SINGLE ENTITY THEORY REJECTED IN DETERMINING AMOUNT OF NONLIFE CONSOLIDATED LOSS ELIGIBLE FOR OFFSET AGAINST LIFE INSURANCE INCOME.

UIL Number(s) 1502.47-00

                                             Date: October 24, 1989

Whether section 1503(c)(2) of the Internal Revenue Code and section 1.1502-47 of the Income Tax Regulations permit taxpayers to treat an acquired affiliated group as a single entity instead of as separate entities in determining the amount of nonlife loss that is ineligible for offset against life income when the acquiring group has made a section 1504(c)(2) election.

FACTS

Before the formation of Parent, Corp X and the predecessor of Corp Y were common parents of affiliated groups filing consolidated returns. For the purposes of this technical advice, Corp Y and its predecessor shall each be referred to as Corp Y. Corp X and Corp Y organized Parent on Date A. Corp X and Corp Y became wholly owned subsidiaries of Parent by means of triangular mergers under section 368 of the Code. The former shareholders of Corp X, as a result of the mergers, acquired more than 50 percent of the Parent stock, resulting in the continuation of the Corp X affiliated group and a termination of the Corp Y affiliated group under section 1.1502- 75(d)(3) of the regulations.

On Date B, a subsidiary of Parent acquired more than 80 percent of the stock of Corp Z, a corporation unrelated to either the Corp X or Corp Y group. Corp Z was the common parent of an affiliated group that had been filing consolidated returns.

Parent made an election under section 1504(c)(2) of the Code to treat certain corporations taxed under section 801 [then section 802] and a member of the affiliated group (without regard to section 1504(b)) for at least 5 years as includible corporations for purposes of affiliation and inclusion in Parent's consolidated return. Since Parent made the election under section 1504(c)(2), the limitations of section 1503(c)(2) were applicable (i.e. limitation on the use of nonlife losses applied against life income).

Parent treated the acquired groups (the Corp Y and Corp Z groups) as single entities when applying the limitations under section 1503(c)(2) of the Code in determining the amount of nonlife consolidated net operating losses that would be ineligible for offset against life insurance company income under section 1.1502-47(m) of the regulations. The examining agent disallowed this approach and required Parent to treat each member of the acquired groups separately.

Parent disagrees with the examining agent's application of section 1503(c)(2) of the Code. Parent's position is that (1) the language of section 1503(c)(2) is ambiguous; (2) since this ambiguity exists, and section 1.1502-47 fails to provide a specific rule, there is no rule prohibiting Parent from treating the Corp Y and Corp Z groups as single entities; and (3) Parent's single entity treatment is reasonable in the absence of a specific rule.

LAW

Section 1504(c)(2) of the Code provides that if an affiliated group (determined without regard to subsection 1504(b)(2)) includes one or more domestic insurance companies taxed under section 801, the common parent of such group may elect to treat all such companies as includible corporations for purposes of applying subsection (a) except that no such company shall be so treated until it has been a member of the affiliated group for the five taxable years immediately preceding the taxable year for which the consolidated return is filed.

Section 1503(c)(1) of the Code (as in effect between calendar years 1982 and 1985) provides as a general rule that if an election under section 1504(c)(2) is in effect for the taxable year and the consolidated taxable income of the members of the group not taxed under section 801 results in a consolidated net operating loss for such taxable year, then under regulations prescribed by the Secretary, the amount of the loss which cannot be absorbed in the applicable carryback periods against the taxable income of the members not taxed under section 801 shall be taken into account in determining the consolidated taxable income of the affiliated group for the taxable year to the extent of 35 percent (30 percent for taxable years ending with or within calendar year 1982) of the loss or 35 percent (30 percent for the taxable years ending with or within calendar year 1982) of the taxable income of the members taxed under section 801, whichever is less.

Section 1503(c)(2) of the Code (as in effect between calendar years 1982-1985) provides, notwithstanding 1503(c)(1), that a net operating loss for a taxable year of a member of the group not taxed under section 801 shall not be taken into account in determining the taxable income of a member taxed under section 801 (either for the taxable year or as a carryover or carryback) if such taxable year precedes the sixth taxable year such members have been members of the same affiliated group (determined without regard to section 1504(b)(2)).

Section 1.1502-47 of the regulations enables life-nonlife groups to make an election to file life-nonlife consolidated returns. The regulation adopts a subgroup method to determine consolidated taxable income.

Section 1.1502-47(m) of the regulations provides, in general, that the nonlife subgroup losses consist of the nonlife consolidated net operating loss and the nonlife consolidated net capital loss.

Section 1.1502-47(m)(3) of the regulations provides nonlife subgroup loss rules and limitations. Section 1.1502-47(m)(3)(vi) provides that (A) the offsetable nonlife consolidated net operating loss that arises in any consolidated return year (that may be set off against consolidated partial life insurance consolidated taxable income in the current taxable or in a succeeding taxable year) is the amount computed under section 1.1502-21(f) reduced by the ineligible net operating loss. For purposes of section 1.1502-47(m)(3) the "ineligible net operating loss" is in the year the loss arose the amount of the separate net operating loss (determined under section 1.1502-79(a)(3)) of any nonlife member that is ineligible in that year, and (B) the carryovers of offsetable nonlife net operating losses do not include an ineligible net operating loss in a consolidated return year or a loss attributable to an ineligible member in a separate return year. See section 1503(c)(2).

Section 1.1502-47(m)(3)(ix) of the regulations provides that the offsetable nonlife consolidated net operating and capital loss carryovers do not include any losses attributable to a nonlife member that were sustained (A) in a separate return limitation year (determined without section 1504(b)(2) of that member (or a predecessor), or (B) in a separate return year ending after December 31, 1980, in which an election was in effect under neither section 1504(c)(2) nor section 243(b)(2). For purposes of this paragraph (m), a separate return limitation year includes a taxable year ending before January 1, 1981.

Section 1.1502-47(m)(4) of the regulations is a reserved section for "Acquired Groups".

ANALYSIS

Parent's initial argument focuses on the statutory silence of section 1503(c)(2) of the Code, especially as it relates to an acquired group. Parent's secondary argument is that since the regulations are silent and because no explicit rule exists as to the acquisition of an acquired group, Parent's treatment of the acquired groups as single entities should be allowed, if reasonable. Parent attempts to support that argument by stating that its single entity method is reasonable because section 1.1502-47(m)(4), entitled "Acquired Groups" is reserved and the preamble to section 1.1502-47 states that the Treasury Department would like to study further the possibility of aggregating the income and losses of ineligible members in certain cases. In the alternative, Parent argues that the reserved section in the regulations creates a void in applying rules to acquired groups. Finally, Parent believes its position is fully supported by both sound tax policy and recent case law.

We disagree with Parent's interpretation that the acquired groups should be treated as "single entities" when applying the limitations under section 1503(c)(2). For the reasons stated below, we conclude that Parent must treat each member of the Corp Y and Corp Z groups separately for purposes of applying the limitations under section 1503(c)(2).

Section 1503(c)(2) of the Code is unambiguous. Section 1503(c)(2) states, in part, that "the net operating loss [of an ineligible nonlife member] . . . shall not be taken into account in determining the taxable income of [an eligible life member] . . ." The legislative history does not provide any relevant guidance as to Congressional intent as to the term "member." Section 1.1502-1(a) of the regulations defines member to mean "a corporation (including the common parent) which is included within such group." Section 1.1502- 47(d)(5), reiterates, in part, section 1.1502-1's definition of member. The term "member" does not refer to group. Viewing the term "member" as a single corporation in life/nonlife acquisitions is consistent with the separate return limitation year rules (SRLY) involving acquisitions of nonlife groups. Moreover, if Congress intended a subgroup approach, it could have inserted subgroup language in the statute.

When a common parent of a nonlife group is acquired and remains in existence as a subsidiary of the acquiring affiliated group, the SRLY rules under section 1.1502-1(f) apply. Section 1.1502-1(f) provides, in part, that the term "SRLY" means any separate return year of a member or of a predecessor of such member. The SRLY rules place limitations on the carryover of net operating losses of a member. The consolidated return regulations apply the SRLY rules on a separate member basis.

Parent maintains that under section 1.1502-47 of the regulations, no clear rule exists for determining the portion of the nonlife consolidated net operating loss attributable to the acquired group. Parent adds that in the absence of a clear rule, Parent's utilization of the "single entity" approach is reasonable. Parent cites Gottesman & Co., Inc., 77 T.C. 1149 (1981), for support. The examining agent has determined that, notwithstanding section 1.1502- 47(m)(4), specific guidelines for determining the amount of the ineligible loss on a separate entity basis exists under section 1.1502-47(m)(3) and that the holding in Gottesman is inapplicable.

In Gottesman, the primary issue was whether the affiliated group was subject to the accumulated earnings tax on a consolidated (group) or separate (member by member) basis. When the revised consolidated return regulations were finalized in 1966 no regulation defining "consolidated accumulated taxable income" was included. In the absence of a specific rule, the taxpayer calculated the accumulated earnings tax on a member by member basis. The Tax Court held that since there was no set of rules for calculating the accumulated earnings tax under the then existing regulations, the taxpayer's position would be acceptable if reasonable. Moreover, since the accumulated earnings tax was a penalty tax, any ambiguity would be resolved in the taxpayer's favor.

The facts and holding in Gottesman are distinguishable from the instant case. Unlike Gottesman, section 1.1502-47 clearly establishes general rules and limitations for ineligible nonlife members. Specifically, sections 1.1502-47(m)(3)(vi) and (ix) establish rules for the acquisition of an ineligible nonlife member, and section 1.1502-47(d) supplies definitions. These general rules under section 1.1502-47(m)(3) apply the SRLY principles to an ineligible nonlife member consistent with acquisitions occurring outside of section 1.1502-47. Moreover, the use of the term "member" is given a specific meaning under section 1.1502-47(d)(5). Member refers to a single corporation. The insertion of the reserved section and the preamble merely indicates the Service's willingness to consider either adding, revising, amending, or expanding the already existing set of rules in the event a group is acquired. Finally, the regulation in question does not involve a penalty tax. The regulations as currently drafted are clear and set forth a reasonable set of rules that deal with Parent's set of facts.

Parent's final argument is that the preamble accompanying section 1.1502-47(m)(4) of the regulations is consistent with Parent's application of section 1503(c)(2) to the Corp Y and Corp Z groups as single taxpayers. The preamble provides that:

The Treasury Department will study further whether it is appropriate to aggregate the income and losses of ineligible members in certain cases. For instance, notwithstanding the ordinary reading of section 1503(c)(2), it may be consistent with the intent of section 1503(c)(2), or correct as a matter of policy, to aggregate the income and losses of ineligible members that filed a consolidated return prior to their acquisition by (and includibility in) another group that files a consolidated return.

The preamble in question merely indicates Treasury's willingness to study the issue of applying a single entity approach in this area. The preamble demonstrates that until the study is completed, the acquisition of a group is treated in the same manner as those in nonlife settings. Section 1.1502-47 of the regulations sets forth a specific set of rules and limitations to be applied to an ineligible nonlife member and therefore no ambiguity exists under section 1.1502-47. Finally, the reserved section is merely a reserved section and no additional weight should be given to it.

In Garvey, Inc. v. United States, 1 Cl. Ct. 108 (Cl. Ct. 1983) aff'd. 726 F.2d 1569 (U.S. Ct. of Appeals, Fed. Cir., 1984) the taxpayer argued that certain distributions which were made in reliance on proposed regulations by Treasury, which would have amended section 1.1502-32 of the regulations and benefited the taxpayer, estopped the Commissioner from taxing the distributions. Taxpayer's underlying assumption was that once a proposed regulation is published, it is binding on the government and may only be modified or deleted so as to favor the taxpayer. Garvey at 118. Treasury did nothing further to encourage taxpayer's belief that it would amend the regulations. In fact, the notice in the preamble stated that the proposed regulations were only tentative.

The Claims Court held that nothing in the proposed regulations prevented Treasury from reconsidering its position and that taxpayer's reliance "fell far short of conduct that merits an estoppel against the Government." Garvey at 118. The Claims Court went one step further by adding that the taxpayer should have requested an advance private letter ruling from the Internal Revenue Service.

In the instant case, Parent relies on the preamble to section 1.1502-47 to support its position. As did the proposed regulation in Garvey, the preamble falls "far short" of endorsing Parent's position. The preamble only expresses that the Internal Revenue Service may consider adopting a "single entity" theory. Clearly, the preamble never goes as far as mandating that theory.

Finally, under the consolidated return regulations each corporation within an affiliated group filing a consolidated return is treated as a separate entity unless consolidated treatment is specified by the Code and/or regulations. This proposition is borne out by the deferred intercompany transaction rules under section 1.1502-13(c) of the regulations and the investment adjustment rules under section 1.1502-32.

CONCLUSION

Section 1503(c)(2) of the Code and section 1.1502-47(m) of the regulations require Parent to treat each member of the Corp Y and Corp Z affiliated groups separately when determining the amount of nonlife loss eligible for offset against life income.

A copy of this Technical Advice Memorandum is to be given to the taxpayer. Section 6110(j)(3) of the Code provides that it may not be used or cited as precedent.

Pursuant to section 6110(c)(1) of the Code, names, addresses, and taxpayer identification numbers are required to be deleted from the copy of the Technical Advice Memorandum that will be made open to public inspection.