Defining an affiliated group.

An affiliated group of corporations can elect to file a consolidated tax return. One of the advantages of doing so is the ability to net a loss from one corporation against the profits of another. To be a member of an affiliated group, the group must own stock representing at least 80% of the voting power and 80% of the value of the subsidiary. A recent case explored the definition of voting power.

Amax, Inc., and a group of Japanese businesses owned the stock of Alumax, Inc., a manufacturer of aluminum products. While each owned 50% of the stock, the stock Amax owned had four votes per share, giving Amax 80% of the votes on both corporate issues and the board of directors. However, a majority of the shareholders of both groups had to approve any merger, purchase or sale of 5% of Alumax's corporate assets and any liquidation, hiring or firing of the CEO or loans to affiliated corporations.

Although the board members Amax elected had 80% of the votes, the directors elected by the Japanese businesses could veto any board action, subject to review by a panel of arbitrators. In addition, Alumax had to pay dividends equal to 35% of its income, 80% of which went to the Japanese investors. Because of these restrictions, the IRS concluded that Amax did not own stock with 80% of Alumax's voting power.

Result. For the IRS. Neither the code nor the regulations define "80% of the voting power." The Eleventh Circuit Court of Appeals reviewed the legislative history and prior decisions to determine congressional intent. Historically, voting power has been interpreted as the ability to elect members of the board of directors. Under this definition, Alumax appears to qualify as a member of Amax's affiliated group. However, that interpretation is based on the assumption that a majority of the board would have the power to control a corporation's affairs. In this case, the board's power was limited (1) on certain issues and (2) by the veto granted to the Japanese businesses. Consequently, the court ruled the affiliated group did not own 80% of the voting power of Alumax stock.

Under normal circumstances, a corporation that owns stock with at least 80% of the votes for board members has control. However, any restriction on either the shareholder's votes or the board's actions will cause the IRS to look more closely at the stock ownership.

* Alumax, Inc. v. Commissioner, 11th Cir. 1999, 165 F.3d 822, 83 AFTR 2d 99-505.

Prepared by Edward J. Schnee, CPA, PhD, Joe Lane Professor of Accounting and director, MTA program, Culverhouse School of Accountancy, University of Alabama, Tuscaloosa.