Eliminating deferred gains from intercompany transactions
Later triggering of deferred gain will not occur
TAX ALERT |
Gains and losses on transactions between corporations in a federal consolidated group (Group) are deferred under the federal consolidated return regulations (Consolidated Regulations) rather than taxed immediately. The Consolidated Regulations protect companies from immediate federal income tax liability on gains deferred under these rules (Deferred Gains). Even so, the Deferred Gains may generate tax risk.
One potential tax risk presented by Deferred Gains is immediate state tax liability. The Deferred Gain may be subject to state income or franchise tax on a current basis if the company realizing the gain is subject to tax in a state that does not apply the federal Consolidated Regulations.
Another potential risk arises due to the potential for subsequently triggering federal taxation of the Deferred Gain. The Group generally will be required to track on an ongoing basis whether any event will occur (or has occurred) that triggers federal taxation of the Deferred Gain.
Deferred Gains can sometimes be eliminated before they are triggered, as was the case in a recent private letter ruling, PLR 201722012. Once a Deferred Gain is eliminated, there is no further need for the Group to track the Deferred Gain.
Creation and tracking of deferred gains
Transactions between Group members generally result in Deferred Gains (or Losses). As an example, where one company in the Group sells to a second Group member stock of a third Group member at a gain, a Deferred Gain arises. Federal income tax is not immediately imposed on the Deferred Gain. Instead, it generally would be imposed upon the occurrence of a triggering event. Returning to the intra-Group stock sale example, triggering events would include sale of the stock to a buyer outside of the Group, or departure of the seller (the first company) from the Group.
Triggering events may be expected in the ordinary course for some Deferred Gains. For example, Deferred Gain on a sale of goods from a manufacturing company’s inventory to a distributor within the same Group may be soon followed by a sale of the goods by the distributor to a customer who is not a member of the Group. In that case, the distributor’s sale would trigger the manufacturer’s Deferred Gain.
For other Deferred Gains, no triggering event is typically anticipated. A sale of stock between Group members, for example, may occur with no subsequent triggering transaction planned. In either case, the Consolidated Regulations require the Group to track the Deferred Gain until it is triggered or eliminated.
Eliminating a deferred gain
The Consolidated Regulations permit elimination of Deferred Gains (or Losses) under some circumstances. They expressly require Deferred Gain elimination, for example, as a result of specified intra-Group merger or liquidation transactions.
Some intra-Group restructuring transactions may differ from the ones specified and still merit Deferred Gain elimination treatment. For example, the transaction may differ from the Consolidated Regulations’ specifications by involving additional steps, or by accomplishing similar steps in a different order.
A Group undertaking this type of transaction may obtain a ruling from the IRS regarding elimination of the Deferred Gain. The Group that requested PLR 201722012 did this. The Group engaged in a restructuring that differed from the specific transactions described in the Consolidated Regulations but reached a similar result. The IRS ruled that the transactions eliminated a Deferred Gain that arose on a prior intra-Group sale of Group member stock.
PLR 201722012 illustrates elimination of Deferred Gains under the Consolidated Regulations. Eliminating a Deferred Gain relieves the Group of the burden of tracking the Deferred Gain further. For guidance regarding intercompany transactions and potential Deferred Gains associated with them, taxpayers should consult with their tax advisors.