Proposed built-in gain regulations now provided with transition rules
On Jan. 10, 2020, the Treasury Department and IRS proposed transition guidance on controversial proposed regulations that limit the ability of corporate taxpayers to utilize net operating losses (NOLs) following an ownership change, as defined in section 382. If finalized, the proposed regulations would significantly curtail the use of NOLs following an ownership change. These proposed regulations have been widely criticized and are viewed as taxpayer-unfriendly. To read our summaries of the proposed regulations and their expected impact on corporate taxpayers, see here and here. (See the Comment Letter we submitted to the Treasury Department and IRS.)
The transition guidance provided in the new proposed regulations is helpful to taxpayers, as compared to the prior proposal. However, the issuance of transition guidance perhaps signals that Treasury and the IRS are close to finalizing the taxpayer-unfriendly proposed regulations.
In proposing revised guidance, the IRS intends to ensure there is no gap between application of existing guidance and finalized regulations. In general, the final regulations would be applicable thirty days after publication of the final regulations in the Federal Register (the Delayed Applicability Date). The new proposed regulations are limited to two issues: (1) duplication of application of section 382 to section 163(j) deferred interest carryovers, and (2) transition relief.
Section 163(j) deferred interest carryovers
To address section 163(j)-related concerns, the new proposed regulations would provide a rule that any deferred interest otherwise deductible during the five-year recognition period following an ownership change would not represent recognized built-in loss. The preamble to the proposed rules states that this rule is not controversial and Treasury intends to finalize this piece prior to the finalization of the rest of the regulations.
While no one, outside Treasury and the IRS, knows when (or if) finalization of the larger package will occur, the language in the preamble implies that Treasury and the IRS understand the existing proposed rules are in fact controversial. Whether this means a more substantial rewrite of the proposed rules is underway is unclear, but perhaps there is hope that the final regulations will provide a more evenhanded set of rules for taxpayers.
In addressing transition relief, the new proposed regulations set out five exceptions for ownership changes occurring after the Delayed Applicability Date that will not be bound by the new regulations.
1. Binding agreement exception: Ownership changes occurring pursuant to a binding agreement entered into prior to the Delayed Applicability Date. For most corporate taxpayers not subject to SEC reporting rules, the binding agreement exception will provide the primary relief for a transaction closing after the Delayed Applicability Date. The term “binding agreement” is well established in tax law and should be administrable.
2. Public announcement exception: Ownership changes occurring pursuant to a transaction publicly announced on or before the Delayed Applicability Date.
3. SEC exception: Ownership changes occurring related to a transaction described in a securities and exchange commission (SEC) filing submitted on or before the Delayed Applicability Date.
4. Bankruptcy exception: Ownership changes occurring under a title 11 or similar bankruptcy transaction where the corporate debtor was before a court on or before the Delayed Applicability Date.
5. Private letter ruling exception: Ownership changes occurring in a transaction described in a private letter ruling request submitted on or before the Delayed Applicability Date.
The transition relief’s five exceptions are welcome news for those exploring an M&A transaction or stock issuance that may result in a change in ownership. These exceptions provide a window from now through the Delayed Applicability Date for corporate taxpayers to enter into excepted transactions and rely upon the existing (and more favorable) safe harbors of Notice 2003-65. (For more on Notice 2003-65, see the RSM summaries referenced above.) The issuance of the proposed built-in gain regulations has already resulted in significant discussions of highly structured transactions to alleviate the impact of the proposed rules. The combination of the Delayed Applicability Date rules and finalization of the existing unfavorable proposed regulations could accelerate M&A transactions or similar transaction resulting in an ownership change, as well as implementation of more non-economic transactions intended to enable utilization of NOLs prior to a change in ownership.
The newly proposed transition guidance, unlike the overall proposed section 382 built-in gain and loss regulations, appears both noncontroversial and sensible. The issuance of transition relief suggests finalization is not far away. However, the preamble to these proposed rules implies that Treasury and the IRS understand the controversial nature of their proposal and could suggest a more balanced set of rules is under development. Because the built-in gain rules of section 382 are both complicated and changing, taxpayers should consult a tax adviser when considering transactions that may implicate these rules.