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Final regs exempt certain Treasury sales of instruments from Code Sec. 382 segregation rules

T.D. 9721, 06/04/2015; Reg. § 1.382-3

IRS has issued final regs that modify the effective date of previously issued regs; the effect of this modification is to exempt Treasury’s sales of instruments issued under certain Emergency Economic Stabilization Act of 2008 (EESA) programs to public shareholders, from the Code Sec. 382 segregation rules. IRS had issued a Notice in 2010 under which such a sale wouldn’t trigger the Code Sec. 382 regs, and the new effective date modification ensures that this rule, which had been unintentionally undermined by a subsequently issued reg, continues to apply as intended.

Background. After an “ownership change,” Code Sec. 382 limits the amount by which a loss corporation (i.e., one entitled to use a net operating loss (NOL) carryover or having an NOL for the tax year in which the ownership change occurs) can offset its taxable income for post-change years by pre-change losses. The amount of the Code Sec. 382 limitation each year is equal to the fair market value of all the stock of the loss corporation immediately before the ownership change multiplied by the applicable long-term tax-exempt rate.

The legislative history of Code Sec. 382 shows that a primary purpose was to prevent the “trafficking” of NOLs—in other words, to limit their benefit when new shareholders who did not bear the actual economic burden of the losses acquire a controlling interest in a loss corporation. Code Sec. 382 also seeks to prevent abuses occurring as a result of an acquisition of loss corporation stock followed by the contribution of income-producing assets, or the diversion of income-producing opportunities, to the corporation.

RIA observation: The 5% threshold, below, basically reflects the notion that less-than-5% shareholders are generally not in a position to acquire loss corporation stock for an abusive purpose.

An ownership change is defined as a change in the percentage of ownership of the loss corporation’s stock owned by the “5% shareholders” of more than 50 percentage points (by value) over a 3-year period. (Code Sec. 382(g), Reg. § 1.382-2T(a)(1) ) A “5% shareholder” can be:

…an individual 5% shareholder, i.e., any person holding 5% or more of the corporation’s stock, directly or indirectly, during the testing period; or
…a “public group,” i.e., an aggregation of shareholders of the loss corporation that own less than 5% of the corporation and are treated as a 5% shareholder. (Code Sec. 382(g)(4)(B)) Public groups that are identified under the aggregation rule, however, can be broken up under the so-called “segregation rules” into two or more public groups after certain transactions (such as mergers) that affect the ownership interests of the public groups. (Reg. § 1.382-2T(g)(1))

One of the segregation rules, which was imposed by former §1.382-2T(j)(3)(i) (until it was superseded; see below), required segregation when an individual or entity that owned 5% or more of the loss corporation transferred an interest in the loss corporation to public shareholders. After the sale, stock owned by a public group that existed immediately before the sale was treated separately from the stock owned by the public group that acquired stock from the seller. This separate public group was treated as a new 5% shareholder.

RIA observation: In general, the more “5% shareholders” there are, the more likely it is that there will be an ownership shift triggering the Code Sec. 382 limitations.

In Notice 2010-2, 2010-2 IRB 251, IRS provided guidance on the application of Code Sec. 382 to corporations whose instruments were acquired and disposed of by Treasury pursuant to the EESA—a law referred to by many as a “bailout” of the U.S. financial system that was enacted in response to the 2007 mortgage crisis. These included instruments acquired by Treasury under the following EESA programs (collectively referred to as Programs):

…the Capital Purchase Program for publicly-traded issuers;
…the Capital Purchase Program for private issuers;
…the Capital Purchase Program for S corporations;
…the Targeted Investment Program;
…the Asset Guarantee Program;
…the Systemically Significant Failing Institutions Program;
…the Automotive Industry Financing Program; and
…the Capital Assistance Program for publicly-traded issuers.

Notice 2010-2, Sec. IIIE, provides that if Treasury sells stock that was issued to it under the Programs (either directly or upon the exercise of a warrant) and the sale creates a public group (New Public Group), the New Public Group’s ownership in the issuing corporation won’t be considered to have increased solely as a result of such a sale (and, thus, the Code Sec. 382 rules won’t be triggered as a result). A New Public Group’s ownership will be treated as having increased to the extent the New Public Group increases its ownership under any transaction other than a sale of stock by Treasury, including pursuant to a stock issuance described in former Reg §1.382-3(j)(2) or a redemption. Such stock is considered outstanding for purposes of determining the percentage of stock owned by other 5% shareholders on any testing date, and Code Sec. 382 (and its regs) will otherwise apply to the New Public Group in the same manner as with respect to other public groups. The rule in Notice 2010-2, Sec. IIIE, was created to prevent a loss corporation from experiencing an owner shift when Treasury sells stock to public shareholders; however, by its terms, the rule relies on the assumption that the stock sale “creates a public group” (as per then-in-effect §1.382-2T(j)(3)(i), above).

In October of 2013, IRS issued final regs on the application of the segregation rules to public groups of shareholders in determining owner shifts and ownership changes for purposes of Code Sec. 382 (2013 segregation regs, see Weekly Alert ¶  5  10/24/2013). One of these regs was Reg. § 1.382-3(j)(13), which rendered the rule in former §1.382-2T(j)(3)(i) inoperative. Under that reg, no new public group is created on the transfer of stock to the public shareholders. Instead, the transferred stock is treated as acquired proportionately by the public groups existing at the time of the transfer.

IRS later became concerned that eliminating the superseded segregation rule may have unintentionally rendered inoperative the rule in Notice 2010-2 that protects a loss corporation from an owner shift when Treasury sells stock that it held under the Programs to public shareholders.

2014 temporary and proposed regs. In 2014, IRS published temporary regs that modified the effective date rule of the 2013 segregation regs so as to except, from the recent changes in the segregation rules, Treasury’s sale to public shareholders of any Program Instrument—i.e., an instrument issued under a Program (or an instrument that is acquired by Treasury in exchange for an instrument that was issued to Treasury under the Programs, or is acquired by Treasury in exchange for another such instrument). Accordingly, under the 2014 temporary regs, a sale of stock by Treasury to the public creates a public group, and Notice 2010-2, Sec. IIIE, continues to apply as intended.

IRS noted that the modified effective date provision only affects the sale of a Program Instrument by Treasury and does not affect the application of the segregation rule changes in the 2013 regs to any other transactions involving stock of the corporations that participated in the Programs.

The 2014 temporary regs also serve as the text of contemporaneously issued proposed regs.

Final regs adopt modified effective date provision. The modified effective date provision described above has now been adopted and made permanent. (Reg. § 1.382-3(j)(17)) Accordingly, the proposed reg is adopted as final, and the temporary reg is removed.

References: For applying less-than-5% shareholder rule separately to each group in equity structure shift, see FTC 2d/FIN ¶  F-7477 United States Tax Reporter ¶  3824; TaxDesk ¶  240,309  ; TG ¶  5375  . For the Code Sec. 382 limitation, see Federal Tax Coordinator 2d ¶  F-7200  et seq.; United States Tax Reporter ¶  3824  et seq. TaxDesk ¶  240,300  et seq.; TG ¶  5352  et seq.

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