Final consolidated zero-basis regulations fix part (but not all) of the problem.

The specter of zero basis has | been haunting tax practitioners for years; therefore, it is no surprise that recent efforts to dispel this spirit have been met with overwhelming approval. In particular, Temp. Regs. Sec. 1.1502-13T(f) (6) (ii) (issued on duly 12, 1995) provided welcome guidance (and relief) in the consolidated return context. It did, however, contain a glitch that provoked comments from a number of practitioners. When the final regulations were released on Mar. 8, 1996 (TD 8660), it seemed at first that the glitch had been addressed. On further reflection, however, it appears that at least some of the original problems still remain.

According to Temp. Regs. Sec. 1.1502-13T(f)(6)(ii), a disposition would be qualified (i.e., would not give rise to a zero-basis problem) provided the requirements of Temp. Regs. Sec. 1.1502-13T(f) (6) (ii) (A)-(F) were met. The apparent glitch was in subparagraph (F), which required that the party disposing of stock "neither becomes nor ceases to be a member as part of, or in contemplation of, the plan or disposition." The concern raised by this language was that in the vast majority of zero-basis situations, it seemed that the requirement of subparagraph (F) would not be met.

Consider the quintessential zero-basis situation, a failed triangular reorganization. In a failed forward triangular reorganization, P will own S, and unrelated Twill merge into S, with the T shareholders receiving P stock (or a combination of P stock and property) . If the transaction does not satisfy the requirements for a tax-free reorganization, S is presumed to have a zero basis in the P stock, which S used as consideration to acquire T's assets. Absent reorganization status, such use of a zero-basis asset cannot be sheltered by Rev. Rul. 57-278, and Sec. 1032 is apparently inapplicable, because it applies only to P's use of its own stock (or, for that matter, S's use of its own stock). (Neither the proposed nor the final triangular basis regulations interpreting Sec. 358 offer solace on this point.)

Temp. Regs. Sec. 1.1502-13T(f) (6) (ii) was apparently intended to contradict the traditional notion that S has a zero basis in the P stock used to acquire the T assets. However, in the vast majority of cases, S will be a new corporation and, therefore, arguably a corporation that "became" a member of the group as part of the plan in which S then disposed of the P stock. On its face, this would have rendered the intended relief of Temp. Regs. Sec. 1.1502-13T(f) (6) (ii) inapplicable.

The final regulations reveal that the IRS heard practitioners' concerns on this issue and tried to remedy the problem. In the final regulations, the language in subparagraph (F) was changed to "is neither a nonmember that becomes a member nor a member that becomes a nonmember as part of, or in contemplation of, the disposition or plan." This change would seem to solve the problem, because if S did not exist prior to the plan, S could not be said to be a "nonmember" who becomes a member. In short, a corporation that does not exist cannot be a "nonmember."

This solution is fine as far as it goes, but it leaves a potential problem for P. In the final regulations, Regs. Sec. 1.1502-13(f) (6) (ii) (E) requires that P neither become nor cease to be the common parent as part of the plan. If P is a stand-alone company prior to the transaction, P might be said to have "become" the common parent in a transaction in which P forms S. Furthermore, this problem would not be solved by the same change in language that was used in subparagraph (F), because P could not argue that P did not exist prior to the transaction. (Note: P is unlikely to "avoid" the issue by choosing not to elect to file a consolidated return. Although such a choice would eliminate the problem caused by subparagraph (E), it would also mean that P would not be subject to any other consolidated return regulations, including the relief provisions of Regs.Sec. 1.1502-13.)

P might argue, however, that the language in subparagraph (E) was not intended to cover situations in which P becomes" the common parent as a result of forming the consolidated group for the first time. Although such an argument is plausible, a clearer indication that the regulation did not intend to cover a case in which P creates a consolidated group by forming a subsidiary would be welcome.

Thus, although the zero-basis specter is fading, it continues to haunt some transactions, and prudence still requires planning to avoid it.

FROM RICHARD W. BAILINE, J.D., LL.M., WASHINGTON, D.C.