Temporary and Final Amendments to Deferred Intercompany Gain Consolidated Return Rules Under Section 1502

 [4830-01]

 ACTION: Temporary and final regulations.

 SUMMARY: This document contains temporary and final regulations under section 1502 that relate to deferred intercompany transactions and distributions of property among members of an affiliated group filing consolidated returns. As a result of changes to the Internal Revenue Code, literal application of the deferral rules may produce tax consequences to the group that are inconsistent with the tax consequences that would have resulted if an intercompany transfer had not occurred.

 The temporary regulations provide rules concerning the creation and restoration of deferred gain or loss in these transfers. The purpose of the temporary regulations is to confirm the original intent of the deferral mechanism by assuring that intercompany transfers generally do not affect the overall federal income tax consequences to the group. The text of the temporary regulations set forth in this document also serves as the text of the proposed regulations cross-referenced in the notice of proposed rulemaking in the proposed rules section of this issue of the Federal Register.

 DATES: These temporary and final regulations are effective for taxable years for which the due date (without extensions) of the federal income tax return is after March 14, 1990. However, transition rules sections 1.1502-13T(m)(4)(ii) and 1.1502-14T(c)(3)(ii) apply to certain dispositions outside the group occurring before March 9, 1990. In addition, section 1.1502-13T(n) applies only to intercompany transactions attributable to long term contracts entered into after June 20, 1988.

 FOR FURTHER INFORMATION CONTACT: Roy A. Hirschhorn or Jerilynn V. Chapman at telephone (202) 566-3231 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

PAPERWORK REDUCTION ACT

This regulation is being issued without prior notice and public procedure pursuant to the Administrative Procedure Act (5 U.S.C. 553). For this reason, the collections of information requirement contained in this regulation has been reviewed and, pending receipt and evaluation of public comments, approved by the Office of Management and Budget (OMB) under control number 1545-1161. The estimated annual burden per respondent varies from 1 1/2 to 2 1/2 hours, depending on individual circumstances, with an estimated average of 2 hours.

 These estimates are an approximation of the average time expected to be necessary for a collection of information. They are based on such information as is available to the Internal Revenue Service. Individual respondents may require greater or less time, depending on their particular circumstances.

 For further information concerning these collections of information, where to submit comments on these collections of information, the accuracy of the estimated burden, and suggestions for reducing this burden, please refer to the preamble to the cross- referenced notice of proposed rulemaking published in the Proposed Rules section of this issue of the Federal Register.

BACKGROUND

 This document amends the Income Tax Regulations (26 CFR Part 1) under section 1502 of the Internal Revenue Code of 1986. The temporary and final regulations added by this document amend sections 1.1502-13T and 1.1502-14T and amend and add cross-references to sections 1.1502-13 and 1.1502-14. The temporary and final regulations added by this document will remain in effect until superseded by later temporary or final regulations relating to these matters.

 The present consolidated return regulations provide a system which replicates in many ways the federal income tax consequences which would arise if the members of an affiliated group of corporations filing consolidated returns were a single entity. Under the regulations, gain or loss realized and recognized on transfers of property from one member ("selling member") to another member ("purchasing member") of an affiliated group filing consolidated returns is deferred and taken into account by the selling member when, for example, the property is depreciated or disposed of outside the group by the purchasing member. Although the gain or loss is deferred, the purchasing member has a cost basis in the transferred property. See sections 1.1502-13, 1.1502-13T, 1.1502-14, 1.1502-14T, and 1.1502-31(a).

 Prior to 1966, the consolidated return regulations provided for the elimination of the selling member's gain or loss if the property was not sold outside the group during the same consolidated return year. Under the prior regulations, the purchasing member received a carryover basis in the property.

 The change to the deferral system was made because the gain elimination system resulted in certain gain escaping tax, being recognized by the wrong member of the group at the wrong time, and being characterized improperly. Further, the earnings and profits of the members were not properly reflected.

 The deferral mechanism was adopted to fix more accurately the location, character and source of the gain or loss on transactions between members. It generally was not intended to affect the group's overall income or loss (or other tax consequences) either while the transferred property remains in the group or after the property is disposed of outside the group.

 As a result of changes in the Internal Revenue Code, literal application of the deferral rules may produce tax consequences to the group that are inconsistent with the tax consequences that would have resulted if an intercompany transfer had not occurred. The purpose of the temporary regulations is to assure that the deferral provisions operate as they were intended -- i.e., to promote neutrality so that the overall tax consequences to the group generally are not affected by transfers of property among members.

EXPLANATION OF PROVISIONS

 Consistent with the neutrality principle, the temporary regulations provide four general rules concerning the creation and restoration of gain or loss deferred as the result of transfers of property between members of a group.

 First, under the temporary regulations, any gain or loss deferred with respect to property sold or exchanged in an intercompany transaction or distributed by one member to another is taken into account in an amount equal to any increase (or decrease) in a deduction or basis recovery attributable to the increase (or decrease) in the basis of the property (or that of any other property the basis of which is determined, directly or indirectly, in whole or in part, by reference to the basis of the property) resulting from the transfer. For example, if, as a result of an intercompany transfer, the purchasing member takes depreciation deductions in excess of the deductions that would have been taken by the selling member, deferred gain must be taken into account at the same time and in the same amount as the excess depreciation deductions. For purposes of this rule, basis is not treated as recovered by reason of a subsequent intercompany transfer.

 Second, if property sold or exchanged in an intercompany transaction or distributed by one member to another member (or property the basis of which is determined, directly or indirectly, in whole or in part, by reference to the basis of the property) is disposed of outside the group, deferred gain (and any associated tax consequences) generally must be taken into account as if the selling member had disposed of the property at the same time and in the same manner as the member making the disposition. The source and character of the gain to the selling member and the status of the selling member for tax purposes, however, is determined at the time of the intercompany transfer. This rule applies to property disposed of in a non-recognition transaction only to the extent gain or loss is recognized.

 For purposes of this rule, an event (other than a non- recognition transaction) requiring restoration of gain under section 1.1502-13(e) or (f) constitutes a disposition of property outside the group. For example, under this rule, if the parent of a group recognizes and defers gain on the sale of property to a subsidiary, and the subsidiary makes an installment sale of the property outside the group, the deferred tax liabilities of both the parent and the subsidiary must be taken into account in determining the interest charge under section 453A beginning with the taxable year in which the subsidiary's sale occurs.

 Third, the temporary regulations provide a special rule for long term contracts subject to section 460. Generally, where a member has entered into a long term contract and is required to account under section 460 for any income and expense attributable to the contract, any other member's activities that benefit, or are performed by reason of, the long term contract must also be accounted for under section 460 (i.e., generally under the percentage of completion method). See Notice 89-15, Q&A-8, 1989-1 C.B. 634, 636. The temporary regulations provide that as the selling member incurs costs attributable to such activities, it must recognize and may not defer gain or loss associated with income and expense accounted for (or required to be accounted for) under the percentage of completion method.

 Fourth, the temporary regulations provide a rule for the restoration of gain attributable to a distribution of the stock of a subsidiary by one member to another. Upon a disposition of the stock of the subsidiary, the distributing member must take into account the deferred gain to the extent that, absent the adjustment to the basis (or excess loss account) of the subsidiary stock resulting from the distribution, the member disposing of the subsidiary stock would have had an excess loss account or increased excess loss account with respect to the subsidiary stock. In addition, following a disposition of the stock of the subsidiary, the distributing member must take into account the deferred gain to the extent that, absent the adjustment to the basis of the former subsidiary's stock resulting from the distribution, distributions with respect to the stock of the former subsidiary owned by a member exceed the member's basis in such stock. For this purpose, a disposition is defined in section 1.1502-19(b)(2), and, for example, includes a case in which a distributed subsidiary ceases to be a member of the group as the result of issuing additional stock outside the group, even though the group retains all of the stock distributed.

EFFECTIVE DATES

 The temporary regulations generally apply to intercompany transfers or dispositions outside the group in taxable years of the group for which the due date (without extensions) of the income tax return is after March 14, 1990. However, several special rules are provided.

 First, where property sold or exchanged in an intercompany transaction or distributed from one member to another member is disposed of outside the group, the temporary regulations do not apply if the intercompany transfer, resulting in deferred gain or loss, occurred before January 1, 1989, and the property was disposed of before March 9, 1990. The temporary regulations apply, however, if the intercompany transfer occurred after December 31, 1988, and the property was disposed of before March 9, 1990, unless, at the time of the intercompany transfer, there was no plan or intention to dispose of such property outside the group, and the group files a disclosure statement for the taxable year in which the property is disposed of outside the group.

 Second, the temporary regulations apply only to long term contracts entered into by a member after June 20, 1988.

 Third, where stock of a subsidiary distributed from one member of the group to another is considered disposed of outside the group, the temporary regulations do not apply to gain deferred with respect to the distributed stock if the distribution of the stock occurred before January 1, 1989, and the stock was disposed of before March 9, 1990.

 The temporary regulations do not limit the application, to transactions occurring before or after the effective date of the regulations, of other sections of the Code or general principles of tax law, including sections 337(d) and 482, the substance-over-form doctrine (e.g., application of Commissioner v. Waterman Steamship Corp., 430 F.2d 1185 (5th Cir. 1970), cert. denied, 401 U.S. 939 (1971)), and the tax benefit rule.

SPECIAL ANALYSES

 It has been determined that these rules are not major rules as defined in Executive Order 12291. Therefore, a Regulatory Impact Analysis is not required. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. Chapter 5) and the Regulatory Flexibility Act (5 U.S.C. Chapter 6) do not apply to these regulations, and therefore, a Regulatory Flexibility Analysis is not required. Pursuant to section 7805(f) of the Internal Revenue Code, the notice of proposed rulemaking for the regulations was submitted to the Administrator of the Small Business Administration for comment on their impact on small business.

DRAFTING INFORMATION

 The principal author of these temporary and final regulations is Roy A. Hirschhorn of the Office of Assistant Chief Counsel (Corporate), Internal Revenue Service. However, other personnel from the Service and the Treasury Department participated in their development.

LIST OF SUBJECTS

26 CFR 1.1501-1 through 1.1564-1

 Income taxes, Controlled group of corporations, Consolidated returns.

Treasury Decision 8295

ADOPTION OF AMENDMENTS TO THE REGULATIONS

Accordingly, 26 CFR Chapter I, Part 1 is amended as follows:

PART 1 -- INCOME TAX; TAXABLE YEARS BEGINNING AFTER DECEMBER 31, 1986.

Paragraph 1. The authority citation for Part 1 is amended by adding the following citation:

Authority: 26 U.S.C. 7805 * * * Sections 1. 1502-13T and 1.1502-14T also issued under 26 U.S.C. 1502.

Par. 2. Section 1.1502-13 is amended as follows:

1. A new sentence is added to the end of paragraph (c)(1)(iii) to read as set forth below:

SECTION 1.1502-13 INTERCOMPANY TRANSACTIONS.

* * *

(c) * * *

(1) * * *

(iii) * * * See section 1.1502-13T, relating to the time and manner of restoring deferred gain or loss in taxable years for which the due date (without extensions) of the income tax return is after March 14, 1990.

* * * * *

Par. 3. Section 1.1502-13T is amended as follows:

1. The last sentence of paragraph (c)(2) is removed.

2. The last sentence of paragraph (f)(2) is removed.

3. New paragraphs (l), (m), (n), and (o) are added to read as follows:

SECTION 1.1502-13T. TEMPORARY REGULATIONS FOR CERTAIN INTERCOMPANY TRANSACTIONS.

* * * * *

(l) RESTORATION OF DEFERRED GAIN BEFORE DISPOSITION OUTSIDE GROUP -- (1) IN GENERAL. For purposes of section 1.1502-13, gain (or loss) deferred with respect to property sold or exchanged in an intercompany transaction shall be taken into account for any taxable year (whether consolidated or separate) in an amount equal to any increase (or decrease) in a deduction or basis recovery for the taxable year that is attributable to an increase (or decrease) in the basis of the property (or to the basis of any other property the basis of which is determined, directly or indirectly, in whole or in part, by reference to the basis of such property) resulting from the sale or exchange. For purposes of the preceding sentence, basis shall not be treated as recovered by reason of a subsequent deferred intercompany transaction or distribution described in section 1.1502-14(a) or (b).

(2) EXAMPLES. The application of this paragraph (l) is illustrated by the following examples.

EXAMPLE (1). (i) Corporations P and S file consolidated returns on a calendar year basis. P owns a 40% interest in the capital and profits of XYZ, a partnership. P has a basis of $20 in its partnership interest. XYZ owns a single depreciable asset. P's share of the basis of the asset is $20 and its share of the value of the asset is $60. In 1989, P sells its partnership interest to S for $60 and recognizes a gain of $40, all of which is deferred under section 1.1502-13(c). S's basis in the XYZ interest is increased to $60 under section 1.1502-31(a). Because XYZ has made an election under section 754, the basis of the asset with respect to S is increased, under section 743, to $60 by reference to S's basis in the XYZ interest.

(ii) If P had not transferred its partnership interest to S, its allocable share of depreciation with respect to the asset would have been $5 for 1990. As a result of the basis adjustment under section 743 resulting from the sale of the XYZ interest to S, S's depreciation with respect to the asset for 1990 is $15 ($10 of which is attributable to the basis adjustment). P is therefore required to take into account $10 of deferred gain under this paragraph (l).

(iii) In 1991, XYZ sells the asset and S's share of the amount realized with respect to the sale is $65. Without regard to depreciation for 1991, if P had not transferred its XYZ interest to S, its basis recovery on the sale of the asset would have been $15. As a result of the basis adjustment under section 743 resulting from the sale of the XYZ interest to S, S's share of the basis of the asset at the time it is sold is $45 ($60 minus $15). Accordingly, there has been a $30 increase in basis recovery in 1991 as a result of the sale of the XYZ interest to S and, under this paragraph (l), P must therefore take into account the remaining $30 of deferred gain at the time of the sale.

EXAMPLE (2). (i) Corporations P and S file consolidated returns on a calendar year basis. S purchases and places in service on August 1, 1989, construction equipment costing $1,000,000. S elects to use the straight-line method over the equipment's recovery period (5 years) and appropriately applies the half-year convention to compute its depreciation deduction for the equipment. Thus, S's depreciation deduction for the equipment for 1989 is $100,000 (1/2 of 20% of $1,000,000). In 1990, S sells the equipment to P and recognizes a gain of $500,000, all of which is deferred under section 1.1502-13(c). P does not dispose of the equipment before 1996.

(ii) Under section 168(i)(7), P must use the same depreciation method that S used over S's remaining recovery period for so much of the adjusted basis of the equipment in P's hands as does not exceed the adjusted basis of the equipment in S's hands immediately before the sale (the "carryover portion"). Therefore, P's depreciation deduction that is attributable to the carryover portion is the same in each year as S's deduction would have been if S had not sold the equipment to P. The amount of the deferred gain attributable to the equipment that S must take into account in any year (that is, the amount of the increased depreciation deduction to the group) is the amount of the depreciation deduction attributable to the portion of P's basis which exceeds the carryover portion (the "excess portion"). P appropriately depreciates the excess portion ($500,000) under the 200-percent declining balance method over a 5-year recovery period, applying a half-year convention. Thus, the amount of deferred gain that S is required to take into account, which equals the amount of depreciation claimed by P on the excess portion, is $100,000 for 1990, $160,000 for 1991, $96,000 for 1992, $57,600 for 1993, $57,600 for 1994, and $28,800 for 1995.

(3) EFFECTIVE DATE. This paragraph (l) applies to intercompany transactions in taxable years for which the due date (without extensions) of the income tax return is after March 14, 1990.

(m) RESTORATION OF DEFERRED GAIN ON DISPOSITION OUTSIDE GROUP -- (1) IN GENERAL. Except as provided in paragraph (m)(2) of this section, for purposes of section 1.1502-13, if property sold or exchanged in an intercompany transaction (or property the basis of which is determined, directly or indirectly, in whole or in part, by reference to the basis of such property) is disposed of outside the group, any remaining deferred gain (and any associated tax consequences) shall be taken into account as if the selling member had disposed of the property at the same time and in the same manner as the property is disposed of outside the group. Notwithstanding the previous sentence, the source and character of the gain to the selling member and the status of the selling member for tax purposes (e.g., as a dealer or non-dealer in the property sold) shall be determined as of the time of the intercompany transaction. Any event requiring the restoration of gain pursuant to section 1.1502-13(e) or section 1.1502-13(f), as modified by paragraph (f) of this section, is treated as a disposition outside the group.

(2) EXCEPTION. Paragraph (m)(1) of this section does not apply, and section 1.1502-13(e) and section 1.1502-13(f), as modified by paragraph (f) of this section, apply, to the extent that gain or loss is not recognized in a transaction in which property, which was sold or exchanged in an intercompany transaction, (or property the basis of which is determined, directly or indirectly, in whole or in part, by reference to such property) is disposed of outside the group. However, to the extent gain or loss is recognized in such transaction, paragraph (m)(1) of this section applies.

(3) EXAMPLES. The application of this paragraph (m) is illustrated by the following examples.

EXAMPLE (1). (i) Corporations P and S file consolidated returns on a calendar year basis. P regularly sells real property in the ordinary course of business. In 1990, P sells nondepreciable real property with a basis of $7,000 to S for $10,000 and P recognizes $3,000 of gain, all of which is deferred under section 1.1502-13(c).

(ii) In 1991, S, which does not regularly sell real property in the ordinary course of business, sells the real property to X, an unrelated third party, for a $12,000 obligation, bearing interest at the applicable federal rate and payable in two equal annual installments of $6,000 in 1992 and 1993. If, instead of selling the property to S in 1990, P had sold it to X, P would not have been eligible, under section 453(b), to use the installment method of reporting with respect to its $3,000 gain because it was a dealer in real property in 1990. When S sells the real property to X in 1991, P must therefore take into account its entire $3,000 of deferred gain.

EXAMPLE (2). (i) Corporations P and S file consolidated returns on a calendar year basis. S owns depreciable property described in section 1245 that it purchased for $10 million. At the end of 1989, when S's basis in the property has been reduced to $7 million as a result of depreciation deductions, S sells the property to P for $20 million and recognizes $13 million of gain, $3 million of which is subject to recapture under section 1245. All of the gain is deferred under section 1.1502-13(c).

(ii) At the end of 1990, P sells the property to X, an unrelated third party, for a $25 million obligation, bearing interest at the applicable federal rate and payable in two equal annual installments of $12.5 million in 1991 and 1992. Without regard to depreciation in 1990, P realizes $5 million of gain, which it reports on the installment method under section 453. If, instead of selling the propertY to P, S had sold it to X in an installment sale, S would have been required to report under section 453(i) the $3 million of recapture income. When P sells the property to X, S must therefore take into account $3 million of deferred gain that is subject to recapture under section 1245.

(iii) Under section 1.1502-13(e)(2), S takes into account the $10 million of deferred gain not subject to recapture as P receives the installment payments. Thus, P recognizes $2.5 million of gain under section 453, and S takes into account $5 million of its deferred gain, in each of 1991 and 1992. Section 453A requires interest to be paid on a group's tax liability deferred by reason of section 453 if the installment obligations of the group (and related persons) outstanding at the close of the group's taxable year exceed an aggregate face amount of $5 million. Because the aggregate face amount of the group's installment obligations, $25 million, exceeds $5 million, the deferred tax liabilities of both P and S must be taken into account in determining the interest charge under section 453A beginning with the taxable year in which P's sale occurs.

Example (3). (i) Corporations P, S and T file consolidated returns on a calendar year basis. S holds nondepreciable property A and T holds nondepreciable property B. Properties A and B each have a basis of $1,000 and a fair market value of $10,000. In 1989, T sells property B to P for $10,000. T recognizes $9,000 of gain in 1989 on its sale of property B to P, all of which is deferred under section 1.1502-13(c). Under section 1.1502-31(a), P's basis in property B is $10,000.

(ii) In 1991, P and S exchange property A and property B in an exchange that qualifies for nonrecognition of gain or loss under section 1031 with respect to both P and S. P does not recognize gain or loss on the exchange, and P's basis in property A is $10,000.

(iii) In 1993, in a transaction to which sections 1031(f) and (g) do not apply, P sells property A to X, an unrelated third party, for $10,000. P realizes no gain on the sale of property A to X. T is required to take into account the $9,000 of deferred gain with respect to property B in 1993, because property A (the basis of which is determined by reference to the basis of property B) was disposed of outside the group.

(4) EFFECTIVE DATE -- (i) IN GENERAL. Except as provided in paragraph (m)(4)(ii) of this section, this paragraph (m) applies to dispositions (as described in this paragraph) of property in taxable years for which the due date (without extensions) of the income tax return is after March 14, 1990.

(ii) EXCEPTION. Notwithstanding paragraph (m)(4)(i) of this section, this paragraph (m) does not apply to deferred gain taken into account on a disposition of property before March 9, 1990, if the gain was deferred in an intercompany transaction --

(A) after December 31, 1988, provided that, at the time of the intercompany transaction, there was no plan or intention to dispose of the property outside the group and the taxpayer files a separate statement with the taxpayer's return for the taxable year in which such property is disposed of disclosing --

(1) a description of the transferred property and the dates of the intercompany transaction and the disposition,

(2) the name and employer identification number (E.I.N.) of the member disposing of the property and the amount realized and gain realized by such member on the disposition, and

(3) the amount realized and gain realized by the selling member on the intercompany transaction with respect to the property and the name and E.I.N. of the selling member; or

(B) before January 1, 1989.

(n) EXCEPTION TO DEFERRAL RULES -- (1) IN GENERAL. Section 1.1502-13(c) shall not apply to defer gain or loss with respect to a sale or exchange in an intercompany transaction of property to the extent the gain (or loss) is attributable to any income and expense (i) accounted for (or required to be accounted for) by the selling member in accordance with the percentage of completion method and (ii) arising from any activity performed by the selling member for the benefit of, or by reason of, a long term contract between a member and a person not a member that is accounted for by such member, in whole or part, under the percentage of completion method.

(2) EXAMPLE. This paragraph (n) is illustrated by the following example.

EXAMPLE. (i) Corporations P and S file consolidated returns on a calendar year basis. In 1990, P enters into a contract with X, a person not a member of the group, for the manufacture and sale of 5 airplanes for a total contract price of $500 million. The contract is a long term contract within the meaning of section 460(f) and P is required to account for income and expense attributable to the contract under the percentage of completion method. By reason of the contract, S manufactures and sells engines for the airplanes to P for a total price of $50 million. S begins to manufacture the engines in 1991 and delivers them in 1992. In 1991, S incurs $20 million out of total estimated costs of $40 million, and, in 1992, S incurs an additional $20 million of costs to complete manufacture of the engines. S accounts for income and expense attributable to the production of the engines pursuant to the percentage of completion method.

(ii) S's sale of the engines to P is a deferred intercompany transaction. However, section 1.1502-13(c) does not apply to defer gain attributable to the income and expense accounted for by S under the percentage of completion method. Under the percentage of completion method, S takes into account $20 million in costs and $25 million in income in each of 1991 and 1992.

(3) EFFECTIVE DATE. This paragraph (n) applies to intercompany transactions in taxable years for which the due date (without extensions) of the income tax return is after March 14, 1990 that are attributable to long term contracts entered into by a member after June 20, 1988.

(o) REFERENCES. A reference in this part to section 1.1502-13 is treated as including a reference to this section.

Par. 4. Section 1.1502-14 is amended by adding the words "or after March 14, 1990" immediately following the word "1988" in paragraph (c)(3).

Par. 5. Section 1.1502-14T is amended as follows:

1. The last sentence of paragraph (a) is revised to read as follows:

Such deferred gain or loss shall be taken into account at the time and in the manner specified in section 1.1502-13(d), (e), and (f), and section 1.1502-13T(l) and (m), as if such distributing corporation were a "selling member," the distributee were a "purchasing member" and the distribution described in section 1.1502-l4 were a "deferred intercompany transaction."

2. The last sentence of paragraph (b) is removed.

3. New paragraphs (c) and (d) are added to read as follows:

SECTION 1.1502-14T TREATMENT OF DISTRIBUTING CORPORATION (TEMPORARY).

* * * * *

(c) LIMITATION ON APPLICATION OF THIS SECTION -- (1) IN GENERAL. For purposes of this section, section 1.1502-13, section 1.1502-13T and section 1.1502-14, gain deferred with respect to a distribution of stock of a subsidiary from one member to another member shall be taken into account (i) upon a disposition (as defined in section 1.1502-19(b)(2)) of the stock of the subsidiary in an amount equal to the amount that would have created or increased the excess loss account if the adjustment to the basis (or the excess loss account) of the stock of the subsidiary resulting from the distribution had not occurred, or (ii) following a disposition, to the extent distributions with respect to any stock owned by a member would exceed the basis of such stock if the adjustment to the basis of the stock resulting from the distribution had not occurred.

(2) EXAMPLES. This paragraph (c) is illustrated by the following examples.

EXAMPLE (1). (i) Corporations P, 5, and T file consolidated returns on a calendar year basis. P owns all 100 shares of the outstanding stock of S. S owns all 200 shares of the outstanding stock of T. The T shares have an adjusted basis of $1,000 and a value of $10,000. S distributes all of its T stock to P. As a result of the distribution, S recognizes $9,000 of gain under section 311(b) and the gain is deferred under paragraph (a) of this section. P receives a $10,000 basis in the T stock under section 1.1502-31(a).

(ii) T borrows $9,000 in 1989 and distributes the $9,000 to P in the same year. T has no current earnings and profits, and the distribution reduces P's basis in the T stock from $10,000 to $1,000. In 1990, T has $1000 of earnings and profits which are not distributed. At the end of 1990, T issues 100 shares of stock to X, an unrelated third party. As a result, P no longer owns 80 percent or more of the stock of T and T ceases to be a member of the group. T's ceasing to be a member of the group constitutes a disposition of the T stock under section 1.1502-19(b)(2)(i). If the basis of the T stock had not been adjusted as a result of S's distribution of the T stock to P, the $9,000 distribution to P would have resulted in an $7,000 excess loss account with respect to the T stock. Accordingly, S is required to take into account $7,000 of deferred gain (the amount that would have been in the excess loss account but for the adjustment to the basis of the T stock resulting from its distribution).

EXAMPLE (2). The facts are the same as in Example (1) except that T borrows and distributes the $9,000 to S before S distributes the T stock to P. The results are the same as in Example (1) because P would have had an excess loss account of $7,000 with respect to the T stock at the time T ceased to be a member of the P group but for the adjustment to the excess loss account resulting from S's distribution of the T stock to P.

(3) EFFECTIVE DATE. -- (i) IN GENERAL. Except as provided in paragraph (c)(3)(ii) of this section, this paragraph (c) applies to dispositions (as defined in this paragraph (c)) of stock of a subsidiary in taxable years for which the due date (without extensions) of the income tax return is after March 14, 1990.

(ii) EXCEPTION. Notwithstanding paragraph (c)(3)(i) of this section, this paragraph (c) does not apply to gain deferred with respect to a distribution of stock of a subsidiary from one member to another member before January 1, 1989, if the disposition (as defined in this paragraph (c)) of the stock of the subsidiary occurs before March 9, 1990.

(d) REFERENCES. A reference in this part to section 1.1502-14 is treated as including a reference to this section.

There is a need for immediate guidance with respect to the provisions contained in this Treasury decision. It is therefore found impracticable and contrary to the public interest to issue this Treasury decision with notice and public procedure under section 553 (b) of Title 5 of the United States Code or subject to the effective date limitations of section 553(d) of Title 5 of the United States Code.