An overpayment cannot offset a former subsidiary's underpayment under these facts

Plain-English summary

Chief Counsel Advice considers whether the IRS could apply a foreign parent's tax overpayment to a former domestic subsidiary's underpayment after the overpayment had been refunded. The IRS concluded that IRC § 6402 did not apply because the underpayment belonged to the former subsidiary, not the corporation that made the overpayment. Because no offset occurred under § 6402, the interest-relief rule in § 6601(f) did not eliminate the subsidiary's underpayment interest. The advice also explains that Internal Revenue Manual procedures did not create a right to the requested interest refund.

Ruling snapshot

• Question: Can the IRS offset one corporation's overpayment against a former subsidiary's underpayment and eliminate related interest under § 6601(f)?
• Outcome: Denied.
• Key authorities: IRC §§ 6402(a), 6601(a), 6601(f); Treas. Reg. § 301.6402-1.

Full text (IRS public release)

       Office of Chief Counsel
       Internal Revenue Service
       memorandum
       Number: 201405013
       Release Date: 1/31/2014
       CC:PA:01
       POSTN-140793-13

UILC: 6402.00-00, 6601.01-00

date: June 24, 2013

 to:   Associate Area Counsel (New York)
       (Large Business & International)

from: Elizabeth Girafalco Chirich
Branch Chief, Branch 1
(Procedure & Administration)

subject: Applicability of Offset and Interest Provision Under Section 6601(f)

       This Chief Counsel Advice responds to your request for additional assistance after we
       issued our advice relating to this taxpayer on another interest-related issue. This advice
       may not be used or cited as precedent.

       LEGEND

       Corporation 1   =   -------------------------.
       Corporation 2   =   -------------------
       Corporation 3   =   --------------------------
       Date 1          =   --------------------------
       Date 2          =   -----------------------
       Date 3          =   -----------------------------
       Date 4          =   -----------------------
       Date 5          =   ---------------------------
       Date 6          =   -------------------
       Date 7          =   --------------------------
       Date 8          =   ------------------
       Date 9          =   --------------------
       Date 10         =   -----------------------
       Date 11         =   --------------------
       TY1             =   -------
       TY2             =   -------
       Amount 1        =   --------------------------

POSTN-140793-13 2

Amount 2 = ------------------------
Amount 3 = ----------------
Amount 4 = ------------

ISSUES

A domestic corporation underpaid its income taxes for TY1; its then-foreign parent
overpaid its income taxes for TY1. On Date 1, the Internal Revenue Service refunded
the foreign parent’s overpayment. Over a year later, on Date 3 and Date 4, the foreign
parent satisfied its former subsidiary’s TY1 underpayment. Can the Service now offset
this foreign parent’s overpayment against the former domestic corporation’s
underpayment? If so, will section 6601(f) apply to eliminate the related interest liability
on the domestic corporation’s tax liability for TY1?

CONCLUSIONS

No. The Service cannot credit the foreign parent’s overpayment against its former
domestic subsidiary’s underpayment because section 6402 is inapplicable. The tax
liability belonged to the former domestic subsidiary, Corporation 1, and was not a
liability “on the part of” the foreign parent, Corporation 2, the Corporation that made the
overpayment.

Section 6601(f) only applies when the Service credits an overpayment against an
underpayment under section 6402. So this issue is moot.

FACTS

Corporate Structure
Corporation 1 filed its TY1 corporate tax return as the parent of a consolidated group.
In TY1, Corporation 1 was 100% owned by Corporation 2, a foreign parent. The
corporations had separate and distinct EINs and were not members of the same
consolidated group. On Date 5, Corporation 1 restructured, liquidated several
subsidiaries, and converted to a State LLC that was also 100% owned by the same
foreign parent, Corporation 2. As a result of this restructuring, Corporation 1 was
treated, for federal tax purposes, as a disregarded entity. In determining the taxation of
Corporation 1’s change in classification for federal income taxes from a “C” corporation
to a disregarded entity, Corporation 1 was deemed to have transferred its assets and
liabilities to its foreign parent. Corporation 1 filed a final tax return and ceased to exist
as a "C" corporation for federal income tax purposes even though Corporation 1
continued in existence as an LLC under State law.1 On Date 6, under State law, the LLC
(previously Corporation 1) dissolved. In so doing, the LLC transferred all of its assets
and liabilities to Corporation 2, its foreign parent, pursuant to an asset and liability
transfer agreement. The foreign parent consented to the transfer and legally

1
See I.R.C § 332.

POSTN-140793-13 3

assumed full responsibility for all of the LLC’s liabilities. Subsequently, the foreign
parent changed its name to Corporation 3.

Deficiency and Overpayment
The Internal Revenue Service audited the TY2 income-tax returns of Corporation 1 and
its then-foreign parent, Corporation 2. As a result of the audit, the Service made a
section 482 adjustment that allocated a TY2 bad-debt deduction from Corporation 1 to
Corporation 2, the foreign parent. The section 482 adjustment increased the foreign
parent’s TY2 net operating loss (NOL), which the foreign parent carried back to its TY1,
resulting in an overpayment of its TY1 taxes. Conversely, the adjustments with regard
to TY2 resulted in a reduced net operating loss for Corporation 1 for TY2, which
ultimately resulted in a reduced net operating loss carryback to TY1. Therefore,
Corporation 1 ended up with a deficiency for TY1 of Amount 2, which the Service
assessed on Date 2. On Date 1, the Service refunded the foreign parent’s
overpayment, in the amount of Amount 1, including interest. On Date 3 and on Date 4,
Corporation 3 paid Corporation 1’s TY1 liability in the respective amounts of Amount 3
and Amount 4, which completely satisfied Corporation 1’s TY1 tax liability, including
interest.

Claim for Refund and Request for Abatement
On Date 7, Corporation 1 filed a Form 843, seeking a refund of the underpayment
interest that had accrued on its TY1 underpayment based on the provisions of section
6601(f). The Service denied the claim on Date 8.2 In the Service’s denial letter, it
provided that it was “no longer able to apply section 6601(f)” because “the overpayment
has been refunded.” Further, the Service explained that it did not apply Corporation 2’s
overpayment against Corporation 1’s underpayment because “the overpayment and the
liability involved two different entities” and “no evidence was provided that Corporation 2
requested their overpayment be applied to Corporation 1 liability.” On Date 11,
Corporation 3, as successor to Corporation 1, filed a Form 843, again seeking a refund
of the underpayment interest that had accrued on Corporation 1’s TY1 underpayment.
Corporation 3 argued that the Service did not follow Internal Revenue Manual
Procedures established to offset refunds and tax liabilities that are generated by section
482 primary and correlative adjustments, and, therefore, it was entitled to a refund of
the interest paid on Corporation 1’s underpayment. (The claim also appears to request
interest abatement under section 6404(e), but we have not been asked to opine on that
issue.) The Service has not yet acted on this claim.

Our advice is based on the information that the taxpayers provided in their three claims
as well as the additional background materials that you submitted.

LAW AND ANALYSIS

2
On Date 9, Corporation 1 filed a claim for interest netting, seeking a refund of a portion of the
underpayment interest that had accrued on its TY1 underpayment. The Service denied the taxpayer’s
claim on Date 10.

POSTN-140793-13 4

In lieu of refunding an overpayment of tax to a taxpayer, the Service “may” credit the
overpayment against an outstanding underpayment “on the part of the person who
made the overpayment.” I.R.C. 6402(a). Thus, whenever the Service determines an
overpayment of tax, and another tax liability of the person who made that overpayment
remains unpaid, the Service has the discretion, under section 6402(a), of refunding that
overpayment or crediting it against the outstanding underpayment. Northern States
Power Co. v. United States, 73 F.3d 764, 767 (8th Cir 1996); Pettibone Corp. v. United
States, 34 F.3d 536, 538 (7th Cir. 1994). See also Treas. Reg. § 301.6402-1. When
such an overpayment is credited against an underpayment, and the taxpayer owes
underpayment interest on the portion of the underpayment so satisfied by that
overpayment, section 6601(f) eliminates that underpayment interest for the overlapping
period during which interest would have been allowable to the taxpayer on the
overpayment had the Service not credited the overpayment to the underpayment.
I.R.C. § 6601(f). While section 6601(f) eliminates underpayment interest, this provision
only applies if the Service first credits an overpayment against an underpayment
pursuant to section 6402(a). See Northern States Power, 73 F.3d at 768. In other
words, if a section 6402(a) credit is not made, interest continues to accrue
independently during an overlapping period on both the overpayments and
underpayments. So interest on an overpayment that is refunded would run from the
date the overpayment arises until a date preceding (but no more than 30 days
preceding) the date when a refund check is sent. IR.C. § 6611(b)(2). And interest
accrues on the tax underpayment from the prescribed payment date until the date on
which the tax is paid. I.R.C. § 6601(a).

Section 6402 is inapplicable in this case, though, because the tax liability belonged to
Corporation 1 and was not a liability “on the part of” Corporation 2, the Corporation that
made the overpayment.3 I.R.C. § 6402(a). Accordingly, the taxpayer's 6402 argument
is without merit. And, as discussed, section 6601(f), which imposes no underpayment
interest on any portion of tax satisfied by credit of an overpayment, applies only when
the Service credits an overpayment under section 6402(a). The overpayment in issue
here was not credited under section 6402(a). Therefore, section 6601(f) is inapplicable
in this case to eliminate the underpayment interest that accrued on Corporation 1’s TY1
underpayment.

You also asked us to address the taxpayer’s argument that it is entitled to a refund of
interest paid on its TY1 underpayment because the Service did not follow IRM
procedures that provide that correlative taxpayers "must be given the opportunity of
applying any overassessment against the deficiencies of the primary taxpayer… ."
IRM 4.10.13.5.2.2. Although the Service has such procedures in place, it does not
follow that the Service acted inappropriately if it did not follow these procedures. See

3
We do not address here whether it can be argued that, because the foreign parent, Corporation 2,
consented to the transfer and legally assumed full responsibility for all of Corporation 1’s liabilities, the tax
liability is "on the part of a person who made the overpayment.” In any event, section 6402 is
discretionary, and the Service did not -- and was not required to -- offset under section 6402.

POSTN-140793-13 5

Vallone v. Commissioner, 88 T.C. 794, 807-08 (1987) (IRM requirements are
necessarily merely directory and not mandatory, and if the Service does not follow these
procedures, that does not render the Service’s action invalid). See also United States.
v. Horne, 714 F.2d 206, 207 (1st Cir. 1983). Further, courts have generally said that
the IRM is “not for the protection of taxpayers.” Vallone, 88 T.C. at 808. Moreover, we
suspect that the objective of the referenced IRM procedures (directing revenue agents
to offer correlative taxpayers the opportunity to apply resulting overpayments against
resulting deficiencies) is not to address interest-rate discrepancies that may arise
following a 482 adjustment, but rather to safeguard the fisc. Collecting the deficiency
immediately by applying the overpayment -- rather than refunding the overpayment and
having to collect the deficiency later -- ensures all or part of the deficiency will be paid.

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Please call (202) 622-4910 if you have any further questions.