The Treatment of Certain Interests in Corporations as Stock or Indebtedness
| Published date | 14 May 2020 |
| Citation | 85 FR 28867 |
| Record Number | 2020-08096 |
| Section | Rules and Regulations |
| Court | Internal Revenue Service |
Federal Register, Volume 85 Issue 94 (Thursday, May 14, 2020)
[Federal Register Volume 85, Number 94 (Thursday, May 14, 2020)]
[Rules and Regulations]
[Pages 28867-28883]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-08096]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 9897]
RIN 1545-BN68
The Treatment of Certain Interests in Corporations as Stock or
Indebtedness
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations and removal of temporary regulations.
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SUMMARY: This document contains final regulations regarding the
treatment of certain interests in corporations as stock or
indebtedness. The final regulations generally affect corporations,
including those that are partners of certain partnerships, when those
corporations or partnerships issue purported indebtedness to related
corporations or partnerships.
DATES:
Effective date: These regulations are effective on May 14, 2020.
Applicability dates: For dates of applicability, see Sec. Sec.
1.385-3(j)(1) and (k) and 1.385-4(g).
FOR FURTHER INFORMATION CONTACT: Azeka J. Abramoff or D. Peter Merkel
of the Office of Associate Chief Counsel (International) at (202) 317-
6938 or Jeremy Aron-Dine of the Office of Associate Chief Counsel
(Corporate) at (202) 317-6848 (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Background
I. Overview
Section 385 authorizes the Secretary of the Treasury (Secretary) to
prescribe rules to determine whether an interest in a corporation is
treated as stock or indebtedness (or as in part stock and in
[[Page 28868]]
part indebtedness). On October 21, 2016, the Treasury Department and
the IRS published T.D. 9790 in the Federal Register (81 FR 72858),
which included final regulations under section 385 and temporary
regulations under section 385 (2016 Final Regulations and Temporary
Regulations, respectively, and together, the 2016 Regulations). On the
same date, the Treasury Department and the IRS also published a notice
of proposed rulemaking (REG-130314-16) in the Federal Register (81 FR
72751) (2016 Proposed Regulations) by cross-reference to the Temporary
Regulations, which included Sec. Sec. 1.385-3T and 1.385-4T. Technical
corrections to the 2016 Regulations were published in the Federal
Register (82 FR 8169) on January 24, 2017.
The 2016 Regulations and the 2016 Proposed Regulations address the
classification of certain related-party debt as stock or indebtedness
(or as in part stock and in part indebtedness) for U.S. Federal income
tax purposes. The 2016 Final Regulations included documentation rules
set forth in Sec. 1.385-2 (the Documentation Regulations). The 2016
Regulations also included Sec. Sec. 1.385-3, 1.385-3T, and 1.385-4T,
which treat certain indebtedness as stock that is issued by a
corporation to a controlling shareholder in a distribution or in
another related-party transaction that achieves an economically similar
result (the Distribution Regulations). The Distribution Regulations
apply to taxable years ending on or after January 19, 2017.
The Temporary Regulations set forth rules regarding the treatment
under the Distribution Regulations of certain qualified short-term debt
instruments, transactions involving controlled partnerships, and
transactions involving consolidated groups. The Temporary Regulations
apply to taxable years ending on or after January 19, 2017. The
Temporary Regulations expired on October 13, 2019. See section 7805(e);
Sec. 1.385-3T(l); Sec. 1.385-4T(h).
The 2016 Proposed Regulations are proposed to apply to taxable
years ending on or after January 19, 2017. The preamble to the 2016
Regulations requested comments on all aspects of the Temporary
Regulations, and the preamble to the 2016 Proposed Regulations
requested comments on all aspects of the 2016 Proposed Regulations.
REG-130314-16, 81 FR 72751, 72858 (October 21, 2016). The preamble to
the 2016 Regulations also requested comments on certain aspects of the
exception for qualified short-term debt instruments.
On October 28, 2019, the Treasury Department and the IRS issued
Notice 2019-58, 2019-44 I.R.B. 1022, which announced that, following
the expiration of the Temporary Regulations, a taxpayer may rely on the
2016 Proposed Regulations until further notice is given in the Federal
Register, provided that the taxpayer consistently applies the rules in
the 2016 Proposed Regulations in their entirety. On November 4, 2019,
the Treasury Department and the IRS published an advance notice of
proposed rulemaking in the Federal Register (84 FR 59318) (the ANPRM),
which announced that the Treasury Department and the IRS intend to
propose more streamlined and targeted Distribution Regulations. The
ANPRM also obsoleted Notice 2019-58 and announced that a taxpayer may
rely on the 2016 Proposed Regulations until further notice is given in
the Federal Register, provided that the taxpayer consistently applies
the rules in the 2016 Proposed Regulations in their entirety. This
Treasury decision finalizes the 2016 Proposed Regulations without any
substantive change (the 2020 Final Regulations).
II. Executive Order 13789
Executive Order 13789 (E.O. 13789), issued on April 21, 2017,
instructed the Secretary to review all significant tax regulations
issued on or after January 1, 2016, and to take concrete action to
alleviate the burdens of regulations that (i) impose an undue financial
burden on U.S. taxpayers; (ii) add undue complexity to the Federal tax
laws; or (iii) exceed the statutory authority of the IRS. E.O. 13789
further instructed the Secretary to submit to the President within 60
days a report (First Report) that identifies regulations that meet
these criteria. The First Report, Notice 2017-38, 2017-30 I.R.B. 147,
which was published on July 24, 2017, included the 2016 Regulations in
a list of eight regulations identified by the Secretary in the First
Report as meeting at least one of the first two criteria specified in
E.O. 13789.
E.O. 13789 further instructed the Secretary to submit to the
President a report (Second Report) that recommended specific actions to
mitigate the burden imposed by regulations identified in the First
Report. On October 16, 2017, the Secretary published in the Federal
Register the Second Report (82 FR 48013), which stated that (i) the
Treasury Department and the IRS were considering a proposal to revoke
the Documentation Regulations as issued and (ii) the Treasury
Department will reassess the distribution regulations in light of
impending tax reform, and the Treasury Department and the IRS may then
propose more streamlined and targeted regulations. On September 24,
2018, the Treasury Department and the IRS published proposed
regulations in the Federal Register that proposed removal of the
Documentation Regulations from the Code of Federal Regulations. See 83
FR 48265 (September 24, 2018) (2018 Proposed Regulations). On November
4, 2019, the Treasury Department and the IRS published T.D. 9880 in the
Federal Register (84 FR 59297), which finalized without change the
proposed regulations removing the Documentation Regulations.
In response to E.O. 13789 and the 2018 Proposed Regulations,
several comments recommended that the Treasury Department and the IRS
revoke the Distribution Regulations in addition to the Documentation
Regulations, while one comment recommended that the Treasury Department
and the IRS issue more streamlined and targeted Distribution
Regulations. The ANPRM stated that the Treasury Department and the IRS
are cognizant that a complete withdrawal of the Distribution
Regulations could restore incentives for multinational corporations to
generate additional interest deductions without new investment.
Accordingly, the Treasury Department and the IRS determined that the
Distribution Regulations continue to be necessary at this time. The
ANPRM also announced that the Treasury Department and the IRS intend to
propose more streamlined and targeted Distribution Regulations.
The 2016 Proposed Regulations cross-reference the Temporary
Regulations, a part of the Distribution Regulations, which expired on
October 13, 2019. Because of the general determination that the
Distribution Regulations continue to be necessary at this time, the
Treasury Department and the IRS are issuing the 2020 Final Regulations,
which finalize the 2016 Proposed Regulations, while the Treasury
Department and the IRS study the appropriate approach to revising the
Distribution Regulations, as discussed in the ANPRM.
III. The Distribution Regulations
Under the Distribution Regulations' general rule, the issuance of a
debt instrument by a member of an expanded group to another member of
the same expanded group in a distribution, or an economically similar
acquisition transaction, may result in the treatment of the debt
instrument as stock. See Sec. 1.385-3(b)(2). The Distribution
Regulations also include a funding rule
[[Page 28869]]
that treats as stock a debt instrument that is issued as part of a
series of transactions that achieves a result similar to a general rule
transaction. See Sec. 1.385-3(b)(3)(i). Specifically, Sec. 1.385-3(b)
treats as stock a debt instrument that was issued in exchange for
property, including cash, to fund a distribution to an expanded group
member or another acquisition transaction that achieves an economically
similar result. Id. Furthermore, the Distribution Regulations include a
per se rule, which treats a debt instrument as funding a distribution
to an expanded group member or other acquisition transaction with a
similar economic effect if it was issued in exchange for property
during the period beginning 36 months before and ending 36 months after
the issuer of the debt instrument made the distribution or undertook an
acquisition transaction with a similar economic effect. See Sec.
1.385-3(b)(3)(iii). The Distribution Regulations also include several
exceptions limiting their scope. See, e.g., Sec. 1.385-3(c).
The Distribution Regulations generally apply to transactions among
members of an expanded group of corporations, which is generally
defined by reference to the term ``affiliated group'' in section
1504(a), with several modifications, such as including foreign
corporations in the expanded group. See Sec. 1.385-1(c)(4). The
Distribution Regulations also generally apply only to ``covered debt
instruments'' that are issued by ``covered members'' other than certain
regulated financial companies and regulated insurance companies. See
Sec. 1.385-3(g)(3)(i). A covered member is a member of an expanded
group that is a domestic corporation. See Sec. 1.385-1(c)(2). A
covered debt instrument is generally a debt instrument that is issued
after April 4, 2016, other than certain excluded specialized debt
instruments. See Sec. 1.385-3(g)(3). In addition to these scope
limitations, the funding rule also excludes qualified short-term debt
instruments, as defined in Sec. 1.385-3(b)(3)(vii). See Sec. 1.385-
3(b)(3)(i).
Summary of Comments
The Treasury Department and the IRS have not received any comments
specifically in response to the Temporary Regulations or the 2016
Proposed Regulations. Accordingly, the 2016 Proposed Regulations are
adopted as final regulations without any substantive change. In
addition, the Temporary Regulations are withdrawn. Comments on the 2016
Regulations that are not specific to the particular matters addressed
in the Temporary Regulations or the 2016 Proposed Regulations are
beyond the scope of this rulemaking and are not addressed in this
preamble.
Pursuant to E.O. 13789 and the ANPRM, the Treasury Department and
the IRS intend to issue proposed regulations modifying the Distribution
Regulations to make them more streamlined and targeted, including by
withdrawing the per se rule. In connection with the intended revisions,
the Treasury Department and the IRS continue to study all appropriate
modifications to the Distribution Regulations.
Applicability Dates
The amendments to Sec. 1.385-3, other than Sec. 1.385-
3(f)(4)(iii), apply to taxable years ending after January 19, 2017.
Sections 1.385-3(f)(4)(iii) and 1.385-4 provide rules applicable to
members of consolidated groups and are issued under section 1502.
Section 1503(a) provides in general, that in any case in which a
consolidated return is made or is required to be made, the tax shall be
determined, computed, assessed, collected, and adjusted in accordance
with the regulations under section 1502 prescribed before the last day
prescribed by law for the filing of such return. Thus, Sec. Sec.
1.385-3(f)(4)(iii) and 1.385-4 apply to taxable years for which the
U.S. Federal income tax return is due, without extensions, after May
14, 2020.
The Temporary Regulations apply to taxable years ending on or after
January 19, 2017, and before their expiration on October 13, 2019. For
rules applying Sec. Sec. 1.385-3T(f)(4)(iii) and 1.385-4T to taxable
years ending on or after January 19, 2017 and for which the U.S.
Federal income tax return was due, without extensions, on or before May
14, 2020, see Sec. Sec. 1.385-3T and 1.385-4T (as contained in 26 CFR
in part 1 revised as of April 1, 2019). The provisions in the Temporary
Regulations and the corresponding provisions in the 2020 Final
Regulations are substantially identical.
For certain taxable years for which the U.S. Federal income tax
return was due, without extensions, on or before May 14, 2020, there
may be a period after October 13, 2019, to which neither Sec. Sec.
1.385-3T(f)(4)(iii) and 1.385-4T nor Sec. Sec. 1.385-3(f)(4)(iii) and
1.385-4 apply. The 2020 Final Regulations allow a taxpayer to choose to
apply Sec. Sec. 1.385-3(f)(4)(iii), 1.385-4, or both to such period,
provided that all members of the expanded group apply that section or
sections. Accordingly, a taxpayer can choose to apply the 2020 Final
Regulations to the period, if any, to which neither the Temporary
Regulations nor the 2020 Final Regulations apply.
Special Analyses
I. Regulatory Planning and Review--Economic Analysis
These regulations are not subject to review under section 6(b) of
Executive Order 12866 pursuant to the Memorandum of Agreement (April
11, 2018) between the Treasury Department and the Office of Management
and Budget regarding review of tax regulations.
II. Paperwork Reduction Act
These regulations do not establish a new collection of information
nor modify an existing collection that requires the approval of the
Office of Management and Budget under the Paperwork Reduction Act (44
U.S.C. chapter 35).
III. Regulatory Flexibility Act
Pursuant to the Regulatory Flexibility Act (5 U.S.C. Chapter 6), it
is hereby certified that the 2020 Final Regulations will not have a
significant economic impact on a substantial number of small entities.
Section 1.385-3 provides that certain interests in a corporation
that are held by a member of the corporation's expanded group and that
otherwise would be treated as indebtedness for Federal tax purposes are
treated as stock. The regulations under Section 1.385-3 finalized in
the 2020 Final Regulations provide that for certain debt instruments
issued by a controlled partnership, the holder is deemed to transfer
all or a portion of the debt instrument to the partner or partners in
the partnership in exchange for stock in the partner or partners.
Section 1.385-4 provides rules regarding the application of Sec.
1.385-3 to members of a consolidated group. Section 1.385-3 includes
multiple exceptions that limit its application. In particular, the
threshold exception provides that the first $50 million of expanded
group debt instruments that otherwise would be reclassified as stock or
deemed to be transferred to a partner in a controlled partnership under
Sec. 1.385-3 will not be reclassified or deemed transferred under
Sec. 1.385-3. Although it is possible that the classification rules in
the 2020 Final Regulations could have an effect on small entities, the
threshold exception of the first $50 million of debt instruments
otherwise subject to recharacterization or deemed transfer under
Sec. Sec. 1.385-3 and 1.385-4 makes it unlikely that a substantial
number of
[[Page 28870]]
small entities will be affected by these provisions.
Pursuant to section 7805(f) of the Code, the proposed regulations
preceding these final regulations were submitted to the Chief Counsel
for Advocacy of the Small Business Administration for comment on their
impact on small business. No comments were received concerning the
economic impact on small entities from the Small Business
Administration.
IV. Unfunded Mandates Reform Act
Section 202 of the Unfunded Mandates Reform Act of 1995 requires
that agencies assess anticipated costs and benefits and take certain
other actions before issuing a final rule that includes any Federal
mandate that may result in expenditures in any one year by a state,
local, or tribal government, in the aggregate, or by the private
sector, of $100 million in 1995 dollars, updated annually for
inflation. This rule does not include any Federal mandate that may
result in expenditures by state, local, or tribal governments, or by
the private sector in excess of that threshold.
V. Executive Order 13132: Federalism
Executive Order 13132 (entitled ``Federalism'') prohibits an agency
from publishing any rule that has federalism implications if the rule
either imposes substantial, direct compliance costs on state and local
governments, and is not required by statute, or preempts state law,
unless the agency meets the consultation and funding requirements of
section 6 of the Executive order. This final rule does not have
federalism implications and does not impose substantial direct
compliance costs on state and local governments or preempt state law
within the meaning of the Executive order.
Statement of Availability of IRS Documents
IRS Notices and other guidance cited in this preamble are published
in the Internal Revenue Bulletin and are available from the
Superintendent of Documents, U.S. Government Publishing Office,
Washington, DC 20402, or by visiting the IRS website at http://www/
irs.gov.
Drafting Information
The principal authors of these final regulations are Azeka J.
Abramoff and D. Peter Merkel of the Office of Associate Chief Counsel
(International). However, other personnel from the IRS and the Treasury
Department participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
Accordingly, 26 CFR part 1 is amended as follows:
PART 1--INCOME TAXES
0
Paragraph 1. The authority citation for part 1 is amended by removing
the entries for Sec. Sec. 1.385-3T and 1.385-4T and adding an entry
for Sec. 1.385-4 in numerical order to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
* * * * *
Section 1.385-4 also issued under 26 U.S.C. 385 and 1502.
* * * * *
Sec. 1.385-1 [Amended]
0
Par. 2. Section 1.385-1 is amended by:
0
1. In paragraph (c)(4)(vii), designating Examples 1 through 4 as
paragraphs (c)(4)(vii)(A) through (D), respectively.
0
2. In newly designated paragraphs (c)(4)(vii)(A) through (D),
redesignating the paragraphs in the first column as the paragraphs in
the second column:
------------------------------------------------------------------------
Old paragraphs New paragraphs
------------------------------------------------------------------------
(c)(4)(vii)(A)(i) and (ii)................ (c)(4)(vii)(A)(1) and (2).
(c)(4)(vii)(B)(i) and (ii)................ (c)(4)(vii)(B)(1) and (2).
(c)(4)(vii)(C)(i) and (ii)................ (c)(4)(vii)(C)(1) and (2).
(c)(4)(vii)(D)(i) and (ii)................ (c)(4)(vii)(D)(1) and (2).
------------------------------------------------------------------------
0
3. Revise the last sentence of newly redesignated paragraph
(c)(4)(vii)(B)(1).
0
4. In newly designated paragraphs (c)(4)(vii)(C)(2) and
(c)(4)(vii)(D)(2), redesignating the paragraphs in the first column as
the paragraphs in the second column:
------------------------------------------------------------------------
Old paragraphs New paragraphs
------------------------------------------------------------------------
(c)(4)(vii)(C)(2)(A) and (B).............. (c)(4)(vii)(C)(2)(i) and
(ii).
(c)(4)(vii)(D)(2)(A) through (C).......... (c)(4)(vii)(D)(2)(i) through
(iii).
------------------------------------------------------------------------
0
5. For each paragraph listed in the table, remove the language in the
``Remove'' column wherever it appears and add in its place the language
in the ``Add'' column as set forth below:
------------------------------------------------------------------------
Paragraph Remove Add
------------------------------------------------------------------------
(a)......................... 1.385-4T............ 1.385-4.
(c) introductory text....... 1.385-4T(e)......... 1.385-4(e).
(c)(4)(i) introductory text. corporations S corporations.
described in
section 1504(b)(8).
(c)(4)(i) introductory text. not described in that is not an S
section 1504(b)(6) corporation or a
or (b)(8) (an regulated
expanded group investment company
parent). or a real estate
investment trust
subject to tax
under subchapter M
of chapter 1 of the
Internal Revenue
Code (a RIC or a
REIT, respectively)
(such common parent
corporation, an
expanded group
parent).
(c)(4)(vii) introductory described in section an S corporation, a
text. 1504(b)(6) or RIC, or a REIT.
(b)(8).
(c)(4)(vii)(B)(2)........... P is a real estate P is a REIT.
investment trust
described in
section 1504(b)(6).
(c)(4)(vii)(B)(2)........... Although S2 is a Although S2 is a
corporation corporation that is
described in a REIT, a REIT may.
section 1504(b)(6),
a corporation
described in
section 1504(b)(6)
may.
(c)(4)(vii)(D)(1)........... Example 3........... paragraph
(c)(4)(vii)(C)(1)
of this section
(Example 3).
(d)(1)(iv)(A)............... 1.385-3T(d)(4)...... 1.385-3(d)(4).
(d)(1)(iv)(B)............... 1.385-3T(f)(4)...... 1.385-3(f)(4).
------------------------------------------------------------------------
The revision reads as follows:
Sec. 1.385-1 General provisions.
* * * * *
(c) * * *
(4) * * *
(vii) * * *
(B) * * *
(1) * * * Both P and S2 are REITs.
* * * * *
0
Par. 3. Section 1.385-3 is amended by:
[[Page 28871]]
0
1. Revising the section heading.
0
2. For each paragraph listed in the table, remove the language in the
``Remove'' column wherever it appears and add in its place the language
in the ``Add'' column as set forth below:
------------------------------------------------------------------------
Paragraph Remove Add
------------------------------------------------------------------------
(a)......................... 1.385-4T............ 1.385-4.
(b)(4) introductory text.... 1.385-3T............ 1.385-3.
(b)(4)(i) introductory text. 1.385-3T............ 1.385-3.
(b)(4)(i)(E)................ 1.385-3T(k)(2)...... 1.385-3(k)(2).
(b)(4)(ii) introductory text 1.385-3T............ 1.385-3.
(b)(4)(ii)(D)............... 1.385-4T............ 1.385-4.
(c)(1)...................... 1.385-3T(f)......... 1.385-3(f).
(c)(2)(i)(C)................ 1.385-3T............ 1.385-3.
(c)(2)(iv).................. 1.385-3T(f)(2)...... 1.385-3(f)(2).
(c)(2)(v)(B)................ 1.385-3T(d)(4)...... 1.385-3(d)(4).
(c)(2)(v)(C)................ 1.385-3T(f)(4) or 1.385-3(f)(4) or
(5). (5).
(c)(3)(i)(C)(4)............. 1.385-3T(f)(4)(i)... 1.385-3(f)(4)(i).
(c)(3)(ii)(D)(6)............ 1.385-3T............ 1.385-3.
(d)(2)(ii)(A)............... 1.385-4T(c)(2)...... 1.385-4(c)(2).
(d)(2)(ii)(B)............... 1.385-3T(f)(5)(i)... 1.385-3(f)(5)(i).
(d)(7)(ii).................. 1.385-3T(d)(4)...... 1.385-3(d)(4).
(g) introductory text....... 1.385-3T and 1.385- 1.385-3 and 1.385-4.
4T.
(g)(3)(iii)(D).............. 1.385-3T............ 1.385-3.
(j)(2)(i)................... 1.385-1, 1.385-3T, 1.385-1, 1.385-3,
and 1.385-4T. and 1.385-4.
(j)(2)(ii).................. 1.385-1, 1.385-3T, 1.385-1, 1.385-3,
and 1.385-4T. and 1.385-4.
(j)(2)(v)................... 1.385-1, 1.385-3, 1.385-1, 1.385-3,
1.385-3T, and 1.385- and 1.385-4.
4T.
------------------------------------------------------------------------
0
3. Revising paragraphs (b)(3)(vii), (d)(4), (f), and (g)(5) through
(8), (15) through (17), (22), and (23).
0
4. In paragraph (h)(3), designating Examples 1 through 19 as paragraphs
(h)(3)(i) through (xix), respectively.
0
5. In newly designated paragraphs (h)(3)(i) through (xi), redesignating
the paragraphs in the first column as the paragraphs in the second
column:
------------------------------------------------------------------------
Old paragraphs New paragraphs
------------------------------------------------------------------------
(h)(3)(i)(i) and (ii)..................... (h)(3)(i)(A) and (B).
(h)(3)(ii)(i) and (ii).................... (h)(3)(ii)(A) and (B).
(h)(3)(iii)(i) and (ii)................... (h)(3)(iii)(A) and (B).
(h)(3)(iv)(i) and (ii).................... (h)(3)(iv)(A) and (B).
(h)(3)(v)(i) and (ii)..................... (h)(3)(v)(A) and (B).
(h)(3)(vi)(i) and (ii).................... (h)(3)(vi)(A) and (B).
(h)(3)(vii)(i) and (ii)................... (h)(3)(vii)(A) and (B).
(h)(3)(viii)(i) and (ii).................. (h)(3)(viii)(A) and (B).
(h)(3)(ix)(i) and (ii).................... (h)(3)(ix)(A) and (B).
(h)(3)(x)(i) and (ii)..................... (h)(3)(x)(A) and (B).
(h)(3)(xi)(i) and (ii).................... (h)(3)(xi)(A) and (B).
------------------------------------------------------------------------
0
6. In newly designated paragraphs (h)(3)(ii)(B), (h)(3)(iii)(B),
(h)(3)(vi)(B), (h)(3)(vii)(B), (h)(3)(viii)(B), (h)(3)(ix)(B), and
(h)(3)(x)(B), redesignating the paragraphs in the first column as the
paragraphs in the second column:
------------------------------------------------------------------------
Old paragraphs New paragraphs
------------------------------------------------------------------------
(h)(3)(ii)(B)(A) and (B).................. (h)(3)(ii)(B)(1) and (2).
(h)(3)(iii)(B)(A) and (B)................. (h)(3)(iii)(B)(1) and (2).
(h)(3)(vi)(B)(A) and (B).................. (h)(3)(vi)(B)(1) and (2).
(h)(3)(vii)(B)(A) and (B)................. (h)(3)(vii)(B)(1) and (2).
(h)(3)(viii)(B)(A) though (F)............. (h)(3)(viii)(B)(1) though
(6).
(h)(3)(ix)(B)(A) and (B).................. (h)(3)(ix)(B)(1) and (2).
(h)(3)(x)(B)(A) though (C)................ (h)(3)(x)(B)(1) through (3).
------------------------------------------------------------------------
0
7. For each newly designated paragraph listed in the table, remove the
language in the ``Remove'' column wherever it appears and add in its
place the language in the ``Add'' column as set forth below:
------------------------------------------------------------------------
Paragraph Remove Add
------------------------------------------------------------------------
(h)(3)(v)(A)................ Example 4 of this paragraph
paragraph (h)(3). (h)(3)(iv)(A) of
this section
(Example 4).
(h)(3)(v)(B)................ Example 4 of this paragraph
paragraph (h)(3). (h)(3)(iv)(B) of
this section
(Example 4).
(h)(3)(vii)(A).............. Example 6 of this paragraph
paragraph (h)(3). (h)(3)(vi)(A) of
this section
(Example 6).
------------------------------------------------------------------------
0
8. Revising newly designated paragraphs (h)(3)(xii) through (xix) and
paragraph (j)(1).
0
9. Adding paragraphs (j)(3) and (k).
The revisions and additions read as follows:
Sec. 1.385-3 Certain distributions of debt instruments and similar
transactions.
* * * * *
(b) * * *
(3) * * *
(vii) Qualified short-term debt instrument. The term qualified
short-term debt instrument means a covered debt instrument that is
described in paragraphs (b)(3)(vii)(A) though (D) of this section.
(A) Short-term funding arrangement. A covered debt instrument is
described in this paragraph (b)(3)(vii)(A) if the requirements of the
specified current assets test described in paragraph (b)(3)(vii)(A)(1)
of this section or the 270-day test described in paragraph
(b)(3)(vii)(A)(2) of this section (the alternative tests) are
satisfied, provided that an issuer may only claim the benefit of one of
the alternative tests with respect to covered debt instruments issued
by the issuer in the same taxable year.
(1) Specified current assets test--(i) In general. The requirements
of this paragraph (b)(3)(vii)(A)(1) are satisfied with respect to a
covered debt instrument if the requirement of paragraph
(b)(3)(vii)(A)(1)(ii) of this section is satisfied, but only to the
extent the requirement of paragraph (b)(3)(vii)(A)(1)(iii) of this
section is satisfied.
(ii) Maximum interest rate. The rate of interest charged with
respect to the covered debt instrument does not exceed an arm's length
interest rate, as determined under section 482 and Sec. Sec. 1.482-1
through 1.482-9, that would be charged with respect to a comparable
[[Page 28872]]
debt instrument of the issuer with a term that does not exceed the
longer of 90 days and the issuer's normal operating cycle.
(iii) Maximum outstanding balance. The amount owed by the issuer
under covered debt instruments issued to members of the issuer's
expanded group that satisfy the requirements of paragraph
(b)(3)(vii)(A)(1)(ii), (b)(3)(vii)(A)(2) (if the covered debt
instrument was issued in a prior taxable year), or (b)(3)(vii)(B) or
(C) of this section immediately after the covered debt instrument is
issued does not exceed the maximum of the amounts of specified current
assets reasonably expected to be reflected, under applicable accounting
principles, on the issuer's balance sheet as a result of transactions
in the ordinary course of business during the subsequent 90-day period
or the issuer's normal operating cycle, whichever is longer. For
purposes of the preceding sentence, in the case of an issuer that is a
qualified cash pool header, the amount owed by the issuer shall not
take into account deposits described in paragraph (b)(3)(vii)(D) of
this section. Additionally, the amount owed by any issuer shall be
reduced by the amount of the issuer's deposits with a qualified cash
pool header, but only to the extent of amounts borrowed from the same
qualified cash pool header that satisfy the requirements of paragraph
(b)(3)(vii)(A)(2) (if the covered debt instrument was issued in a prior
taxable year) or (b)(3)(vii)(A)(1)(ii) of this section.
(iv) Specified current assets. For purposes of paragraph
(b)(3)(vii)(A)(1)(iii) of this section, the term specified current
assets means assets that are reasonably expected to be realized in cash
or sold (including by being incorporated into inventory that is sold)
during the normal operating cycle of the issuer, other than cash, cash
equivalents, and assets that are reflected on the books and records of
a qualified cash pool header.
(v) Normal operating cycle. For purposes of paragraph
(b)(3)(vii)(A)(1) of this section, the term normal operating cycle
means the issuer's normal operating cycle as determined under
applicable accounting principles, except that if the issuer has no
single clearly defined normal operating cycle, then the normal
operating cycle is determined based on a reasonable analysis of the
length of the operating cycles of the multiple businesses and their
sizes relative to the overall size of the issuer.
(vi) Applicable accounting principles. For purposes of paragraph
(b)(3)(vii)(A)(1) of this section, the term applicable accounting
principles means the financial accounting principles generally accepted
in the United States, or an international financial accounting
standard, that is applicable to the issuer in preparing its financial
statements, computed on a consistent basis.
(2) 270-day test--(i) In general. A covered debt instrument is
described in this paragraph (b)(3)(vii)(A)(2) if the requirements of
paragraphs (b)(3)(vii)(A)(2)(ii) through (iv) of this section are
satisfied.
(ii) Maximum term and interest rate. The covered debt instrument
must have a term of 270 days or less or be an advance under a revolving
credit agreement or similar arrangement and must bear a rate of
interest that does not exceed an arm's length interest rate, as
determined under section 482 and Sec. Sec. 1.482-1 through 1.482-9,
that would be charged with respect to a comparable debt instrument of
the issuer with a term that does not exceed 270 days.
(iii) Lender-specific indebtedness limit. The issuer is a net
borrower from the lender for no more than 270 days during the taxable
year of the issuer, and in the case of a covered debt instrument
outstanding during consecutive tax years, the issuer is a net borrower
from the lender for no more than 270 consecutive days, in both cases
taking into account only covered debt instruments that satisfy the
requirement of paragraph (b)(3)(vii)(A)(2)(ii) of this section other
than covered debt instruments described in paragraph (b)(3)(vii)(B) or
(C) of this section.
(iv) Overall indebtedness limit. The issuer is a net borrower under
all covered debt instruments issued to members of the issuer's expanded
group that satisfy the requirements of paragraphs (b)(3)(vii)(A)(2)(ii)
and (iii) of this section, other than covered debt instruments
described in paragraph (b)(3)(vii)(B) or (C) of this section, for no
more than 270 days during the taxable year of the issuer, determined
without regard to the identity of the lender under such covered debt
instruments.
(v) Inadvertent error. An issuer's failure to satisfy the 270-day
test will be disregarded if the failure is reasonable in light of all
the facts and circumstances and the failure is promptly cured upon
discovery. A failure to satisfy the 270-day test will be considered
reasonable if the taxpayer maintains due diligence procedures to
prevent such failures, as evidenced by having written policies and
operational procedures in place to monitor compliance with the 270-day
test and management-level employees of the expanded group having
undertaken reasonable efforts to establish, follow, and enforce such
policies and procedures.
(B) Ordinary course loans. A covered debt instrument is described
in this paragraph (b)(3)(vii)(B) if the covered debt instrument is
issued as consideration for the acquisition of property other than
money in the ordinary course of the issuer's trade or business,
provided that the obligation is reasonably expected to be repaid within
120 days of issuance.
(C) Interest-free loans. A covered debt instrument is described in
this paragraph (b)(3)(vii)(C) if the instrument does not provide for
stated interest or no interest is charged on the instrument, the
instrument does not have original issue discount (as defined in section
1273 and Sec. Sec. 1.1273-1 and 1.1273-2), interest is not imputed
under section 483 or section 7872 and Sec. Sec. 1.483-1 through 1.483-
4 or Sec. Sec. 1.7872-1 through 1.7872-16, respectively, and interest
is not required to be charged under section 482 and Sec. Sec. 1.482-1
through 1.482-9.
(D) Deposits with a qualified cash pool header--(1) In general. A
covered debt instrument is described in this paragraph (b)(3)(vii)(D)
if it is a demand deposit received by a qualified cash pool header
described in paragraph (b)(3)(vii)(D)(2) of this section pursuant to a
cash-management arrangement described in paragraph (b)(3)(vii)(D)(3) of
this section. This paragraph (b)(3)(vii)(D) does not apply if a purpose
for making the demand deposit is to facilitate the avoidance of the
purposes of this section with respect to a qualified business unit (as
defined in section 989(a) and Sec. 1.989(a)-1) (QBU) that is not a
qualified cash pool header.
(2) Qualified cash pool header. The term qualified cash pool header
means an expanded group member, controlled partnership, or QBU
described in Sec. 1.989(a)-1(b)(2)(ii), that has as its principal
purpose managing a cash-management arrangement for participating
expanded group members, provided that the excess (if any) of funds on
deposit with such expanded group member, controlled partnership, or QBU
(header) over the outstanding balance of loans made by the header is
maintained on the books and records of the header in the form of cash
or cash equivalents, or invested through deposits with, or the
acquisition of obligations or portfolio securities of, persons that do
not have a relationship to the header (or, in the case of a header that
is a QBU described in Sec. 1.989(a)-1(b)(2)(ii), its owner) described
in section 267(b) or section 707(b).
(3) Cash-management arrangement. The term cash-management
arrangement means an arrangement the principal
[[Page 28873]]
purpose of which is to manage cash for participating expanded group
members. For purposes of the preceding sentence, managing cash means
borrowing excess funds from participating expanded group members and
lending funds to participating expanded group members, and may also
include foreign exchange management, clearing payments, investing
excess cash with an unrelated person, depositing excess cash with
another qualified cash pool header, and settling intercompany accounts,
for example through netting centers and pay-on-behalf-of programs.
* * * * *
(d) * * *
(4) Treatment of disregarded entities. This paragraph (d)(4)
applies to the extent that a covered debt instrument issued by a
disregarded entity, the regarded owner of which is a covered member,
would, absent the application of this paragraph (d)(4), be treated as
stock under this section. In this case, rather than the covered debt
instrument being treated as stock to such extent (applicable portion),
the covered member that is the regarded owner of the disregarded entity
is deemed to issue its stock in the manner described in this paragraph
(d)(4). If the applicable portion otherwise would have been treated as
stock under paragraph (b)(2) of this section, then the covered member
is deemed to issue its stock to the expanded group member to which the
covered debt instrument was, in form, issued (or transferred) in the
transaction described in paragraph (b)(2) of this section. If the
applicable portion otherwise would have been treated as stock under
paragraph (b)(3)(i) of this section, then the covered member is deemed
to issue its stock to the holder of the covered debt instrument in
exchange for a portion of the covered debt instrument equal to the
applicable portion. In each case, the covered member that is the
regarded owner of the disregarded entity is treated as the holder of
the applicable portion of the debt instrument issued by the disregarded
entity, and the actual holder is treated as the holder of the remaining
portion of the covered debt instrument and the stock deemed to be
issued by the regarded owner. Under Federal tax principles, the
applicable portion of the debt instrument issued by the disregarded
entity generally is disregarded. This paragraph (d)(4) must be applied
in a manner that is consistent with the principles of paragraph (f)(4)
of this section. Thus, for example, stock deemed issued is deemed to
have the same terms as the covered debt instrument issued by the
disregarded entity, other than the identity of the issuer, and payments
on the stock are determined by reference to payments made on the
covered debt instrument issued by the disregarded entity. See Sec.
1.385-4(b)(3) for additional rules that apply if the regarded owner of
the disregarded entity is a member of a consolidated group. If the
regarded owner of a disregarded entity is a controlled partnership,
then paragraph (f) of this section applies as though the controlled
partnership were the issuer in form of the debt instrument.
* * * * *
(f) Treatment of controlled partnerships--(1) In general. For
purposes of this section and Sec. 1.385-4, a controlled partnership is
treated as an aggregate of its partners in the manner described in this
paragraph (f). Paragraph (f)(2) of this section sets forth rules
concerning the aggregate treatment when a controlled partnership
acquires property from a member of the expanded group. Paragraph (f)(3)
of this section sets forth rules concerning the aggregate treatment
when a controlled partnership issues a debt instrument. Paragraph
(f)(4) of this section deems a debt instrument issued by a controlled
partnership to be held by an expanded group partner rather than the
holder-in-form in certain cases. Paragraph (f)(5) of this section sets
forth the rules concerning events that cause the deemed results
described in paragraph (f)(4) of this section to cease. Paragraph
(f)(6) of this section exempts certain issuances of a controlled
partnership's debt to a partner and a partner's debt to a controlled
partnership from the application of this section. For definitions
applicable for this section, see paragraph (g) of this section. For
examples illustrating the application of this section, see paragraph
(h) of this section.
(2) Acquisitions of property by a controlled partnership--(i)
Acquisitions of property when a member of the expanded group is a
partner on the date of the acquisition--(A) Aggregate treatment. Except
as otherwise provided in paragraphs (f)(2)(i)(C) and (f)(6) of this
section, if a controlled partnership, with respect to an expanded
group, acquires property from a member of the expanded group
(transferor member), then, for purposes of this section, a member of
the expanded group that is an expanded group partner on the date of the
acquisition is treated as acquiring its share (as determined under
paragraph (f)(2)(i)(B) of this section) of the property. The expanded
group partner is treated as acquiring its share of the property from
the transferor member in the manner (for example, in a distribution, in
an exchange for property, or in an issuance), and on the date on which,
the property is actually acquired by the controlled partnership from
the transferor member. Accordingly, this section applies to a member's
acquisition of property described in this paragraph (f)(2)(i)(A) in the
same manner as if the member actually acquired the property from the
transferor member, unless explicitly provided otherwise.
(B) Expanded group partner's share of property. For purposes of
paragraph (f)(2)(i)(A) of this section, a partner's share of property
acquired by a controlled partnership is determined in accordance with
the partner's liquidation value percentage (as defined in paragraph
(g)(17) of this section) with respect to the controlled partnership.
The liquidation value percentage is determined on the date on which the
controlled partnership acquires the property.
(C) Exception if transferor member is an expanded group partner. If
a transferor member is an expanded group partner in the controlled
partnership, paragraph (f)(2)(i)(A) of this section does not apply to
such partner.
(ii) Acquisitions of expanded group stock when a member of the
expanded group becomes a partner after the acquisition--(A) Aggregate
treatment. Except as otherwise provided in paragraph (f)(2)(ii)(C) of
this section, if a controlled partnership, with respect to an expanded
group, owns expanded group stock, and a member of the expanded group
becomes an expanded group partner in the controlled partnership, then,
for purposes of this section, the member is treated as acquiring its
share (as determined under paragraph (f)(2)(ii)(B) of this section) of
the expanded group stock owned by the controlled partnership. The
member is treated as acquiring its share of the expanded group stock on
the date on which the member becomes an expanded group partner.
Furthermore, the member is treated as if it acquires its share of the
expanded group stock from a member of the expanded group in exchange
for property other than expanded group stock, regardless of the manner
in which the partnership acquired the stock and in which the member
acquires its partnership interest. Accordingly, this section applies to
a member's acquisition of expanded group stock described in this
paragraph (f)(2)(ii)(A) in the same manner as if the member actually
acquired the stock from a member of the expanded group in exchange for
property other than expanded group
[[Page 28874]]
stock, unless explicitly provided otherwise.
(B) Expanded group partner's share of expanded group stock. For
purposes of paragraph (f)(2)(ii)(A) of this section, a partner's share
of expanded group stock owned by a controlled partnership is determined
in accordance with the partner's liquidation value percentage with
respect to the controlled partnership. The liquidation value percentage
is determined on the date on which a member of the expanded group
becomes an expanded group partner in the controlled partnership.
(C) Exception if an expanded group partner acquires its interest in
a controlled partnership in exchange for expanded group stock.
Paragraph (f)(2)(ii)(A) of this section does not apply to a member of
an expanded group that acquires its interest in a controlled
partnership either from another partner in exchange solely for expanded
group stock or upon a partnership contribution to the controlled
partnership comprised solely of expanded group stock.
(3) Issuances of debt instruments by a controlled partnership to a
member of an expanded group--(i) Aggregate treatment. If a controlled
partnership, with respect to an expanded group, issues a debt
instrument to a member of the expanded group, then, for purposes of
this section, a covered member that is an expanded group partner is
treated as the issuer with respect to its share (as determined under
paragraph (f)(3)(ii) of this section) of the debt instrument issued by
the controlled partnership. This section applies to the portion of the
debt instrument treated as issued by the covered member as described in
this paragraph (f)(3)(i) in the same manner as if the covered member
actually issued the debt instrument to the holder-in-form, unless
otherwise provided. See paragraph (f)(4) of this section, which deems a
debt instrument issued by a controlled partnership to be held by an
expanded group partner rather than the holder-in-form in certain cases.
(ii) Expanded group partner's share of a debt instrument issued by
a controlled partnership--(A) General rule. An expanded group partner's
share of a debt instrument issued by a controlled partnership is
determined on each date on which the partner makes a distribution or
acquisition described in paragraph (b)(2) or (b)(3)(i) of this section
(testing date). An expanded group partner's share of a debt instrument
issued by a controlled partnership to a member of the expanded group is
determined in accordance with the partner's issuance percentage (as
defined in paragraph (g)(16) of this section) on the testing date. A
partner's share determined under this paragraph (f)(3)(ii)(A) is
adjusted as described in paragraph (f)(3)(ii)(B) of this section.
(B) Additional rules if there is a specified portion with respect
to a debt instrument--(1) An expanded group partner's share (as
determined under paragraph (f)(3)(ii)(A) of this section) of a debt
instrument issued by a controlled partnership is reduced, but not below
zero, by the sum of all of the specified portions (as defined in
paragraph (g)(23) of this section), if any, with respect to the debt
instrument that correspond to one or more deemed transferred
receivables (as defined in paragraph (g)(8) of this section) that are
deemed to be held by the partner.
(2) If the aggregate of all of the expanded group partners' shares
(as determined under paragraph (f)(3)(ii)(A) of this section and
reduced under paragraph (f)(3)(ii)(B)(1) of this section) of the debt
instrument exceeds the adjusted issue price of the debt, reduced by the
sum of all of the specified portions with respect to the debt
instrument that correspond to one or more deemed transferred
receivables that are deemed to be held by one or more expanded group
partners (excess amount), then each expanded group partner's share (as
determined under paragraph (f)(3)(ii)(A) of this section and reduced
under paragraph (f)(3)(ii)(B)(1) of this section) of the debt
instrument is reduced. The amount of an expanded group partner's
reduction is the excess amount multiplied by a fraction, the numerator
of which is the partner's share, and the denominator of which is the
aggregate of all of the expanded group partners' shares.
(iii) Qualified short-term debt instrument. The determination of
whether a debt instrument is a qualified short-term debt instrument for
purposes of paragraph (b)(3)(vii) of this section is made at the
partnership-level without regard to paragraph (f)(3)(i) of this
section.
(4) Recharacterization when there is a specified portion with
respect to a debt instrument issued by a controlled partnership--(i)
General rule. A specified portion, with respect to a debt instrument
issued by a controlled partnership and an expanded group partner, is
not treated as stock under paragraph (b)(2) or (b)(3)(i) of this
section. Except as otherwise provided in paragraphs (f)(4)(ii) and
(iii) of this section, the holder-in-form (as defined in paragraph
(g)(15) of this section) of the debt instrument is deemed to transfer a
portion of the debt instrument (a deemed transferred receivable, as
defined in paragraph (g)(8) of this section) with a principal amount
equal to the adjusted issue price of the specified portion to the
expanded group partner in exchange for stock in the expanded group
partner (deemed partner stock, as defined in paragraph (g)(6) of this
section) with a fair market value equal to the principal amount of the
deemed transferred receivable. Except as otherwise provided in
paragraph (f)(4)(vi) of this section (concerning the treatment of a
deemed transferred receivable for purposes of section 752) and
paragraph (f)(5) of this section (concerning specified events
subsequent to the deemed transfer), the deemed transfer described in
this paragraph (f)(4)(i) is deemed to occur for all Federal tax
purposes.
(ii) Expanded group partner is the holder-in-form of a debt
instrument. If the specified portion described in paragraph (f)(4)(i)
of this section is with respect to an expanded group partner that is
the holder-in-form of the debt instrument, then paragraph (f)(4)(i) of
this section will not apply with respect to that specified portion
except that only the first sentence of paragraph (f)(4)(i) of this
section is applicable.
(iii) Expanded group partner is a consolidated group member. This
paragraph (f)(4)(iii) applies when one or more expanded group partners
is a member of a consolidated group that files (or is required to file)
a consolidated U.S. Federal income tax return. In this case,
notwithstanding Sec. 1.385-4(b)(1) (which generally treats members of
a consolidated group as one corporation for purposes of this section),
the holder-in-form of the debt instrument issued by the controlled
partnership is deemed to transfer the deemed transferred receivable or
receivables to the expanded group partner or partners that are members
of a consolidated group that make, or are treated as making under
paragraph (f)(2) of this section, the regarded distributions or
acquisitions (within the meaning of Sec. 1.385-4(e)(5)) described in
paragraph (b)(2) or (b)(3)(i) of this section in exchange for deemed
partner stock in such partner or partners. To the extent those regarded
distributions or acquisitions are made by a member of the consolidated
group that is not an expanded group partner (excess amount), the
holder-in-form is deemed to transfer a portion of the deemed
transferred receivable or receivables to each member of the
consolidated group that is an expanded group partner in exchange for
deemed partner stock in the expanded group partner. The portion is the
excess amount multiplied by a fraction, the numerator of which is
[[Page 28875]]
the portion of the consolidated group's share (as determined under
paragraph (f)(3)(ii) of this section) of the debt instrument issued by
the controlled partnership that would have been the expanded group
partner's share if the partner was not a member of a consolidated
group, and the denominator of which is the consolidated group's share
of the debt instrument issued by the controlled partnership.
(iv) Rules regarding deemed transferred receivables and deemed
partner stock--(A) Terms of deemed partner stock. Deemed partner stock
has the same terms as the deemed transferred receivable with respect to
the deemed transfer, other than the identity of the issuer.
(B) Treatment of payments with respect to a debt instrument for
which there is one or more deemed transferred receivables. When a
payment is made with respect to a debt instrument issued by a
controlled partnership for which there is one or more deemed
transferred receivables, then, if the amount of the retained receivable
(as defined in paragraph (g)(22) of this section) held by the holder-
in-form is zero and a single deemed holder is deemed to hold all of the
deemed transferred receivables, the entire payment is allocated to the
deemed transferred receivables held by the single deemed holder. If the
amount of the retained receivable held by the holder-in-form is greater
than zero or there are multiple deemed holders of deemed transferred
receivables, or both, the payment is apportioned among the retained
receivable, if any, and each deemed transferred receivable in
proportion to the principal amount of all the receivables. The portion
of a payment allocated or apportioned to a retained receivable or a
deemed transferred receivable reduces the principal amount of, or
accrued interest with respect to, as applicable depending on the
payment, the retained receivable or deemed transferred receivable. When
a payment allocated or apportioned to a deemed transferred receivable
reduces the principal amount of the receivable, the expanded group
partner that is the deemed holder with respect to the deemed
transferred receivable is deemed to redeem the same amount of deemed
partner stock, and the specified portion with respect to the debt
instrument is reduced by the same amount. When a payment allocated or
apportioned to a deemed transferred receivable reduces accrued interest
with respect to the receivable, the expanded group partner that is the
deemed holder with respect to the deemed transferred receivable is
deemed to make a matching distribution in the same amount with respect
to the deemed partner stock. The controlled partnership is treated as
the paying agent with respect to the deemed partner stock.
(v) Holder-in-form transfers debt instrument in a transaction that
is not a specified event. If the holder-in-form transfers the debt
instrument (which is disregarded for Federal tax purposes) to a member
of the expanded group or a controlled partnership (and therefore the
transfer is not a specified event described in paragraph (f)(5)(iii)(F)
of this section), then, for Federal tax purposes, the holder-in-form is
deemed to transfer the retained receivable and the deemed partner stock
to the transferee.
(vi) Allocation of deemed transferred receivable under section 752.
A partnership liability that is a debt instrument with respect to which
there is one or more deemed transferred receivables is allocated for
purposes of section 752 without regard to any deemed transfer.
(5) Specified events affecting ownership following a deemed
transfer--(i) General rule. If a specified event (within the meaning of
paragraph (f)(5)(iii) of this section) occurs with respect to a deemed
transfer, then, immediately before the specified event, the expanded
group partner that is both the issuer of the deemed partner stock and
the deemed holder of the deemed transferred receivable is deemed to
distribute the deemed transferred receivable (or portion thereof, as
determined under paragraph (f)(5)(iv) of this section) to the holder-
in-form in redemption of the deemed partner stock (or portion thereof,
as determined under paragraph (f)(5)(iv) of this section) deemed to be
held by the holder-in-form. The deemed distribution is deemed to occur
for all Federal tax purposes, except that the distribution is
disregarded for purposes of paragraph (b) of this section. Except when
the deemed transferred receivable (or portion thereof, as determined
under paragraph (f)(5)(iv) of this section) is deemed to be
retransferred under paragraph (f)(5)(ii) of this section, the principal
amount of the retained receivable held by the holder-in-form is
increased by the principal amount of the deemed transferred receivable,
the deemed transferred receivable ceases to exist for Federal tax
purposes, and the specified portion (or portion thereof) that
corresponds to the deemed transferred receivable (or portion thereof)
ceases to be treated as a specified portion for purposes of this
section.
(ii) New deemed transfer when a specified event involves a
transferee that is a covered member that is an expanded group partner.
If the specified event is described in paragraph (f)(5)(iii)(E) of this
section, the holder-in-form of the debt instrument is deemed to
retransfer the deemed transferred receivable (or portion thereof, as
determined under paragraph (f)(5)(iv) of this section) that the holder-
in-form is deemed to have received pursuant to paragraph (f)(5)(i) of
this section, to the transferee expanded group partner in exchange for
deemed partner stock issued by the transferee expanded group partner
with a fair market value equal to the principal amount of the deemed
transferred receivable (or portion thereof) that is retransferred. For
purposes of this section, this deemed transfer is treated in the same
manner as a deemed transfer described in paragraph (f)(4)(i) of this
section.
(iii) Specified events. A specified event, with respect to a deemed
transfer, occurs when, immediately after the transaction and taking
into account all related transactions:
(A) The controlled partnership that is the issuer of the debt
instrument either ceases to be a controlled partnership or ceases to
have an expanded group partner that is a covered member.
(B) The holder-in-form is a member of the expanded group
immediately before the transaction, and the holder-in-form and the
deemed holder cease to be members of the same expanded group for the
reasons described in paragraph (d)(2) of this section.
(C) The holder-in-form is a controlled partnership immediately
before the transaction, and the holder-in-form ceases to be a
controlled partnership.
(D) The expanded group partner that is both the issuer of deemed
partner stock and the deemed holder transfers (directly or indirectly
through one or more partnerships) all or a portion of its interest in
the controlled partnership to a person that neither is a covered member
nor a controlled partnership with an expanded group partner that is a
covered member. If there is a transfer of only a portion of the
interest, see paragraph (f)(5)(iv) of this section.
(E) The expanded group partner that is both the issuer of deemed
partner stock and the deemed holder transfers (directly or indirectly
through one or more partnerships) all or a portion of its interest in
the controlled partnership to a covered member or a controlled
partnership with an expanded group partner that is a covered member. If
there is a transfer of only a portion of
[[Page 28876]]
the interest, see paragraph (f)(5)(iv) of this section.
(F) The holder-in-form transfers the debt instrument (which is
disregarded for Federal tax purposes) to a person that is neither a
member of the expanded group nor a controlled partnership. See
paragraph (f)(4)(v) of this section if the holder-in-form transfers the
debt instrument to a member of the expanded group or a controlled
partnership.
(iv) Specified event involving a transfer of only a portion of an
interest in a controlled partnership. If, with respect to a specified
event described in paragraph (f)(5)(iii)(D) or (E) of this section, an
expanded group partner transfers only a portion of its interest in a
controlled partnership, then, only a portion of the deemed transferred
receivable that is deemed to be held by the expanded group partner is
deemed to be distributed in redemption of an equal portion of the
deemed partner stock. The portion of the deemed transferred receivable
referred to in the preceding sentence is equal to the product of the
entire principal amount of the deemed transferred receivable deemed to
be held by the expanded group partner multiplied by a fraction, the
numerator of which is the portion of the expanded group partner's
capital account attributable to the interest that is transferred, and
the denominator of which is the expanded group partner's capital
account with respect to its entire interest, determined immediately
before the specified event.
(6) Issuance of a partnership's debt instrument to a partner and a
partner's debt instrument to a partnership. If a controlled
partnership, with respect to an expanded group, issues a debt
instrument to an expanded group partner, or if a covered member that is
an expanded group partner issues a covered debt instrument to a
controlled partnership, and in each case, no partner deducts or
receives an allocation of expense with respect to the debt instrument,
then this section does not apply to the debt instrument.
(g) * * *
(5) Deemed holder. The term deemed holder means, with respect to a
deemed transfer, the expanded group partner that is deemed to hold a
deemed transferred receivable by reason of the deemed transfer.
(6) Deemed partner stock. The term deemed partner stock means, with
respect to a deemed transfer, the stock deemed issued by an expanded
group partner as described in paragraphs (f)(4)(i) and (iii) and
(f)(5)(ii) of this section. The amount of deemed partner stock is
reduced as described in paragraphs (f)(4)(iv)(B) and (f)(5)(i) of this
section.
(7) Deemed transfer. The term deemed transfer means, with respect
to a specified portion, the transfer described in paragraph (f)(4)(i)
or (iii) or (f)(5)(ii) of this section.
(8) Deemed transferred receivable. The term deemed transferred
receivable means, with respect to a deemed transfer, the portion of the
debt instrument described in paragraph (f)(4)(i) or (iii) or (f)(5)(ii)
of this section. The deemed transferred receivable is reduced as
described in paragraphs (f)(4)(iv)(B) and (f)(5)(i) of this section.
* * * * *
(15) Holder-in-form. The term holder-in-form means, with respect to
a debt instrument issued by a controlled partnership, the person that,
absent the application of paragraph (f)(4) of this section, would be
the holder of the debt instrument for Federal tax purposes. Therefore,
the term holder-in-form does not include a deemed holder (as defined in
paragraph (g)(5) of this section).
(16) Issuance percentage. The term issuance percentage means, with
respect to a controlled partnership and an expanded group partner, the
ratio (expressed as a percentage) of the partner's reasonably
anticipated distributive share of all the partnership's interest
expense over a reasonable period, divided by all of the partnership's
reasonably anticipated interest expense over that same period, taking
into account any and all relevant facts and circumstances. The relevant
facts and circumstances include, without limitation, the term of the
debt instrument; whether the partnership anticipates issuing other debt
instruments; and the partnership's anticipated section 704(b) income
and expense, and the partners' respective anticipated allocation
percentages, taking into account anticipated changes to those
allocation percentages over time resulting, for example, from
anticipated contributions, distributions, recapitalizations, or
provisions in the controlled partnership agreement.
(17) Liquidation value percentage. The term liquidation value
percentage means, with respect to a controlled partnership and an
expanded group partner, the ratio (expressed as a percentage) of the
liquidation value of the expanded group partner's interest in the
partnership divided by the aggregate liquidation value of all the
partners' interests in the partnership. The liquidation value of an
expanded group partner's interest in a controlled partnership is the
amount of cash the partner would receive with respect to the interest
if the partnership (and any partnership through which the partner
indirectly owns an interest in the controlled partnership) sold all of
its property for an amount of cash equal to the fair market value of
the property (taking into account section 7701(g)), satisfied all of
its liabilities (other than those described in Sec. 1.752-7), paid an
unrelated third party to assume all of its Sec. 1.752-7 liabilities in
a fully taxable transaction, and then the partnership (and any
partnership through which the partner indirectly owns an interest in
the controlled partnership) liquidated.
* * * * *
(22) Retained receivable. The term retained receivable means, with
respect to a debt instrument issued by a controlled partnership, the
portion of the debt instrument that is not transferred by the holder-
in-form pursuant to one or more deemed transfers. The retained
receivable is adjusted for decreases described in paragraph
(f)(4)(iv)(B) of this section and increases described in paragraph
(f)(5)(i) of this section.
(23) Specified portion. The term specified portion means, with
respect to a debt instrument issued by a controlled partnership and a
covered member that is an expanded group partner, the portion of the
debt instrument that is treated under paragraph (f)(3)(i) of this
section as issued on a testing date (within the meaning of paragraph
(f)(3)(ii) of this section) by the covered member and that, absent the
application of paragraph (f)(4)(i) of this section, would be treated as
stock under paragraph (b)(2) or (b)(3)(i) of this section on the
testing date. A specified portion is reduced as described in paragraphs
(f)(4)(iv)(B) and (f)(5)(i) of this section.
* * * * *
(h) * * *
(3) * * *
(xii) Example 12: Distribution of a covered debt instrument to a
controlled partnership--(A) Facts. CFC and FS are equal partners in
PRS. PRS owns 100% of the stock in X Corp, a domestic corporation.
On Date A in Year 1, X Corp issues X Note to PRS in a distribution.
(B) Analysis. (1) Under Sec. 1.385-1(c)(4), in determining
whether X Corp is a member of the FP expanded group that includes
CFC and FS, CFC and FS are each treated as owning 50% of the X Corp
stock held by PRS. Accordingly, 100% of X Corp's stock is treated as
owned by CFC and FS, and X Corp is a member of the FP expanded
group.
(2) Together CFC and FS own 100% of the interests in PRS capital
and profits, such that PRS is a controlled partnership under Sec.
1.385-1(c)(1). CFC and FS are both expanded group partners on the
date on which PRS acquired X Note. Therefore,
[[Page 28877]]
pursuant to paragraph (f)(2)(i)(A) of this section, each of CFC and
FS is treated as acquiring its share of X Note in the same manner
(in this case, by a distribution of X Note), and on the date on
which, PRS acquired X Note. Likewise, X Corp is treated as issuing
to each of CFC and FS its share of X Note. Under paragraph
(f)(2)(i)(B) of this section, each of CFC's and FS's share of X
Note, respectively, is determined in accordance with its liquidation
value percentage determined on Date A in Year 1, the date X Corp
distributed X Note to PRS. On Date A in Year 1, pursuant to
paragraph (g)(17) of this section, each of CFC's and FS's
liquidation value percentages is 50%. Accordingly, on Date A in Year
1, under paragraph (f)(2)(i)(A) of this section, for purposes of
this section, CFC and FS are each treated as acquiring 50% of X Note
in a distribution.
(3) Under paragraphs (b)(2)(i) and (d)(1)(i) of this section, X
Note is treated as stock on the date of issuance, which is Date A in
Year 1. Under paragraph (f)(2)(i)(A) of this section, each of CFC
and FS are treated as acquiring 50% of X Note in a distribution for
purposes of this section. Therefore, X Corp is treated as
distributing its stock to PRS in a distribution described in section
305.
(xiii) Example 13: Loan to a controlled partnership;
proportionate distributions by expanded group partners--(A) Facts.
DS, USS2, and USP are partners in PRS. USP is a domestic corporation
that is not a member of the FP expanded group. Each of DS and USS2
own 45% of the interests in PRS profits and capital, and USP owns
10% of the interests in PRS profits and capital. The PRS partnership
agreement provides that all items of PRS income, gain, loss,
deduction, and credit are allocated in accordance with the
percentages in the preceding sentence. On Date A in Year 1, FP lends
$200x to PRS in exchange for PRS Note with stated principal amount
of $200x, which is payable at maturity. PRS Note also provides for
annual payments of interest that are qualified stated interest. PRS
uses all $200x in its business and does not distribute any money or
other property to a partner. Subsequently, on Date B in Year 1, DS
distributes $90x to USS1, USS2 distributes $90x to FP, and USP
distributes $20x to its shareholder. Each of DS's and USS2's
issuance percentage is 45% on Date B in Year 1, the date of the
distributions and therefore a testing date under paragraph
(f)(3)(ii)(A) of this section.
(B) Analysis. (1) DS and USS2 together own 90% of the interests
in PRS profits and capital and therefore PRS is a controlled
partnership under Sec. 1.385-1(c)(1). Under Sec. 1.385-1(c)(2),
each of DS and USS2 is a covered member.
(2) Under paragraph (f)(3)(i) of this section, each of DS and
USS2 is treated as issuing its share of PRS Note, and under
paragraph (f)(3)(ii)(A) of this section, DS's and USS2's share is
each $90x (45% of $200x). USP is not an expanded group partner and
therefore has no issuance percentage and is not treated as issuing
any portion of PRS Note.
(3) The $90x distributions made by DS to USS1 and by USS2 to FP
are described in paragraph (b)(3)(i)(A) of this section. Under
paragraph (b)(3)(iii)(A) of this section, the portions of PRS Note
treated as issued by each of DS and USS2 are treated as funding the
distribution made by DS and USS2 because the distributions occurred
within the per se period with respect to PRS Note. Under paragraph
(b)(3)(i) of this section, the portions of PRS Note treated as
issued by each of DS and USS2 would, absent the application of
paragraph (f)(4)(i) of this section, be treated as stock of DS and
USS2 on Date B in Year 1, the date of the distributions. See
paragraph (d)(1)(ii) of this section. Under paragraph (g)(23) of
this section, each of the $90x portions is a specified portion.
(4) Under paragraph (f)(4)(i) of this section, the specified
portions are not treated as stock under paragraph (b)(3)(i) of this
section. Instead, FP is deemed to transfer a portion of PRS Note
with a principal amount equal to $90x (the adjusted issue price of
the specified portion with respect to DS) to DS in exchange for
deemed partner stock in DS with a fair market value of $90x.
Similarly, FP is deemed to transfer a portion of PRS Note with a
principal amount equal to $90x (the adjusted issue price of the
specified portion with respect to USS2) to USS2 in exchange for
deemed partner stock in USS2 with a fair market value of $90x. The
principal amount of the retained receivable held by FP is $20x
($200x-$90x-$90x).
(xiv) Example 14: Loan to a controlled partnership;
disproportionate distributions by expanded group partners--(A)
Facts. The facts are the same as in paragraph (h)(3)(xiii)(A) of
this section (Example 13), except that on Date B in Year 1, DS
distributes $45x to USS1 and USS2 distributes $135x to FP.
(B) Analysis. (1) The analysis is the same as in paragraph
(h)(3)(xiii)(B)(1) of this section (Example 13).
(2) The analysis is the same as in paragraph (h)(3)(xiii)(B)(2)
of this section (Example 13).
(3) The $45x and $135x distributions made by DS to USS1 and by
USS2 to FP, respectively, are described in paragraph (b)(3)(i)(A) of
this section. Under paragraph (b)(3)(iii)(A) of this section, the
portion of PRS Note treated as issued by DS is treated as funding
the distribution made by DS because the distribution occurred within
the per se period with respect to PRS Note, but under paragraph
(b)(3)(i) of this section, only to the extent of DS's $45x
distribution. USS2 is treated as issuing $90x of PRS Note, all of
which is treated as funding $90x of USS2's $135x distribution under
paragraph (b)(3)(iii)(A) of this section. Under paragraph (b)(3)(i)
of this section, absent the application of paragraph (f)(4)(i) of
this section, $45x of PRS Note would be treated as stock of DS and
$90x of PRS Note would be treated as stock of USS2 on Date B in Year
1, the date of the distributions. See paragraph (d)(1)(ii) of this
section. Under paragraph (g)(23) of this section, $45x of PRS Note
is a specified portion with respect to DS and $90x of PRS Note is a
specified portion with respect to USS2.
(4) Under paragraph (f)(4)(i) of this section, the specified
portions are not treated as stock under paragraph (b)(3)(i) of this
section. Instead, FP is deemed to transfer a portion of PRS Note
with a principal amount equal to $45x (the adjusted issue price of
the specified portion with respect to DS) to DS in exchange for
stock of DS with a fair market value of $90x. Similarly, FP is
deemed to transfer a portion of PRS Note with a principal amount
equal to $90x (the adjusted issue price of the specified portion
with respect to USS2) to USS2 in exchange for stock of USS2 with a
fair market value of $90x. The principal amount of the retained
receivable held by FP is $65x ($200x-$45x-$90x).
(xv) Example 15: Loan to partnership; distribution in later
year--(A) Facts. The facts are the same as in paragraph
(h)(3)(xiii)(A) of this section (Example 13), except that USS2 does
not distribute $90x to FP until Date C in Year 2, which is less than
36 months after Date A in Year 1. On Date C in Year 2, DS's, USS2's,
and USP's issuance percentages under paragraph (g)(16) of this
section are unchanged at 45%, 45%, and 10%, respectively.
(B) Analysis. (1) The analysis is the same as in paragraph
(h)(3)(xiii)(B)(1) of this section (Example 13).
(2) The analysis is the same as in paragraph (h)(3)(xiii)(B)(2)
of this section (Example 13).
(3) With respect to the distribution made by DS, the analysis is
the same as in paragraph (h)(3)(xiii)(B)(3) of this section (Example
13).
(4) With respect to the deemed transfer to DS, the analysis is
the same as in paragraph (h)(3)(xiii)(B)(4) of this section (Example
13). Accordingly, the amount of the retained receivable held by FP
as of Date B in Year 1 is $110x ($200x-$90x).
(5) Under paragraph (f)(3)(ii)(A) of this section, USS2's share
of PRS Note is determined on Date C in Year 2. On Date C in Year 2,
DS's, USS2's, and USP's respective shares of PRS Note under
paragraph (f)(3)(ii)(A) of this section are $90x, $90x, and $20x.
However, because DS is treated as the issuer with respect to a $90x
specified portion of PRS Note, DS's share of PRS Note is reduced by
$90x to $0 under paragraph (f)(3)(ii)(B)(1) of this section. No
reduction to either of USS2's or USP's share of PRS Note is required
under paragraph (f)(3)(ii)(B)(2) of this section because the
aggregate of DS's, USS2's, and USP's shares of PRS Note as reduced
is $110x (DS has a $0 share, USS2 has a $90x share, and USP has a
$20x share), which does not exceed $110x (the $200x adjusted issue
price of PRS Note reduced by the $90x specified portion with respect
to DS). Under paragraph (f)(3)(i) of this section, USS2 is treated
as issuing its share of PRS Note.
(6) The $90x distribution made by USS2 to FP is described in
paragraph (b)(3)(i)(A) of this section. Under paragraph
(b)(3)(iii)(A) of this section, the portion of PRS Note treated as
issued by USS2 is treated as funding the distribution made by USS2,
because the distribution occurred within the per se period with
respect to PRS Note. Accordingly, the portion of PRS Note treated as
issued by USS2 would, absent the application of paragraph (f)(4)(i)
of this section, be treated as stock of USS2 under paragraph
(b)(3)(i) of this section on Date C in Year 2. See paragraph
(d)(1)(ii) of this section. Under paragraph (g)(23) of this section,
the $90x portion is a specified portion.
[[Page 28878]]
(7) Under paragraph (f)(4)(i) of this section, the specified
portion of PRS Note treated as issued by USS2 is not treated as
stock under paragraph (b)(3)(i) of this section. Instead, on Date C
in Year 2, FP is deemed to transfer a portion of PRS Note with a
principal amount equal to $90x (the adjusted issue price of the
specified portion with respect to USS2) to USS2 in exchange for
stock in USS2 with a fair market value of $90x. The principal amount
of the retained receivable held by FP is reduced from $110x to $20x.
(xvi) Example 16: Loan to a controlled partnership; partnership
ceases to be a controlled partnership--(A) Facts. The facts are the
same as in paragraph (h)(3)(xiii)(A) of this section (Example 13),
except that on Date C in Year 4, USS2 sells its entire interest in
PRS to an unrelated person.
(B) Analysis. (1) On date C in Year 4, PRS ceases to be a
controlled partnership with respect to the FP expanded group under
Sec. 1.385-1(c)(1). This is the case because DS, the only remaining
partner that is a member of the FP expanded group, only owns 45% of
the total interest in PRS profits and capital. Because PRS ceases to
be a controlled partnership, a specified event (within the meaning
of paragraph (f)(5)(iii)(A) of this section) occurs with respect to
the deemed transfers with respect to each of DS and USS2.
(2) Under paragraph (f)(5)(i) of this section, on Date C in Year
4, immediately before PRS ceases to be a controlled partnership,
each of DS and USS2 is deemed to distribute its deemed transferred
receivable to FP in redemption of FP's deemed partner stock in DS
and USS2. The specified portion that corresponds to each of the
deemed transferred receivables ceases to be treated as a specified
portion. Furthermore, the deemed transferred receivables cease to
exist, and the retained receivable held by FP increases from $20x to
$200x.
(xvii) Example 17: Transfer of an interest in a partnership to a
covered member--(A) Facts. The facts are the same as in paragraph
(h)(3)(xiii)(A) of this section (Example 13), except that on Date C
in Year 4, USS2 sells its entire interest in PRS to USS1.
(B) Analysis. (1) After USS2 sells its interest in PRS to USS1,
DS and USS1 together own 90% of the interests in PRS profits and
capital and therefore PRS continues to be a controlled partnership
under Sec. 1.385-1(c)(1). A specified event (within the meaning of
paragraph (f)(5)(iii)(E) of this section) occurs as result of the
sale only with respect to the deemed transfer with respect to USS2.
(2) Under paragraph (f)(5)(i) of this section, on Date C in Year
4, immediately before USS2 sells its entire interest in PRS to USS1,
USS2 is deemed to distribute its deemed transferred receivable to FP
in redemption of FP's deemed partner stock in USS2. Because the
specified event is described in paragraph (f)(5)(iii)(E) of this
section, under paragraph (f)(5)(ii) of this section, FP is deemed to
retransfer the deemed transferred receivable deemed received from
USS2 to USS1 in exchange for deemed partner stock in USS1 with a
fair market value equal to the principal amount of the deemed
transferred receivable that is retransferred to USS1.
(xviii) Example 18: Loan to partnership and all partners are
members of a consolidated group--(A) Facts. USS1 and DS are equal
partners in PRS. USS1 and DS are members of a consolidated group, as
defined in Sec. 1.1502-1(h). The PRS partnership agreement provides
that all items of PRS income, gain, loss, deduction, and credit are
allocated equally between USS1 and DS. On Date A in Year 1, FP lends
$200x to PRS in exchange for PRS Note. PRS uses all $200x in its
business and does not distribute any money or other property to any
partner. On Date B in Year 1, DS distributes $200x to USS1, and USS1
distributes $200x to FP. If neither of USS1 or DS were a member of
the consolidated group, each would have an issuance percentage under
paragraph (g)(16) of this section, determined as of Date A in Year
1, of 50%.
(B) Analysis. (1) Pursuant to Sec. 1.385-4(b)(6), PRS is
treated as a partnership for purposes of this section. Under Sec.
1.385-4(b)(1), DS and USS1 are treated as one corporation for
purposes of this section, and thus a single covered member under
Sec. 1.385-1(c)(2). For purposes of this section, the single
covered member owns 100% of the PRS profits and capital and
therefore PRS is a controlled partnership under Sec. 1.385-1(c)(1).
Under paragraph (f)(3)(i) of this section, the single covered member
is treated as issuing all $200x of PRS Note to FP, a member of the
same expanded group as the single covered member. DS's distribution
to USS1 is a disregarded distribution because it is a distribution
between members of a consolidated group that is disregarded under
the one-corporation rule described in Sec. 1.385-4(b)(1). However,
under paragraph (b)(3)(iii)(A) of this section, PRS Note, treated as
issued by the single covered member, is treated as funding the
distribution by USS1 to FP, which is described in paragraph
(b)(3)(i)(A) of this section and which is a regarded distribution.
Accordingly, PRS Note, absent the application of paragraph (f)(4)(i)
of this section, would be treated as stock under paragraph (b) of
this section on Date B in Year 1. Thus, pursuant to paragraph
(g)(23) of this section, the entire PRS Note is a specified portion.
(2) Under paragraphs (f)(4)(i) and (iii) of this section, the
specified portion is not treated as stock and, instead, FP is deemed
to transfer PRS Note with a principal amount equal to $200x to USS1
in exchange for stock of USS1 with a fair market value of $200x.
Under paragraph (f)(4)(iii) of this section, FP is deemed to
transfer PRS Note to USS1 because only USS1 made a regarded
distribution described in paragraph (b)(3)(i) of this section.
(xix) Example 19: Loan to a disregarded entity--(A) Facts. DS
owns DRE, a disregarded entity within the meaning of Sec. 1.385-
1(c)(3). On Date A in Year 1, FP lends $200x to DRE in exchange for
DRE Note. Subsequently, on Date B in Year 1, DS distributes $100x of
cash to USS1.
(B) Analysis. Under paragraph (b)(3)(iii)(A) of this section,
$100x of DRE Note would be treated as funding the distribution by DS
to USS1 because DRE Note is issued to a member of the FP expanded
group during the per se period with respect to DS's distribution to
USS1. Accordingly, under paragraphs (b)(3)(i)(A) and (d)(1)(ii) of
this section, $100x of DRE Note would be treated as stock on Date B
in Year 1. However, under paragraph (d)(4) of this section, DS, as
the regarded owner, within the meaning of Sec. 1.385-1(c)(5), of
DRE is deemed to issue its stock to FP in exchange for a portion of
DRE Note equal to the $100x applicable portion (as defined in
paragraph (d)(4) of this section). Thus, DS is treated as the holder
of $100x of DRE Note, which is disregarded, and FP is treated as the
holder of the remaining $100x of DRE Note. The $100x of stock deemed
issued by DS to FP has the same terms as DRE Note, other than the
issuer, and payments on the stock are determined by reference to
payments on DRE Note.
* * * * *
(j) * * * (1) In general. Except as provided in paragraph (j)(2) or
(3) or (k) of this section, this section applies to taxable years
ending on or after January 19, 2017.
* * * * *
(3) Paragraph (f)(4)(iii) of this section. Paragraph (f)(4)(iii) of
this section applies to taxable years for which the U.S. Federal income
tax return is due, without extensions, after May 14, 2020. For taxable
years ending on or after January 19, 2017, and for which the U.S.
Federal income tax return is due, without extensions, on or before May
14, 2020, see Sec. 1.385-3T(f)(4)(iii), as contained in 26 CFR in part
1 in effect on April 1, 2019. In the case of a taxable year that ends
after October 13, 2019, and on or before May 14, 2020, a taxpayer may
choose to apply paragraph (f)(4)(iii) of this section to the portion of
the taxable year that occurs after the expiration of Sec. 1.385-3T on
October 13, 2019, provided that all members of the taxpayer's expanded
group apply such paragraph.
(k) Additional transition rules. See transition rules in Sec.
1.385-3T(k)(2) as contained in 26 CFR in part 1 in effect on April 1,
2019.
Sec. Sec. 1.385-3T and 1.385-4T [Removed]
0
Par. 4. Sections 1.385-3T and 1.385-4T are removed.
0
Par. 5. Section 1.385-4 is added to read as follows:
Sec. 1.385-4 Treatment of consolidated groups.
(a) Scope. This section provides rules for applying Sec. 1.385-3
to members of consolidated groups. Paragraph (b) of this section sets
forth rules concerning the extent to which, solely for purposes of
applying Sec. 1.385-3, members of a consolidated group that file (or
that are required to file) a consolidated U.S. Federal income tax
return are treated as one corporation. Paragraph (c) of this
[[Page 28879]]
section sets forth rules concerning the treatment of a debt instrument
that ceases to be, or becomes, a consolidated group debt instrument.
Paragraph (d) of this section provides rules for applying the funding
rule of Sec. 1.385-3(b)(3) to members that depart a consolidated
group. For definitions applicable to this section, see paragraph (e) of
this section and Sec. Sec. 1.385-1(c) and 1.385-3(g). For examples
illustrating the application of this section, see paragraph (f) of this
section.
(b) Treatment of consolidated groups--(1) Members treated as one
corporation. For purposes of this section and Sec. 1.385-3, and except
as otherwise provided in this section and Sec. 1.385-3, all members of
a consolidated group (as defined in Sec. 1.1502-1(h)) that file (or
that are required to file) a consolidated U.S. Federal income tax
return are treated as one corporation. Thus, for example, when a member
of a consolidated group issues a covered debt instrument that is not a
consolidated group debt instrument, the consolidated group generally is
treated as the issuer of the covered debt instrument for purposes of
this section and Sec. 1.385-3. Also, for example, when one member of a
consolidated group issues a covered debt instrument that is not a
consolidated group debt instrument and therefore is treated as issued
by the consolidated group, and another member of the consolidated group
makes a distribution or acquisition described in Sec. 1.385-
3(b)(3)(i)(A) through (C) with an expanded group member that is not a
member of the consolidated group, Sec. 1.385-3(b)(3)(i) may treat the
covered debt instrument as funding the distribution or acquisition made
by the consolidated group. In addition, except as otherwise provided in
this section, acquisitions and distributions described in Sec. 1.385-
3(b)(2) and (b)(3)(i) in which all parties to the transaction are
members of the same consolidated group both before and after the
transaction are disregarded for purposes of this section and Sec.
1.385-3.
(2) One-corporation rule inapplicable to expanded group member
determination. The one-corporation rule described in paragraph (b)(1)
of this section does not apply in determining the members of an
expanded group. Notwithstanding the previous sentence, an expanded
group does not exist for purposes of this section and Sec. 1.385-3 if
it consists only of members of a single consolidated group.
(3) Application of Sec. 1.385-3 to debt instruments issued by
members of a consolidated group--(i) Debt instrument treated as stock
of the issuing member of a consolidated group. If a covered debt
instrument treated as issued by a consolidated group under the one-
corporation rule described in paragraph (b)(1) of this section is
treated as stock under Sec. 1.385-3, the covered debt instrument is
treated as stock in the member of the consolidated group that would be
the issuer of such debt instrument without regard to this section. But
see Sec. 1.385-3(d)(7) (providing that a covered debt instrument that
is treated as stock under Sec. 1.385-3(b)(2), (3), or (4) and that is
not described in section 1504(a)(4) is not treated as stock for
purposes of determining whether the issuer is a member of an affiliated
group (within the meaning of section 1504(a)).
(ii) Application of the covered debt instrument exclusions. For
purposes of determining whether a debt instrument issued by a member of
a consolidated group is a covered debt instrument, each test described
in Sec. 1.385-3(g)(3) is applied on a separate member basis without
regard to the one-corporation rule described in paragraph (b)(1) of
this section.
(iii) Qualified short-term debt instrument. The determination of
whether a member of a consolidated group has issued a qualified short-
term debt instrument for purposes of Sec. 1.385-3(b)(3)(vii) is made
on a separate member basis without regard to the one-corporation rule
described in paragraph (b)(1) of this section.
(4) Application of the reductions of Sec. 1.385-3(c)(3) to members
of a consolidated group--(i) Application of the reduction for expanded
group earnings--(A) In general. A consolidated group maintains one
expanded group earnings account with respect to an expanded group
period, and only the earnings and profits, determined in accordance
with Sec. 1.1502-33 (without regard to the application of Sec.
1.1502-33(b)(2), (e), and (f)), of the common parent (within the
meaning of section 1504) of the consolidated group are considered in
calculating the expanded group earnings for the expanded group period
of the consolidated group. Accordingly, a regarded distribution or
acquisition made by a member of a consolidated group is reduced to the
extent of the expanded group earnings account of the consolidated
group.
(B) Effect of certain corporate transactions on the calculation of
expanded group earnings--(1) Consolidation. A consolidated group
succeeds to the expanded group earnings account of a joining member
under the principles of Sec. 1.385-3(c)(3)(i)(F)(2)(ii).
(2) Deconsolidation--(i) In general. Except as otherwise provided
in paragraph (b)(4)(i)(B)(2)(ii) of this section, no amount of the
expanded group earnings account of a consolidated group for an expanded
group period, if any, is allocated to a departing member. Accordingly,
immediately after leaving the consolidated group, the departing member
has no expanded group earnings account with respect to its expanded
group period.
(ii) Allocation of expanded group earnings to a departing member in
a distribution described in section 355. If a departing member leaves
the consolidated group by reason of an exchange or distribution to
which section 355 (or so much of section 356 that relates to section
355) applies, the expanded group earnings account of the consolidated
group is allocated between the consolidated group and the departing
member in proportion to the earnings and profits of the consolidated
group and the earnings and profits of the departing member immediately
after the transaction.
(ii) Application of the reduction for qualified contributions--(A)
In general. For purposes of applying Sec. 1.385-3(c)(3)(ii)(A) to a
consolidated group--
(1) A qualified contribution to any member of a consolidated group
that remains a member of the consolidated group immediately after the
qualified contribution from a person other than a member of the same
consolidated group is treated as made to the one corporation described
in paragraph (b)(1) of this section;
(2) A qualified contribution that causes a member of a consolidated
group to become a departing member of that consolidated group is
treated as made to the departing member and not to the consolidated
group of which the departing member was a member immediately prior to
the qualified contribution; and
(3) No contribution of property by a member of a consolidated group
to any other member of the consolidated group is a qualified
contribution.
(B) Effect of certain corporate transactions on the calculation of
qualified contributions--(1) Consolidation. A consolidated group
succeeds to the qualified contributions of a joining member under the
principles of Sec. 1.385-3(c)(3)(ii)(F)(2)(ii).
(2) Deconsolidation--(i) In general. Except as otherwise provided
in paragraph (b)(4)(ii)(B)(2)(ii) of this section, no amount of the
qualified contributions of a consolidated group for an expanded group
period, if any, is allocated to a departing member.
[[Page 28880]]
Accordingly, immediately after leaving the consolidated group, the
departing member has no qualified contributions with respect to its
expanded group period.
(ii) Allocation of qualified contributions to a departing member in
a distribution described in section 355. If a departing member leaves
the consolidated group by reason of an exchange or distribution to
which section 355 (or so much of section 356 that relates to section
355) applies, each qualified contribution of the consolidated group is
allocated between the consolidated group and the departing member in
proportion to the earnings and profits of the consolidated group and
the earnings and profits of the departing member immediately after the
transaction.
(5) Order of operations. For purposes of this section and Sec.
1.385-3, the consequences of a transaction involving one or more
members of a consolidated group are determined as provided in
paragraphs (b)(5)(i) and (ii) of this section.
(i) First, determine the characterization of the transaction under
Federal tax law without regard to the one-corporation rule described in
paragraph (b)(1) of this section.
(ii) Second, apply this section and Sec. 1.385-3 to the
transaction as characterized to determine whether to treat a debt
instrument as stock, treating the consolidated group as one corporation
under paragraph (b)(1) of this section, unless otherwise provided.
(6) Partnership owned by a consolidated group. For purposes of this
section and Sec. 1.385-3, and notwithstanding the one-corporation rule
described in paragraph (b)(1) of this section, a partnership that is
wholly owned by members of a consolidated group is treated as a
partnership. Thus, for example, if members of a consolidated group own
all of the interests in a controlled partnership that issues a debt
instrument to a member of the consolidated group, such debt instrument
would be treated as a consolidated group debt instrument because, under
Sec. 1.385-3(f)(3)(i), for purposes of this section and Sec. 1.385-3,
a consolidated group member that is an expanded group partner is
treated as the issuer with respect to its share of the debt instrument
issued by the partnership.
(7) Predecessor and successor--(i) In general. Pursuant to
paragraph (b)(5) of this section, the determination as to whether a
member of an expanded group is a predecessor or successor of another
member of the consolidated group is made without regard to paragraph
(b)(1) of this section. For purposes of Sec. 1.385-3(b)(3), if a
consolidated group member is a predecessor or successor of a member of
the same expanded group that is not a member of the same consolidated
group, the consolidated group is treated as a predecessor or successor
of the expanded group member (or the consolidated group of which that
expanded group member is a member). Thus, for example, a departing
member that departs a consolidated group in a distribution or exchange
to which section 355 applies is a successor to the consolidated group
and the consolidated group is a predecessor of the departing member.
(ii) Joining members. For purposes of Sec. 1.385-3(b)(3), the term
predecessor also means, with respect to a consolidated group, a joining
member and the term successor also means, with respect to a joining
member, a consolidated group.
(c) Consolidated group debt instruments--(1) Debt instrument ceases
to be a consolidated group debt instrument but continues to be issued
and held by expanded group members--(i) Consolidated group member
leaves the consolidated group. For purposes of this section and Sec.
1.385-3, when a debt instrument ceases to be a consolidated group debt
instrument as a result of a transaction in which the member of the
consolidated group that issued the instrument (the issuer) or the
member of the consolidated group holding the instrument (the holder)
ceases to be a member of the same consolidated group but both the
issuer and the holder continue to be members of the same expanded
group, the issuer is treated as issuing a new debt instrument to the
holder in exchange for property immediately after the debt instrument
ceases to be a consolidated group debt instrument. To the extent the
newly-issued debt instrument is a covered debt instrument that is
treated as stock under Sec. 1.385-3(b)(3), the covered debt instrument
is then immediately deemed to be exchanged for stock of the issuer. For
rules regarding the treatment of the deemed exchange, see Sec. 1.385-
1(d). For examples illustrating the rule in this paragraph (c)(1)(i),
see paragraphs (f)(3)(iv) and (v) of this section (Examples 4 and 5).
(ii) Consolidated group debt instrument that is transferred outside
of the consolidated group. For purposes of this section and Sec.
1.385-3, when a member of a consolidated group that holds a
consolidated group debt instrument transfers the debt instrument to an
expanded group member that is not a member of the same consolidated
group (transferee expanded group member), the debt instrument is
treated as issued by the consolidated group to the transferee expanded
group member immediately after the debt instrument ceases to be a
consolidated group debt instrument. Thus, for example, for purposes of
this section and Sec. 1.385-3, the sale of a consolidated group debt
instrument to a transferee expanded group member is treated as an
issuance of the debt instrument by the consolidated group to the
transferee expanded group member in exchange for property. To the
extent the newly-issued debt instrument is a covered debt instrument
that is treated as stock upon being transferred, the covered debt
instrument is deemed to be exchanged for stock of the member of the
consolidated group treated as the issuer of the debt instrument
(determined under paragraph (b)(3)(i) of this section) immediately
after the covered debt instrument is transferred outside of the
consolidated group. For rules regarding the treatment of the deemed
exchange, see Sec. 1.385-1(d). For examples illustrating the rule in
this paragraph (c)(1)(ii), see paragraphs (f)(3)(ii) and (iii) of this
section (Examples 2 and 3).
(iii) Overlap transactions. If a debt instrument ceases to be a
consolidated group debt instrument in a transaction to which both
paragraphs (c)(1)(i) and (ii) of this section apply, then only the
rules of paragraph (c)(1)(ii) of this section apply with respect to
such debt instrument.
(iv) Subgroup exception. A debt instrument is not treated as
ceasing to be a consolidated group debt instrument for purposes of
paragraphs (c)(1)(i) and (ii) of this section if both the issuer and
the holder of the debt instrument are members of the same consolidated
group immediately after the transaction described in paragraph
(c)(1)(i) or (ii) of this section.
(2) Covered debt instrument treated as stock becomes a consolidated
group debt instrument. When a covered debt instrument that is treated
as stock under Sec. 1.385-3 becomes a consolidated group debt
instrument, then immediately after the covered debt instrument becomes
a consolidated group debt instrument, the issuer is deemed to issue a
new covered debt instrument to the holder in exchange for the covered
debt instrument that was treated as stock. In addition, in a manner
consistent with Sec. 1.385-3(d)(2)(ii)(A), when the covered debt
instrument that previously was treated as stock becomes a consolidated
group debt instrument, other covered debt instruments issued by the
issuer of that instrument (including a consolidated group that includes
the
[[Page 28881]]
issuer) that are not treated as stock when the instrument becomes a
consolidated group debt instrument are re-tested to determine whether
those other covered debt instruments are treated as funding the
regarded distribution or acquisition that previously was treated as
funded by the instrument (unless such distribution or acquisition is
disregarded under paragraph (b)(1) of this section). Further, also in a
manner consistent with Sec. 1.385-3(d)(2)(ii)(A), a covered debt
instrument that is issued by the issuer (including a consolidated group
that includes the issuer) after the application of this paragraph
(c)(2) and within the per se period may also be treated as funding that
regarded distribution or acquisition.
(3) No interaction with the intercompany obligation rules of Sec.
1.1502-13(g). The rules of this section do not affect the application
of the rules of Sec. 1.1502-13(g). Thus, any deemed satisfaction and
reissuance of a debt instrument under Sec. 1.1502-13(g) and any deemed
issuance and deemed exchange of a debt instrument under this paragraph
(c) that arise as part of the same transaction or series of
transactions are not integrated. Rather, each deemed satisfaction and
reissuance under the rules of Sec. 1.1502-13(g), and each deemed
issuance and exchange under the rules of this section, are respected as
separate steps and treated as separate transactions.
(d) Application of the funding rule of Sec. 1.385-3(b)(3) to
members departing a consolidated group. This paragraph (d) provides
rules for applying the funding rule of Sec. 1.385-3(b)(3) when a
departing member ceases to be a member of a consolidated group, but
only if the departing member and the consolidated group are members of
the same expanded group immediately after the deconsolidation.
(1) Continued application of the one-corporation rule. A
disregarded distribution or acquisition by any member of the
consolidated group continues to be disregarded when the departing
member ceases to be a member of the consolidated group.
(2) Continued recharacterization of a departing member's covered
debt instrument as stock. A covered debt instrument of a departing
member that is treated as stock of the departing member under Sec.
1.385-3(b) continues to be treated as stock when the departing member
ceases to be a member of the consolidated group.
(3) Effect of issuances of covered debt instruments that are not
consolidated group debt instruments on the departing member and the
consolidated group. If a departing member has issued a covered debt
instrument (determined without regard to the one-corporation rule
described in paragraph (b)(1) of this section) that is not a
consolidated group debt instrument and that is not treated as stock
immediately before the departing member ceases to be a consolidated
group member, then the departing member (and not the consolidated
group) is treated as issuing the covered debt instrument on the date
and in the manner the covered debt instrument was issued. If the
departing member is not treated as the issuer of a covered debt
instrument pursuant to the preceding sentence, then the consolidated
group continues to be treated as issuing the covered debt instrument on
the date and in the manner the covered debt instrument was issued.
(4) Treatment of prior regarded distributions or acquisitions. This
paragraph (d)(4) applies when a departing member ceases to be a
consolidated group member in a transaction other than a distribution to
which section 355 (or so much of section 356 as relates to section 355)
applies, and the consolidated group has made a regarded distribution or
acquisition. In this case, to the extent the distribution or
acquisition has not caused a covered debt instrument of the
consolidated group to be treated as stock under Sec. 1.385-3(b) on or
before the date the departing member leaves the consolidated group,
then--
(i) If the departing member made the regarded distribution or
acquisition (determined without regard to the one-corporation rule
described in paragraph (b)(1) of this section), the departing member
(and not the consolidated group) is treated as having made the regarded
distribution or acquisition.
(ii) If the departing member did not make the regarded distribution
or acquisition (determined without regard to the one-corporation rule
described in paragraph (b)(1) of this section), then the consolidated
group (and not the departing member) continues to be treated as having
made the regarded distribution or acquisition.
(e) Definitions. The definitions in this paragraph (e) apply for
purposes of this section.
(1) Consolidated group debt instrument. The term consolidated group
debt instrument means a covered debt instrument issued by a member of a
consolidated group and held by a member of the same consolidated group.
(2) Departing member. The term departing member means a member of
an expanded group that ceases to be a member of a consolidated group
but continues to be a member of the same expanded group. In the case of
multiple members leaving a consolidated group as a result of a single
transaction that continue to be members of the same expanded group, if
such members are treated as one corporation under paragraph (b)(1) of
this section immediately after the transaction, that one corporation is
a departing member with respect to the consolidated group.
(3) Disregarded distribution or acquisition. The term disregarded
distribution or acquisition means a distribution or acquisition
described in Sec. 1.385-3(b)(2) or (b)(3)(i) between members of a
consolidated group that is disregarded under the one-corporation rule
described in paragraph (b)(1) of this section.
(4) Joining member. The term joining member means a member of an
expanded group that becomes a member of a consolidated group and
continues to be a member of the same expanded group. In the case of
multiple members joining a consolidated group as a result of a single
transaction that continue to be members of the same expanded group, if
such members were treated as one corporation under paragraph (b)(1) of
this section immediately before the transaction, that one corporation
is a joining member with respect to the consolidated group.
(5) Regarded distribution or acquisition. The term regarded
distribution or acquisition means a distribution or acquisition
described in Sec. 1.385-3(b)(2) or (b)(3)(i) that is not disregarded
under the one-corporation rule described in paragraph (b)(1) of this
section.
(f) Examples--(1) Assumed facts. Except as otherwise stated, the
following facts are assumed for purposes of the examples in paragraph
(f)(3) of this section:
(i) FP is a foreign corporation that owns 100% of the stock of
USS1, a covered member, and 100% of the stock of FS, a foreign
corporation;
(ii) USS1 owns 100% of the stock of DS1 and DS3, both covered
members;
(iii) DS1 owns 100% of the stock of DS2, a covered member;
(iv) FS owns 100% of the stock of UST, a covered member;
(v) At the beginning of Year 1, FP is the common parent of an
expanded group comprised solely of FP, USS1, FS, DS1, DS2, DS3, and UST
(the FP expanded group);
(vi) USS1, DS1, DS2, and DS3 are members of a consolidated group of
which USS1 is the common parent (the USS1 consolidated group);
(vii) The FP expanded group has outstanding more than $50 million
of
[[Page 28882]]
debt instruments described in Sec. 1.385-3(c)(4) at all times;
(viii) No issuer of a covered debt instrument has a positive
expanded group earnings account, within the meaning of Sec. 1.385-
3(c)(3)(i)(B), or has received a qualified contribution, within the
meaning of Sec. 1.385-3(c)(3)(ii)(B);
(ix) All notes are covered debt instruments, within the meaning of
Sec. 1.385-3(g)(3), and are not qualified short-term debt instruments,
within the meaning of Sec. 1.385-3(b)(3)(vii);
(x) All notes between members of a consolidated group are
intercompany obligations within the meaning of Sec. 1.1502-
13(g)(2)(ii);
(xi) Each entity has as its taxable year the calendar year;
(xii) No domestic corporation is a United States real property
holding corporation within the meaning of section 897(c)(2);
(xiii) Each note is issued with adequate stated interest (as
defined in section 1274(c)(2)); and
(xiv) Each transaction occurs after January 19, 2017.
(2) No inference. Except as otherwise provided in this section, it
is assumed for purposes of the examples in paragraph (f)(3) of this
section that the form of each transaction is respected for Federal tax
purposes. No inference is intended, however, as to whether any
particular note would be respected as indebtedness or as to whether the
form of any particular transaction described in an example in paragraph
(f)(3) of this section would be respected for Federal tax purposes.
(3) Examples. The following examples illustrate the rules of this
section.
(i) Example 1: Order of operations--(A) Facts. On Date A in Year
1, UST issues UST Note to USS1 in exchange for DS3 stock
representing less than 20% of the value and voting power of DS3.
(B) Analysis. UST is acquiring the stock of DS3, the non-common
parent member of a consolidated group. Pursuant to paragraph
(b)(5)(i) of this section, the transaction is first analyzed without
regard to the one-corporation rule described in paragraph (b)(1) of
this section, and therefore UST is treated as issuing a covered debt
instrument in exchange for expanded group stock. The exchange of UST
Note for DS3 stock is not an exempt exchange within the meaning of
Sec. 1.385-3(g)(11) because UST and USS1 are not parties to an
asset reorganization. Pursuant to paragraph (b)(5)(ii) of this
section, Sec. 1.385-3 (including Sec. 1.385-3(b)(2)(ii)) is then
applied to the transaction, thereby treating UST Note as stock for
Federal tax purposes when it is issued by UST to USS1. The UST Note
is not treated as property for purposes of section 304(a) because it
is not property within the meaning specified in section 317(a).
Therefore, UST's acquisition of DS3 stock from USS1 in exchange for
UST Note is not an acquisition described in section 304(a)(1).
(ii) Example 2: Distribution of consolidated group debt
instrument--(A) Facts. On Date A in Year 1, DS1 issues DS1 Note to
USS1 in a distribution. On Date B in Year 2, USS1 distributes DS1
Note to FP.
(B) Analysis. Under paragraph (b)(1) of this section, the USS1
consolidated group is treated as one corporation for purposes of
Sec. 1.385-3. Accordingly, when DS1 issues DS1 Note to USS1 in a
distribution on Date A in Year 1, DS1 is not treated as issuing a
debt instrument to another member of DS1's expanded group in a
distribution for purposes of Sec. 1.385-3(b)(2), and DS1 Note is
not treated as stock under Sec. 1.385-3. When USS1 distributes DS1
Note to FP, DS1 Note is deemed satisfied and reissued under Sec.
1.1502-13(g)(3)(ii), immediately before DS1 Note ceases to be an
intercompany obligation. Under paragraph (c)(1)(ii) of this section,
when USS1 distributes DS1 Note to FP, the USS1 consolidated group is
treated as issuing DS1 Note to FP in a distribution on Date B in
Year 2. Accordingly, DS1 Note is treated as stock under Sec. 1.385-
3(b)(2)(i). Under paragraph (c)(1)(ii) of this section, DS1 Note is
deemed to be exchanged for stock of the issuing member, DS1,
immediately after DS1 Note is transferred outside of the USS1
consolidated group. Under paragraph (c)(3) of this section, the
deemed satisfaction and reissuance under Sec. 1.1502-13(g)(3)(ii)
and the deemed issuance and exchange under paragraph (c)(1)(ii) of
this section, are respected as separate steps and treated as
separate transactions.
(iii) Example 3: Sale of consolidated group debt instrument--(A)
Facts. On Date A in Year 1, DS1 lends $200x of cash to USS1 in
exchange for USS1 Note. On Date B in Year 2, USS1 distributes $200x
of cash to FP. Subsequently, on Date C in Year 2, DS1 sells USS1
Note to FS for $200x.
(B) Analysis. Under paragraph (b)(1) of this section, the USS1
consolidated group is treated as one corporation for purposes of
Sec. 1.385-3. Accordingly, when USS1 issues USS1 Note to DS1 for
property on Date A in Year 1, the USS1 consolidated group is not
treated as a funded member, and when USS1 distributes $200x to FP on
Date B in Year 2, that distribution is a transaction described in
Sec. 1.385-3(b)(3)(i)(A), but does not cause USS1 Note to be
recharacterized under Sec. 1.385-3(b)(3). When DS1 sells USS1 Note
to FS, USS1 Note is deemed satisfied and reissued under Sec.
1.1502-13(g)(3)(ii), immediately before USS1 Note ceases to be an
intercompany obligation. Under paragraph (c)(1)(ii) of this section,
when the USS1 Note is transferred to FS for $200x on Date C in Year
2, the USS1 consolidated group is treated as issuing USS1 Note to FS
in exchange for $200x on that date. Because USS1 Note is issued by
the USS1 consolidated group to FS within the per se period as
defined in Sec. 1.385-3(g)(19) with respect to the distribution by
the USS1 consolidated group to FP, USS1 Note is treated as funding
the distribution under Sec. 1.385-3(b)(3)(iii)(A) and, accordingly,
is treated as stock under Sec. 1.385-3(b)(3). Under Sec. 1.385-
3(d)(1)(i) and paragraph (c)(1)(ii) of this section, USS1 Note is
deemed to be exchanged for stock of the issuing member, USS1,
immediately after USS1 Note is transferred outside of the USS1
consolidated group. Under paragraph (c)(3) of this section, the
deemed satisfaction and reissuance under Sec. 1.1502-13(g)(3)(ii)
and the deemed issuance and exchange under paragraph (c)(1)(ii) of
this section are respected as separate steps and treated as separate
transactions.
(iv) Example 4: Treatment of consolidated group debt instrument
and departing member's regarded distribution or acquisition when the
issuer of the instrument leaves the consolidated group--(A) Facts.
The facts are the same as provided in paragraph (f)(1) of this
section, except that USS1 and FS own 90% and 10% of the stock of
DS1, respectively. On Date A in Year 1, DS1 distributes $80x of cash
and newly-issued DS1 Note, which has a value of $10x, to USS1. Also
on Date A in Year 1, DS1 distributes $10x of cash to FS. On Date B
in Year 2, FS purchases all of USS1's stock in DS1 (90% of the stock
of DS1), resulting in DS1 ceasing to be a member of the USS1
consolidated group.
(B) Analysis. Under paragraph (b)(1) of this section, the USS1
consolidated group is treated as one corporation for purposes of
Sec. 1.385-3. Accordingly, DS1's distribution of $80x of cash to
USS1 on Date A in Year 1 is a disregarded distribution or
acquisition, and under paragraph (d)(1) of this section, continues
to be a disregarded distribution or acquisition when DS1 ceases to
be a member of the USS1 consolidated group. In addition, when DS1
issues DS1 Note to USS1 in a distribution on Date A in Year 1, DS1
is not treated as issuing a debt instrument to a member of DS1's
expanded group in a distribution for purposes of Sec. 1.385-
3(b)(2)(i), and DS1 Note is not treated as stock under Sec. 1.385-
3(b)(2)(i). DS1's issuance of DS1 Note to USS1 is also a disregarded
distribution or acquisition, and under paragraph (d)(1) of this
section, continues to be a disregarded distribution or acquisition
when DS1 ceases to be a member of the USS1 consolidated group. The
distribution of $10x cash by DS1 to FS on Date A in Year 1 is a
regarded distribution or acquisition. When FS purchases 90% of the
stock of DS1's from USS1 on Date B in Year 2 and DS1 ceases to be a
member of the USS1 consolidated group, DS1 Note is deemed satisfied
and reissued under Sec. 1.1502-13(g)(3)(ii), immediately before DS1
Note ceases to be an intercompany obligation. Under paragraph
(c)(1)(i) of this section, for purposes of Sec. 1.385-3, DS1 is
treated as issuing a new debt instrument to USS1 in exchange for
property immediately after DS1 Note ceases to be a consolidated
group debt instrument. Under paragraph (d)(4)(i) of this section,
the departing member, DS1 (and not the USS1 consolidated group) is
treated as having distributed $10x to FS on Date A in Year 1 (a
regarded distribution or acquisition) for purposes of applying Sec.
1.385-3(b)(3) after DS1 ceases to be a member of the USS1
consolidated group. Because DS1 Note is reissued by DS1 to USS1
within the per se period (as defined in Sec. 1.385-3(g)(19)) with
respect to DS1's regarded distribution to FS, DS1 Note is treated as
funding the distribution under Sec. 1.385-3(b)(3)(iii)(A) and,
[[Page 28883]]
accordingly, is treated as stock under Sec. 1.385-3(b)(3). Under
Sec. 1.385-3(d)(1)(i) and paragraph (c)(1)(i) of this section, DS1
Note is immediately deemed to be exchanged for stock of DS1 on Date
B in Year 2. Under paragraph (c)(3) of this section, the deemed
satisfaction and reissuance under Sec. 1.1502-13(g)(3)(ii) and the
deemed issuance and exchange under paragraph (c)(1)(i) of this
section are respected as separate steps and treated as separate
transactions. Under Sec. 1.385-3(d)(7)(i), after DS1 Note is
treated as stock held by USS1, DS1 Note is not treated as stock for
purposes of determining whether DS1 is a member of the USS1
consolidated group.
(v) Example 5: Treatment of consolidated group debt instrument
and consolidated group's regarded distribution or acquisition--(A)
Facts. On Date A in Year 1, DS1 issues DS1 Note to USS1. On Date B
in Year 2, USS1 distributes $100x of cash to FP. On Date C in Year
3, USS1 sells all of its interest in DS1 to FS, resulting in DS1
ceasing to be a member of the USS1 consolidated group.
(B) Analysis. Under paragraph (b)(1) of this section, the USS1
consolidated group is treated as one corporation for purposes of
Sec. 1.385-3. Accordingly, when DS1 issues DS1 Note to USS1 in a
distribution on Date A in Year 1, DS1 is not treated as issuing a
debt instrument to a member of DS1's expanded group in a
distribution for purposes of Sec. 1.385-3(b)(2)(i), and DS1 Note is
not treated as stock under Sec. 1.385-3(b)(2)(i). DS1's issuance of
DS1 Note to USS1 is also a disregarded distribution or acquisition,
and under paragraph (d)(1) of this section, continues to be a
disregarded distribution or acquisition when DS1 ceases to be a
member of the USS1 consolidated group. The distribution of $100x
cash by DS1 to USS1 on Date B in Year 2 is a regarded distribution
or acquisition. When FS purchases all of the stock of DS1 from USS1
on Date C in Year 3 and DS1 ceases to be a member of the USS1
consolidated group, DS1 Note is deemed satisfied and reissued under
Sec. 1.1502-13(g)(3)(ii), immediately before DS1 Note ceases to be
an intercompany obligation. Under paragraph (c)(1)(i) of this
section, for purposes of Sec. 1.385-3, DS1 is treated as issuing a
new debt instrument to USS1 in exchange for property immediately
after DS1 Note ceases to be a consolidated group debt instrument.
Under paragraph (d)(4)(ii) of this section, the USS1 consolidated
group (and not DS1) is treated as having distributed $100x to FP on
Date B in Year 2 (a regarded distribution or acquisition) for
purposes of applying Sec. 1.385-3(b)(3) after DS1 ceases to be a
member of the USS1 consolidated group. Because DS1 has not engaged
in a regarded distribution or acquisition that would have been
treated as funded by the reissued DS1 Note, the reissued DS1 Note is
not treated as stock.
(vi) Example 6: Treatment of departing member's issuance of a
covered debt instrument--(A) Facts. On Date A in Year 1, FS lends
$100x of cash to DS1 in exchange for DS1 Note. On Date B in Year 2,
USS1 distributes $30x of cash to FP. On Date C in Year 2, USS1 sells
all of its DS1 stock to FP, resulting in DS1 ceasing to be a member
of the USS1 consolidated group.
(B) Analysis. Under paragraph (b)(1) of this section, the USS1
consolidated group is treated as one corporation for purposes of
Sec. 1.385-3. Accordingly, on Date A in Year 1, the USS1
consolidated group is treated as issuing DS1 Note to FS, and on Date
B in Year 2, the USS1 consolidated group is treated as distributing
$30x of cash to FP. Because DS1 Note is issued by the USS1
consolidated group to FS within the per se period as defined in
Sec. 1.385-3(g)(19) with respect to the distribution by the
USS1consoldiated group of $30x cash to FP, $30x of DS1 Note is
treated as funding the distribution under Sec. 1.385-
3(b)(3)(iii)(A), and, accordingly, is treated as stock on Date B in
Year 2 under Sec. 1.385-3(b)(3) and Sec. 1.385-3(d)(1)(ii). Under
paragraph (d)(3) of this section, DS1 (and not the USS1 consolidated
group) is treated as the issuer of the remaining portion of DS1 Note
for purposes of applying Sec. 1.385-3(b)(3) after DS1 ceases to be
a member of the USS1 consolidated group.
(g) Applicability date. This section applies to taxable years for
which the U.S. Federal income tax return is due, without extensions,
after May 14, 2020. For taxable years ending on or after January 19,
2017, and for which the U.S. Federal income tax return is due, without
extensions, on or before May 14, 2020, see Sec. 1.385-4T, as contained
in 26 CFR in part 1 in effect on April 1, 2019. In the case of a
taxable year that ends after October 13, 2019, and on or before May 14,
2020, a taxpayer may choose to apply this section to the portion of the
taxable year that occurs after the expiration of Sec. 1.385-4T on
October 13, 2019, provided that all members of the taxpayer's expanded
group apply this section in its entirety.
Sunita Lough,
Deputy Commissioner for Services and Enforcement.
Approved: April 2, 2020.
David J. Kautter,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2020-08096 Filed 5-13-20; 8:45 am]
BILLING CODE 4830-01-P
