CCA 201933009 (Aug. 16, 2019) had a lot of blanks spaces (literally) but reinforces the concept that the IRS takes a substance-over-form approach to determine whether a transaction invokes Reg. sections 1.1502-75(d)(2) and (d)(3) (the "reverse acquisition rules"), despite a change in a consolidated group’s common parent.
In the Advice, the consolidated group that created a new company in a foreign country, and subsequently entered into a merger, remained in existence despite those transactions.
The Transaction
On Date 1, Parent, the common parent of a consolidated group (the "Parent Group"), formed New Parent under the laws of Country A. New Parent made an initial election to be treated as a disregarded entity for U.S. federal income tax purposes. New Parent then formed Merger Sub on or after Date 1 but before Date 2.
On Date 2, Parent, New Parent and Merger Sub entered into an agreement with Third Party (the "Agreement").
Subsequently, New Parent made an election to be treated as an association for federal income tax purposes (the "New Parent Formation") that was effective on Date 6.
LLC1 also made an election to be treated as an association for federal income tax purposes (the "Sub 1 Formation") that was effective on Date 7.
Applicable law
In general, when a consolidated group acquires a target corporation or target consolidated group, the target’s tax year ends and the acquiring consolidated group continues. However, if the transactions invokes the reverse acquisition rules, the acquiring consolidated group ends and the target remains in existence.
Under Reg. section 1.1502-75(d)(3), a "reverse acquisition" generally occurs when one corporation (the first corporation) acquires the stock or substantially all the assets of another corporation (the second or target corporation) and the second corporation becomes a member of the consolidated group of which the first corporation is the common parent. If, immediately after the acquisition, the second corporation’s shareholders have a controlling interest (i.e., more than 50% of the fair market value) of the outstanding stock (including preferred stock) of the acquirer as a result of owning the target’s stock, the target corporation’s consolidated group remains in existence with the first corporation as the common parent. A transaction may qualify as a reverse acquisition whether it is a nontaxable or a taxable exchange.
Under Reg. section 1.1502-75(d)(2)(ii), a consolidated group may also remain in existence, if a member of a consolidated group becomes the new common parent succeeding to substantially all of the assets of the old common parent and the consolidated group otherwise remains intact. Whether one consolidated group remains in existence over another consolidated group has several important implications, including, inter alia, filing requirements and separate return limitation year rules.
In applying the reverse acquisition rules, the IRS has generally taken a substance-over-form approach in determining whether a consolidated group remains in existence after a change in common parent as illustrated by several rulings, including Rev. Rul. 82-152, 1982-2 C.B. 205 and GCM 39528 (July 14, 1986). Under these rulings, the IRS has held that despite the form of a transaction, a consolidated group will remain in existence where the consolidated group otherwise remains intact and/or the target consolidated group is larger (by value) than the acquiring corporation or consolidated group, though the common parent of the group may change. In Rev. Rul. 82-152 specifically, the Service determined that the consolidated group in substance continued to exist though the common parent of a consolidated group remained in existence. In that ruling, after a downstream merger in which a first-tier subsidiary became the new common parent, the old common parent remained in existence as a member of the same consolidated group. Under the explicit language of Reg. section 1.1502-75(d)(2)(ii), the old common parent must go out of existence. However, the IRS opined that since the consolidated group otherwise stayed intact the consolidated group remained in existence.
Conclusion
Without much in the way of analysis, the IRS generally ruled that the Parent Group continued to exist with New Parent as the new common parent of the Parent Group based on the consolidated return rules.
In reaching its conclusion, the Service laid out the reverse acquisition rules and several rules around timing of elections and joining and exiting a consolidated group. Presumably, the IRS treated New Parent as succeeding to Parent's assets, including the stock of the Parent Group as part of the New Parent formation after which the Parent Group survived with New Parent as the common parent. It is further presumed that the Service treated the Third Party’s acquisition of New Parent and the subsequent Sub 1 Formation as a reverse acquisition. Though the Transaction did not follow the letter of the rules, the IRS seemingly considered the Transaction to fall within the reverse acquisition rules in substance.
Because the Parent Group remained in existence, the Parent Group's tax year did not end at the time of the Transaction. As a result, the Parent Group with New Parent as the common parent was required to file a consolidated return through the end of the tax year in which the Transaction occurred.
Takeaway
The CCA reinforces the oft-cited principle that the IRS is willing to look at the substance of a transaction when determining whether the reverse acquisition rules apply.
Taxpayers should proceed with caution when engaging in the restructuring or acquisition of a consolidated group, in which the common parent ceases to exist or merely changes. We recommend that you consult with your tax advisor to consider the reverse acquisitions rules and the implications thereunder and whether a PLR may be available.
