Final Consolidated Return Regs on Distributions After the Sale of a Subsidiary's Stock

 DEPARTMENT OF THE TREASURY

 ACTION: Temporary and final regulations.

 SUMMARY: This document contains final regulations providing rules for dividends and other distributions declared with respect to the stock of a subsidiary in a consolidated group if the stock is disposed of after the selling member becomes entitled to the distribution but before the distribution is made. The temporary regulations contained in section 1.1502-32T(b), also issued as proposed regulations in a cross-reference notice of proposed rulemaking (see 54 FR 11007), are adopted as final regulations and redesignated as section 1.1502-32(k)(1). Additional corrective and anti-avoidance rules are adopted as section 1.1502-32(k)(2).

 EFFECTIVE DATES: Except as provided below, these regulations are effective for distributions described in section 301 that are declared in taxable years for which the due date (without extensions) of the Federal income tax return is after March 14, 1989. The new rules adopted as section 1.1502-32(k)(2) are effective March 13, 1992, and apply to distributions described in section 301 that are declared on or after March 13, 1992.

 FOR FURTHER INFORMATION CONTACT: Steven B. Teplinsky, 202-566-4324 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

BACKGROUND

On March 14, 1989, temporary regulations (T.D. 8245) amending section 1.1502-32T(b) were filed with the Office of the Federal Register (see 54 FR 10980; 1989-1 C.B. 270). A Notice of Proposed Rulemaking (CO-5-89) cross-referencing the temporary regulations was filed with the Office of the Federal Register (see 54 FR 11007; 1989-1 C.B. 924) on the same day. Written comments were received, and a public hearing on the proposed regulations was held on September 18, 1989. After consideration of the comments, the temporary regulations contained in section 1.1502-32T(b) are adopted as final regulations and redesignated as section 1.1502-32(k)(1). In addition, section 1.1502-32(k)(2) is adopted in response to comments.

 The proposed and temporary regulations provide that, if a member of a consolidated group disposes of a share of stock of another member after a distribution subject to section 301 has been declared on that share and after the disposing member becomes entitled to the distribution, but before the distribution has been made, the distribution is deemed to be made for all Federal tax purposes immediately before the disposition. The final regulations continue this rule without change. The regulations address the Federal tax treatment of certain post-sale dividends and are not intended to affect the principles of existing case law under which these dividends may be recharacterized as part of the purchase price of the stock. See, e.g., Waterman Steamship Corporation v. Comm'r, 430 F.2d 1185 (5th Cir. 1970), rev'g 50 T.C. 650 (1968), cert. denied, 401 U.S. 939 (1971).

 Comments objected to the effective date of the temporary and proposed regulations. As discussed in the preamble to the temporary regulations, the regulations were adopted to clarify the investment adjustment rules under section 1.1502-32 and to ensure that the income and losses of members are taken into account only once in computing taxable income of a group. See T.D. 8245, 1989-1 C.B. 270. The Service and the Treasury Department believe that the effective date of the regulations is consistent with section 1503(a) of the Internal Revenue Code and section 553 of title 5 of the United States Code regarding temporary rules.

 Comments also argued that the regulations incorrectly fail to distinguish between "true" dividends and "sham" transactions designed to abuse the investment adjustment provisions of the consolidated return regulations. However, a principal purpose of the investment adjustment rules is to ensure that the income and losses of members are taken into account only once in computing taxable income of a group. Thus, the rule in the regulations is necessary to carry out that purpose without regard to taxpayer intent.

 Comments objected to the provision in the regulations that accelerates the year in which a distribution is treated as made. Under the regulations, the selling member is treated as receiving a distribution out of earnings and profits at the time of the sale, rather than out of earnings and profits at the time of the distribution. Similarly, any gain to the distributing member under section 311 is recognized at the time of the sale rather than at the time of the distribution. The Service and the Treasury Department believe that it is a reasonable approach to treat the distribution as made immediately before the disposition for all Federal tax purposes.

 One comment suggested that the regulations work improperly if the selling member sells less than all of the stock of the distributing member. This is corrected in the final regulations. Under the final regulations, proper adjustments must be made to the earnings and profits of the distributing member accrued to the date of the disposition to take into account the fact that the rules of section 1.1502-32(k) do not apply to all of the distributing corporation's stock.

 Another comment suggested that, because the regulations apply to a member's disposition of stock of another member (the "distributing corporation"), the regulations could be avoided by the distributing corporation ceasing to be included in the selling member's consolidated group prior to declaration of the distribution. In order to prevent avoidance of the regulations, an anti-avoidance provision has been added. Under this rule, if the distributing corporation ceases to be included in the selling member's consolidated group with a view to avoiding the application of this paragraph (k) to a distribution, the basis of the stock of the distributing corporation is adjusted in accordance with the purposes of this paragraph (k).

 These final regulations are added as section 1.1502-32(k) of the consolidated return regulations. Temporary section 1.1502-32T(b) is redesignated as section 1.1502-32(k)(1) and remains effective for distributions subject to section 301 that are declared in taxable years for which the due date (without extensions) of the Federal income tax return is after March 14, 1989.

 The earnings and profits allocation rule and the anti-abuse rule are contained in section 1.1502-32(k)(2), and are effective with respect to distributions described in section 301 that are declared on or after March 13, 1992.

SPECIAL ANALYSES

 These rules are not major rules as defined in Executive Order 12291. Therefore, a Regulatory Impact Analysis is not required.

 These rules will not have a significant economic impact on a substantial number of small entities. These rules apply only to consolidated groups, which tend to be larger businesses. These rules will not significantly alter the reporting or record keeping duties of small entities. Therefore, a final Regulatory Flexibility Analysis under the Regulatory Flexibility Act (5 U.S.C. chapter 6) 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 Chief Counsel for Advocacy of the Small Business Administration for comment on the impact of the rules on small businesses.

DRAFTING INFORMATION

The principal author of these regulations is Steven B. Teplinsky, of the Office of Assistant Chief Counsel (Corporate), Internal Revenue Service. Other personnel of the Service and the Treasury Department participated in their development.

LIST OF SUBJECTS

26 CFR 1.1502-12 THROUGH 1.1502-34

Income taxes.

Treasury Decision 8401

ADOPTION OF AMENDMENTS TO THE REGULATIONS

Accordingly, 26 CFR part 1 is amended as follows:

PART 1 -- INCOME TAX; TAXABLE YEARS BEGINNING AFTER DECEMBER 31, 1953

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

Authority: Sec. 7805, 68A Stat. 917; 26 U.S.C. 7805 * * * Section 1.1502-32(k) is also issued under 26 U.S.C. 1502. * * *

Par. 2. Section 1.1502-14(a)(5) is revised to read as follows:

SECTION 1.1502-14 STOCK, BONDS, AND OTHER OBLIGATIONS OF MEMBERS.

(a) * * *

(5) DISTRIBUTIONS AFTER THE DISPOSITION OF STOCK OF A MEMBER. For rules relating to certain distributions subject to section 301, declared before but paid after the disposition of stock, see section 1.1502-32(k).

* * * * *

Par. 3. Section 1.1502-32 is amended as follows:

1. Revising paragraphs (b)(3) and (c)(4) as set forth below.

2. Adding new paragraph (k) with the heading set forth below.

3. The paragraph (b) heading and paragraphs (b)(1), (2) and (3) of section 1.1502-32T are redesignated as the paragraph (k)(1) heading and paragraphs (k)(1)(i), (ii) and (iii), respectively, of section 1.1502-32.

4. Adding paragraph (k)(2) as set forth below.

SECTION 1.1502-32 INVESTMENT ADJUSTMENT.

* * * * *

(b) * * *

(3) DISTRIBUTIONS AFTER THE DISPOSITION OF STOCK OF A MEMBER. For rules relating to certain distributions subject to section 301, declared before but paid after the disposition of stock, see section 1.1502-32(k).

(c) * * *

(4) DISTRIBUTIONS AFTER THE DISPOSITION OF STOCK OF A MEMBER. For rules relating to certain distributions subject to section 301, declared before but paid after the disposition of stock, see section 1.1502-32(k).

* * * * *

(k) DISTRIBUTIONS AFTER CERTAIN STOCK DISPOSITIONS.

* * * * *

(2) SPECIAL RULES -- (i) SALES OF LESS THAN ALL THE STOCK OF THE DISTRIBUTING MEMBER. If paragraph (k)(1) of this section applies to a member's disposition of less than all of the shares of stock of the distributing member, proper adjustments to carry out the purposes of this paragraph (k) must be made to the earnings and profits of the distributing member accrued to the date of the disposition to take into account the fact that the rules of section 1.1502-32(k) do not apply to all of the distributing corporation's stock.

(ii) ANTI-AVOIDANCE RULE. If the distributing corporation ceases to be a member of the same consolidated group as the selling member with a view to avoiding the application of this paragraph (k) to a distribution, the basis of the stock of the distributing corporation is adjusted in accordance with the purposes of this paragraph (k).

(iii) EFFECTIVE DATE. This paragraph (k)(2) applies to distributions described in section 301 that are declared on or after March 13, 1992.

Par. 4. Section 1.1502-32T(b) is removed and reserved to read as follows:

SECTION 1.1502-32T INVESTMENT ADJUSTMENTS (TEMPORARY).

* * * * *

(b) [Reserved]