This Month in M&A / Issue 21 / December 2014 Did you know…? p2 / Court Watch p4 / Treasury Regulations p4 M&A tax recent guidance This month features: CCA appears to apply a novel approach for the application of the step transaction doctrine in the context of a retroactive check-the-box election (CCA 201446019) Second Circuit affirms Tax Court decision that funds received through a controlled foreign corporation in substance constituted dividend payments (Barnes Group) Final regulations limit ability to choose tax attribute location following asset reorganizations (T.D. 9700) Final regulations address basis allocations in ‘All Cash D’ reorganizations (T.D. 9702) Final GRA regulations address filing failures, other GRA administrative deficiencies (T.D. 9704) www.pwc.com Did you know…? A recently released Chief Counsel Advice applies a novel approach for application of the step transaction doctrine in the context of a retroactive REIT election (CCA 201446019). While REIT elections are available only to a limited class of taxpayers, the question arises whether this CCA could have broader application and might signal potential IRS positions in other ‘retroactive election’ situations, such as a retroactive check-the-box (CTB) election under Reg. sec. 301.7701-3. The new CCA, supplementing a CCA issued June 20, 2014 (the June CCA), concludes that a deemed contribution occurring pursuant to a retroactive election was a taxable exchange rather than a tax-free section 351 transfer because the deemed contribution failed to satisfy the section 351 control requirement. Background Section 351 generally provides that no gain or loss is recognized upon the transfer of property to a corporation in exchange for stock in such corporation, if immediately thereafter the transferors are in control of the transferee corporation (the section 351 control requirement). For this purpose, control is determined under section 368(c), which requires ownership of at least 80 percent of the voting stock and at least 80 percent of each class of nonvoting stock of the corporation. A section 351 exchange generally differs from a sale in that the transferors continue to have a beneficial interest in the transferred property and retain dominion over the property through their interest in the corporation. Generally, courts and the IRS have stated that the purpose of section 351 is to allow nonrecognition when a taxpayer has not economically ‘cashed in’ investments but merely has changed the form of its ownership in such investments. See, for example, Portland Oil Company v. Commissioner, 109 F.2d 479, 488 (1st Cir. 1940), and CCA 200840040. Applying the step transaction doctrine in the section 351 context, courts and the IRS generally have agreed that if at the time of engaging in a purported section 351 exchange, the transferor has a binding commitment to transfer the transferee’s shares following the exchange, the section 351 control requirement may not be satisfied. See, for example, Intermountain Lumber Co. v. Commissioner, 65 T.C. 1025 (1976), and Rev. Rul. 79-70. Reg. sec. 301.7701-3 provides that a retroactive CTB election can be made up to 75 days after the desired effective date of the election. However, the tax treatment of a change in classification of an entity under the CTB regulations is determined under all relevant provisions of the Code and general principles of tax law, including the step transaction doctrine (see Reg. sec. 301.7701-3(g)(2)(i)). Similar to the REIT election in the CCA that imposed a deemed contribution fiction, a disregarded entity (DE) that elects to change its classification from a DE to a corporation is treated for US federal income tax purposes as if the DE owner contributed all the assets and liabilities of the DE to a newly formed corporation solely in exchange for its stock (see Reg. sec. 301.7701-3(g)(1)(iv)). Facts in the CCA As depicted in the timeline below, on Date 1 of Year 1 (Date 1) a financial institution (Failed Institution) formed a single-member LLC (BankLLC) treated from its formation as a disregarded entity (DE) for US federal tax purposes. On the same date, Failed Institution transferred REMIC securities (qualifying REIT assets under section 856) to BankLLC. On Date 2 of Year 1 (Date 2), subsequent to Failed Institution’s failure as a bank, an unrelated purchaser (Bank) acquired Failed Institution’s deposit liabilities and assets, including the REMIC securities held by BankLLC, in a taxable acquisition (the Acquisition). On Date 6 of Year 2 (Date 6), BankLLC elected to be treated as a REIT for US federal income tax purposes effective as of Date 1 (the Retroactive REIT Election). 2 PwC IRS analysis The IRS stated that if the Retroactive REIT Election were respected as being effective as of Date 1, then the following would be deemed to occur for US federal income tax purposes: (1) BankLLC would be deemed to be treated as a corporation as of the start of Date 1, and (2) consequently, Failed Institution would be deemed to have contributed all of BankLLC’s assets and liabilities to BankLLC in exchange for BankLLC units immediately before the close of the day prior to Date 1 (the Deemed Contribution). In the CCA, the IRS first acknowledged its prior conclusion in the June CCA that the Deemed Contribution qualified as a section 351 transfer for US federal income tax purposes. The IRS then, however, rejected its prior conclusion on the ground that the IRS now viewed Failed Institution as having failed to meet the section 351 control requirement. In determining that the Deemed Contribution failed to satisfy the section 351 control requirement, the IRS analogized to the body of well-developed case law, and its own prior revenue rulings, which hold that the control requirement is not satisfied if the transferor is under a binding commitment at the time of the exchange to transfer the transferee corporation’s stock to another person in a taxable disposition. Specifically, the IRS stated that because Failed Institution no longer owned BankLLC when BankLLC made the Retroactive REIT Election, Failed Institution “should be viewed as having irrevocably foregone or relinquished at the time of the Deemed Contribution the legal right to determine whether to keep the BankLLC shares.” As a result of the Retroactive REIT Election, the IRS viewed the circumstances of the Deemed Contribution as ‘analogous’ to Failed Institution being under a binding commitment to transfer the REMIC securities to BankLLC in a purported section 351 exchange, and then to sell the LLC units of BankLLC to Bank. Accordingly, the IRS concluded that the Deemed Contribution failed to qualify as a section 351 exchange. Observations Although the IRS analogized the facts of the CCA to a binding commitment standard, the CCA does not state that there was such a binding commitment to sell in place as of Date 1. An alternative application of the binding commitment standard for a retroactive CTB election would have been that the binding commitment must be present at the effective date of the retroactive election and taxpayers could not use hindsight to effectively create a ‘busted’ section 351 transaction for tax planning purposes. Thus, the approach taken in this CCA appears to create a new approach for application of the step transaction doctrine in the context of a retroactive REIT election (Note: Because REIT elections have to be made through filing a 1120-REIT for the applicable period, they are always retroactive elections, see section 856(c)(1)). While REIT elections are available only to a limited category of taxpayers, the question arises whether this CCA could have broader application and might signal PwC 3 potential IRS positions in other ‘retroactive election’ situations, such as a retroactive CTB election under Reg. sec. 301.7701-3. Although a CCA cannot be used or cited as precedent, it can provide useful insight as to how the IRS viewed the issues considered therein. This CCA seems to provide a new or different line of reasoning by the IRS. Query whether the IRS will permit taxpayers to obtain a single-issue private letter ruling applying the CCA’s rationale to retroactive CTB elections. For additional information, please contact Tim Lohnes, Henry Miyares, or Rob Calabrese. Court watch Barnes Group, Inc. v. Commissioner, Second Circuit 13-4298 (November 5, 2014) The Second Circuit Court of Appeals recently affirmed the Tax Court’s April 2013 decision in Barnes v. Commissioner that substance-over-form and step transaction doctrine principles applied to a reinvestment plan such that the series of transactions occurring under the plan in substance constituted a constructive dividend distribution. See the May 2013 edition of This Month in M&A for discussion of the steps comprising the reinvestment plan and a summary of the Tax Court decision. The Second Circuit agreed with the Tax Court’s holding that the taxpayer did not reasonably rely on Rev. Rul. 74-503, on the ground that the ruling was factually inapplicable to the facts in Barnes. Observations The Second Circuit found Rev. Rul. 74-503 to be factually inapplicable to the taxpayer’s circumstances in Barnes on the ground that because the steps of the reinvestment plan occurred pursuant to an integrated plan, while the revenue ruling addressed only an isolated exchange. Thus, the Second Circuit’s opinion does not resolve a broader question raised by the Barnes’ Tax Court decision as to how close the facts of a taxpayer’s transaction must be to the facts of an existing revenue ruling in order to justify reliance on that ruling. Also, the opinion indicates that providing additional business purposes for the steps of a transaction will not necessarily preclude application of the step transaction doctrine. Most notably, the Second Circuit’s affirmation of the Tax Court decision signifies the importance of executing and implementing the transaction as planned and following through in a manner that complies with all applicable legal and regulatory requirements. For additional information, please contact Gary Wilcox, Tim Lohnes, or Rob Calabrese. Final Treasury Regulations Final regulations under sections 381 and 312 (T.D. 9700) The IRS on November 10 published final regulations under sections 381 and 312 (T.D. 9700) that limit the degree of electivity afforded to taxpayers regarding the location of tax attributes inherited from a target corporation in an asset reorganization. The final regulations apply to transactions occurring on or after November 10, 2014. The preamble states that the final regulations adopt proposed section 312 regulations published April 16, 2012 (REG-141268-11) and proposed section 381 regulations published May 7, 2014 (REG-131239-13) without substantive change to either set of proposed regulations. See the May 2012 and June 2014 editions of This Month in M&A for a background discussion of section 381 and the interaction of the prior final and proposed regulations under sections 381 and 312. 4 PwC Final rules Under the final section 381 regulations, the definition of the acquiring corporation is modified to mean the corporation that directly acquires the assets transferred by the transferor corporation, even if that corporation ultimately retains none of the transferred assets. The final section 312 regulations provide that in the case of an asset reorganization, the acquiring corporation (and only the acquiring corporation) as defined in the final section 381 regulations succeeds to the earnings and profits (E&P) of the transferor corporation. Thus, under the final regulations, if transferor corporation (T) merges into acquiring corporation (A), A is treated as the acquiring corporation that succeeds to T’s tax attributes (including T’s E&P) regardless of whether A subsequently transferred all of T’s acquired assets to a wholly owned subsidiary (S) pursuant to the plan of reorganization. Prior to these final regulations, if A had transferred all of T’s acquired assets to S, S would have succeeded to all of T’s E&P. However, if A had transferred all of T’s acquired assets among several wholly owned subsidiaries, it had been unclear whether T’s E&P would be allocated among the wholly owned subsidiaries. The preamble states that this rule is appropriate “because it generally maintains such earnings and profits at the corporation closest to the transferor corporation’s former shareholders in a manner that minimizes electivity and administrative burden.” Observations The final regulations provide clarity in adopting a ‘bright-line’ rule that can be applied by taxpayers in evaluating the anticipated results of various structuring alternatives. Taxpayers may seek to retain some measure of ability to choose the location of inherited tax attributes through the form of the transaction itself, as techniques such as downstream mergers and triangular reorganizations could prove viable alternatives in appropriate situations resulting in a preferential location of tax attributes under the bright-line rule. For additional information, please contact Robert Black or Jon Lewbel. Final basis allocation regulations in ‘All Cash D’ reorganizations (T.D. 9702) The IRS on November 12 published final regulations under section 358 regarding determination of the basis of stock or securities of the acquiring corporation in ‘All Cash D’ reorganizations. The final regulations adopt temporary regulations issued in November 2011 without substantive changes. See the December 2011 edition of This Month in M&A for a detailed discussion of the temporary regulations. Background In general, the All Cash D regulations provide that a transaction is treated as satisfying the distribution requirement of section 368(a)(1)(D) notwithstanding that there is no actual issuance of stock and/or securities of the acquiring corporation so long as the same person or persons own, directly or indirectly, all the stock of the target and acquiring corporations in identical proportions. In these situations, assuming a value-for-value exchange between the transferor and acquiring corporations, the All Cash D regulations deem the acquiring corporation to issue a nominal share of its stock in addition to the actual consideration exchanged for the transferor corporation’s assets. In a non value-for-value exchange—i.e., a situation where the acquiring corporation provides the transferor corporation with no consideration or consideration having a value less than the transferor corporation’s assets—the acquiring corporation is treated as issuing shares of its stock having a value necessary to create a value-for-value exchange. Temporary regulations In a value-for-value exchange, the temporary regulations provided a special rule that allowed a shareholder that was deemed to receive a nominal share of acquiring corporation stock to designate a share of the acquiring corporation stock to which the basis of the nominal share would attach (the nominal share basis designation rule). PwC 5 Prior to issuance of the temporary regulations, in the context of an All Cash D reorganization with a lower-tier target corporation where the acquiring corporation was in a different chain of ownership, some taxpayers had interpreted the earlier regulations as allowing shareholders of the transferor corporation who did not actually own stock of the acquiring corporation to designate a share of ‘actual’ acquiring corporation stock to which the basis in the nominal share would attach prior to any deemed distribution/contribution of the nominal share. The IRS considered this result inappropriate, prompting issuance of the temporary regulations. The final regulations, which apply to exchanges and distributions of stock occurring on or after November 12, 2014, reiterate this view of the IRS. Final rules The final regulations apply to value-for-value and non value-for-value (bargain exchange) Cash D reorganizations. The final regulations clarify that the deemed recapitalization under the second step of the ‘bargain exchange basis rule’ occurs only after the stock treated as issued by the acquiring corporation pursuant to Reg. sec. 1.368-2(l) is held by a shareholder that actually owns stock of the acquiring corporation. Similarly, the final regulations provide that the nominal share basis designation rule applies only after an actual shareholder of the acquiring corporation receives the nominal share pursuant to Reg. sec. 1.368-2(l), and that such shareholder must attach the nominal share’s basis (even if the share’s basis is zero) to a share of the acquiring corporation’s stock that the shareholder actually owns. Observations As noted in the December 2011 edition of This Month in M&A, taxpayers that want to preserve the basis in lower-tier target corporations that otherwise would be eliminated as a consequence of the mechanics of the All Cash D regulations should cause the acquiring corporation to actually issue some shares in the reorganization. For additional information, please contact Tim Lohnes or Brian Corrigan. Final GRA regulations (T.D. 9704) The IRS on November 19 published final and temporary regulations that apply to US persons who fail to file gain recognition agreements (GRAs) and related documents, or to satisfy other reporting obligations required for certain transfers of property to foreign corporations in nonrecognition exchanges. These regulations generally apply effective on that date (see regulations for specific effective date rules). The new regulations generally incorporate the provisions of proposed regulations issued January 31, 2013, with certain modifications. See the February 2013 edition of This Month in M&A for a discussion of the proposed regulations and PwC Tax Insight: New final GRA regulations: failures to file and deficiencies in GRAs and other documents for additional discussion of the final and temporary regulations. Under the final regulations, US persons who either fail to timely file a GRA or related documents, or file such documents with material deficiencies, face rules for obtaining relief that are similar to those in the 2013 proposed regulations. The final regulations also address failures to file (and deficient filings of) certain documents required in the sections 367(a) and 6038B regulations concerning outbound transfers, as well as Form 926, and the section 367(e)(2) regulations for liquidations into foreign corporations. The final regulations require the US person to demonstrate that any failure was not ‘willful,’ a less burdensome standard than ‘reasonable cause’ standard in the withdrawn regulations. At the same time, the final regulations continue to apply the ‘reasonable cause and not willful neglect’ standard to US persons seeking relief from failure to report penalties under section 6038B. Additional highlights of the final regulations include: 6 The IRS directive put into place in 2010, which applies to timely filed but deficient GRAs and related documents, is revoked effective November 19, 2014. PwC Whether the failure to file a GRA or to comply in all material respects with the GRA regulations was willful is to be determined based on all the relevant facts and circumstances. Application of the ‘willful’ standard is illustrated through a series of examples. The requirement that the IRS respond to requests for relief for missed and deficient GRA filings within 120 days of receipt of the request is eliminated. The requirement to file Form 926 is extended to outbound stock transfers where the US transferor files a GRA. Relief rules are provided similar to the proposed GRA relief rules for failures to file statements required by Reg. secs. 1.367(a)-2T, 1.367(a)-3(c)(6), 1.367(a)-3(c)(7), 1.367(a)-3(d)(2)(vi)(B)(1)(ii), 1.367(a)-7, and 1.367(e)-2. Observations Because the final regulations set forth a less burdensome standard for failure to file a GRA, taxpayers who were denied relief under the prior reasonable cause standard may be able to resubmit for relief under the final regulations claiming that the failure to timely file a GRA, or file a GRA with material deficiencies was not willful. Consult with your tax advisors to determine whether it is advisable to resubmit based on all the relevant facts and circumstances. For additional information, please contact Marty Collins, Carl Dubert, or Sean Mullaney. PwC 7 Let’s talk For a deeper discussion of how this issue might affect your business, please contact: Tim Lohnes, Washington, DC Henry Miyares, Washington, DC +1 (202) 414-1686 +1 (202) 312-7595 [email protected] [email protected] Marty Collins, Washington, DC Gary Wilcox, Washington, DC +1 (202) 414-1571 +1 (202) 312-7942 [email protected] [email protected] Sean Mullaney, Washington, DC Carl Dubert, Washington, DC +1 (202) 495-9545 +1 (202) 414-1873 [email protected] [email protected] Olivia Ley, Washington, DC Robert Black, Washington, DC +1 (202) 312-7699 +1 (202) 414-1870 [email protected] [email protected] Meryl Yelen, Los Angeles, CA Jon Lewbel, Washington, DC +1 (202) 346-5175 +1 (202) 312-7980 [email protected] [email protected] Brian Corrigan, Washington, DC Rob Calabrese, Washington, DC +1 (202) 414-1717 +1 (202) 346-5205 [email protected] [email protected] This document is for general information purposes only, and should not be used as a substitute for consultation with professional advisors. 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