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September 22, 2021

Reconciliation bill approved by Ways & Means committee contains proposals affecting corporate M&A

Recently proposed tax provisions in the Build Back Better Act reconciliation bill, which were approved by the House Ways & Means Committee, would make changes relating to taxable liquidations, securities exchanges in spin-offs and dividends from acquired controlled foreign corporations (CFCs). The House Ways & Means Committee also released a section-by-section summary of the provisions.

IRC Section 331 liquidation losses

In an IRC Section 331 liquidation, amounts received by a shareholder in a distribution completely liquidating a corporation are treated as full payment in exchange for stock. This generally results in the shareholder recognizing capital gain or loss pursuant to the liquidation. The liquidating corporation recognizes gain or loss on the distributed assets under IRC Section 336. Under IRC Section 267, loss from property sales or exchanges among certain related parties are either disallowed or deferred; however, in its current form, IRC Section 267 does not apply to a distributing corporation's or a distributee shareholder's loss in the case of a distribution in complete liquidation.

The W&M proposal would amend IRC Section 267 by adding new IRC Section 267(h), which would defer losses on the stock or securities of the liquidating corporation arising from an IRC Section 331 liquidation between related corporations. The loss would be deferred until the corporate shareholder that received property in the liquidation (or that received property in exchange for securities of the liquidating corporation) has disposed of substantially all the property it received to an unrelated party. The W&M proposal would also direct Treasury to write regulations necessary or appropriate to carry out the provision, including requiring loss deferral in the case of a corporation that owns an interest in a subsidiary through a partnership. This proposal would apply to liquidations on or after the date of enactment.

Implications: This proposal appears to target "Granite Trust Planning," so-named for a 1956 case in which the First Circuit Court of Appeals endorsed the ability of taxpayers to plan in to, or out of, taxable liquidation treatment by restructuring a corporation's ownership. Pursuant to such planning, taxpayers may be able to accelerate losses in a subsidiary's stock through a transfer of a portion of the stock to a related party and a subsequent subsidiary liquidation, thereby triggering a capital loss. The W&M proposal would effectively remove the longstanding ability to trigger a capital loss on subsidiary stock while retaining the underlying assets and activities of the subsidiary within the worldwide group of corporations. The proposal would apply regardless of whether the taxpayer took affirmative steps to cause an IRC Section 331 liquidation instead of a tax-free IRC Section 332 liquidation. That is, the proposal applies to all IRC Section 331 liquidations, regardless of whether the shareholding structure is longstanding — "old and cold" — or the result of relatively recent "Granite Trust" tax planning. The W&M proposal, however, would not apply to stock loss arising from worthlessness under IRC Section 165(g) (including ordinary stock loss under IRC Section 165(g)(3)), or to the "inside" loss recognized by the liquidating corporation under IRC Section 336.

The proposal would go further than deferring loss with respect to stock of a liquidating subsidiary. Curiously, the W&M proposal would apply to loss recognized on the creditor position of debt securities of a liquidating corporation too, even though this is outside the scope of IRC Section 331, and current Treas. Reg. Section 1.332-7 affirmatively allows loss on such debt securities in the case of an otherwise tax-free IRC Section 332 liquidation. In many cases, however, if there is a loss on the debt of the liquidating corporation, the stock of the corporation may be worthless, causing the transaction to be governed by IRC Section 165(g) and not IRC Section 331, so the transaction would not be subject to the deferral required by the W&M proposal.

To further underscore the broad sweep of the W&M proposal, it appears that deferral would also be required where a subsidiary corporation sells all of its assets and then completely liquidates, distributing only cash to its shareholders. Given the fungibility of cash, taxpayers that realize and recognize a loss in such a complete liquidation could expect significant administrative challenges in determining whether or when they have "disposed of" — to one or more unrelated persons — substantially all of "the property" they received. In such a case, taxpayers would have to structure and sequence their transactions to avoid this difficulty.

Treatment of a securities exchange in divisive transactions

The W&M proposal would change a distributing corporation's treatment of securities of a controlled corporation under IRC Section 361 in a divisive reorganization under IRC Sections 355 and 368(a)(1)(D) (e.g., a spin-off). A common spin-off transaction involves a corporation (the distributing corporation) (1) transferring active trade or business property to an existing or newly-formed controlled corporation, (2) in exchange for all of the controlled corporation stock and the assumption of associated liabilities, (3) followed by the distribution of all, or at least 80%, of the controlled corporation stock to the distributing corporation shareholders.

Under current law, a distributing corporation may receive debt securities of the controlled corporation and transfer these controlled securities to the distributing corporation's creditors (i.e., a securities exchange), without recognizing gain on the asset transfer to the controlled corporation or on the subsequent transfer to creditors, and without such nonrecognition treatment being limited by the basis in assets transferred by the distributing corporation to the controlled corporation. This favorable treatment for a securities exchange can be contrasted with economically similar transactions with respect to which nonrecognition treatment is basis-limited. For example, if (1) the controlled corporation assumes debt owed by the distributing corporation, or (2) the controlled corporation borrows and distributes the borrowed cash to the distributing corporation, which in turn uses such cash to repay its creditors, the amount of debt assumption in (1), or the amount cash distributed in (2), is (in aggregate) limited to the basis in assets transferred from the distributing corporation to the controlled corporation. Unlike in a securities exchange (which is not basis-limited under current law), the distributing corporation recognizes gain to the extent of any excess debt assumption or cash distribution. The W&M proposal would add a new subsection (d) to IRC Section 361, apparently intended to treat controlled corporation debt securities that are transferred to distributing corporation creditors in a manner similar to money or other property (boot). This treatment would result in the boot being limited by the adjusted basis of assets transferred by the distributing corporation to the controlled corporation (i.e., causing a securities exchange to also be basis-limited). In addition, non-qualified preferred stock (NQPS) of the controlled corporation would be taken into account for purposes of determining the amount of boot that could be distributed to the distributing corporation's creditors.

In particular, the distributing corporation would recognize any realized gain to the extent that the sum of the following amounts exceeds the basis of assets transferred to the controlled corporation:

  1. Amount of liabilities assumed by the controlled corporation;
  2. Amount of money and "other property" (including "nonqualified preferred stock" of the controlled corporation) transferred by the distributing corporation to its creditors, in the case of transfers of boot to creditors under IRC Section 361(b)(3); and
  3. The total principal amount of debt securities of the controlled corporation treated as qualified property, transferred to the distributing corporation creditors, in the case of transfers of controlled debt securities to creditors under IRC Section 361(c)(3).

This proposal would apply to reorganizations after the date of enactment.

Implications: This proposal would reduce financing options for certain divisive transactions. It appears intended to limit the amount of debt securities that may be issued by a controlled corporation in a divisive reorganization used to pay off or pay down debt of the distributing corporation. This result would come from requiring gain to be recognized by a distributing corporation to the extent the principal amount of controlled debt securities (along with the other property described above) exceeds the basis of assets transferred to the controlled corporation. That is, the amount of controlled corporation debt securities that may be received without gain recognition by a distributing corporation in a divisive reorganization under IRC Section 368(a)(1)(D) would be treated similarly to the receipt of boot by a distributing corporation or the assumption of distributing corporation liabilities. Some sort of coordinating or allocating mechanism may be required, under the proposal, for a divisive reorganization that involves a combination of boot subject to IRC Section 361(b)(3) and debt securities subject to IRC Section 361(c)(3), particularly where controlled corporation NQPS is also issued.

In summary, a securities exchange has been a common technique to allocate the distributing corporation's debt between the distributing corporation's business and the controlled corporation's business without being basis-limited, and the proposal would diminish the benefits of that technique.

Dividends from acquired CFCs

The W&M proposal would add new IRC Section 1059(g), which would require US shareholders to reduce their basis in CFC stock (and potentially recognize gain) upon receipt of CFC dividends paid out of earnings and profits earned (or attributable to gain on property that accrued) before the CFC was a CFC or before it was owned by a 10% US shareholder.

Under new IRC Section 1059(g), any disqualified CFC dividend would be treated as an extraordinary dividend regardless of the taxpayer's holding period in the stock. Additionally, it would define a "disqualified CFC dividend" as any dividend paid by a CFC to a US shareholder if that dividend is attributable to earnings generated in, or asset gain accrued in, the disqualified period. IRC Section 1059(g) also would define "disqualified period" as any period during which the foreign corporation was not a CFC or its stock was not owned by a US shareholder. The W&M proposal would redesignate the authority to issue regulations as IRC Section 1059(h). This proposal would apply to distributions made after the date of enactment.

Implications: This proposal appears intended to ensure that earnings and profits (E&P) of a foreign corporation that accrued when such corporation was not a CFC or otherwise not held by a US shareholder cannot give rise to tax-free income to a US shareholder. Without this proposal, the acquisition by a US corporation of a foreign target with untaxed E&P could allow the US corporate acquiror to later dispose of the foreign target at a gain (assuming the foreign target appreciated in value while held by the US corporate acquiror) without paying tax, because the pre-acquisition E&P of the foreign target could be eligible for the IRC Section 245A 100% dividends received deduction (DRD) upon distribution of a dividend. The proposal would also prevent the US corporate acquiror from realizing loss on a future disposition of the foreign target by reason of stripping out dividends eligible for IRC Section 245A. In many (but not all) cases, current law, however, prevents realizing a loss through the impact of IRC Section 961(d), which reduces basis by the amount of the IRC Section 245A DRD taken, for purposes of computing the US corporate shareholder's loss on disposition of foreign corporation stock.


Contact Information
For additional information concerning this Alert, please contact:
National Tax M&A Group - International Tax and Transaction Services
   • Donald Bakke (
   • Marc Countryman (
   • Andrew Herman (
   • Andrew Dubroff (