Investment advisor ownership ignored for section 382 ownership testing
In an effort to limit loss trafficking, Congress enacted section 382 to limit the use of corporate NOLs following an ownership change. Section 382 limits a corporation's ability to utilize net operating losses (NOLs) following a change in ownership. If an ownership change occurs, the amount of the loss corporation's pre-change losses that may offset taxable income for a post-change tax year cannot exceed the section 382 limitation for such year as defined by section 382(b) with various adjustments. As defined within section 382(g), an ownership change occurs when the ownership of five-percent shareholders increases by more than 50 percentage points over the lowest percentage of stock owned by those shareholders at any time during the prior three-year testing period.
The issue in the ruling arose as a result of the taxpayer’s emergence from bankruptcy and their application of section 382(l)(5). Section 382(l)(5) is a taxpayer favorable provision for companies emerging from bankruptcy where the existing shareholders and/or qualified creditors retain control of the company post emergence. Pursuant to section 382(l)(5), the NOLs, after certain adjustments, avoid the section 382 limitation that would normally exist following an ownership change that would likely have severely limited the use of the taxpayer’s NOLs. However, the favorable result of section 382(l)(5) is lost in the event a second ownership change occurs within two years of the first change date, i.e., the date the company emerges from bankruptcy and the new capital structure is put in place. As a result, movement in ownership during the two-year period following emergence is critical to retaining the section 382(l)(5) benefit.
Where the taxpayer is a publicly traded company, presumptions as to five percent shareholders are generally based upon SEC Schedules 13D and 13G filings by five percent or greater shareholders. Private Letter Ruling 201902002 addressed the status of investment advisors as five percent shareholders for purposes of determining whether a change in ownership had occurred. While the analysis in the ruling was somewhat different than Private Letter Rulings 200747016, 201305001 and a number of similar rulings, the IRS affirmed their view on treatment of investment advisors and mutual funds reporting ownership with a common investment advisor (family of funds). The ruling confirmed the following:
- The taxpayer should look to the economic owner of the shares, i.e., the taxpayer with the rights to dividends and proceeds upon a sale or liquidation, as opposed to the beneficial owner, as such term is defined for SEC reporting of ownership on Schedules 13G and 13D. Note that the term beneficial owner generally has a different meaning for US tax purposes, wherein beneficial ownership means the holder of the benefits and burdens of ownership, which is much more in line with the economic owner concept utilized in section 382 and the rulings
- An acquisition of ownership by a family of funds based upon investment advice from a common advisor is not a coordinated acquisition unless the funds’ investment decisions are based on the decisions of the other funds.
The ruling addressed three reporting shareholders that were each investment advisors. The ruling affirmed the IRS view as to the treatment of investment advisor filings, which allowed the taxpayer to ignore the investment advisor as a five percent shareholder, thereby ignoring changes in shareholdings by the investment advisor and lessening the likelihood of a second ownership change. Based upon the SEC filings of each investment advisor and the taxpayers' representations that they were not aware of information to the contrary, the IRS ruled that none of the investment advisors for any member of the family of funds was a five percent shareholder despite the filing of Schedules 13G.
This ruling is good reminder to taxpayers of the necessity to carefully review Schedules 13D and 13G filings and the potential favorable outcomes in terms of avoiding a section 382 ownership change. For companies considering the use of trading restrictions or poison pill arrangements to avoid a change, understanding the status of your five percent reporting entities could limit the need to implement such a plan or provide flexibility to grant exceptions to investment advisors.
