On March 4, 2011, the Treasury issued T.D.9515, containing final regulations on the treatment of certain intercompany gains with respect to stock owned by members of a consolidated group. The regulations provide for the redetermination of intercompany gain excluded from gross income in certain transactions involving stock transfers between members of a consolidated group. The temporary regulations portion of T.D. 9515 were included solely for the purpose of retaining the portion of the existing temporary regulations that are not being promulgated as final regulations at this time.  As background, on March 7, 2008, the IRS and the Treasury Department published temporary regulations § 1.1502-13T. See TD 9383, 2008-15 IRB 738. Also on March 7, 2008, the IRS and the Treasury Department published a notice of proposed rulemaking cross-referencing those temporary regulations. See REG-137573-07, 2008-15 IRB 750.

The 2008 temporary regulations addressed the treatment of certain intercompany gain with respect to consolidated group member stock. Treas. Reg. Section 1.1502-13 provides rules governing the timing and characterization of items resulting from transactions between consolidated group members. Treas. Reg. Section 1.1502-13(c) provides general rules under which the timing and character of those items can be deferred or recharacterized to clearly reflect the taxable income (and tax liability) of the group as a whole. These rules, in general, require application of a  “matching” principle under which the timing of inclusion of gain on the sale of property by the seller is linked to the buyer's recovery of its basis in the property and the seller’s and the buyer’s characterization are subject to redetermination in order to treat both seller and buyer as divisions of a single corporation.

The proposed regulations provide that intercompany gain with respect to member stock may be permanently excluded from gross income following certain stock basis elimination transactions such as in a tax-free spin off or section 332 liquidation. The IRS and the Treasury Department, in issuing the final regulations, reconsidered the requirement contained in the proposed regulations that, immediately before intercompany gain would otherwise be taken into account, the common parent  must be the member that holds the member stock with respect to which the intercompany gain was realized, and that the gain must be common parent’s intercompany item. Given the other requirements of the regulation, namely that (i) the group has not and will not derive any Federal income tax benefit from the intercompany transaction; and (ii) the excluded gain will not be treated as tax-exempt income for purposes of the investment adjustment regulations—it is appropriate to provide relief where a member other than the common parent holds the subject stock. The final regulations, therefore,  allow the exclusion of gain where a member holds the target member stock with respect to which the intercompany gain was realized, and the holding member is either (i) the buyer or seller, as a successor to the other party (either buyer or seller); or (ii) a third member that is the successor to both the buyer and seller corporate members.  

Previously, the preamble to the proposed regulations requested comments as to whether the “Commissioner's Discretionary Rule” ( Treas. Reg. Section 1.1502-13(c)(6)(ii)(D)) should be retained. The preamble also stated that the IRS and Treasury Department were considering eliminating the Commissioner's Discretionary Rule. Upon further consideration, T.D. 9515 states there may be circumstances where application of such discretion is warranted. Thus, for example, the final regulations do not provide automatic relief for transactions involving property other than member stock (such as the stock of non-members), but relief may be available after review by the IRS under the Commissioner's Discretionary Rule. The final regulations retain the Commissioner's Discretionary Rule in a form revised to describe the conditions to be satisfied for that discretion to be exercised, and to indicate that relief is available only through a request for a letter ruling. Finally, the final regulations provide that excluded gain is not treated as tax exempt income for purposes of  Treas. Reg. Section  § 1.1502-32 and does not increase earnings and profits.

An example from the final regulations is quoted.  

“ Example 16. Intercompany stock distribution followed by section 332 liquidation. (a) Facts. P owns all of the stock of S, S owns all the stock of T, a member of the P group, and T owns all of the stock of T1, also a member of the P group. On January 1 of Year 1, S distributes all of the T stock to P in a distribution to which section 301 applies. At the time of this distribution, the value of the T stock is $100 and S has a $40 basis in the T stock. Under section 311(b), the distribution creates $60 of intercompany gain to S. Under section 301(d), P's basis in the T stock is $100. S will take its $60 intercompany gain into account under the matching rule. On January 1 of Year 4, in an independent transaction, S distributes all of its assets to P in a complete liquidation to which section 332 applies, and, under paragraph (j)(2) of this section, P succeeds to S's $60 gain. On January 1 of Year 7, T distributes all of its T1 stock to P in a transaction to which  section 355 applies. At the time of this distribution, P has a basis in the T stock of $100, the value of the T stock (without regard to T1) is $75, and the value of the T1 stock is $25. Under section 358, P allocates $25 of its $100 basis in the T stock to the T1 stock, and, under paragraph (j)(1) of this section, the T1 stock becomes a successor asset to the T stock. On January 1 of Year 9, in an independent transaction, T distributes all of its assets to P in a complete liquidation to which section 332 applies.

(b) Analysis. Under paragraphs (b)(1) and (f)(2) of this section, S's distribution in Year 1 of the T stock to P is an intercompany transaction, S is the selling member, and P is the buying member. In Year 9 when T liquidates, P has no gain or loss under section 332. Under paragraph (b)(3)(ii) of this section, P's $0 gain or loss with respect to the T stock under section 332 is a corresponding item. P takes $45 (75/100 × $60) of its intercompany gain into account under the matching rule in Year 9 to reflect the difference between P's $0 of unrecognized gain and P's $45 of recomputed unrecognized gain. (If P and S were divisions of a single corporation, P would have had a $40 basis in the T stock, and, after the Year 7 distribution of the T1 stock, would have held the T stock with a $30 basis.) However, paragraph (c)(6) of this section does not prevent the redetermination of P's intercompany gain as excluded from gross income provided P succeeds to S's intercompany item; P and S are a single entity; P's basis in the T stock that reflects the $45 intercompany gain taken into account is eliminated without the recognition of gain or loss (and this eliminated basis is not further reflected in the basis of any successor asset); the group has not derived and no taxpayer will derive any Federal income tax benefit from the basis in the T stock and will not derive any Federal income tax benefit from a redetermination of this portion of the gain; and the effects of the intercompany transaction have not previously been reflected, directly or indirectly, on the P group's consolidated return. (See paragraph (c)(6)(ii)(C) of this section.) Accordingly, under paragraph (c)(6)(ii)(C) of this section, the $45 intercompany gain that P takes into account is redetermined to be excluded from gross income. P's basis in its T1 stock continues to reflect $15 of intercompany gain.”