Rev. Rul. 70-489

Advice has been requested whether a bad debt deduction and a worthless security deduction may be taken by a parent corporation where all of the assets of its insolvent, wholly-owned subsidiary are transferred to the parent in complete liquidation of the subsidiary, and where the parent continues to operate as a branch the business formerly conducted by the subsidiary.

X, a domestic corporation, owned all the stock of Y, a domestic corporation. Y was insolvent because its bona fide indebtedness to X exceeded the fair market value of its assets. Y had no other liabilities. In 1965 Y transferred all of its assets to X in partial satisfaction of its debt to X, and X continued the former subsidiary's operations as a branch. The amount of the debt was greater than the fair market value of the assets transferred and it was established that the stock of Y corporation became worthless in the taxable year of X during which the assets were transferred.

Revenue Ruling 59-296, C.B. 1959-2, 87, holds that a parent corporation is entitled to a bad debt deduction, to the extent provided in section 166 of the Internal Revenue Code of 1954, where the fully solvent parent was the subsidiary's bona fide creditor for cash advances in an amount greater than the fair market value of all the subsidiary's assets and where all the subsidiary's assets were transferred to the parent in a transaction which was a merger or consolidation under the applicable state statutes, since the transfer under such circumstances is regarded as "a transfer made in satisfaction of indebtedness." All of the subsidiary's property was worth less than the debt, and thus no part of the transfer was attributable to the stock interest of the parent. Consequently, the transaction is neither a nontaxable distribution under section 332 of the Code nor a tax-free "reorganization" under section 368(a)(1)(A) of the Code.

Section 165(g)(1) of the Code provides that if any security which is a capital asset becomes wholly worthless during the taxable year, the loss resulting therefrom shall be treated as a loss from the sale or exchange of a capital asset. Section 165(g)(3) of the Code provides, however, that any security in a corporation affiliated (as defined therein) with a taxpayer which is a domestic corporation shall not be treated as a capital asset. Section 1.165-5(d)(1) of the Income Tax Regulations provides that if a taxpayer which is a domestic corporation owns any security of a domestic or foreign corporation which is affiliated with the taxpayer and such security becomes wholly worthless during the taxable year, the loss resulting therefrom may be deducted under section 165(a) of the Code as an ordinary loss.

Accordingly, X corporation is entitled to a bad debt deduction to the extent provided in section 166 of the Code in the taxable year in which the balance of the debt became worthless, and further, X is entitled to an ordinary loss deduction under section 165(a) of the Code for its taxable year during which the Y stock became worthless.

Revenue Ruling 59-296 is hereby amplified to provide that a parent may liquidate a subsidiary and continue to operate as a branch the business formerly conducted by the subsidiary without thereby jeopardizing the position of the parent under such ruling with respect to the bad debt deduction. In addition, Revenue Ruling 59-296 is amplified to provide that in the year in which the stock of the subsidiary became worthless the parent will also be entitled to a deduction attributable to such worthlessness that will be an ordinary loss under section 165(a) of the Code, provided the subsidiary is, within the meaning of section 165(g)(3) of the Code, treated as being affiliated with the parent.