Alternative disposition technique using sec. 338(h)(10).
Under Sec. 338(h)(10), a corporate seller of a consolidated subsidiary and the corporate purchaser of that subsidiary may jointly elect to treat the stock sale as an asset sale for federal income tax purposes. If such an election is made, the subsidiary is treated as if it sold all its assets for the grossed-up purchase price or fair market value, followed by a tax-free liquidation of the subsidiary into its selling parent under Sec. 332. The selling consolidated group recognizes the gain on the deemed sale of assets in its consolidated return for the year of the transaction. In turn, the subsidiary's assets take a stepped-up basis when the subsidiary becomes affiliated with its new corporate purchaser.
IRS Letter Rulings 8938036 and 9044063 provide a road map for a planning technique under which the results of a "busted" spinoff under Sec. 355 can be achieved using Sec. 338(h)(10) without generating a tax on a presale intracorporate restructuring. Under the appropriate circumstances, careful planning can result in substantial tax savings to corporate taxpayers that wish to dispose of a first-tier subsidiary in a taxable transaction, but desire to retain one or more second-tier subsidiaries or other assets of the first-tier subsidiary.
Both of these letter rulings involve situations in which a Sec. 338(h)(10) election was going to be made by the respective parties. In each situation, a first-tier subsidiary adopted a complete plan of liquidation under Sec. 332 before the sale of the stock of the first-tier subsidiary or any presale distributions. Immediately before (or concurrently with) the stock sale, the first-tier subsidiary distributed to the selling corporation, among other assets, the stock of a second-tier subsidiary that the selling corporation wanted to keep and/or the purchasing corporation did not want to purchase. Because of the fictional application of Sec. 332 to the Sec. 338(h)(10) transaction, the IRS ruled that no gain or loss was recognized by either the subsidiary or its parent on the deemed liquidating distribution or on the actual liquidating distribution, which included the stock of the second-tier subsidiary.
Effect of a prearranged sale on a liquidation
Because the prearranged sale of the first-tier subsidiary would otherwise cause the presale distribution of the second-tier subsidiary to be ineligible for Sec. 355 protection, the distribution of the second-tier subsidiary would ordinarily result in a dividend to the parent (eliminated in consolidation) and Sec. 311(b) gain recognition to the first-tier subsidiary. Under the consolidated return regulations, this gain would be deferred, albeit briefly, until the first-tier subsidiary left the selling consolidated group. However, by structuring the same transaction using Sec. 338(h)(10), there is no gain (deferred or otherwise) recognized as a result of the presale distribution of the second-tier subsidiary. A formal plan of liquidation must be adopted before the presale distribution, to properly bring the distribution within the (tax-free) purview of Secs. 332 and 337.
To evaluate the economic advantages of this technique, it is necessary to measure the tax cost of the subsidiary's deemed asset sale relative to the tax cost of a stock sale, with the associated tax on the Sec. 311 gain on the retained assets. Note that the tax on the Sec. 311(b) gain may be partially offset by the tax benefit resulting from the corresponding basis step-up in the retained assets. The technique outlined generally will be advantageous only when its tax costs are less, relative to the combined tax realized on the stock sale and Sec. 311(b) gain (taking into account possible state tax consequences). Gain on the sale of the subsidiary's stock may be sheltered (but no loss created) from the "son of mirror" effect of the presale distribution and related investment adjustments. This circumstance, or a substantially greater amount of unrealized appreciation in assets to be disposed of vis-a-vis assets retained, would generally lessen the value of the "busted" spinoff technique.
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|Author:||Sheahen, Paul F.|
|Publication:||The Tax Adviser|
|Date:||Nov 1, 1991|
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