The Internal Revenue Service issued a notice on January 30, 2009 addressing the tax treatment of certain programs under the Troubled Asset Relief Program (“TARP”) of the Emergency Economic Stabilization Act of 2008, Div. A of Pub. Law No. 110-343 (“EESA”). IRS Notice 2009-14 provides guidance regarding the impact of the Internal Revenue Code (the “Code”) section 382 net operating loss limitation rules on corporations that sell debt instruments, preferred stock, and warrants to the Treasury Department under the TARP Capital Purchase Program (“CPP”).
As a general matter, section 382 of the Code limits a corporation’s ability to deduct losses incurred before an “ownership change” against post-change corporate income. An “ownership change” is deemed to occur if there has been an increase of more than 50 percentage points in the amount of “stock” held by shareholders holding at least five percent of the corporation’s stock (determined by comparing such shareholders’ ownership percentage at the time of the change with the lowest percentage of stock owned at any time during the applicable testing period).
The “stock” that is considered for purposes of section 382 includes all stock other than so-called “pure preferred stock” under section 1504(a)(4) of the Code (stock that is non-voting, limited, and preferred as to dividends, limited as to redemption and liquidation rights and nonconvertible). “Pure preferred stock” is ignored for purposes of determining whether there has been an “ownership change” with respect to the corporation (however, such stock is counted for purposes of determining the value of the loss corporation). Options are generally deemed to be exercised and thus considered to be “stock” owned by the holder if that ownership would trigger an ownership change.
The section 382 limitation is determined by multiplying the long-term tax-exempt rate applicable at the change date by the equity value of the corporation immediately before the ownership change. For purposes of calculating the loss corporation’s equity value, section 382(l)(1) provides that certain capital contributions made as part of a plan to avoid or increase the section 382 limitation are disregarded.
It was initially unclear how acquisitions by the Treasury pursuant to the CPP would impact the application of the section 382 rules described above. In October 2008, the IRS released Notice 2008-100, which generally provided that purchases of stock by the Treasury under the CPP will not result in an ownership change for purposes of section 382.
IRS Notice 2009-14 amplifies and supersedes Notice 2008-100, by providing more detailed guidance to corporations whose instruments are acquired through purchase programs under EESA. The Notice provides guidance with respect to the following purchase programs: (i) the Capital Purchase Program for publicly-traded issues (“Public CPP”); (ii) the Capital Purchase Program for private issuers (“Private CPP”); (iii) the Capital Purchase Program for S corporations (“S Corp CPP”); (iv) the Targeted Investment Program (“TARP TIP”); and (v) the Automotive Industry Financing Program (“TARP Auto”) (collectively, the “Programs”). Pursuant to the Notice, taxpayers may rely on the following rules until further guidance is issued:
- Treatment of indebtedness and preferred stock acquired by the Treasury. Any instrument issued to the Treasury pursuant to the Programs (whether owned by the Treasury or subsequent holders) will be treated as an instrument of indebtedness if denominated as such, and as “pure preferred stock” if denominated as preferred stock. In other words, instruments denominated as indebtedness or preferred stock are not treated as stock under section 382. However, preferred stock will be treated as stock for purposes of determining the value of the old loss corporation under section 382(e)(1).
- Treatment of warrants acquired by the Treasury. Warrants to purchase stock acquired by the Treasury pursuant to the Public CPP, TARP TIP, and TARP Auto (whether owned by the Treasury or subsequent holders) will be treated as options and not as stock. While held by the Treasury, such warrants will not be deemed exercised for purposes of determining whether there has been an ownership change under section 382. Warrants acquired pursuant to the Private CPP will be treated as an ownership interest in the underlying stock, which will be treated as pure preferred stock. Warrants acquired pursuant to the S Corp CPP will be treated as an ownership interest in the underlying indebtedness (and therefore will not affect the validity of the corporation’s S election).
- Section 382 treatment of stock acquired by the Treasury. For purposes of section 382, the purchase of stock (other than preferred stock) by the Treasury pursuant to the Programs will not be treated as an increase in the Treasury’s ownership in the loss corporation over its lowest percentage of stock owned on any earlier date.
- Section 382 treatment of redemptions of stock from the Treasury. Shares acquired and held by the Treasury pursuant to the Programs and then later redeemed by the issuing corporation will be treated as if they were never outstanding for purposes of determining ownership changes on the date of the redemption or any subsequent testing date. However, shares acquired by the Treasury generally will be treated as outstanding for purposes of determining changes in ownership by other five percent shareholders.
- Section 382(l)(1) not applicable with respect to capital contributions made by the Treasury. Any capital contribution made by the Treasury pursuant to the Programs will not be considered to have been made as part of a plan to avoid or increase the section 382 limitation.
Notice 2009-14 (and its predecessor, Notice 2008-100) addresses only the Code section 382 impact of purchases by the Treasury Department under the CPP and is thus separate from the more general guidance issued by the IRS last fall in Notice 2008-83. That Notice provided relief for banks from section 382 for losses and deductions incurred following an ownership change. Although the economic stimulus bill approved by Congress contains a provision that would repeal Notice 2008-83, Notice 2009-14 would be unaffected by this provision (H.R. 1, 111th Cong. § 1261 (as passed by Congress, Feb. 13, 2009)).