Loss from an intercompany stock sale remained deferred after liquidation

Plain-English summary

The IRS considered whether a parent could recognize a loss from selling part of a subsidiary's stock to a foreign affiliate when the subsidiary later liquidated. The parent and the foreign affiliate remained members of the same controlled group after the liquidation. The IRS concluded that the loss continued to be deferred under Treas. Reg. § 1.267(f)-1(c)(1)(iv), because the intercompany transaction rules would have treated the loss as a noncapital, nondeductible amount in a single-entity analysis. The memo states that the liquidation did not allow the parent to take the loss into account while the relevant controlled-group relationship continued.

Ruling snapshot

• Question: May a parent recognize a deferred loss from selling subsidiary stock to a controlled-group affiliate when the subsidiary later liquidates?
• Outcome: Denied
• Key authorities: IRC §§ 267, 331, 332, 351, and 368; Treas. Reg. §§ 1.267(f)-1 and 1.1502-13; 26 U.S.C. § 6110(k)(3).

Full text (IRS public release)

       Office of Chief Counsel
       Internal Revenue Service
       memorandum
       Number: 201025046
       Release Date: 6/25/2010
       CC:CORP:03:BADecker                                   Third Party Communication: None
       POSTF-148451-09                                       Date of Communication: Not Applicable

UILC: 267.01-00

date: March 12, 2010

 to:   Team Coordinator/Lead Agent

       Christopher J. Smith, International Issue Specialist

       Compliance Team

from: Bruce A. Decker
Assistant Branch Chief, Branch 3
(Corporate)

       Marie C. Milnes-Vasquez
       Senior Technician Reviewer, Branch 4
       (Corporate)

subject: ---------------

       This Chief Counsel Advice responds to your request for assistance. This advice may
       not be used or cited as precedent.

       LEGEND

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

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

       Sub 2                                                          =        -------------------------------

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

       Foreign Sub 2                                                  =        --------------------------------------------
       ----------

POSTF-148451-09 2

Foreign Sub 3 = -----------------------------------

Business A = --------------------------

State A = -------------

Country A = ----------------------

Country B = ---------

Date A = ------------------

Date B = --------------------------

Date C = --------------------------

Date D = --------------------------

Date E = --------------------------

Date F = --------------------------

Date G = --------------------------

a = ----------------

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

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

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

e = -----

f = ----

g = -----------------

h = --------

i = ----

POSTF-148451-09 3

n = -----------------

o = --------

p = ----------------

ISSUE

Whether, upon the liquidation of Sub 1, Parent may include a loss of $n from its sale of f
percent of Sub 1 stock to Foreign Sub 2, which had been deferred under section
267(f)(2)?

CONCLUSION

Upon the liquidation of Sub 1, Parent may not include the loss of $n from its sale of f
percent of Sub 1 stock to Foreign Sub 2. This loss continues to be deferred pursuant to
Treas. Reg. § 1.267(f)-1(c)(1)(iv).

FACTS

Parent, a publicly-traded State A corporation, conducts Business A in the U.S. and
abroad through direct and indirect affiliates. Parent is the common parent of a group of
domestic subsidiaries that together file a consolidated return for U.S. federal income tax
purposes (the "U.S. Consolidated Group").

On Date A, Parent acquired 100 percent of the stock of Sub 1 in an exchange qualifying
for non-recognition income tax treatment pursuant to section 368(a)(1)(B) of the Internal
Revenue Code (the “Code”). Following the acquisition, Sub 1 was a direct, wholly-
owned subsidiary of Parent and a member of the U.S. Consolidated Group. Since the
acquisition, Sub 1 has provided its services predominately to and through Parent and its
subsidiaries. As of Date B, Sub 1 had issued and outstanding o shares of a single class
of common stock. As of that date, Parent had a built-in loss of $a in the stock of Sub 1.

Parent also owns all of the outstanding stock of Sub 2, a State A corporation and
member of the U.S. Consolidated Group. Sub 2 conducts its business in the U.S. and
abroad through wholly-owned affiliates, including Foreign Sub 1, a direct subsidiary
organized under the laws of Country A, and Foreign Sub 2, an indirect, wholly-owned
subsidiary that is a nonresident of Country B with its corporate address in Country A.

Parent claims that it needed to simplify its organizational structure and to centralize the
management of its intangible assets, thereby obtaining cost efficiencies and additional
value from such assets. Parent identified Foreign Sub 2 as the entity best suited to hold
and manage Parent's foreign intellectual property. Parent decided to undertake the

POSTF-148451-09 4

transaction described below, which resulted in the transfer of Sub 1's foreign intellectual
property rights and other assets to Foreign Sub 2.

Parent and its subsidiaries engaged in the following steps:

1. On Date C, Parent purchased certain assets from Sub 1 for $b.

2. On Date C, Foreign Sub 1 subscribed to c ordinary shares of Foreign Sub 2
   stock for $d, and immediately paid for the shares using funds that were borrowed
   pursuant to a promissory note.

3. On Date C, Parent sold e shares of common stock in Sub 1 (representing f
   percent of Sub 1's outstanding stock) to Foreign Sub 2 in exchange for g shares
   of h percent Cumulative Redeemable Preference Stock (the "Preferred Shares").

4. On Date D, Sub 1's board of directors adopted a plan of complete liquidation,
   which was approved by the Sub 1 shareholders (Parent and Foreign Sub 2) on
   that date.

5. Between Date E and Date F, Sub 1 distributed all of its assets to Parent and
   Foreign Sub 2 in redemption and cancellation of their equity interests.

6. On Date G, Sub 1 dissolved under State A law.

The Taxpayer claims that the Preferred Shares that Foreign Sub 2 issued to Parent in
Step 3 above in exchange for f percent of Parent's stock in Sub 1 were nonqualified
preferred stock within the meaning of section 351(g). Therefore, the Taxpayer claims
that Step 3 should be treated as a taxable sale or exchange on which Parent recognizes
the $n loss. Taxpayer concedes that any such loss on the sale would be deferred under
section 267(f). However, Parent takes the position that it was entitled to take into
account its $n loss when Sub 1 liquidated. In addition, Parent reported a loss of $p on the
transfer of its remaining i percent of Sub 1 stock to Sub 1 in the liquidation
transaction.

LAW AND ANALYSIS

Overview

Section 267(f)(2) generally defers losses from the sale or exchange of property between
members of a controlled group until the property is transferred outside the controlled
group and the loss would be taken into account under consolidated return principles.
The regulations under section 267(f)(2) were promulgated to prevent members of a
controlled group from taking into account a loss or deduction solely as a result of a
transfer of property between a selling member (S) and a buying member (B). Following
the liquidation of Sub 1, Parent and Foreign Sub 2 remain members of the same

POSTF-148451-09 5

controlled group. Therefore, Parent’s $n loss on its sale of f percent of Sub 1 stock
should be deferred until Parent and Foreign Sub 2 are no longer in a controlled group
relationship.

Law

Treas. Reg. § 1.267(f)-1(a)(1) provides the purpose of the regulations under section
267(f):

   This section provides rules under section 267(f) to defer losses and deductions
   from certain transactions between members of a controlled group (intercompany
   sales). The purpose of this section is to prevent members of a controlled group
   from taking into account a loss or deduction solely as the result of the transfer of
   property between a selling member (S) and a buying member (B).

Pursuant to Treas. Reg. § 1.267(f)-1(a)(1), Parent’s loss from the sale of Sub 1 stock is
taken into account under the timing principles of Treas. Reg. § 1.1502-13, treating such
sale as an intercompany transaction. For this purpose, the matching and acceleration
rules of Treas. Reg. § 1.1502-13(c) and (d) apply with certain adjustments that provide
that the rules of § 1.1502-13 apply on a controlled group basis and affect only the timing
of a loss or deduction, and not its attributes. See Treas. Reg. §§ 1.267(f)-1(a)(2)(i) and
1.267(f)-1(c)(2).

Treas. Reg. § 1.267(f)-1(c)(1)(iv) provides:

   To the extent S's loss would be redetermined to be a noncapital, nondeductible
   amount under the principles of section 1.1502-13 but is not redetermined
   because of paragraph (c)(2) of this section, then * * * S's loss continues to be
   deferred and is not taken into account until S and B are no longer in a controlled
   group relationship. For example, if S sells all of the stock of corporation T to B at
   a loss and T subsequently liquidates into B in a transaction qualifying under
   section 332, S's loss is deferred until S and B (including their successors) are no
   longer in a controlled group relationship.

The intercompany transaction regulations of Treas. Reg. § 1.1502-13 provide rules for
taking into account items of income, gain, deduction, and loss of consolidated group
members from intercompany transactions. The purpose of the intercompany
transaction regulations is to provide rules to clearly reflect the taxable income (and tax
liability) of the group as a whole by preventing intercompany transactions from creating,
accelerating, avoiding, or deferring consolidated taxable income (or consolidated tax
liability). Treas. Reg. § 1.1502-13(a)(1).

The regulations define “intercompany transaction” broadly, as any transaction between
corporations that are members of the same consolidated group immediately after the
transaction. The regulations further define “S” as the member transferring property or

POSTF-148451-09 6

providing services, and “B” as the member receiving the property or services. Treas.
Reg. § 1.1502-13(b)(1).

Treas. Reg. § 1.1502-13(a)(2) provides:

   Separate entity and single entity treatment.—Under this section, the selling
   member (S) and the buying member (B) are treated as separate entities for some
   purposes but as divisions of a single corporation for other purposes. The amount
   and location of S’s intercompany items and B’s corresponding items are
   determined on a separate entity basis (separate entity treatment). * * * The
   timing, and the character, source, and other attributes of the intercompany items
   and corresponding items, although initially determined on a separate entity basis,
   are redetermined under this section to produce the effect of transactions between
   divisions of a single corporation (single entity treatment). For example, if S sells
   land to B at a gain and B sells the land to a nonmember, S does not take its gain
   into account until B’s sale to the nonmember.

Treas. Reg. § 1.1502-13(c)(3) provides that, “as divisions of a single corporation, S and
B are treated as engaging in their actual transaction and owning any actual property
involved in the transaction (rather than treating the transaction as not occurring).”

S’s income, gain, deduction, and loss from an intercompany transaction are its
intercompany items. An item is an intercompany item whether it is directly or indirectly
from an intercompany transaction. Treas. Reg. § 1.1502-13(b)(2)(i). B’s income, gain,
deduction, and loss from an intercompany transaction, or from property acquired in an
intercompany transaction, are its corresponding items. An item is a corresponding item
whether it is directly or indirectly from an intercompany transaction (or from property
acquired in an intercompany transaction). Treas. Reg. § 1.1502-13(b)(3)(i).

The recomputed corresponding item is the corresponding item that B would take into
account if S and B were divisions of a single corporation and the intercompany
transaction was between those divisions. Treas. Reg. § 1.1502-13(b)(4). The
regulations provide that, “[a]lthough neither S nor B actually takes the recomputed
corresponding item into account, it is computed as if B did take it into account (based on
reasonable and consistently applied assumptions, including any provision of the Internal
Revenue Code or regulations that would affect its timing or attributes).” Id.

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). The regulations provide that the treatment of
an item as excluded from gross income or as a noncapital, nondeductible amount
constitutes an “attribute”. Treas. Reg. § 1.1502-13(b)(6).

The principal rule within the intercompany transaction regulations that implements
single entity treatment is the matching rule of Treas. Reg. § 1.1502-13(c). Under the

POSTF-148451-09 7

matching rule, S and B are generally treated as divisions of a single corporation for
purposes of taking into account their items from intercompany transactions. Treas.
Reg. § 1.1502-13(a)(6). The matching rule provides a timing rule, which directs when B
and S must take into account their items from an intercompany transaction. Under this
timing rule, B takes its corresponding item into account under its own, separate entity
accounting method. Treas. Reg. § 1.1502-13(c)(2)(i). S does not take its intercompany
item into account under its own accounting method; rather, it takes its intercompany
item into account to reflect the difference for the year between B’s corresponding item
taken into account and the recomputed corresponding item (the item that B would have
taken into account if S and B were divisions of a single corporation). Treas. Reg. §
1.1502-13(c)(2)(ii).

The matching rule also provides guidance regarding the manner in which the single-
entity principles of the intercompany transaction regulations affect the attributes of
intercompany and corresponding items. This rule provides that the separate entity
attributes of S’s intercompany items and B’s 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. Thus, the activities of
both S and B might affect the attributes of both intercompany items and corresponding
items. Treas. Reg. § 1.1502-13(c)(1)(i).

Application of the Principles of the Intercompany Transaction Regulations

The appropriate application of Treas. Reg. § 1.267(f)-1(c)(1)(iv) is at the heart of the
current controversy.1 That provision states:

    To the extent S's loss would be redetermined to be a noncapital, nondeductible
    amount under the principles of section 1.1502-13 but is not redetermined
    because of paragraph (c)(2) of this section, then * * * S's loss continues to be
    deferred and is not taken into account until S and B are no longer in a controlled
    group relationship. [Emphasis added.]

Thus, by its own terms, Treas. Reg. § 1.267(f)-1(c)(1)(iv) requires an analysis of the
hypothetical treatment of the transactions at issue under the principles of the
intercompany transaction rules of Treas. Reg. § 1.1502-13. If such hypothetical
treatment would result in S’s item being redetermined to be a noncapital, nondeductible
item, such item will continue to be deferred.

As discussed above, the matching rule is the principal means by which the
intercompany transaction regulations enforce single entity treatment. The matching rule

1
In order for Treas. Reg. § 1.267(f)-1(c)(1)(iv) to apply to the transaction, the transaction must not be
directly governed by Treas. Reg. § 1.1502-13, and Treas. Reg. § 1.267(f)-1(c)(1)(iii) (dealing with
subsequent transfers by B to nonmembers that are related to any member of the controlled group) must
not apply. We assume that these requirements have been satisfied.

POSTF-148451-09 8

requires that the attributes of the intercompany item and the corresponding item be
redetermined to the extent necessary to produce the effect of a transaction between
divisions of a single corporation. Treas. Reg. § 1.1502-13(c)(1)(i). The recomputed
corresponding item represents the single-entity outcome to the group (that is, the net
tax impact that the group would have taken into account if S and B had been divisions
of a single corporation). Generally, B takes its corresponding item into account under
its separate method of accounting. S generally takes its intercompany item into account
so as to reflect the difference between the recomputed corresponding item and the
corresponding item. In other words, intercompany item taken into account in any given
year should equal the recomputed corresponding item for that year, minus the
corresponding item taken into account in that year (RCI - CI = II).

For purposes of applying the matching rule, Parent’s intercompany item is the amount
of loss that it had on the intercompany sale of the Sub 1 stock. Foreign Sub 2’s
corresponding item is the amount that Foreign Sub 2 actually recognizes (on a separate
entity basis) as a result of Sub 1’s liquidation. Here, we assume Parent’s intercompany
item to be the $n loss claimed by the Taxpayer. Further, assuming that Foreign Sub 2’s
basis in the Sub 1 stock is equal to its fair market value at the time of the liquidation,
Foreign Sub 2 would recognize no gain or loss as a result of the liquidation. Therefore,
Foreign Sub 2’s corresponding item for this purpose is $0.

The recomputed corresponding item is the corresponding item that Foreign Sub 2 would
take into account if Foreign Sub 2 (B) and Parent (S) were divisions of a single
corporation. If Foreign Sub 2 and Parent were divisions of a single corporation,
Foreign Sub 2 would take no basis increase in the Sub 1 stock on the transfer of the
shares from Parent. Solely for purposes of arriving at the recomputed corresponding item,
upon the liquidation, Foreign Sub 2 is treated as realizing $f of loss. However, that
realized loss would be treated as unrecognized, by application of section 332. This is
because, to the extent that the transactions are analyzed as if B and S were divisions of a
single corporation, the liquidation is controlled by section 332, and not section 331.
Although there is actually no single 80 percent shareholder, for purposes of computing
the recomputed corresponding item, the previous intercompany stock sale is treated as
the movement of that asset within a single corporation, and not as a sale between two
corporations. Thus, for purposes of this computation, Sub 1 is treated as being wholly
owned by a single shareholder.

In this case, Foreign Sub 2’s corresponding item is assumed to be zero, as Parent
claims that Foreign Sub 2 (B) took a fair market value basis in the Sub 1 stock. As
described above, the single-entity, recomputed corresponding item would be an
unrecognized loss of $n. Excludability or treatment as a noncapital, nondeductible item
is an attribute.2 Therefore, the intercompany item must be redetermined as being

2
Treasury Reg. § 1.1502-13(c)(6)(i) illustrates the meaning of the term “noncapital, nondeductible
amount”:

POSTF-148451-09 9

excluded (and therefore, a noncapital, nondeductible item) in order to ensure that the
corresponding item and the intercompany item together equal the recomputed
corresponding item (unrecognized $n [RCI] – 0 [CI] = unrecognized $n [II]). Compare
Treas. Reg. § 1.1502-13(f)(7), ex. 5 (liquidation under section 332, following
intercompany stock sale). This redetermination ensures single-entity treatment.

This outcome comports with the stated intent of the intercompany transaction
regulations: preventing the existence of an intercompany transaction from creating,
accelerating, avoiding, or deferring consolidated taxable income (or consolidated tax
liability). Treas. Reg. § 1.1502-13(a)(1). That is, the overall tax impact on the group
should not change based on whether or not the initial stock sale (an intercompany
transaction) occurs. Taxpayer does not dispute that, had there been no stock sale,
section 332 would have applied to the liquidation, and no loss would have been
recognized on the subject stock. The mere existence of the stock sale (treated as an
intercompany transaction for purposes of this analysis) should not change this answer.

Responses to Taxpayer’s Arguments

The Taxpayer objects to the Service’s application of the attribute redetermination rule of
the intercompany transaction regulations, as outlined above. However, the precise
nature of the Taxpayer’s objection is not clear. The Taxpayer appears to acknowledge
the existence of the redetermination rules and the fact that, under those rules, the
attributes of the taxable items of B and S may be redetermined to produce single entity
treatment. See Protest at 4-5 (“[C]ertain aspects of the transaction, namely timing and
attributes, may be redetermined to produce the effect of transactions between divisions
of a single corporation (known as ‘single entity treatment’).”) However, despite this
acknowledgement that the regulations call for single entity treatment, the Taxpayer
appears to argue that Treas. Reg. § 1.1502-13 cannot and does not apply to create a
hypothetical transaction from which a recomputed corresponding item is identified. See,
e.g., Protest at 9 (“[T]he IRS . . . asserts that [Parent’s] loss on the sale . . . is a
nondeductible loss ‘because if S and B were divisions of a single corporation the loss
would not have been recognized under section 332.’ This conclusion is incorrect

    Under Treasury Regulation section 1.1502-13(c)(1), seller’s intercompany item might be
    redetermined to be excluded from gross income or treated as a noncapital, nondeductible
    amount. For example, seller’s intercompany loss from the sale of property to buyer is treated as
    a noncapital, nondeductible amount if buyer distributes the property to a nonmember shareholder
    at no further gain or loss (because, if seller and buyer were divisions of a single corporation, the
    loss would not have been recognized under section 311(a).

In other words, seller’s intercompany loss would be treated as a noncapital, nondeductible amount if the
buyer’s corresponding item is permanently disallowed or permanently eliminated. Treas. Reg. § 1.1502-
13(b)(3)(ii) provides than an item permanently disallowed or permanently eliminated can include amounts
not recognized under section 332. See Treas. Reg. § 1.1502-13(f)(7), Example 5(c). Therefore, Parent’s
loss from the intercompany transaction would be redetermined to be a noncapital, nondeductible amount
under Treas. Reg. § 1.1502-13 if Foreign Sub 2’s corresponding item is not recognized for tax purposes.

POSTF-148451-09 10

because it ignores the actual transaction that occurred . . .”); Protest at 10 (“As
discussed at length above, there are no consolidated return rules that would reconstruct
the actual stock ownership; instead, the actual stock ownership must be respected.”)

If the Taxpayer’s position is that redetermination of items does not contemplate the
generation of single entity outcomes that are different from the outcomes that would
occur on a separate entity basis, the Taxpayer is clearly incorrect. See Treas. Reg. §§
1.1502-13(a)(2) (“The timing, and the character, source, and other attributes of the
intercompany items and corresponding items, although initially determined on a separate
entity basis, are redetermined under this section to produce the effect of transactions
between divisions of a single corporation (single entity treatment)”); and
1.1502-13(b)(4) (“The recomputed corresponding item is the corresponding item that B
would take into account if S and B were divisions of a single corporation and the
intercompany transaction were between those divisions”). The operation of these
provisions is described in detail, above.

In making its argument, the Taxpayer cites portions of the intercompany transaction
regulations that actually support the government’s position. The Taxpayer cites to an
example in Treas. Reg. § 1.1502-13(c)(6) that illustrates the operation of the attribute
redetermination rule. That example related to an intercompany sale followed by a
distribution of the same property, and states:

   S’s intercompany loss from the sale of property to B is treated as a noncapital,
   nondeductible amount if B distributes the property to a nonmember shareholder
   at no further gain or loss (because, if S and B were divisions of a single
   corporation, the loss would not have been recognized under section 311(a)).
   [Emphasis added.]

With regard to the example, the Taxpayer states: “The example does not treat S as
having distributed the property because that would ignore the fact that B actually
distributed the property. Instead, S’s loss from the sale to B is redetermined to be
nondeductible.” Protest at 6.

This redetermination of a loss to be noncapital, nondeductible is exactly the point at
issue in this case. Treas. Reg. § 1.267(f)-1(c)(1)(iv) requires additional deferral where a
loss would have been redetermined to be a noncapital, nondeductible item if the
intercompany transaction regulations had applied. For purposes of applying the
matching rule of the intercompany transaction regulations, the single entity answer is
the tax result of the hypothetical transaction that would have occurred if S and B had
been two divisions of a single corporation. This example illustrates the regulation’s
requirement that such a hypothetical transaction be constructed and examined. In the
example, the distribution of the property was examined as if it had been a distribution of
built-in loss property by the hypothetical S-B single entity to a nonmember shareholder.
On the basis of the tax results of the hypothetical transaction, S’s intercompany loss is
redetermined to be a noncapital, nondeductible item. In the current case, if Parent and

POSTF-148451-09 11

Foreign Sub 2 had been divisions of a single corporation, Parent’s loss on the earlier
stock sale would have been redetermined to be a noncapital, nondeductible amount
because the liquidation would have constituted a section 332 transaction, rather than a
section 331 transaction.3

In the alternative, the Taxpayer’s position may be that, although redetermination may
generally occur to produce single entity treatment, such treatment is not applicable
where member stock is the asset that is the subject of the sale. See Protest at 5 (“S
and B are not treated as divisions of a single corporation for purposes of analyzing a
transaction involving a member, S’s, stock.”) In support of this position, the Taxpayer
points to a statement in Treas. Reg. § 1.1502-13(c)(3), which provides that section 1032
is not to be applied on a single entity basis. See Protest at 5.

The Taxpayer is mistaken. The government agrees that, pursuant to the regulations,
section 1032 is not applied on a single entity basis. However, where stock of a member
other than B or S (or stock of a non-member) is the property that is the subject of the
intercompany transaction, the ownership of that stock is clearly analyzed on a single
entity basis. For instance, Treas. Reg. § 1.1502-13(f)(7)(i), example 5, involves the
intercompany sale of stock of T, followed by a section 332 liquidation of T into B. The
analysis of the attributes and timing of the items in that example illustrates that B and S
are indeed treated as a single entity, and that the possible redetermination of timing and
attributes is considered based on the tax results from a hypothetical recast of the
transaction, with B and S treated as divisions of a single corporation.4

In addition, Taxpayer appears to imply that the government has taken the position that a
liquidation of Target would not be a triggering event with regard to Parent’s loss on the
Sub 1 stock under the intercompany transaction regulations. See Protest at 8. That is
not the government’s position. Under the regulations, Target’s liquidation would be a
triggering event and S’s intercompany item would be taken into account as taxable gain,
or as an excluded loss.

Deferral under section 267(f)(2) and the regulations thereunder.

Treasury Reg. § 1.267(f)-1(c)(1)(iv) provides:

3
The government does not argue that section 332 actually governs the taxability of the liquidation.
Section 331 governs the transaction, and the issue herein is simply the proper timing of the losses under
the rules of section 267(f). The hypothetical liquidation of Sub 1 into a sole shareholder is applicable only
with regard to applying the principles of the intercompany transaction regulations under section 267(f).
4
See Treas. Reg. § 1.1502-13(f)(7)(i), Example 5(b) (“Under paragraph (c)(1)(i) of this section, the
attributes of S’s gain and B’s corresponding item are redetermined as if S and B were divisions of a single
corporation. Although S’s gain ordinarily would be redetermined to be treated as excluded from gross
income to reflect the nonrecognition of B’s gain under 332, S’s gain remains capital because B’s
unrecognized gain under section 332 is not permanently and explicitly disallowed . . .”).

POSTF-148451-09 12

   To the extent S's loss would be redetermined to be a noncapital, nondeductible
   amount under the principles of section 1.1502-13 but is not redetermined
   because of paragraph (c)(2) of this section, then * * * S's loss continues to be
   deferred and is not taken into account until S and B are no longer in a controlled
   group relationship. For example, if S sells all of the stock of corporation T to B at
   a loss and T subsequently liquidates into B in a transaction qualifying under
   section 332, S's loss is deferred until S and B (including their successors) are no
   longer in a controlled group relationship. [Emphasis added.]

As discussed above, the rules of section 267(f) and the regulations thereunder generally
apply only the timing rules of the intercompany transaction regulations and not the
attribute redetermination rules. See Treas. Reg. § 1.267(f)-1(c)(2). Therefore, a seller’s
loss is generally deferred until it is taken into account under the timing principles of the
matching and acceleration rules of Treas. Reg. § 1.1502-13(c) and (d). However,
Treas. Reg. § 1.267(f)-1(c)(1)(iv) makes clear that the operation of the attribute
redetermination rules is taken into account in certain circumstances. Specifically, to the
extent that a seller’s loss would be redetermined to be a noncapital, nondeductible
amount under the principles of Treas. Reg. § 1.1502-13 (and thus, the loss would be
disallowed under those principles), that loss continues to be deferred and is not taken
into account until the buyer and seller are no longer in a controlled group relationship.
In other words, Treas. Reg. § 1.267(f)-1(c)(1)(iv) provides for continued deferral where
the intercompany transaction regulations would have disallowed the loss at issue.

The Preamble to the final regulations under section 267(f) explains the addition of this
rule:

   [T]he regulations clarify that to the extent S's loss would have been treated as a
   noncapital, nondeductible amount under the attribute rules of the regulations
   under § 1.1502-13, the loss is deferred under section 267(f) until S and B are no
   longer in a controlled group relationship with each other. Section 267 is intended
   to prevent a taxpayer from taking a loss into account from the sale or exchange
   of property when the property continues to be held by a member of the same
   controlled group. Under § 1.1502-13, S's loss might be taken into account but
   redetermined to be noncapital or nondeductible, permanently preventing the loss
   from being taken into account. It could be argued that this is the result of the
   attribute provisions of § 1.1502-13, which do not apply under section 267(f), not a
   result of the timing provisions of § 1.1502-13, and thus, a controlled group
   member could take its loss into account. The change made in the final
   regulations assures that the purpose of section 267 is not defeated as a result of
   the non-application of the attribute redetermination rules of § 1.1502-13 for
   purposes of section 267(f).

T.D. 8597, 1995-2 C.B. 147, 154 [Emphasis added].

The section 267(f) rules, on their face, were written to result in deferral of loss, and not
its complete disallowance, in contrast with the intercompany transaction regulations.

POSTF-148451-09 13

Therefore, the section 267(f) regulations generally invoke only the timing rules of the
intercompany transaction regulations, and not the attribute redetermination rule.
However, as indicated by the Preamble, the drafters were concerned that a failure to
apply the attribute redetermination rules would result in taxpayers claiming that they
may take into account losses on intercompany sales when neither the property sold nor
either of the transacting parties had left the controlled group (“It could be argued that
this is the result of the attribute provisions of § 1.1502-13, which do not apply under
section 267(f), not a result of the timing provisions of § 1.1502-13, and thus, a controlled
group member could take its loss into account.”). To prevent this outcome, the final
regulation included Treas. Reg. § 1.267(f)-1(c)(1)(iv), the paragraph here at issue.

As discussed above, for purposes of the matching rule, Treas. Reg. § 1.1502-13(c)(1)(i)
provides that the separate entity attributes of the seller’s intercompany items and
buyer’s corresponding items are redetermined to the extent necessary to produce the
same effect on consolidated taxable income (and consolidated tax liability) as if the
seller and the buyer were divisions of a single corporation, and the intercompany
transaction were a transaction between divisions.

In applying the principles of Treas. Reg. § 1.1502-13, Parent and Foreign Sub 2 are
treated as divisions of a single corporation, and Parent’s sale of the Sub 1 stock to
Foreign Sub 2 is a transaction between divisions. To the extent that the sale of f
percent of the Sub 1 stock is treated as occurring between divisions of a single
corporation, the liquidation of Sub 1 is nontaxable under section 332 because the
hypothetical single corporation owns all the stock of Sub 1 at the time of the liquidation.
Therefore, Parent’s (S’s) loss would be recharacterized under the intercompany
transaction regulations as a noncapital, nondeductible amount to mirror the nontaxable
nature of the liquidation in the hypothetical transaction. Where such a redetermination
would occur, Treas. Reg. § 1.267(f)-1(c)(1)(iv) imposes continuing deferral. Thus,
Parent’s loss must be further deferred until Parent and Foreign Sub 2 are no longer in a
controlled group relationship.

Responses to Taxpayer’s Arguments

The Taxpayer argues that the requirements for the application of Treas. Reg. § 1.267(f)-
1(c)(1)(iv) have not been met. The Taxpayer posits three requirements: First, there
must be a sale at a loss. Second, the sale must be governed by the intercompany sale
rules of section 267(f), and not the intercompany transaction rules of Treas. Reg. §
1.1502-13. The government agrees with the Taxpayer’s basic formulation of those two
requirements. However, the Taxpayer incorrectly asserts that there is a third
requirement that “the acquired corporation (T) liquidates under section 332 of the Code
(in actuality, not on some hypothetical divisional basis).” Protest at 10.5 Although the

5
Although the Taxpayer never directly asserts that the example in Treas. Reg. § 1.267(f)-1(c)(1)(iv) acts
to limit the application of that regulation to section 332 transactions, its Protest may be so read. However,
it is a long-established principle that examples in regulations are illustrative only. See, e.g., Solomon v.

POSTF-148451-09 14

Taxpayer’s argument is not perfectly clear, it appears that the Taxpayer either argues
(1) that the intercompany transaction regulations do not call for the creation of a
hypothetical transaction from which single entity outcome is determined, or (2) that
Treas. Reg. § 1.267(f)-1(c)(1)(iv) does not invoke the single entity redetermination rules
of the intercompany transaction regulations to create a hypothetical transaction from
which the single entity outcome is determined.

The first interpretation of the Taxpayer’s argument constitutes a rehash of its argument
with regard to the general application of the intercompany transaction regulations. As
discussed in detail above, the most basic requirement of the intercompany transaction
rules is the imposition of “single entity treatment.” To achieve this treatment, the
regulations expressly provide for the examination of the hypothetical transaction to
which the Taxpayer appears to object. See Treas. Reg. § 1.1502-13(b)(4) (“Although
neither S nor B actually takes the recomputed corresponding item into account, it is
computed as if B did take it into account”); and § 1.1502-13(c)(1)(i) (“The separate entity
attributes of S’s intercompany items and B’s 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.”).

Further, the text of Treas. Reg. § 1.267(f)-1(c)(1)(iv) and the Preamble to that regulation
refute any argument that Treas. Reg. § 1.267(f)-1(c)(1)(iv) does not invoke the attribute
redetermination principles of the intercompany transaction regulations. Rather, the
regulations expressly provide for application of the redetermination rules of the
intercompany transaction regulations. (“To the extent S's loss would be redetermined to
be a noncapital, nondeductible amount under the principles of section 1.1502-13 but is
not redetermined because of paragraph (c)(2) of this section . . .”).

In addition, the Taxpayer argues that application of Treas. Reg. § 1.267(f)-1(c)(1)(iv)
would violate the intent behind that regulation, because “Section 1.267(f)-1(c)(1)(iv) of
the Regulations was included in the final regulations merely to ensure that the seller’s
deferred loss would not be permanently deferred in the case of a liquidation under
Section 332 of the Code.” Protest at 11. The Taxpayer further argues that, because
the taxation of this transaction is actually controlled by section 331 and not 332,
permanent denial of the loss was never an issue, and, therefore, this regulation can
have no application. Protest at 10, 12.

The Taxpayer is incorrect. Absent Treas. Reg. § 1.267(f)-1(c)(1)(iv), permanent deferral
was not the problem. This is because Treas. Reg. § 1.267(f)-1(c)(2) applies to turn off
the redetermination of attributes, and to ensure that the section 267(f) regulations
imported only the timing provisions of the intercompany transaction regulations. Thus,
on the occurrence of the nonrecognition transaction (and the disappearance of the

C.I.R., 67 T.C. 379, 386 (1976) (examples in Treasury regulations are merely illustrative and do not
purport to limit application of the statute).

POSTF-148451-09 15

target stock), the intercompany item would be triggered. See Treas. Reg. § 1.1502-
13(f)(ii), ex. 5. Under strict application of the intercompany transaction regulations, the
intercompany loss would be triggered, but its attributes would be redetermined to result
in the loss being excluded. However, because Treas. Reg. § 1.267(f)-1(c)(2) turns off
the attribute redetermination rules, there was the possibility that the loss would be
currently allowed, although the controlled group remained in control of all pertinent
assets. This result would run afoul of the basic purpose of the rules under section
267(f), which is to defer losses until a separation of the controlled group members, or
their disposal of the asset. Therefore, Treas. Reg. § 1.267(f)-1(c)(1)(iv) extended
deferral. The section 267(f) regulations thus invoke the attribute redetermination rules
of the intercompany transaction regulations as a mechanism to determine when the
possibility of such improper inclusion might exist. Any item that would have been
redetermined to be a capital, nondeductible item under the principles of § 1.1502-13,
instead is further deferred, and not disallowed. This understanding of the regulation has
been adopted by experts within the tax bar.6

Contrary to the Taxpayer’s claims, application of Treas. Reg. § 1.267(f)-1(c)(1)(iv) to
this transaction fits within the expressed intent of the section 267(f) regulations. Treas.
Reg. § 1.267(f)-1(a)(1) provides that “[t]he purpose of this section is to prevent
members of a controlled group from taking into account a loss or deduction solely as the
result of the transfer of property between a selling member (S) and a buying member
(B).” If the regulation did not apply in this case, the existence of the intercompany sale

6
The leading commentator in the consolidated return area discusses the purpose of § 1.267(f)-1(c)(1)(iv)
as follows:

    This continued deferral rule was introduced in the final regulations. IRC Section 267 is intended to
    prevent a taxpayer from taking a loss into account from the sale or exchange of property when
    the property continues to be held by a member of the same controlled group. The government
    rejected the argument that the recharacterization under Treas. Reg. § 1.1502-13 as a noncapital,
    nondeductible amount is simply the result of the attribute provisions of Treas. Reg. § 1.1502-13,
    which do not apply under IRC Section 267(f). When Congress incorporated the intercompany
    transaction rules into IRC Section 267(f), it could not have foreseen the attribute redetermination
    that the current regulations require. Thus, a controlled group member should not expect to take the
    loss into account simply because a corresponding noncapital, nondeductible amount is allowed to a
    consolidated group.

    The additional deferral under IRC Section 267(f) is intended to prevent the perceived purpose of
    IRC Section 267 from being defeated as a result of the inapplicability of the attribute
    redetermination rules of Treas. Reg. § 1.1502-13 for purposes of IRC Section 267(f). Many
    instances where recharacterization as a noncapital, nondeductible amount is required involve
    transactions in member stock that never leaves the group. Where Treas. Reg. § 1.1502-13
    permits restoration of a loss, the restoration appears to have been premised on the
    recharacterization, and the government was not satisfied to allow the loss under IRC Section
    267(f) simply because of the timing rules of Treas. Reg. § 1.1502-13.

Dubroff, et al., Federal Income Taxation of Corporations Filing Consolidated Returns, §31.11[3][b][iv];
see also, Hennessey, et al., The Consolidated Tax Return, ¶ 6.02[9], Example 6-21 (the addition of
§1.267(f)-1(c)(1)(iv) results in the continued deferral of an item that would otherwise be includable in
income.)

POSTF-148451-09 16

would result in the controlled group taking into account a loss that it otherwise could not
have, as a result of having entered into the intercompany sale. Absent the
intercompany sale of Sub 1 stock, Sub 1 would have been wholly owned by Parent at
the time of the liquidation, and, thus, section 332 would have been applicable to the
liquidation.

Finally, the Taxpayer argues that “[u]nder the NOPA’s faulty reasoning, every taxable
liquidation within a controlled group would constitute a tax-free liquidation under Section
332 of the Code.” Protest at 9. Taxpayer either misunderstands or misconstrues the
government’s argument. Section 267(f) is not the equivalent of the application of Treas.
Reg. § 1.1502-34, which treats all stock ownership of a corporation by members of a
consolidated group as held by a single shareholder for purposes of applying section

332. Section 267(f) and the regulations thereunder adopt certain principles of the
     intercompany transaction regulations and apply these principles only where an
     intercompany sale has occurred. Therefore, where there is split ownership of the stock
     of a member of a controlled group, but that split ownership is not the result of an
     intercompany sale of target stock, there will be no application of section 267(f).
     However, any time there has been an intercompany stock sale, the transaction must be
     tested against the rules of section 267(f).

We express no opinion about the Taxpayer’s purported business purposes or any other
issues raised by the facts of this transaction.

CASE DEVELOPMENT, HAZARDS AND OTHER CONSIDERATIONS

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writing may undermine our ability to protect the privileged information. If disclosure is
determined to be necessary, please contact this office for our views.

Please call (202) 622-7790 if you have any further questions.

                               By: _____________________________
                                   Bruce A. Decker
                                   Assistant Branch Chief, Branch 3
                                   (Corporate)