sales occurring pursuant to
contracts entered into in years beginning before July 12, 1995, see the
applicable regulations issued under sections 267(f) and 1502, including
Secs. 1.267(f)-1T, 1.267(f)-2T, and 1.1502-13(n) (as contained in the
26 CFR part 1 edition revised as of April 1, 1995).
(4) Consent to change method of accounting. For transactions and
sales to which this paragraph (j) applies, the Commissioner's consent
under section 446(e) is hereby granted to the extent any changes in
method of accounting are necessary solely to comply with this section,
provided the changes are made in the first taxable year of the taxpayer
to which the rules of this paragraph (j) apply. Changes in method of
accounting for these transactions are to be effected on a cut-off
basis.
Par. 10. In Sec. 1.469-0, the table of contents is amended by:
1. Revising the entries for Sec. 1.469-1:
a. Paragraphs (a) through (d)(1).
b. Paragraphs (g)(5) through (h)(3).
c. Paragraphs (h)(5) through (k).
2. Revising the entries for Sec. 1.469-1T, paragraphs (c)(8), and
(h)(1), (2), and (6). The revisions read as follows:
Sec. 1.469-0 Table of contents.
* * * * *
Sec. 1.469-1 General rules.
(a) through (c)(7) [Reserved]
(c)(8) Consolidated groups.
(c)(9) through (d)(1) [Reserved]
* * * * *
(g)(5) [Reserved]
(h)(1) In general.
(h)(2) Definitions.
(h)(3) [Reserved]
* * * * *
(h)(5) [Reserved]
(h)(6) Intercompany transactions.
(i) In general.
(ii) Example.
(iii) Effective dates.
(h)(7) through (k) [Reserved]
Sec. 1.469-1T General rules (temporary).
* * * * *
(c)(8) [Reserved]
* * * * *
(h)(1) [Reserved]
(h)(2) [Reserved]
* * * * *
(h)(6) [Reserved]
* * * * *
Par. 11. Section 1.469-1 is amended by adding paragraphs (c)(8),
(h)(1), (h)(2) and (h)(6) to read as follows (paragraphs (a) through
(c)(7), (c)(9) through (d)(1), (g)(5), (h)(3), (h)(5) and (h)(7)
through (k) continue to be reserved):
Sec. 1.469-1 General rules.
(a) through (c)(7) [Reserved]
(c)(8) Consolidated groups. Rules relating to the application of
section 469 to consolidated groups are contained in paragraph (h) of
this section.
(c)(9) through (d)(1) [Reserved]
* * * * *
(g)(5) [Reserved]
(h)(1) In general. This paragraph (h) provides rules for applying
section 469 in computing a consolidated group's consolidated taxable
income and consolidated tax liability (and the separate taxable income
and tax liability of each member).
(2) Definitions. The definitions and nomenclature in the
regulations under section 1502 apply for purposes of this paragraph
(h). See, e.g., Secs. 1.1502-1 (definitions of group, consolidated
group, member, subsidiary, and consolidated return year), 1.1502-2
(consolidated tax liability), 1.1502-11 (consolidated taxable income),
1.1502-12 (separate taxable income), 1.1502-13 (intercompany
transactions), 1.1502-21 (consolidated net operating loss), and 1.1502-
22 (consolidated net capital gain or loss).
(3) [Reserved]
* * * * *
(5) [Reserved]
(6) Intercompany transactions--(i) In general. Section 1.1502-13
applies to determine the treatment under section 469 of intercompany
items and corresponding items from intercompany transactions between
members of a consolidated group. For example, the matching rule of
Sec. 1.1502-13(c) treats the selling member (S) and the buying member
(B) as divisions of a single corporation for purposes of determining
whether S's intercompany items and B's corresponding items are from a
passive activity. Thus, for purposes of applying Sec. 1.469-
2(c)(2)(iii) and Sec. 1.469- 2T(d)(5)(ii) to property sold by S to B in
an intercompany transaction--
(A) S and B are treated as divisions of a single corporation for
determining the uses of the property during the 12-month period
preceding its disposition to a nonmember, and generally have an
aggregate holding period for the property; and
[[Page 36685]]
(B) Sec. 1.469-2(c)(2)(iv) does not apply.
(ii) Example. The following example illustrates the application of
this paragraph (h)(6).
Example. (i) P, a closely held corporation, is the common parent
of the P consolidated group. P owns all of the stock of S and B. X
is a person unrelated to any member of the P group. S owns and
operates equipment that is not used in a passive activity. On
January 1 of Year 1, S sells the equipment to B at a gain. B uses
the equipment in a passive activity and does not dispose of the
equipment before it has been fully depreciated.
(ii) Under the matching rule of Sec. 1.1502-13(c), S's gain
taken into account as a result of B's depreciation is treated as
gain from a passive activity even though S used the equipment in a
nonpassive activity.
(iii) The facts are the same as in paragraph (a) of this
Example, except that B sells the equipment to X on December 1 of
Year 3 at a further gain. Assume that if S and B were divisions of a
single corporation, gain from the sale to X would be passive income
attributable to a passive activity. To the extent of B's
depreciation before the sale, the results are the same as in
paragraph (ii) of this Example. B's gain and S's remaining gain
taken into account as a result of B's sale are treated as
attributable to a passive activity.
(iv) The facts are the same as in paragraph (iii) of this
Example, except that B recognizes a loss on the sale to X. B's loss
and S's gain taken into account as a result of B's sale are treated
as attributable to a passive activity.
(iii) Effective dates. This paragraph (h)(6) applies with respect
to transactions occurring in years beginning on or after July 12, 1995.
For transactions occurring in years beginning before July 12, 1995, see
Sec. 1.469-1T(h)(6) (as contained in the 26 CFR part 1 edition revised
as of April 1, 1995).
(h)(7) through (k) [Reserved]
Sec. 1.469-1T [Amended]
Par. 12. Section 1.469-1T is amended by removing and reserving
paragraphs (c)(8), (h)(1), (2), and (6).
Par. 13. Section 1.1502-13 is revised to read as follows:
Sec. 1.1502-13 Intercompany transactions.
(a) In general--(1) Purpose. This section provides rules for taking
into account items of income, gain, deduction, and loss of members from
intercompany transactions. The purpose of this section is to provide
rules to clearly reflect the taxable income (and tax liability) of the
group as a whole by preventing intercompany transactions from creating,
accelerating, avoiding, or deferring consolidated taxable income (or
consolidated tax liability).
(2) Separate entity and single entity treatment. Under this
section, the selling member (S) and the buying member (B) are treated
as separate entities for some purposes but as divisions of a single
corporation for other purposes. The amount and location of S's
intercompany items and B's corresponding items are determined on a
separate entity basis (separate entity treatment). For example, S
determines its gain or loss from a sale of property to B on a separate
entity basis, and B has a cost basis in the property. The timing, and
the character, source, and other attributes of the intercompany items
and corresponding items, although initially determined on a separate
entity basis, are redetermined under this section to produce the effect
of transactions between divisions of a single corporation (single
entity treatment). For example, if S sells land to B at a gain and B
sells the land to a nonmember, S does not take its gain into account
until B's sale to the nonmember.
(3) Timing rules as a method of accounting--(i) In general. The
timing rules of this section are a method of accounting for
intercompany transactions, to be applied by each member in addition to
the member's other methods of accounting. See Sec. 1.1502-17. To the
extent the timing rules of this section are inconsistent with a
member's otherwise applicable methods of accounting, the timing rules
of this section control. For example, if S sells property to B in
exchange for B's note, the timing rules of this section apply instead
of the installment sale rules of section 453. S's or B's application of
the timing rules of this section to an intercompany transaction clearly
reflects income only if the effect of that transaction as a whole
(including, for example, related costs and expenses) on consolidated
taxable income is clearly reflected.
(ii) Automatic consent for joining and departing members--(A)
Consent granted. Section 446(e) consent is granted under this section
to the extent a change in method of accounting is necessary solely by
reason of the timing rules of this section--
(1) For each member, with respect to its intercompany transactions,
in the first consolidated return year which follows a separate return
year and in which the member engages in an intercompany transaction;
and
(2) For each former member, with respect to its transactions with
members that would otherwise be intercompany transactions if the former
member were still a member, in the first separate return year in which
the former member engages in such a transaction.
(B) Cut-off basis. Any change in method of accounting described in
paragraph (a)(3)(ii)(A) of this section is to be effected on a cut-off
basis for transactions entered into on or after the first day of the
year for which consent is granted under paragraph (a)(3)(ii)(A) of this
section.
(4) Other law. The rules of this section apply in addition to other
applicable law (including nonstatutory authorities). For example, this
section applies in addition to sections 267(f) (additional rules for
certain losses), 269 (acquisitions to evade or avoid income tax), and
482 (allocations among commonly controlled taxpayers). Thus, an item
taken into account under this section can be deferred, disallowed, or
eliminated under other applicable law, for example, section 1091
(losses from wash sales).
(5) References. References in other sections to this section
include, as appropriate, references to prior law. For effective dates
and prior law see paragraph (l) of this section.
(6) Overview--(i) In general. The principal rules of this section
that implement single entity treatment are the matching rule and the
acceleration rule of paragraphs (c) and (d) of this section. Under the
matching rule, S and B are generally treated as divisions of a single
corporation for purposes of taking into account their items from
intercompany transactions. The acceleration rule provides additional
rules for taking the items into account if the effect of treating S and
B as divisions cannot be achieved (for example, if S or B becomes a
nonmember). Paragraph (b) of this section provides definitions.
Paragraph (e) of this section provides simplifying rules for certain
transactions. Paragraphs (f) and (g) of this section provide additional
rules for stock and obligations of members. Paragraphs (h) and (j) of
this section provide anti-avoidance rules and miscellaneous operating
rules.
(ii) Table of examples. Set forth below is a table of the examples
contained in this section.
Matching rule. (Sec. 1.1502-13(c)(7)(ii))
Example 1. Intercompany sale of land.
Example 2. Dealer activities.
Example 3. Intercompany section 351 transfer.
Example 4. Depreciable property.
Example 5. Intercompany sale followed by installment sale.
Example 6. Intercompany sale of installment obligation.
Example 7. Performance of services.
Example 8. Rental of property.
Example 9. Intercompany sale of a partnership interest.
Example 10. Net operating losses subject to section 382 or the
SRLY rules.
Example 11. Section 475.
Example 12. Section 1092.
[[Page 36686]]
Example 13. Manufacturer incentive payments.
Example 14. Source of income under section 863.
Example 15. Section 1248.
Acceleration rule. (Sec. 1.1502-13(d)(3))
Example 1. Becoming a nonmember--timing.
Example 2. Becoming a nonmember--attributes.
Example 3. Selling member's disposition of installment note.
Example 4. Cancellation of debt and attribute reduction under
section 108(b).
Example 5. Section 481.
Simplifying rules--inventory. (Sec. 1.1502-13(e)(1)(v))
Example 1. Increment averaging method.
Example 2. Increment valuation method.
Example 3. Other reasonable inventory methods.
Stock of members. (Sec. 1.1502-13(f)(7))
Example 1. Dividend exclusion and property distribution.
Example 2. Excess loss accounts.
Example 3. Intercompany reorganization.
Example 4. Stock redemptions and distributions.
Example 5. Intercompany stock sale followed by section 332
liquidation.
Example 6. Intercompany stock sale followed by section 355
distribution.
Obligations of members. (Sec. 1.1502-13(g)(5))
Example 1. Interest on intercompany debt.
Example 2. Intercompany debt becomes nonintercompany debt.
Example 3. Loss or bad debt deduction with respect to
intercompany debt.
Example 4. Nonintercompany debt becomes intercompany debt.
Example 5. Notional principal contracts.
Anti-avoidance rules. (Sec. 1.1502-13(h)(2))
Example 1. Sale of a partnership interest.
Example 2. Transitory status as an intercompany obligation.
Example 3. Corporate mixing bowl.
Example 4. Partnership mixing bowl.
Example 5. Sale and leaseback.
Miscellaneous operating rules. (Sec. 1.1502-13(j)(9))
Example 1. Intercompany sale followed by section 351 transfer to
member.
Example 2. Intercompany sale of member stock followed by
recapitalization.
Example 3. Back-to-back intercompany transactions--matching.
Example 4. Back-to-back intercompany transactions--acceleration.
Example 5. Successor group.
Example 6. Liquidation--80% distributee.
Example 7. Liquidation--no 80% distributee.
(b) Definitions. For purposes of this section--
(1) Intercompany transactions--(i) In general. An intercompany
transaction is a transaction between corporations that are members of
the same consolidated group immediately after the transaction. S is the
member transferring property or providing services, and B is the member
receiving the property or services. Intercompany transactions include--
(A) S's sale of property (or other transfer, such as an exchange or
contribution) to B, whether or not gain or loss is recognized;
(B) S's performance of services for B, and B's payment or accrual
of its expenditure for S's performance;
(C) S's licensing of technology, rental of property, or loan of
money to B, and B's payment or accrual of its expenditure; and
(D) S's distribution to B with respect to S stock.
(ii) Time of transaction. If a transaction occurs in part while S
and B are members and in part while they are not members, the
transaction is treated as occurring when performance by either S or B
takes place, or when payment for performance would be taken into
account under the rules of this section if it were an intercompany
transaction, whichever is earliest. Appropriate adjustments must be
made in such cases by, for example, dividing the transaction into two
separate transactions reflecting the extent to which S or B has
performed.
(iii) Separate transactions. Except as otherwise provided in this
section, each transaction is analyzed separately. For example, if S
simultaneously sells two properties to B, one at a gain and the other
at a loss, each property is treated as sold in a separate transaction.
Thus, the gain and loss cannot be offset or netted against each other
for purposes of this section. Similarly, each payment or accrual of
interest on a loan is a separate transaction. In addition, an accrual
of premium is treated as a separate transaction, or as an offset to
interest that is not a separate transaction, to the extent required
under separate entity treatment. If two members exchange property, each
member is S with respect to the property it transfers and B with
respect to the property it receives. If two members enter into a
notional principal contract, each payment under the contract is a
separate transaction and the member making the payment is B with
respect to that payment and the member receiving the payment is S. See
paragraph (j)(4) of this section for rules aggregating certain
transactions.
(2) Intercompany items--(i) In general. S's income, gain,
deduction, and loss from an intercompany transaction are its
intercompany items. For example, S's gain from the sale of property to
B is intercompany gain. An item is an intercompany item whether it is
directly or indirectly from an intercompany transaction.
(ii) Related costs or expenses. S's costs or expenses related to an
intercompany transaction are included in determining its intercompany
items. For example, if S sells inventory to B, S's direct and indirect
costs properly includible under section 263A are included in
determining its intercompany income. Similarly, related costs or
expenses that are not capitalized under S's separate entity method of
accounting are included in determining its intercompany items. For
example, deductions for employee wages, in addition to other related
costs, are included in determining S's intercompany items from
performing services for B, and depreciation deductions are included in
determining S's intercompany items from renting property to B.
(iii) Amounts not yet recognized or incurred. S's intercompany
items include amounts from an intercompany transaction that are not yet
taken into account under its separate entity method of accounting. For
example, if S is a cash method taxpayer, S's intercompany income might
be taken into account under this section even if the cash is not yet
received. Similarly, an amount reflected in basis (or an amount
equivalent to basis) under S's separate entity method of accounting
that is a substitute for income, gain, deduction or loss from an
intercompany transaction is an intercompany item.
(3) Corresponding items--(i) In general. B's income, gain,
deduction, and loss from an intercompany transaction, or from property
acquired in an intercompany transaction, are its corresponding items.
For example, if B pays rent to S, B's deduction for the rent is a
corresponding deduction. If B buys property from S and sells it to a
nonmember, B's gain or loss from the sale to the nonmember is a
corresponding gain or loss; alternatively, if B recovers the cost of
the property through depreciation, B's depreciation deductions are
corresponding deductions. An item is a corresponding item whether it is
directly or indirectly from an intercompany transaction (or from
property acquired in an intercompany transaction).
(ii) Disallowed or eliminated amounts. B's corresponding items
include amounts that are permanently disallowed or permanently
eliminated, whether directly or indirectly. Thus, corresponding items
include amounts disallowed under section 265 (expenses relating to tax-
exempt income), and amounts not recognized under section 311(a)
(nonrecognition of loss on distributions), section 332
[[Page 36687]]
(nonrecognition on liquidating distributions), or section 355(c)
(certain distributions of stock of a subsidiary). On the other hand, an
amount is not permanently disallowed or permanently eliminated (and
therefore is not a corresponding item) to the extent it is not
recognized in a transaction in which B receives a successor asset
within the meaning of paragraph (j)(1) of this section. For example,
B's corresponding items do not include amounts not recognized from a
transaction with a nonmember to which section 1031 applies or from
another transaction in which B receives exchanged basis property.
(4) Recomputed corresponding items. The recomputed corresponding
item is the corresponding item that B would take into account if S and
B were divisions of a single corporation and the intercompany
transaction were between those divisions. For example, if S sells
property with a $70 basis to B for $100, and B later sells the property
to a nonmember for $90, B's corresponding item is its $10 loss, and the
recomputed corresponding item is $20 of gain (determined by comparing
the $90 sales price with the $70 basis the property would have if S and
B were divisions of a single corporation). Although neither S nor B
actually takes the recomputed corresponding item into account, it is
computed as if B did take it into account (based on reasonable and
consistently applied assumptions, including any provision of the
Internal Revenue Code or regulations that would affect its timing or
attributes).
(5) Treatment as a separate entity. Treatment as a separate entity
means treatment without application of the rules of this section, but
with the application of the other consolidated return regulations. For
example, if S sells the stock of another member to B, S's gain or loss
on a separate entity basis is determined with the application of
Sec. 1.1502-80(b) (non-applicability of section 304), but without
redetermination under paragraph (c) or (d) of this section.
(6) Attributes. The attributes of an intercompany item or
corresponding item are all of the item's characteristics, except
amount, location, and timing, necessary to determine the item's effect
on taxable income (and tax liability). For example, attributes include
character, source, treatment as excluded from gross income or as a
noncapital, nondeductible amount, and treatment as built-in gain or
loss under section 382(h) or 384. In contrast, the characteristics of
property, such as a member's holding period, or the fact that property
is included in inventory, are not attributes of an item, but these
characteristics might affect the determination of the attributes of
items from the property.
(c) Matching rule. For each consolidated return year, B's
corresponding items and S's intercompany items are taken into account
under the following rules:
(1) Attributes and holding periods--(i) Attributes. The separate
entity attributes of S's intercompany items and B's corresponding items
are redetermined to the extent necessary to produce the same effect on
consolidated taxable income (and consolidated tax liability) as if S
and B were divisions of a single corporation, and the intercompany
transaction were a transaction between divisions. Thus, the activities
of both S and B might affect the attributes of both intercompany items
and corresponding items. For example, if S holds property for sale to
unrelated customers in the ordinary course of its trade or business, S
sells the property to B at a gain and B sells the property to an
unrelated person at a further gain, S's intercompany gain and B's
corresponding gain might be ordinary because of S's activities with
respect to the property. Similar principles apply if S performs
services, rents property, or engages in any other intercompany
transaction.
(ii) Holding periods. The holding period of property transferred in
an intercompany transaction is the aggregate of the holding periods of
S and B. However, if the basis of the property is determined by
reference to the basis of other property, the property's holding period
is determined by reference to the holding period of the other property.
For example, if S distributes stock to B in a transaction to which
section 355 applies, B's holding period in the distributed stock is
determined by reference to B's holding period in the stock of S.
(2) Timing--(i) B's items. B takes its corresponding items into
account under its accounting method, but the redetermination of the
attributes of a corresponding item might affect its timing. For
example, if B's sale of property acquired from S is treated as a dealer
disposition because of S's activities, section 453(b) prevents any
corresponding income of B from being taken into account under the
installment method.
(ii) S's items. S takes its intercompany item into account to
reflect the difference for the year between B's corresponding item
taken into account and the recomputed corresponding item.
(3) Divisions of a single corporation. As divisions of a single
corporation, S and B are treated as engaging in their actual
transaction and owning any actual property involved in the transaction
(rather than treating the transaction as not occurring). For example,
S's sale of land held for investment to B for cash is not disregarded,
but is treated as an exchange of land for cash between divisions (and B
therefore succeeds to S's basis in the property). Similarly, S's
issuance of its own stock to B in exchange for property is not
disregarded, B is treated as owning the stock it receives in the
exchange, and section 1032 does not apply to B on its subsequent sale
of the S stock. Although treated as divisions, S and B nevertheless are
treated as:
(i) Operating separate trades or businesses. See, e.g., Sec. 1.446-
1(d) (accounting methods for a taxpayer engaged in more than one
business).
(ii) Having any special status that they have under the Internal
Revenue Code or regulations. For example, a bank defined in section
581, a domestic building and loan association defined in section
7701(a)(19), and an insurance company to which section 801 or 831
applies are treated as divisions having separate special status. On the
other hand, the fact that a member holds property for sale to customers
in the ordinary course of its trade or business is not a special
status.
(4) Conflict or allocation of attributes. This paragraph (c)(4)
provides special rules for redetermining and allocating attributes
under paragraph (c)(1)(i) of this section.
(i) Offsetting amounts--(A) In general. To the extent B's
corresponding item offsets S's intercompany item in amount, the
attributes of B's corresponding item, determined based on both S's and
B's activities, control the attributes of S's offsetting intercompany
item. For example, if S sells depreciable property to B at a gain and B
depreciates the property, the attributes of B's depreciation deduction
(ordinary deduction) control the attributes of S's offsetting
intercompany gain. Accordingly, S's gain is ordinary.
(B) B controls unreasonable. To the extent the results under
paragraph (c)(4)(i)(A) are inconsistent with treating S and B as
divisions of a single corporation, the attributes of the offsetting
items must be redetermined in a manner consistent with treating S and B
as divisions of a single corporation. To the extent, however, that B's
corresponding item on a separate entity basis is excluded from gross
income, is a noncapital, nondeductible amount, or
[[Page 36688]]
is otherwise permanently disallowed or eliminated, the attributes of
B's corresponding item always control the attributes of S's offsetting
intercompany item.
(ii) Allocation. To the extent S's intercompany item and B's
corresponding item do not offset in amount, the attributes redetermined
under paragraph (c)(1)(i) of this section must be allocated to S's
intercompany item and B's corresponding item by using a method that is
reasonable in light of all the facts and circumstances, including the
purposes of this section and any other rule affected by the attributes
of S's intercompany item and B's corresponding item. A method of
allocation or redetermination is unreasonable if it is not used
consistently by all members of the group from year to year.
(5) Special status. Notwithstanding the general rule of paragraph
(c)(1)(i) of this section, to the extent an item's attributes
determined under this section are permitted or not permitted to a
member under the Internal Revenue Code or regulations by reason of the
member's special status, the attributes required under the Internal
Revenue Code or regulations apply to that member's items (but not the
other member). For example, if S is a bank to which section 582(c)
applies, and sells debt securities at a gain to B, a nonbank, the
character of S's intercompany gain is ordinary as required under
section 582(c), but the character of B's corresponding item as capital
or ordinary is determined under paragraph (c)(1)(i) of this section
without the application of section 582(c). For other special status
issues, see, for example, sections 595(b) (foreclosure on property
securing loans), 818(b) (life insurance company treatment of capital
gains and losses), and 1503(c) (limitation on absorption of certain
losses).
(6) Treatment of intercompany items if corresponding items are
excluded or nondeductible--(i) In general. Under paragraph (c)(1)(i) of
this section, S's intercompany item might be redetermined to be
excluded from gross income or treated as a noncapital, nondeductible
amount. For example, S's intercompany loss from the sale of property to
B is treated as a noncapital, nondeductible amount if B distributes the
property to a nonmember shareholder at no further gain or loss
(because, if S and B were divisions of a single corporation, the loss
would not have been recognized under section 311(a)). Paragraph
(c)(6)(ii) of this section, however, provides limitations on the
application of this rule to intercompany income or gain. See also
Secs. 1.1502-32 and 1.1502-33 (adjustments to S's stock basis and
earnings and profits to reflect amounts so treated).
(ii) Limitation on treatment of intercompany items as excluded from
gross income. Notwithstanding the general rule of paragraph (c)(1)(i)
of this section, S's intercompany income or gain is redetermined to be
excluded from gross income only to the extent one of the following
applies:
(A) Disallowed amounts. B's corresponding item is a deduction or
loss and, in the taxable year the item is taken into account under this
section, it is permanently and explicitly disallowed under another
provision of the Internal Revenue Code or regulations. For example,
deductions that are disallowed under section 265 are permanently and
explicitly disallowed. An amount is not permanently and explicitly
disallowed, for example, to the extent that--
(1) The Internal Revenue Code or regulations provide that the
amount is not recognized (for example, a loss that is realized but not
recognized under section 332 or section 355(c) is not permanently and
explicitly disallowed, notwithstanding that it is a corresponding item
within the meaning of paragraph (b)(3)(ii) of this section (certain
disallowed or eliminated amounts));
(2) A related amount might be taken into account by B with respect
to successor property, such as under section 280B (demolition costs
recoverable as capitalized amounts);
(3) A related amount might be taken into account by another
taxpayer, such as under section 267(d) (disallowed loss under section
267(a) might result in nonrecognition of gain for a related person);
(4) A related amount might be taken into account as a deduction or
loss, including as a carryforward to a later year, under any provision
of the Internal Revenue Code or regulations (whether or not the
carryforward expires in a later year); or
(5) The amount is reflected in the computation of any credit
against (or other reduction of) Federal income tax (whether allowed for
the taxable year or carried forward to a later year).
(B) Section 311. The corresponding item is a loss that is realized,
but not recognized under section 311(a) on a distribution to a
nonmember (even though the loss is not a permanently and explicitly
disallowed amount within the meaning of paragraph (c)(6)(ii)(A) of this
section).
(C) Other amounts. The Commissioner determines that treating S's
intercompany item as excluded from gross income is consistent with the
purposes of this section and other applicable provisions of the
Internal Revenue Code and regulations.
(7) Examples--(i) In general. For purposes of the examples in this
section, unless otherwise stated, P is the common parent of the P
consolidated group, P owns all of the only class of stock of
subsidiaries S and B, X is a person unrelated to any member of the P
group, the taxable year of all persons is the calendar year, all
persons use the accrual method of accounting, tax liabilities are
disregarded, the facts set forth the only corporate activity, no member
has any special status, and the transaction is not otherwise subject to
recharacterization. If a member acts as both a selling member and a
buying member (e.g., with respect to different aspects of a single
transaction, or with respect to related transactions), the member is
referred to as M, M1, or M2 (rather than as S or B).
(ii) Matching rule. The matching rule of this paragraph (c) is
illustrated by the following examples.
Example 1. Intercompany sale of land followed by sale to a
nonmember. (a) Facts. S holds land for investment with a basis of
$70. S has held the land for more than one year. On January 1 of
Year 1, S sells the land to B for $100. B also holds the land for
investment. On July 1 of Year 3, B sells the land to X for $110.
(b) Definitions. Under paragraph (b)(1) of this section, S's
sale of the land to B is an intercompany transaction, S is the
selling member, and B is the buying member. Under paragraphs (b)(2)
and (3) of this section, S's $30 gain from the sale to B is its
intercompany item, and B's $10 gain from the sale to X is its
corresponding item.
(c) Attributes. Under the matching rule of paragraph (c) of this
section, S's $30 intercompany gain and B's $10 corresponding gain
are taken into account to produce the same effect on consolidated
taxable income (and consolidated tax liability) as if S and B were
divisions of a single corporation. In addition, the holding periods
of S and B for the land are aggregated. Thus, the group's entire $40
of gain is long-term capital gain. Because both S's intercompany
item and B's corresponding item on a separate entity basis are long-
term capital gain, the attributes are not redetermined under
paragraph (c)(1)(i) of this section.
(d) Timing. For each consolidated return year, S takes its
intercompany item into account under the matching rule to reflect
the difference for the year between B's corresponding item taken
into account and the recomputed corresponding item. If S and B were
divisions of a single corporation and the intercompany sale were a
transfer between the divisions, B would succeed to S's $70 basis in
the land and would have a $40 gain from the sale to X in Year 3,
instead of a $10 gain. Consequently, S takes no gain
[[Page 36689]]
into account in Years 1 and 2, and takes the entire $30 gain into
account in Year 3, to reflect the $30 difference in that year
between the $10 gain B takes into account and the $40 recomputed
gain (the recomputed corresponding item). Under Secs. 1.1502-32 and
1.1502-33, P's basis in its S stock and the earnings and profits of
S and P do not reflect S's $30 gain until the gain is taken into
account in Year 3. (Under paragraph (a)(3) of this section, the
results would be the same if S sold the land to B in an installment
sale to which section 453 would otherwise apply, because S must take
its intercompany gain into account under this section.)
(e) Intercompany loss followed by sale to a nonmember at a gain.
The facts are the same as in paragraph (a) of this Example 1, except
that S's basis in the land is $130 (rather than $70). The attributes
and timing of S's intercompany loss and B's corresponding gain are
determined under the matching rule in the manner provided in
paragraphs (c) and (d) of this Example 1. If S and B were divisions
of a single corporation and the intercompany sale were a transfer
between the divisions, B would succeed to S's $130 basis in the land
and would have a $20 loss from the sale to X instead of a $10 gain.
Thus, S takes its entire $30 loss into account in Year 3 to reflect
the $30 difference between B's $10 gain taken into account and the
$20 recomputed loss. (The results are the same under section
267(f).) S's $30 loss is long-term capital loss, and B's $10 gain is
long-term capital gain.
(f) Intercompany gain followed by sale to a nonmember at a loss.
The facts are the same as in paragraph (a) of this Example 1, except
that B sells the land to X for $90 (rather than $110). The
attributes and timing of S's intercompany gain and B's corresponding
loss are determined under the matching rule. If S and B were
divisions of a single corporation and the intercompany sale were a
transfer between the divisions, B would succeed to S's $70 basis in
the land and would have a $20 gain from the sale to X instead of a
$10 loss. Thus, S takes its entire $30 gain into account in Year 3
to reflect the $30 difference between B's $10 loss taken into
account and the $20 recomputed gain. S's $30 gain is long-term
capital gain, and B's $10 loss is long-term capital loss.
(g) Intercompany gain followed by distribution to a nonmember at
a loss. The facts are the same as in paragraph (a) of this Example
1, except that B distributes the land to X, a minority shareholder
of B, and at the time of the distribution the land has a fair market
value of $90. The attributes and timing of S's intercompany gain and
B's corresponding loss are determined under the matching rule. Under
section 311(a), B does not recognize its $10 loss on the
distribution to X. If S and B were divisions of a single corporation
and the intercompany sale were a transfer between divisions, B would
succeed to S's $70 basis in the land and would have a $20 gain from
the distribution to X instead of an unrecognized $10 loss. Under
paragraph (b)(3)(ii) of this section, B's loss that is not
recognized under section 311(a) is a corresponding item. Thus, S
takes its $30 gain into account under the matching rule in Year 3 to
reflect the difference between B's $10 corresponding unrecognized
loss and the $20 recomputed gain. B's $10 corresponding loss offsets
$10 of S's intercompany gain and, under paragraph (c)(4)(i) of this
section, the attributes of B's corresponding item control the
attributes of S's intercompany item. Paragraph (c)(6) of this
section does not prevent the redetermination of S's intercompany
item as excluded from gross income. (See paragraph (c)(6)(ii)(B) of
this section). Thus, $10 of S's $30 gain is redetermined to be
excluded from gross income.
(h) Intercompany sale followed by section 1031 exchange with
nonmember. The facts are the same as in paragraph (a) of this
Example 1, except that, instead of selling the land to X, B
exchanges the land for land owned by X in a transaction to which
section 1031 applies. There is no difference in Year 3 between B's
$0 corresponding item taken into account and the $0 recomputed
corresponding item. Thus, none of S's intercompany gain is taken
into account under the matching rule as a result of the section 1031
exchange. Instead, B's gain is preserved in the land received from X
and, under the successor asset rule of paragraph (j)(1) of this
section, S's intercompany gain is taken into account by reference to
the replacement property. (If B takes gain into account as a result
of boot received in the exchange, S's intercompany gain is taken
into account under the matching rule to the extent the boot causes a
difference between B's gain taken into account and the recomputed
gain.)
(i) Intercompany sale followed by section 351 transfer to
nonmember. The facts are the same as in paragraph (a) of this
Example 1, except that, instead of selling the land to X, B
transfers the land to X in a transaction to which section 351(a)
applies and X remains a nonmember. There is no difference in Year 3
between B's $0 corresponding item taken into account and the $0
recomputed corresponding item. Thus, none of S's intercompany gain
is taken into account under the matching rule as a result of the
section 351(a) transfer. However, S's entire gain is taken into
account in Year 3 under the acceleration rule of paragraph (d) of
this section (because X, a nonmember, reflects B's $100 cost basis
in the land under section 362).
Example 2. Dealer activities. (a) Facts. S holds land for
investment with a basis of $70. On January 1 of Year 1, S sells the
land to B for $100. B develops the land as residential real estate,
and sells developed lots to customers during Year 3 for an aggregate
amount of $110.
(b) Attributes. S and B are treated under the matching rule as
divisions of a single corporation for purposes of determining the
attributes of S's intercompany item and B's corresponding item.
Thus, although S held the land for investment, whether the gain is
treated as from the sale of property described in section 1221(1) is
based on the activities of both S and B. If, based on both S's and
B's activities, the land is described in section 1221(1), both S's
gain and B's gain are ordinary income.
Example 3. Intercompany section 351 transfer. (a) Facts. S holds
land with a $70 basis and a $100 fair market value for sale to
customers in the ordinary course of business. On January 1 of Year
1, S transfers the land to B in exchange for all of the stock of B
in a transaction to which section 351 applies. S has no gain or loss
under section 351(a), and its basis in the B stock is $70 under
section 358. Under section 362, B's basis in the land is $70. B
holds the land for investment. On July 1 of Year 3, B sells the land
to X for $100. Assume that if S and B were divisions of a single
corporation, B's gain from the sale would be ordinary income because
of S's activities.
(b) Timing and attributes. Under paragraph (b)(1) of this
section, S's transfer to B is an intercompany transaction. Under
paragraph (c)(3) of this section, S is treated as transferring the
land in exchange for B's stock even though, as divisions, S could
not own stock of B. S has no intercompany item, but B's $30 gain
from its sale of the land to X is a corresponding item because the
land was acquired in an intercompany transaction. B's $30 gain is
ordinary income that is taken into account under B's method of
accounting.
(c) Intercompany section 351 transfer with boot. The facts are
the same as in paragraph (a) of this Example 3, except that S
receives $10 cash in addition to the B stock in the transfer. S
recognizes $10 of gain under section 351(b), and its basis in the B
stock is $70 under section 358. Under section 362, B's basis in the
land is $80. S takes its $10 intercompany gain into account in Year
3 to reflect the $10 difference between B's $20 corresponding gain
taken into account and the $30 recomputed gain. Both S's $10 gain
and B's $20 gain are ordinary income.
(d) Partial disposition. The facts are the same as in paragraph
(c) of this Example 3, except B sells only a one- half, undivided
interest in the land to X for $50. The timing and attributes are
determined in the manner provided in paragraph (b) of this Example
3, except that S takes only $5 of its gain into account in Year 3 to
reflect the $5 difference between B's $10 gain taken into account
and the $15 recomputed gain.
Example 4. Depreciable property. (a) Facts. On January 1 of Year
1, S buys 10-year recovery property for $100 and depreciates it
under the straight-line method. On January 1 of Year 3, S sells the
property to B for $130. Under section 168(i)(7), B is treated as S
for purposes of section 168 to the extent B's $130 basis does not
exceed S's adjusted basis at the time of the sale. B's additional
basis is treated as new 10-year recovery property for which B elects
the straight-line method of recovery. (To simplify the example, the
half-year convention is disregarded.)
(b) Depreciation through Year 3; intercompany gain. S claims $10
of depreciation for each of Years 1 and 2 and has an $80 basis at
the time of the sale to B. Thus, S has a $50 intercompany gain from
its sale to B. For Year 3, B has $10 of depreciation with respect to
$80 of its basis (the portion of its $130 basis not exceeding S's
adjusted basis). In addition, B has $5 of depreciation with respect
to the $50 of its additional basis that exceeds S's adjusted basis.
(c) Timing. S's $50 gain is taken into account to reflect the
difference for each
[[Page 36690]]
consolidated return year between B's depreciation taken into account
with respect to the property and the recomputed depreciation. For
Year 3, B takes $15 of depreciation into account. If the
intercompany transaction were a transfer between divisions of a
single corporation, B would succeed to S's adjusted basis in the
property and take into account only $10 of depreciation for Year 3.
Thus, S takes $5 of gain into account in Year 3. In each subsequent
year that B takes into account $15 of depreciation with respect to
the property, S takes into account $5 of gain.
(d) Attributes. Under paragraph (c)(1)(i) of this section, the
attributes of S's gain and B's depreciation must be redetermined to
the extent necessary to produce the same effect on consolidated
taxable income as if the intercompany transaction were between
divisions of a single corporation (the group must have a net
depreciation deduction of $10). In each year, $5 of B's
corresponding depreciation deduction offsets S's $5 intercompany
gain taken into account and, under paragraph (c)(4)(i) of this
section, the attributes of B's corresponding item control the
attributes of S's intercompany item. Accordingly, S's intercompany
gain that is taken into account as a result of B's depreciation
deduction is ordinary income.
(e) Sale of property to a nonmember. The facts are the same as
in paragraph (a) of this Example 4, except that B sells the property
to X on January 1 of Year 5 for $110. As set forth in paragraphs (c)
and (d) of this Example 4, B has $15 of depreciation with respect to
the property in each of Years 3 and 4, causing S to take $5 of
intercompany gain into account in each year as ordinary income. The
$40 balance of S's intercompany gain is taken into account in Year 5
as a result of B's sale to X, to reflect the $40 difference between
B's $10 gain taken into account and the $50 of recomputed gain ($110
of sale proceeds minus the $60 basis B would have if the
intercompany sale were a transfer between divisions of a single
corporation). Treating S and B as divisions of a single corporation,
$40 of the gain is section 1245 gain and $10 is section 1231 gain.
On a separate entity basis, S would have more than $10 treated as
section 1231 gain, and B would have no amount treated as section
1231 gain. Under paragraph (c)(4)(ii) of this section, all $10 of
the section 1231 gain is allocated to S. S's remaining $30 of gain,
and all of B's $10 gain, is treated as section 1245 gain.
Example 5. Intercompany sale followed by installment sale. (a)
Facts. S holds land for investment with a basis of $70x. On January
1 of Year 1, S sells the land to B for $100x. B also holds the land
for investment. On July 1 of Year 3, B sells the land to X in
exchange for X's $110x note. The note bears a market rate of
interest in excess of the applicable Federal rate, and provides for
principal payments of $55x in Year 4 and $55x in Year 5. The
interest charge under section 453A(c) applies to X's note.
(b) Timing and attributes. S takes its $30x gain into account to
reflect the difference in each consolidated return year between B's
gain taken into account for the year and the recomputed gain. Under
section 453, B takes into account $5x of gain in Year 4 and $5x of
gain in Year 5. Thus, S takes into account $15x of gain in Year 4
and $15x of gain in Year 5 to reflect the $15x difference in each of
those years between B's $5x gain taken into account and the $20x
recomputed gain. Both S's $30x gain and B's $10x gain are subject to
the section 453A(c) interest charge beginning in Year 3.
(c) Election out under section 453(d). If, under the facts in
paragraph (a) of this Example 5, the P group wishes to elect not to
apply section 453 with respect to S's gain, an election under
section 453(d) must be made for Year 3 with respect to B's gain.
This election will cause B's $10x gain to be taken into account in
Year 3. Under the matching rule, this will result in S's $30x gain
being taken into account in Year 3. (An election by the P group
solely with respect to S's gain has no effect because the gain from
S's sale to B is taken into account under the matching rule, and
therefore must reflect the difference between B's gain taken into
account and the recomputed gain.)
(d) Sale to a nonmember at a loss, but overall gain. The facts
are the same as in paragraph (a) of this Example 5, except that B
sells the land to X in exchange for X's $90x note (rather than $110x
note). If S and B were divisions of a single corporation, B would
succeed to S's basis in the land, and the sale to X would be
eligible for installment reporting under section 453, because it
resulted in an overall gain. However, because only gains may be
reported on the installment method, B's $10x corresponding loss is
taken into account in Year 3. Under paragraph (b)(4) of this section
the recomputed corresponding item is $20x gain that would be taken
into account under the installment method, $0 in Year 3 and $10x in
each of Years 4 and 5. Thus, in Year 3 S takes $10x of gain into
account to reflect the difference between B's $10x loss taken into
account and the $0 recomputed gain for Year 3. Under paragraph
(c)(4)(i) of this section, B's $10x corresponding loss offsets $10x
of S's intercompany gain, and B's attributes control. S takes $10x
of gain into account in each of Years 4 and 5 to reflect the
difference in those years between B's $0 gain taken into account and
the $10x recomputed gain that would be taken into account under the
installment method. Only the $20x of S's gain taken into account in
Years 4 and 5 is subject to the interest charge under section
453A(c) beginning in Year 3. (If P elects under section 453(d) for
Year 3 not to apply section 453 with respect to the gain, all of S's
$30x gain will be taken into account in Year 3 to reflect the
difference between B's $10x loss taken into account and the $20x
recomputed gain.)
(e) Intercompany loss, installment gain. The facts are the same
as in paragraph (a) of this Example 5, except that S has a $130x
(rather than $70x) basis in the land. Under paragraph (c)(1)(i) of
this section, the separate entity attributes of S's and B's items
from the intercompany transaction must be redetermined to produce
the same effect on consolidated taxable income (and tax liability)
as if the transaction had been a transfer between divisions. If S
and B were divisions of a single corporation, B would succeed to S's
basis in the land and the group would have $20x loss from the sale
to X, installment reporting would be unavailable, and the interest
charge under section 453A(c) would not apply. Accordingly, B's gain
from the transaction is not eligible for installment treatment under
section 453. B takes its $10x gain into account in Year 3, and S
takes its $30x of loss into account in Year 3 to reflect the
difference between B's $10x gain and the $20x recomputed loss.
(f) Recapture income. The facts are the same as in paragraph (a)
of this Example 5, except that S bought depreciable property (rather
than land) for $100x, claimed depreciation deductions, and reduced
the property's basis to $70x before Year 1. (To simplify the
example, B's depreciation is disregarded.) If the intercompany sale
of property had been a transfer between divisions of a single
corporation, $30x of the $40x gain from the sale to X would be
section 1245 gain (which is ineligible for installment reporting)
and $10x would be section 1231 gain (which is eligible for
installment reporting). On a separate entity basis, S would have
$30x of section 1245 gain and B would have $10x of section 1231
gain. Accordingly, the attributes are not redetermined under
paragraph (c)(1)(i) of this section. All of B's $10x gain is
eligible for installment reporting and is taken into account $5x
each in Years 4 and 5 (and is subject to the interest charge under
section 453A(c)). S's $30x gain is taken into account in Year 3 to
reflect the difference between B's $0 gain taken into account and
the $30x of recomputed gain. (If S had bought the depreciable
property for $110x and its recomputed basis under section 1245 had
been $110x (rather than $100x), B's $10x gain and S's $30x gain
would both be recapture income ineligible for installment
reporting.)
Example 6. Intercompany sale of installment obligation. (a)
Facts. S holds land for investment with a basis of $70x. On January
1 of Year 1, S sells the land to X in exchange for X's $100x note,
and S reports its gain on the installment method under section 453.
X's note bears interest at a market rate of interest in excess of
the applicable Federal rate, and provides for principal payments of
$50x in Year 5 and $50x in Year 6. Section 453A applies to X's note.
On July 1 of Year 3, S sells X's note to B for $100x, resulting in
$30x gain from S's prior sale of the land to X under section
453B(a).
(b) Timing and attributes. S's sale of X's note to B is an
intercompany transaction, and S's $30x gain is intercompany gain. S
takes $15x of the gain into account in each of Years 5 and 6 to
reflect the $15x difference in each year between B's $0 gain taken
into account and the $15x recomputed gain. S's gain continues to be
treated as its gain from the sale to X, and the deferred tax
liability remains subject to the interest charge under section
453A(c).
(c) Worthlessness. The facts are the same as in paragraph (a) of
this Example 6, except that X's note becomes worthless on December 1
of Year 3 and B has a $100x short-term capital loss under section
165(g) on a separate entity basis. Under paragraph (c)(1)(ii) of
this section, B's holding period
[[Page 36691]]
for X's note is aggregated with S's holding period. Thus, B's loss is a
long- term capital loss. S takes its $30x gain into account in Year
3 to reflect the $30x difference between B's $100x loss taken into
account and the $70x recomputed loss. Under paragraph (c)(1)(i) of
this section, S's gain is long-term capital gain.
(d) Pledge. The facts are the same as in paragraph (a) of this
Example 6, except that, on December 1 of Year 3, B borrows $100x
from an unrelated bank and secures the indebtedness with X's note.
X's note remains subject to section 453A(d) following the sale to B.
Under section 453A(d), B's $100x of proceeds from the secured
indebtedness is treated as an amount received on December 1 of Year
3 by B on X's note. Thus, S takes its entire $30x gain into account
in Year 3.
Example 7. Performance of services. (a) Facts. S is a driller of
water wells. B operates a ranch in a remote location, and B's
taxable income from the ranch is not subject to section 447. B's
ranch requires water to maintain its cattle. During Year 1, S drills
an artesian well on B's ranch in exchange for $100 from B, and S
incurs $80 of expenses (e.g., for employees and equipment). B
capitalizes its $100 cost for the well under section 263, and takes
into account $10 of cost recovery deductions in each of Years 2
through 11. Under its separate entity method of accounting, S would
take its income and expenses into account in Year 1. If S and B were
divisions of a single corporation, the costs incurred in drilling
the well would be capitalized.
(b) Definitions. Under paragraph (b)(1) of this section, the
service transaction is an intercompany transaction, S is the selling
member, and B is the buying member. Under paragraph (b)(2)(ii) of
this section, S's $100 of income and $80 of related expenses are
both included in determining its intercompany income of $20.
(c) Timing and attributes. S's $20 of intercompany income is
taken into account under the matching rule to reflect the $20
difference between B's corresponding items taken into account (based
on its $100 cost basis in the well) and the recomputed corresponding
items (based on the $80 basis that B would have if S and B were
divisions of a single corporation and B's basis were determined by
reference to S's $80 of expenses). In Year 1, S takes into account
$80 of its income and the $80 of expenses. In each of Years 2
through 11, S takes $2 of its $20 intercompany income into account
to reflect the annual $2 difference between B's $10 of cost recovery
deductions taken into account and the $8 of recomputed cost recovery
deductions. S's $100 income and $80 expenses, and B's cost recovery
deductions, are ordinary items (because S's and B's items would be
ordinary on a separate entity basis, the attributes are not
redetermined under paragraph (c)(1)(i) of this section). If S's
offsetting $80 of income and expense would not be taken into account
in the same year under its separate entity method of accounting,
they nevertheless must be taken into account under this section in a
manner that clearly reflects consolidated taxable income. See
paragraph (a)(3)(i) of this section.
(d) Sale of capitalized services. The facts are the same as in
paragraph (a) of this Example 7, except that B sells the ranch
before Year 11 and recognizes gain attributable to the well. To the
extent of S's income taken into account as a result of B's cost
recovery deductions, as well as S's offsetting $80 of income and
expense, the timing and attributes are determined in the manner
provided in paragraph (c) of this Example 7. The attributes of the
remainder of S's $20 of income and B's gain from the sale are
redetermined to produce the same effect on consolidated taxable
income as if S and B were divisions of a single corporation.
Accordingly, S's remaining intercompany income is treated as
recapture income or section 1231 gain, even though it is from S's
performance of services.
Example 8. Rental of property. B operates a ranch that requires
grazing land for its cattle. S owns undeveloped land adjoining B's
ranch. On January 1 of Year 1, S leases grazing rights to B for Year
1. B's $100 rent expense is deductible for Year 1 under its separate
entity accounting method. Under paragraph (b)(1) of this section,
the rental transaction is an intercompany transaction, S is the
selling member, and B is the buying member. S takes its $100 of
income into account in Year 1 to reflect the $100 difference between
B's rental deduction taken into account and the $0 recomputed rental
deduction. S's income and B's deduction are ordinary items (because
S's intercompany item and B's corresponding item would both be
ordinary on a separate entity basis, the attributes are not
redetermined under paragraph (c)(1)(i) of this section).
Example 9. Intercompany sale of a partnership interest. (a)
Facts. S owns a 20% interest in the capital and profits of a general
partnership. The partnership holds land for investment with a basis
equal to its value, and operates depreciable assets which have value
in excess of basis. S's basis in its partnership interest equals its
share of the adjusted basis of the partnership's land and
depreciable assets. The partnership has an election under section
754 in effect. On January 1 of Year 1, S sells its partnership
interest to B at a gain. During Years 1 through 10, the partnership
depreciates the operating assets, and B's depreciation deductions
from the partnership reflect the increase in the basis of the
depreciable assets under section 743(b).
(b) Timing and attributes. S's gain is taken into account during
Years 1 through 10 to reflect the difference in each year between
B's depreciation deductions from the partnership taken into account
and the recomputed depreciation deductions from the partnership.
Under paragraphs (c)(1)(i) and (c)(4)(i) of this section, S's gain
taken into account is ordinary income. (The acceleration rule does
not apply to S's gain as a result of the section 743(b) adjustment,
because the adjustment is solely with respect to B and therefore no
nonmember reflects any part of the intercompany transaction.)
(c) Partnership sale of assets. The facts are the same as in
paragraph (a) of this Example 9, and the partnership sells some of
its depreciable assets to X at a gain on December 31 of Year 4. In
addition to the intercompany gain taken into account as a result of
the partnership's depreciation, S takes intercompany gain into
account in Year 4 to reflect the difference between B's partnership
items taken into account from the sale (which reflect the basis
increase under section 743(b)) and the recomputed partnership items.
The attributes of S's additional gain are redetermined to produce
the same effect on consolidated taxable income as if S and B were
divisions of a single corporation (recapture income or section 1231
gain).
(d) B's sale of partnership interest. The facts are the same as
in paragraph (a) of this Example 9, and on December 31 of Year 4, B
sells its partnership interest to X at no gain or loss. In addition
to the intercompany gain taken into account as a result of the
partnership's depreciation, the remaining balance of S's
intercompany gain is taken into account in Year 4 to reflect the
difference between B's $0 gain taken into account from the sale of
the partnership interest and the recomputed gain. The character of
S's remaining intercompany item and B's corresponding item are
determined on a separate entity basis under section 751, and then
redetermined to the extent necessary to produce the same effect as
treating the intercompany transaction as occurring between divisions
of a single corporation.
(e) No section 754 election. The facts are the same as in
paragraph (d) of this Example 9, except that the partnership does
not have a section 754 election in effect, and B recognizes a
capital loss from its sale of the partnership interest to X on
December 31 of Year 4. Because there is no difference between B's
depreciation deductions from the partnership taken into account and
the recomputed depreciation deductions, S does not take any of its
gain into account during Years 1 through 4 as a result of B's
partnership's items. Instead, S's entire intercompany gain is taken
into account in Year 4 to reflect the difference between B's loss
taken into account from the sale to X and the recomputed gain or
loss.
Example 10. Net operating losses subject to section 382 or the
SRLY rules. (a) Facts. On January 1 of Year 1, P buys all of S's
stock. S has net operating loss carryovers from prior years. P's
acquisition results in an ownership change under section 382 with
respect to S's loss carryovers, and S has a net unrealized built-in
gain (within the meaning of section 382(h)(3)). S owns
nondepreciable property with a $70 basis and $100 value. On July 1
of Year 3, S sells the property to B for $100, and its $30 gain is
recognized built-in gain (within the meaning of section 382(h)(2))
on a separate entity basis. On December 1 of Year 5, B sells the
property to X for $90.
(b) Timing and attributes. S's $30 gain is taken into account in
Year 5 to reflect the $30 difference between B's $10 loss taken into
account and the recomputed $20 gain. S and B are treated as
divisions of a single corporation for purposes of applying section
382 in connection with the intercompany transaction. Under a single
entity analysis, the single corporation has losses subject to
limitation under section 382, and this limitation may be increased
under section
[[Page 36692]]
382(h) if the single corporation has recognized built-in gain with
respect to those losses. B's $10 corresponding loss offsets $10 of
S's intercompany gain, and thus, under paragraph (c)(4)(i) of this
section, $10 of S's intercompany gain is redetermined not to be
recognized built-in gain. S's remaining $20 intercompany gain
continues to be treated as recognized built-in gain.
(c) B's recognized built-in gain. The facts are the same as in
paragraph (a) of this Example 10, except that the property declines
in value after S becomes a member of the P group, S sells the
property to B for its $70 basis, and B sells the property to X for
$90 during Year 5. Treating S and B as divisions of a single
corporation, S's sale to B does not cause the property to cease to
be built-in gain property. Thus, B's $20 gain from its sale to X is
recognized built-in gain that increases the section 382 limitation
applicable to S's losses.
(d) SRLY limitation. The facts are the same as in paragraph (a)
of this Example 10, except that S's net operating loss carryovers
are subject to the separate return limitation year (SRLY) rules. See
Sec. 1.1502-21(c). The application of the SRLY rules depends on S's
status as a separate corporation having losses from separate return
limitation years. Under paragraph (c)(5), the attribute of S's
intercompany item as it relates to S's SRLY limitation is not
redetermined, because the SRLY limitation depends on S's special
status. Accordingly, S's $30 intercompany gain is included in
determining its SRLY limitation for Year 5.
Example 11. Section 475. (a) Facts. S, a dealer in securities
within the meaning of section 475(c), owns a security with a basis
of $70. The security is held for sale to customers and is not
identified under section 475(b) as within an exception to marking to
market. On July 1 of Year 1, S sells the security to B for $100. B
is not a dealer and holds the security for investment. On December
31 of Year 1, the fair market value of the security is $100. On July
1 of Year 2, B sells the security to X for $110.
(b) Attributes. Under section 475, a dealer in securities can
treat a security as within an exception to marking to market under
section 475(b) only if it timely identifies the security as so
described. Under the matching rule, attributes must be redetermined
by treating S and B as divisions of a single corporation. As a
result of S's activities, the single corporation is treated as a
dealer with respect to securities, and B must continue to mark to
market the security acquired from S. Thus, B's corresponding items
and the recomputed corresponding items are determined by continuing
to treat the security as not within an exception to marking to
market. Under section 475(d)(3), it is possible for the character of
S's intercompany items to differ from the character of B's
corresponding items.
(c) Timing and character. S has a $30 gain when it disposes of
the security by selling it to B. This gain is intercompany gain that
is taken into account in Year 1 to reflect the $30 difference
between B's $0 gain taken into account from marking the security to
market under section 475 and the recomputed $30 gain that would be
taken into account. The character of S's gain and B's gain are
redetermined as if the security were transferred between divisions.
Accordingly, S's gain is ordinary income under section
475(d)(3)(A)(i), but under section 475(d)(3)(B)(ii) B's $10 gain
from its sale to X is capital gain that is taken into account in
Year 2.
(d) Nondealer to dealer. The facts are the same as in paragraph
(a) of this Example 11, except that S is not a dealer and holds the
security for investment with a $70 basis, B is a dealer to which
section 475 applies and, immediately after acquiring the security
from S for $100, B holds the security for sale to customers in the
ordinary course of its trade or business. Because S is not a dealer
and held the security for investment, the security is treated as
properly identified as held for investment under section 475(b)(1)
until it is sold to B. Under section 475(b)(3), the security
thereafter ceases to be described in section 475(b)(1) because B
holds the security for sale to customers. The mark-to-market
requirement applies only to changes in the value of the security
after B's acquisition. B's mark-to-market gain taken into account
and the recomputed mark-to-market gain are both determined based on
changes from the $100 value of the security at the time of B's
acquisition. There is no difference between B's $0 mark-to-market
gain taken into account in Year 1 and the $0 recomputed mark-to-
market gain. Therefore, none of S's gain is taken into account in
Year 1 as a result of B's marking the security to market in Year 1.
In Year 2, B has a $10 gain when it disposes of the security by
selling it to X, but would have had a $40 gain if S and B were
divisions of a single corporation. Thus, S takes its $30 gain into
account in Year 2 under the matching rule. Under section 475(d)(3),
S's gain is capital gain even though B's subsequent gain or loss
from marking to market or disposing of the security is ordinary gain
or loss. If B disposes of the security at a $10 loss in Year 2, S's
gain taken into account in Year 2 is still capital because on a
single entity basis section 475(d)(3) would provide for $30 of
capital gain and $10 of ordinary loss. Because the attributes are
not redetermined under paragraph (c)(1)(i) of this section,
paragraph (c)(4)(i) of this section does not apply. Furthermore, if
B held the security for investment, and so identified the security
under section 475(b)(1), the security would continue to be excepted
from marking to market.
Example 12. Section 1092. (a) Facts. On July 1 of Year 1, S
enters into offsetting long and short positions with respect to
actively traded personal property. The positions are not section
1256 contracts, and they are the only positions taken into account
for purposes of applying section 1092. On August 1 of Year 1, S
sells the long position to B at an $11 loss, and there is $11 of
unrealized gain in the offsetting short position. On December 1 of
Year 1, B sells the long position to X at no gain or loss. On
December 31 of Year 1, there is still $11 of unrealized gain in the
short position. On February 1 of Year 2, S closes the short position
at an $11 gain.
(b) Timing and attributes. If the sale from S to B were a
transfer between divisions of a single corporation, the $11 loss on
the sale to X would have been deferred under section 1092(a)(1)(A).
Accordingly, there is no difference in Year 1 between B's
corresponding item of $0 and the recomputed corresponding item of
$0. S takes its $11 loss into account in Year 2 to reflect the
difference between B's corresponding item of $0 taken into account
in Year 2 and the recomputed loss of $11 that would have been taken
into account in Year 2 under section 1092(a)(1)(B) if S and B had
been divisions of a single corporation. (The results are the same
under section 267(f)).
Example 13. Manufacturer incentive payments. (a) Facts. B is a
manufacturer that sells its products to independent dealers for
resale. S is a credit company that offers financing, including
financing to customers of the dealers. S also purchases the product
from the dealers for lease to customers of the dealers. During Year
1, B initiates a program of incentive payments to the dealers'
customers. Under B's program, S buys a product from an independent
dealer for $100 and leases it to a nonmember. S pays $90 to the
dealer for the product, and assigns to the dealer its $10 incentive
payment from B. Under their separate entity accounting methods, B
would deduct the $10 incentive payment in Year 1 and S would take a
$90 basis in the product. Assume that if S and B were divisions of a
single corporation, the $10 payment would not be deductible and the
basis of the property would be $100.
(b) Timing and attributes. Under paragraph (b)(1) of this
section, the incentive payment transaction is an intercompany
transaction. Under paragraph (b)(2)(iii) of this section, S has a
$10 intercompany item not yet taken into account under its separate
entity method of accounting. Under the matching rule, S takes its
intercompany item into account to reflect the difference between B's
corresponding item taken into account and the recomputed
corresponding item. In Year 1 there is a $10 difference between B's
$10 deduction taken into account and the $0 recomputed deduction.
Accordingly, under the matching rule S must take the $10 incentive
payment into account as intercompany income in Year 1. S's $10 of
income and B's $10 deduction are ordinary items. S's basis in the
product is $100 rather than the $90 it would be under S's separate
entity method of accounting. S's additional $10 of basis in the
product is recovered based on subsequent events (e.g., S's cost
recovery deductions or its sale of the product).
Example 14. Source of income under section 863. (a) Intercompany
sale with no independent factory price. S manufactures inventory in
the United States, and recognizes $75 of income on sales to B in
Year 1. B distributes the inventory in Country Y and recognizes $25
of income on sales to X, also in Year 1. Title passes from S to B,
and from B to X, in Country Y. There is no independent factory price
(as defined in regulations under section 863) for the sale from S to
B. Under the matching rule, S's $75 intercompany income and B's $25
corresponding income are taken into account in Year 1. In
determining the source of income, S and B are treated as divisions
of a single corporation, and section 863 applies
[[Page 36693]]
as if $100 of income were recognized from producing in the United
States and selling in Country Y. Assume that applying the section
863 regulations on a single entity basis, $50 is treated as foreign
source income and $50 as U.S. source income. Assume further that on
a separate entity basis, S would have $37.50 of foreign source
income and $37.50 of U.S. source income, and that all of B's $25 of
income would be foreign source income. Thus, on a separate entity
basis, S and B would have $62.50 of combined foreign source income
and $37.50 of U.S. source income. Accordingly, under single entity
treatment, $12.50 that would be treated as foreign source income on
a separate entity basis is redetermined to be U.S. source income.
Under paragraph (c)(1)(i) of this section, attributes are
redetermined only to the extent of the $12.50 necessary to achieve
the same effect as a single entity determination. Under paragraph
(c)(4)(ii) of this section, the redetermined attribute must be
allocated between S and B using a reasonable method. For example, it
may be reasonable to recharacterize only S's foreign source income
as U.S. source income because only S would have any U.S. source
income on a separate entity basis. However, it may also be
reasonable to allocate the redetermined attribute between S and B in
proportion to their separate entity amounts of foreign source income
(in a 3:2 ratio, so that $7.50 of S's foreign source income is
redetermined to be U.S. source and $5 of B's foreign source income
is redetermined to be U.S. source), provided the same method is
applied to all similar transactions within the group.
(b) Intercompany sale with independent factory price. The facts
are the same as in paragraph (a) of this Example 14, except that an
independent factory price exists for the sale by S to B such that
$70 of S's $75 of income is attributable to the production function.
Assume that on a single entity basis, $70 is treated as U.S. source
income (because of the existence of the independent factory price)
and $30 is treated as foreign source income. Assume that on a
separate entity basis, $70 of S's income would be treated as U.S.
source, $5 of S's income would be treated as foreign source income,
and all of B's $25 income would be treated as foreign source income.
Because the results are the same on a single entity basis and a
separate entity basis, the attributes are not redetermined under
paragraph (c)(1)(i) of this section.
(c) Sale of property reflecting intercompany services or
intangibles. S earns $10 of income performing services in the United
States for B. B capitalizes S's fees into the basis of property that
it manufactures in the United States and sells to an unrelated
person in Year 1 at a $90 profit, with title passing in Country Y.
Under the matching rule, S's $10 income and B's $90 income are taken
into account in Year 1. In determining the source of income, S and B
are treated as divisions of a single corporation, and section 863
applies as if $100 were earned from manufacturing in the United
States and selling in Country Y. Assume that on a single entity
basis $50 is treated as foreign source income and $50 is treated as
U.S. source income. Assume that on a separate entity basis, S would
have $10 of U.S. source income, and B would have $45 of foreign
source income and $45 of U.S. source income. Accordingly, under
single entity treatment, $5 of income that would be treated as U.S.
source income on a separate entity basis is redetermined to be
foreign source income. Under paragraph (c)(1)(i) of this section,
attributes are redetermined only to the extent of the $5 necessary
to achieve the same effect as a single entity determination. Under
paragraph (c)(4)(ii) of this section, the redetermined attribute
must be allocated between S and B using a reasonable method. (If
instead of performing services, S licensed an intangible to B and
earned $10 that would be treated as U.S. source income on a separate
entity basis, the results would be the same.)
Example 15. Section 1248. (a) Facts. On January 1 of Year 1, S
forms FT, a wholly owned foreign subsidiary, with a $10
contribution. During Years 1 through 3, FT has earnings and profits
of $40. None of the earnings and profits is taxed as subpart F
income under section 951, and FT distributes no dividends to S
during this period. On January 1 of Year 4, S sells its FT stock to
B for $50. While B owns FT, FT has a deficit in earnings and profits
of $10. On July 1 of Year 6, B sells its FT stock for $70 to X, an
unrelated foreign corporation.
(b) Timing. S's $40 of intercompany gain is taken into account
in Year 6 to reflect the difference between B's $20 of gain taken
into account and the $60 recomputed gain.
(c) Attributes. Under the matching rule, the attributes of S's
intercompany gain and B's corresponding gain are redetermined to
have the same effect on consolidated taxable income (and
consolidated tax liability) as if S and B were divisions of a single
corporation. On a single entity basis, there is $60 of gain and the
portion which is characterized as a dividend under section 1248 is
determined on the basis of FT's $30 of earnings and profits at the
time of the sale of FT to X (the sum of FT's $40 of earnings and
profits while held by S and FT's $10 deficit in earnings and profits
while held by B). Therefore, $30 of the $60 gain is treated as a
dividend under section 1248. The remaining $30 is treated as capital
gain. On a separate entity basis, all of S's $40 gain would be
treated as a dividend under section 1248 and all of B's $20 gain
would be treated as capital gain. Thus, as a result of the single
entity determination, $10 that would be treated as a dividend under
section 1248 on a separate entity basis is redetermined to be
capital gain. Under paragraph (c)(4)(ii) of this section, this
redetermined attribute must be allocated between S's intercompany
item and B's corresponding item by using a reasonable method. On a
separate entity basis, only S would have any amount treated as a
dividend under section 1248 available for redetermination.
Accordingly, $10 of S's income is redetermined to be not subject to
section 1248, with the result that $30 of S's intercompany gain is
treated as a dividend and the remaining $10 is treated as capital
gain. All of B's corresponding gain is treated as capital gain, as
it would be on a separate entity basis.
(d) B has loss. The facts are the same as in paragraph (a) of
this Example 15, except that FT has no earnings and profits or
deficit in earnings and profits while B owns FT, and B sells the FT
stock to X for $40. On a single entity basis, there is $30 of gain,
and section 1248 is applied on the basis of FT's $40 earnings and
profits at the time of the sale of FT to X. Under section 1248, the
amount treated as a dividend is limited to $30 (the amount of the
gain). On a separate entity basis, S's entire $40 gain would be
treated as a dividend under section 1248, and B's $10 loss would be
a capital loss. B's $10 corresponding loss offsets $10 of S's
intercompany gain and, under paragraph (c)(4)(i) of this section,
the attributes of B's corresponding item control. Accordingly, $10
of S's gain must be redetermined to be capital gain. B's $10 loss
remains a capital loss. (If, however, S sold FT to B at a loss and B
sold FT to X at a gain, it may be unreasonable for the attributes of
B's corresponding gain to control S's offsetting intercompany loss.
If B's attributes were to control, for example, the group could
possibly claim a larger foreign tax credit than would be available
if S and B were divisions of a single corporation.)
(d) Acceleration rule. S's intercompany items and B's corresponding
items are taken into account under this paragraph (d) to the extent
they cannot be taken into account to produce the effect of treating S
and B as divisions of a single corporation. For this purpose, the
following rules apply:
(1) S's items--(i) Timing. S takes its intercompany items into
account to the extent they cannot be taken into account to produce the
effect of treating S and B as divisions of a single corporation. The
items are taken into account immediately before it first becomes
impossible to achieve this effect. For this purpose, the effect cannot
be achieved--
(A) To the extent an intercompany item or corresponding item will
not be taken into account in determining the group's consolidated
taxable income (or consolidated tax liability) under the matching rule
(for example, if S or B becomes a nonmember, or if S's intercompany
item is no longer reflected in the difference between B's basis (or an
amount equivalent to basis) in property and the basis (or equivalent
amount) the property would have if S and B were divisions of a single
corporation); or
(B) To the extent a nonmember reflects, directly or indirectly, any
aspect of the intercompany transaction (e.g., if B's cost basis in
property purchased from S is reflected by a nonmember under section 362
following a section 351 transaction).
(ii) Attributes. The attributes of S's intercompany items taken
into account
[[Page 36694]]
under this paragraph (d)(1) are determined as follows:
(A) Sale, exchange, or distribution. If the item is from an
intercompany sale, exchange, or distribution of property, its
attributes are determined under the principles of the matching rule as
if B sold the property, at the time the item is taken into account
under paragraph (d)(1)(i) of this section, for a cash payment equal to
B's adjusted basis in the property (i.e., at no net gain or loss), to
the following person:
(1) Property leaves the group. If the property is owned by a
nonmember immediately after S's item is taken into account, B is
treated as selling the property to that nonmember. If the nonmember is
related for purposes of any provision of the Internal Revenue Code or
regulations to any party to the intercompany transaction (or any
related transaction) or to the common parent, the nonmember is treated
as related to B for purposes of that provision. For example, if the
nonmember is related to P within the meaning of section 1239(b), the
deemed sale is treated as being described in section 1239(a). See
paragraph (j)(6) of this section, under which property is not treated
as being owned by a nonmember if it is owned by the common parent after
the common parent becomes the only remaining member.
(2) Property does not leave the group. If the property is not owned
by a nonmember immediately after S's item is taken into account, B is
treated as selling the property to an affiliated corporation that is
not a member of the group.
(B) Other transactions. If the item is from an intercompany
transaction other than a sale, exchange, or distribution of property
(e.g., income from S's services capitalized by B), its attributes are
determined on a separate entity basis.
(2) B's items--(i) Attributes. The attributes of B's corresponding
items continue to be redetermined under the principles of the matching
rule, with the following adjustments:
(A) If S and B continue to join with each other in the filing of
consolidated returns, the attributes of B's corresponding items (and
any applicable holding periods) are determined by continuing to treat S
and B as divisions of a single corporation.
(B) Once S and B no longer join with each other in the filing of
consolidated returns, the attributes of B's corresponding items are
determined as if the S division (but not the B division) were
transferred by the single corporation to an unrelated person. Thus, S's
activities (and any applicable holding period) before the intercompany
transaction continue to affect the attributes of the corresponding
items (and any applicable holding period).
(ii) Timing. If paragraph (d)(1) of this section applies to S, B
nevertheless continues to take its corresponding items into account
under its accounting method. However, the redetermination of the
attributes of a corresponding item under this paragraph (d)(2) might
affect its timing.
(3) Examples. The acceleration rule of this paragraph (d) is
illustrated by the following examples.
Example 1. Becoming a nonmember--timing. (a) Facts. S owns land
with a basis of $70. On January 1 of Year 1, S sells the land to B
for $100. On July 1 of Year 3, P sells 60% of S's stock to X for $60
and, as a result, S becomes a nonmember.
(b) Matching rule. Under the matching rule, none of S's $30 gain
is taken into account in Years 1 through 3 because there is no
difference between B's $0 gain or loss taken into account and the
recomputed gain or loss.
(c) Acceleration of S's intercompany items. Under the
acceleration rule of paragraph (d) of this section, S's $30 gain is
taken into account in computing consolidated taxable income (and
consolidated tax liability) immediately before the effect of
treating S and B as divisions of a single corporation cannot be
produced. Because the effect cannot be produced once S becomes a
nonmember, S takes its $30 gain into account in Year 3 immediately
before becoming a nonmember. S's gain is reflected under
Sec. 1.1502-32 in P's basis in the S stock immediately before P's
sale of the stock. Under Sec. 1.1502-32, P's basis in the S stock is
increased by $30, and therefore P's gain is reduced (or loss is
increased) by $18 (60% of $30). See also Secs. 1.1502-33 and 1.1502-
76(b). (The results would be the same if S sold the land to B in an
installment sale to which section 453 would otherwise apply, because
S must take its intercompany gain into account under this section.)
(d) B's corresponding items. Notwithstanding the acceleration of
S's gain, B continues to take its corresponding items into account
under its accounting method. Thus, B's items from the land are taken
into account based on subsequent events (e.g., its sale of the
land).
(e) Sale of B's stock. The facts are the same as in paragraph
(a) of this Example 1, except that P sells 60% of B's stock (rather
than S stock) to X for $60 and, as a result, B becomes a nonmember.
Because the effect of treating S and B as divisions of a single
corporation cannot be produced once B becomes a nonmember, S takes
its $30 gain into account under the acceleration rule immediately
before B becomes a nonmember. (The results would be the same if S
sold the land to B in an installment sale to which section 453 would
otherwise apply, because S must take its intercompany gain into
account under this section.)
(f) Discontinue filing consolidated returns. The facts are the
same as in paragraph (a) of this Example 1, except that the P group
receives permission under Sec. 1.1502-75(c) to discontinue filing
consolidated returns beginning in Year 3. Under the acceleration
rule, S takes its $30 gain into account on December 31 of Year 2.
(g) No subgroups. The facts are the same as in paragraph (a) of
this Example 1, except that P simultaneously sells all of the stock
of both S and B to X (rather than 60% of S's stock), and S and B
become members of the X consolidated group. Because the effect of
treating S and B as divisions of a single corporation in the P group
cannot be produced once S and B become nonmembers, S takes its $30
gain into account under the acceleration rule immediately before S
and B become nonmembers. (Paragraph (j)(5) of this section does not
apply to treat the X consolidated group as succeeding to the P group
because the X group acquired only the stock of S and B.) However, so
long as S and B continue to join with each other in the filing of
consolidated returns, B continues to treat S and B as divisions of a
single corporation for purposes of determining the attributes of B's
corresponding items from the land.
Example 2. Becoming a nonmember--attributes. (a) Facts. S holds
land for investment with a basis of $70. On January 1 of Year 1, S
sells the land to B for $100. B holds the land for sale to customers
in the ordinary course of business, and expends substantial
resources over a two-year period subdividing, developing, and
marketing the land. On July 1 of Year 3, before B has sold any of
the land, P sells 60% of S's stock to X for $60 and, as a result, S
becomes a nonmember.
(b) Attributes. Under the acceleration rule, the attributes of
S's gain are redetermined under the principles of the matching rule
as if B sold the land to an affiliated corporation that is not a
member of the group for a cash payment equal to B's adjusted basis
in the land (because the land continues to be held within the
group). Thus, whether S's gain is capital gain or ordinary income
depends on the activities of both S and B. Because S and B no longer
join with each other in the filing of consolidated returns, the
attributes of B's corresponding items (e.g., from its subsequent
sale of the land) are redetermined under the principles of the
matching rule as if the S division (but not the B division) were
transferred by the single corporation to an unrelated person at the
time of P's sale of the S stock. Thus, B continues to take into
account the activities of S with respect to the land before the
intercompany transaction.
(c) Depreciable property. The facts are the same as in paragraph
(a) of this Example 2, except that the property sold by S to B is
depreciable property. Section 1239 applies to treat all of S's gain
as ordinary income because it is taken into account as a result of
B's deemed sale of the property to a affiliated corporation that is
not a member of the group (a related person within the meaning of
section 1239(b)).
Example 3. Selling member's disposition of installment note. (a)
Facts. S owns land with a basis of $70. On January 1 of Year 1, S
sells the land to B in exchange for B's $110 note. The note bears a
market rate of interest in excess of the applicable Federal rate,
and
[[Page 36695]]
provides for principal payments of $55 in Year 4 and $55 in Year 5. On
July 1 of Year 3, S sells B's note to X for $110.
(b) Timing. S's intercompany gain is taken into account under
this section, and not under the rules of section 453. Consequently,
S's sale of B's note does not result in its intercompany gain from
the land being taken into account (e.g., under section 453B). The
sale does not prevent S's intercompany items and B's corresponding
items from being taken into account in determining the group's
consolidated taxable income under the matching rule, and X does not
reflect any aspect of the intercompany transaction (X has its own
cost basis in the note). S will take the intercompany gain into
account under the matching rule or acceleration rule based on
subsequent events (e.g., B's sale of the land). See also paragraph
(g) of this section for additional rules applicable to B's note as
an intercompany obligation.
Example 4. Cancellation of debt and attribute reduction under
section 108(b). (a) Facts. S holds land for investment with a basis
of $0. On January 1 of Year 1, S sells the land to B for $100. B
also holds the land for investment. During Year 3, B is insolvent
and B's nonmember creditors discharge $60 of B's indebtedness.
Because of insolvency, B's $60 discharge is excluded from B's gross
income under section 108(a), and B reduces the basis of the land by
$60 under sections 108(b) and 1017.
(b) Acceleration rule. As a result of B's basis reduction under
section 1017, $60 of S's intercompany gain will not be taken into
account under the matching rule (because there is only a $40
difference between B's $40 basis in the land and the $0 basis the
land would have if S and B were divisions of a single corporation).
Accordingly, S takes $60 of its gain into account under the
acceleration rule in Year 3. S's gain is long-term capital gain,
determined under paragraph (d)(1)(ii) of this section as if B sold
the land to an affiliated corporation that is not a member of the
group for $100 immediately before the basis reduction.
(c) Purchase price adjustment. Assume instead that S sells the
land to B in exchange for B's $100 purchase money note, B remains
solvent, and S subsequently agrees to discharge $60 of the note as a
purchase price adjustment to which section 108(e)(5) applies. Under
applicable principles of tax law, $60 of S's gain and $60 of B's
basis in the land are eliminated and never taken into account.
Similarly, the note is not treated as satisfied and reissued under
paragraph (g) of this section.
Example 5. Section 481. (a) Facts. S operates several trades or
businesses, including a manufacturing business. S receives
permission to change its method of accounting for valuing inventory
for its manufacturing business. S increases the basis of its ending
inventory by $100, and the related $100 positive section 481(a)
adjustment is to be taken into account ratably over six taxable
years, beginning in Year 1. During Year 3, S sells all of the assets
used in its manufacturing business to B at a gain. Immediately after
the transfer, B does not use the same inventory valuation method as
S. On a separate entity basis, S's sale results in an acceleration
of the balance of the section 481(a) adjustment to Year 3.
(b) Timing and attributes. Under paragraph (b)(2) of this
section, the balance of S's section 481(a) adjustment accelerated to
Year 3 is intercompany income. However, S's $100 basis increase
before the intercompany transaction eliminates the related
difference for this amount between B's corresponding items taken
into account and the recomputed corresponding items in subsequent
periods. Because the accelerated section 481(a) adjustment will not
be taken into account in determining the group's consolidated
taxable income (and consolidated tax liability) under the matching
rule, the balance of S's section 481 adjustment is taken into
account under the acceleration rule as ordinary income at the time
of the intercompany transaction. (If S's sale had not resulted in
accelerating S's section 481(a) adjustment on a separate entity
basis, S would have no intercompany income to be taken into account
under this section.)
(e) Simplifying rules--(1) Dollar-value LIFO inventory methods--(i)
In general. This paragraph (e)(1) applies if either S or B uses a
dollar-value LIFO inventory method to account for intercompany
transactions. Rather than applying the matching rule separately to each
intercompany inventory transaction, this paragraph (e)(1) provides
methods to apply an aggregate approach that is based on dollar-value
LIFO inventory accounting. Any method selected under this paragraph
(e)(1) must be applied consistently.
(ii) B uses dollar-value LIFO--(A) In general. If B uses a dollar-
value LIFO inventory method to account for its intercompany inventory
purchases, and includes all of its inventory costs incurred for a year
in its cost of goods sold for the year (that is, B has no inventory
increment for the year), S takes into account all of its intercompany
inventory items for the year. If B does not include all of its
inventory costs incurred for the year in its cost of goods sold for the
year (that is, B has an inventory increment for the year), S does not
take all of its intercompany inventory income or loss into account. The
amount not taken into account is determined under either the increment
averaging method of paragraph (e)(1)(ii)(B) of this section or the
increment valuation method of paragraph (e)(1)(ii)(C) of this section.
Separate computations are made for each pool of B that receives
intercompany purchases from S, and S's amount not taken into account is
layered based on B's LIFO inventory layers.
(B) Increment averaging method. Under this paragraph (e)(1)(ii)(B),
the amount not taken into account is the amount of S's intercompany
inventory income or loss multiplied by the ratio of the LIFO value of
B's current-year costs of its layer of increment to B's total inventory
costs incurred for the year under its LIFO inventory method. If B
includes more than its inventory costs incurred during any subsequent
year in its cost of goods sold (a decrement), S takes into account the
intercompany inventory income or loss layers in the same manner and
proportion as B takes into account its inventory decrements.
(C) Increment valuation method. Under this paragraph (e)(1)(ii)(C),
the amount not taken into account is the amount of S's intercompany
inventory income or loss for the appropriate period multiplied by the
ratio of the LIFO value of B's current-year costs of its layer of
increment to B's total inventory costs incurred in the appropriate
period under its LIFO inventory method. The principles of paragraph
(e)(1)(ii)(B) of this section otherwise apply. The appropriate period
is the period of B's year used to determine its current-year costs.
(iii) S uses dollar-value LIFO. If S uses a dollar-value LIFO
inventory method to account for its intercompany inventory sales, S may
use any reasonable method of allocating its LIFO inventory costs to
intercompany transactions. LIFO inventory costs include costs of prior
layers if a decrement occurs. For example, a reasonable allocation of
the most recent costs incurred during the consolidated return year can
be used to compute S's intercompany inventory income or loss for the
year if S has an inventory increment and uses the earliest acquisitions
costs method, but S must apportion costs from the most recent
appropriate layers of increment if an inventory decrement occurs for
the year.
(iv) Other reasonable methods. S or B may use a method not
specifically provided in this paragraph (e)(1) that is expected to
reasonably take into account intercompany items and corresponding items
from intercompany inventory transactions. However, if the method used
results, for any year, in a cumulative amount of intercompany inventory
items not taken into account by S that significantly exceeds the
cumulative amount that would not be taken into account under paragraph
(e)(1)(ii) or (iii) of this section, S must take into account for that
year the amount necessary to eliminate the excess. The method is
thereafter applied with appropriate adjustments to reflect the amount
taken into account.
(v) Examples. The inventory rules of this paragraph (e)(1) are
illustrated by the following examples.
Example 1. Increment averaging method. (a) Facts. Both S and B
use a double-
[[Page 36696]]
extension, dollar-value LIFO inventory method, and both value inventory
increments using the earliest acquisitions cost valuation method.
During Year 2, S sells 25 units of product Q to B on January 15 at
$10/unit. S sells another 25 units on April 15, on July 15, and on
September 15, at $12/unit. S's earliest cost of product Q is $7.50/
unit and S's most recent cost of product Q is $8.00/unit. Both S and
B have an inventory increment for the year. B's total inventory
costs incurred during Year 2 are $6,000 and the LIFO value of B's
Year 2 layer of increment is $600.
(b) Intercompany inventory income. Under paragraph (e)(1)(iii)
of this section, S must use a reasonable method of allocating its
LIFO inventory costs to intercompany transactions. Because S has an
inventory increment for Year 2 and uses the earliest acquisitions
cost method, a reasonable method of determining its intercompany
cost of goods sold for product Q is to use its most recent costs.
Thus, its intercompany cost of goods sold is $800 ($8.00 most recent
cost, multiplied by 100 units sold to B), and its intercompany
inventory income is $350 ($1,150 sales proceeds from B minus $800
cost).
(c) Timing. (i) Under the increment averaging method of
paragraph (e)(1)(ii)(B) of this section, $35 of S's $350 of
intercompany inventory income is not taken into account in Year 2,
computed as follows:
[GRAPHIC][TIFF OMITTED]TR18JY95.002
(ii) Thus, $315 of S's intercompany inventory income is taken
into account in Year 2 ($350 of total intercompany inventory income
minus $35 not taken into account).
(d) S incurs a decrement. The facts are the same as in paragraph
(a) of this Example 1, except that in Year 2, S incurs a decrement
equal to 50% of its Year 1 layer. Under paragraph (e)(1)(iii) of
this section, S must reasonably allocate the LIFO cost of the
decrement to the cost of goods sold to B to determine S's
intercompany inventory income.
(e) B incurs a decrement. The facts are the same as in paragraph
(a) of this Example 1, except that B incurs a decrement in Year 2. S
must take into account the entire $350 of Year 2 intercompany
inventory income because all 100 units of product Q are deemed sold
by B in Year 2.
Example 2. Increment valuation method. (a) The facts are the
same as in Example 1. In addition, B's use of the earliest
acquisition's cost method of valuing its increments results in B
valuing its year-end inventory using costs incurred from January
through March. B's costs incurred during the year are: $1,428 in the
period January through March; $1,498 in the period April through
June; $1,524 in the period July through September; and $1,550 in the
period October through December. S's intercompany inventory income
for these periods is: $50 in the period January through March
((25 x $10)-(25 x $8)); $100 in the period April through June
((25 x $12)-(25 x $8)); $100 in the period July through September
((25 x $12)-(25 x $8)); and $100 in the period October through
December ((25 x $12)-(25 x $8)).
(b) Timing. (i) Under the increment valuation method of
paragraph (e)(1)(ii)(C) of this section, $21 of S's $350 of
intercompany inventory income is not taken into account in Year 2,
computed as follows:
[GRAPHIC][TIFF OMITTED]TR18JY95.003
(ii) Thus, $329 of S's intercompany inventory income is taken
into account in Year 2 ($350 of total intercompany inventory income
minus $21 not taken into account).
(c) B incurs a subsequent decrement. The facts are the same as
in paragraph (a) of this Example 2. In addition, assume that in Year
3, B experiences a decrement in its pool that receives intercompany
purchases from S. B's decrement equals 20% of the base-year costs
for its Year 2 layer. The fact that B has incurred a decrement means
that all of its inventory costs incurred for Year 3 are included in
cost of goods sold. As a result, S takes into account its entire
amount of intercompany inventory income from its Year 3 sales. In
addition, S takes into account $4.20 of its Year 2 layer of
intercompany inventory income not already taken into account (20% of
$21).
Example 3. Other reasonable inventory methods. (a) Facts. Both S
and B use a dollar-value LIFO inventory method for their inventory
transactions. During Year 1, S sells inventory to B and to X. Under
paragraph (e)(1)(iv) of this section, to compute its intercompany
inventory income and the amount of this income not taken into
account, S computes its intercompany inventory income using the
transfer price of the inventory items less a FIFO cost for the
goods, takes into account these items based on a FIFO cost flow
assumption for B's corresponding items, and the LIFO methods used by
S and B are ignored for these computations. These computations are
comparable to the methods used by S and B for financial reporting
purposes, and the book methods and results are used for tax
purposes. S adjusts the amount of intercompany inventory items not
taken into account as required by section 263A.
(b) Reasonable method. The method used by S is a reasonable
method under paragraph (e)(1)(iv) of this section if the cumulative
amount of intercompany inventory items not taken into account by S
is not significantly greater than the cumulative amount that would
not be taken into account under the methods specifically described
in paragraph (e)(1) of this section. If, for any year, the method
results in a cumulative amount of intercompany inventory items not
taken into account by S that significantly exceeds the cumulative
amount that would not be taken into account under the methods
specifically provided, S must take into account for that year the
amount necessary to eliminate the excess. The method is thereafter
applied with appropriate adjustments to reflect the amount taken
into account (e.g., to prevent the amount from being taken into
account more than once).
(2) Reserve accounting--(i) Banks and thrifts. Except as provided
in paragraph (g)(3)(iv) of this section (deferral of items from an
intercompany obligation), a member's addition to, or reduction of, a
reserve for bad debts that is maintained under section 585 or 593 is
taken into account on a separate entity basis. For example, if S makes
a loan to a nonmember and subsequently sells the loan to B, any
deduction for an addition to a bad debt reserve under section 585 and
any recapture income (or reduced bad debt deductions) are taken into
account on a separate entity basis rather than as intercompany items or
corresponding items taken into account under this section. Any gain or
loss of S from its sale of the loan to B is taken into account under
this section, however, to the extent it is not attributable to
recapture of the reserve.
(ii) Insurance companies--(A) Direct insurance. If a member
provides insurance to another member in an intercompany transaction,
the
[[Page 36697]]
transaction is taken into account by both members on a separate entity
basis. For example, if one member provides life insurance coverage for
another member with respect to its employees, the premiums, reserve
increases and decreases, and death benefit payments are determined and
taken into account by both members on a separate entity basis rather
than taken into account under this section as intercompany items and
corresponding items.
(B) Reinsurance--(1) In general. Paragraph (e)(2)(ii)(A) of this
section does not apply to a reinsurance transaction that is an
intercompany transaction. For example, if a member assumes all or a
portion of the risk on an insurance contract written by another member,
the amounts transferred as reinsurance premiums, expense allowances,
benefit reimbursements, reimbursed policyholder dividends, experience
rating adjustments, and other similar items are taken into account
under the matching rule and the acceleration rule. For purposes of this
section, the assuming company is treated as B and the ceding company is
treated as S.
(2) Reserves determined on a separate entity basis. For purposes of
determining the amount of a member's increase or decrease in reserves,
the amount of any reserve item listed in section 807(c) or 832(b)(5)
resulting from a reinsurance transaction that is an intercompany
transaction is determined on a separate entity basis. But see section
845, under which the Commissioner may allocate between or among the
members any items, recharacterize any such items, or make any other
adjustments necessary to reflect the proper source and character of the
separate taxable income of a member.
(3) Consent to treat intercompany transactions on a separate entity
basis--(i) General rule. The common parent may request consent to take
into account on a separate entity basis items from intercompany
transactions other than intercompany transactions with respect to stock
or obligations of members. Consent may be granted for all items, or for
items from a class or classes of transactions. The consent is effective
only if granted in writing by the Internal Revenue Service. Unless
revoked with the written consent of the Internal Revenue Service, the
separate entity treatment applies to all affected intercompany
transactions in the consolidated return year for which consent is
granted and in all subsequent consolidated return years. Consent under
this paragraph (e)(3) does not apply for purposes of taking into
account losses and deductions deferred under section 267(f).
(ii) Time and manner for requesting consent. The request for
consent described in paragraph (e)(3)(i) of this section must be made
in the form of a ruling request. The request must be signed by the
common parent, include any information required by the Internal Revenue
Service, and be filed on or before the due date of the consolidated
return (not including extensions of time) for the first consolidated
return year to which the consent is to apply. The Internal Revenue
Service may impose terms and conditions for granting consent. A copy of
the consent must be attached to the group's consolidated returns (or
amended returns) as required by the terms of the consent.
(iii) Effect of consent on methods of accounting. A consent for
separate entity accounting under this paragraph (e)(3), and a
revocation of that consent, may require changes in members' methods of
accounting for intercompany transactions. Because the consent, or a
revocation of the consent, is effective for all intercompany
transactions occurring in the consolidated return year for which the
consent or revocation is first effective, any change in method is
effected on a cut-off basis. Section 446(e) consent is granted for any
changes in methods of accounting for intercompany transactions that are
necessary solely to conform a member's methods to a binding consent
with respect to the group under this paragraph (e)(3) or the revocation
of that consent, provided the changes are made in the first
consolidated return year for which the consent or revocation under this
paragraph (e)(3) is effective. Therefore, section 446(e) consent must
be separately requested under applicable administrative procedures if a
member has failed to conform its practices to the separate entity
accounting provided under this paragraph (e)(3) or the revocation of
that treatment in the first consolidated return year for which the
consent to use separate entity accounting or revocation of that consent
is effective.
(iv) Consent to treat intercompany transactions on a separate
entity basis under prior law. A group that has received consent that is
in effect as of the first day of the first consolidated return year
beginning on or after July 12, 1995 to treat certain intercompany
transactions as provided in Sec. 1.1502-13(c)(3) of the regulations (as
contained in the 26 CFR part 1 edition revised as of April 1, 1995)
will be considered to have obtained the consent of the Commissioner to
take items from intercompany transactions into account on a separate
entity basis as provided in paragraph (e)(3)(i) of this section. This
treatment is applicable only to the items, class or classes of
transactions for which consent was granted under prior law.
(f) Stock of members--(1) In general. In addition to the general
rules of this section, the rules of this paragraph (f) apply to stock
of members.
(2) Intercompany distributions to which section 301 applies--(i) In
general. This paragraph (f)(2) provides rules for intercompany
transactions to which section 301 applies (intercompany distributions).
For purposes of determining whether a distribution is an intercompany
distribution, it is treated as occurring under the principles of the
entitlement rule of paragraph (f)(2)(iv) of this section. A
distribution is not an intercompany distribution to the extent it is
deducted by the distributing member. See, for example, section
1382(c)(1).
(ii) Distributee member. An intercompany distribution is not
included in the gross income of the distributee member (B). However,
this exclusion applies to a distribution only to the extent there is a
corresponding negative adjustment reflected under Sec. 1.1502-32 in B's
basis in the stock of the distributing member (S). For example, no
amount is included in B's gross income under section 301(c)(3) from a
distribution in excess of the basis of the stock of a subsidiary that
results in an excess loss account under Sec. 1.1502-32(a) which is
treated as negative basis under Sec. 1.1502-19. See Sec. 1.1502-26(b)
(applicability of the dividends received deduction to distributions not
excluded from gross income, such as a distribution from the common
parent to a subsidiary owning stock of the common parent).
(iii) Distributing member. The principles of section 311(b) apply
to S's loss, as well as gain, from an intercompany distribution of
property. Thus, S's loss is taken into account under the matching rule
if the property is subsequently sold to a nonmember. However, section
311(a) continues to apply to distributions to nonmembers (for example,
loss is not recognized).
(iv) Entitlement rule--(A) In general. For all Federal income tax
purposes, an intercompany distribution is treated as taken into account
when the shareholding member becomes entitled to it (generally on the
record date). For example, if B becomes entitled to a cash distribution
before it is made, the distribution is treated as made when B becomes
entitled to it. For this purpose, B is treated as entitled to a
distribution
[[Page 36698]]
no later than the time the distribution is taken into account under the
Internal Revenue Code (e.g., under section 305(c)). To the extent a
distribution is not made, appropriate adjustments must be made as of
the date it was taken into account.
(B) Nonmember shareholders. If nonmembers own stock of the
distributing corporation at the time the distribution is treated as
occurring under this paragraph (f)(2)(iv), appropriate adjustments must
be made to prevent the acceleration of the distribution to members from
affecting distributions to nonmembers.
(3) Boot in an intercompany reorganization--(i) Scope. This
paragraph (f)(3) provides additional rules for an intercompany
transaction in which the receipt of money or other property
(nonqualifying property) results in the application of section 356. For
example, the distribution of stock of a lower-tier member to a higher-
tier member in an intercompany transaction to which section 355 would
apply but for the receipt of nonqualifying property is a transaction to
which this paragraph (f)(3) applies. This paragraph (f)(3) does not
apply if a party to the transaction becomes a member or nonmember as
part of the same plan or arrangement. For example, if S merges into a
nonmember in a transaction described in section 368(a)(1)(A), this
paragraph (f)(3) does not apply.
(ii) Treatment. Nonqualifying property received as part of a
transaction described in this paragraph (f)(3) is treated as received
by the member shareholder in a separate transaction. See, for example,
sections 302 and 311 (rather than sections 356 and 361). The
nonqualifying property is treated as taken into account immediately
after the transaction if section 354 would apply but for the fact that
nonqualifying property is received. It is treated as taken into account
immediately before the transaction if section 355 would apply but for
the fact that nonqualifying property is received. The treatment under
this paragraph (f)(3)(ii) applies for all Federal income tax purposes.
(4) Acquisition by issuer of its own stock. If a member acquires
its own stock, or an option to buy or sell its own stock, in an
intercompany transaction, the member's basis in that stock or option is
treated as eliminated for all purposes. Accordingly, S's intercompany
items from the stock or options of B are taken into account under this
section if B acquires the stock or options in an intercompany
transaction (unless, for example, B acquires the stock in exchange for
successor property within the meaning of paragraph (j)(1) of this
section in a nonrecognition transaction). For example, if B redeems its
stock from S in a transaction to which section 302(a) applies, S's gain
from the transaction is taken into account immediately under the
acceleration rule.
(5) Certain liquidations and distributions--(i) Netting allowed.
S's intercompany item from a transfer to B of the stock of another
corporation (T) is taken into account under this section in certain
circumstances even though the T stock is never held by a nonmember
after the intercompany transaction. For example, if S sells all of T's
stock to B at a gain, and T subsequently liquidates into B in a
separate transaction to which section 332 applies, S's gain is taken
into account under the matching rule. Under paragraph (c)(6)(ii) of
this section, S's intercompany gain taken into account as a result of a
liquidation under section 332 or a comparable nonrecognition
transaction is not redetermined to be excluded from gross income. Under
this paragraph (f)(5)(i), if S has both intercompany income or gain and
intercompany deduction or loss attributable to stock of the same
corporation having the same material terms, only the income or gain in
excess of the deduction or loss is subject to paragraph (c)(6)(ii) of
this section. This paragraph (f)(5)(i) applies only to a transaction in
which B's basis in its T stock is permanently eliminated in a
liquidation under section 332 or any comparable nonrecognition
transaction, including--
(A) A merger of B into T under section 368(a);
(B) A distribution by B of its T stock in a transaction described
in section 355; or
(C) A deemed liquidation of T resulting from an election under
section 338(h)(10).
(ii) Elective relief--(A) In general. If an election is made
pursuant to this paragraph (f)(5)(ii), certain transactions are
recharacterized to prevent S's items from being taken into account or
to provide offsets to those items. This paragraph (f)(5)(ii) applies
only if T is a member throughout the period beginning with S's transfer
and ending with the completion of the nonrecognition transaction.
(B) Section 332--(1) In general. If section 332 applies to T's
liquidation into B, and B transfers T's assets to a new member (new T)
in a transaction not otherwise pursuant to the same plan or arrangement
as the liquidation, the transfer is nevertheless treated for all
Federal income tax purposes as pursuant to the same plan or arrangement
as the liquidation. For example, if T liquidates into B, but B forms
new T by transferring substantially all of T's former assets to new T,
S's intercompany gain or loss generally is not taken into account
solely as a result of the liquidation if the liquidation and transfer
would qualify as a reorganization described in section 368(a). (Under
paragraph (j)(1) of this section, B's stock in new T would be a
successor asset to B's stock in T, and S's gain would be taken into
account based on the new T stock.)
(2) Time limitation and adjustments. The transfer of an asset to
new T not otherwise pursuant to the same plan or arrangement as the
liquidation is treated under this paragraph (f)(5)(ii)(B) as pursuant
to the same plan or arrangement only if B transfers it to new T
pursuant to a written plan, a copy of which is attached to a timely
filed original return (including extensions) for the year of T's
liquidation, and the transfer is completed within 12 months of the
filing of that return. Appropriate adjustments are made to reflect any
events occurring before the formation of new T and to reflect any
assets not transferred to new T as part of the same plan or
arrangement. For example, if B retains an asset in the reorganization,
the asset is treated under paragraph (f)(3) of this section as acquired
by new T but distributed to B immediately after the reorganization.
(3) Downstream merger, etc. The principles of this paragraph
(f)(5)(ii)(B) apply, with appropriate adjustments, if B's basis in the
T stock is eliminated in a transaction similar to a section 332
liquidation, such as a transaction described in section 368 in which B
merges into T. For example, if S and B are subsidiaries, and S sells
all of T's stock to B at a gain followed by B's merger into T in a
separate transaction described in section 368(a), S's gain is not taken
into account solely as a result of the merger if T (as successor to B)
forms new T with substantially all of T's former assets.
(C) Section 338(h)(10)--(1) In general. This paragraph
(f)(5)(ii)(C) applies to a deemed liquidation of T under section 332 as
the result of an election under section 338(h)(10). This paragraph
(f)(5)(ii)(C) does not apply if paragraph (f)(5)(ii)(B) of this section
is applied to the deemed liquidation. Under this paragraph, B is
treated with respect to each share of its T stock as recognizing as a
corresponding item any loss or deduction it would recognize (determined
after adjusting stock basis under Sec. 1.1502-32) if section 331
applied to the deemed liquidation. For
[[Page 36699]]
all other Federal income tax purposes, the deemed liquidation remains
subject to section 332.
(2) Limitation on amount of loss. The amount of B's loss or
deduction under this paragraph (f)(5)(ii)(C) is limited as follows--
(i) The aggregate amount of loss recognized with respect to T stock
cannot exceed the amount of S's intercompany income or gain that is in
excess of S's intercompany deduction or loss with respect to shares of
T stock having the same material terms as the shares giving rise to S's
intercompany income or gain; and
(ii) The aggregate amount of loss recognized under this paragraph
(f)(5)(ii)(C) from T's deemed liquidation cannot exceed the net amount
of deduction or loss (if any) that would be taken into account from the
deemed liquidation if section 331 applied with respect to all T shares.
(3) Asset sale, etc. The principles of this paragraph (f)(5)(ii)(C)
apply, with appropriate adjustments, if T transfers all of its assets
to a nonmember and completely liquidates in a transaction comparable to
the section 338(h)(10) transaction described in paragraph
(f)(5)(ii)(C)(1) of this section. For example, if S sells all of T's
stock to B at a gain followed by T's merger into a nonmember in
exchange for a cash payment to B in a transaction treated for Federal
income tax purposes as T's sale of its assets to the nonmember and
complete liquidation, the merger is ordinarily treated as a comparable
transaction.
(D) Section 355. If B distributes the T stock in an intercompany
transaction to which section 355 applies (including an intercompany
transaction to which 355 applies because of the application of
paragraph (f)(3) of this section), the redetermination of the basis of
the T stock under section 358 could cause S's gain or loss to be taken
into account under this section. This paragraph (f)(5)(ii)(D) applies
to treat B's distribution as subject to sections 301 and 311 (as
modified by this paragraph (f)), rather than section 355. The election
will prevent S's gain or loss from being taken into account immediately
to the extent matching remains possible, but B's gain or loss from the
distribution will also be taken into account under this section.
(E) Election. An election to apply this paragraph (f)(5)(ii) is
made in a separate statement entitled ``[Insert Name and Employer
Identification Number of Common Parent] HEREBY ELECTS THE APPLICATION
OF Sec. 1.1502-13(f)(5)(ii).'' The election must include a description
of S's intercompany transaction and T's liquidation (or other
transaction). It must specify which provision of Sec. 1.1502-
13(f)(5)(ii) applies and how it alters the otherwise applicable results
under this section (including, for example, the amount of S's
intercompany items and the amount deferred or offset as a result of
this Sec. 1.1502-13(f)(5)(ii)). A separate election must be made for
each application of this paragraph (f)(5)(ii). The election must be
signed by the common parent and filed with the group's income tax
return for the year of T's liquidation (or other transaction). The
Commissioner may impose reasonable terms and conditions to the
application of this paragraph (f)(5)(ii) that are consistent with the
purposes of this section.
(6) [Reserved]
(7) Examples. The application of this section to intercompany
transactions with respect to stock of members is illustrated by the
following examples.
Example 1. Dividend exclusion and property distribution. (a)
Facts. S owns land with a $70 basis and $100 value. On January 1 of
Year 1, P's basis in S's stock is $100. During Year 1, S declares
and makes a dividend distribution of the land to P. Under section
311(b), S has a $30 gain. Under section 301(d), P's basis in the
land is $100. On July 1 of Year 3, P sells the land to X for $110.
(b) Dividend elimination and stock basis adjustments. Under
paragraph (b)(1) of this section, S's distribution to P is an
intercompany distribution. Under paragraph (f)(2)(ii) of this
section, P's $100 of dividend income is not included in gross
income. Under Sec. 1.1502-32, P's basis in S's stock is reduced from
$100 to $0 in Year 1.
(c) Matching rule and stock basis adjustments. Under the
matching rule (treating P as the buying member and S as the selling
member), S takes its $30 gain into account in Year 3 to reflect the
$30 difference between P's $10 gain taken into account and the $40
recomputed gain. Under Sec. 1.1502-32, P's basis in S's stock is
increased from $0 to $30 in Year 3.
(d) Loss property. The facts are the same as in paragraph (a) of
this Example 1, except that S has a $130 (rather than $70) basis in
the land. Under paragraph (f)(2)(iii) of this section, the
principles of section 311(b) apply to S's loss from the intercompany
distribution. Thus, S has a $30 loss that is taken into account
under the matching rule in Year 3 to reflect the $30 difference
between P's $10 gain taken into account and the $20 recomputed loss.
(The results are the same under section 267(f).) Under Sec. 1.1502-
32, P's basis in S's stock is reduced from $100 to $0 in Year 1, and
from $0 to a $30 excess loss account in Year 3. (If P had
distributed the land to its shareholders, rather than selling the
land to X, P would take its $10 gain under section 311(b) into
account, and S would take its $30 loss into account under the
matching rule with $10 offset by P's gain and $20 recharacterized as
a noncapital, nondeductible amount.)
(e) Entitlement rule. The facts are the same as in paragraph (a)
of this Example 1, except that, after P becomes entitled to the
distribution but before the distribution is made, S issues
additional stock to the public and becomes a nonmember. Under
paragraph (f)(2)(i) of this section, the determination of whether a
distribution is an intercompany distribution is made under the
entitlement rule of paragraph (f)(2)(iv) of this section. Treating
S's distribution as made when P becomes entitled to it results in
the distribution being an intercompany distribution. Under paragraph
(f)(2)(ii) of this section, the distribution is not included in P's
gross income. S's $30 gain from the distribution is intercompany
gain that is taken into account under the acceleration rule
immediately before S becomes a nonmember. Thus, there is a net $70
decrease in P's basis in its S stock under Sec. 1.1502-32 ($100
decrease for the distribution and a $30 increase for S's $30 gain).
See also Sec. 1.1502-20(b) (additional stock basis reductions
applicable to certain deconsolidations). Under paragraph (f)(2)(iv)
of this section, P does not take the distribution into account again
under separate return rules when received, and P is not entitled to
a dividends received deduction.
Example 2. Excess loss accounts. (a) Facts. S owns all of T's
only class of stock with a $10 basis and $100 value. S has
substantial earnings and profits, and T has $10 of earnings and
profits. On January 1 of Year 1, S declares and distributes a
dividend of all of the T stock to P. Under section 311(b), S has a
$90 gain. Under section 301(d), P's basis in the T stock is $100.
During Year 3, T borrows $90 and declares and makes a $90
distribution to P to which section 301 applies, and P's basis in the
T stock is reduced under Sec. 1.1502-32 from $100 to $10. During
Year 6, T has $5 of earnings that increase P's basis in the T stock
under Sec. 1.1502-32 from $10 to $15. On December 1 of Year 9, T
issues additional stock to X and, as a result, T becomes a
nonmember.
(b) Dividend exclusion. Under paragraph (f)(2)(ii) of this
section, P's $100 of dividend income from S's distribution of the T
stock, and its $10 of dividend income from T's $90 distribution, are
not included in gross income.
(c) Matching and acceleration rules. Under Sec. 1.1502-19(b)(1),
when T becomes a nonmember P must include in income the amount of
its excess loss account (if any) in T stock. P has no excess loss
account in the T stock. Therefore P's corresponding item from the
deconsolidation of T is $0. Treating S and P as divisions of a
single corporation, the T stock would continue to have a $10 basis
after the distribution, and the adjustments under Sec. 1.1502-32 for
T's $90 distribution and $5 of earnings would result in a $75 excess
loss account. Thus, the recomputed corresponding item from the
deconsolidation is $75. Under the matching rule, S takes $75 of its
$90 gain into account in Year 9 as a result of T becoming a
nonmember, to reflect the difference between P's $0 gain taken into
account and the $75 recomputed gain. S's remaining $15 of gain is
taken into account under the matching and acceleration rules based
on subsequent
[[Page 36700]]
events (for example, under the matching rule if P subsequently sells
its T stock, or under the acceleration rule if S becomes a
nonmember).
(d) Reverse sequence. The facts are the same as in paragraph (a)
of this Example 2, except that T borrows $90 and makes its $90
distribution to S before S distributes T's stock to P. Under
paragraph (f)(2)(ii) of this section, T's $90 distribution to S ($10
of which is a dividend) is not included in S's gross income. The
corresponding negative adjustment under Sec. 1.1502-32 reduces S's
basis in the T stock from $10 to an $80 excess loss account. Under
section 311(b), S has a $90 gain from the distribution of T stock to
P. Under section 301(d) P's initial basis in the T stock is $10 (the
stock's fair market value), and the basis increases to $15 under
Sec. 1.1502-32 as a result of T's earnings in Year 6. The timing and
attributes of S's gain are determined in the manner provided in
paragraph (c) of this Example 2. Thus, $75 of S's gain is taken into
account under the matching rule in Year 9 as a result of T becoming
a nonmember, and the remaining $15 is taken into account under the
matching and acceleration rules based on subsequent events.
(e) Partial stock sale. The facts are the same as in paragraph
(a) of this Example 2, except that P sells 10% of T's stock to X on
December 1 of Year 9 for $1.50 (rather than T's issuing additional
stock and becoming a nonmember). Under the matching rule, S takes $9
of its gain into account to reflect the difference between P's $0
gain taken into account ($1.50 sale proceeds minus $1.50 basis) and
the $9 recomputed gain ($1.50 sale proceeds plus $7.50 excess loss
account).
(f) Loss, rather than cash distribution. The facts are the same
as in paragraph (a) of this Example 2, except that T retains the
loan proceeds and incurs a $90 loss in Year 3 that is absorbed by
the group. The timing and attributes of S's gain are determined in
the same manner provided in paragraph (c) of this Example 2. Under
Sec. 1.1502-32, the loss in Year 3 reduces P's basis in the T stock
from $100 to $10, and T's $5 of earnings in Year 6 increase the
basis to $15. Thus, $75 of S's gain is taken into account under the
matching rule in Year 9 as a result of T becoming a nonmember, and
the remaining $15 is taken into account under the matching and
acceleration rules based on subsequent events. (The timing and
attributes of S's gain would be determined in the same manner
provided in paragraph (d) of this Example 2 if T incurred the $90
loss before S's distribution of the T stock to P.)
(g) Stock sale, rather than stock distribution. The facts are
the same as in paragraph (a) of this Example 2, except that S sells
the T stock to P for $100 (rather than distributing the stock). The
timing and attributes of S's gain are determined in the same manner
provided in paragraph (c) of this Example 2. Thus, $75 of S's gain
is taken into account under the matching rule in Year 9 as a result
of T becoming a nonmember, and the remaining $15 is taken into
account under the matching and acceleration rules based on
subsequent events.
Example 3. Intercompany reorganization. (a) Facts. P forms S and
B by contributing $200 to the capital of each. During Years 1
through 4, S and B each earn $50, and under Sec. 1.1502-32 P adjusts
its basis in the stock of each to $250. (See Sec. 1.1502-33 for
adjustments to earnings and profits.) On January 1 of Year 5, the
fair market value of S's assets and its stock is $500, and S merges
into B in a tax-free reorganization. Pursuant to the plan of
reorganization, P receives B stock with a fair market value of $350
and $150 of cash.
(b) Treatment as a section 301 distribution. The merger of S
into B is a transaction to which paragraph (f)(3) of this section
applies. P is treated as receiving additional B stock with a fair
market value of $500 and, under section 358, a basis of $250.
Immediately after the merger, $150 of the stock received is treated
as redeemed, and the redemption is treated under section 302(d) as a
distribution to which section 301 applies. Because the $150
distribution is treated as not received as part of the merger,
section 356 does not apply and no basis adjustments are required
under section 358(a)(1)(A) and (B). Because B is treated under
section 381(c)(2) as receiving S's earnings and profits and the
redemption is treated as occurring after the merger, $100 of the
distribution is treated as a dividend under section 301 and P's
basis in the B stock is reduced correspondingly under Sec. 1.1502-
32. The remaining $50 of the distribution reduces P's basis in the B
stock. Section 301(c)(2) and Sec. 1.1502-32. Under paragraph
(f)(2)(ii) of this section, P's $100 of dividend income is not
included in gross income. Under Sec. 1.302-2(c), proper adjustments
are made to P's basis in its B stock to reflect its basis in the B
stock redeemed, with the result that P's basis in the B stock is
reduced by the entire $150 distribution.
(c) Depreciated property. The facts are the same as in paragraph
(a) of this Example 3, except that property of S with a $200 basis
and $150 fair market value is distributed to P (rather than cash of
B). As in paragraph (b) of this Example 3, P is treated as receiving
additional B stock in the merger and a $150 distribution to which
section 301 applies immediately after the merger. Under paragraph
(f)(2)(iii) of this section, the principles of section 311(b) apply
to B's $50 loss and the loss is taken into account under the
matching and acceleration rules based on subsequent events (e.g.,
under the matching rule if P subsequently sells the property, or
under the acceleration rule if B becomes a nonmember). The results
are the same under section 267(f).
(d) Divisive transaction. Assume instead that, pursuant to a
plan, S distributes the stock of a lower-tier subsidiary in a spin-
off transaction to which section 355 applies together with $150 of
cash. The distribution of stock is a transaction to which paragraph
(f)(3) of this section applies. P is treated as receiving the $150
of cash immediately before the section 355 distribution, as a
distribution to which section 301 applies. Section 356(b) does not
apply and no basis adjustments are required under section 358(a)(1)
(A) and (B). Because the $150 distribution is treated as made before
the section 355 distribution, the distribution reduces P's basis in
the S stock under Sec. 1.1502-32, and the basis allocated under
section 358(c) between the S stock and the lower-tier subsidiary
stock received reflects this basis reduction.
Example 4. Stock redemptions and distributions. (a) Facts.
Before becoming a member of the P group, S owns P stock with a $30
basis. On January 1 of Year 1, P buys all of S's stock. On July 1 of
Year 3, P redeems the P stock held by S for $100 in a transaction to
which section 302(a) applies.
(b) Gain under section 302. Under paragraph (f)(4) of this
section, P's basis in the P stock acquired from S is treated as
eliminated. As a result of this elimination, S's intercompany item
will never be taken into account under the matching rule because P's
basis in the stock does not reflect S's intercompany item.
Therefore, S's $70 gain is taken into account under the acceleration
rule in Year 3. The attributes of S's item are determined under
paragraph (d)(1)(ii) of this section by applying the matching rule
as if P had sold the stock to an affiliated corporation that is not
a member of the group at no gain or loss. Although P's corresponding
item from a sale of its stock would have been excluded from gross
income under section 1032, paragraph (c)(6)(ii) of this section
prevents S's gain from being treated as excluded from gross income;
instead S's gain is capital gain.
(c) Gain under section 311. The facts are the same as in
paragraph (a) of this Example 4, except that S distributes the P
stock to P in a transaction to which section 301 applies (rather
than the stock being redeemed), and S has a $70 gain under section
311(b). The timing and attributes of S's gain are determined in the
manner provided in paragraph (b) of this Example 4.
(d) Loss stock. The facts are the same as in paragraph (a) of
this Example 4, except that S has a $130 (rather than $30) basis in
the P stock and has a $30 loss under section 302(a). The limitation
under paragraph (c)(6)(ii) of this section does not apply to
intercompany losses. Thus, S's loss is taken into account in Year 3
as a noncapital, nondeductible amount.
Example 5. Intercompany stock sale followed by section 332
liquidation. (a) Facts. S owns all of the stock of T, with a $70
basis and $100 value, and T's assets have a $10 basis and $100
value. On January 1 of Year 1, S sells all of T's stock to B for
$100. On July 1 of Year 3, when T's assets are still worth $100, T
distributes all of its assets to B in an unrelated complete
liquidation to which section 332 applies.
(b) Timing and attributes. Under paragraph (b)(3)(ii) of this
section, B's unrecognized gain or loss under section 332 is a
corresponding item for purposes of applying the matching rule. In
Year 3 when T liquidates, B has $0 of unrecognized gain or loss
under section 332 because B has a $100 basis in the T stock and
receives a $100 distribution with respect to its T stock. Treating S
and B as divisions of a single corporation, the recomputed
corresponding item would have been $30 of unrecognized gain under
section 332 because B would have succeeded to S's $70 basis in the T
stock. Thus, under the matching rule, S's $30 intercompany gain is
taken into account in
[[Page 36701]]
Year 3 as a result of T's liquidation. Under paragraph (c)(1)(i) of
this section, the attributes of S's gain and B's corresponding item
are redetermined as if S and B were divisions of a single
corporation. Although S's gain ordinarily would be redetermined to
be treated as excluded from gross income to reflect the
nonrecognition of B's gain under section 332, S's gain remains
capital gain because B's unrecognized gain under section 332 is not
permanently and explicitly disallowed under the Code. See paragraph
(c)(6)(ii) of this section. However, relief may be elected under
paragraph (f)(5)(ii) of this section.
(c) Intercompany sale at a loss. The facts are the same as in
paragraph (a) of this Example 5, except that S has a $130 (rather
than $70) basis in the T stock. The limitation under paragraph
(c)(6)(ii) of this section does not apply to intercompany losses.
Thus, S's intercompany loss is taken into account in Year 3 as a
noncapital, nondeductible amount. However, relief may be elected
under paragraph (f)(5)(ii) of this section.
Example 6. Intercompany stock sale followed by section 355
distribution. (a) Facts. S owns all of the stock of T with a $70
basis and a $100 value. On January 1 of Year 1, S sells all of T's
stock to M for $100. On June 1 of Year 6, M distributes all of its T
stock to its nonmember shareholders in a transaction to which
section 355 applies. At the time of the distribution, M has a basis
in T stock of $100 and T has a value of $150.
(b) Timing and attributes. Under paragraph (b)(3)(ii) of this
section, M's $50 gain not recognized on the distribution under
section 355 is a corresponding item. Treating S and M as divisions
of a single corporation, the recomputed corresponding item would be
$80 of unrecognized gain under section 355 because M would have
succeeded to S's $70 basis in the T stock. Thus, under the matching
rule, S's $30 intercompany gain is taken into account in Year 6 as a
result of the distribution. Under paragraph (c)(1)(i) of this
section, the attributes of S's intercompany item and M's
corresponding item are redetermined to produce the same effect on
consolidated taxable income as if S and M were divisions of a single
corporation. Although S's gain ordinarily would be redetermined to
be treated as excluded from gross income to reflect the
nonrecognition of M's gain under section 355(c), S's gain remains
capital gain because M's unrecognized gain under section 355(c) is
not permanently and explicitly disallowed under the Code. See
paragraph (c)(6)(ii) of this section. Because M's distribution of
the T stock is not an intercompany transaction, relief is not
available under paragraph (f)(5)(ii) of this section.
(c) Section 355 distribution within the group. The facts are the
same as under paragraph (a) of this Example 6, except that M
distributes the T stock to B (another member of the group), and B
takes a $75 basis in the T stock under section 358. Under paragraph
(j)(2) of this section, B is a successor to M for purposes of taking
S's intercompany gain into account, and therefore both M and B might
have corresponding items with respect to S's intercompany gain. To
the extent it is possible, matching with respect to B's
corresponding items produces the result most consistent with
treating S, M, and B as divisions of a single corporation. See
paragraphs (j)(3) and (j)(4) of this section. However, because there
is only $5 difference between B's $75 basis in the T stock and the
$70 basis the stock would have if S, M, and B were divisions of a
single corporation, only $5 can be taken into account under the
matching rule with respect to B's corresponding items. (This $5 is
taken into account with respect to B's corresponding items based on
subsequent events.) The remaining $25 of S's $30 intercompany gain
is taken into account in Year 6 under the matching rule with respect
to M's corresponding item from its distribution of the T stock. The
attributes of S's remaining $25 of gain are determined in the same
manner as in paragraph (b) of this Example 6.
(d) Relief elected. The facts are the same as in paragraph (c)
of this Example 6 except that P elects relief pursuant to paragraph
(f)(5)(ii)(D) of this section. As a result of the election, M's
distribution of the T stock is treated as subject to sections 301
and 311 instead of section 355. Accordingly, M recognizes $50 of
intercompany gain from the distribution, B takes a basis in the
stock equal to its fair market value of $150, and S and M take their
intercompany gains into account with respect to B's corresponding
items based on subsequent events. (None of S's gain is taken into
account in Year 6 as a result of M's distribution of the T stock.)
(g) Obligations of members--(1) In general. In addition to the
general rules of this section, the rules of this paragraph (g) apply to
intercompany obligations.
(2) Definitions. For purposes of this section--
(i) Obligation of a member. An obligation of a member is--
(A) Any obligation of the member constituting indebtedness under
general principles of Federal income tax law (for example, under
nonstatutory authorities, or under section 108, section 163, section
171, or section 1275), but not an executory obligation to purchase or
provide goods or services; and
(B) Any security of the member described in section 475(c)(2)(D) or
(E), and any comparable security with respect to commodities, but not
if the security is a position with respect to the member's stock. See
paragraph (f)(4) of this section and Sec. 1.1502-13T(f)(6) for special
rules applicable to positions with respect to a member's stock.
(ii) Intercompany obligations. An intercompany obligation is an
obligation between members, but only for the period during which both
parties are members.
(3) Deemed satisfaction and reissuance of intercompany
obligations--(i) Application--(A) In general. If a member realizes an
amount (other than zero) of income, gain, deduction, or loss, directly
or indirectly, from the assignment or extinguishment of all or part of
its remaining rights or obligations under an intercompany obligation,
the intercompany obligation is treated for all Federal income tax
purposes as satisfied under paragraph (g)(3)(ii) of this section and,
if it remains outstanding, reissued under paragraph (g)(3)(iii) of this
section. Similar principles apply under this paragraph (g)(3) if a
member realizes any such amount, directly or indirectly, from a
comparable transaction (for example, a marking-to-market of an
obligation or a bad debt deduction), or if an intercompany obligation
becomes an obligation that is not an intercompany obligation.
(B) Exceptions. This paragraph (g)(3) does not apply to an
obligation if any of the following applies:
(1) The obligation became an intercompany obligation by reason of
an event described in Sec. 1.108-2(e) (exceptions to the application of
section 108(e)(4)).
(2) The amount realized is from reserve accounting under section
585 or section 593 (see paragraph (g)(3)(iv) of this section for
special rules).
(3) The amount realized is from the conversion of an obligation
into stock of the obligor.
(4) Treating the obligation as satisfied and reissued will not have
a significant effect on any person's Federal income tax liability for
any year. For this purpose, obligations issued in connection with the
same transaction or related transactions are treated as a single
obligation. However, this paragraph (g)(3)(i)(B)(4) does not apply to
any obligation if the aggregate effect of this treatment for all
obligations in a year would be significant.
(ii) Satisfaction--(A) General rule. If a creditor member sells
intercompany debt for cash, the debt is treated as satisfied by the
debtor immediately before the sale for the amount of the cash. For
other transactions, similar principles apply to treat the intercompany
debt as satisfied immediately before the transaction. Thus, if the debt
is transferred for property, it is treated as satisfied for an amount
consistent with the amount for which the debt is deemed reissued under
paragraph (g)(3)(iii) of this section, and the basis of the property is
also adjusted to reflect that amount. If this paragraph (g)(3) applies
because the debtor or creditor becomes a nonmember, the obligation is
treated as satisfied for cash in an amount equal to its fair market
value immediately before
[[Page 36702]]
the debtor or creditor becomes a nonmember. Similar principles apply to
intercompany obligations other than debt.
(B) Timing and attributes. For purposes of applying the matching
rule and the acceleration rule--
(1) Paragraph (c)(6)(ii) of this section (limitation on treatment
of intercompany income or gain as excluded from gross income) does not
apply to prevent any intercompany income or gain from being excluded
from gross income; and
(2) Any gain or loss from an intercompany obligation is not subject
to section 108(a), section 354 or section 1091.
(iii) Reissuance. If a creditor member sells intercompany debt for
cash, the debt is treated as a new debt (with a new holding period)
issued by the debtor immediately after the sale for the amount of cash.
For other transactions, if the intercompany debt remains outstanding,
similar principles apply to treat the debt as reissued immediately
after the transaction. Thus, if the debt is transferred for property,
it is treated as new debt issued for the property. See, for example,
section 1273(b)(3) or section 1274. If this paragraph (g)(3) applies
because the debtor or creditor becomes a nonmember, the debt is treated
as new debt issued for an amount of cash equal to its fair market value
immediately after the debtor or creditor becomes a nonmember. Similar
principles apply to intercompany obligations other than debt.
(iv) Bad debt reserve. A member's deduction under section 585 or
section 593 for an addition to its reserve for bad debts with respect
to an intercompany obligation is not taken into account, and is not
treated as realized under this paragraph (g)(3) until the intercompany
obligation becomes an obligation that is not an intercompany
obligation, or, if earlier, the redemption or cancellation of the
intercompany obligation.
(4) Deemed satisfaction and reissuance of obligations becoming
intercompany obligations--(i) Application--(A) In general. This
paragraph (g)(4) applies if an obligation that is not an intercompany
obligation becomes an intercompany obligation.
(B) Exceptions. This paragraph (g)(4) does not apply to an
obligation if--
(1) The obligation becomes an intercompany obligation by reason of
an event described in Sec. 1.108-2(e) (exceptions to the application of
section 108(e)(4)); or
(2) Treating the obligation as satisfied and reissued will not have
a significant effect on any person's Federal income tax liability for
any year. For this purpose, obligations issued in connection with the
same transaction or related transactions are treated as a single
obligation. However, this paragraph (g)(4)(i)(B)(2) does not apply to
any obligation if the aggregate effect of this treatment for all
obligations in a year would be significant.
(ii) Intercompany debt. If this paragraph (g)(4) applies to an
intercompany debt--
(A) Section 108(e)(4) does not apply;
(B) The debt is treated for all Federal income tax purposes,
immediately after it becomes an intercompany debt, as satisfied and a
new debt issued to the holder (with a new holding period) in an amount
determined under the principles of Sec. 1.108-2(f);
(C) The attributes of all items taken into account from the
satisfaction are determined on a separate entity basis, rather than by
treating S and B as divisions of a single corporation;
(D) Any intercompany gain or loss taken into account is treated as
not subject to section 354 or section 1091; and
(E) Solely for purposes of Sec. 1.1502-32(b)(4) and the effect of
any election under that provision, any loss taken into account under
this paragraph (g)(4) by a corporation that becomes a member as a
result of the transaction in which the obligation becomes an
intercompany obligation is treated as a loss carryover from a separate
return limitation year.
(iii) Other intercompany obligations. If this paragraph (g)(4)
applies to an intercompany obligation other than debt, the principles
of paragraph (g)(4)(ii) of this section apply to treat the intercompany
obligation as satisfied and reissued for an amount of cash equal to its
fair market value immediately after the obligation becomes an
intercompany obligation.
(5) Examples. The application of this section to obligations of
members is illustrated by the following examples.
Example 1. Interest on intercompany debt. (a) Facts. On January
1 of Year 1, B borrows $100 from S in return for B's note providing
for $10 of interest annually at the end of each year, and repayment
of $100 at the end of Year 5. B fully performs its obligations.
Under their separate entity methods of accounting, B accrues a $10
interest deduction annually under section 163, and S accrues $10 of
interest income annually under section 61(a)(4).
(b) Matching rule. Under paragraph (b)(1) of this section, the
accrual of interest on B's note is an intercompany transaction.
Under the matching rule, S takes its $10 of income into account in
each of Years 1 through 5 to reflect the $10 difference between B's
$10 of interest expense taken into account and the $0 recomputed
expense. S's income and B's deduction are ordinary items. (Because
S's intercompany item and B's corresponding item would both be
ordinary on a separate entity basis, the attributes are not
redetermined under paragraph (c)(1)(i) of this section.)
(c) Original issue discount. The facts are the same as in
paragraph (a) of this Example 1, except that B borrows $90 (rather
than $100) from S in return for B's note providing for $10 of
interest annually and repayment of $100 at the end of Year 5. The
principles described in paragraph (b) of this Example 1 for stated
interest also apply to the $10 of original issue discount. Thus, as
B takes into account its corresponding expense under section 163(e),
S takes into account its intercompany income. S's income and B's
deduction are ordinary items.
(d) Tax-exempt income. The facts are the same as in paragraph
(a) of this Example 1, except that B's borrowing from S is allocable
under section 265 to B's purchase of state and local bonds to which
section 103 applies. The timing of S's income is the same as in
paragraph (b) of this Example 1. Under paragraph (c)(4)(i) of this
section, the attributes of B's corresponding item of disallowed
interest expense control the attributes of S's offsetting
intercompany interest income. Paragraph (c)(6)(ii) of this section
does not prevent the redetermination of S's intercompany item as
excluded from gross income, because section 265 permanently and
explicitly disallows B's corresponding deduction. Accordingly, S's
intercompany income is treated as excluded from gross income.
Example 2. Intercompany debt becomes nonintercompany debt. (a)
Facts. On January 1 of Year 1, B borrows $100 from S in return for
B's note providing for $10 of interest annually at the end of each
year, and repayment of $100 at the end of Year 20. As of January 1
of Year 3, B has paid the interest accruing under the note and S
sells B's note to X for $70, reflecting a change in the value of the
note as a result of increases in prevailing market interest rates. B
is never insolvent within the meaning of section 108(d)(3).
(b) Deemed satisfaction. Under paragraph (g)(3) of this section,
B's note is treated as satisfied for $70 immediately before S's sale
to X. As a result of the deemed satisfaction of the obligation for
less than its adjusted issue price, B takes into account $30 of
discharge of indebtedness income under section 61(a)(12). On a
separate entity basis, S's $30 loss would be a capital loss under
section 1271(a)(1). Under the matching rule, however, the attributes
of S's intercompany item and B's corresponding item must be
redetermined to produce the same effect as if the transaction had
occurred between divisions of a single corporation. B's
corresponding item completely offsets S's intercompany item in
amount. Accordingly, under paragraph (c)(4)(i) of this section, the
attributes of B's $30 of discharge of indebtedness income control
the attributes of S's loss. Thus, S's loss is treated as ordinary
loss.
(c) Deemed reissuance. Under paragraph (g)(3) of this section, B
is also treated as reissuing, directly to X, a new note with a $70
issue price and a $100 stated redemption
[[Page 36703]]
price at maturity. The new note is not an intercompany obligation, it
has a $70 issue price and $100 stated redemption price at maturity,
and the $30 of original issue discount will be taken into account by
B and X under sections 163(e) and 1272.
(d) Creditor deconsolidation. The facts are the same as in
paragraph (a) of this Example 2, except that P sells S's stock to X
(rather than S's selling the note of B). Under paragraph (g)(3) of
this section, the note is treated as satisfied by B for its $70 fair
market value immediately before S becomes a nonmember, and B is
treated as reissuing a new note to S immediately after S becomes a
nonmember. The results for S's $30 of loss and B's discharge of
indebtedness income are the same as in paragraph (b) of this Example
2. The new note is not an intercompany obligation, it has a $70
issue price and $100 stated redemption price at maturity, and the
$30 of original issue discount will be taken into account by B and S
under sections 163(e) and 1272.
(e) Debtor deconsolidation. The facts are the same as in
paragraph (a) of this Example 2, except that P sells B's stock to X
(rather than S's selling the note of B). The results are the same as
in paragraph (d) of this Example 2.
(f) Appreciated note. The facts are the same as in paragraph (a)
of this Example 2, except that S sells B's note to X for $130
(rather than $70), reflecting a decline in prevailing market
interest rates. Under paragraph (g)(3) of this section, B's note is
treated as satisfied for $130 immediately before S's sale of the
note to X. Under Sec. 1.163-7(c), B takes into account $30 of
repurchase premium. On a separate entity basis, S's $30 gain would
be a capital gain under section 1271(a)(1), and B's $30 premium
deduction would be an ordinary deduction. Under the matching rule,
however, the attributes of S's intercompany item and B's
corresponding item must be redetermined to produce the same effect
as if the transaction had occurred between divisions of a single
corporation. Under paragraph (c)(4)(i) of this section, the
attributes of B's corresponding premium deduction control the
attributes of S's intercompany gain. Accordingly, S's gain is
treated as ordinary income. B is also treated as reissuing a new
note directly to X which is not an intercompany obligation. The new
note has a $130 issue price and a $100 stated redemption price at
maturity. Under Sec. 1.61-12(c), B's $30 premium income under the
new note is taken into account over the life of the new note.
Example 3. Loss or bad debt deduction with respect to
intercompany debt. (a) Facts. On January 1 of Year 1, B borrows $100
from S in return for B's note providing for $10 of interest annually
at the end of each year, and repayment of $100 at the end of Year 5.
In Year 3, S sells B's note to P for $60. B is never insolvent
within the meaning of section 108(d)(3). Assume B's note is not a
security within the meaning of section 165(g)(2).
(b) Deemed satisfaction and reissuance. Under paragraph (g)(3)
of this section, B is treated as satisfying its note for $60
immediately before the sale, and reissuing a new note directly to P
with a $60 issue price and a $100 stated redemption price at
maturity. On a separate entity basis, S's $40 loss would be a
capital loss, and B's $40 income would be ordinary income. Under the
matching rule, however, the attributes of S's intercompany item and
B's corresponding item must be redetermined to produce the same
effect as if the transaction had occurred between divisions of a
single corporation. Under paragraph (c)(4)(i) of this section, the
attributes of B's corresponding discharge of indebtedness income
control the attributes of S's intercompany loss. Accordingly, S's
loss is treated as ordinary loss.
(c) Partial bad debt deduction. The facts are the same as in
paragraph (a) of this Example 3, except that S claims a $40 partial
bad debt deduction under section 166(a)(2) (rather than selling the
note to P). The results are the same as in paragraph (b) of this
Example 3. B's note is treated as satisfied and reissued with a $60
issue price. S's $40 intercompany deduction and B's $40
corresponding income are both ordinary.
(d) Insolvent debtor. The facts are the same as in paragraph (a)
of this Example 3, except that B is insolvent within the meaning of
section 108(d)(3) at the time that S sells the note to P. On a
separate entity basis, S's $40 loss would be capital, B's $40 income
would be excluded from gross income under section 108(a), and B
would reduce attributes under section 108(b) or section 1017.
However, under paragraph (g)(3)(ii)(B) of this section, section
108(a) does not apply to B's income to characterize it as excluded
from gross income. Accordingly, the attributes of S's intercompany
loss and B's corresponding income are redetermined in the same
manner as in paragraph (b) of this Example 3.
Example 4. Nonintercompany debt becomes intercompany debt. (a)
Facts. On January 1 of Year 1, B borrows $100 from X in return for
B's note providing for $10 of interest annually at the end of each
year, and repayment of $100 at the end of Year 5. As of January 1 of
Year 3, B has fully performed its obligations, but the note's fair
market value is $70. On January 1 of Year 3, P buys all of X's
stock. B is solvent within the meaning of section 108(d)(3).
(b) Deemed satisfied and reissuance. Under paragraph (g)(4) of
this section, B is treated as satisfying its indebtedness for $70
(determined under the principles of Sec. 1.108-2(f)(2)) immediately
after X becomes a member. Both X's $30 capital loss under section
1271(a)(1) and B's $30 of discharge of indebtedness income under
section 61(a)(12) are taken into account in determining consolidated
taxable income for Year 3. Under paragraph (g)(4)(ii)(C) of this
section, the attributes of items resulting from the satisfaction are
determined on a separate entity basis. But see section 382 and
Sec. 1.1502-15 (limitations on the absorption of built-in losses). B
is also treated as reissuing a new note. The new note is an
intercompany obligation, it has a $70 issue price and $100 stated
redemption price at maturity, and the $30 of original issue discount
will be taken into account by B and X in the same manner as provided
in paragraph (c) of Example 1 of this paragraph (g)(5).
(c) Election to file consolidated returns. Assume instead that B
borrows $100 from S during Year 1, but the P group does not file
consolidated returns until Year 3. Under paragraph (g)(4) of this
section, B's indebtedness is treated as satisfied and a new note
reissued immediately after the debt becomes intercompany debt. The
satisfaction and reissuance are deemed to occur on January 1 of Year
3, for the fair market value of the note (determined under the
principles of Sec. 1.108-2(f)(2)) at that time.
Example 5. Notional principal contracts. (a) Facts. On April 1
of Year 1, M1 enters into a contract with counterparty M2 under
which, for a term of five years, M1 is obligated to make a payment
to M2 each April 1, beginning in Year 2, in an amount equal to the
London Interbank Offered Rate (LIBOR), as determined on the
immediately preceding April 1, multiplied by a $1,000 notional
principal amount. M2 is obligated to make a payment to M1 each April
1, beginning in Year 2, in an amount equal to 8% multiplied by the
same notional principal amount. LIBOR is 7.80% on April 1 of Year 1.
On April 1 of Year 2, M2 owes $2 to M1.
(b) Matching rule. Under Sec. 1.446-3(d), the net income (or net
deduction) from a notional principal contract for a taxable year is
included in (or deducted from) gross income. Under Sec. 1.446-3(e),
the ratable daily portion of M2's obligation to M1 as of December 31
of Year 1 is $1.50 ($2 multiplied by 275/365). Under the matching
rule, M1's net income for Year 1 of $1.50 is taken into account to
reflect the difference between M2's net deduction of $1.50 taken
into account and the $0 recomputed net deduction. Similarly, the
$.50 balance of the $2 of net periodic payments made on April 1 of
Year 2 is taken into account for Year 2 in M1's and M2's net income
and net deduction from the contract. In addition, the attributes of
M1's intercompany income and M2's corresponding deduction are
redetermined to produce the same effect as if the transaction had
occurred between divisions of a single corporation. Under paragraph
(c)(4)(i) of this section, the attributes of M2's corresponding
deduction control the attributes of M1's intercompany income.
(Although M1 is the selling member with respect to the payment on
April 1 of Year 2, it might be the buying member in a subsequent
period if it owes the net payment.)
(c) Dealer. The facts are the same as in paragraph (a) of this
Example 5, except that M2 is a dealer in securities, and the
contract with M1 is not inventory in the hands of M2. Under section
475, M2 must mark its securities to market at year-end. Assume that
under section 475, M2's loss from marking to market the contract
with M1 is $100. Under paragraph (g)(3) of this section, M2 is
treated as making a $100 payment to M1 to terminate the contract
immediately before section 475 is applied. M1's $100 of income from
the termination payment is taken into account under the matching
rule to reflect M2's deduction under Sec. 1.446-3(h). The attributes
of M1's intercompany income and M2's corresponding deduction are
redetermined to produce the same effect as if the transaction had
occurred between divisions of a single corporation. Under paragraph
(c)(4)(i) of this section, the attributes of M2's corresponding
[[Page 36704]]
deduction control the attributes of M1's intercompany income.
Accordingly, M1's income is treated as ordinary income. Paragraph
(g)(3) of this section also provides that, immediately after section
475 would apply, a new contract is treated as reissued with an
upfront payment of $100. Under Sec. 1.446-3(f), the deemed $100
payment by M2 to M1 is taken into account over the term of the new
contract in a manner reflecting the economic substance of the
contract (for example, allocating the payment in accordance with the
forward rates of a series of cash-settled forward contracts that
reflect the specified index and the $1,000 notional principal
amount). (The timing of taking items into account is the same if M1,
rather than M2, is the dealer subject to the mark-to-market
requirement of section 475 at year-end. However in this case,
because the attributes of the corresponding deduction control the
attributes of the intercompany income, M1's income from the deemed
termination payment might be ordinary or capital.)
(h) Anti-avoidance rules--(1) In general. If a transaction is
engaged in or structured with a principal purpose to avoid the purposes
of this section (including, for example, by avoiding treatment as an
intercompany transaction), adjustments must be made to carry out the
purposes of this section.
(2) Examples. The anti-avoidance rules of this paragraph (h) are
illustrated by the following examples. The examples set forth below do
not address common law doctrines or other authorities that might apply
to recast a transaction or to otherwise affect the tax treatment of a
transaction. Thus, in addition to adjustments under this paragraph (h),
the Commissioner can, for example, apply the rules of section 269 or
Sec. 1.701-2 to disallow a deduction or to recast a transaction.
Example 1. Sale of a partnership interest. (a) Facts. S owns
land with a $10 basis and $100 value. B has net operating losses
from separate return limitation years (SRLYs) subject to limitation
under Sec. 1.1502-21(c). Pursuant to a plan to absorb the losses
without limitation by the SRLY rules, S transfers the land to an
unrelated, calendar-year partnership in exchange for a 10% interest
in the capital and profits of the partnership in a transaction to
which section 721 applies. The partnership does not have a section
754 election in effect. S later sells its partnership interest to B
for $100. In the following year, the partnership sells the land to X
for $100. Because the partnership does not have a section 754
election in effect, its $10 basis in the land does not reflect B's
$100 basis in the partnership interest. Under section 704(c), the
partnership's $90 built-in gain is allocated to B, and B's basis in
the partnership interest increases to $190 under section 705. In a
later year, B sells the partnership interest to a nonmember for
$100.
(b) Adjustments. Under Sec. 1.1502-21(c), the partnership's $90
built-in gain allocated to B ordinarily increases the amount of B's
SRLY limitation, and B's $90 loss from its sale of the partnership
interest ordinarily is not subject to limitation under the SRLY
rules. Because the contribution of property to the partnership and
the sale of the partnership interest were part of a plan a principal
purpose of which was to achieve a reduction in consolidated tax
liability by creating offsetting gain and loss for B while deferring
S's intercompany gain, B's allocable share of the partnership's gain
from its sale of the land is treated under paragraph (h)(1) of this
section as not increasing the amount of B's SRLY limitation.
Example 2. Transitory status as an intercompany obligation. (a)
Facts. P historically has owned 70% of X's stock and the remaining
30% is owned by unrelated shareholders. On January 1 of Year 1, S
borrows $100 from X in return for S's note requiring $10 of interest
annually at the end of each year, and repayment of $100 at the end
of Year 20. As of January 1 of Year 3, the P group has substantial
net operating loss carryovers, and the fair market value of S's note
falls to $70 due to an increase in prevailing market interest rates.
X is not permitted under section 166(a)(2) to take into account a
$30 loss with respect to the note. Pursuant to a plan to permit X to
take into account its $30 loss without disposing of the note, P
acquires an additional 10% of X's stock, causing X to become a
member, and P subsequently resells the 10% interest. X's $30 loss
with respect to the note is a net unrealized built-in loss within
the meaning of Sec. 1.1502-15.
(b) Adjustments. Under paragraph (g)(4) of this section, X
ordinarily would take into account its $30 loss as a result of the
note becoming an intercompany obligation, and S would take into
account $30 of discharge of indebtedness income. Under Sec. 1.1502-
22(c), X's loss is not combined with items of the other members and
the loss would be carried to X's separate return years as a result
of X becoming a nonmember. However, the transitory status of S's
indebtedness to X as an intercompany obligation is structured with a
principal purpose to accelerate the recognition of X's loss. Thus,
S's note is treated under paragraph (h)(1) of this section as not
becoming an intercompany obligation.
Example 3. Corporate mixing bowl. (a) Facts. M1 and M2 are
subsidiaries of P. M1 operates a manufacturing business on land it
leases from M2. The land is the only asset held by M2. P intends to
dispose of the M1 business, including the land owned by M2; P's
basis in the M1 stock is equal to the stock's fair market value.
M2's land has a value of $20 and a basis of $0 and P has a $0 basis
in the stock of M2. In Year 1, with a principal purpose of avoiding
gain from the sale of the land (by transferring the land to M1 with
a carry-over basis without affecting P's basis in the stock of M1 or
M2), M1 and M2 form corporation T; M1 contributes cash in exchange
for 80% of the T stock and M2 contributes the land in exchange for
20% of the stock. In Year 3, T liquidates, distributing $20 cash to
M2 and the land (plus $60 cash) to M1. Under Sec. 1.1502-34, section
332 applies to both M1 and M2. Under section 337, T recognizes no
gain or loss from its liquidating distribution of the land to M1. T
has neither gain nor loss on its distribution of cash to M2. In Year
4, P sells all of the stock of M1 to X and liquidates M2.
(b) Adjustments. A principal purpose for the formation and
liquidation of T was to avoid gain from the sale of M2's land. Thus,
under paragraph (h)(1) of this section, M2 must take $20 of gain
into account when the stock of M1 is sold to X.
Example 4. Partnership mixing bowl. (a) Facts. M1 owns a self-
created intangible asset with a $0 basis and a fair market value of
$100. M2 owns land with a basis of $100 and a fair market value of
$100. In Year 1, with a principal purpose of creating basis in the
intangible asset (which would be eligible for amortization under
section 197), M1 and M2 form partnership PRS; M1 contributes the
intangible asset and M2 contributes the land. X, an unrelated
person, contributes cash to PRS in exchange for a substantial
interest in the partnership. PRS uses the contributed assets in
legitimate business activities. Five years and six months later, PRS
liquidates, distributing the land to M1, the intangible to M2, and
cash to X. The group reports no gain under sections 707(a)(2)(B) and
737(a) and claims that M2's basis in the intangible asset is $100
under section 732 and that the asset is eligible for amortization
under section 197.
(b) Adjustments. A principal purpose of the formation and
liquidation of PRS was to create additional amortization without an
offsetting increase in consolidated taxable income by avoiding
treatment as an intercompany transaction. Thus, under paragraph
(h)(1) of this section, appropriate adjustments must be made.
Example 5. Sale and leaseback. (a) Facts. S operates a factory
with a $70 basis and $100 value, and has loss carryovers from SRLYs.
Pursuant to a plan to take into account the $30 unrealized gain
while continuing to operate the factory, S sells the factory to X
for $100 and leases it back on a long-term basis. In the
transaction, a substantial interest in the factory is transferred to
X. The sale and leaseback are not recharacterized under general
principles of Federal income tax law. As a result of S's sale to X,
the $30 gain is taken into account and increases S's SRLY
limitation.
(b) No adjustments. Although S's sale was pursuant to a plan to
accelerate the $30 gain, it is not subject to adjustment under
paragraph (h)(1) of this section. The sale is not treated as engaged
in or structured with a principal purpose to avoid the purposes of
this section.
(i) [Reserved]
(j) Miscellaneous operating rules. For purposes of this section--
(1) Successor assets. Any reference to an asset includes, as the
context may require, a reference to any other asset the basis of which
is determined, directly or indirectly, in whole or in part, by
reference to the basis of the first asset.
(2) Successor persons--(i) In general. Any reference to a person
includes, as the context may require, a reference to a predecessor or
successor. For this
[[Page 36705]]
purpose, a predecessor is a transferor of assets to a transferee (the
successor) in a transaction--
(A) To which section 381(a) applies;
(B) In which substantially all of the assets of the transferor are
transferred to members in a complete liquidation;
(C) In which the successor's basis in assets is determined
(directly or indirectly, in whole or in part) by reference to the basis
of the transferor, but the transferee is a successor only with respect
to the assets the basis of which is so determined; or
(D) Which is an intercompany transaction, but only with respect to
assets that are being accounted for by the transferor in a prior
intercompany transaction.
(ii) Intercompany items. If the assets of a predecessor are
acquired by a successor member, the successor succeeds to, and takes
into account (under the rules of this section), the predecessor's
intercompany items. If two or more successor members acquire assets of
the predecessor, the successors take into account the predecessor's
intercompany items in a manner that is consistently applied and
reasonably carries out the purposes of this section and applicable
provisions of law.
(3) Multiple triggers. If more than one corresponding item can
cause an intercompany item to be taken into account under the matching
rule, the intercompany item is taken into account in connection with
the corresponding item most consistent with the treatment of members as
divisions of a single corporation. For example, if S sells a truck to
B, its intercompany gain from the sale is not taken into account by
reference to B's depreciation if the depreciation is capitalized under
section 263A as part of B's cost for a building; instead, S's gain
relating to the capitalized depreciation is taken into account when the
building is sold or as it is depreciated. Similarly, if B purchases
appreciated land from S and transfers the land to a lower-tier member
in exchange for stock, thereby duplicating the basis of the land in the
basis of the stock, items with respect to both the stock and the land
can cause S's intercompany gain to be taken into account; if the lower-
tier member becomes a nonmember as a result of the sale of its stock,
the attributes of S's intercompany gain are determined with respect to
the land rather than the stock.
(4) Multiple or successive intercompany transactions. If a member's
intercompany item or corresponding item affects the accounting for more
than one intercompany transaction, appropriate adjustments are made to
treat all of the intercompany transactions as transactions between
divisions of a single corporation. For example, if S sells property to
M, and M sells the property to B, then S, M, and B are treated as
divisions of a single corporation for purposes of applying the rules of
this section. Similar principles apply with respect to intercompany
transactions that are part of the same plan or arrangement. For
example, if S sells separate properties to different members as part of
the same plan or arrangement, all of the participating members are
treated as divisions of a single corporation for purposes of
determining the attributes (which might also affect timing) of the
intercompany items and corresponding items from each of the properties.
(5) Acquisition of group--(i) Scope. This paragraph (j)(5) applies
only if a consolidated group (the terminating group) ceases to exist as
a result of--
(A) The acquisition by a member of another consolidated group of
either the assets of the common parent of the terminating group in a
reorganization described in section 381(a)(2), or the stock of the
common parent of the terminating group; or
(B) The application of the principles of Sec. 1.1502-75(d)(2) or
(d)(3).
(ii) Application. If the terminating group ceases to exist under
circumstances described in paragraph (j)(5)(i) of this section, the
surviving group is treated as the terminating group for purposes of
applying this section to the intercompany transactions of the
terminating group. For example, intercompany items and corresponding
items from intercompany transactions between members of the terminating
group are taken into account under the rules of this section by the
surviving group. This treatment does not apply, however, to members of
the terminating group that are not members of the surviving group
immediately after the terminating group ceases to exist (for example,
under section 1504(a)(3) relating to reconsolidation, or section
1504(c) relating to includible insurance companies).
(6) Former common parent treated as continuation of group. If a
group terminates because the common parent is the only remaining
member, the common parent succeeds to the treatment of the terminating
group for purposes of applying this section so long as it neither
becomes a member of an affiliated group filing separate returns nor
becomes a corporation described in section 1504(b). For example, if the
only subsidiary of the group liquidates into the common parent in a
complete liquidation to which section 332 applies, or the common parent
merges into the subsidiary and the subsidiary is treated as the common
parent's successor under paragraph (j)(2)(i) of this section, the
taxable income of the surviving corporation is treated as the group's
consolidated taxable income in which the intercompany and corresponding
items must be included. See Sec. 1.267(f)-1 for additional rules
applicable to intercompany losses or deductions.
(7) Becoming a nonmember. For purposes of this section, a member is
treated as becoming a nonmember if it has a separate return year
(including another group's consolidated return year). A member is not
treated as having a separate return year if its items are treated as
taken into account in computing the group's consolidated taxable income
under paragraph (j)(5) or (6) of this section.
(8) Recordkeeping. Intercompany and corresponding items must be
reflected on permanent records (including work papers). See also
section 6001, requiring records to be maintained. The group must be
able to identify from these permanent records the amount, location,
timing, and attributes of the items, so as to permit the application of
the rules of this section for each year.
(9) Examples. The operating rules of this paragraph (j) are
illustrated generally throughout this section, and by the following
examples.
Example 1. Intercompany sale followed by section 351 transfer to
member. (a) Facts. S holds land for investment with a basis of $70.
On January 1 of Year 1, S sells the land to M for $100. M also holds
the land for investment. On July 1 of Year 3, M transfers the land
to B in exchange for all of B's stock in a transaction to which
section 351 applies. Under section 358, M's basis in the B stock is
$100. B holds the land for sale to customers in the ordinary course
of business and, under section 362(b), B's basis in the land is
$100. On December 1 of Year 5, M sells 20% of the B stock to X for
$22. In an unrelated transaction on July 1 of Year 8, B sells 20% of
the land for $22.
(b) Definitions. Under paragraph (b)(1) of this section, S's
sale of the land to M and M's transfer of the land to B are both
intercompany transactions. S is the selling member and M is the
buying member in the first intercompany transaction, and M is the
selling member and B is the buying member in the second intercompany
transaction. M has no intercompany items under paragraph (b)(2) of
this section. Because B acquired the land in an intercompany
transaction, B's items from the land are corresponding items to be
taken into account under this section. Under the successor asset
rule of paragraph (j)(1) of this section, references to the land
include references to M's B stock. Under the successor person rule
of paragraph (j)(2) of this section, references to M include
references to B with respect to the land.
[[Page 36706]]
(c) Timing and attributes resulting from the stock sale. Under
paragraph (c)(3) of this section, M is treated as owning and selling
B's stock for purposes of the matching rule even though, as
divisions, M could not own and sell stock in B. Under paragraph
(j)(3) of this section, both M's B stock and B's land can cause S's
intercompany gain to be taken into account under the matching rule.
Thus, S takes $6 of its gain into account in Year 5 to reflect the
$6 difference between M's $2 gain taken into account from its sale
of B stock and the $8 recomputed gain. Under paragraph (j)(4) of
this section, the attributes of this gain are determined by treating
S, M, and B as divisions of a single corporation. Under paragraph
(c)(1) of this section, S's $6 gain and M's $2 gain are treated as
long-term capital gain. The gain would be capital on a separate
entity basis (assuming that section 341 does not apply), and this
treatment is not inconsistent with treating S, M, and B as divisions
of a single corporation because the stock sale and subsequent land
sale are unrelated transactions and B remains a member following the
sale.
(d) Timing and attributes resulting from the land sale. Under
paragraph (j)(3) of this section, S takes $6 of its gain into
account in Year 8 under the matching rule to reflect the $6
difference between B's $2 gain taken into account from its sale of
an interest in the land and the $8 recomputed gain. Under paragraph
(j)(4) of this section, the attributes of this gain are determined
by treating S, M, and B as divisions of a single corporation and
taking into account the activities of S, M, and B with respect to
the land. Thus, both S's gain and B's gain might be ordinary income
as a result of B's activities. (If B subsequently sells the balance
of the land, S's gain taken into account is limited to its remaining
$18 of intercompany gain.)
(e) Sale of successor stock resulting in deconsolidation. The
facts are the same as in paragraph (a) of this Example 1, except
that M sells 60% of the B stock to X for $66 on December 1 of Year 5
and B becomes a nonmember. Under the matching rule, M's sale of B
stock results in $18 of S's gain being taken into account (to
reflect the difference between M's $6 gain taken into account and
the $24 recomputed gain). Under the acceleration rule, however, the
entire $30 gain is taken into account (to reflect B becoming a
nonmember, because its basis in the land reflects M's $100 cost
basis from the prior intercompany transaction). Under paragraph
(j)(4) of this section, the attributes of S's gain are determined by
treating S, M, and B as divisions of a single corporation. Because
M's cost basis in the land will be reflected by B as a nonmember,
all of S's gain is treated as from the land (rather than a portion
being from B's stock), and B's activities with respect to the land
might therefore result in S's gain being ordinary income.
Example 2. Intercompany sale of member stock followed by
recapitalization. (a) Facts. Before becoming a member of the P
group, S owns P stock with a basis of $70. On January 1 of Year 1, P
buys all of S's stock. On July 1 of Year 3, S sells the P stock to M
for $100. On December 1 of Year 5, P acquires M's original P stock
in exchange for new P stock in a recapitalization described in
section 368(a)(1)(E).
(b) Timing and attributes. Although P's basis in the stock
acquired from M is eliminated under paragraph (f)(4) of this
section, the new P stock received by M is exchanged basis property
(within the meaning of section 7701(a)(44)) having a basis under
section 358 equal to M's basis in the original P stock. Under the
successor asset rule of paragraph (j)(1) of this section, references
to M's original P stock include references to M's new P stock.
Because it is still possible to take S's intercompany item into
account under the matching rule with respect to the successor asset,
S's gain is not taken into account under the acceleration rule as a
result of the basis elimination under paragraph (f)(4) of this
section. Instead, the gain is taken into account based on subsequent
events with respect to M's new P stock (for example, a subsequent
distribution or redemption of the new stock).
Example 3. Back-to-back intercompany transactions--matching. (a)
Facts. S holds land for investment with a basis of $70. On January 1
of Year 1, S sells the land to M for $90. M also holds the land for
investment. On July 1 of Year 3, M sells the land for $100 to B, and
B holds the land for sale to customers in the ordinary course of
business. During Year 5, B sells all of the land to customers for
$105.
(b) Timing. Under paragraph (b)(1) of this section, S's sale of
the land to M and M's sale of the land to B are both intercompany
transactions. S is the selling member and M is the buying member in
the first intercompany transaction, and M is the selling member and
B is the buying member in the second intercompany transaction. Under
paragraph (j)(4) of this section, S, M and B are treated as
divisions of a single corporation for purposes of determining the
timing of their items from the intercompany transactions. See also
paragraph (j)(2) of this section (B is treated as a successor to M
for purposes of taking S's intercompany gain into account). Thus,
S's $20 gain and M's $10 gain are both taken into account in Year 5
to reflect the difference between B's $5 gain taken into account
with respect to the land and the $35 recomputed gain (the gain that
B would have taken into account if the intercompany sales had been
transfers between divisions of a single corporation, and B succeeded
to S's $70 basis).
(c) Attributes. Under paragraphs (j)(4) of this section, the
attributes of the intercompany items and corresponding items of S,
M, and B are also determined by treating S, M, and B as divisions of
a single corporation. For example, the attributes of S's and M's
intercompany items are determined by taking B's activities into
account.
Example 4. Back-to-back intercompany transactions--acceleration.
(a) Facts. During Year 1, S performs services for M in exchange for
$10 from M. S incurs $8 of employee expenses. M capitalizes the $10
cost of S's services under section 263 as part of M's cost to
acquire real property from X. Under its separate entity method of
accounting, S would take its income and expenses into account in
Year 1. M holds the real property for investment and, on July 1 of
Year 5, M sells it to B at a gain. B also holds the real property
for investment. On December 1 of Year 8, while B still owns the real
property, P sells all of M's stock to X and M becomes a nonmember.
(b) M's items. M takes its gain into account immediately before
it becomes a nonmember. Because the real property stays in the
group, the acceleration rule redetermines the attributes of M's gain
under the principles of the matching rule as if B sold the real
property to an affiliated corporation that is not a member of the
group for a cash payment equal to B's adjusted basis in the real
property, and S, M, and B were divisions of a single corporation.
Thus, M's gain is capital gain.
(c) S's items. Under paragraph (b)(2)(ii) of this section, S
includes the $8 of expenses in determining its $2 intercompany
income. In Year 1, S takes into account $8 of income and $8 of
expenses. Under paragraph (j)(4) of this section, appropriate
adjustments must be made to treat both S's performance of services
for M and M's sale to B as occurring between divisions of a single
corporation. Thus, S's $2 of intercompany income is not taken into
account as a result of M becoming a nonmember, but instead will be
taken into account based on subsequent events (e.g., under the
matching rule based on B's sale of the real property to a nonmember,
or under the acceleration rule based on P's sale of the stock of S
or B to a nonmember). See the successor person rules of paragraph
(j)(2) of this section (B is treated as a successor to M for
purposes of taking S's intercompany income into account).
(d) Sale of S's stock. The facts are the same as in paragraph
(a) of this Example 4, except that P sells all of S's stock (rather
than M's stock) and S becomes a nonmember on July 1 of Year 5. S's
remaining $2 of intercompany income is taken into account
immediately before S becomes a nonmember. Because S's intercompany
income is not from an intercompany sale, exchange, or distribution
of property, the attributes of the intercompany income are
determined on a separate entity basis. Thus, S's $2 of intercompany
income is ordinary income. M does not take any of its intercompany
gain into account as a result of S becoming a nonmember.
(e) Intercompany income followed by intercompany loss. The facts
are the same as in paragraph (a) of this Example 4, except that M
sells the real property to B at a $1 loss (rather than a gain). M
takes its $1 loss into account under the acceleration rule
immediately before M becomes a nonmember. But see Sec. 1.267(f)-1
(which might further defer M's loss if M and B remain in a
controlled group relationship after M becomes a nonmember). Under
paragraph (j)(4) of this section appropriate adjustments must be
made to treat the group as if both intercompany transactions
occurred between divisions of a single corporation. Accordingly, P's
sale of M stock also results in S taking into account $1 of
intercompany income as capital gain to offset M's $1 of
corresponding capital loss. The remaining $1 of S's intercompany
income is taken into account based on subsequent events.
[[Page 36707]]
Example 5. Successor group. (a) Facts. On January 1 of Year 1, B
borrows $100 from S in return for B's note providing for $10 of
interest annually at the end of each year, and repayment of $100 at
the end of Year 20. As of January 1 of Year 3, B has paid the
interest accruing under the note. On that date, X acquires all of
P's stock and the former P group members become members of the X
consolidated group.
(b) Successor. Under paragraph (j)(5) of this section, although
B's note ceases to be an intercompany obligation of the P group, the
note is not treated as satisfied and reissued under paragraph (g) of
this section as a result of X's acquisition of P stock. Instead, the
X consolidated group succeeds to the treatment of the P group for
purposes of paragraph (g) of this section, and B's note is treated
as an intercompany obligation of the X consolidated group.
(c) No subgroups. The facts are the same as in paragraph (a) of
this Example 5, except that X simultaneously acquires the stock of S
and B from P (rather than X acquiring all of P's stock). Paragraph
(j)(5) of this section does not apply to X's acquisitions. Unless an
exception described in paragraph (g)(3)(i)(B) applies, B's note is
treated as satisfied immediately before S and B become nonmembers,
and reissued immediately after they become members of the X
consolidated group. The amount at which the note is satisfied and
reissued under paragraph (g)(3) of this section is based on the fair
market value of the note at the time of P's sales to X. Paragraph
(g)(4) of this section does not apply to the reissued B note in the
X consolidated group, because the new note is always an intercompany
obligation of the X consolidated group.
Example 6. Liquidation--80% distributee. (a) Facts. X has had
preferred stock described in section 1504(a)(4) outstanding for
several years. On January 1 of Year 1, S buys all of X's common
stock for $60, and B buys all of X's preferred stock for $40. X's
assets have a $0 basis and $100 value. On July 1 of Year 3, X
distributes all of its assets to S and B in a complete liquidation.
Under Sec. 1.1502-34, section 332 applies to both S and B. Under
section 337, X has no gain or loss from its liquidating distribution
to S. Under sections 336 and 337(c), X has a $40 gain from its
liquidating distribution to B. B has a $40 basis under section
334(a) in the assets received from X, and S has a $0 basis under
section 334(b) in the assets received from X.
(b) Intercompany items from the liquidation. Under the matching
rule, X's $40 gain from its liquidating distribution to B is not
taken into account under this section as a result of the liquidation
(and therefore is not yet reflected under Secs. 1.1502-32 and
1.1502-33). Under the successor person rule of paragraph (j)(2)(i)
of this section, S and B are both successors to X. Under section
337(c), X recognizes gain or loss only with respect to the assets
distributed to B. Under paragraph (j)(2)(ii) of this section, to be
consistent with the purposes of this section, S succeeds to X's $40
intercompany gain. The gain will be taken into account by S under
the matching and acceleration rules of this section based on
subsequent events. (The allocation of the intercompany gain to S
does not govern the allocation of any other attributes.)
Example 7. Liquidation--no 80% distributee. (a) Facts. X has
only common stock outstanding. On January 1 of Year 1, S buys 60% of
X's stock for $60, and B buys 40% of X's stock for $40. X's assets
have a $0 basis and $100 value. On July 1 of Year 3, X distributes
all of its assets to S and B in a complete liquidation. Under
Sec. 1.1502-34, section 332 applies to both S and B. Under sections
336 and 337(c), X has a $100 gain from its liquidating distributions
to S and B. Under section 334(b), S has a $60 basis in the assets
received from X and B has a $40 basis in the assets received from X.
(b) Intercompany items from the liquidation. Under the matching
rule, X's $100 intercompany gain from its liquidating distributions
to S and B is not taken into account under this section as a result
of the liquidation (and therefore is not yet reflected under
Secs. 1.1502-32 and 1.1502-33). Under the successor person rule of
paragraph (j)(2)(i) of this section, S and B are both successors to
X. Under paragraph (j)(2)(ii) of this section, to be consistent with
the purposes of this section, S succeeds to X's $40 intercompany
gain with respect to the assets distributed to B, and B succeeds to
X's $60 intercompany gain with respect to the assets distributed to
S. The gain will be taken into account by S and B under the matching
and acceleration rules of this section based on subsequent events.
(The allocation of the intercompany gain does not govern the
allocation of any other attributes.)
(k) Cross references--(1) Section 108. See Sec. 1.108-3 for the
treatment of intercompany deductions and losses as subject to attribute
reduction under section 108(b).
(2) Section 263A(f). See section 263A(f) and Sec. 1.263A-9(g)(5)
for special rules regarding interest from intercompany transactions.
(3) Section 267(f). See section 267(f) and Sec. 1.267(f)-1 for
special rules applicable to certain losses and deductions from
transactions between members of a controlled group.
(4) Section 460. See Sec. 1.460-4(j) for special rules regarding
the application of section 460 to intercompany transactions.
(5) Section 469. See Sec. 1.469-1(h) for special rules regarding
the application of section 469 to intercompany transactions.
(6) Sec. 1.1502-80. See Sec. 1.1502-80 for the non-application of
certain Internal Revenue Code rules.
(l) Effective dates--(1) In general. This section applies with
respect to transactions occurring in years beginning on or after July
12, 1995. If both this section and prior law apply to a transaction, or
neither applies, with the result that items may be duplicated, omitted,
or eliminated in determining taxable income (or tax liability), or
items may be treated inconsistently, prior law (and not this section)
applies to the transaction. For example, S's and B's items from S's
sale of property to B which occurs before July 12, 1995 are taken into
account under prior law, even though B may dispose of the property
after July 12, 1995. Similarly, an intercompany distribution to which a
shareholder becomes entitled before July 12, 1995 but which is
distributed after that date is taken into account under prior law
(generally when distributed), because this section generally takes
dividends into account when the shareholder becomes entitled to them
but this section does not apply at that time. If application of prior
law to S's deferred gain or loss from a deferred intercompany
transaction (as defined under prior law) occurring prior to July 12,
1995 would be affected by an intercompany transaction (as defined under
this section) occurring after July 12, 1995, S's deferred gain or loss
continues to be taken into account as provided under prior law, and the
items from the subsequent intercompany transaction are taken into
account under this section. Appropriate adjustments must be made to
prevent items from being duplicated, omitted, or eliminated in
determining taxable income as a result of the application of both this
section and prior law to the successive transactions, and to ensure the
proper application of prior law.
(2) Avoidance transactions. This paragraph (l)(2) applies if a
transaction is engaged in or structured on or after April 8, 1994, with
a principal purpose to avoid the rules of this section (and instead to
apply prior law). If this paragraph (l)(2) applies, appropriate
adjustments must be made in years beginning on or after July 12, 1995,
to prevent the avoidance, duplication, omission, or elimination of any
item (or tax liability), or any other inconsistency with the rules of
this section. For example, if S is a dealer in real property and sells
land to B on March 16, 1995 with a principal purpose of converting any
future appreciation in the land to capital gain, B's gain from the sale
of the land on May 11, 1997 might be characterized as ordinary income
under this paragraph (l)(2).
(3) Election for certain stock elimination transactions--(i) In
general. A group may elect pursuant to this paragraph (l)(3) to apply
this section (including the elections available under paragraph
(f)(5)(ii) of this section) to stock elimination transactions to which
prior law would otherwise apply. If an election is made, this section,
and not prior law, applies to determine the timing and attributes of
S's and B's gain
[[Page 36708]]
or loss from stock with respect to all stock elimination transactions.
(ii) Stock elimination transactions. For purposes of this paragraph
(l)(3), a stock elimination transaction is a transaction in which stock
transferred from S to B--
(A) Is cancelled or redeemed on or after July 12, 1995;
(B) Is treated as cancelled in a liquidation pursuant to an
election under section 338(h)(10) with respect to a qualified stock
purchase with an acquisition date on or after July 12, 1995;
(C) Is distributed on or after July 12, 1995; or
(D) Is exchanged on or after July 12, 1995 for stock of a member
(determined immediately after the exchange) in a transaction that would
cause S's gain or loss from the transfer to be taken into account under
prior law.
(iii) Time and manner of making election. An election under this
paragraph (l)(3) is made by attaching to a timely filed original return
(including extensions) for the consolidated return year including July
12, 1995 a statement entitled ``[Insert Name and Employer
Identification Number of Common Parent] HEREBY ELECTS THE APPLICATION
OF Sec. 1.1502-13(l)(3).'' See paragraph (f)(5)(ii)(E) of this section
for the manner of electing the relief provisions of paragraph
(f)(5)(ii) of this section.
(4) Prior law. For transactions occurring in S's years beginning
before July 12, 1995, see the applicable regulations issued under
section 1502. See Secs. 1.1502-13, 1.1502-13T, 1.1502-14, 1.1502-14T,
1.1502-31, and 1.1502-32 (as contained in the 26 CFR part 1 edition
revised as of April 1, 1995).
(5) Consent to adopt method of accounting. For intercompany
transactions occurring in a consolidated group's first taxable year
beginning on or after July 12, 1995, the Commissioner's consent under
section 446(e) is hereby granted for any changes in methods of
accounting that are necessary solely by reason of the timing rules of
this section. Changes in method of accounting for these transactions
are to be effected on a cut-off basis.
Secs. 1.1502-13T, 1.1502-14, and 1.1502-14T [Removed]
Par. 14. Sections 1.1502-13T, 1.1502-14, and 1.1502-14T are
removed.
Par. 15. Section 1.1502-17 is amended as follows:
1. Paragraph (b) is revised.
2. Paragraph (c) is redesignated as paragraph (d).
3. New paragraphs (c) and (e) are added.
4. Newly designated paragraph (d) is amended by:
a. Revising the paragraph heading and the introductory text.
b. Designating the existing example as Example 1 and adding a
heading.
c. Adding Examples 2 and 3.
The added and revised provisions read as follows:
Sec. 1.1502-17 Methods of accounting.
* * * * *
(b) Adjustments required if method of accounting changes--(1)
General rule. If a member of a group changes its method of accounting
for a consolidated return year, the terms and conditions prescribed by
the Commissioner under section 446(e), including section 481(a) where
applicable, shall apply to the member. If the requirements of section
481(b) are met because applicable adjustments under section 481(a) are
substantial, the increase in tax for any prior year shall be computed
upon the basis of a consolidated return or a separate return, whichever
was filed for such prior year.
(2) Changes in method of accounting for intercompany transactions.
If a member changes its method of accounting for intercompany
transactions for a consolidated return year, the change in method
generally will be effected on a cut-off basis.
(c) Anti-avoidance rules--(1) General rule. If one member (B)
directly or indirectly acquires an activity of another member (S), or
undertakes S's activity, with the principal purpose to avail the group
of an accounting method that would be unavailable (or would be
unavailable without securing consent from the Commissioner) if S and B
were treated as divisions of a single corporation, B must use the
accounting method for the acquired or undertaken activity determined
under paragraph (c)(2) of this section or must secure consent from the
Commissioner under applicable administrative procedures to use a
different method.
(2) Treatment as divisions of a single corporation. B must use the
method of accounting that would be required if B acquired the activity
from S in a transaction to which section 381 applied. Thus, the
principles of section 381 (c)(4) and (c)(5) apply to resolve any
conflicts between the accounting methods of S and B, and the acquired
or undertaken activity is treated as having the accounting method used
by S. Appropriate adjustments are made to treat all acquisitions or
undertakings that are part of the same plan or arrangement as a single
acquisition or undertaking.
(d) Examples. The provisions of this section are illustrated by the
following examples:
Example 1. Separate return treatment generally. * * *
Example 2. Adopting methods. Corporation P is a member of a
consolidated group. P provides consulting services to customers
under various agreements. For one type of customer, P's agreements
require payment only when the contract is completed (payment-on-
completion contracts). P uses an overall accrual method of
accounting. Accordingly, P takes its income from consulting
contracts into account when earned, received, or due, whichever is
earlier. With the principal purpose to avoid seeking the consent of
the Commissioner to change its method of accounting for the payment-
on-completion contracts to the cash method, P forms corporation S,
and S begins to render services to those customers subject to the
payment-on-completion contracts. P continues to render services to
those customers not subject to these contracts.
(b) Under paragraph (c) of this section, S must account for the
consulting income under the payment-on-completion contracts on an
accrual method rather than adopting the cash method contemplated by
P.
Example 3. Changing inventory sub-method. (a) Corporation P is a
member of a consolidated group. P operates a manufacturing business
that uses dollar-value LIFO, and has built up a substantial LIFO
reserve. P has historically manufactured all its inventory and has
used one natural business unit pool. P begins purchasing goods
identical to its own finished goods from a foreign supplier, and is
concerned that it must establish a separate resale pool under
Sec. 1.472-8(c). P anticipates that it will begin to purchase,
rather than manufacture, a substantial portion of its inventory,
resulting in a recapture of most of its LIFO reserve because of
decrements in its manufacturing pool. With the principal purpose to
avoid the decrements, P forms corporation S in Year 1. S operates as
a distributor to nonmembers, and P sells all of its existing
inventories to S. S adopts LIFO, and elects dollar-value LIFO with
one resale pool. Thereafter, P continues to manufacture and purchase
inventory, and to sell it to S for resale to nonmembers. P's
intercompany gain from sales to S is taken into account under
Sec. 1.1502-13. S maintains its Year 1 base dollar value of
inventory so that P will not be required to take its intercompany
items (which include the effects of the LIFO reserve recapture) into
account.
(b) Under paragraph (c) of this section, S must maintain two
pools (manufacturing and resale) to the same extent that P would be
required to maintain those pools under Sec. 1.472-8 if it had not
formed S.
(e) Effective dates. Paragraph (b) of this section applies to
changes in method of accounting effective for years beginning on or
after July 12, 1995. For changes in method of accounting effective for
years beginning before that date, see Sec. 1.1502-17 (as contained in
the 26 CFR part 1 edition revised as of
[[Page 36709]]
April 1, 1995). Paragraphs (c) and (d) apply with respect to
acquisitions occurring or activities undertaken in years beginning on
or after July 12, 1995.
Par. 16. Section 1.1502-18 is amended by revising the heading for
paragraph (f) and adding paragraph (g) to read as follows:
Sec. 1.1502-18 Inventory adjustment.
* * * * *
(f) Transitional rules for years before 1966. * * *
(g) Transitional rules for years beginning on or after July 12,
1995. Paragraphs (a) through (f) of this section do not apply for
taxable years beginning on or after July 12, 1995. Any remaining
unrecovered inventory amount of a member under paragraph (c) of this
section is recovered in the first taxable year beginning on or after
July 12, 1995, under the principles of paragraph (c)(3) of this section
by treating the first taxable year as the first separate return year of
the member. The unrecovered inventory amount can be recovered only to
the extent it was previously included in taxable income. The principles
of this section apply, with appropriate adjustments, to comparable
amounts under paragraph (f) of this section.
Par. 17. Section 1.1502-20 is amended as follows:
1. Paragraph (a)(5) Example 6 is amended as follows:
a. The fifth sentence of paragraph (i) is revised.
b. Paragraph (ii) is revised.
c. Paragraphs (iii) and (iv) are added.
2. Paragraph (b)(6) Example 5 is amended as follows:
a. The fifth sentence of paragraph (i) is revised.
b. A sentence is added at the beginning of paragraph (ii).
c. Paragraph (iii) is revised.
d. Paragraph (iv) is removed.
3. Paragraph (b)(6) Example 7 is amended as follows:
a. The fourth sentence of paragraph (i) is revised.
b. The first sentence of paragraph (iii) is revised.
4. Paragraph (c)(4) is amended as follows:
a. Example 3 is amended by removing paragraph (iii).
b. Example 9 is added.
5. Paragraph (e)(3) is amended as follows:
a. Examples 2 and 8 are removed.
b. Example 3 through Example 7 are redesignated as Example 2
through Example 6.
c. Newly designated Example 5 is revised.
6. In paragraph (h)(1), the second sentence is revised. The revised and
added provisions read as follows:
Sec. 1.1502-20 Disposition or deconsolidation of subsidiary stock.
(a) * * *
(5) * * *
Example 6. * * *
(i) * * * S sells its T stock to P for $100 in an intercompany
transaction, recognizing a $60 intercompany loss that is deferred
under section 267(f) and Sec. 1.1502-13. * * *
(ii) Under paragraph (a)(3)(i) of this section, the application
of paragraph (a)(1) of this section to S's $60 intercompany loss on
the sale of its T stock to P is deferred, because S's intercompany
loss is deferred under section 267(f) and Sec. 1.1502-13. P's sale
of the T stock to X ordinarily would result in S's intercompany loss
being taken into account under the matching rule of Sec. 1.1502-
13(c). The deferred loss is not taken into account under
Sec. 1.267(f)-1, however, because P's sale to X (a member of the
same controlled group as P) is a second intercompany transaction for
purposes of section 267(f). Nevertheless, paragraph (a)(3)(ii) of
this section provides that paragraph (a)(1) of this section applies
to the intercompany loss as a result of P's sale to X because the T
stock ceases to be owned by a member of the P consolidated group.
Thus, the loss is disallowed under paragraph (a)(1) of this section
immediately before P's sale and is therefore never taken into
account under section 267(f).
(iii) The facts are the same as in (i) of this Example, except
that S is liquidated after its sale of the T stock to P, but before
P's sale of the T stock to X, and P sells the T stock to X for $110.
Under Secs. 1.1502-13(j) and 1.267(f)-1(b), P succeeds to S's
intercompany loss as a result of S's liquidation. Thus, paragraph
(a)(3)(i) of this section continues to defer the application of
paragraph (a)(1) of this section until P's sale to X. Under
paragraph (a)(4) of this section, the amount of S's $60 intercompany
loss disallowed under paragraph (a)(1) of this section is limited to
$50 because P's $10 gain on the disposition of the T stock is taken
into account as a consequence of the same plan or arrangement.
(iv) The facts are the same as in (i) of this Example, except
that P sells the T stock to A, a person related to P within the
meaning of section 267(b)(2). Although S's intercompany loss is
ordinarily taken into account under the matching rule of
Sec. 1.1502-13(c) as a result of P's sale, Sec. 1.267(f)-1(c)(2)(ii)
provides that none of the intercompany loss is taken into account
because A is a nonmember that is related to P under section 267(b).
Under paragraph (a)(3)(i) of this section, paragraph (a)(1) of this
section does not apply to loss that is disallowed under any other
provision. Because Sec. 1.267(f)-1(c)(2)(ii) and section 267(d)
provide that the benefit of the intercompany loss is retained by A
if the property is later disposed of at a gain, the intercompany
loss is not disallowed for purposes of paragraph (a)(3)(i) of this
section. Thus, the intercompany loss is disallowed under paragraph
(a)(1) of this section immediately before P's sale and is therefore
never taken into account under section 267(d).
(b) * * *
(6) * * *
Example 5. * * *
(i) * * * S sells its T stock to P for $100 in an intercompany
transaction, recognizing a $60 intercompany loss that is deferred
under section 267(f) and Sec. 1.1502-13. * * *
(ii) Under paragraph (a)(3)(i) of this section, the application
of paragraph (a)(1) of this section to S's intercompany loss on the
sale of its T stock to P is deferred because S's loss is deferred
under section 267(f) and Sec. 1.1502-13. * * *
(iii) T's issuance of the additional shares to the public does
not result in S's intercompany loss being taken into account under
the matching or acceleration rules of Sec. 1.1502-13(c) and (d), or
under the application of the principles of those rules in section
267(f). However, the deconsolidation of T is an overriding event
under paragraph (a)(3)(ii) of this section, and paragraph (a)(1) of
this section disallows the intercompany loss immediately before the
deconsolidation even though the intercompany loss is not taken into
account at that time.
Example 7. * * *
(i) * * * S recently purchased its T stock from S1, a lower tier
subsidiary, in an intercompany transaction in which S1 recognized a
$30 intercompany gain that was deferred under Sec. 1.1502-13. * * *
* * * * *
(iii) Under the matching rule of Sec. 1.1502-13, S's sale of its
T stock results in S1's $30 intercompany gain being taken into
account. * * *
* * * * *
(c) * * *
(4) * * *
Example 9. Intercompany stock sales.
(i) P is the common parent of a consolidated group, S is a
wholly owned subsidiary of P, and T is a wholly owned recently
purchased subsidiary of S. S has a $100 basis in the T stock, and T
has a capital asset with a basis of $0 and a value of $100. T's
asset declines in value to $60. Before T has any positive investment
adjustments or extraordinary gain dispositions, S sells its T stock
to P for $60. T's asset reappreciates and is sold for $100, and T
recognizes $100 of gain. Under the investment adjustment system, P's
basis in the T stock increases to $160. P then sells all of the T
stock for $100 and recognizes a loss of $60.
(ii) S's sale of the T stock to P is an intercompany
transaction. Thus, S's $40 loss is deferred under section 267(f) and
Sec. 1.1502-13. Under paragraph (a)(3) of this section, the
application of paragraph (a)(1) of this section to S's $40 loss is
deferred until the loss is taken into account. Under the matching
rule of Sec. 1.1502-13(c), the loss is taken into account to reflect
the difference for each year between P's corresponding items taken
into account and P's recomputed corresponding items (the
corresponding items that P would take into account for the year if S
and P were divisions of a single corporation). If S and P
[[Page 36710]]
were divisions of a single corporation and the intercompany sale were a
transfer between the divisions, P would succeed to S's $100 basis
and would have a $200 basis in the T stock at the time it sells the
T stock ($100 of initial basis plus $100 under the investment
adjustment system). S's $40 loss is taken into account at the time
of P's sale of the T stock to reflect the $40 difference between the
$60 loss P takes into account and P's recomputed $100 loss.
(iii) Under the matching rule of Sec. 1.1502-13(c), the
attributes of S's $40 loss and P's $60 loss are redetermined to
produce the same effect on consolidated taxable income (and
consolidated tax liability) as if S and P were divisions of a single
corporation. Under Sec. 1.1502-13(b)(6), attributes of the losses
include whether they are disallowed under this section. Because the
amount described in paragraph (c)(1) of this section is $100, both
S's $40 loss and P's $60 loss are disallowed.
* * * * *
(e) * * *
(3) * * *
Example 5. Absence of a view.
(i) In Year 1, P buys all the stock of T for $100, and T becomes
a member of the P group. T has 2 historic assets, asset 1 with a
basis of $40 and value of $90, and asset 2 with a basis of $60 and
value of $10. In Year 2, T sells asset 1 for $90. Under the
investment adjustment system, P's basis in the T stock increases
from $100 to $150. Asset 2 is not essential to the operation of T's
business, and T distributes asset 2 to P in Year 5 with a view to
having the group retain its $50 loss inherent in the asset. Under
Sec. 1.1502-13(f)(2), and the application of the principles of this
rule in section 267(f), T has a $50 intercompany loss that is
deferred. Under Sec. 1.1502-32(b)(3)(iv), the distribution reduces
P's basis in the T stock by $10 to $140 in Year 5. In Year 6, P
sells all the T stock for $90. Under the acceleration rule of
Sec. 1.1502-13(d), and the application of the principles of this
rule in section 267(f), T's intercompany loss is ordinarily taken
into account immediately before P's sale of the T stock. Assuming
that the loss is absorbed by the group, P's basis in T's stock would
be reduced from $140 to $90 under Sec. 1.1502-32(b)(3)(i), and there
would be no gain or loss from the stock disposition. (Alternatively,
if the loss is not absorbed and the loss is reattributed to P under
paragraph (g) of this section, the reattribution would reduce P's
basis in T's stock from $140 to $90.)
(ii) A $50 loss is reflected both in T's basis in asset 2 and in
P's basis in the T stock. Because the distribution results in the
loss with respect to asset 2 being taken into account before the
corresponding loss reflected in the T stock, and asset 2 is an
historic asset of T, the distribution is not with the view described
in paragraph (e)(2) of this section.
* * * * *
(h) * * *
(1) * * * For this purpose, dispositions deferred under
Sec. 1.1502-13 are deemed to occur at the time the deferred gain or
loss is taken into account unless the stock was deconsolidated before
February 1, 1991. * * *
* * * * *
Par. 18. Section 1.1502-26 is amended by revising paragraph (b) to
read as follows:
Sec. 1.1502-26 Consolidated dividends received deduction.
* * * * *
(b) Intercompany dividends. The deduction determined under
paragraph (a) of this section is determined without taking into account
intercompany dividends to the extent that, under Sec. 1.1502-13(f)(2),
they are not included in gross income. See Sec. 1.1502-13 for
additional rules relating to intercompany dividends.
* * * * *
Par. 19. Section 1.1502-33 is amended by revising paragraph (c)(2)
to read as follows:
Sec. 1.1502-33 Earnings and profits.
* * * * *
(c) * * *
(2) Intercompany transactions. Intercompany items and corresponding
items are not reflected in earnings and profits before they are taken
into account under Sec. 1.1502-13. See Sec. 1.1502-13 for the
applicable rules and definitions.
* * * * *
Sec. 1.1502-79 [Amended]
Par. 20. Section 1.1502-79 is amended by removing paragraph (f).
Par. 21. Section 1.1502-80 is amended by adding paragraphs (e) and
(f) to read as follows:
Sec. 1.1502-80 Applicability of other provisions of law.
* * * * *
(e) Non-applicability of section 163(e)(5). Section 163(e)(5) does
not apply to any intercompany obligation (within the meaning of
Sec. 1.1502-13(g)) issued in a consolidated return year beginning on or
after July 12, 1995.
(f) Non-applicability of section 1031. Section 1031 does not apply
to any intercompany transaction occurring in consolidated return years
beginning on or after July 12, 1995.
PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT
Par. 22. The authority citation for part 602 continues to read as
follows:
Authority: 26 U.S.C. 7805.
Par. 23. In Sec. 602.101, paragraph (c) is amended as follows:
1. Removing the following entries from the table:
Sec. 602.101 OMB Control numbers.
* * * * *
(c) * * *
------------------------------------------------------------------------
Current OMB
CFR part or section where identified and described control
number
------------------------------------------------------------------------
* * * * *
1.267(f)-1T............................................... 1545-0885
* * * * *
1.469-1T.................................................. 1545-1008
* * * * *
1.1502-14................................................. 1545-0123
1.1502-14T................................................ 1545-1161
* * * * *
------------------------------------------------------------------------
2. Adding entries in numerical order to the table for
Secs. 1.267(f)-1 and 1.469-1 and revising the entry for Sec. 1.1502-13
to read as follows:
Sec. 602.101 OMB Control numbers.
* * * * *
------------------------------------------------------------------------
Current OMB
CFR part or section where identified and described control number
------------------------------------------------------------------------
* * * * *
1.267(f)-1............................................. 1545-0885
* * * * *
1.469-1................................................ 1545-1008
* * * * *
1.1502-13.............................................. 1545-0123, 1545-
0885, 1545-
1161, 1545-
1433
* * * * *
------------------------------------------------------------------------
Michael P. Dolan,
Acting Commissioner of Internal Revenue.
Approved: June 29, 1995.
Leslie Samuels,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 95-16973 Filed 7-12-95; 8:45 am]
BILLING CODE 4830-01-U
