How is a federal IRC section 338(h)(10) election treated for New York tax when the target sold is an Article 9 corporation, and how is the parent's stock-sale gain treated?

Plain-English summary

A practitioner asked how a federal IRC section 338(h)(10) election is treated for New York when parent P (taxable under Article 9-A) sells all the stock of subsidiary T (taxable under Article 9). A 338(h)(10) election generally treats the target as having sold all its assets and liquidated, while the stock sale is ignored for federal purposes.

The Department reached a two-part answer:

The parent (Article 9-A). New York's published treatment of 338(h)(10) elections (TSB-M-91(4)C) applies for Article 9-A purposes. P's starting point is its separate pro forma federal taxable income.
- If P is a "selling affiliate" under Treasury Regulation section 1.338(h)(10)-1(c)(4), the election is available on P's pro forma return, so no gain or loss on the stock sale is recognized, and there is no New York modification to add it back.
- If P is not a selling affiliate, the stock-sale gain is recognized on the pro forma return, but it is attributable to subsidiary capital and is eliminated from entire net income under section 208.9(a)(1).

Either way, P recognizes no New York tax on the stock-sale gain.

The target (Article 9). Article 9 is not federally conformed -- it uses its own definitions and GAAP, not federal taxable income. So the federal 338(h)(10) result (target recognizes gain on a deemed asset sale) does not carry over: any imputed gain on the deemed sale of T's assets is not recognized for T's Article 9 franchise tax.

What this means for you

A federal election does not automatically bind Article 9

Article 9-A starts from federal taxable income, so federal elections flow through (subject to New York modifications). Article 9 does not -- a federal deemed-asset-sale gain has no Article 9 effect.

Subsidiary-capital exclusion is the backstop for the parent

Even when the parent must recognize the stock-sale gain federally, that gain is from subsidiary capital and drops out of Article 9-A entire net income.

The "selling affiliate" status matters federally, not to the New York bottom line

Whether P is a selling affiliate changes the mechanics, but the New York result for the parent is the same: no tax on the stock-sale gain.

Common questions

Q: Does the federal 338(h)(10) deemed asset sale create Article 9 tax for the target?
A: No. Article 9 is not federally conformed, so the imputed gain on the deemed asset sale is not recognized under Article 9.

Q: Is the parent taxed on its gain from selling the target's stock?
A: No. Either the election removes the gain on the pro forma return, or the gain is excluded as subsidiary capital under section 208.9(a)(1).

Q: Does TSB-M-91(4)C apply to Article 9 corporations?
A: No. Its 338(h)(10) treatment is for Article 9-A purposes.

Citations and references

Statutes, regulations, and authorities:
- Tax Law section 208.9 (entire net income; subsidiary capital)
- Tax Law section 208.9(a)(1) (gains and losses from subsidiary capital excluded)
- IRC section 338(a) and 338(h)(10) (deemed asset sale election)
- Treasury Regulation section 1.338(h)(10)-1 (selling affiliate)
- TSB-M-91(4)C (New York treatment of section 338(h)(10) elections)
- Roger Cukras, TSB-A-99(22)C (Sept. 14, 1999)

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/corporation_ao_1999.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/corporation/a99_22c.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-99(22)C
Corporation Tax
September 14, 1999

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. C990727B

On July 27, 1999, a Petition for Advisory Opinion was received from Roger Cukras, Hutton
Ingram Yuzek Gainen Carroll & Bertolotti, LLP, 250 Park Avenue, New York, New York 10177.
The issue raised by Petitioner, Roger Cukras, is whether the tax treatment accorded to
elections under section 338(h)(10) of the Internal Revenue Code ("IRC") as specified in TSB-M­
91(4)C, applies to the sale of stock of a subsidiary which is an Article 9 corporation. If not, what
tax treatment would be accorded to the sale of the stock of such a subsidiary, and the deemed sale
of the subsidiary's assets.
Petitioner submits the following facts as the basis for this Advisory Opinion.
Assume that P, the parent of a federal consolidated group, is selling to X all of the stock of
T, P's wholly-owned subsidiary. Assume further that P is taxable under Article 9-A of the Tax Law,
and that T is taxable under Article 9 of the Tax Law. Also assume that an election will be properly
made under section 338(h)(10) of the IRC with respect to the sale of T.
Discussion
Under section 338(a) of the IRC an election may be made by the purchaser in a qualified
stock purchase, which generally is one involving the purchase of 80 percent or more of the stock of
a corporation within a 12 month period. Pursuant to this election, the target corporation (old target)
is "treated as having sold all of its assets at the close of the acquisition date" (the date of the qualified
stock purchase) "at fair market value in a single transaction" and is then "treated as a new
corporation" (new target) "which purchased all of the assets ... as of the beginning of the day after
the acquisition date." The result of the election is that the difference between the fair market value
of the assets and the adjusted basis of the assets is recognized as gain or loss to old target, and the
basis of the assets in the hands of new target is stepped up or down, as the case may be.
If the election is made under section 338(a) of the IRC, a further election may be made under
section 338(h)(10) of the IRC, and section 1.338(h)(10)-1 of the Treasury Regulations, by the seller
and purchaser of target stock. Under this election, target generally is deemed to sell all of its assets
and distribute the proceeds in complete liquidation, and the sale of target stock included in the
qualified stock purchase generally is ignored. This election may be made for target only if it is a
member of a selling consolidated group, a member of a selling affiliated group filing separate
returns, or an S corporation. The gain or loss on the deemed asset sale is included in the tax return

-2­
TSB-A-99(22)C
Corporation Tax
September 14, 1999

of target, but no gain or loss is recognized on the sale of target stock by members of the consolidated
group, the selling affiliate or the S corporation shareholders.
Technical Services Bureau Memorandum TSB-M-91(4)C, April 17, 1991, revised the New
York treatment of elections made under section 338(h)(10) of the IRC set forth in Technical Services
Bureau Memorandum TSB-M-87(4)C, April 10, 1987 by making technical corrections to the
treatment of the elections and simplifying the filing requirements. In both memoranda, the treatment
of the elections made under section 338(h)(10) of the IRC is for purposes of Article 9-A of the Tax
Law.
The starting point for computing the parent's entire net income base under Article 9-A of the
Tax Law is its federal taxable income computed as if it had filed separately for federal income tax
purposes (pro forma federal return). Pursuant to TSB-M-91(4)C, if the parent had filed separately
for federal purposes, the election under section 338(h)(10) of the IRC would not be available, and,
therefore, any gain or loss from the parent's sale of the stock of the target corporation would be
included in its pro forma federal return, and in the starting point for computing the parent's entire
net income under section 208.9 of Article 9-A of the Tax Law. However, such gain or loss would
be attributable to subsidiary capital, and pursuant to section 208.9 of the Tax Law, income, gains and
losses from subsidiary capital are excluded from entire net income.
However, subsequent to the issuance of TSB-M-91(4)C, section 1.338(h)(10)-1 of the
Treasury Regulations, relating to the stock and asset consistency rules under section 338 of the IRC
was adopted on January 12, 1994. This final regulation extended section 338(h)(10) of the IRC
treatment to nonconsolidated affiliates. Section 1.338(h)(10)-1(c)(4) of the Treasury Regulations
defines a "selling affiliate" as a domestic corporation that is not a member of the selling consolidated
group and from which, on the acquisition date, the purchasing corporation purchases an amount of
target stock that satisfies the requirements of section 1504(a)(2) of the IRC. Thus, on the acquisition
date, the selling affiliate and the target corporation are affiliated (within the meaning of section 1504
of the IRC) but are not includible members of a consolidated group.
In this case, P, a corporation taxable under Article 9-A of the Tax Law, would file on a
separate basis, and P's starting point for computing entire net income would be P's federal taxable
income computed on a pro forma basis as if P had filed a separate return for federal income tax
purposes. Assuming P would be a selling affiliate pursuant to section 1.338(h)(10)-1(c)(4) of the
Treasury Regulations, the election made under section 338(h)(10) of the IRC to exclude the gain or
loss on the sale of the target's stock would be available on P's pro forma federal return. Therefore,
when P sells T's stock, any gain or loss on the sale of the stock would not be recognized on P's pro
forma federal return, or in the starting point for computing P's entire net income pursuant to section
208.9 of the Tax Law. There is no modification under section 208.9 of the Tax Law that would
require P to recognize any gain or loss on the sale of T's stock.

-3­
TSB-A-99(22)C
Corporation Tax
September 14, 1999

However, if P would not be a selling affiliate pursuant to section 1.338(h)(10)(c)(4) of the
Treasury Regulations, then the provisions of TSB-M-91(4)C would apply. In that case, on P's pro
forma federal return, the election made under section 338(h)(10) of the IRC to exclude the gain or
loss on the sale of T's stock would not be available. The gain or loss on the sale of T's stock would
be recognized on P's pro forma federal return and in the starting point for computing P's entire net
income, but would be attributable to subsidiary capital and eliminated from P's entire net income
pursuant to section 208.9(a)(1) of the Tax Law.
Unlike Article 9-A of the Tax Law, which uses federal taxable income as the starting point
for computing entire net income, the provisions of Article 9 are not federally conformed. Under
Article 9 of the Tax Law, the definitions contained in the pertinent sections of Article 9 and
generally accepted accounting principles are applied.
In this case, with respect to T, a corporation that is taxable under Article 9 of the Tax Law,
the federal tax treatment of an election made under section 338(h)(10) of the IRC, whereby any
amount of gain or loss recognized upon a deemed sale of assets by the target corporation is
recognized by the target corporation, is not applicable when determining the franchise tax liability
of T. Any imputed gain attributable to the deemed sale of T's assets under the section 338(a) of the
IRC election would not be recognized under Article 9 of the Tax Law.

DATED: September 14, 1999

NOTE:

/s/
John W. Bartlett
Deputy Director
Technical Services Bureau

The opinions expressed in Advisory Opinions are
limited to the facts set forth therein.