The Internal Revenue Service issued a notice on April 13, 2009 providing guidance regarding 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 2009-38 reiterates and clarifies guidance that had previously been issued in Notice 2009-14 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 certain TARP programs. IRS notice 2009-38 also expands on Notice 2009-14 by providing related guidance for corporations participating in more-recently developed TARP programs.
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 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 CPP will not result in an ownership change for purposes of section 382. In January 2009, the IRS released Notice 2009-14, which amplified and superseded Notice 2008-100, by providing more detailed guidance to corporations whose instruments were issued to the Treasury under the initial purchase programs offered pursuant to EESA.
Notice 2009-38 reiterates much of the substance of Notice 2009-14, while providing additional guidance for corporations whose instruments are issued to the Treasury pursuant to TARP programs that were developed since the release of Notice 2009-14. The Notice provides guidance with respect to the following programs: (i) the Capital Purchase Program for publicly-traded issuers; (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; (v) the Asset Guarantee Program; (vi) the Systemically Significant Failing Institutions Program; (vii) the Automotive Industry Financing Program; and (viii) the Capital Assistance Program for publiclytraded issuers (TARP CAP) (collectively, the “Programs”). Pursuant to the Notice, taxpayers may rely on the following rules until further guidance is issued:
- Characterization of instruments (other than warrants) issued to the Treasury. Any instrument issued to the Treasury pursuant to any of the Programs except TARP CAP (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). Any instrument issued to the Treasury pursuant to TARP CAP will be characterized by applying general principles of federal tax law.
- Characterization of warrants issued to the Treasury. Warrants to purchase stock issued to the Treasury pursuant to any of the Programs except Private CPP and S Corp CPP (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 issued 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 issued 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).
- Value-for-value exchange. Any amount received by an issuer in exchange for instruments issued to the Treasury under the Programs shall be treated as received, in its entirety, as consideration for such instruments.
- 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 issued to 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.
- Certain exchanges. Paragraphs (C), (D), (E), and (F), but not paragraphs (A) and (B), apply to “Covered Instruments” as though such instruments were issued directly to the Treasury under the Programs. The term “Covered Instrument” means any instrument acquired by the Treasury in exchange for an instrument that was issued to the Treasury under the Programs, and also includes any instrument acquired by the Treasury in exchange for a Covered Instrument. Covered Instruments will be characterized by applying general principles of federal tax law.
Notice 2009-38 (and its predecessors, Notices 2008-100 and 2009-14) addresses only the Code section 382 impact of purchases by the Treasury Department under the Programs 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, but was in large part repealed by the American Recovery and Reinvestment Act of 2009. Pub. L. No. 111-5, § 1261 (2009).