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OBRA and court ruling: trouble for thrift buyers.

Many companies can't resist the lure of consolidated tax returns. When corporate parent companies file such returns, they can offset profits with losses from any members of their affiliated groups.

Companies that acquired troubled thrifts in the late 1980s benefited greatly from consolidated returns. But their fortunes fell with the passage of President Clinton's budget package and a recent appellate court ruling.

Budget deters "double dipping." In the late 1980s, the Federal Savings and Loan Insurance Corporation (FSLIC) agreed to compensate buyers of troubled thrifts for the difference between the book value and the ultimate sales proceeds of so-called covered assets acquired in the transactions.

Generally, no deductions are allowed for the amount of a loss on a sale of property that is compensated by insurance (or otherwise compensated). The FSLIC's promise of tax deductions, then, opened the door to double dipping by buyers of troubled thrifts.

The Omnibus Budget Reconciliation Act of 1993 (OBRA) disallowed losses on the sales of covered assets and deductions for the worthlessness of covered receivables when the taxpayer is entitled to FSLIC reimbursement for the losses. The legislation applies retroactively to assistance credited after March 3, 1991.

However, "built-in" losses and deductions - latent losses and deductions of a subsidiary acquired by a parent - still are recognized. Although accrued before acquisition, such losses and deductions are recognized for tax purposes after he acquisition.

On consolidated tax returns, built-in losses and deduction can be offset only by income generated by the acquired subsidiary.

Ninth Circuit limits rehabilitation exception. Companies had been able to use what in effect were built-in losses thanks to an exception in the tax code.

The exception, under regulations section 1.1502-15, allows a subsidiary's losses accrued before acquisition to be used to offset any income generated by the affiliated group when the parent acquires the subsidiary to rehabilitate it.

Needless to say, buyers tried to take advantage of the exception by characterizing their acquisitions of troubled thrifts as attempts to rehabilitate them. Just three years ago, the Tax Court had backed this view in Idaho First National Bank v. Commissioner, 95 TC 195 (1990). But that decision was reversed by the Ninth Circuit Court of Appeals earlier this year.

The Ninth Circuit found that the Tax Court's definition of rehabilitation under the exception was too broad - and would have, in effect, allowed any company to say it was making an acquisition for benevolent purposes and thereby enjoy the deduction.

The appellate court concluded the rehabilitation exception applied only when (1) there was a rehabilitation motive and (2) the deduction resulted from postacquisition economic investments. No exception would be made for the built-in losses accrued before affiliation regardless of any desire to rehabilitate.

Observation: Although OBRA changes the general status of losses accrued after March 3, 1991, the reversal of the Idaho First National Bank decision affects all companies that file consolidated returns. The ruling makes clear just what constitutes a built-in loss and says they can be offset only against the acquired company's income.

The new interpretation of the exception can only reduce the benefit of acquiring a target company that falls within these guidelines. More specifically, buyers of troubled thrifts may find that losses incurred are of little value in light of the expanded built-in-loss concept (and the more restrictive exception) fashioned by the Ninth Circuit Court of Appeals.
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Title Annotation:Omnibus Budget Reconciliation Act of 1993
Publication:Journal of Accountancy
Date:Oct 1, 1993
Previous Article:$1 million compensation to a sole shareholder found reasonable.
Next Article:Rulings clarify income sourcing regulations.

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