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Reconsolidation of subsidiary corporations; waiver of the 60-month waiting period.

An affiliated group of corporations that elects to file on a consolidated basis does so because of the tax benefits that are available. Various events can cause an affiliated group to be restructured so that one or more subsidiary corporations are no longer affiliated; that is, they no longer meet the stock ownership or includible corporation requirements for affiliation and cannot participate in the consolidated return election. When disaffiliation occurs, both the tax benefits and the tax problems of consolidation disappear.(1)

The choice to disaffiliate is often driven by business rather than tax considerations. A need for working capital may cause part or all of an investment in a subsidiary corporation to be sold or may lead to additional stock being issued by the subsidiary. The acquisition of the assets or stock of a target corporation may be paid for with additional stock issued by the subsidiary. These transactions result in disaffiliation if the subsidiary fails the stock ownership requirement.(2) The subsidiary's acquisition of a special tax status (e.g., as a Sec. 936 possessions credit corporation, Sec. 801 insurance company, regulated investment company, or real estate investment trust) also can result in disaffiliation.

Results of Disaffiliation

Some unfavorable tax results may occur from disaffiliation. Separate tax returns are required of the disaffiliated corporations. Net operating losses (NOLs) of the disaffiliated member can no longer be used to offset the taxable income of other group members. The disaffiliated member's NOL, credit and other carryovers are subject to the separate return limitation year (SRLY) rules. Deferred intercompany gains may need to be restored. An excess loss account balance for the parent corporation's investment in the subsidiary corporation may require the recognition of income or gain. Allocation of tax attributes between the remaining group members and the departing member also may be needed.

However, there clearly are some situations in which disaffiliation of a subsidiary can generate significant tax benefits. For example, disaffiliation may permit the recognition of some or all of the realized loss on the sale of the investment in the subsidiary's stock under Regs. Sec. 1.1502-20. Loss, credit and other carryforwards that are allocable to the departing group member can be used on a separate company basis when such amounts might not be usable on a consolidated basis because of a limitation based on the group's consolidated taxable income or tax liability.(3) Specifically, a profitable subsidiary may be able to use loss or credit carryovers on a separate return basis that would not be available to a consolidated group reporting a smaller consolidated taxable income amount (or even a consolidated NOL) arising from other subsidiaries reporting substantial losses. The use of a consolidated tax attribute in a separate return year that is about to expire may be another reason for disaffiliating.

Disaffiliation also can involve a profitable corporation becoming part of an affiliated group that has substantial loss carryforwards. The profits of the new group member can be used to offset the group's current losses and loss carryovers. After such losses have been fully used, the profitable corporation, subject to certain restrictions, can rejoin its original affiliated group.

Congress became aware that corporations were abusing the consolidated return rules in two ways. First, firms were complying with the literal requirement of Sec. 1504(a) and were acquiring 80% or more of the voting power of a subsidiary so that the two firms could be consolidated. However, some firms were acquiring necessary voting power while much, if not most, of the value of the stock was in the hands of individuals or entities that were not part of the affiliated group.

A second perceived abuse grew out of the potential for disaffiliating from a consolidated group in order to achieve some specific tax benefit and then reaffiliating with the original group at a later date. This article will examine this problem, the statutory solution and the IRS's willingness to waive the five-year waiting period for reconsolidation that is mandated by statute.

Legislative Remedies

Congress added two provisions to Sec. 1504 in the Deficit Reduction Act of 1984 (DRA) to deal with abuses it perceived occurring with consolidated tax returns.

* Stock ownership requirement

The first change requires ownership of 80% of the total voting power and 80% of the total value (excluding certain nonvoting preferred stock issues) of a subsidiary's stock for affiliation to occur in tax years beginning after Dec. 31, 1984.(4) In addition to changing the minimum ownership requirement, Congress granted the Treasury the ability to draft regulations to cover the following situations. 1. Treat warrants, obligations convertible into stock and other similar interests as stock and to exclude certain stock issues (e.g., puttable stock) from the "stock" definition. 2. Treat options to acquire or sell stock as having been exercised. 3. Treat the 80%-of-value requirement as having been met if the affiliated group, in reliance on a good faith (but erroneous) determination of value, treated such requirement as having been met. 4. Disregard a failure to meet the 80%-of-value requirement resulting from inadvertent, small changes in the relative values of different classes of stock. 5. Disregard transfers of stock within the affiliated group for purposes of determining whether a corporation ceases to be a group member. 6. Disregard changes in voting power that are disproportionate to related changes in value.(5)

To date, regulations implementing these changes have not been issued. This lack of guidance has created uncertainty regarding whether disaffiliation has, in fact, taken place.(6)

* Reconsolidation waiting period

The second change to the consolidated return rules added by the DRA was a five-year waiting period between a corporation's disaffiliation and reconsolidation with the same affiliated group.(7) The Code prevents a corporation from being consolidated with the original affiliated group (or another affiliated group with the same common parent or a successor to that common parent)(8) before the sixty-first month after the first tax year in which the disaffiliated corporation was not included in the consolidated return.(9) Sec. 1504(a)(3)(B) permits the five-year waiting period to be waived by the IRS. The DRA Conference Report provided an example of a situation in which the waiver should be granted.

For example, assume that operating corporation A owns all the stock of operating corporation X and that the two file a consolidated return. On July 1, 1986, A merges into unrelated operating corporation B in a transaction qualifying under section 368(a)(1)(A). Assume that the transaction is not a reverse acquisition. Absent other factors, X should be able to join in filing a consolidated return with the group of which B is the common parent for the period beginning July 1, 1986, and regulations should so provide.(10)

The five-year waiting period would generally apply in this situation (unless a waiver were granted) because X Corporation, which was a member of the A-X group (old group) before the merger, would become a member of the B-X group (new group) following the merger and the new group's parent corporation (B) is a successor to the old group's parent corporation (A).

Letter Rulings

Disaffiliated firms that wished to reconsolidate before the end of the five-year waiting period are required to request a waiver from the IRS. The IRS National Office has issued approximately 100 letter rulings authorizing a waiver of the five-year waiting period. These rulings have permitted reconsolidation when the taxpayer established that the disaffiliation and reconsolidation did not secure for any of the affiliated groups or corporations involved the benefit of any deduction, credit or other allowance that would not otherwise have been available if disaffiliation and reconsolidation had not taken place. From the Dec. 31, 1984 enactment date of Sec. 1504(a)(3) until the release of Rev. Proc. 90-53(11) in October 1990, these letter rulings provided the only guidance on how far the IRS would go in applying Sec. 1504(a)(3)(B).

The letter rulings were issued in many different circumstances covering a wide variety of situations that resulted first in the disaffiliation of a corporation from a consolidated group and, within a 60-month period from the first tax year of disaffiliation, a desire to reaffiliate the corporation with the same consolidated group. Disaffiliations covered by the letter rulings resulted from both carefully planned corporate action and inadvertent events. Events that triggered loss of consolidated group status in these rulings included the following. * Issuance of additional stock: When stock is issued to an entity or individual that is not a part of the affiliated group, the ownership interest of the affiliated group may fall below the 80% -of-voting-power and 80%-of-value minimums. The new stock may be issued as a result of the sale of previously unissued stock or Treasury stock, the exercise of stock options or the exercise of stock warrants that were issued in conjunction with a debt offering.(12) * Sale of stock outside the affiliated group: Sale of stock in a subsidiary by any member of the affiliated group to an individual or entity outside of the affiliated group may cause the ownership interest within the group to fall below the 80%-of-voting-power and 80%-of-value minimums. Sales made to other members of the affiliated group are disregarded under Sec. 1504(a)(5)(E) in determining whether disaffiliation occurs. Sales to outsiders may vary in complexity from a sale to a single individual or entity to a public offering of shares previously held by group members.(13) * Reverse acquisitions: Under Regs. Sec. 1. 1502-75(d)(3), a reverse acquisition results in the termination of the acquiring group of affiliated corporations (known as the old group) and the continuation of the target corporation's affiliated group. The parent corporation of the acquiring group becomes the common parent corporation of the new, larger affiliated group. As a result of this assumption, the subsidiaries of the acquiring group are disaffiliated from the old group when the reverse acquisition occurs and are reaffiliated with the new successor group.(14) * Reorganizations: A transaction specifically mentioned in the legislative history of Sec. 1504(a)(3) is the reconsolidation of a subsidiary from the target affiliated group following a merger involving the parent corporations of two consolidated groups.(15) * Financial difficulties: When some or all members of an affiliated group face financial difficulty, it may be necessary to sell stock held by group members to outsiders, issue new stock to outsiders, or restructure the affiliated group or some part of the group. Any of these transactions undertaken in bankruptcy or in financial distress may cause a subsidiary to become disaffiliated.(16)

The methods of reaffiliation mentioned in the letter rulings differed widely with little apparent consequence for receiving a waiver or not. Many rulings did not discuss at all the specific business purpose behind reaffiliation. In some, it appears that reaffiliation occurred primarily to enable the group to again file a consolidated return. Other rulings provided extensive business justification for the transaction that led to reaffiliation. Again, this difference apparently has little impact on receiving the waiver. The overriding factor cited in the letter rulings for securing a waiver is that the parent corporation must be able to represent that the disaffiliation and reconsolidation will not secure for any affiliated group, member of the affiliated group or person the benefit of any deduction, credit or other allowance that would not have been secured had disaffiliation and reconsolidation not occurred.

Rev. Procs. 90-53 and 91-71

By issuing Rev. Proc. 90-53, the IRS established a method for waiving the five-year waiting period for reconsolidation if the taxpayer met certain conditions. Rev. Proc. 90-53 was clarified and superseded by Rev. Proc. 91-71.(17) The following discussion explains primarily Rev. Proc. 91-71.

Reaffiliation can occur under two different sets of circumstances. The first situation involves those reaffiliations that would have required a letter ruling request before Rev. Proc. 90-53. The waiver request procedures of Rev. Proc. 90-53 (and now Rev. Proc. 91-71) had to be used in lieu of a letter ruling request by any affiliated group that met its conditions.(18) These procedures were intended to reduce the number of letter rulings that must be issued. Rev. Proc. 91-71 has retained the basic waiver requirements, but has changed the requirements for reaffiliations resulting from certain acquisitive tax-free reorganizations. Reconsolidation is mandatory and no waiver request must be made for any corporations that are members of an affiliated group that terminates as a result of certain acquisitive tax-free reorganizations. By making reconsolidation mandatory in some situations, Rev. Proc. 91-71 further reduces the need for letter rulings and/or waivers.

Rev. Proc. 91-71 is effective for any consolidated group for which the due date (including any extensions) of its consolidated return for the tax year in which a corporation rejoins the group is on or after Oct. 15, 1990.(19)

* When waiver requests are required

Rev. Proc. 91-71 requires a waiver if a corporation was a member of a consolidated group, subsequently ceased to be a member of that group, and later rejoined the same group before the sixty-first month after the beginning of its first tax year in which it was not a member of the group.(20) As highlighted earlier, the disaffiliation may be part of a complex plan or it may be totally inadvertent. Likewise, the reaffiliation may be the result of plans made solely to reconsolidate or the reaffiliation may result from transactions undertaken solely for business reasons. Regardless of the circumstances surrounding the disaffiliation and reaffiliation, a waiver must be requested and received if the entire affiliated group is to file a consolidated return within 60 months after the beginning of its first tax year in which the subsidiary was not a member of the group.

A major difficulty arises for unwary taxpayers when the disaffiliation of a subsidiary was inadvertent. For example, as described in the fact situations in several rulings, stock options may be granted without careful calculations, or the exercise of stock options may occur with greater frequency than anticipated, and too many shares of a subsidiary corporation's stock may be in the hands of individuals and entities outside the affiliated group. * A subsidiary became disaffiliated because the parent company's founder gave himself, and then exercised, a substantial number of options to acquire stock of the subsidiary. While the shareholders filed suit against the founder over the issuance of the options, the subsidiary required a waiver to reaffiliate with the group after the ownership level was returned to an acceptable level for affiliation.(21) * A public offering of exactly 20% of the stock of a subsidiary was accompanied by an overallotment option granted to the underwriter. The underwriter exercised the option and sold additional shares so that the group's ownership of the subsidiary was reduced to less than 80%.(22) * Shareholders of a subsidiary chose to convert shares of cumulative preferred stock into common stock rather than redeem them. As a result of the conversions, the affiliated group no longer satisfied the 80% minimums required for affiliation.(23)

Under these and other similar circumstances, the affiliated group must request a waiver to file a consolidated return once sufficient ownership is returned to the group members. The inadvertence of the disaffiliation is not itself justification for the waiver. Instead, the affiliated group must establish that there was no tax benefit derived from the disaffiliation and reaffiliation. Since the disaffiliation was not planned, some benefit may have accrued to the subsidiary during the separate return year(s) but, as long as the benefit is no larger than what would have occurred had disaffiliation and reconsolidation not occurred early, reaffiliation is permitted.

A corporation that qualifies to use Rev. Proc. 91-71 to obtain permission to reconsolidate must follow its procedures to obtain the waiver. In general, a waiver is obtained by filing the appropriate request and supporting information with the affiliated group's timely filed consolidated tax return, which includes the date of reaffiliation.

Example 1: P Corporation is the common parent corporation of the P-S-T consolidated group. P owns 100% of the single classes of stock of S and T Corporations. On June 30, 1992, P sells the S stock to a group of unrelated investors. On Apr. 30, 1995, P repurchases the S stock from the investors. Under Sec. 1504(a)(3), S may not be reconsolidated as part of the P-T affiliated group since the 60-month waiting period has not passed. Alternatively, P may seek a waiver for S under Rev. Proc. 91-71 by filing the appropriate waiver request with the P-S-T group's 1995 consolidated tax return.

Example 2: Assume the same facts as in Example 1, except that the affiliated group includes only P and S and the S stock was instead purchased by A Corporation on June 30, 1992. A is the parent corporation of the A-B-C affiliated group that has filed consolidated returns for a number of years. S joins in the 1992 consolidated return of the A-B-C group commencing with its, acquisition. Sec. 1504(a)(3) does not apply since S is joining a new affiliated group and A is not the successor corporation to P. P's repurchase of the S stock, at first glance, does not trigger the application of Sec. 1504(a)(3) to prevent P and S from making a new consolidated return election since the old P-S affiliated group terminated in 1992 when the S stock was sold. However, Sec. 1504(a)(3) applies when affiliation occurs with another affiliated group having the same common parent corporation. Accordingly, P and S must file separate returns unless a ruling request is made to seek a waiver of the five-year requirement. Rev. Proc. 91-71 does not apply since the new P-S affiliated group is not the same affiliated group that existed in 1992.

Can previously consolidated firms choose not to reconsolidate even after becoming reaffiliated by the simple method of failing to file a waiver request? It would appear that this is possible, except in situations when reconsolidation is mandatory. Such a possibility provides interesting planning potential.

Example 3: Subsidiary C became disaffiliated from the A-B-C group on July 1, 1992 when C sold additional stock to raise needed capital. The subsidiary took with it a large NOL that it had incurred before it was a member of the affiliated group. During the 10 years that the A-B-C group had filed consolidated returns, the return had shown either small profits or small losses. After disaffiliation, C became more profitable but the A-B consolidated group continued to operate at approximately break-even. On July 1, 1994, A has the opportunity to purchase some C stock from a minority shareholder. Following the purchase A would again meet the affiliation requirements. Without consolidating with C, the A-B group expects a loss for their 1994, 1995 and 1996 operations. C clearly would prefer not to reconsolidate in order to use as much of the expiring NOL as possible. it appears that C may be able to obtain this result by either delaying the stock purchase until the NOL has been fully used, or by not requesting the needed waiver.

Interesting questions arise if reaffiliation occurs, but the waiver of the five-year waiting period either is not requested or is not approved by the IRS. Before the end of the five-year period, the acquired corporation is a "member" of the affiliated group, but it is prohibited from joining in the filing of a consolidated return. Is reconsolidation mandatory at the end of the five-year waiting period? Can the need to reconsolidate a particular subsidiary at the end of five years permit a consolidated return election to be terminated? Do the various benefits or detriments of the consolidated return regulations that hinge on being a member or nonmember of the affiliated group (e.g., deferral of intercompany gains and losses, SRLY limitations) apply to the corporation that is a "member" but is unable to be included in the consolidated return?

* Mandatory reconsolidation

Rev. Proc. 91-71 provides for mandatory consolidation in two situations involving acquisitive reorganizations. Mandatory inclusion is required of: 1. Any corporation that was a member of a consolidated group (the terminating group) and ceased to be a member of such group solely as a result of a transaction in which a nonmember corporation acquired the assets of the common parent of the terminating group in a type A, C or acquisitive D reorganization and, immediately after the reorganization, the acquiring corporation is the common parent of another affiliated group (the acquiring group).(24) 2. Any corporation that was a member of a consolidated group (the terminating group) and ceased to be a member of such group solely as a result of a transaction in which a member of the terminating group acquired (a) the assets of a nonmember corporation in a type A, C or acquisitive D reorganization or (b) the stock of a nonmember corporation, and the acquisition was a reverse acquisition in which the terminating group ceased to exist.(25)

In the first situation, the acquired corporation(s) is not prevented by Sec. 1504(a)(3) from joining in a consolidated return filed by the acquiring group. In fact, all corporations that are members of the acquired group must be included in any consolidated return election that the acquiring group has previously made.

Example 4: V Corporation is the common parent of the V-W consolidated group. X Corporation is the common parent of the X-Y consolidated group. Both affiliated groups use a calendar year as their tax year. On July 23, 1992, V acquired all of the assets of X (including the Y stock) in a merger transaction. The acquisition is not a reverse acquisition because the former X shareholders, as a result of their X stock ownership, do not own more than 50% of the fair market value (FMV) of the outstanding V stock. The X-Y consolidated group ceases to exist on the acquisition date as a result of the merger and Y's results for the postacquisition portion of 1992 are included in the consolidated return filed by the V-W group for 1992.(26)

In the second situation; the terminating consolidated group (i.e., the acquiring group) is not prevented by Sec. 1504(a)(3) from joining in the consolidated return filed by the continuing consolidated group (i.e., the acquired group). In fact, the acquiring corporations must be included in any consolidated return election that the acquired group has previously made.

Example 5: V Corporation is the common parent of the V-W consolidated group. X Corporation is the common parent of the X-Y consolidated group. V acquired all of the assets of X (including the Y stock) in a merger transaction. The acquisition is a reverse acquisition because the former X shareholders, as a result of their X stock ownership, own more than 50% of the FMV of the outstanding V stock. The V-W consolidated group ceases to exist on the acquisition date as a result of the merger. The X-Y group continues to exist with V as its common parent corporation. V and W's results for the postacquisition portion of 1992 are included in the consolidated return filed by the X-Y group for 1992.(27)

A corporation that comes under the general waiver requirements (i.e., member of a consolidated group, ceases to be a member, rejoins within 60 months) and also comes under one of the two reorganization exceptions described above must file a waiver request under the general Rev. Proc. 91-71 rules.(28)

* Waiver not required

Rev. Proc. 91-71 does not apply to situations in which a corporation (including a common parent corporation) was a member of a consolidated group (old group) and ceased to be a member of that group because of the acquisition of its stock or the assets of its common parent by a member (other than the common parent) of another affiliated group (new group). in this situation, the common parent of the new group is not the same entity as the common parent of the old group nor is the acquiring corporation a successor to the old group's common parent. Accordingly, no waiver is required; the acquired corporation is not reconsolidating with the old group nor with a group that has the old group's common parent (or a successor corporation to the old group's common parent) as the common parent of the new group.

Example 6: P Corporation owns all of the stock of S Corporation. A Corporation owns all of the stock of B Corporation. Both groups have filed consolidated returns for a number of years. P merges into B in a transaction that is not a reverse acquisition. The five-year waiting period does not apply since B is the successor to P, and it is not the common parent of the A-B-S affiliated group. The three corporations apparently could file on a consolidated basis without any waiting period or obtaining a waiver.

Significant difficulty for the unwary is obvious in these rules since unsophisticated taxpayers may not be aware that a disaffiliation and a reaffiliation have occurred in the context of these complex transactions. Nevertheless, some of the transactions described above require mandatory participation in a consolidated return election. Other transactions do not require mandatory consolidation, but must be followed by the filing of a waiver or ruling request in order to shorten the 60-month waiting period.

Waiver Requirements

A waiver will be granted under Rev. Proc. 91-71 only to a corporation that joins in the filing of a consolidated return beginning with the tax year of the affiliated group in which it rejoins the affiliated group.(29) The common parent corporation of an affiliated group with a corporation that is being reconsolidated must file a waiver request that includes certain information attached to the first consolidated return filed after the return to the group. The consolidated return accompanied by the waiver request must be filed on or before its due date (including extensions).(30)

The information included with the waiver request (listed below) is required by the IRS to determine that deconsolidation and reconsolidation will not provide unwarranted tax benefits to the disaffiliated corporation or to either the old or new affiliated group. 1. The statement "WAIVER OF THE APPLICATION OF SECTION 1504(a)(3) FILED PURSUANT TO REV. PROC. 91-71" reproduced at the top of the request. 2. The name, address and employer identification number of the corporation for which the waiver is requested. 3. The tax year in which the consolidated group of which the corporation is now a member elected to file consolidated returns. 4. The date on which the corporation in question ceased to be a group member. 5. The date on which the corporation in question rejoined the group. 6. A description of how the corporation ceased to be a group member (e.g., issuance of additional stock, stock redemption, etc.) and how the corporation rejoined the same group. The business purpose for the disaffiliation and reaffiliation must be disclosed, as well as whether the transactions involved a related party. 7. The taxable income of the consolidated group for all tax years, beginning with the tax year before the tax year in which the disaffiliated corporation departed the consolidated group and ending with the tax year in which the disaffiliated corporation rejoined the consolidated group. 8. The taxable income (or separate taxable income, as the case may be) of the disaffiliated corporation for the same tax years that the consolidated group must report its taxable income for in item 7.(31) 9. An analysis of the effects of the deconsolidation and reconsolidation on the taxable income, deferred gains and losses, excess loss accounts, tax liability, NOL and capital loss carryovers, and investment and foreign tax credits of both the consolidated group and the disaffiliated corporation. This analysis must cover the same time periods that the consolidated group must report its taxable income for in item 7. 10. A special requirement applies in the case of a consolidated group having one or more members that are reporting corporations under Sec. 6038A(a). For these groups, an analysis of the effect of the disaffiliation and reconsolidation on the U.S. taxation of any related party (as defined by Sec. 6038A(c)(2)) other than group members is required. The analysis must take into account any money or property transfers occurring during the disaffiliation period and directly or indirectly involving the corporation seeking the waiver and any reporting corporation or related party if the transfers occur outside of the ordinary course of business. 11. A statement representing that the consolidated group, the disaffiliated corporation, or any other person or entity has not secured or will not secure any benefit (e.g., income reduction, increase in loss, deduction, credit or allowance, or increase in use of an NOL or credit carryover that would have otherwise expired) from the disaffiliation and reconsolidation that could not otherwise have been received had the events not occurred.(32)

Rev. Proc. 91-71 provides two situations in which no net benefit occurred to the parties involved in the disaffiliation and reaffiliation: (1) the gross income of one affiliated group increased by $100,000 and a deduction of the same group increased creased by $100,000, but the taxable income of the other affiliated group was not affected; (2) the taxable income of one affiliated group decreased by $100,000 and the taxable income of the other affiliated group increased by $100,000.

Particularly troublesome is the lack of a de minimis rule in Rev. Proc. 91-71 for a small net benefit being received by the affected groups. Without such a rule, proof of even a small benefit for on member of an affiliated group that is not offset by a similar detriment for another group member or a member of another affiliated group could prevent reaffiliation before the end of the 60-month period. If Sec. 1504(a)(3)(B) is truly an anti-abuse statute, some exception needs to be made for those groups receiving insignificantly small net benefits.

Similarly, no guidance has been given on the tax treatment of a corporation that has rejoined an affiliated group before the end of the 60-month period for which no waiver request was made. in both of these situations, the affiliated group needs to know how to handle transactions occurring between group members and a reaffiliated subsidiary corporation that is either unable or unwilling to request a waiver.

Any corporation not qualifying to use Rev. Proc. 91-71 because it is outside its scope or it cannot satisfy the above requirements can apply for the waiver by filing a ruling request. This ruling request must be filed by the common parent corporation of the affiliated group which the disaffiliated corporation has rejoined and must be filed on or before the due date (including extensions) for the first postaffiliation consolidated return. The same information required under the basic Rev. Proc. 91-71 waiver procedures must be filed with the ruling request.(33)

* Effect of the waiver

A waiver granted by the IRS is binding on the affiliated group when the common parent corporation has properly requested the waiver under Rev. Proc. 91-71 and the group has filed a consolidated return including the disaffiliated corporation. The disaffiliated corporation must continue to file as a member of the consolidated group as long as it meets the requirements to file with the group, unless the entire group receives permission to cease filing on a consolidated basis.(34) However if the waiver request was filed with incorrect information, the waiver may be revoked at any time by the IRS. The revocation is effective for the first tax year for which the waiver was granted.(35)

Summary

The Code requires that a minimum of 60 months pass between the beginning of the first tax year in which a corporation is no longer part of an affiliated group and the time the corporation participates in a consolidated tax return with the same group. However, the IRS can waive the five-year waiting period.

The most critical factor in obtaining a Sec. 1504(a)(3) waiver in a letter ruling or under Rev. Proc. 91-71 remains the same. The parent corporation must be able to represent that the disaffiliation and reconsolidation will not secure for any member of the affiliated group the benefit of any income reduction, deduction, loss, credit or other allowance that would not have been secured had disaffiliation and reconsolidation not occurred.

Regulations still have not been promulgated concerning stock, near-stock items and transactions that come under the special rules of Sec. 1504(a)(5). This provision exempts certain transactions from causing disaffiliation (e.g., transfers of stock within the affiliated group) but its scope is unclear. Promulgation of regulations outlining the transactions that do and do not trigger disaffiliation may greatly clarify the question of which firms must use Rev. Proc. 91-71 or apply for a letter ruling to file consolidated returns after a reaffiliation. (1) Deconsolidation, in contrast to disaffiliation, involves the affiliated group surrendering its election to file on a consolidated basis. A summary of the advantages and disadvantages of deconsolidation are outlined in Sacks and Stern, "Candidates for Deconsolidation," 22 The Tax Adviser 327 (May 1991). (2) Disaffiliation of an affiliated group's only subsidiary could also result in termination of the affiliated group and its consolidated return election. (3) Division of a commonly controlled group of U.S. corporations into two or more affiliated groups cant take place in order to use excess foreign tax credits (FTCs) or FTC carryovers that could not be used by the entire group. Because each affiliated group's FTC limitation is calculated separately, the total FTC claimed by the various groups may be larger than the credit available if the entire group of commonly controlled corporations filed a single consolidated return. (4) Sec. 1504(a)(2), amended by DRA Section 60(a). (5) Sec. 1504(a)(5). (6) In an Aug. 10, 1991 meeting with the ABA Tax Section Affiliated and Related Corporations Committee, IRS Branch Chief Edward S. Cohen indicated that regulations dealing with Sec. 1504(a)(5) should be issued within the next two months. See Sheppard, "Affiliation Reconsolidation Guidance Due Out Soon," 52 Tax Notes 864 (8/19/91). As of March 1992, these regulations had not been issued. (7) Sec. 1504(a)(3) applies to any corporation that is included in (or required to be included in) a consolidated return for a tax year that includes any period after Dec. 31, 1984, and that ceases to be a member of the affiliated group after Dec. 31, 1984. (8) A successor corporation is defined for consolidated return purposes as a corporation that succeeds to the tax assets of a predecessor corporation under Sec. 381(a). Consolidated group refers to an affiliated group that has elected to file on a consolidated basis for federal income tax purposes. Prop. Regs. Sec. 1.15021(f)(4). (9) The waiting period is referred to as five years in this article. Because of the possibility of short tax years, the 60-month requirement may be longer than five tax years of the affiliated group and disaffiliated corporation. (10) H. Rep. No. 98-861, 98th Cong., 2d Sess., 833-834 (1984). (11) Rev. Proc. 90-53, 1990-2 CB 636. (12) Rulings in which a subsidiary issued additional shares to a limited number of outsiders and the affiliation was broken include IRS Letter Rulings 8817043 (1/29/88), 8817054 (1/29/88), 8825064 (3/24/88), 8947050 (8/30/89), 9033042 (5/22/90), 9034007 (5/22/90), 9108019 (11/23/90) and 9112002 (12/17/90). (13) Examples of stock sales to outsiders include IRS Letter Rulings 8817056 (1/29/88), 8817060 (1/29/88), 9045025 (8/10/90), 9050048 (9/18/90) and 9125014 (3/21/91). (14) Examples of reverse acquisitions include IRS Letter Rulings 8849044 (9/12/88), 8914027 (1/4/89), 9016036 (1/19/90) and 9042037 (7/23/90). (15) Of the 12 private letter rulings issued in the reorganization area, mergers account for a majority of the acquisitions. See, e.g., IRS Letter Rulings 8937023 (6/19/89) and 9034032 (5/24/90). (16) Examples of disaffiliations resulting from financial difficulties include IRS Letter Rulings 9008067 (11/29/89) and 9023056 (3/12/90). (17) Rev. Proc. 91-71, IRB 1991-52, 25. (18) See Rev. Proc. 92-3, IRB 1992-1, 55, at Section 6.03, in which the IRS specifically says that rulings in this area will not ordinarily be issued because of the availability of automatic approval procedures. (19) Rev. Proc. 91-71, note 17, at Section 9. (20) Section 4.01 of Rev. Proc. 91-71 defines the "same" affiliated group to be an affiliated group that remains in existence within the meaning of Regs. Sec. 1.1502-75(d). (21) IRS Letter Ruling 8817048 (1/29/88). (22) IRS Letter Ruling 8817053 (1/29/88). (23) IRS Letter Ruling 8849043 (9/13/88). (24) Rev. Proc. 91-71, note 17, at Section 4.02. The IRS has ruled that a waiver is not required when the parent corporation of an affiliated group transferred its assets and liabilities to a new corporation that became the parent corporation of the affiliated group in a type F reorganization. Sec. 1504(a)(3)(A) does not apply to the transaction and the group must continue to file consolidated returns (IRS Letter Ruling 9137015 (6/14/91)). (25) Rev. Proc. 91-71, note 17, at Section 4.03. (26) Example adapted from Rev. Rul. 91-70, IRB 1991-52, 25. Regs. Sec. 1.1502-75(d)(1) holds that a consolidated group remains in existence if the common parent corporation remains as the common parent and has at least one subsidiary affiliated with it at all times. (27) Id. (28) Rev. Proc. 91-71, note 17, at Section 4.04. (29) Id., at Section 4.05. (30) Id., at Section 7. (31) Losses from the disaffiliated corporation(s) separate return years (or consolidated return years as part of a new affiliated group) are subject to the SRLY limitations when reaffiliation occurs and the corporations are once again included in the consolidated return of the old affiliated group. (32) Rev. Proc. 91-71, note 17, at Section 5. (33) Id., at Section 8. (34) Id., at Section 6.01. (35) Id., at Section 6.02.
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Author:Kramer, Sandra S.
Publication:The Tax Adviser
Date:Apr 1, 1992
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