PLR 200851018: a group that underwrote its own stock offering cannot deduct the fee, so the matching profit is excluded from income

Plain-English summary

A publicly traded holding company sold securities to the public in two offerings on the same day. Underwriting those offerings is normally work you hire an investment bank to do. This group did it in house. The underwriter was a limited liability company sitting three levels down the chain, owned by a subsidiary of a subsidiary, and disregarded as a separate entity for federal tax purposes. So the parent paid an underwriting fee, and the money landed with a member of its own consolidated group.

That creates a problem the consolidated return rules exist to solve. Two separate rules pull in opposite directions. The first is the treatment of the fee in the parent's hands. Costs of raising capital by issuing stock are not a business expense. They reduce the proceeds of the offering, and the ruling states the position plainly: the aggregate underwriting fee is not deductible or amortizable now or in the future. The second is the treatment of the money in the recipient's hands. The underwriting subsidiary charged a fee, spent something less than that performing the work, and was left with a net underwriting profit. Standing alone that profit is income.

Put those together without a correcting rule and the group pays tax on money it moved from one pocket to another. The payer gets no deduction, ever. The recipient reports income. The group is worse off than if it had hired an outsider, and worse off than if the underwriting desk had been a department of the parent rather than a separate legal entity.

The intercompany transaction regulations fix this by treating the group as a single entity. The attributes of the selling member's item and the buying member's corresponding item are redetermined to the extent necessary to produce the same effect on consolidated taxable income as if the two members were divisions of one corporation and the transaction were a transfer between divisions. Attributes include, expressly, treatment as excluded from gross income or as a noncapital, nondeductible amount. Had the underwriting desk been a division of the parent, no fee would have existed at all.

The Service ruled accordingly. Because the fee is permanently nondeductible to the parent, the net underwriting profit is redetermined to be excluded from the subsidiary's gross income, and it has no effect on the consolidated taxable income of the group. The intra-group payment washes out on both sides.

The letter cites no Code section. Its legal analysis relies on the consolidated return regulations. The applicable law section cites section 1.1502-13(c)(6)(i), while the ruling paragraph cites section 1.1502-13(c)(6).

Ruling snapshot

• Question: Where a consolidated group's own disregarded subsidiary underwrote the parent's public securities offerings, and the underwriting fee is permanently nondeductible to the parent, how is the subsidiary's net underwriting profit treated on the group's consolidated return?
• Outcome: Approved. The aggregate underwriting fee is not deductible or amortizable now or in the future. The net underwriting profit is redetermined to be excluded from the subsidiary's gross income under the intercompany transaction regulations and has no effect on the consolidated taxable income of the group.
• Key authorities: Treas. Reg. sections 1.1502-13(b)(6), 1.1502-13(c)(1)(i), 1.1502-13(c)(6) and 1.1502-13(c)(6)(i) (the letter cites no Code section).

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 200851018 Third Party Communication: None
Release Date: 12/19/2008 Date of Communication: Not Applicable Person To Contact: Index Numbers: 263.00-00, 1502.13-00 --------------------, ID No. ------------ Telephone Number:
--------------------
----------------------------------------------- Refer Reply To:
-------------------------------------- CC:CORP:B03
------------------------------ PLR-126517-08
-------------------- Date:
---------------------------- September 17, 2008
-

Legend:

Parent = --------------------------------------
----------------------------------------------------------------------------
-------------------------------------------------------------------

Sub = ---------------------------------
-------------------------------
-------------------------------------------------------------------

Sub 1 = -----------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------
-------------------------------
-------------------------------------------------------------------

LLC = ------------------------------------------
--------------------------------------------------------------------------------------------

Offering 1 = ---------------------------------------
---------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------

Offering 2 = ------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------------

State X = ------------

Date = -----------------------
a = ---------------

b = ----------------

c = -------------------

d = -------------------

e = ----------------

f = ------------------------------------

Dear ----------------:

We respond to your representative’s letter dated June 9, 2008, requesting rulings as to the Federal income tax consequences of a transaction. Additional information was submitted in a letter dated September 11, 2008. The information submitted is summarized below.

The rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party. This Office has not verified any of the material submitted in support of the request for rulings. Verification of the information, representations, and other data may be required as part of the audit process.

STATEMENT OF FACTS

Parent is a publicly-traded holding company which is the common parent of a consolidated group. Parent, a State X Corporation, owns all of the stock of Sub and Sub owns all of the stock of Sub 1. Both Sub and Sub 1 are State X corporations and members of Parent’s consolidated group. Sub 1 owns all of the stock of LLC. LLC is an entity disregarded from its owner, Sub 1, for Federal income tax purposes.

On Date, Parent made two public offerings of securities, “Offering 1” and “Offering 2”. (Offering 1 and Offering 2 may be referred to as the “Offerings”). Parent paid an underwriting fee of $a for Offering 1 and $b for Offering 2. The net proceeds were $c from Offering 1 and $d from Offering 2. LLC underwrote the Offerings and received an aggregate fee of $e (“Aggregate Underwriting Fee”) for providing these services ($a plus $b). LLC incurred certain expenses in providing the underwriting services of $f (“Underwriting Expenses”). When the $f Underwriting Expenses were netted against the $e Aggregate Underwriting Fee, LLC realized a net profit (“Net Underwriting Profit”). The net proceeds of the Offerings were used for general corporate purposes.

APPLICABLE LAW

Section 1.1502-13(b)(6) provides that the attributes of an intercompany item or corresponding item are all of the item's characteristics, except amount, location, and timing, necessary to determine the item's effect on taxable income (and tax liability). Attributes include treatment as excluded from gross income or as a noncapital, nondeductible amount.

Section 1.1502-13(c)(1)(i) provides that the separate entity attributes of S's [the member transferring property or providing services] intercompany items and B's [the member receiving the property or services] corresponding items are redetermined to the extent necessary to produce the same effect on consolidated taxable income (and consolidated tax liability) as if S and B were divisions of a single corporation, and the intercompany transaction were a transaction between divisions.

Section 1.1502-13(c)(6)(i) provides that under §1.1502-13(c)(1)(i), S's intercompany item might be redetermined to be excluded from gross income or treated as a noncapital, nondeductible amount.

RULING

Based solely on the information submitted and representations made, we rule as follows:

The Aggregate Underwriting Fee incurred by Parent in the Offerings is not deductible or amortizable now or in the future. Accordingly, the Net Underwriting Profit will be redetermined to be excluded from Sub 1’s gross income under §1.1502- 13(c)(1)(i) of the Income Tax Regulations and will have no effect on the consolidated taxable income of Parent’s consolidated group (§1.1502-13(c)(6)).

CAVEAT

We express no opinion about the tax treatment of any transaction described above under other provisions of the Code and regulations or the tax treatment of any condition existing at the time of, or effect resulting from, any of these transactions that is not specifically covered by the above rulings.

PROCEDURAL STATEMENTS

This ruling is directed only to the taxpayer who requested it. Section 6110(k)(3) provides that it may not be used or cited as precedent.

A copy of this ruling letter must be attached to the Federal income tax return of the Parent consolidated group for the taxable year in which the transaction covered by this letter is consummated. Alternatively, taxpayers filing their returns electronically may satisfy this requirement by attaching a statement to their returns that provides the date and control number of the letter ruling.

Pursuant to the power of attorney on file in this Office, copies of this letter are being sent to Parent’s authorized representatives.

Sincerely,

Ken Cohen
Senior Technician Reviewer, Branch 3
Office of Associate Chief Counsel (Corporate)

cc: