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IRS position on restoration of deferred intercompany items.

In recent Letter Ruling 9709052, a consolidated group distributed certain controlled corporations to its shareholders tax-free under Sec. 355, and was then acquired in a reorganization under Sec. 368(a)(1)(B) (exchange of controlling stock solely for voting stock). This type of transaction is commonly referred to as a "Morris Trust" transaction. (Note that, as of Apr. 17, 1997, such transactions are the subject of proposed legislation that would substantially curtail them.) The IRS ruled that the acquisition would not cause the distributing corporation's group to take into account any deferred intercompany items. On its surface, this new ruling appears to represent a change in the Service's position with respect to triggering deferred intercompany items that are still governed by the former regulations.

The current consolidated return regulations governing intercompany transactions generally apply to transactions occurring in tax years beginning after duly 11, 1995. The former regulations continue to apply indefinitely, however, in cases in which an intercompany transaction took place before this effective date, regardless of when restoration occurs. The general rule provided in the former regulations is that the termination of a consolidated group will cause any deferred intercompany items to be triggered. Former Regs. Sec. 1.1502-13(f)(2)(i) provided an "acquired group" exception to that general rule only if all the members of the terminating group (determined immediately before the acquisition) become members (immediately after the acquisition) of another consolidated group.

In Letter Ruling 9501027, the Service ruled that a Morris Trust transaction in which a historical subsidiary is spun off does not fall within this exception, because not all of the members of the terminating group immediately before the spin-off become members of the new consolidated group immediately afterwards.

In Letter Ruling 9709052 (which supplements Letter Ruling 9704025), the IRS ruled that no member of a distributing corporation's consolidated group (as it existed immediately after the spin-off) was required to take into account any intercompany items as a result of the distributing corporation's acquisition by another group in a Sec. 368(a)(1)(B) reorganization. This ruling seems inconsistent with Letter Ruling 9501027. A likely explanation for the different outcomes is that the acquiring corporation in Letter Ruling 9709052 may not have acquired an amount of the distributing corporation's stock necessary to affiliate under Sec. 1504(a)(2) (i.e., at least 80% vote and value), even though it acquired control for "B" reorganization purposes under Sec. 368(c) (i.e., at least 80% vote and at least 80% of value of each class of nonvoting stock). The precise amount of stock acquired was not determinable from the letter ruling, but if it was insufficient, the acquisition would not have caused the distributing consolidated group to terminate.

Although Letter Ruling 9709052 might be read as a shift in IRS position, the cautious practitioner should assume that there has been no change in the Service's position established by Letter Ruling 9501027 on the restoration of deferred intercompany items that continue to be governed by the former regulations.

From Richard Yates, J.D., Steve Rainey, CPA, and David Hering, CPA, Washington, D.C.
COPYRIGHT 1997 American Institute of CPA's
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Author:Hering, David
Publication:The Tax Adviser
Date:Jun 1, 1997
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