In another recent private letter ruling,19 the IRS ruled that an ownership change pursuant to a bankruptcy reorganization plan qualified for an exception to the general rule limiting net operating loss ("NOL") carryforwards under Section 382(a).

The transaction at issue concerned a reorganization of a holding company, the common parent of an affiliated group of corporations that filed a consolidated federal income tax return. As part of the reorganization, the parent holding company’s creditors became equity owners — an ownership change under Section 382 of the Code. The parent’s principal operating subsidiary, which did not declare bankruptcy, carried on a business in a regulated industry.

However, to preserve the parent corporation’s net operating losses, the bankruptcy court approved a stock and claims trading order that provided for various requirements designed to allow the parent corporation’s plan of reorganization to fall within the scope of Section 382(l) (5), the so-called “bankruptcy exception” to the NOL loss limitation rules set forth in Section 382(a).

Typical of reorganizations designed to maintain NOLs, the trading order contained the following provisions: 1) requirement that substantial equity holders provide notice of their ownership percentage to the parent company; 2) requirement that substantial equity holders notify the bankruptcy court of any transaction that would increase or decrease their ownership of the parent; 3) right of the parent company to file a reporting notice with the bankruptcy court, requiring any claimholder to report its holdings; and, 4) option by the parent company to file a request for a “sell-down” order with the bankruptcy court, authorizing the parent company to require claimholders to sell down a certain percentage of their claims (ostensibly to meet the 5% stock ownership cutoff under Section 382).

After reviewing the salient features of the parent company’s trading order and plan of reorganization, the IRS determined that the change in ownership resulting from the bankruptcy reorganization, although an ownership change for purposes of Section 382(a), would nonetheless qualify for the bankruptcy exception under Section 382(l) (5). As a result, the parent company’s NOLs would not be subject to an NOL loss limitation upon exit from bankruptcy.

The IRS also ruled that because the parent’s operating subsidiary maintained its operations throughout the bankruptcy, the subsidiary’s activities qualified as a significant active trade or business of the parent group for purposes of Treasury Regulation Section 1.269-3(d), which provides that in the absence of a significant active trade or business during and subsequent to the bankruptcy, the IRS is authorized to disallow the benefits (i.e., NOL preservation) afforded by Section 382(l)(5).