Section 382 limits a loss corporation’s ability to use its tax net operating losses following an "ownership change."1 An ownership change is triggered if one or more "5-percent shareholders" of the loss corporation increases their ownership in the aggregate by more than 50 percentage points during a testing period. Once an ownership change has occurred, the amount of NOLS that the corporation may use to offset taxable income in any year is limited to the "Section 382 limitation" resulting from the ownership change.2
Built-In Gains and Notice 2003-65
Section 382(h)(1)(A) further provides that the annual limitation under Section 382(b) is increased to the extent a taxpayer with a net unrealized built-in gain (NUBIG) on the change date triggers recognized built-in gains (RBIG) during a post-change five-year "recognition period." Thus, in specific circumstances a taxpayer subject to an annual Section 382 limitation may be able to utilize pre-change NOLs in excess of the original annual limitation. The increased Section 382 limitation requires that the taxpayer have a NUBIG under Section 382(h)(3)(A) prior to the ownership change date.
NUBIG is measured under Section 382(h)(3)(A) as the difference between the fair market value and the adjusted tax basis of the taxpayer’s assets immediately before an ownership change. In addition, the calculated NUBIG must exceed a de minimis threshold under Section 382(h)(3)(B).3 In an attempt to provide some more clarity on calculating a NUBIG and other related issues, the IRS issued Notice 2003-65 (the Notice) as a form of interim guidance until regulations are promulgated.4 The Notice outlines two alternative approaches to identify built-in items under Section 382(h). The Section 338 hypothetical purchase approach (the 338 approach), uses a hypothetical purchase analysis to identify items of RBIG and Recognized Built-In Losses (RBIL). The Section 338 approach compares a loss corporation’s actual items of income, gain, deduction and loss with those that would have resulted if a Section 338 election had been made on a hypothetical purchase of the loss corporation’s stock on the change date.5
The District Court of Colorado recently ruled in favor of a taxpayer’s motion for summary judgment in an interesting case related to the application of the Notice in Vail Resorts Inc. v. U.S.6 The taxpayer, Vail Resorts, Inc. (Vail), filed claims for income tax refunds allegedly overpaid in tax years 2000 and 2001 by amending those tax returns for those years in 2004 and 2005, but the IRS denied Vail’s refund claims. As a result of a transaction in bankruptcy, Vail’s predecessor, GHI, had undergone an ownership change under Section 382(g) in 1991. Vail executed a closing agreement with the IRS for tax years 1995 through 1998 in 2003, prior to filing the amended returns, and including the amount of a significant net operating loss carryforward. Prior to the issuance of the Notice, Vail added RBIG to its Section 382 limitation only when it sold an asset at a gain during the recognition period. By applying the 338 Approach outlined in the Notice, Vail could treat assets as generating RBIG even if those assets were not actually sold but were instead constructively disposed of at a gain during the recognition period.7 As a result, Vail amended its 2000 and 2001 tax returns to increase the amount of RBIG it could recognize in those tax years and thus provided a greater available NOL in 2000 and 2001 under the Notice.
In the case, the IRS argues that since consolidated NOLs are present in the closing agreements with defined, fixed amounts attached to them, this must be taken to be a conclusively agreed-upon matter. Therefore, the IRS maintains that any tax amendment that would alter these fixed consolidated NOL values is foreclosed under the terms of the closing agreements and the finality provision contained in Section 7121(b). The District Court disagreed and found that the closing agreements did not fix the amount of the net operating loss carryforwards. Importantly, the court held that the Notice is clear that it can be applied retroactively at the discretion of the taxpayer. Since the parties did not fix the amount of NOL in the closing agreements, Vail was entitled to take advantage of the Notice to file an amended tax return and recover its overpaid taxes.
Although the case is primarily procedural, it does reaffirm the idea that loss corporations (or companies looking to acquire loss corporations) should carefully review the Notice as it applies not just to current ownership changes, but also to previous ownership changes no matter when they occurred. The District Court makes it clear that even in situations in which taxpayers may have entered into a closing agreement with the IRS, they may be able to take advantage of the Notice and gain additional access to the use of their NOLs.