Does a two-step corporate restructuring -- merging one subsidiary into another, then merging the survivor into a newly created holding company -- reduce or eliminate the group's Connecticut corporation business tax operating loss carry-overs?

Plain-English summary

A Connecticut operating loss carry-over lets a company use a past year's net operating loss to reduce corporation business tax in later years (Conn. Gen. Stat. § 12-217(a)). A recurring worry in reorganizations is whether shuffling corporate entities destroys those accumulated losses. This ruling maps out when they survive.

The parent, T, owned two printer-manufacturing subsidiaries: I (New York) and M (Connecticut). T and M file a combined Connecticut return that had generated net operating losses. To prepare for a public offering, T planned a two-step restructuring: (1) merge I into M (a statutory merger, represented to qualify as a tax-free reorganization under 26 U.S.C. § 368(a)(1)(A)); then (2) create a new Delaware holding company A, move M's stock into A (a § 351 nonrecognition transfer), and merge M into A (represented to be a § 368(a)(1)(F) "mere change of form" reorganization). T asked whether either step would cut its loss carry-overs.

DRS said no at both steps.

• Step one — losses stay with the survivor. Under the case law and the 1939 Internal Revenue Code, the Connecticut operating loss carry-overs of the surviving corporation after a statutory merger are not affected by the merger. Because M (which generated the losses in the combined group) survives, it keeps its carry-overs. DRS cited Ruling No. 93-23.

• Step two — the six-factor test. For the merger of M into the new company A, DRS applied a six-factor test drawn from the 1939 IRC: (1) is it a statutory merger? (yes — a represented type F reorganization); (2) is ownership the same before and after? (yes — T is the sole shareholder throughout); (3) is tax avoidance not the primary purpose? (yes — the purpose is to raise capital via a public offering); (4) is there continuity of business enterprise? (yes — M's business continues, minus a small ribbon line under 10% of sales); (5) is the loss entity maintained separately or its income separately accounted for? (not needed — A's only business is M's business); and (6) are the carry-overs used only against income generated after the merger? (yes — only M's business income). All satisfied, so the carry-overs survive into the T-and-A group.

The upshot: a genuine business reorganization that keeps the same ownership and continues the same business, without tax avoidance as its primary purpose, doesn't forfeit Connecticut loss carry-overs. DRS applied the identical six-factor test the same day in the companion Ruling No. 97-2 (a state bank converting to a national bank), named here in prose, not linked.

What this means for you

Corporations reorganizing entities that hold tax losses

Connecticut operating loss carry-overs can survive a statutory merger or type F reorganization if the deal keeps the same ownership, continues the same business, isn't primarily tax-motivated, and uses the losses only against the ongoing business's future income. Plan the restructuring so it satisfies each of DRS's six factors, and be ready to show the business (not tax) purpose — here, a public offering.

M&A and corporate counsel

The framework is the 1939 Internal Revenue Code's six-factor test, not the modern § 382-style limitations. The survivor of a statutory merger keeps its own carry-overs automatically (Ruling No. 93-23); a merger into a newly created entity is scrutinized under the six factors. Continuity of business enterprise tolerates dropping a small, unrelated line (here, a ribbon business under 10% of sales) without breaking the chain.

Accountants and corporate tax professionals

The carry-over deduction sits in § 12-217(a), with combined-return mechanics in Regs. § 12-223a-2. Document that each represented federal characterization holds (§ 368(a)(1)(A) for step one; § 351 and § 368(a)(1)(F) for step two), and that all six DRS factors are met. Losses may be used only to offset income of the same continuing business post-transaction.

Common questions

Q: Does merging subsidiaries wipe out Connecticut loss carry-overs?
A: Not necessarily. The survivor of a statutory merger keeps its own carry-overs. And when the survivor is then merged into a newly created entity, the carry-overs survive if DRS's six-factor test is met.

Q: What are the six factors?
A: (1) statutory merger; (2) same ownership before and after; (3) tax avoidance not the primary purpose; (4) continuity of business enterprise; (5) the loss entity maintained separately or its income separately accounted for; and (6) carry-overs used only against income generated after the transaction.

Q: Does selling off a small business line break "continuity of business enterprise"?
A: Not here. M sold a ribbon business unrelated to its printer manufacturing and accounting for under 10% of sales, and DRS still found continuity of the business enterprise.

Q: Is there a companion ruling?
A: Yes. The same day, Ruling No. 97-2 applied the same six-factor test to a state bank converting to a national bank and likewise preserved the carry-overs.

Citations and references

Statutes and regulations:

• Conn. Gen. Stat. § 12-217(a) (corporation business tax operating loss carry-over deduction)
• Conn. Agencies Regs. § 12-223a-2 (operating loss carry-overs, combined returns)

Federal provisions referenced:

• 26 U.S.C. § 368(a)(1)(A) (statutory merger reorganization — step one)
• 26 U.S.C. § 351 (nonrecognition transfer to a controlled corporation)
• 26 U.S.C. § 368(a)(1)(F) (mere change in identity or form reorganization — step two)

Related rulings:

• Ruling No. 93-23 (the surviving corporation of a statutory merger keeps its Connecticut operating loss carry-overs)
• Ruling No. 97-2 (companion; same six-factor test applied to a state-bank-to-national-bank conversion)

Source

• Landing page: Connecticut DRS Rulings
• Ruling: Ruling 97-3

Original ruling text

Ruling 97-3, Corporation Business Tax / Operating Loss Carry-Overs

Ruling 97-3

Corporation Business Tax

Operating Loss Carry-Overs

FACTS:

Corporation T (" T "), a corporation organized under the laws of Connecticut, owns all the stock of Corporation I (" I ") and Corporation M (" M "). I and M are both engaged in the printer manufacturing business. I is organized under the laws of New York and conducts it business in New York. M is organized in Connecticut and conducts its business in Connecticut. T and M file a combined Connecticut corporation business tax return. The combined filing of T and M has generated a Connecticut net operating loss, part of which may be deductible as an operating loss carry-over under the rules of Conn. Gen. Stat. §12-217(a) and Conn. Agencies Reg. §12-223a-2.

T proposes to engage in a public offering with respect to the printer manufacturing businesses that I and M operate. To facilitate this, T proposes the following. I will be merged into M in a statutory merger, which, it is represented, will qualify as a tax-free reorganization under 26 U.S.C. §368(a)(1)(A). Then T will organize a wholly-owned subsidiary, Corporation A (" A "), under the laws of Delaware for the sole purpose of holding the stock of M and conducting the public offering. The stock of M will be transferred to A in a transaction which qualifies for non-recognition treatment under 26 U.S. C. §351. As part of the plan to make M a good candidate for a public offering, M will sell to T a part of M's business (its ribbon business), which business is not connected to its printer manufacturing business and which accounts for less than 10% of M's sales Then M will merge into A in a statutory merger which, it has been represented, will qualify as a tax-free reorganization under section 26 U.S. C. §368(a)(1)(F). T and A will file a combined Connecticut corporation business tax return.

ISSUES:

Whether the merger of one corporation into another corporation will reduce or eliminate the operating loss carry-overs generated by the surviving corporation, where those operating losses arose prior to the proposed restructuring and would otherwise be deductible as an operating loss carry-over by the surviving corporation under the rules of Conn. Gen. Stat. §12-217(a) and Conn. Agencies Reg. §12-223a-2.

If the operating loss carry-overs are not reduced or eliminated and continue to be deductible, then whether the subsequent step of merging the surviving corporation into a newly created corporation, which newly created corporation will be a wholly-owned subsidiary of the parent of the surviving corporation, will eliminate or reduce the operating loss carry-overs which may be deducted as operating loss carry-overs after the first step of the corporate restructuring.

DISCUSSION:

As to the first step in the corporate restructuring, the merger of I into M, such restructuring will not have any effect on the deductibility of the operating loss carry-overs of the T and M group. Under the case law and the 1939 Internal Revenue Code, the Connecticut operating loss carry-overs of a corporation which is the surviving corporation after a statutory merger are not affected by the merger. See Ruling No. 93-23 .

In determining whether the second step of the corporate restructure, the merger of M into a newly created corporation, A, reduces or eliminates the amount of the T and M group's operating loss carry-overs, the Department looks to the following 6 factors:

1. Whether the merger is a statutory merger. The merger of M into A will be a statutory merger, qualifying, it is represented, as a type F tax-free reorganization for federal corporation income tax purposes.

2. Whether the ownership of the corporation whose existence ceases and the ownership of the surviving corporation are the same. Prior to the merger, T is the sole shareholder of M , as well as A , and after the merger, T is the sole shareholder of A, the surviving corporation.

3. Whether tax avoidance is not the primary purpose of the merger . The primary purpose of the transaction is to restructure I and M , both of which operate substantially the same printer manufacturing business, for purposes of obtaining financing from the public capital market.

4. Whether after the merger there is a continuity of business enterprise. The business of M , except for a small part of its business (which accounts for less than 10% of M's business sales), will continue to be operated after M merges into A.

5. Whether the entity which generated the net operating loss is maintained as a separate division, or its assets separately accounted for, such that the taxpayer can show that the non-surviving entity or its assets generated income following the merger. The only business of A will be M's business, so there is not any need to segregate or separately account for income from the M business.

6. Whether the losses which are carried over are used only to offset that income which is generated following the merger. The only income which will be offset by the operating loss carry-overs will be income from M's business.

Accordingly, the proposed merger of M into A will not eliminate or reduce the operating loss carry-overs of M which may be deducted by the T and A group.

RULINGS:

1. The first step in the corporate restructuring (a statutory merger which, it is represented, will qualify as a tax-free reorganization under 26 U.S.C. §368(a)(1)(A)) will not reduce or eliminate the operating loss carry-overs that may be deducted by the surviving corporation because the surviving corporation is the corporation which generated the operating loss carry-overs.

2. The second step in the corporate restructuring (the proposed merger of the corporation which is the surviving corporation from the first step into a newly-created corporation) will not eliminate or reduce the operating loss carry-overs that may be deducted by the newly-created corporation and its parent (the former parent of the corporation which generated the operating loss carry-overs) because the tests required under the 1939 Internal Revenue Code are met.

LEGAL DIVISION

July 7, 1997