Co-Authored by Byron Hamlett & Gregory Fairbanks
Have you recently given careful consideration to the value and protection of Net Operating Losses?
With the downturn in the economy in late 2008, many companies have been generating net operating losses (“NOL”s). As the economy improves, companies are beginning to utilize NOLs. However, such NOLs may not be available if a company has had a change in control due which results in NOL limitation under Section 382. With the changing economy and intense focus on operational needs, there can be oversight with regard to determining whether Section 382 may restrict NOL usage. While the statute appears straightforward, the Treasury regulations are complex and application of the law often results in finding that an ownership change has occurred when it was not facially apparent at first. In general, Section 382 can limit the ability for a company to use all of its NOLs when there has been a greater than 50% change in ownership. Ownership changes are to be tested on a three-year rolling period.
There are times when a change in ownership can cause inadvertent consequences. As the economy continues to improve, many companies are seeing increasing stock prices and trading volumes are up. Because of the increased value and volumes, shareholders may wish to cash out their investment. These sales of stock can cause an inadvertent ownership change that allows Section 382 to limit future use of NOLs. To prevent against such Section 382 changes, some companies have attempted to file asset protection agreements, preventing the purchase of greater than 5% of a company’s stock; however, companies cannot prevent greater than 5% shareholders from selling off. Despite the best planning efforts, companies can still be limited by Section 382.
Companies should always have documentation and tracking for ownership changes that may subject them to Section 382 limits. This can affect financial statements and the filing of tax returns and is a reporting and loss of value risk that should be managed and monitored. From a compliance perspective, companies need to focus on tracking ownership changes and have documentation and computations available. Such documentation may be obtained through a complete Section 382 study.
In addition to NOLs, companies should be aware that Section 382, and other similar rules, can impact the ability to use research and development credits, capital losses, foreign tax credits, and other tax attributes.
While ownership changes cannot always be prevented or controlled, open communication and careful planning can help companies (especially private companies) prevent unexpected changes. Some considerations to planning follow:
- Consideration of debt versus equity financing, including possibly staggering equity offerings over multiple closings
- Possible amendments to the articles of incorporation and bylaws to help guard against inadvertent changes of control
- Structuring considerations when entering into any merger, acquisition, or divisive transaction
- Bankruptcy and troubled company planning techniques to maximize attribute usage in the future
Let us know your thoughts on additional considerations to take in the comments below.
Greg Fairbanks is a Senior Manager with the Corporate Tax group at Grant Thornton’s Washington National Tax Office. Within this group, Greg provides consultation on corporate and transaction matters including section 382 analyses, e&p analyses, corporate formations, liquidations, mergers, acquisitions, distributions, redemptions and other general corporate tax matters.