TECHNICAL ASSISTANCE ADVISORY95-003
SUBJECT:WVCNIT -- In an I.R.C. § 338(h)(10) transaction with deemedliquidation under § 332, the West Virginia net operatinglosses of target subsidiaries flow through to their former parentcorporation.
This is in reply to your recent letter requestingon behalf of your client, XYZ Company, issuance of a technicalassistance advisory under W. Va. Code § 11-10-5r, regardingthe West Virginia Corporation Net Income Tax ("WVCNIT")treatment of the transaction described below.
Prior to a date certain in 1994, after January 19,1994, XYZ Company had no ownership interest in ABC Holding Company,a Delaware corporation or in DEF Company, a Delaware corporation.
Also prior to January 1, 1994, ABC Company ownedthe following subsidiaries: Subsidiary "A", Subsidiary"B", Subsidiary "C", and Subsidiary "D". Each of these subsidiaries filed separate WVCNIT returns. Overthe last several years, Subsidiaries "B", "C",and "D" incurred substantial West Virginia net operatinglosses (WVNOLs) that have not expired and are to be carried forward.
The following sequence of transactions occurredon a date certain in 1994, after January 19, 1994:
1. XYZ Company purchased, for cash, all of thestock of ABC Holding Company and Subsidiary "A".
2. ABC Holding Company sold the stock of Subsidiaries"B", "C", and "D" to an unrelatedthird party in an I.R.C. § 338(h)(10) transaction. Pursuantto this transaction, the federal net operating loses of Subsidiaries"B", "C", and "D" were transferredto ABC Holding Company.
3. ABC Holding Company and Subsidiary "A"were merged into ABC Holding Company. ABC Holding Company isthe surviving corporation.
4. ABC Holding Company sold interests in West Virginiaand Kentucky real estate formerly held by Subsidiary "A"to an unrelated third party at a substantial gain.
ABC Holding Company will file a WVCNIT returnreflecting (as appropriate) the first, third and fourth transactionsthat occurred on a date certain in 1994, after January 19, 1994,as follows:
a. XYZ Company's purchase of the stock of ABC HoldingCompany and Subsidiary "A" does not create a directWVCNIT consequence to either ABC Holding Company or to Subsidiary"A".
b. The merger of Subsidiary "A" intoABC Holding Company is a tax-free, parent-subsidiary liquidationunder I.R.C. § 332 for federal income tax purposes. Themerger does not create taxable income (or taxable loss) for federalincome tax purposes. The transaction will receive similar non-recognitiontreatment for WVCNIT purposes because the starting point for determiningWest Virginia taxable income for WVCNIT purposes is federal taxableincome, W. Va. Code § 11-24-6(a). See also, W. Va.Code § 11-24-3(a) (incorporating federal definitions forWVCNIT purposes).
c. ABC Holding Company's sale of West Virginialand formerly held by Subsidiary "A" generates capitalgains which are allocated to West Virginia for WVCNIT purposesto the extent the capital gains are considered "nonbusinessincome" or are apportioned to the extent the gains are businessincome. W. Va. Code § 11-24-7.
This technical assistance advisory focuses on theWVCNIT consequences of the second transaction that occurred ona date certain in 1994, after January 19, 1994 -- ABC HoldingCompany sells stock of Subsidiaries "B", "C",and "D" to an unrelated third party, and the partiesmake an I.R.C. § 338(h)(10) election for federal income taxpurposes with respect to the sale.
The issue presented for ruling is: What is the effectof the I.R.C. § 338(h)(10) election for WVCNIT purposes.
When a section 338(h)(10) election is made for federalincome tax purposes, the target generally is deemed to sell allof its assets and distribute the proceeds in complete liquidation. Thus, the sale of target stock included in the qualified stockpurchase generally is ignored. A section 338(h)(10) electionmay be made for a target only if it is a member of a selling consolidatedgroup, a member of a selling affiliated group filing separatereturns, or an S corporation. See Treas. Reg. § 1.338(h)(10-1(a)).
There are certain consequences of a section 338(h)(10)election for federal income tax purposes. First, Old T recognizesgain or loss as if, while Old T was a member of the selling consolidatedgroup (or owned by the selling affiliate or S corporation shareholders)it sold all of its assets in a single transaction at the closeof the acquisition date (but before the deemed liquidation). Old T's gain or loss on each asset is determined under paragraph1.338(h)(10)-1(f). If P makes a qualified stock purchase froma selling affiliate or S corporation shareholders, the principlesof §§ 1.338-1(c)(6) and (e)(1), (5), and (6)(i) applyto the return filed by old T that includes the gain or loss andtaxability from the deemed sale. See Treas. Reg. §1.338(h)(10)-1(e)(2).
Second, for purposes of this subtitle A of the InternalRevenue Code, Old T is treated as if, while T was a member ofthe selling consolidated group (or owned by the selling affiliateor S corporation shareholders), it distributed all of its assetsin complete liquidation. See section 331 or 332 for gain or lossrecognized by the Old T shareholders as a result of the deemedliquidation. See Treas. Reg. 1.338(h)(10)-1(e)(2)(ii).
Third, no gain or loss is recognized on the saleor exchange by the selling consolidated group (or the sellingaffiliate or an S corporation shareholder) of T stock includedin the qualified stock purchase. See Treas. Reg. §1.338(h)(10)-1(e)(2)(iv).
Under I.R.C. § 381(a), the acquisition of assetsof a corporation by another corporation in a transaction to whichI.R.C. § 332 (relating to liquidation of subsidiaries) applies,the acquiring corporation succeeds to and takes into account asof the close of the day of the distribution of transfer, the itemsdescribed in subsection 381(c) of the distributor or transferorcorporation, subject to the conditions and limitations specifiedin subsections 381(b) (operating rules) and (c) (items of distributoror transferor). One item listed in subsection 381(c) is net operatingloss carryovers. I.R.C. § 381(c)(1).
In summary, under I.R.C. § 338(h)(10), theparties in a taxable stock acquisition transaction may elect totreat the stock purchase as a deemed asset sale by the targetcorporation and the target's former parent may further treat thetransaction as a § 332 deemed liquidation of the target intothe target's former parent. "An election under § 338(h)(10)preserves the target's tax attributes (e.g., loss carryovers)for the benefit of the selling parent corporation, which inheritsthose attributes in the deemed § 332 liquidation of the target-subsidiary." Bittker & Eustice, Federal Income Taxation of Corporationsand Shareholders ¶ 10.42 (6th ed. 1994).
The Tax Commissioner will assume, for purposes ofthis technical assistance advisory, that ABC Holding Company'ssale of the stock of Subsidiaries "B", "C",and "D" to an unrelated third party will be treated,for federal income tax purposes, as a 338(h)(10) transaction witha section 332 deemed liquidation of the target subsidiaries intoABC Holding Company. The Tax Commissioner further assumes thatthe federal net operating loss carryovers of the target corporationsare one of the tax attributes that flowed to ABC Holding Company,the parent corporation, under I.R.C. § 381.
The WVCNIT law and regulations are silent on theeffect an I.R.C. § 338(h)(10) election has for WVCNIT purposes,and no technical assistance advisory or other written guidancehas been published by the Tax Commissioner.
Because federal taxable income is the starting pointfor determining West Virginia taxable income, the WVCNIT is generallycharacterized as a "conformity" law. Accordingly, inthe absence of a statutory adjustment to federal taxable income,to the extent a § 338(h)(10) election affects a taxpayer'sfederal taxable income, taxpayer's West Virginia taxable incomeis likewise affected. To the extent other federal tax attributesare affected by a § 338(h)(10) election, WVCNIT attributesare likewise affected.
W. Va. Code § 11-24-6(b)(7) provides that theamount of any net operating loss deduction taken for federal incometax purposes under I.R.C. § 172 must be added back to federaltaxable income,
when determining West Virginia taxable income.
When a corporation incurs a West Virginia net operatingloss in a taxable year ending after June 30, 1988, subsection11-24-6(d) allows that loss to be carried back 3 years and carriedforward 15 years in accordance with the rules of I.R.C. §172. Adjusted federal taxable income for the year is therebyreduced by the amount of the WVNOL deduction.
Subsection 11-24-6(d) reads, in relevant part:
(d) Net operating loss deduction. -- Exceptas otherwise provided in this subsection, there shall be allowedas a deduction for the taxable year an amount equal to the aggregateof (1) the West Virginia net operating loss carryovers to suchyear plus (2) the net operating loss carrybacks to such year. For purposes of this subsection, the term "West Virginianet operating loss deduction" means the deduction allowedby this subsection, determined in accordance with section 172of the Internal Revenue Code of 1986, as amended.
(1) Special rules:
(A) When the corporation further adjusts its adjustedfederal taxable income under section seven of this article, theWest Virginia net operating loss deduction allowed by this subsection(d) shall be deducted after the section seven adjustments aremade;
(B) The tax commissioner shall prescribe suchtransition regulations as he deems necessary for fair and equitableadministration of this section as amended by this act [W.Va. Acts1988, c. 119].
(2) Effective date. -- The provisions ofthis subsection (d), as amended by this act [W.Va. Acts 1988,c. 119], shall apply to all taxable years ending after the thirtiethday of june, one thousand nine hundred eighty-eight; and to allloss carryovers from taxable years ending on or before said thirtiethday of June.
In particular, the WVNOL's of the target corporations(Subsidiaries "B", "C", and "D"are preserved as WVNOL's of the targets' former parent, as a resultof the deemed § 332 liquidation of the targets into theirformer parent for federal income tax purposes.
Here, ABC Holding Company succeeds to the WVNOL'sof Subsidiary "A", "B", and "C". This result is consistent with the federal treatment of net operatinglosses and other tax attributes. See Bittker & Eustice,supra. Without this result, the parties would be forcedto treat WVNOL's substantially different than other tax attributeswithout legislative authority or administrative rationale.
After due consideration of the facts presented andapplication of current law, we make the following rulings:
When a parent corporation sells the stock of itswholly owned subsidiary to an unrelated third party and the partiesmake an election under I.R.C. § 338(h)(10) to treat the transactionas a sale of assets to the purchaser, rather than as a sale ofstock, and there is a deemed liquidation of the target subsidiaryinto its former parent under I.R.C. § 332, the tax attributesof the subsidiary flow to the former parent under I.R.C. §381, due to the § 332 liquidation election, and any similarWVCNIT attributes will similarly flow to the parent.
The conclusions reached in this technical assistanceadvisory are based upon the facts submitted and application ofcurrent law. In the event there is a material change in the facts,or if it is determined that material facts were omitted or arematerially different from those furnished to us for purposes ofthis ruling, or there is a material change in the applicable law,the conclusions reached in this advisory may no longer apply.
Precedential Value --Under W. Va. Code § 11-10-5r(b), a technical assistance advisoryhas no precedential value except to the taxpayer who requeststhe advisory, unless the Tax Commissioner specifically statesthat it has precedential value. Taxpayers are advised that thistechnical assistance advisory may be relied upon when an electionunder I.R.C. § 338(h)(10) and deemed liquidation under I.R.C.§ 332 affect their taxable income for federal income taxpurposes.
Publication. -- UnderW. Va. Code § 11-10-5r(e), the Tax Commissioner is requiredto release technical assistance advisories to the public afterthey are modified to delete identifying characteristics, unlessthe taxpayer waives its right to confidentiality. This technicalassistance advisory will be released as Technical Assistance Advisory95-003.
If you have any question about this advisory, pleasecontact this office.
Issued: May 15, 1995 James H. Paige III